Inherent risk analysis for Admiralty Resources NL audit

Inherent Risk and the Audit Plan

Financial Report Audit Risk Analysis for Admiralty Resources NL.

Hi, wasn't sure if you wanted/needed an abstract for this kind of report, so I left the page blank just in case you wanted to fill in a short one.

This report is a risk analysis of the inherent risks for the financial report audit for Admiralty Resources NL (ADY). The following report will form the basis for the Audit Plan for Admiralty Resources NL.

Analytic Review for Admiralty Resources NL. (Part I)

Industry

Admiralty Resources NL. is a diversified mining company operating in South America, Northern Chile where they mine for iron ore. Additionally they explore for nickel in Western Australia (Pyke Hill Tenement), and explore for zinc and lead in the Northern Territory (Bulman Tenement) (Australian Securities Exchange, 2010).

The Pyke Hill Resources Party Ltd.: The Pyke Hill Resources Party Ltd. is a wholly owned subsidiary of Admiralty Resources. Mining Lease M39/159 is co-owed with Richfile Party Ltd. This mining lease is in an area considered as a potential high grade nickel deposit and cobalt. Cougar Metals NL. holds the mining rights to the lease, and will pay royalties to Admiralty Resources for nickel and cobalt that is mined, and Admiralty retains the right to explore and mine for other minerals on the tenement (Aspect Huntley FinAnalysis - Admiralty Resources, 2010).

Bulman North Territory: The zinc and lead deposits are held 100% by Admiralty Resources through its subsidiary, Bulman Resources (Admiralty Resources, 2009).

SCM Vallenar Iron Company: Admiralty Resources acquired a 49% share interest in SCM Vallenar Iron Ore Mines located in Northern Chile, which they increased to 60% in 2007 and 100% in 2009 by acquiring the remaining 40% share interest from Wyndham Explorations. They own and operate nine existing iron ore mines at the present time (Aspect Huntley FinAnalysis - Admiralty Resources, 2010).

For the time period of 2009, ADY experienced a decline in price per share, and an overall decline in relative performance compared to the S&P ASX 200 over the last six months:

(Australian Securities Exchange, 2010).

Relevant Inherent Risk Information

From the Annual Report 2009:

Over 2009, Admiralty Resources has encountered a reduced market share performance as well as a reduced stock price. Information from the Annual Report for 2009 shows that the Total Assets have decreased from the previous period by more than 30% (2008), Total Liabilities have decreased slightly from the previous period, with Net Assets decreasing by approximately half from the previous period.

For the Cash Flow summary, Operating Cash Flow shows a negative only slightly smaller from the previous period, Financing Cash Flow is significantly reduced, yet Investment Cash Flow is significantly increased (Aspect Huntley FinAnalysis, 2010).

The Annual Report 2009 appears to suggest a decline in the operating income of the company, with slowing in EPS and an overall decline in market share performance relative to the S&P ASX200. It appears that operating cash flow has been a problem for previous periods, yet the period 2009 shows a heavy investment of cash.

Period Relevant Information (Part II)

Other Source Information on the Business

Admiralty Resources NL is one of 652 mining and metals industry companies on the ASX. On the ADY website, the 2008 Annual Report is very positive and talks about a leap in growth for 2009 based on the Argentinean acquisition (Admiralty Resources, 2009). However, recent news from Reuters tells a different story that should raise some red flags in the plan for the audit process.

In November of 2008, ADY had to cancel a deal for the sale of Rincon Lithium due to the inability of the potential buyer to secure funds. In December of 2008, the sale of Rincon Lithium was made to a different buyer. In March of 2009, Admiralty Resources was involved in a lawsuit involving its subsidiary, SCM Vallenar. SCM Vallenar was being sued for nonpayment of invoices by Besalco Maquinarias S.A. Vallenar countersued claiming that Besalco did not meet targets (Admiralty Resources, 2008). Besalco countersued for $10million dollars alleging that Vallenar owed them money in late interest payments on invoices, mobilization and demobilization expenses, damages, and severance pay (Reuters News Service, 2010). Details of the settlement that was reached are not included in this report; however the inherent risk to the audit plan must include the payout to the settlement agreement.

On May 4th and June 19th of 2009, large volumes of shares were issued to pay in part a convertible loan. Between the first stock issuance and the second, Admiralty acquired the remaining interest of SCM Vallenar from Wyndham Exploration. The side story is that the acquisition was the final outcome of a long and protracted legal battle with Wyndham. The cost of the settlement should be of concern to the audit plan process.

In October of 2009, the company announced that no dividends were paid during the year and recommended that none be paid (Reuters News Service, 2010). While the company has issued shares in 2010 that have raised investment income, this has little bearing on the inherent risks involved in the 2009 Financial Report audit due to being a different time period under review.

The sale of Rincon Lithium's impact into 2009, the lawsuit settlement with Besalco in 2009, the acquisition of the remaining shares of SCM Vallenar in 2009, and the acquisition of S.B. Granelas S.A. In 2009, should all be of concern in the understatement of costs and the overstatement of income raised from all sources, including the issuance of stocks twice in the spring of 2009.

Potential Misstatements of Reporting

The following areas of the financial reports are flagged for potential misstatements:

Short-Term Debt: may be understated due to lawsuit payouts

Total Current Liabilities: potential understatement due to acquisitions and lawsuits.

Total Liabilities: potential understatement re: acquisitions and lawsuits.

PP&E: Properties, Plants and Equipment may be overstated. Acquisition of S.B. Granelas S.A. needs to be fully explored as to what debts they held prior to the sale and what debts transferred to Admiralty. Also, the acquisition of SCM Vallenar involved a settlement in which stockyard items were supposedly evenly divided up. This needs to be explored as to the veracity of the statement.

Net Assets may potentially be understated due to the possibility of liabilities and PP&E being misstated.

Investment Cash Flow: may be overstated due to the use of stock issuance sales being utilized to pay down loans.

Expenses: may be understated due to payouts to legal settlements, investments in acquisition of Argentinean company Granelas, and deals with SCM Vallenar's settlement with Besalco.

Tax Expense: The Annual Report is not listing any tax expense. This needs to be flagged as a potential misstatement.

Additionally, the investment holding company's particular financial reports should be scrutinized for any other activity.

Impact of Tight Credit Market and Global Recession on the Audit Risk Analysis

Admiralty Resources is a global diversified mining company, which has been subject to recent legal action, as well as conducting several large business deals in South America. Admiralty has also issued stock to raise capital to pay down loans and increase investment capital. The impact of the tight credit market may be evident to some degree in the dramatic decrease in Admiralty's Financing Cash Flow, which went from $48.61million to -$9.25million from 2008 to 2009.

The global recession has impacts in various sectors of the economy, though for the mining and metals industry it is not felt to the same degree as it would be in front-line consumer retail industries like Wal-Mart. The strength of mining industry should remain viable through global recession and be poised for growth, though prices have fallen in areas of gold and precious metals and minerals, which would not directly impact Admiralty except in terms in a global credit crunch as financial markets tighten. Admiralty may be pressured to raise funds and misstate financial information to soothe investors and attract new investors. The risk of misstatements to the financial reports in light of reduced financing due to the global recession may hit Admiralty if their fundamentals were not in order to begin with, hence pressuring the company to alter their financials to appear in a growth position when they might not actually be so.

Memo

To: Partner X, Auditor

From: Partner Y, Auditor

Re: Inherent Risks to the Financial Report Audit for Admiralty Resources NL.

This memo is to discuss some specific areas of risk to the Audit Plan for Admiralty Resources NL. Admiralty Resources is a global diversified mining company, with primary operations in South America (Chile and Argentina) and Australia. They mine and explore for iron ore, nickel, zinc, and cobalt. Admiralty owns three subsidiaries directly involved in the mining process, with one more subsidiary brought on board in 2009 which will commence mining operations in Argentina soon. These mining operation subsidiaries are Pyke Hill Resources Party Ltd., Bulman Resources Party Ltd., and SCM Vallenar Iron Company. Other subsidiaries are ADY Investments Pty Ltd., which is an investment holding company, Five Star Resources Party Ltd., which is engages in mineral exploration, and Fortune Global Holdings Company, which is a holding company for SCM Vallenar. Additionally, during the period 2009, Admiralty acquired S.B. Granelas S.A., a mining company in Argentina, as well as completed the remaining acquisition of share interests in SCM Vallenar

In 2009, they were coming off the heels of a sale of one of their subsidiaries, Rincon Lithium, as well as engaging in the acquisition of the remaining share of SCM Vallenar. Clearly there were a lot of business deals happening during 2009 for Admiralty, which is why as auditors we need to be extra cautious in indentifying potential areas of risk of material misstatements in the financial reporting of the company.

During the Analytic Review portion of assessing risks to the audit plan, some items raised concern that we should address. First, the company profile shows a global firm with operations in two different countries. Cash flow issues across borders can be tricky, and since major sales and acquisitions have happened for Admiralty during 2009, we should be extra cautious in scrutinizing costs as they are stated on the company's financial reports.

The company has experienced a steady decline in EPS and in market share over 2009, which shows to be the trend historically over the last 10 years. While the Company's Annual Report that they publish on their website is very positive and talks about growth, it does not talk about the issues that may face us as auditors in determining potential misstatements in the financial reporting.

The 2009 Annual Report shows a decline in operating income, with decreases in operating cash flow and financing cash flow. However, in 2009 there is a significant increase in investment cash flow. In the spring of 2009, Admiralty made two large stock issuances. Between those stock issuances, they settled an acquisition for SCM Vallenar from Wyndham Exploration, becoming sole owner of the subsidiary. The issue in this deal is that there were legal suits happening between SCM Vallenar and Wyndham, which Admiralty settled within their acquisition deal. This should be of concern to the audit process as we are dealing with cross-border money transfers, unknown inventory allocations, and possibly faulty misstatements on the value of Property, Plants, and Equipment. Also, the stock issuances which occurred in this climate of upheaval in the company was made in part to pay down a convertible loan, though on their annual report this is not stated to investors; rather it is stated as a capital raising venture to open their mining market operations in Argentina.

In light of the sales, legal settlements, acquisitions, stock issuances, declining market position and overall declining EPS performance, the following areas are highlighted as potential material misstatements in the account subject to audit:

1. Short-Term Debt

2. Total Current Liabilities

3. Total Liabilities

4. Property, Plant, and Equipment

5. Net Assets

6. Investment Cash Flow

7. Expenses

8. Tax Expenses

9. Related financials of their investment holding company.

Additionally, we need to keep in mind that the global credit crunch may have impacted how Admiralty wanted to represent themselves to potential investors, especially in a climate of decreasing EPS and market performance. Investors have choices in the mining and metals industry, and Admiralty has not been demonstrating any great profits over the last year, and even over the last 10 years. In a time when the company may have really needed to float some debts while they were acquiring mining operations in South America, they may not have been able to secure a loan, especially since at least some part of their 2009 stock issuance went to pay down debt for a convertible loan they already had.

In summary, there are areas of concern that may be material misstatements in the audit process plan for Admiralty Resources, as identified above, and all related to sales and acquisitions, legal settlements and stock transactions, during the volatile business climate that Admiralty was engaging in during the 2009 period.