FEDERAL STATE-FUNDED EDUCATIONAL INSTITUTION OF HIGHER EDUCATION
FINANCIAL UNIVERSITY UNDER THE GOVERNMENT OF THE
RUSSIAN FEDERATION
KPMG Department
Computational-analytical task
Audit and risk assessment of Company “Severstal”
Prepared by:
Klypin N.
Student of IFF 4-3 group
Supervisor:
Bodyako A.V.
Moscow 2018
1. Description of industry and position of the company.
In order to start audit process we should make an overview of a steel mining sector
in Russia with main trends, participants and key financial figures in order to identify
the business environment and the conditions of the company in the sector.
Russia’s metals and mining industry represents around 3%-5% of Russia’s 2015
GDP and also accounted for 16% of total Russian exports in 2015 (or USD53
billion), the second-largest sector after oil and gas. Most Russian metals production
is exported. Russia is one of the world’s largest exporters of raw materials. Despite
its significance for the economy, metals and mining is a largely privately owned
sector, as opposed to oil and gas where the share of state ownership is significant.
Russia’s metals production index was 96.4 percent in 2017. However, a closer look
at products by category reveals that many products demonstrated positive dynamics
by yearend as compared to the previous year. Wire products and seamless casing
pipes showed the highest growth – 31.7 percent and 19.8 percent, respectively.
In monetary terms, Russian exports of basic metal products were up 38 percent for
rolled products and up 116 percent for tube products in 2017.
At the same time, Russian imports of basic metal products increased by 42 percent
for rolled products and 40 percent for tube products in 2017.
Investments
While seeing a huge potential for enhanced processing technology to spark growth
for Russian steelmakers in terms of new capacities, new products, and new product
lines, experts from the Institute for Scientific Forecasting of the Russian Academy
of Sciences point to insufficient strategic investment in this area. At the current
stage, over 50 percent of exports (pig iron, blooms, and hot-rolled products) go to
other countries for further processing.
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Consumers
The metals industry has a customer engagement model that is focused on relatively
simple tasks to serve the needs of construction businesses, large fuel and energy
customers, transportation companies, and the machine-building industry.
Developing an SME segment that would be based on the use of metal products
requires a relevant engagement model, which Russia has started to build.
Governance
The metals industry is particularly known for the fact that key management and
strategic decisions are concentrated in the hands of large shareholders. Despite this,
experts believe that the industry has one of the most efficient governance models.
This model enables a low risk of conflict between owners and managers, while the
international nature of the metals industry helps to reduce other risks related to
economic processes in a specific country. This allows us to conclude that the existing
challenges will not have any significant impact on the development of the industry
in the mid-term.
The industry is undergoing a change, with steelmakers transforming into investment
companies to distribute their income more efficiently to areas other than their core
operations.
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The metals production index is 96.4 percent for 2017. This is explained by positive
developments in the internal and external economic environment. High prices for
steel in other countries worked to drive prices for Russian steel products up to a level
of export price parity. As a result, 2017 saw a growth in production accompanied by
a growth in prices for steel products. This increase was mainly driven by
consumption of rolled products growing by 9.6 percent for eight months in 2017 as
compared to the same period in 2016. A look at products by category reveals that
many products demonstrated positive dynamics by yearend as compared to the
previous year. Wire products and seamless casing pipes showed the highest growth
– 31.7 percent and 19.8 percent, respectively.
Strong domestic demand during the year was maintained by increased consumption
from the construction industry (e.g. large-scale construction projects such as the
Crimean Bridge and the Power of Siberia) and the machine-building industry,
including
the
automotive
sector.
In 2017, output from EVRAZ, NLMK, Severstal, MMK, Metalloinvest and Mechel
totaled 64.7 tonnes, accounting for 90 percent of the steel produced in Russia. The
top Russian metal makers demonstrated margins varying from 24 to 33 percent, all
up on the previous year except for MMK, whose EBITDA margin was down 2
percent.
In 2017, product shipments from Severstal to Russian machine building companies
were up 7 percent to 504 thousand tonnes on 2016. This increase was primarily due
to higher demand for metal products from machine building sectors such as railway,
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agriculture, transportation, and lifting/transportation machinery. Last year Severstal
achieved the highest product quality for one of its major clients (Caterpillar Tosno)
as product rejections were down to a 10-year minimum (0.0005 percent), with only
two items rejected.
The year 2017 saw several significant infrastructure facilities commissioned. These
facilities were constructed with bridge steel produced by Ural Steel that is part of
Metalloinvest, including the bridge over the Volga River in Nizhny Novgorod and
the bridge over the Tur River in Tyumen. An opening ceremony held in late 2017
saw a highway bridge put into operation near Budovo in the Tver region. The 122.3meter-long bridge was built with 974 tonnes of steel supplied by Ural Steel.
Severstal predicts domestic demand for steel to increase by 3–4 percent in 2018. The
company also expects long-term consumption to go up by another 8 percent (3.3
million tonnes) by 2021 as construction gains momentum. This year Severstal
operates at full capacity utilization, with output remaining the same as in the
previous
year.
Let’s briefly comment on key performance indicators and its dynamics. We could
see that key return ratios tend to decrease during last two years. It could be explained
by increase in equity and decrease in asset turnover. We should also comment on
negative figures in most performance indicators during 2014, what was due to loss
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exchange loss. Current ratio fluctuated during the whole period but still it is more
than average in industry. We should also pay attention to debt-to-equity ratio. The
company's strategy is largely aimed at reducing the debt burden, that is why debtto-equity ratio tend to decrease during the period.
2.Materiality
After identifying the industry, the business environment and the position of our
client in the sector, we should apply to the next important step in our audit processcalculation of materiality. This is the on of the most crucial points, because it has
influence on whether we provide modified or unmodified opinion. According to our
experience and professional judgement we could estimate materiality items and
materiality values, based on the sector in which company operates, size of the
company and main business activities. The items are: Revenue, Profit before tax,
Total assets, Total equity, Total non-current assets. All the values are calculated in
mln USD.
2017
7 848
1 764
7 209
3 398
Revenue
Profit before tax
Total assets
Total equity
Total
non-current
assets
4 257
%initial materiality
0,5%
5,0%
0,5%
0,5%
materiality level
39,24
88,20
36,05
16,99
0,5%
21,29
The figures we get are have a wide range. Then we have to provide some adjustments
in materiality levels by items in order to get less differing figures.
2017
7 848
1 764
7 209
3 398
Revenue
Profit before tax
Total assets
Total equity
Total
non-current
assets
4 257
%initial materiality
0,7%
3,0%
0,7%
1,5%
materiality level
54,94
52,92
50,46
50,97
1,3%
55,34
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After adjusting the items we get much more narrower range with an average of 52,95
mln usd. As we can see the level of materiality in Profit before tax was changed the
most. The deviation between minimum and maximum value is only 4,56%.
Now we have perfect conditions we could determine overall and performance
materiality values. As overall materiality represents the highest amount of
misstatement, in our case it would be better to state the level of overall materiality
as 55 mln USD (0,7% of revenue or 1,3% of Total non-current assets). The
percentage we get is 3,9%, which is acceptable. It means that if amount of
misstatement does not exceed 55 mln usd, then auditor will provide an unmodified
opinion.
Item
Value
7848
1764
7209
3398
Revenue
Profit before tax
Total assets
Total equity
Total
non-current
assets
4 257
Average
4 895,20
0,7%
3,0%
0,7%
1,5%
54,94
52,92
50,46
50,97
PM (75%)
41,20
39,69
37,85
38,23
1,3%
55,34
52,93
41,51
39,69
In order to reduce risk of undetected material misstatement we should also define
the level of performance materiality. It should be less than the level of overall
materiality. As we have considered last reported financial statements of “Severstal”
and there were no huge adjustments, then we could estimate the level of performance
materiality as 75% of overall materiality level. The amount we get is equal to 41,25
mln USD.
3.Selection of items for testing.
The next step in our audit process is to choose the most valuable items from
Statement of financial position and Profit and loss statement and identify assertions
for them. In case of our company “Severstal” rom P/L statement we will select:
Revenue, Cost of sales, Gross profit and Profit before tax. From Statement of
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financial position we select: Cash and cash equivalents, Inventories, PPE, Long-term
debt finance, Share capital, Translation reserve, Retained earnings.
4.Reasonableness check
The next step is to provide a reasonableness check of retained earnings and net
income. It would be easier to follow this step with reporting information in RUR.
According to dividend policy a we estimate the dividend per share, number of shares
of “Severstal” and then dividends accrued. Then we take beginning retained earnings
for 31.12.2016 and net income for 2017. The ending retained earnings are calculated
by applying to basic formula:
Reained earnings= Beginning RE + Net income-dividends
Calculation
Beginning RE
Net income 2017
dividend per share,rur
number of shares (in mln)
dividend accrued
Reatained earnings as for 31.12.2017
58 209,00
146 029,00
110,06
837,7
92 197,26
112 040,74
Actual
Retained earnings
Net income 2017
Other loss
dividends
Other changes
Purchases of non-controlling share
Deviation
58 209,00
146 029,00
460,00
89 417,00
3 084,00
111 277,00
0,69%
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In table above we compare our recalculated figures with actual figures from financial
statement. As we can see the deviation between them is only 0,69%, which is really
insignificant. The underlying reason most likely lies in the unpaid internal dividends.
5.Accounts receivable turnover ratio.
Revenue
Beginning AR
Ending AR
AR
turnover
ratio
Days
7848
507
614
14,0017841
26,0681065
AR turnover ratio is significantly important part of our observation in order to
identify how fast company collects money from debtors. In ours case accounts
receivable consist of trade receivables and accounts receivable from related parties.
As we can estimate from our calculations, it takes less than a month to collect money
from its customers. That seems to us that most of customers pay in time without
delays. By this indicator company bypasses its main competitors. Average indicator
figure in steel and mining sector is near 32 days.
6. Depreciation expectation test.
To provide qualified opinion about going concern we also should recalculate
depreciation figures and compare it with actual ones by items. In order to prevent
huge descrepancies we won’t include construction-in-progress in our calculations.
Our expectation test will check such items as Land and buildings, Plant and
machinery, infrastructure and other financial assets.
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In table above we can see actual figures of costs, accumulated depreciation and net
balance value.
The next step of our testing is to calculate share of depreciation by item in total cost
and then estimate average figures.
Plant and buildings
Facilities
Machinery
Other
% of total % of total % of total
cost
cost
cost
39,40%
41,76%
38,53%
56,40%
58,03%
61,05%
47,89%
55,84%
38,72%
54,00%
56,67%
65,45%
Total
Average
47,33%
49,42%
49,34%
45,37%
48,67%
43,04%
After estimating average shares of total costs we have to multiply actual cost figures
by average depreciation shares estimated before. Then we compare estimated figures
with actual and identify deviation. The deviation in our period (2015-2017) varies
from 9,85% up to 11,98%.
The level of deviation is material, for 2017 it is for example 400 mln usd, while the
level overall materiality is only 55 mln usd. Maybe it is more appropriate to include
useful life years in calculations, but actually we do not have exact numbers financial
statements, they provide only ranges. That is why our calculations based only on
average share in total cost. So we could only identify some reasons for such
deviation. Company “Severstal” operating in steel and mining assets, where assets
play an important role. Such a big company with such operations always has a
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changeable structure of assets. Moreover assets in such company could be often
revalued. Mainly these reasons cause such a high deviation.
7. Ability on going concern
According to analysis of financial statements, our recalculations and provided
procedures we could sum up that company “Severstal” has an ability onn going
concern. In recent years company is one of the leaders not only in the Russian market
but on the global as well. The company shows stable accelerated growth in all key
indicators. We should particularly note that company has significant superiority in
terms of EBITDA margin over other competitors. Moreover company launched a
major innovation program aimed at ensuring business growth without a significant
increase in production. This approach will create an even more effective platform
for business development and sustainable growth. The only case we should pay
attention in our analysis is depreciation check. We need to resort to more detailed
calculations to make sure that the results are correct.
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Appendix 1.
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Appendix 2.
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