5024 Industry, regulatory and other external factors

Sep-2022

Industry factors: The industry in which the entity operates may give rise to risks of material misstatement arising from industry factors. Industry factors may include items such as the level of competition, barriers to entry, volatility/seasonality of revenue, level of technological change and level of concentration of industry operators. Changes in the macroeconomic environment often impact industry factors. For example, a decrease in the level of household disposable income due to a global recession can lead to significant decreases of revenue for industries where products are mainly discretionary purchases. Our understanding of industry factors and their impact on the entity helps us in identifying risks of material misstatement.

• Pressure to “buy market share” by heavy discounting and other incentive arrangements due to increased competition

• Exposure to adverse commercial pressure from either customers or suppliers who command excessive negotiating power

• Excessive inventory levels resulting from entry into new markets or new product launches where market demand or level of market share has been over‑estimated

• Abnormal recognition of sales in response to difficult market conditions (e.g., sales acceleration trough discounts, cut off arrangements window dressing of balance sheet, title to inventory)

• Adverse impact on production due to loss of skilled labor or shortage of critical raw materials

• Loss of market share due to delays in bringing new products to market

• Industry news in the media, whether print, broadcast or internet (e.g., short seller blogs, social media posts)

• Industry information available through Knowledge Management tools OAG Audit 7035 and other external information sources (e.g. industry journals, analyst and market reports)

  • Industry outlook (by geography, business segment, and/or product)

  • Level of current and future competition in the industry

  • Market growth, historic and prospective analysis (by geography, business segment, and/or product)

  • Market share (by geography, business segment, and/or product)

Regulatory factors: The nature of, and changes to, the regulatory environment can have a significant impact on an entity’s business activities. In some industries, regulation has a high level of direct control over business activities (e.g., in financial services, utilities and pharmaceutical industries). We consider the impact of the regulatory environment encompassing, among other matters, the applicable financial reporting framework, and assess how it will impact the entity. We also consider whether local regulations specify certain financial reporting requirements for the industry in which the entity operates, since the financial statements may be materially misstated in the context of the applicable financial reporting framework if management fails to prepare the financial statements in accordance with such regulations.

Furthermore, changing public perceptions and attitudes, especially those of third‑party organizations, such as political action groups, trade associations, or other interested stakeholder groups, are often a forerunner to changes in regulation. These changing perceptions are understood, monitored and often responded to in advance of regulation being enacted. We consider available information relating to these changing perceptions and assess any impact on the entity. An example of such an initiative is the Global Reporting Initiative (GRI) related to Sustainability, whereby entities have subjected themselves to a level of self‑imposed reporting regulation. See OAG Audit 5026  for guidance on understanding the entity’s climate‑related risks. See OAG Audit 7510  for guidance on understanding the legal and regulatory framework applicable to the entity and the industry or sector in which the entity operates and how the entity is complying with that framework as required by CAS 315.19(a).

• Significant adverse impact on economic value of the business as a consequence of proposed changes in regulations

• Negative financial and/or reputational impact of illegal acts or breaches of regulations

• Aggressive management interpretation of regulations and other standards, including accounting standards

• Inability to produce required information to comply with regulatory and other reporting requirements

• Adverse impact on operations resulting from the entity’s deteriorating relationship and/or reputation with regulators, other governmental bodies or NGOs

• Environmental requirements affecting the industry and the entity’s business

• Information in the media, whether print, broadcast or internet (e.g., trade bodies or regulatory websites) on changes and proposed changes to legislation

• Evidence of compliance with regulatory requirements (e.g., regulatory returns, government publications)

• Actions of advocacy groups and /or actions by lobbyists

Other external factors: Economic cycles affect the performance of entities in different ways. Management assesses risks to achieving their business objectives including external factors that have a significant impact on performance, even though they are for the most part outside the direct control of management. These factors can be viewed as both business risks and opportunities. For example, the emergence of a deadly virus that becomes a sustained global pandemic may cause a decline in business travel which may negatively impact for example an airline or hotel business model, whereas providers of remote working platforms may experience a significant increase in demand for their products and services.

• Pressures on liquidity and cash flow due to economic downturn (e.g., inability to comply with debt covenants, inability to refinance debt or access equity or debt market)

• Pressures on assumptions (e.g., growth rates) and their impact to the overall financial performance

• Relevance and robustness of valuation due to change in economic circumstances (e.g., inventory, property, plant and equipment)

• Increased product reliability, warranty and obsolescence issues due to shortened product life cycles from rapidly changing technology.

• Disappearance or deterioration of markets due to changes in government leadership or changes in the stability of the government.

• Adverse impact on sales due to changes in social attitudes in the industry (e.g., tobacco, genetics)

• Published economic indicators (e.g., GDP, interest rates, inflation rates, unemployment)

• Information in the media, whether print,
  broadcast or internet related to industry dynamics and political and geographic risks

• Technological developments facing the industry as a whole

• Climate-change studies addressing industry and geographical impacts (e.g., National Oceanic and Atmospheric Administration studies, EU Science Hub publications)

• Social media and other media coverage related to changing social considerations