Shortcuts to Remember CA Final Audit Chapter - Due Diligence

Due Diligence: Process of Investigation performed by investors into details of potential investment

1. Applicability: HILAR

• Hand Over of Charge within in the same group from one management to another management
• Recommendation for Investment
• Recommendation for advancing a Loan/credit
• Acquiring a controlling interest in a company
• Corporate Restructuring

2. Importance of Due Diligence: VINC

• Verify that transactions complies with investment or acquisition criteria
• Identify potential defects in the target and avoid a bad business transaction
• Gain Information for valuing assets and or Negotiating Price Concessions
• Confirm that the Business is what it appears to be

3. Areas/Classification of Due Diligence: FILE CPT

• Financial Due Diligence - Analysing books of accounts and financial information
• Information System Due Diligence - computer systems
• Legal Due Diligence - Review Legal Aspects
• Environmental Due Diligence - Studying the Entity's Environment
• Commercial Due Diligence - Evaluation from commercial and operational perspectives
• Personal Due Diligence - Entity's Personal Policies
• Tax DUe Diligence - Evaluate the Tax Affect

4. Scope of Financial Due Diligence: CHAPTERS

• Cash Flow - PreDICT
  • Review Historical Cash Flows and their Pattern
  • How well does it Deploy its funds
  • Are there any funds lying Idle or is the company able to get maximum benefits out of the available funds
  • Is the company able to honor its Commitments to the trade payables
  • How well the company able to turn its trade receivables and inventories
• Brief History of the Target and Background of its Promoters
• Significant Accounting Policies
• Financial Projections
• Taxation
• Management and Employees
• Review of Financial Statements - COBRE (Similar to Cobra)
  • Compare the actual figures with budgeted figures
  • Objective is to look specifically for any hidden liabilities or over valued assets
  • Benchmark normal operating profits against other similar companies
  • Applicable Financial Reporting Framework
  • Extraordinary Item of Income or Expense that might affect operating results
• Statutory Compliances

5. Examples of Hidden Liabilities: - SUBCELLS + WTP

• ​​​​​​​Company agreed to pay liabilities of Subsidaries
• Unfunded Gratuity/Superannuation/Leave Salary liabilities/ incorrect gratuity valuations
• Agreement to Buy Back shares at stated Price
• Letter of Comfort given by company not disclosed in the balance sheet
• Environmental Problems
• All Litigations
• Future Lease Liabilities
• Show Cause notice which has not matured into demands
• +
• Warranty Liabilites
• Tax Liabilities
• Pending Final Assessment of Customs

6. Examples of Over-Valued Assets: NEUROPIL

• ​​​​​​​Investments at Cost though NRV is lower
• Infructurous Project Expenditure
• Uncollectable Receivables
• Capitalisation of Revenue Expenditure
• Obsolete Inventories
• Obsolete Plant and Machinery
• Intangible Assets of No Value
• Litigated Assets and Property

7. Contents of a Due Diligence Report - SHOE + FRONTALS + SOFA

• ​​​​​​​Share Holding Pattern
• Brief History of the Target
• Objective and Scope of Due Diligence
• Executive Summary --> Introudction
• +
• Financial Liabilities
• Review of Components of Due Diligence
• Operating Results
• Net Worth
• Taxation and Statutory Liabilities
• Valuation of Assets
• Possible Liabilites on account of litigations and legal proceedings
• Management Structure
• +
• Swot Analysis
• Financial and other Obligations
• Comment on Future Projections
• Status of Charges, Liens, mortgages, Assets and properties of the company 
• Suggestions on various aspects to be taken care of

Note: Above information is only informative and for remembering purposes only. For detailed information it is always advisable to refer ICAI Study Material

Also Read: Shortcuts to Remember Advanced Auditing and Professional Ethics - CA Final