Ibm Risk Analysis
Relative Size in the Industry
IBM is part of the technology sectors in the diversified computer systems industry (IBM: Summary for International Business Machines- Yahoo! Finance). The market cap is 254 billion with IBM making up 218. 6 billion. IBM is the largest company relative to the diversified computer systems industry. In a less specific industry of computers IBM only trails Microsoft Corporation by 12 billion dollars (“International Business Machines Corp. “).
Because of IBM’s large size relative to its industry the relative size does not pose a large business risk to IBM because they can leverage their large market share, capabilities, and achieve economies of scales. Acceptable audit risk is affected by the relative size of IBM in the industry it operates. IBM is a large global corporation and thus there are a very large number of financial statement users. The large number of financial statement users causes the auditors to set acceptable audit risk at a lower number and thus lowering planned detection risk and increasing the amount of evidence that must be accumulated.
Major Competitors IBM’s major competitors in the diversified computer systems industry are Hewlett Packard Company Common, Teradata Corporation, Cray Inc. , and Silicon Graphics International (IBM: Summary for International Business Machines- Yahoo! Finance). These competitors do not pose a large risk to IBM because they have much smaller market-shares than IBM Hewlett Packard Company Common IBM’s closest competitor only has a market capitalization of 24. 4 billion and the next closes which is Teradata Corporation only has a market cap of 10. billion (IBM: Summary for International Business Machines- Yahoo! Finance). In the computer industry IBM’s major competitors are Microsoft, Apple, Oracle, Cisco Systems, and Intel Corporation (“International Business Machines Corp. “) IBM due to operating in over 170 different countries in multiple different industry segments and competitors vary by segment from large international enterprises to smaller narrowly focused entities and thus IBM recognizes 100s of competitors (International Business Machines Corporation 2011).
Intense competition regardless of IBM being a leader in almost all segments however does increase risks for IBM such as price competition which lowers gross margin ratios, losing market share, and obsolescence of current products. IBM’s major competitors by business segment are discussed in the next section. Major Products & Competition by Product IBM’s major business segments are Global Technology Services, Global Business Services, Software, Systems and Technology, and Global Financing.
Global Technology Services includes strategic Information Technology outsourcing services to transform clients existing infrastructures, global process services which includes process platforms and business process outsourcing, integrated technology services which are a project based portfolio of services to optimize IT which is built around key assets and patented software to drive efficiency, flexibility, productivity, and reduce costs, and the GTS services delivery which is responsibly or delivery of IBM technology worldwide. International Business Machines Corporation 2011) Global Business Services provides consulting and system integration which bring value to the customer by improving strategy and transformation, application innovation services, enterprise application, and business analytics and optimization.
Global Business Services also includes application management services which provide assistance in application development, management, maintenance and support for software and custom and legacy applications. International Business Machines Corporation 2011) IBM faces major competition in the global services segments global technology services and global business services from the broad based competitors Accenture, Computer Sciences Corporation, Fujitsu and Hewlett-Packard Company. IBM also competes with India-based service providers, public accounting firms providing consulting services, and companies that focus on local market and niche service areas. International Business Machines Corporation 2011) IBMs software segment includes the sale of middleware software which enables clients to integrate systems, processes, and applications across a standard software platform. Operating systems are the software engines that run computers. Two thirds of the revenue from software is from annuity based recurring license charges and ongoing subscription and support.
One third of the revenue comes from one time charge arrangements where customers pay up front for a license which is typically from one year of subscription and support but they can purchase subscriptions and support after the first year. Software offerings include information management software, trivoli software, lotus software, rational software, security systems software and operating systems. This segment is in a highly competitive market and the companies main competitors are CA. Inc. , Microsoft Corporation and Oracle Corporation. International Business Machines Corporation 2011)
The IBM systems System Z, Power Systems, and System X range from general purpose and integrated systems designed and optimized for specific business, public, and scientific computing needs and form the foundation for IBM’s integrated offerings. Storage includes data storage products and solutions to help clients retain and manage complex volumes or rapidly growing digital information. They address vitally important issues such as security, compliance, storage optimization, and retention and archiving, availability, etc.
Retail store solutions include Point-of Sales and self-service systems and include hardware, software and services. Lastly microelectronics include semiconductor design and manufacturing primarily for use in IBM systems. In systems and technology IBM’s major competitors are Cisco, Dell, HP, Oracle, and EMC Corporation. (International Business Machines Corporation 2011) Global Financing facilitates customers acquisition of IBM systems, software and services and includes client financing, commercial financing, and remanufacturing and remarketing.
Client financing includes lease and loan financing to end users and internal clients with terms between 1 and 7 years. Internal financing supports long term client service contracts in the Global Services department and Global financing also factors a portion of the company’s accounts receivable. Commercial financing includes short term inventory and accounts receivable financing to dealers and remarketers of IT products. Remanufacturing and Remarketing includes equipment which is returned at the conclusion of a lease contract which is they sold or leased to another client internally or externally.
The company competes with Cisco HP and non-captive financing entities of companies like General Electric and banks and financial institutions and in remarketing the company competes with local and regional brokers and original manufacturers. (International Business Machines Corporation 2011) The nature of IBM’s products and the intense competition in all its business segments causes many risks on the audit as a whole and the audit of specific accounts.
The overall audit risks because there are many inherent risks associated with intensely competitive environments which can cause products to become obsolete, loss in market share and lowering gross margin, and the inherent risks associated with financing. One particular account that is affected by this is inventory which should be checked for realizable value and possible obsolescence. The software and services that are provided to customers are highly complicated and are bundled together and thus sales and accounts receivable should be checked for proper classification and timing.
Global financing poses many risks to IBM because of its exposure to the risk of economic downturns and the tightening of credit spreads and also there is a risk that the clients they provide financing for will not be able to meet contractual obligations and or default on payments. With global financing the auditors must make sure that leasing arrangements are properly accounted for and that the appropriate presentation and disclosures are included in the notes to the financial statements.
For leases the audit objectives of classification, accuracy, and realizable value are of particular importance. Major Customers No clients represent more than 10% of the company’s revenue so lack of major customers reduces risk. (International Business Machines Corporation 2011). Having major customers could be risky because losing the major customer could have a large impact on sales; also having major customers could allow those customers to have bargaining power over IBM.
IBM while it does not have any major customers it is overly dependent on the geographic region of the Americas for revenue. In 2011 the Americas were the source of 43. 1% of the total geographic revenue. (“International Business Machines Corporation- Financial and Strategic Analysis Review. “) This over dependence on the Americas could cause substantial business risk due to the economic downturn in the Americas and if conditions were to become adverse and or demand were to decline this could hurt the business. “International Business Machines Corporation- Financial and Strategic Analysis Review. “) Locations IBM operates in over 170 different countries and one of its major strategies is to expand into emerging markets. IBM’s major markets are Canada, France, Germany, Italy, Japan, the United States, the UK, the Bahamas, Belgium, the Caribbean, Cyprus, Denmark, Finland, Greece, Iceland, Ireland, Israel, Malta, the Netherlands, Norway, Portugal, Spain, Sweden and Switzerland (International Business Machines Corporation 2011).
The emerging markets that IBM is focusing on which have higher market growth rates than the global average are countries in Southeast Asia, Eastern Europe, the Middle East and Latin America (International Business Machines Corporation 2011). This causes substantial risk for the company because each country is going to have different laws to which IBM must comply with or face possible law suits.
The fluctuations in different currencies can cause a lot of risk to IBM because the value of revenue in certain countries could decrease substantially and they also must value the different currencies in US dollars for the financial statements. Other risks for companies that operate internationally include acquiring export licenses, laws and business practices that favor local businesses, trade restrictions, duties and tariffs, and the risk of not accounting for taxes correctly in the multiple jurisdictions that the company operates in.
IBM operating in over 170 companies and is looking to expand into other emerging markets causes a substantial amount of risk for the company and should be considered when conducting the audit. First it affects the audit as a whole because the inherent risk and therefore risk of material misstatement is increased because of IBM’s international operations. Specific accounts and or assertions that are affected by this risk would be sales. Sales should be checked to make sure that the values are accurate and that the appropriate currency conversion rates were applied when changing foreign currency to US dollars.
Another balance related audit objective would be accuracy and classification related to taxes payable and tax expense because tax laws are highly complex and the company would owe taxes to multiple local, state, and federal jurisdictions due to global operations. Another audit objective that should be checked would be that all necessary disclosures regarding law suits and other contingencies related to foreign operations are present in the notes to the financial statements and thus satisfy the completeness audit objective and the accuracy and valuation objectives in the presentation and disclosure-related udit objectives.
Impact of Technology on Business Operations IBM is part of the technology sector and thus the impact of technology on the business operations of IBM is huge. In IBM’s business of being a computer and software manufacturer and service provider the pace of technological change is extremely rapid. IBM in order to be competitive with other major companies in the industry must be a leader in innovation and constantly be developing new products and capabilities to be competitive with other companies also trying to provide similar services in the same sector.
Due to the rapid change in technology IBM must invest heavily in research and development which it does with annual expenses of approximately 6. 258 billion dollars, 5. 99 billion was for scientific research and application of scientific advances for new and improved products, their uses, and also services and their applications and the other 267 million was for product engineering (International Business Machines Corporation 2011).
This investment in research and development is necessary but still has inherent risks because if competitors are able to come out with similar products to IBM’s products before IBM then they could lose a substantial amount of market share also the research and development process itself is a long and risky process because it may or may not result in a marketable product with sufficient consumer demand. Rapid technological change also has the inherent risks of causing IBM’s inventory to become out- dated and thus obsolete.
Rapid technological change also affects the business operations of IBM because IBM will have a lot of intellectual property as a part of their assets on the balance sheet. In 2011 alone IBM was awarded 6,180 patents and in the last 19 years IBM has been awarded 47,000 patents and been the leader in receiving patents (“International Business Machines Corporation- Financial and Strategic Analysis Review. “) There is a risk that IBM won’t value these intangible items properly and thus cause misstatements in the financial statements.
Rapid technological change has the overall effect on the audit of increasing the amount of inherent risk in such accounts as intangible assets, and also research and development expenses. Specifically the audit of intangible assets will be affected because the auditor must pay specific attention to the valuation and allocation assertion and make sure that the intangible assets are valued at the correct amounts and that any necessary adjustments to the value of the intangible assets is made. Another balance related objective they should make sure the client satisfies is rights and obligations.
The auditor should make sure that the client has the right to this intellectual property which can be satisfied by checking the related patents. The other account that must receive special attention is research and development. The auditor needs to make sure that all research and development is being expensed and is not capitalized and thus the classification of transactions related to research and development are properly classified as expenses and that related product expenses are only capitalized once the product has hit the market. Special Accounting Practices
IBM is affected by special accounting principles for revenue recognition. Revenue recognition for software vendors can be extremely complex and one of the complexities for software vendors is for multiple-deliverable revenue arrangements. Software vendors are able to account for individual products and services that are bundled together as a package separately if they can make a best estimate of each items fair value selling price. Companies must come up with vendor specific objective evidence (VSOE) of the fair value in order to account for them separately.
If VSOE exists for undelivered items but not for delivered items the company uses the residual method but if VSOE of fair value doesn’t exist for the undelivered items then revenue cannot be recognized until VSOE of fair value does exist or all items have been delivered. Other issues that complicate revenue recognition for software companies such as IBM are whether or not new products are more than minimally different from existing products or whether it is just an upgrade.
If an arrangement does include the right to an upgrade it must be determined whether the right is specified and whether VSOE of fair value can be determined or if it is unspecified and just included in PCS. Lastly if the company makes price concessions those must be analyzed to see whether they are stand-alone concessions or whether they expect to make similar price concessions to other customers because this could have a large effect on the realizable value of accounts receivable and the appropriate numbers to report in sales. (Triplett & Miller)
The complexity of multiple deliverable revenue arrangements has a large impact on the audit. First and foremost the complexity of these accounting rules causes a large increase in the inherent risk. Specific audit objectives which are affected by these risks would be the realizable value of accounts receivable, the accuracy of sales, and the timing of revenue recognition in the sales cycle. If the company commonly makes price concessions then the realizable value of accounts receivable could be over-valued unless the company makes reasonable estimates of this and recognizes it with the original sales.
Sales could be over or under valued if the VSOE of fair value is not accurate and the auditors must check that there is substantial evidence to support the prices the vendors come up with. Lastly the timing of sales could be greatly affected by these accounting principles because if VSOE of fair value cannot be established then revenue recognition must be delayed until all items in the arrangement are delivered.
- “Diversified Computer Systems Overview: Industry Center – Yahoo!Finance. ” Diversified Computer Systems Overview: Industry Center – Yahoo!
- Finance. Yahoo, 2012. Web. 30 Nov. 2012. <http://biz. yahoo. com/ic/810. html>. “FASB Accounting Standards Update Number 2011-02. ” FASB. org.
- Financial Accounting Standards Board of the Financial Accounting Foundation, Apr. 2011. Web. 30 Nov. 2012. <FASB Accounting Standards Update Number 2011-02>. “IBM: Summary for International Business Machines- Yahoo! Finance. ” Yahoo!
- Finance. Yahoo, 2012. Web. 0 Nov. 2012. http://finance. yahoo. com/q? s=IBM “International Business Machines Corp. ” International Business Machines Corp. : NYSE:IBM
- Quotes & News – Google Finance. Google, 2012. Web. 30 Nov. 2012. <http://www. google. com/finance? q=IBM>.
- International Business Machines Corporation (2011). 10-K Annual Report 2011. Retrieved from SEC EDGAR website http://www. sec. gov/edgar. shtml “International Business Machines Corporation- Financial and Strategic Analysis Review. ” Global