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    Business Risks and Inherent risks of Chemeq Ltd

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    I'm having problems in identifying the risk factors for Chemeq Ltd.

    You are the Senior Audit Partner of Cassidy and Sundance, Chartered Accountants. Your firm is one of the Big 4 accounting and audit firms in Australia and has significant experience in the audit of ASX listed companies and all industries.
    It is the 31st May 2006 and you have been approached by the Chief Executive Officer (CEO) of Chemeq Limited about conducting the audit of the company for the 2005/06 financial year, and subsequent financial years. Some issues have emerged with the current auditors which have meant that new auditors need to be located. Ms Etta Place, the Managing Partner of Cassidy and Sundance is keen to locate more audit clients in Western Australia and sees this a good opportunity to meet that objective. However, Ms Place only wants to take on audit clients if the business risks of those clients is acceptable to the firm.
    You are asked by Ms Place to prepare a Memorandum to her outlining the business and inherent risks associated with the audit of Chemeq Limited. Given the Commercial In Confidence of this request you are only able to locate information from publicly available information on Chemeq Limited.

    Prepare a Memorandum for Ms Place on the business risks of Chemeq Limited. This should also include an overall assessment of business risk and inherent risk factors.

    1. Annual Report from Chemeq's website will provide help as starting point to solve the question. Analyse it so that you get a reasonable understanding of the company and then seek other relevant information from various websites (eg the Australian Stock Exchange).
    2. Try to locate 20 different risk factors. Each risk factor should identify the following:
    ? A clear description of the risk
    ? The basis of the risk (ie what you found that identified the risk)
    ? Why the risk is a risk (ie the impact on the audit)
    ? The level of risk (ie, low, medium or high)
    3. Finally, ensure that you do provide a concluding section which provides an overall assessment of the business and inherent risks.
    4. Ensure that you do reference all sources where you get information from. It is important that you do recognise and acknowledge those sources. It will help me to look back at source so that I can get clear understanding of the risk factors involved.

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    1. The factory of Chemeq in Rockingham has not got unconditional regulatory approval of the factory. The building and running of the factory is uncertain and when it will be profitable is even more unforeseeable. The business risk is that the factory may either not get approval or it may get a much delayed approval. The financial reports do not mention that the factory is in violation of any regulation and this amounts to a misstatement. The inherent risk is "The financial reports do not mention that the factory is in violation of any regulation and this amounts to a misstatement". The investigative task for this risk is that audit should determine when the factory will be able to start production, what regulatory aspects are preventing it from going full steam and how much more time it will take to reach full production. The level of this risk is high.

    2. The business risk is that Australian Securities and Investment Commission has brought action in the Federal Court alleging continuous disclosure breaches against Chemeq. In sharp contrast the annual report of the company states in its annual report that the 'entity is is subject to a range of environmental regulations. During the financial year, all reporting requirements under all relevant legislation were met. There were no incidents which required reporting." This appears to be a misstatement. The inherent risk is that 'entity is subject to a range of environmental regulations. During the financial year, all reporting requirements under all relevant legislation were met. There were no incidents which required reporting.". The investigative nature of the audit task is to ascertain the truth in the charges made by the Australian Securities and Investment Commission. This is a high risk.

    3. Since June 2002, Chemeq has spent so much cash in getting the plant up that it has almost exhausted its capacity to raise share capital. This is a major business risk. It has raised capital eight times since June 2002. The basis of the risk is that major consultants have downgraded the Chemeq stock and have advised investors that the price may fall. The inherent risk in 3 is that the company's impaired capacity to raise capital is not mentioned. This weakens the very foundation of the company and may lead to serious liquidity crisis. This is a medium level risk.

    4. As the prices of the stock have been falling, the company has now turned to Mizuho International, a Japanese bank for a $60 million rescue package. This is a major business risk. The company is taking this funding through the use of convertible bonds. After the first conversion takes place Mizuho could take up to 40 percent of the company. The inherent risk in 4 is that the company does not mention in the annual report that Mizuho could take up 40 percent of the company with the first conversion. There is a serious risk that the company may be then be controlled by Mizuho and its management may be taken over by the bank. This is a high level risk.

    5. In addition to the convertible bonds, Chemeq has agreed to pay Mizuho an interest at the rate of 8.5%! This is a serious risk because this interest is payable quarterly and will directly affect the liquidity of the company. Chemeq may even ...

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