CASE STUDY: Acquisition Decisions Through FInancial Due Dilligence

Written by Eri Budiman and Fajri Yudha Pratama on 5/7/2024

The author’s views are entirely their own and may not always reflect the views of Putranto Alliance.

Financial Due Diligence (FDD) is a critical component of the investment decision-making process, providing in-depth insights into the financial health and regulatory compliance of potential investment targets. A fund and asset management company, hereinafter referred to as The Company, renowned for its strategic focus on real estate and venture capital within dynamic Asian markets, has engaged the service of Putranto Alliance to conduct an FDD on a prospective investment to ensure that the financial and tax records of the target company are accurate and reflective of actual operations. By leveraging the findings and recommendations provided by Putranto Alliance, The Company seeks to make an informed investment decision, aligning with its commitment to responsible and sustainable investment practices. 

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Situation

The Company specializes in investments primarily in real estate and venture capital within rapidly developing markets across Asia. The Company is committed to being a responsible investor and fund manager.  

To achieve its investment goals, The Company adopts a long-term perspective, integrating Environmental, Social, and Governance (ESG) factors into its investment strategies and corporate operations. By prioritizing ESG considerations, The Company aims to foster sustainable growth, mitigate risks associated with environmental and social factors, and uphold the highest standards of governance. 

Complication

The Company planned to invest in other entities as part of its investment strategy. As an early stage in the investment process, The Company conducted an in-depth evaluation to understand the actual financial condition of the entity targeted, hereinafter referred to as the “FDD Target”, for investment.  

FDD Target is a technology-based enterprise in Indonesia, focusing on the waste management sector. Since the FDD Target started the business activities, the limited understanding of accounting standards and tax regulations has resulted in non-compliance with current standards and regulations, including: 

  1. Inconsistency in accounting recognition method;
  2. Non-compliance with tax regulations such as monthly withholding tax, annual income tax, etc., resulting in the possibility of tax exposure in the future. 

These potential issues can bring the possibility for fines and tax underpayment in the future. 

Question

To address the issues above, Putranto Alliance was asked to provide FDD service that included an assessment of the accuracy of the financial statements, compliance with tax laws and regulations, as well as identification of critical findings and recommendations to improve their accounting & tax practices. 

The FDD process involves a comprehensive analysis of the accounting standard’s application in their bookkeeping and the potential tax exposure of the FDD Target. This assignment aims to provide The Company with a comprehensive and detailed understanding to make informed and appropriate investment decisions. 

During the assessment of the FDD Target, we identified the following key challenges in their finance, accounting, and tax practices: 

  1. Inconsistency in The Financial Report Preparation Process: Inconsistency in the preparation of financial statements, such as the calculation and classification of items, can result in inaccurate data and potentially lead management to make erroneous strategic decisions. 
  2. Non-Compliance with Tax Law and Regulations: The tax obligations of the FDD Target were not fully aligned with the relevant tax law & regulations, resulting in potential tax exposure. 
  3. Insufficient Documentation and Record-Keeping: There was a lack of adequate documentation to support the validity of financial records, which could undermine the credibility of financial statements and limited findings and recommendations. 

Answer

Putranto Alliance conducted a thorough assessment of finance, accounting, and tax of the FDD Target. 

The key points are as follows: 

Financial Due Diligence Issue Tree

Financial Analysis

Financial statement analysis in FDD involves 3 (three) main aspects: 

  1. Verification of Financial Statements Accuracy: This stage involves a thorough examination of the financial statements to ensure that all presented information is true and accurate. This includes rechecking account balances, supporting documents transactions, and disclosures made by FDD Target. 
  2. Consistency of Financial Statements:
    This evaluation assesses whether the FDD Target uses consistent accounting methods in preparing its financial statements. Consistency in these methods is crucial as it allows for easier comparison between different financial periods and ensures that the information presented is consistent over time. For example, whether the FDD Target is consistent in recognizing revenue, calculating asset depreciation, or assessing accounts receivable. 
  3. Accounting Adjustments:
    Accounting adjustments are made to align the financial statements with correct accounting principles and comply with applicable accounting standards. Examples of adjustments include correcting errors in revenue recognition, adjusting fixed asset values with appropriate depreciation, or recognizing relevant contingency liabilities.

Tax compliant analysis

Tax compliance analysis in FDD includes: 

  1. Tax Compliance:
    This aspect focuses on evaluating whether the FDD Target complies with all relevant tax laws & regulations. It includes assessing the accuracy of tax calculations, the timeliness of tax payments, and the proper reporting of various types of taxes. 
  2. Tax Risk:
    Tax risk assessment examines the potential exposure to various tax risks for all types of transactions. 

Findings and Recomendations

The findings and recommendations process in the FDD aims not only to identify key findings but also to provide strategic direction that can improve accounting & tax compliance. 

The summary of the key findings also provides a clear picture of the current financial state, while the strategic recommendations focus on prioritized actions to improve the operation of FDD Target. 

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