Collapse of Forge Group Limited

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Collapse of Forge Group Limited

Forge group limited was established as Clampter Pty Ltd on 30 June, 1994. It became an unlisted public company in June 2005.then it changed its name to Forge Group Limited on 5 June, 2007 and finally got listed on ASX on 26 June, 2007. It has four key divisions power, asset management, construction, minerals and resources. It emerged from a small business and managed to capture a significant market presence in past years but it failed to continue its presence and put itself in voluntary administration as on 11 Feb, 2014 sacking about 1500 employees without pay and $500 Million in debts.

Here is a detailed analysis of the failure of the Forge group

Major reasons of collapse:

From the analysis of the financial statements and the administrator’s report by Ferrior Hodgson, it is clear that major reasons of the downfall were:

  • The forge group had a debt focused capital structure and the market conditions were not supportive for such capital rising so it resulted in high leverage. Due to debt focused structure, management failed to take restructuring initiatives and the risks relating to the business structure had materialized.
  • It lacked the diversification and risk control measures. It made investments on low margins and failed to control the cost which resultantly consumed the profits.
  • General market downturn in mining industry over the last 18 to 24 months is also a reason of the failure
  • Cost escalations in relation to a number of construction projects including DPS and WAPS were identified in September 2013
  • Directors tried to take restructuring initiatives to raise capital despite of being aware of group’s inability to pay its debts.
  • Group ignored advice from the financial advisor about the tight liquidity conditions.

Analysis

Cost analysis

Cost escalations are one of the main reasons of the collapse of this group. From the profit and loss statement as at 1st January, 2014, it is observed that there was variation in budgeted and actual costs i.e. direct labor, material and overhead costs were over the budget. Moreover general expenses also showed a huge variation as anticipated were 36M but the actual reached 77M. Due to the uplift in costs, the group needed to raise capital to b a going concern so it adopted debt financing to grow the business.

Insufficient risk management:

The group adopted debt financing, it made acquisitions but did not have sufficient processing and risk controlling measures due to which risks could not be properly mitigated and the leverage became an issue leading to the failure. The group could not acquire further debt after that.

Net profit analysis:

The comparative statements of 2013-14 are showing a decrease in the net profits of forge group and the major decrease is in the profits of power division containing the major projects i.e. DPS and WAPS. So it shows that the major investments are made without the proper risk analysis so it failed to generate a good outcome.

Balance sheet analysis:

The comparative statements of 2013-14 are showing a decrease in the current assets and the major decrease is in the cash and inventory. Though noncurrent assets are showing a rise but overall assets have decreased which is not a good indication and showing the inefficiency of management.

On the other hand over all liabilities have shown a sharp rise which is showing company is relying much on the debts. But as the company assets are much less than its liabilities so it was not suitable to keep borrowing but the group kept doing so it also led to the failure.

Moreover, the group’s external funds are also higher than the internal funds (equity) which resultantly increase the burden of fixed financial charges that also put a negative effect on the profitability of the group and may have caused the decline in the profits.

So it’s quite clear that debt focused capital structure is one of the main reasons of its failure.

Solvency

The group has a surplus of the assets and working capital as at June 2012-13 but after that the assets have fallen by 116M and working capital decreased by 227M.The c

Group’s earning were materially effected as on 30 June 2014 due to under performance of the DPS and WAPS projects which were acquired as a part of CTEC in Jan, 2012.

There was a cash management crisis from14 November 2013.

The administrator’s review shows that FGP, FGC, FGMR, FGL may have been insolvent as on November, 2013.

Considering the earlier date of insolvency, the directors may be entered into the criminal offence however considering director’s restructuring efforts; the expected success of these initiatives may give a defense to directors.

(source: annual reports, Ferrior Hodgson’s report, news, article by Brian Robbin)

Collapse of Gunns LIMITED

The Gunns is one of the Australian largest hardwood and softwood products company. It was established in 1875, incorporated in 1951 and listed on ASX on 10 Feb, 1983.it has three key divisions: plantation, forest product and other businesses. Last year, it failed to be a going concern and was put into administration on September 25, 2012 sacking 664 jobs without payment and debt exceeding $500M

Reasons of the failure:

From the analysis of the financial statements and the administrator’s report by Danial M Bryant , it is clear that major reasons of the downfall were:

  • A continuous decline in the revenues and profitability in the past years.
  • Adverse changes in the hardwood exports followed by a decline in hardwood demand and prices in target market
  • Market forces (fall in wood demand and prices) affected the capital raising, profitability and cash flows. so the group failed to meet its cash flow requirements
  • Significant asset impairments and write downs of $1.4 B from 2011 to Sep, 2012
  • In March, 2012 its one equity partner withdrew its support from the Pulp mill project and it failed to arrange for alternative equity.
  • Management’s poor decisions also led to the failure. The group was unable to raise capital and was relying on the lender’s support. Though it was aware of its uncertainty to be a going concern, yet it kept trading.
  • The increasing level of debt raised concerns for the potential investors.
  • The restructuring efforts could not be successful as when on 21 sep, 2012 lenders declined to retain money from asset sale
  • On 24 Sep 2014, refusal of lender support for another restructuring proposal and further decline in export prices led to put it into administration.
  • Environmental claim against the proposal to build Pulp mill.

Analysis

Profit and loss analysis:

Statements are showing that sales have fallen in every year and the major fall is in 2012 by 35% resulting in operating loss of $34.4M.

Operating profits have fallen after 2010 and became negative in 2012 followed by increase in financing cost and the exit from native foresting operations.

Profits have become negative after 2010 due to the significant impairments and write-down in these years. The statements are showing net loss of $454m, $1.0b, and $47 m in 2011, 2012, and 2013 respectively.

These losses led the Gunns towards failure.

Balance sheet analysis:

Statements are showing that overall assets are exceeding the liabilities but the significant impairments have reduced the value of net assets after 2010.

However current liabilities are exceeding the current assets in 2012 and 2013 which is showing the group is having liquidity issues.

Trade payables have reduced from 2010-12 and there is a significant decrease in the borrowings due to the sale of assets

Cash flow analysis:

From the statements, Cash flow patterns are showing declining finance position. It sold assets amounting to$529 m but still cash flows generated were not enough to fund the acquisitions so it had to acquire more debt which along with the high borrowing cost led to the negative cash flows.

Solvency and liquidity:

The Gunns’ Working capital have decreased in 2012 and 2013 which is showing group was having liquidity problems which led it to the failure.

Gunns assets are positive but as there is a doubt of over statement of assets so there is a possibility that the further impairment may result in exceeding liabilities hence increasing company’s inability to meet obligations.

(Source: Annual reports, administrator’s report by PPB Advisory, article by Carrie La Frenz on 26 Feb. 2013 , article by Terry Cook on 11 October 2012)

Auditors

The annual reports of Forge group limited and Gunns Limited, both are audited by KPMG before the year of collapse.

Breaches by the auditor of Forge Group Limited:

  • The act require the timely disclosure of market sensitive information but Forge did not disclose the problems with the power station and constructions projects till the late November. Auditors failed to locate this.
  • The act requires the accurate disclosure of all information but the forge did not disclose the fact that its ANG ongoing support was conditional on securing a fresh equity. And giving misleading information is a criminal offence under section 1309 of the corporations act.

(Sources: Bentham IMF Limited press release 20/2/14)

  • KPMG breached its duty of professional care as it failed to identify the insufficient disclosure of necessary information
  • KPMG is also auditing the accounts of ANZ (secured funder of FORGE) since 1969 which is a threat to independence .it also provided additional services like consultation which is again a threat to its independence

(Source: article by George Wilkins March 18, 2014)

Breaches by the auditor of Gunns LIMITED:

  • Due to fall in operating profits after 2010, gunns started restructuring initiatives. as cash flows from 2011-13 were just 20M so the chances of the success of restructuring was very less.moreover.the withdrawal of a partner’s support in march, 2012 was also making it clear that Gunns were not in a position to continue as going concern but it kept on trading till 25, September. This put the directors in breach of insolvent trading.
  • Directors used third party funding for working capital purposes i.e.
  1. insurance premium by growers were not forwarded to insurer and used by Gunns for working capital purposes
  2. Harvest product were not paid to covenant holders and used by Gunns for working capital purposes.
  • Considering the market news on Aug, 6 about negative tangible assets, there is a room for doubt that asset values were over stated after June, 2012.
  • As auditors failed to report the above said breaches, they are suspected in breach of not complying with the Australian auditing standards.

Current situation of KPMG

KMPG is one of the world’s leading provider of audit tax and advisory services and one of the four big auditors. In Australia, currently it has 13 offices with around 5200 people.

Awards and achievements:

It has made significant achievements and has received various awards.

  • The most recent is in 2013 when it got the fourth ranking in Australian Workplace Equality Index.
  • It also achieved the Employer of choice from women citation from Australian government’s agency for the sixth consecutive year.
  • It is considered an employer of choice and ranked first of the big four auditors.
  • It was ranked 2nd in world’s most attractive list n 2010 and in 2011, it is ranked no 2 in world’s best outsourcing

Penalties:

KPMG’s major penalties are as

  • In 2003, KPMG agreed to pay $126 million to settle a lawsuit.
  • In 2004, KPMG agreed to pay $115 million to settle claims arising from the collapse of a software company.
  • In early 2005, it agreed to pay $456 million for criminal violations however in 2007 these charges were dropped due to its compliance of government’s agreement.
  • In 2006, it was sued for approving the wrong financial statements
  • Recently, In April 2013, a former senior KPMG partner is sentenced for 14 months prison on disclosing some confidential information to a close friend about the firm’s clients. Resultantly, KPMG resigned as auditors of two companies

(source: by Edward Petterson April 25, 2014) (http://en.wikipedia.org/wiki/KPMG)

Current civil/criminal penalty status of KPMG:

  • There is no current penalty declared against KMPG regarding the forge group limited as it has raised concerns that it warned Forge Group of insolvency days before its collapse.
  • There is no current penalty declared against KMPG regarding the audit of Gunns limited as the breaches suspected are not yet approved.

Comparison of The Companies Act 2001 and Sarbanes Oxley Act 2002

Corporations Act 2001 in Australia

Sarbanes Oxley Act 2002 in U.S.

Auditors duty is to just to audit the financial statements

Auditor’s duty is to check the the reliability, accuracy of the statements and compliance with the standards.

Auditor himself has to identify and evaluate the issues regarding the accounts and statements.

Auditor’s duty is to adopt detective or corrective approach

Auditor’ duty is to reach a conclusion about the statements by being objective, provided that he has given access to all necessary information.

Auditor has to present a report to the shareholders based on its own conclusion.

Auditor is responsible for the statements on which he forms an opinion.

Auditor must be independent

Auditor must follow auditing standards to reach an opinion.

Auditor’s duty is to audit the internal control and the financial statements.

Auditor’s duty is to check the effectiveness of management’s internal control over financial statements.

Auditor requires managers to identify, document and evaluate the significant controls and the statements

Auditor’s duty is to adopt the preventive approach.

Auditor doesn’t have to reach conclusion about the statements. However, he can help to managers in gathering information but being objective and independent.

Auditor has to present report to shareholders and audit committee based on management’ conclusion.

Auditor doesn’t take this responsibility, it’s on managers.

Auditor must be independent

Auditor must follow auditing standards to form an opinion on management’s control.

(Source: the companies Act 2001, Sarbanes Oxley Act 2002, publication: what an auditor does and what does not)

Conclusion

The main reasons of collapse of Forge Group Limited were debt focused capital structure, cost escalations, limited diversification, market downturn in mining industry, excess of long term debts and acquisition of CTEC

The main reasons of collapse of Gunns Limited were market forces, declining profits, poor management, investors ‘ lack of confidence due to the level of debt, lender’s withdrawal of support and stepping back of major investors.

Directors of both the companies were found to be in breach o various duties such as timely and accurate disclosure of necessary information, trading being insolvent, using funds of third party asset overstatement etc.

KPMG who conducted the audit of both the groups in the review year seems to be not complying with the Australian auditing standards as it raised no proper concerns about director’s breaches in its auditing reports.however it claims to raise concern about Forge’s insolvency position before its going into administration so it may provide KPMg a possible defence against the expected breach but in case of Gunns limited, there is no news about even its raising any such concerns

There is no current civil/ criminal penalty has been filed against KPMG yet.

Under The Company Act 2001 in Australia, the auditor is just responsible for reporting on the reliability of financial statements but under Sarbanes Oxley Act 2002, auditor is required to adopt a broad perspective and have to report on the management’s assessment of internal controls which actually promotes risk management and governance process within the organization.

In my opinion, the main reason of the corporate collapses is the absence of internal control and internal check. Unless the management doesn’t recognize its responsibility towards the organization, the collapses can’t be controlled. There must be a proper system of internal control. Management should develop accounting controls to assure the asset safeguard and reliability of accounting records. There must be administrative controls as well to assure transparent and prudent decision making. Internal audit, internal check, work standards, quality controls etc all must be adopted in order to reduce the failure chances and to make the company efficient.

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