Client Risk Profile

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We have been appointed as an auditor of Performance Sports Group Ltd for the year ended May 31, 2016. In order to express an opinion on the true & fair view of the financial statements, it is the prerequisite to have an understanding of the internal and external environment of the business entity under the audit. Performance Sports Group Ltd. is a top manufacturer of sports equipment for ice hockey, roller hockey, lacrosse, baseball and softball. The products of the company are available in over 45 countries through a network of more than 7,000 retail locations and over 60 distributors. The company is a world leader and renowned brand in hockey. The products manufactured are marketed under the brand name of BAUER, MISSION, MAVERIK, CASCADE, INARIA, COMBAT and EASTON. The products manufactured are distributed throughout the world. The main focus of the company is to build up a leading position in the world through acquiring major market share in all the product categories. Therefore, the company operates in a highly competitive environment with diversified products manufactured by it, creating a high inherent risk to the auditor.

The Board of Directors consists of eight directors, namely, Bernard McDonell, Karyn O. Barsa, Joan Dea, Dan Friedberg, C. Michael Jacobi, Harlan Kent, Matthew M. Mannelly and Bob Nicholson. The Company has constituted Audit Committee, Compensation Committee, Corporate Governance and Nominating Committee and Risk Committee. The Audit Committee comprises of Bernard McDonell, Joan Dea, C. Michael Jacobi. The Compensation Committee comprises of Karyn O. Barsa, Dan Friedberg and Bob Nicholson. The Corporate Governance and Nominating Committee comprises of Dan Friedberg, C. Michael Jacobi, Matthew M. Mannelly and Bob Nicholson. The Risk Committee comprises of Karyn O. Barsa, Joan Dea and Matthew M. Mannelly.

The executive panel of the company consists of highly experienced and dedicated personnel with a success past track in the field of marketing products, integrating strategic acquisitions and planning and implementation of growth strategies. The top level employee turnover is very low which can be noticed by the fact that the executives have been working with the company since an average of ten years. The executive panel comprises of Harlen Kent (Chief Executive Officer, Director), Amir Rosenthal (President, PSG Brands), Mark Vendetti (Executive Vice-President/ Chief Financial Officer), Angela Bass (Executive Vice-President, Global Human Resources), Paul Dachsteiner (Vice President of Information Services), Paul Gibson (Executive Vice President, Chief Supply Chain Officer), Todd Harman (Executive Vice President of Baseball/ Softball), Troy Mohns (Executive Vice President, New Business Development & Corporate Strategy)Matt Smith (Executive Vice President, Marketing) and Michael J. Wall (Executive Vice President, General Counsel and Corporate Secretary).

The Board of Directors of the company thinks good corporate governance to be the essential part for the smooth functioning of the company and increase in shareholders’ value in the long run. The company is dedicated to provide fair and timely information in the form of compliance with the corporate governance standards of United States and Canadian securities regulators, the New York Stock Exchange and the Toronto Stock Exchange.

The business strategy of the company is to manufacture, develop and deliver quality products that improve the performance of athletes. The company aims to increase the net revenue and also the net profit margin through reducing the costs and increasing the overall efficiency throughout all the processes, namely, supply, manufacturing and distribution. The following are the strategies that had been formed by the company in order to deliver net revenue growth:

1. Increase Ice and Roller Hockey Share;
2. Leverage Cost Leadership to increase Profitability;
3. Target Emerging and Underdeveloped Consumer Segments;
4. Grow Apparel Across all Sports Categories;
5. Capitalize on the rapidly growing lacrosse market;
6. Pursue Strategic Acquisition.

Therefore, from the understanding that we have gathered so far of the business environment of the entity, it can be said that the risk profile of the company is high as the company deals in a number of products worldwide, it operates in a highly competitive environment which can lead to material misstatement of financial statements. The company operates in an industry where there are rapid changes and a need to maintain pace with the changing environment in order to preserve the current position and grab future growth opportunities. Further, the company deals worldwide and therefore have foreign exchange exposure. The company have various brands and a wide marketing channel through which the distribution of products takes place. Hence, there are a number of areas that needs to be considered while planning the audit of the entity as the inherent risk involved and assessed through the understanding of the internal and external environment of the entity is very high. But, on the other hand, the entity has good corporate governance, code of ethics and being regular in the compliances, which marks that there is a nice control mechanism operating in the organisation. Hence, the control risk involved in the audit of the entity is low. Therefore, it can be concluded from the analysis of the inherent and the control risk that the risk of material misstatement involved is average.

 

During the planning stage, the analytical procedures are undertaken in order to understand the financial position of the entity and analyze the issues (in case any) for the adverse variance from industry averages. Also, it helps to compute the overall audit risk involved through the analysis of the data. The data considered while the analysis has been taken from the quarterly results for the quarter ended August, 2015, November, 2015 and February, 2016.
The reported revenue for the quarter ended August, 2015, November, 2015 and February, 2016 were $175, $153 and $126.1 respectively. During all the three quarters, there had been unfavourable foreign currency impact over the revenue, which had, however been at a diminishing rate. The total reported revenue of the company in its quarterly report is allocated to Canada, United States and rest of the world. As per the comparative information of the company (period over period), the revenue growth rate of the company had reduced except for in quarter ended August, 2015 for revenue from United States. Moreover, the revenue during the said period has also reduced.

Secondly, as a percentage of revenue, currency neutral gross profit increased to 33.9% for the nine month period ended 29 February, 2016 from 32.0% in the nine month period ended 28 February, 2015. Including the impact of foreign exchange, the gross profit margin for the nine months ended February, 2016 decreased from 32.0% to 29.5% as compared with the corresponding period of the previous year. The same has been due to the decrease in revenue along with the increase in selling, general and administrative expenses from 21.5% to 29.5% and research and development expenses from 3.6% to 4.1% (as per period over period comparison). However the Industrial Average Gross Margin for the Quarter ending, 29 February, 2016 is 40.82% which is far more than the Gross profit of the Company i.e. 33.9%.

Further, the Earnings before Interest, Tax, Depreciation and Amortization also decreased from 15.5% to 4.6% for the nine months ended February, 2016 compared to February, 2015. The EBITDA margin of the Industry for the Quarter ended February, 2016 is 10.65% as compared to 4.6% of the company. The results have decreased significantly during the period.

The leverage ratio as on 29 February, 2016 was 10.98, excluding the impact of foreign exchange on the Company’s trailing twelve month EBITDA, the Leverage Ratio was 5.72. While the Industrial Leverage ratio for the quarter ending 29 February, 2016 is 2.6. therefore concluding that the leverage ratio of the company is muvh higher as compared to the Industrial average.

The closing cash balance as on 29 February, 2016 was $2.5. The management believes that the ongoing operations and resultant cash flows along with the cash reserves would provide sufficient liquidity to the business operations.

The cost of goods sold during the nine month ended February 29, 2016 decreased by $24.6 million or 7.1% to $320.4 million. This has been primarily due to the decrease in revenue, lower Hockey product costs driven by productivity and sourcing initiatives in connection with the previously announced five-year supply chain initiative, reduction in commodity-related factory input costs from Asian vendors, lower non-cash charges to cost of goods sold.

The negative EPS calculated after adjustment of impact of foreign exchange for the nine month period ended 29 February, 2016 was $0.06. This signifies that the return to the shareholders of the company has decreased, as the comparative EPS for the period of previous year reported a positive earning per share of $0.84.

The analytical procedures applied and mentioned here above had helped us to form a more informed understanding about the workings and the environment of the entity. The company has diverse revenue sources, in terms of geographic segments and business segment (product-wise). Further, being a company operating in different countries, the company is exposed to foreign currency fluctuations which may lead to material misstatements. Further, the areas to be emphasised are revenue, cost of goods sold, foreign fluctuations and debts due.

 

The financial statements are very much important to both the internal and external users. They exhibits the performance of the company as well as helps the users to take decisions make investments and other decisions. Therefore, it becomes very much necessary that the financial statements be free from material misstatement and gives a true and fair view of the operating results during the period and of the assets and liabilities as on the reporting date. This signifies the role and importance of auditors’ opinion thereon.

Audit Risk refers to the risk that the auditor may issue an inappropriate opinion on the financial statements. The overall audit risk is a product of inherent risk, control risk (collectively known as risk of material misstatement) and detection risk. Where the risk of material misstatement is high, the detection risk is set to low, in order to minimize the overall audit risk and vice versa.

Inherent Risk is the susceptibility of assertion the financial transactions, i.e., account balnce, class of transactions and disclosure, which may be single or collectively materially misstated, where there are no controls set by the management. In other words, the auditor computes the inherent risk through the analysis of the business environment in which the organization operates and estimates the inherent risk to be the risk to form an opinion in such an environment, without considering the controls that are in place.

In the case of Performance Sports Group, the inherent risk involved is high. The company operates in a highly dynamic environment prone to a number of changes, both in the internal as well as external environment.

 

During the year ended, the company, through its wholly owned subsidiary acquired Easten Hockey Holdings, Inc. The purchase consideration for the acquisition was agreed at $5,585 to be paid in cash. The company had financed the acquisition through additional borrowing. The acquisition had resulted in gain on bargain amounting to $987. Assessment of inherent risk in business acquisition is high as the assets acquired and the liabilities assumed along with the gain arising due to the acquisition requires high consideration in order to check whether any misstatement exists.
Trade Receivables
The company had recorded expense on account of bad debts of $24,203 in the nine months ended February, 2016. The bad debt included receivable from a U.S. national sporting goods retailer and an internet baseball retailer. This shows that attention should be paid while the audit of trade receivables and bad debts.
Impairment of Intangible Assets
The company has recorded impairment on trade names and trademarks, purchased technology, customer relationships and goodwill. The total impairment recorded was for $145,112 during the nine months ended February 29, 2016. We should while performing audit procedures over the assets, check the method adopted by the management while computing and recording impairment of assets.
Other Non-Current Assets
During the year, the company purchased non-controlling interest in Cocona, Inc. and in Q30 Sports Science. Both the investments are accounted at cost. Therefore, attention is needed to be paid on as to the valuation of these investments and their accounting.
Discontinued Operations
During the year, the company discontinued distribution operations at its distribution facility in Mississaunga, Ontario resulting in termination of around 56 employees. It pose inherent risk over the going concern of the entity and also consideration is needed to be paid to the factors behind and the financial impacts of the discontinuation. It must be ensured that the management’s decision should be in the interest of the stakeholders.
Control Risk
Control risk is the risk that the management would not be able to place sufficient and appropriate controls over the inherent risk and that it would result into errors of frauds that may singly or collectively consequent to misstatement of financial statements.
In Performance Sports Group, the management is experienced and reliable, also there exists a code of ethics which decreases the control risk. However, through analysis of decreasing revenue and increasing bad debts, the control risk seems to be high as the management is unable to realize its receivables and also the turnover of the company is diminishing continuously, quarter to quarter.
Detection Risk
Detection risk is the risk that the auditor might fail to identify any error or fraud present in any financial assertion, which may lead to material misstatement in the financial statement. In order to express opinion on the financial statements, it is needed that the detection risk should be set at low as the risk of material misstatement of the business is high. It means that the there should be sufficient and appropriate audit evidences to support the opinion. Also, there is need to apply substantive audit procedures.
Overall Planning Materiality (Refer Appendice II)
The determination of planning materiality is a matter of professional judgement based on the risks involved in the audit and the percerption as to whether the transaction or class of transactions would have any impact over the financial decisions of the users of the financial statements. Any transaction is said to be materially misstated when such errors or frauds, individually or collectively can influence the decision of the stakeholders. Further, while planning materiality, we had considered the environment of the company and the factors that would effect the stakeholders’ decision making.
We have planned materiality on the basis of materiality range (upper range for high and lower range to low) for four different categories. As per our belief, we have taken Net Profit Before Taxes to be the most suitable category, as it provides information about the performance and operations of the company.

Performance Sports Group Ltd. operates throughout the world, especially in Canada and U.S. The company, further operates in different products, especially in Hockey and Baseball/ Softball. As mentioned in the analytical procedures, the revenue of the company is decreasing. The key audit issue is to identify any potential fraud as the total revenue transactions is significant and material. It should be ensured where sampling is adopted in case of vouching of invoices issue, the sample size should be appropriate and proper technique should be adopted. Further, it should be noticed that the invoices are consecutively numbered and serially arranged. We plan to have a proper understanding of the invoicing mechanism of the company and the controls established by the management to regulate the issue of invoice to the clients. There should be proper authority under which any invoice is issued. Further, it had been noticed that there had been bad debts to the entity during the year. It should be examined that there exists proper controls for evaluation of clients before making sales and also that proper realization methods have been practiced by the management to avoid the write-offs.

The company has recently discontinued distribution operation in Mississaunga, Ontario, which had resulted into termination of around 56 employees. We should verify that the number of employees reported to be terminated by the company is correct and that the full and final settlement made to them is as per the company’s practices or in terms with the contract of employment with the personnel.

Further, the company has adopted Omnibus Equity Incentive Plan under which the employees are granted nonqualified stock options, incentive stock options, stock appreciation rights, restricted stocks, restricted stock units, deffered stock units, other stock based awards, and performance compensation awards. Under the plan, the company grant awards to its employees, non-employees, directors and its affiliates. Therefore, as an auditor it is needed to check the grants recorded by the company. Further, the valuation assumptions involved in the accounting of the same should be verified.

 

The company had acquired all the assets and certain liabilities of a company through its wholly owned subsidiary during the year under audit. Also, the company has acquired non-controlling rights in two companies. The acquisition resulted in gain which has been recorded in the intangible assets of the company and the purchase of non-controlling interest is recorded at cost. It is needful to apply substantive procedures for the physical verification and valuations of the assets and liabilities involved under the acquisitions.

 

Pursuant to acquisition of Kohelberg Sports Group Inc. in 2008, a contingency to pay Nike, Inc. exists based on qualifying exit event. However, the management had determined that no exit event had occurred. We need to verify the same through taking additional management representations and other audit procedures.

Further, various legal proceedings stands pending against the company involving contractual and employment relationships, product liability claims, trademark rights, etc. On March 18, 2016, a class action securities fraud complaint was filed by Brian Apel, individually and on behalf of all others, against the company seeking unspecified damages, as well as costs, attorneys’ fees, and other unspecified relief. External confirmation relaing to all the pending legal proceedings against the company for the status and assumed future monetary outflow in case the contingency occurs by the legal professional of the company is seeked to confirm that the information provided by the company is true and no other material information is concealed.