Audit Risk Research Based on SWOT Analysis -The CIMIC Group As An Example

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1 Audit Risk Research Based on SWOT Analysis -The CIMIC Group As An Example Mingyu Dai The university of New South Wales UNSW Sydney 2052 Australia Abstract The CIMIC Group (formerly known as Leighton Holdings before April 2015) was officially listed on the Australian Security Exchange on 11 December It is now one of the leading international contractors and the contract miners in the world. It provides a wide array of services, such as mining, construction, engineering and mineral processing, to the infrastructure and property industry. This report aims to examine the background information regarding to operations and market environment of CIMIC and identify three major audit risks which would affect the audit of CIMIC. Specifically, this report starts with an overview of the company through analyzing the financial reports, industry reports and related business assessment. Following is the investigation into the factors which would have material impacts on CIM s business through SWOT analysis. The subsequent sections analyses the potential audit risks faced by CIMIC using findings obtained from previous research and audit plan for CIMIC. Key words: Audit Risk, CIMIC Group, SWOT Analysis 1. OVERVIEW OF CIMIC 1.1. Revenue Streams As shown in Figure 1, there are five primary subsidiaries controlled by CIMIC Group, namely CPB Contractors, Thiess, Sedgman, Pacific Partnerships and EIC Activities. They are accountable for the major operations of CIMIC Group. In addition, CIMIC also make investments in other business, which is included Habtoor Leighton Group (45%), Devine (59.11%) and Ventia (50%). The table below outlines the major revenue streams of each operating business. Figure 1. Corporate Structure of CIMIC (Source: CIMIC Profile 2016.) As shown in Figure 1, there are five primary subsidiaries controlled by CIMIC Group, namely CPB Contractors, Thiess, Sedgman, Pacific Partnerships and EIC Activities. They are accountable for the major operations of CIMIC Group. In addition, CIMIC also make investments in other business, which is included Habtoor Leighton Group (45%), Devine (59.11%) and Ventia (50%). The table below outlines the major revenue streams of each operating business. 373

2 Operating Business CPB Contractors Thiess Sedgman Pacific Partnerships EIC Activities Table 1. The main revenue streams of CIMIC Revenue Stream Mainly from delivering projects across all key sectors of the construction industry, including roads, rail, tunnel and building. Providing the full suite of mine services all over the world s major mineral commodities. Providing of mineral processing and associated infrastructure solutions to the global resources industry. Infrastructure projects which are built by CIMIC s operating companies as a developer and investor. And it is also as a provider of operation and maintenance services to clients. Providing design, technical support, research and technology. Figure 2. Revenue allocation (Source: CIMIC Annual Report 2015.) In financial year 2015, CIMIC s revenue reached AUD16.22 billion, taking into consideration Joint Ventures and Associates. The revenue sources can be divided into five segments. As presented in the chart above, the Construction segment was operated by CPB Contractors (AUD9.51 billion), which was the largest part of the total revenue; The Contract Mining segment was responsible to Thiess (AUD3.06 billion); The Commercial and Residential segment was implemented by Leighton Properties (AUD1.11 billion); The remaining derived from the Habtoor Leighton Group segment (AUD1.19 billion) and corporate segment (AUD1.35 billion) Products and Services CPB Contractors is a construction company of CIMIC, combining the businesses with Thiess and Leighton Contractors, which mainly provides construction services for infrastructures including roads, rails, and resources facilities and so on. Additionally, its business collaborates with the Pacific Partnerships and government sectors, which involves the services regarding public private partnerships. Thiess is a contract mining company as well as the biggest mining service provider in the world. It focuses on technical and operational services, capabilities and projects across world s six major mineral regions, namely Australia, New Zealand, Indonesia, India, Botswana and Chile. Sedgman provides mineral processing and associated infrastructure solutions to the global resources industry with create, build, operate model as whole-of-life commitment to clients. Pacific Partnerships, formed by combining the Public Private Partnerships capabilities of CIMIC s operating companies into a single entity, provides infrastructure construction, operation and maintenance services to clients. EIC Activities delivers solutions, capabilities and innovations across the industries of infrastructure, industrial and building and in the disciplines of knowledge management, engineering methodology, specialist design and technical services Business Processes With respect to business processes, sustainability is the major issue for CIMIC. It aims to maximise shareholders value in long term and be beneficial to ecosystems. 374

3 Provide safe communities and workplaces. Safety is one of the most important things should be considered as for CIMIC. During 2015, it commenced a series of safety programs across all operating companies. Under accountability and responsibility, CIMIC can learn from mistakes and improve the business. Act with integrity. Everyone in CIMIC is being respectful and honest, accountable for the performance of business (including stakeholders, clients, suppliers etc.). A majority of employees in CIMIC has trained in the code of Conduct which describes the expectations and standards of CIMIC s business processes. Develop a performance culture. Employees understand that the quality of the service has an important role in developing client loyalty to CIMIC. In order to encourage employees, CIMIC creates performance culture to achieve best performance for clients. Innovate to deliver project. Gain competitive advantages by lowering cost base to satisfy the needs of clients. Therefore, CIMIC managed to challenge conventional practices and invent new technology. For example, GeoView tool was developed to improve its engineering processes in Use resources efficiently. With rising environmental concerns from the public, CIMIC launched new Environmental Management Systems in 2015; it delivered environmental friendly projects by reducing waste and costs Competitive Environment The Australian construction market comprises a range of activities, such as construction of buildings, railroads, roads, river works, sewerage infrastructure, water infrastructure, electricity infrastructure and civil engineering projects. The four major players in the market are CMIC Group Ltd, Lend Lease, Downer EDI ltd and Bechtel Australia Pty ltd. The market shares of these companies are presented in the figure below. Figure 3. Market shares of major companies in Australian construction industry (Source: construction in Australia; IBIS World industry report) It is obvious that CIMIC Group is the largest construction company in the domestic construction industry, which accounts for 2.5 percentage of the market share. In addition, the construction industry in Australia has a low level of market share concentration as it involves a large number of small-scale businesses that operate in narrow service markets. Over the past few years, there has been a significant influx of big overseas construction companies into the Australian market, which indicates an intensified competition for domestic investors. With overseas companies moving aggressively into the Australian market, CIMIC, as a domestic company, may need to make it more efficient in many aspects (e.g. prices and quality) as a way to retain market share Strategy Figure 4. Strategy model of CIMIC 375

4 As shown in Figure 4, the key operating strategy of CIMIC focuses on the integration of skills, experience and expertise into services for a variety of activities, such as construction, mining, mineral processing and engineering. In 2014, CMIC Group adopted new operating model, centring around the delivery construction, mining, PPPs as well as engineering via devoted, activity-focused business. The novel strategy has allowed CIMIC to increase its efficiency in regards to cost base, project delivery and cash generation. These outcomes have considerably reduced the cost base of CIMIC, enabling better performance in the market. In order to manage capital effectively, changes in share equity has been made by CIMIC. For instance, CIMIC made an off-market takeover bid for shares in Devine on 11 November 2015, which resulted in a dramatically increase (59.11%) in its stake in Devine (Annual report 2015). Additionally, managing risk is a crucial component of the entire business operating approach and has been a major boost in its success. CIMIC s risk management program is set specifically to its business, incorporated largely in its current operation and aligned to the company s short-term and long-term goals. CIMIC is aiming to develop the world-class capacities in respect of its operation areas, which are in demand throughout the Asia Pacific, the Middle East, Sub-Saharan Africa, North America and South America. The expansions in these markets are the primary driving factors of demand for the Group. Further, sustainability strategy is being utilised by CIMIC. This contains several of initiatives regarding to workplace, community and marketplace Governance and management The board of CIMIC is accountable for the long-term operating efficiency of the company and ensuring the execution of proper governance relating to the CIMIC affairs. It aims to involve a proper range of experience and expertise on its board for efficient discharge of the governance and oversight responsibilities. Below is a table showing a number of governance principles and applications. Principles Table 2. Governance and management Applications Effective corporate governance,management and oversight responsibility Structure of the board and valueadded measure Responsible and ethical behaviour Timely and continuously disclosure Safeguard integrity in corporate reporting Respect the rights of shareholders The board of CIMIC takes the major responsibility for the corporate governance. The CEO is responsible for the day-to-day management of the group while the senior executives are accountable for specific transactions and activities. Formal induction sessions are provided for each new directors aiming to gain their understanding of company s issues. All directors in CIMIC can attend professional development and training projects to maintain or strengthen their knowledge and skills. The board of CIMIC values the independence of non-executive directors. The code of conduct presents the standards of behaviour for all levels of company members to guide their actions and decisions. All employees in CIMIC are required to understand the new code. All the information offered to shareholders or market should comply with the purpose and meaning of ASX Listing rules. Continuous Disclosure Committee set up by CIMIC is responsible for the disclosure documents. CIMIC has the Audit and Risk Committee which is chaired by an independent director who is not the chairperson of the board. The Audit and Risk Committee is accountable for disclosure the experiences and qualifications of the committee members and review the financial reporting to insure it meets the relevant regulations and policies. The CEO and CFO are required to offer an annual declaration to the board prior to the entire financial results which are approved by the board. Both existing and potential shareholders of CIMIC can participate in an open and timely communication provided by the CIMIC to help them to make informed and reasonable investment decisions. The risk framework of CIMIC relies on the International Standard ISO 31000:2009 Risk management. Recognise and risk management The corporate governance oversight responsibilities are achieved by the board. It is essential to review the corporate risk management framework annually by the Audit and Risk Committee. Remunerate fairly and Remuneration report summarises the remuneration framework for senior executives and responsibly directors. 376

5 2. SWOT ANALYSIS 2.1. Strengths CIMIC Group has a wide coverage of operating and earning ability CIMIC Group has a wide coverage of operating and earning ability. The coverage of its operating in variety areas, which provide design, engineering, project development, construction, maintenance and other related services to civil engineering, commercial and industrial construction, residential, oil and gas, and environmental markets. Several contracts provide a great number of projects, such as CPB, Leighton and LNG. CPB Contract protect various major contract and Leighton Asia contributed to growth in the construction sector. LNG-related contracts in Western Australia, the Northern Territory and Queensland; They are responsible for social infrastructure projects such as the Fakeeh Academic Medical Centre in Dubai; rail and road projects, including the New M5 Motorway and M4 East Motorway in Sydney, level crossing removals and the CityLink Tulla widening both in Victoria, the Torrens Road to River Torrens motorway in Adelaide, and expanding the rail network in Hong Kong. Order Backlog A strong order backlog can ensure the future source of earning and have time to make decisions and analyse strategy. CIMIC s total work in hand amount is AUD29 billion in 31 December,2015, which of billion is stem from continuing operations in both of construction and mining areas. Though a decline of work in hand comparing to previous year, the increase in non-lng construction partially captured the completion in construction projects and reduce the contract mining work in hand. The total work in hand under the construction segment in December 2015, amount to 12.4 billion which is accounted for 43%, followed by Contract Mining with 33%, HLG with 8%, Commercial and Residential with 5%, and Corporate with 11%. Cost Control Although the company reported a decline in total revenue from million in FY2014 to AUD13370 million in FY2015 and mark a decline of 20.7%, it indicated an improvement in profitability position. In addition, operating income increased dramatically from AUD 85.6 million in FY2014 to AUD959.3 million in FY2015.Its operating profit margin stood at 7.1% in 2015 as against 0.5% in Lastly, there exists some decline in provision from 600 to 10, overhead and expense also decline respectively Weakness Decline in revenue CIMIC reported a decreased trend from AUD billion in FY2014 to AUD billion in FY2015 in revenue the fiscal year ended December The company s revenue indicates a significant decline of 20.77%. The main reason of decline in revenue is that construction and mining contracting services has been changed. It shows that A decline of 23.5% and revenue from the contract mining segment declined from AUD3973 million to AUD million, indicating a decline of 22.9%. Project cannot be completed in schedule due to external irresistible factors CIMIC has already become the most famous construction company in Australia, so it is inevitable that production and the amount of raw material supply chain will be affected due to massive orders. At this time, if the company have effect on the internal and external factors, such as backward technology, global economic recession, climate disasters, government intervention and so on, company cannot finish schedule within a predetermined time. If this happens, the company will face a major crisis and losses in terms of finance and reputation Opportunities New contracts According to the annual report of FY2015, CIMIC was awarded new contracts worth $14.13 billion. This amount is plausible to ensure the future revenue for the company. Among the projects CIMIC has undertaken in 2015, the major ones are WestConnex M4 East Motorway and New M5 Motorway in NSW; LNG-related contracts in WA; Sydney Metro Northwest in NSW; and New Royal Adelaide Hospital in SA. Furthermore, the company received contracts on gas infrastructure such as Collaborative Well Delivery project for Australia Pacific LNG. The company has also cooperated with China state construction on working on the Shatin to Central Link in Hong Kong. These projects are assumed to be profitable. Last but not least, the company is expecting a much larger amount of project revenue (approximately AUD$60 billion in 2016) due to a strong pipeline of infrastructure and mining projects. Growth Initiatives CIMIC is able to concentrate on its core business (construction), capture more market share, and thereby hold its company position in the industry. Followed the merge of Thiess construction and Leighton Contactors in 2015, a new name of CPB contractors, which reflects the heritage and capacity in construction, projects and 377

6 Building, was launched in January In 2015, Thiess also launched FleetCo, a company which provides sorts of services including advanced equipment and maintenance. Potentiality of domestic construction market Based on the 2014 Federal Budget, the government has committed new projects of AUD50 billion by 2020 to upgrade the country s infrastructure and stimulate the government and private sector investments. The Prime Minister of Australia has reaffirmed the commitment of government to invest in infrastructure and major projects under pipeline and the objective to exceed AUD125 billion investment over the next decade. In addition, PPP models (Public Private Partnership) is regarded to grow under a considerable rate. For the reasons presented above, the infrastructure construction market is believed to become one of the primary contributions to economic growth over the next five years in Australia. While CIMIC has a strong presence in the construction market in Australia, it has a high opportunity to benefit from the market growth Threats Political Unrest in the Middle East Political uncertainty, instability and security gradually become a thorny concern in a stagnancy in those countries, such as Saudi Arabia, Qatar and Kuwait. These issues affect CIMIC s reputation and lead to extension the time limit of project in case of these political uncertainty. In 2014, some regions cannot meet the expectations partly because of making slow political decisions and reset of project scopes. Reduction in Demand for Global Commodities Reduced demand for global commodities could affect the company s operations due to curtail or cease of capital investment programs by the clients, and adjustment of operations to reduce associated costs. Safety in construction and engineering Employees worked in construction and mining area in CIMIC are at risk of workplace accidents and incidents. Although the company s total recordable frequency rate (TRIFR) shows that they have a good job and achieve some successes in reducing accidents and incidents, the possibility of them cannot avoid completely. If an employee is injury even die in the workplace due to accidents, it will result in a irretrievable loss on finance and work related accidents will have a negative influence in reputation. So the issue of safety could not be avoided and the directors should get sufficient ready for accidents and reduce injury accidents as much as possible. Competition may increase Although the leading position of CIMIC among its core market share has already settled. There are still three different circumstances for the competition. Firstly, as the competitors for CIMIC, the major competitors of CIMIC Group is the Brookfield Multiplex Limited and Downer EDI Limited, both of them also have a mature developing trend and their market share increase gradually. In addition, CIMIC s competitive position may deteriorate as a result of actions by existing competitors, the entry of new competitors (including manufacturers and suppliers of products who decide to sell direct to end consumers) or a failure by CIMIC to successfully respond to changes in the market. Lastly, if the management team cannot come up with more countermeasures, the competitors would grow more market share. Obviously, the more substitutes the more threats for CIMIC. 3. AUDIT RISK 3.1. Audit Risk 1 Key Account Revenue Assertion Cut-off There is a risk of revenue not being recognised in the correct period. Contract revenue is the main revenue stream for CIMIC, which takes up 69% of the CIMIC total revenue. Contract revenues are recognized on percentage-completion method under AASB 111. Each project, CIMIC shall assess the project percentage completion based on the cost incurred over the total estimated cost of the project. This percentage is applied to the contract value to calculate the revenue to recognize for the relevant reporting period. There is a risk of CIMIC mis-assessing the percentage completion therefore not having correct revenue recognized in the relevant period. Support argument A. Due to the negative impact from the reduction in demand for global commodities, CIMIC meets the declining revenue from 2013 to 2015.Compared to the report of the previous financial year, there is a 32 percent of decrease in revenue to AUD $3.2 billion in the construction segment. The commercial and residential division performed worse with a revenue decline of 67 percent to AUD $205million. The mining and mineral processing division also has 12 percent of revenues down. The shareholders and brokers were disappointed with 378

7 the financial performance of CIMIC (ABC News), which was highly different with their expectation. Therefore, management might tend to over-estimate the percentage completion so higher revenue can be recognized at the end of 2016, which can meet the performance expectations and their remuneration incentive may be linking with the finance performance as well. B. The other possible reasons for incorrect assessment of the percentage completion is: a) As the construction companies provides services to the clients through the contract, which may have a lot of variation in the constructing period. Then, any contract variation without being updated in the system will result in the incorrect percentage completion. On the other hand, the relevant cost associated with variation may also be misstated. b) Incorrect estimation of the cost to complete can be another possible reason, for example, potential warranty claims or liquidated damages not being considered Audit Risk 2 Key Account Work in hand Assertion Accuracy, Valuation & Allocation This risk would lead to an overstatement of work in hand as a decrease in demand of mining commodity in recent years. The assertion should be considered in respect to this risk account is the accuracy, allocation and valuation. It is important to revalue the work in hand regarding to mining contract via making an impairment assessment. Support argument A. According to the Annual Report of 2015, it presents that the total work in hand of CIMIC was about AUD29 billion, in which contract mining segment was AUD9billion, taking up 33% of total work in hand in In addition, contract mining occupied 36% of total work in hand in 2014 (around AUD11 billion). B. It also should be noted that contract mining revenue of CIMIC decreased by 22.9% from 2014 to 2015 as a result of deterioration in mining industry. A decrease in demand of global commodities regarding to mining would give rise to a situation that clients may cease capex programs related to the mining contract, which would affect the existing or future mining contracts of CIMIC. So it is essential to adjust its operations in order to decline the associated costs. Hence, it is vital to revalue the work in hand in mining contract segment via making an impairment assessment, which is necessary to determine whether the impairment is required or not Audit Risk 3 Key Account Impairment loss Assertion Accuracy, Valuation & Allocation Impairment loss on the CIMIC s operation in Middle East is a significant risk, this relates to the value of the CIMIC s subsidiary that operates in the Middle East area. In financial year 2014, CIMC had a AUD675 million impairment loss of contract debtor provision, which represented a sharp decreased to AUD8 million in financial year This is one of the most significant contributors to profit increase in There is a risk that CIMIC misstated the impairment loss then presenting a lower expense in the relevant period. Support argument A. The political uncertainty and instability affect CIMIC s reputation as CIMIC fails to delivery on time. Government grants from these Middle East countries, except Qatar, Saudi Arabia and Kuwait, failed to meet the expectation. This is mainly because these countries have a very slow political decision making and project scope revisiting. According to the 2015 financial report, there is a 11.7 percentage increase revenue from CIMIC subsidiary, Habtoor-Leighton Group managed the operation in Middle East. However, the management note mentioned that the clients from this area will make a slow payment to CIMIC. This will raise the audit risk of CIMIC. B. From the last year, if CIMIC has already provided some service and recognized the revenue and receivable from these Middle East countries, there is a risk of recoverability of the receivable as a result of the uncertainty of the investment commitment of the countries. According to AASB 136, an annual impairment assessment on the Middle East operation, using value-in-model, is required to determine the fair value of the asset, impairment, estimation of recoverable amount. Whether CIMIC has used a reasonable a verifiable assessment to determine the impairment can be a significant audit risk. 379

8 REFERENCES: CIMIC Group Limited, 2015 Annual Report, February 2016, Australia. CIMIC Group Limited, financial report for the half year ended 30 June 2015, 23 July 2015, Australia. CIMIC Group Limited, 2015 Sustainability Report, February 2016, Australia. CIMIC Group Limited, 2015 Corporate Government Statement, February 2016, Australia. Kelly A, 2016, Construction in Australia, IBISWorld industry report E, August 2016, Australia. CIMIC Group Limited 2015 CIMIC PPPs. Available at: Level Crossing Removal Authority, 2016, the Caulfield to Dandenong project. Accessed on 21 September Available at: ABC News, 2016, CIMIC: Construction giant pummelled after first-half results (Australian Broadcasting Corporation). Accessed on 21 September Available at: / construction - giant-cimic-pummelled -after-first-half-results/ PACE, 2016, CIMIC announces Nextgen Group divestment. Assessed on 9 September Available at: 380