Risk Analysis
Operational and Market Risk
At first, the operational and market uncertainties of both Magna International Inc. and Linamar Corporation are visible upon reviewing the annual reports management discussion and analysis section. Regarding systemic risks, there were foreign business problems that impacted the business operations of the two companies. The political and government policies affected Asia and America’s manufacturing and equipment acquisition (Li et al., 2019). For example, the United States trade dispute resulted in the reduced demand and production of vehicles, distorted commodity pricing, interfered with the supply, and created vitality in the foreign exchange rates. Since the two based Canadian firms rely on Chinese products, the trade feuds between China and America resulted in the imposition of tariffs. This was particularly on a broader range of Chinese-origin imports, which impacted their venture supply network operations.
For Linamar, the 2019 transportation sales decreased by 1.7 percent compared with 2018, a factor attributed to the changes in the currency convertibility for the initial nine months of the year. There was a negative four percentage change between the Chinese renminbi and US dollars, whereby the foreign exchange rate in 2018 was 0.151 and in 2019 was 0.145, creating expenses for organizations importing the goods (Linamar, n.d). Besides that, the Bank of Canada’s interest rates and adoption of IFRS 16 standards adversely impacted the manufacturing and automobile supply across various international regions (Magna, n.d). The free movement of products, services, people, and money via bilateral and regional trade agreements, notably in North America and Europe, has helped the global automobile sector flourish. In that case, introducing policies that restrict free trade might significantly negatively impact the automotive venture.
Another possible market risk encountered is the poor weather conditions. Flooding and drought have a disadvantageous effect on the new equipment orders. The required raw materials cannot be acquired without favorable conditions due to considerably impaired transportation (Linamar, n.d). The phenomenon engenders a lower production rate prompting the customers to look for alternative suppliers. Poor weather causes damage to the infrastructure or delays the exportation and importation of commodities. Most automobile parts become damaged when exposed to bad meteorological conditions, resulting in increased company loss. The drastic economic deterioration due to external factors lowers the supply of products in the market.
In both the manufacturing and automotive industry, economic cyclicality is inevitable in the market. The international technological mobility industry is cyclical with the prospective for regional discrepancies in the timing of contraction and expansion of economic cycles (Li et al., 2019). A deteriorating political, social, and economic circumstances in Asia, Europe, and North America engendered by the coronavirus pandemic decline the consumer confidence, which translates to lower vehicle production levels and sales (Schwabe, 2020). For instance, Linamar company realized a considerable decline in vehicle production volumes from the preexisting number, which could negatively impact their financial condition and profitability (Linamar, n.d). The organization’s product demand is cyclically spearheaded by transitioning market factors to which they sell to (Magna, n.d). The present and anticipated events in the market or the mobility and industrial sector specifically causes material adverse effect on the companies’ financial operations. The seasonality of particular operational units can lower earnings disrupting typical production schedules.
There is intense competition, outsourcing, and insourcing in the vehicle production and selling market. The two firms encounter various sources of business rivalry in their automobile parts manufacturing. Auto parts are a highly competitive market, and this trend is expected to continue. In certain products or geographic areas, their rivals own a larger or rising percentage of the market than they do (Magna, n.d). Many established electronics and semiconductor businesses have entered or increased their position in the automobile sector, while disruptive technology entrepreneurs have been providing unique product and service remedies that conventional automotive suppliers may be incapable of competing with (Li et al., 2019). A lack of performance in the marketplace, particularly a lack of growth in Magna and Linamar electronics content, might harm their ability to execute their business plan.
Large precision machining firms with several production sites and extensive financial resources to invest in equipment for high volume, high precision, and long-term contracts compete for machining and assembly jobs. Several of these firms supply significant Original Equipment Manufacturing (OEMs) in the automobile sector. The organizations anticipate that no supplier can supply all the components, modules, and systems they now produce (Li et al., 2019). More vendors compete for each product; therefore, Linamar and Magna have more competition. These rivals may be bigger and have more resources than them, but they feel none of them are dominating in their markets. Quality, service, earlier performance, delivery timeliness, proprietary technologies, in-house prowess scope, prevailing agreements, responsiveness, and the supplier’s general interactions with the OEM are all factors that suppliers consider when selecting suppliers (Suh et al., 2019). In certain cases, vendors have requested fewer rivals per product, and management anticipates this number to shrink further as they declare their desire to deal with fewer suppliers and give them longer-term contracts.
Financial Reporting (Fraud) Risks
The organization’s financial assets exposed to credit risk significantly comprise receivables, cash, and equivalents. In both companies, their credit uncertainty for cash and cash equivalent declined as the balances became held with important financial institutions, including the central bank of Canada, with speculation grade ratings (Linamar, n.d). For instance, Linamar’s considerable part of its receivables is with vast clients in the truck, automotive, industrial, and commercial sectors, giving rise to concentration risk within those areas. In that case, the firm cannot promise that its customers will fail to encounter monetary obstacles, making it incapable of collecting its receivables wholly.
The capital and liquidity risks are highly present in the market. Both Linamar and Magna engage in capital-intensive ventures and have lower financial resources than some of their principal competitors. To a greater extent, there lacks assurance on whether they will acquire equity or additional debt financing that is highly needed to attain their strategic plans successfully (Schwabe, 2020). Magna’s current credit facility and the 2021 notes mandate them to comply with separate financial agreements, adequately service its debt, and acquire frequent commitments from the loan providers (Magna, n.d). At the same time, the organizations, if demanded, cannot guarantee accessibility to additional capital or equity provided the current or forecasted market events associated with changes in their segments.
Tax laws, securities regulations compliance, and corporate governance are considerable market risks. Canada’s foreign and tax laws keep continuously transforming, and there is no assurance given that abroad jurisdictions and provisional policies will not change in a way that adversely impacts the two companies. Even though most countries have reduced their corporate tax rate to attract new venture investments over the past years, they lack a solid covenant that they will not change, given Magna and Linamar have both diversified. With increased tax losses and credit in the countries they are operating in, given the unforeseen levy transitions, they may be negatively affected, forcing them to shut some branches (Magna, n.d). Therefore, expanding into the new and promising emerging markets will be derailed as the tariff rules depend on social or political conditions. Besides the impact of securities regulations, compliance and organizational governance standards may drastically shift and adversely influence the profitability of the two firms.
The environmental matters, sources, and the availability of the raw materials serve as market risks affecting Magna and Linamar companies. Both firms’ production operations are subject to various policies and regulations imposed by federal administration in the jurisdictions they conduct their business. This includes storage, the affluent and discharge of materials, and the transportation of hazardous components rules to engender health and safety (Li et al., 2019). The environmental compliance laws are highly expensive, impacting revenue generation. Although the executive management frequently examines the costs and work needed to address the ecological issues, it cannot predict the future material expenditures incurred to meet obligations.
The crucial raw materials used by the firm’s precision machining, access, and harvesting tools operations include aluminum and iron forgings and castings, acquired from multiple international suppliers. Since Linamar company does not rely on one vendor, a supply disruption of components could result in temporary closure due to the inability to insource or resource essential elements (Linamar, n.d). Raw materials chain network conditions, like pricing, transportation, quality, allocations, warehousing costs, and delivery timeliness, may impact the sourcing decisions of the companies and their attached manufacturing plants (Schwabe, 2020). The insufficient supply of resources causes a massive material adverse impact on the profitability of the companies, as they cannot meet the customer’s demand.
Furthermore, both companies encounter multiple operational risk factors. At first, the product launch is a sophisticated process. Its success relies on a broader range of conditions, including customers’ timing of design changes, manufacturing readiness of the suppliers’ facilities, manufacturing processes, launch volumes, quality, and production preparedness of tooling and equipment, workers, and the quality of the initial product quality. The failure to effectively launch new materials or takeover business adversely affects their reputation and profitability (PCAOB, 2020). Besides, the divisional operational underperformance by not achieving the expected earning levels may cause financial loss that derives undertakings of the companies. The complexity of automotive production activities frequently makes it challenging to attain an immediate turnaround of languishing departments. Having more than one non-successful division adversely affects operations and benefits (Li et al., 2019). The two companies face restructuring costs and operational uncertainties, particularly realized when trying to sell some product lines or downsizing (trading or closing specific operational sections). Such actions tend to create substantial non-recurring expenditures. These prices might be higher in some nations than others and negatively impact profitability.
The firms have previously recorded substantial impairment charges associated with joint ventures, goodwill, and long-lived assets, which might occur in the future. Some key indicators of defacement include early termination, delay in the execution of production contractions, loss of renegotiation of terms, and technological obsolescence of the products (Schwabe, 2020). Some of the disfigurement assumptions not met include the effect of turnaround blueprints on underperforming operations, program cost and price on present and future ventures, new business opportunities, and forecast manufacturing volumes. Another one is the timing and success of modern initiative launches, which causes impairment loss, leading to a negative material impact on their income (Li et al., 2019). The supply interruptions can serve as operational uncertainties resulting in delays in supplying automotive parts across different regions. Customers’ penalties or business interruption claims, business losses, and reputational harm are all possible outcomes of events that prohibit the organizations from providing their customers with items (Linamar, n.d). Due to the coronavirus outbreak, industrial stoppages might lead to supply disruptions both inside China and for components manufactured outside. A long-term supply interruption might negatively affect both companies’ operations and earnings.
Lastly, another operational risk is attached to skilled labor retention and attraction. The absence of qualified and experienced personnel may cause the automotive industry to record massive exits from the companies due to a lack of favorable incentives. The business competitors have increased the demand for employees with high and particular skills. For example, in Magna, due to rapid changes in response to MaaS trends, autonomous driving, and electrification, they have a growing demand for workers with technical expertise (Magna, n.d). Due to such, they encounter substantial competition even from traditional software firms. The incapability to attract and retain high talents causes a decline in auto-parts productions, translating to losses.
There are two primary fraud risks associated with both Linamar and Magna companies. They include the misstatement risks arising from fraudulent financial reporting and the misstatements resulting from the misappropriation of funds. This can be attributed to managerial incompetence, declining economic conditions, and poor oversight by the board of directors (Suh et al., 2019). However, these risks become adequately explained through the fraud triangle.
Fraud Triangle
There are multiple risk factors associated with misstatements due to fraudulent financial reporting. In that case, the two companies’ management face pressure to participate in imposture. At first, the high degree of competition or the market, accompanied by deteriorating profitability margins, prompts the management to commit fraud (Huang et al., 2017). Both companies face business rivalry from the OEMs suppliers causing profitability deterioration. The two companies are automotive companies that rely on technology. The rapid susceptibility to such enables the senior management to engage in counterfeits. The rapid changes in the interest rates influenced both companies, making them fake materials to indicate the profitability of the companies. Another pressure for them arises from substantial declines in the client demand for automotive parts and escalating venture failures in the general economy (Fitri et al., 2019). The new statutory requirements to enable both companies to comply with the IFRS 16 standards exert incentives for the management to perform fraud. The management derives excessive pressure from the third parties to meet their expectations.
Therefore, they require acquiring equity financing or additional debt to stay competitive, including financing of primary research, like automotive programs. The executive is obligated to develop the marginal capability to meet exchange listing prerequisites, debt repayment, and other loan agreement requirements. The significant financial interests in the entity and substantial compensation portions, including earn-out arrangements and bonuses, and being contingent upon attaining aggressive targets for cash flow and stock price exerts pressure on management. The executives commit fraud due to misstatements arising from assets misappropriation due to internal control weaknesses or ineffective monitoring. Individual financial obligations have access to cash and other assets vulnerable to theft and misappropriating, which is the case of the two companies’ management. The negative correlations created, including anticipated layoff or the compensation, promotions, and other rewards inconsistent with the projected expectations, cause the internal control to commit fraud.
Opportunities
There are several opportunities for fraud from the misstatements arising from fraudulent financial reporting. The internal control elements are deficient due to insufficient control monitoring, involving the automated ones and those over interim financial reporting mandating for the external reporting (Magna, n.d). The inadequate accounting and information systems, like situations embracing reportable requirements, serve as the best opportunity for fraud. The inability to attract and retain workers causes high turnover or employment of internal audit, ineffective accounting, and information technology staff engenders counterfeit in both companies (Fitri et al., 2019). The unstable or sophisticated organizational structure of both Linamar and Magna companies creates an opportunity for fraud. For instance, the challenge in establishing the individuals and organizations with controlling interest in the entity and the unusual managerial lines of the authority create such chances for the two firms.
The opportunities to misappropriate assets may be due to inadequate internal control due to the various rationales. At first, the lack of independent checks, insufficient segregation of responsibilities, and poor recordkeeping regarding assets create chances for fraud. Skimpy physical safeguards over cash, inventory, and cash and short approval of transactions and authorization systems provide extensive imposture opportunities (Huang et al., 2017). Besides that, a lack of timely and appropriate transaction documentation and poor reconciliation of assets may trigger chances for fraud. The internal control not giving the mandatory vacations to those performing key control duties and the insufficient access controls atop computerized records, involving reviewing computer systems event logs, create fraud opportunities (Suh et al., 2019). Lastly, meager management comprehension of the database technology enables the workers to perpetuate an asset misappropriation.
Rationalization
The risk factors reflective of attitudes of the management, board members, and workers may allow them to justify or engage in fraudulent financial reporting, which might not be vulnerable to observation by the auditor. However, when the auditor develops awareness of the existence of such a database must consider it in pinpointing the uncertainties of material misstatement arising from the counterfeit financial reporting (PCAOB, 2020). The information identified may include management’s failure to communicate or execute the entity’s values or ethical standards effectively, its failure to promote those values or ethics, or the communication of incorrect values or ethical standards (Huang et al., 2017). Another rationalization is an overzealous involvement in or obsession with accounting rules or large estimations by nonfinancial management. The management’s excessive interest in increasing or sustaining the entity’s earnings trend and the stock price and their involvement in committing to analysts and third parties to attain realistic forecasts serve as companies’ attitudes.
The fraudulent financial reporting may result from an established history of violations of laws and claims against the companies, and bogus allegations from the board members. It arises when the two firms’ management fails to correct known reportable situations timely and escalated interest them in deploying deficient means to reduce reported earnings for levy-inspired rationales. Fraud can be spearheaded during recurrent trials by the executive to prove marginal or inadequate accounting on a materiality basis (Linamar, n.d). The correlation between the predecessor or auditor and the management becomes strained, as exhibited by the constant disputes regarding reporting, auditing, and accounting matters. The management may make unreasonable demands on the auditor, including the unappealing time constraints, like issuing their report and completing the inspection.
The management may put official or informal constraints on the auditor that unreasonably limit access to individuals or information or the capacity to interact effectively with the audit committee or the board of directors. The annual report indicates overbearing management conduct in dealing with the auditor (PCAOB, 2020). Notably, it entails efforts to influence the scope of the auditor’s work or the selection or duration of people assigned to or consulted on the audit engagement.
Typically, uncertainty reflective of worker rationalizations that enable them to justify asset misappropriations is not susceptible to the auditor’s observations. However, any auditor aware of such a database must consider it while establishing the risks of material misstatement deriving from asset theft. For instance, there are various attitudes that a worker who has embezzled assets has. The drastic changes in lifestyle, behavior, and conduct showcasing dissatisfaction or displeasure with the company or its treatment of given staff indicate expropriation of assets (Fitri et al., 2019). Other situations include disregard for the requirement for checking or minimizing uncertainties associated with commodity stealing. The theft can trigger by abandoning internal control over the pilfering of benefits by overriding earlier management or by failure to rectify established board of directors, staff, and executive deficiencies.
References
Fitri, F. A., Syukur, M., & Justisa, G. (2019). Do the fraud triangle components motivate fraud in Indonesia? Australasian Accounting, Business and Finance Journal, 13(4), 63-72.
Huang, S. Y., Lin, C. C., Chiu, A. A., & Yen, D. C. (2017). Fraud detection using fraud triangle risk factors. Information Systems Frontiers, 19(6), 1343-1356.
Li, J., Zhu, X., Lee, C. F., Wu, D., Feng, J., & Shi, Y. (2015). On the aggregation of credit, market, and operational risks. Review of Quantitative Finance and Accounting, 44(1), 161-189.
Linamar. (n.d). Annual report Linamar Corporation. Web.
Magna. (n.d). 2019 Annual report for Magna International Inc. Web.
PCAOB, A. (2020). AS 2401. Consideration of fraud in a financial statement audit. Web.
Suh, J. B., Nicolaides, R., & Trafford, R. (2019). The effects of reducing opportunity and fraud risk factors on the occurrence of occupational fraud in financial institutions. International Journal of Law, Crime and Justice, 56, 79-88.
Schwabe, J. (2020). Risk and counter-strategies: The impact of electric mobility on German automotive suppliers. Geoforum, 110, 157-167.