will you please answer my questions i just posted 6. Audit Considerations: a. What material types of transactions and transaction cycles are involved? b. What are the high-risk areas? c. What are the low-risk areas? d. Assess the interests of the company's management and audit committee to better "pitch" the audit proposal. Are there any integrity issues at play? e. To what extent do you believe it would be appropriate to select this client, in terms of its profits and the "client selection decision" discussed in the text? f. How will audit effort be allocated among geographical areas? g. Have you encountered anything in gathering your evidential material that suggests problems with external control, as it is so important in terms of Sarbanes-Oxley Section 404? h. Comment on your proposed use of internal audit (AU 322), outside specialists (AU 336) and specific areas of audit expertise (AU 311) needed to complete the audit. What form of auditors' report do you expect would be issued; what does it mean? j. What are the implications of SOX (Sarbanes-Oxley) especially section 404? IMPORTANT!

\fMemorandum To: Mark Dirsmith, Director of Auditing From: KALL, LLP (Student 1, Student 2, Student 3, and Student 4) Subject: Air Products and Chemicals, Inc.'s Prospective Client Risk Assessment Date: April 12, 2012 Air Products and Chemicals, Inc. (\"Air Products\") is an industrial chemical manufacturing corporation with operations in over 40 countries. They are the world's only integrated gases and chemicals company, and are among the top four competitors in the gases industry. These four corporations make up approximately 80% of the gases market, leading researchers to believe that an economic downturn will not affect Air Product's stock remarkably. Air Products provides products to a large variety of industries including: food and beverage, healthcare, energy, metals, and transportation. The company, founded in 1940, strives to maintain operational excellence, create innovative and safe products, and develop strong and lasting relationships with their customers. Air Products currently operates in four business segments: Merchant Gases, Tonnage Gases, Electronics and Performance Materials, and Equipment and Energy. Since 2009, Air Products and Chemicals Inc.'s revenue, net income, and gross profit have been steadily increasing. In 2011, they had $10.08 billion in sales, which is an 11.7% increase over 2010. They also had a net income increase of 18.96% over 2010, resulting in a net income of $1.22 billion. Gross profit margins were 27.44% during the same period, which is a 1.3% increase since 2008. KALL, LLP has completed a prospective client risk assessment on Air Products and Chemicals, Inc. in order to decide whether or not to accept them as an audit client. The attached documents contain all necessary and relevant information needed to make this decision. To create the prospective client risk assessment, we have thoroughly examined Air Products and Chemicals, Inc.'s, and their major competitors' financial statements, 2011 Annual Report, and SEC 10-K Filing. Using this information, we have constructed a Z score analysis, strategic profits model, and risk map for Air Products, to aid us in making our decision. After thorough analysis of the research and information collected, we are proposing the acceptance of Air Products and Chemicals, Inc. as an audit client. They have had steadily increasing sales, net income, and gross profit and are continuing to create innovative products to meet the various needs of their customers. Air Products is a low risk company that is in the maturity stage, leading us to believe that they would be an excellent client. Student 1 Student 2 Student 3 Student 4 2 April 12, 2012 Contents Memorandum ......................................................................................................2 Company Overview..............................................................................................6 Industry...........................................................................................................6 Products...........................................................................................................7 Corporate Strategy............................................................................................8 Raw Materials...................................................................................................8 Size of the Company...........................................................................................9 Locations.......................................................................................................10 Related Parties..................................................................................................11 Primary Customers...........................................................................................11 Annual Report.................................................................................................12 Industry Overview...............................................................................................14 Key Economic Factors .........................................................................................14 Life Cycle.........................................................................................................15 Factors for Success and Standing with Respect to these Factors.....................................16 3 Global Economic Conditions..........................................................................17 Supply and Cost of Raw Materials..................................................................18 Effective Competition in International Markets.................................................19 Technological Product Development...............................................................19 Foreign Economic Factors...........................................................................20 Notable Accounting Considerations.........................................................................22 Legal and Regulatory Matters ...............................................................................23 Social Matters....................................................................................................24 Primary Competitors...........................................................................................26 Turnover of Personnel.........................................................................................28 Ease of Entry into Industry....................................................................................29 Integrity...........................................................................................................29 Agenda............................................................................................................31 SWOT Analysis..................................................................................................34 Strengths.................................................................................................34 Weaknesses..............................................................................................35 Opportunities...........................................................................................35 Threats...................................................................................................36 Porter's Five Forces Model...................................................................................36 Threat of New Entrants...............................................................................37 4 Bargaining Power of Suppliers......................................................................37 Bargaining Power of Buyers.........................................................................38 Threat of Substitutes..................................................................................38 Rivalry among Competition..................................................................................39 Accounting and Governance Risk...........................................................................39 Financial Health.................................................................................................41 Ratio Analysis....................................................................................................46 Profitability Ratios.....................................................................................47 Efficiency Ratios.......................................................................................47 Cash Flow Ratios.......................................................................................47 Investing Ratios........................................................................................48 Industry Comparison...........................................................................................48 Liquidity Ratios........................................................................................49 Financial Leverage....................................................................................51 Profitability Ratios.....................................................................................52 Company Health ...............................................................................................55 Z-Score Analysis ..........................................................................................................................56 Strategic Profit Model ........................................................................................60 DuPont Model ...................................................................................................61 Which Way Company is Moving ............................................................................62 Sources and Value of Capital ................................................................................62 5 Capital Market Place Response .............................................................................63 Quality of Earnings ............................................................................................64 Stock Comparison to Industry ...............................................................................64 Auditor ...........................................................................................................65 Perception of the Company...............................................................................67 APD Equity Summary Score ................................................................................67 Summary of All Options .....................................................................................67 Stock Analyst Report Summary ...........................................................................68 Auditor Concerns................................................................................................71 Transactions and Transaction Cycles......................................................................71 Material Transactions.................................................................................71 Air Products Attempt to Acquire Airgas...........................................................72 Air Products Sells U.S. Healthcare Business..................................................................74 Air Products Acquires SAGA Group................................................................74 Air Products Acquires Abdullah Hashim Industrial Gases & Equipment...................75 Air Products Forms Long-Term ASU Contracts..................................................75 Transaction Cycles.....................................................................................76 High Risk Areas.................................................................................................78 Low Risk Areas..................................................................................................80 Integrity Issues ..................................................................................................81 Client Selection Decision ......................................................................................82 Allocation among Geographical Areas ....................................................................83 6 Internal Audit Use .............................................................................................83 Outside Specialists Use........................................................................................84 Specific Areas of Audit Expertise ...........................................................................85 Expected Auditor's Report ..................................................................................85 Sarbanes-Oxley Act, Section 404 Compliance............................................................86 Client Business Risk Matrix.............................................................................89 Appendix: A.........................................................................................................91 Work Cited.......................................................................................................91 5 Year Financial Summary..........................................................................................................96 Appendix: B.........................................................................................................98 Budget.............................................................................................................98 Leadership........................................................................................................99 Coordination......................................................................................................99 Norms.............................................................................................................100 Conflict...........................................................................................................101 Contribution ...................................................................................................101 Instructions......................................................................................................103 Other.............................................................................................................103 \"The Oral\"......................................................................................................103 Company Overview Industry 7 Air Products and Chemicals, Inc. is a manufacturing company that specializes in industrial chemical manufacturing. It operates in four main business segments: Merchant Gases, Tonnage Gases, Electronics and Performance Materials, and Equipment and Energy. In the Merchant Gases segment, which makes up roughly 40% of sales, Air Products manufactures atmospheric, process, and specialty gases often used for health care facilities. These gases can be delivered by tankers, trucks, trailers, or on-site. 33% of Air Products' sales are attributable to their Tonnage Gas segment, which serves the global refining and chemical industries. The Electronics and Performance materials division, which contributes approximately 23% of sales, produces materials useful for electronics and other manufacturing companies. Air Products' smallest segment, Equipment and Energy, constitutes only 4% of sales and is comprised of the creation of gas containers and equipment that separates air, purifies hydrogen, and liquefies gas. Overall, Air Products has been quite successful in each individual segment. Products 8 Air Products and Chemicals, Inc. is the world's only integrated gases and chemicals company, providing atmospheric gases, process and specialty gases, equipment, performance materials, and services to industries such as health and personal care, food and beverage, semiconductors and transportation (airproducts.com). Their four primary products are: gases, chemicals, equipment, and services and solutions. Air Products' gases include carbon dioxide, hydrogen, nitrogen, oxygen, and helium. Currently, Air Products is in the process of creating and testing a hydrogenpowered car, in order to provide environmentally friendly product solutions to its consumers. Although they produce a large variety of chemicals, some significant examples include polyurethane additives, specialty surfactants, and resins. Many of their chemicals are used in inks, coatings, adhesives, and personal care products, among other industries. Air Products and Chemicals, Inc. also provides gas handling and application equipment, liquefied natural gas heat exchangers, and gas production equipment. These are just some of the many types of equipment offered by Air Products. In order to further help other businesses, Air Products offers innovative services and solutions. For example, they have created new energy and environmental solutions and can fulfill a company's special gas supply requirements. The strategic way Air Products and Chemicals, Inc. has designed their four primary types of products helps them remain aligned with their overall corporate business strategy. Corporate Strategy 9 Air Products and Chemicals, Inc.'s corporate business strategy, as stated in their 2011 Annual Report, is: \"Winning in the energy, environmental, and emerging markets; executing on innovation, integration and improvement; delivering on revenue, margin and return goals\" (page II). Air Products believes that they will be able to drive their growth and achieve their financial goals because of their leading positions in hydrogen, electronics, and crucial Asian markets. By focusing on innovation, integration, and improvement, Air Products will be able to deliver their margin and sustain continuous improvement, positioning them to reach their 2015 financial goals. Air Products' President and CEO, John McGlade, believes that by having challenging, but achievable future financial goals, it will drive the team to work harder and provide the team with focus for future years (Air Products Annual Report 2011, page IV). Raw Materials Air Products and Chemicals, Inc. spends over $6 billion in materials, equipment, power, and services every year (airproducts.com). A unique feature about Air Products is that many of their products are created from building-block chemicals, essentially eliminating some of their raw material costs. However, Air Products also uses a variety of other chemicals, such as catalysts, surfactants, and biocides in order to create their products. In 2011, Air Products announced many price increases due to the escalating costs of their raw materials. Size of the Company 10 Air Products and Chemicals, Inc. has seen a consistent increase in sales over the past three years, which is shown in the following graph on the left. The graph on the right demonstrates Air Products' annual sales compared to their major competitors. Revenue: 2011 Annual Sales vs. Competitors: In 2009, the company generated sales of $8.26 billion and in 2010, the company had sales of $9.03 billion. Sales are continuing to improve, and in 2011, they recorded sales of $10.08 billion. This amount of sales put them in the 89th percentile in their industry. By 2015, Air Products hopes to have $15 billion plus in sales, a 20% operating margin, and a 15% return on capital employed. Last year, Air Products assets totaled $14.29 billion, which is a $784.8 million increase since 2010. Air Products' current market capitalization is $19.04 billion, which far exceeds the industry average of $9.39 billion, putting them in the 93rd percentile in their industry. The balance sheet shareholders' equity, which has increased since 2010, reported $5.8 billion. All of Air Products' equity is in the form of common equity, as they do not have preferred stock. Air Products' headquarters are located in Allentown, Pennsylvania and they have a presence in over forty countries worldwide. 11 As demonstrated in the following graph, from 2007 until 2010, the number of employees at Air Products had been decreasing. However, from 2010 to 2011, there has been an increase of about 600 employees. Their headquarters now has over 3,800 employees and Air Products and Chemicals, Inc. has a combined total of more than 18,900 employees at all of their locations. Employees: Locations As mentioned previously, Air Products and Chemicals, Inc. is a multinational company with operations in over forty countries. The company's headquarters is located in Allentown, Pennsylvania and it has regional offices in the United Kingdom, the Netherlands, Hong Kong, Singapore, and Shanghai. Additionally, Air Products has over six hundred production facilities in the United States, Europe, South America, Canada, Asia, and elsewhere. 12 Related Parties Air Products' primary related parties are equity affiliates operating in the industrial gas business. Some of these industrial gas businesses include: Air Products South Africa Limited, Bangkok Cogeneration Company Limited, Bangkok Industrial Gases Limited, Chengdu Air & Gas Products Limited, Daido Air Products Electronics, Inc., DuPont Air Products NanoMaterials Limited, Helap S.A., High-Tech Gases (Beijing) Company, INFRA Group, INOX Air Products Limited, Kulim Industrial Gases Sdn. Bhd., Sapio Produzione Idrogeno Ossigeno S.r.l, SembCorp Air Products, Tecnologia en Nitrogeno S. de R.L. de C.V., Tyczka Industrie-Gases GmbH, WuXi Hi-Tech Gas Company Limited, and other smaller industrial gas producers (Air Products Annual Report 2011, page 59 of 10-K). However, they do not have any material transactions with related parties that differ from independent party transactions. Thus, any related party transactions would not affect the financial statements materially. Further, Air Products has wholly owned or majority owned subsidiaries in Canada and seventeen European countries, which allow them to conduct business globally. Air Products enters into forward exchange contracts with certain foreign subsidiaries and affiliates in order to reduce the cash flow exposure to foreign currency fluctuations. Because Air Products operates with many subsidiaries, these must be fully disclosed in the financial statements. Primary Customers Since Air Products has such a wide variety of products, no single customer accounts for more than 10% of their consolidated revenues, even with their large volume customers. Each business segment tends to have its own concentration of customers. For example, the Tonnage Gases and 13 Electronics and Performance Materials segments have their concentration of customers in refining, chemicals, and electronics. Sales are broken up as follows: 38% in the United States, 31% in Europe, 24% in Asia, and 7% in Latin America and Canada (Air Products Annual Report 2011, page 2). Annual Report Air Products and Chemicals, Inc.'s annual report portrays the company's potential for growth through their strong sales and earnings, and resilience even through tough economic times. The company's mission statement depicts a desire to be the best in their industry because of their \"winning\" mentality. Air Products thoroughly explains need-to-know information throughout their entire annual report. The annual report is broken up into nine parts that discuss different aspects of the company. The parts include: the cover, financial highlights, their businesses, the Chairman's Letter, non-GAAP measures, Form 10-K, shareholder's information, leadership, and the back cover. The financial highlights display the most relevant facts about Air Products for 2011. This includes return on shareholders' equity, sales, and earnings per share numbers. The businesses section delves deeper into the various business segments in which Air Products participates: Merchant Gases, Tonnage Gases, Equipment and Energy, and Electronics and Performance Materials. The Chairman's letter explains Air Products' mission: \"Winning in the energy, environmental, and emerging markets; executing on innovation, integrity, improvement; delivering on revenue, margin and return goals.\" The non-GAAP measures section adequately describes the changes from GAAP with respect to the return on capital employed calculation, capital expenditures, and the return on shareholders' equity number. The Form 10-K section is divided into four parts. 14 The first part includes information about the business segments, economic risk factors, properties, and legal proceedings. Included in the second section is information on equity securities, stock information, financial data, management's discussion and analysis of financial condition and results of operations, a summary of 2011, comparisons between years, a 2012 outlook, quantitative and qualitative disclosures about market risk, and the audit report by KPMG LLP. The third section discusses corporate governance, executive compensation and security ownership. Lastly, the fourth section displays exhibits and financial statement schedules. Next, the shareholder's information section lists common stock information, the company's dividend policy, annual meeting information, terminology, the direct investment program, and annual certificates. Overall, the annual report includes a vast amount of vital information for investors, and is extremely thorough in the majority of aspects. After reviewing the annual report and financial statements, it is clear that Air Products and Chemicals Inc.'s main cost drivers include labor, raw materials, depreciation, production supplies, material packaging costs, and maintenance costs. Also, shipping and handling are included in their cost of sales figure. Additionally, the annual report describes how significant Air Products' research and development efforts are. R&D expenditures for 2011 were $118.8 million, which is an increase from 2009 and 2010. Also, $29.1 million was devoted to customer-sponsored research in 2011, which is roughly the same as 2009 and 2010. As of November 2011, Air Products owned 931 United States patents and 2,933 foreign patents. Air Products and Chemicals, Inc.'s research and development takes place in their science and technology centers in the United States, United Kingdom, Germany, Spain, the Netherlands, and Asia. Specifically in the United States, Air Products' facilities are in Pennsylvania, California, Wisconsin, and Arizona. Air Products takes a 15 market-oriented approach to technology development funds, and cooperates in research and development with major universities and research funded by the government. Furthermore, research and development represents a substantial portion of Air Products expenditures. Industry Overview Key Economic Factors Due to the fact that Air Products manufactures a variety of products with production facilities around the world, they are subject to risk with respect to the economy. Some of the economic factors to be examined are sensitivity to business cycles, inflation, international competition, international turmoil, and technological obsolescence. First, none of Air Products' business segments are subject to seasonal fluctuations in any material amount (Air Products Annual Report 2011, page 7 of 10-K). However, the Electronics and Performance Materials business segment is subject to the cyclical nature of the electronics industry. Secondly, the company states in their annual report that, although their financial statements are in accordance with GAAP, they may not fully reflect the impact of inflation from the prior year (Air Products Annual Report 2011, page 35 of 10-K). The annual report discusses how inflation has been moderate in the past few years, so it would not have a material effect. Air Products and Chemicals, Inc. has operations in countries that are more volatile than the United States, which results in an increase in uncertainty with respect to economic conditions related to inflation. Air Products does have strong international competition with several large global companies and many smaller regional corporations in all of their business segments. As stated in the annual 16 report, introduction of new technology by their competitors would weaken the demand for their products and this would, in turn, materially impact their profitability (Air Products Annual Report 2011, page 9). Further, international turmoil could also impact their profitability and operations. Economic and political conditions in areas where they have production facilities could cause fluctuations in demand, supply, price volatility, and potentially a loss of property. Next, Air Products uses technological obsolescence to estimate the useful life of many of their assets. They regularly review the potential obsolescence of their property, plant, and equipment. Air Products also writes off obsolete inventory and uses the lower of cost or market approach (Air Products Annual Report 2011, page 53). Overall, economic conditions have a strong impact on Air Products' success and there may be decreased demand for goods and services during recessionary periods. This would potentially have an impact on revenue, operating income, and cash flow, as was experienced in 2008 and 2009. Life Cycle Air Products is in the maturity stage of the life cycle. Often during this stage, companies experience strong competition, slow growth rates, and have a desire to find ways to maintain a strong market share. Although Air Products has reached maturity, they are still experiencing reasonable growth in sales and revenue. This demonstrates the health of Air Products and its potential to continue to grow despite being in the maturity stage. Also, this is the longest of all 17 stages; therefore, if Air Products can continue to grow they should remain successful for many years to come. Furthermore, Air Products was able to maintain relative financial health during the last recession, exhibiting the strength of the company and the quality of management. Looking forward, Air Products plans to keep a culture of continuous improvement in order to maintain market share and meet their financial goals of 2015. The following graph portrays the life cycle of a company and demonstrates that Air Products would fit best into the maturity stage due to the fact that they are past the rapid growth stage and not yet at the decline stage. 18 Factors for Success and Standing with Respect to These Factors Many factors contribute to the welfare of a company in the Industrial Chemical Manufacturing industry. However, there are five specific goals pertaining to the success of Air Products. Each of the four business segments has its own success factors, but in aggregate, they are all very similar. Global Economic Conditions The success of Air Products greatly relies on the overall international economic conditions of the industrial and energy markets. Overall, there must be appropriate demand for goods and services within the forty countries in which the company transacts business. Expected future demand, presence of competition, and strength of the economy are a few factors that change market conditions for this industry. Looking ahead to the 2011-2012 fiscal year, there is a significant element of uncertainty about the global economy. Indicated by the decline in economic growth, from 3.9% to 3.3% in the previous year, it is expected that these conditions will continue (Global Economic Outlook). However, in the various international markets of Air Products presence, growth is expected to range from 2% to 5%, as management asserted in the most recent Annual Report. This statistic is 19 confirmed by The Conference Board, a global research association, which reports an expected global growth rate of 3.5% in 2012. Additionally, the International Monetary Fund forecasts world real GDP growth to be 4.5% in the upcoming year (World Economic Outlook). Asia appears to be the region with the greatest growth potential, with an expected increase of 4% to 9%, followed by the U.S. and Europe. The United States should see positive growth of 1% to 5%, whereas Europe is expected to range from a negative 2% to 1% growth (Air Products Annual Report 2011, page 20). Despite all of the recent international economic suffering, Air Products has been able to steadily increase sales and net income since 2009, demonstrated in the table on the next page. The continued demand for gas and chemical products has allowed the company to overcome the generally unfavorable market conditions. Furthermore, the Annual Report projects volume growth and plant expansion in three of their business segments, mitigating potential economic downturns. Air Products should be able to remain profitable and competitive in the industrial and energy segments of the market despite the instability of the global economy. Sales (million) Net Income (million) 2011 $10,082 $1,224 Supply and Cost of Raw Materials 20 2010 $9,026 $1,029 2009 $8,256 $631 Air Products' success strongly depends upon the supply and cost of raw materials. The company needs control over energy and materials in order to keep up with production demand, minimize costs, and remain profitable. This includes maintaining relationships with suppliers through long-term contracts and ensuring undisrupted flow of materials. Air Products heavily relies on natural gas, steel, alcohols, and other chemicals to make its products, so it is of utmost importance to acquire these with cost-effectiveness and consistency. This past year, the world suffered an industry-wide helium shortage that most prominently impacted Air Products' Merchant Gases segment. Gasworld reports that U.S. Bureau of Land Management plant outages caused this recent shortfall and predicts supply levels to remain static into 2013 (Dawson). Other than helium, the company faced no issues with raw materials supply last year. The most vital imports continue to be readily available. Electric power is a large component in the cost of production, and energy costs have been on the rise in Europe. However, Air Products and Chemicals, Inc. employs a variety of techniques to mitigate energy and raw material price fluctuations, including the formation of long-term cost pass-through contracts and commodity swap contracts (Air Products Annual Report 2011, page 62). These have been successful in smoothing out the effects of current economic turmoil and exchange rate fluctuation. Also, raw material cost increases are moderated through pricing formulas and surcharges. The supply, availability, and cost of necessary inputs are not expected to cause material harm, but Air Products has adequate techniques in place to mitigate any potential changes that may occur. 21 Effective Competition in International Markets Air Products and Chemicals, Inc. must be able to compete effectively in the international market with a wide range of competitors. Both large global corporations, and small local companies, create strong competition that Air Products must stack up against. To thrive, the company has to be innovative, reliable, and cost-savvy. The company consistently provides customers with a reliable supply of reasonably-priced products that perform to desired standards. Air Products has a competitive advantage in regions with pipeline networks, which provide a stable supply of product to its customers. Currently, these pipelines exist in the United States, Canada, Europe, Asia, and parts of South America. The Merchant and Tonnage Gases sectors are expected to drive competitiveness due to volume growth and new plant start-ups (Air Products Annual Report 2011, pages 4, 20-24). Technological Product Development The capability for product technological development is a contributing factor to the success of Air Products and Chemicals, Inc. Research and development is critical in creating new products and improving current processes. The company needs to outperform competitors by continually developing better means of producing and delivering goods. 22 Air Products accomplishes technological product development through research and development, engineering, and commercial development processes. Since 2009, research and development efforts and expenditures have increased, and in 2011 alone, Air Products spent nearly $120 million (Air Products Annual Report 2011, page 6). Additionally, Air Products funds and participates in R&D programs with universities and the United States Government. The company is involved in a joint venture with MATGAS regarding sustainability; specifically hydrogen fuel development and carbon capture and storage. As a result, Air Products launched its Sustainable Technologies Center (STC) at its company headquarters in Pennsylvania in 2010 (Sustainability and CO2). They also have a major R&D project underway with the China University of Geosciences to accelerate the development of materials in the microelectronics industry (Pilgrim). Furthermore, in early 2012, Air Product's BIP technology, a gas purity system, was recognized at the European Technology Group's innovation exhibit as a momentous R&D accomplishment. Some other areas of research and development include innovating wasteto-energy facilities, carbon capture technologies, and hydrogen as an energy carrier to serve energy markets. Since 2009, Air Products has been granted 205 new foreign patents (Air Products Annual Report 2009, page 6 and Air Products Annual Report 2011, page 6). Foreign Economic Factors 23 Foreign economic factors have a great impact on achievement in the Industrial Chemical Manufacturing industry. With subsidiaries, plants, and customers in over forty countries, the company is subject to unlimited international forces. Fluctuations in currency exchange rates significantly influence the well-being of a multi-national company like Air Products and Chemicals, Inc. The general economic atmosphere points towards inflationary cost increases and an estimated 10% change in foreign exchange rates. Also, there is some uncertainty regarding tax changes in the U.S. and abroad. However, Air Products engages in foreign exchange-forward contracts and cross country interest rate swaps to reduce exposure to international fluctuations (Air Products Annual Report 2011, page 62). Below, you will find tables that summarize the company's portfolio of risk management instruments. Outstanding Forward Exchange Contracts: 24 Outstanding Interest Rate Swaps: Notable Accounting Considerations There are many accounting considerations for a publicly-held company in the Industrial Chemical Manufacturing industry. Outlined in the annual report are some of the major accounting policies, in addition to new policies that will impact the company. In 2011, two new FASB accounting guidance measures were implemented. The report states that neither guidance measure had a material effect on the consolidated financial statements (pages 54-55). The first new guidance was Update No. 2009-13 Revenue Recognition (Topic 605) MultipleDeliverable Revenue Arrangements. For sales that include multiple components, consideration is now allocated to each deliverable at the start of the arrangement based on their relative selling price (Weinstein). This FASB guidance became effective on October 1, 2010, when Air Products began prospectively applying this standard to new or materially modified arrangements. 25 In June 2009, FASB issued reconsideration of FASB Interpretation No. 46 Consolidation of Variable Interest Entities. FASB Statements 166 and 167 contain new guidance for determining whether or not an entity is a variable interest entity (VIE). A company is now required to evaluate whether it is responsible to ensure that a VIE operates as designed and is required to complete an ongoing reassessment of whether or not an enterprise is the primary beneficiary of a VIE (FASB). This guidance was also adopted by the company on October 1, 2010. Air Products consolidates all entities that they control, and is not a primary beneficiary in many material variable interest entities. The FASB also issued new authoritative guidance throughout 2011, which will be adopted in the near future. These include changes to testing for goodwill impairment, disclosure of multiemployer pension plans, presentation of comprehensive income, and measurement and disclosure of fair value (Air Products Annual Report, page 55). For companies in Air Products' industry, some accounting policies are more relevant than others. A fundamental consideration is the accounting for and disclosure of environmental matters. This includes accounting for loss contingencies, expensing and capitalizing costs, measuring liabilities, and evaluating assessments and remediation progress. It is also essential for companies to properly account for and disclose the impairment of long-lived assets. Companies in this industry are very capital-intensive, thus, they must report assets at the lower of cost or market value and determine when their value may not be recoverable. 26 Legal and Regulatory Matters The majority of Air Products' legal and regulatory concerns relate to regulatory and environmental controls in the various countries in which it operates. Industrial chemical plants are bound by a variety of environmental and safety regulations administered by the EPA and OSHA. In both the United States and countries abroad, Air Products must comply with various regulations addressing environmental protection, import and export restrictions, and taxes. These extensive environmental and safety laws regulate green house gas emissions, discharges to land and water, and disposal of hazardous waste. A final regulatory concern is the restrictions placed on the transportation of industrial chemical products by the Department of Transportation. Air Products and Chemicals, Inc. is currently impacted by three legal proceedings, one of which could still result in a large monetary loss; the company believes litigation will be resolved without adverse material impacts. First, a nitric acid plant in Pasadena, Texas was unexpectedly shutdown in February 2010, which caused nitrogen dioxide and nitric acid to be released into the atmosphere. Various environmental regulatory authorities, including the U.S. Occupational Safety and Health Administration (OSHA) examined the incident, but found no harmful damage. Despite this conclusion, two complaints were filed locally, and Air Products settled the action in August 2011 for a total of $36,600 paid to the plaintiffs, plus $4,500 in attorneys' fees (Air Products Annual Report 2011, page 14). In September 2010, the Brazilian Administrative Council for Economic Defense (CADE) alleged that Air Products' Brazilian subsidiary was involved in anticompetitive activities. They imposed 27 a civil fine of approximately $95 million. However, Air Products denies these allegations and appealed to the Brazilian courts in October 2010. This is an ongoing proceeding, and it is believed that an adverse final decision is reasonably possible. No provisions to the consolidated financial statements have been made for this litigation (Air Products Annual Report 2011, pages 14-15). Lastly, in August of 2011, the U.S. Environmental Protection Agency (EPA) alleged that Air Products failed to meet air monitoring standards at their Stockholm, California plant. The company ultimately settled for a $140,600 administrative penalty, which was finalized on September 30, 2011 (Air Products Annual Report 2011, page 14). Social Matters A few areas of business that may see shifts in the future are the healthcare and food and beverage industries. The aging of the baby boomer generation has caused a recent surge in access to the healthcare system. Reported in the 2010 U.S. Census, the forty-five to sixty-four aged population grew 31.5% to 81.5 million since 2000. Census data in the graph on the following page shows the increase in the population over age sixty-five. More than 3.5 million baby boomers turn fifty-five each year (The Demographics of Aging). As depicted in the following table, the number of doctor visits is predicted to increase as the elderly population grows. This shift has caused an increase in the demand for healthcare, and in turn, a demand for technology and materials to sustain this change. Air Products and Chemicals, Inc. provides medical grade 28 gases to support healthcare services in surgical centers, MRI centers, and hospitals. The use of these gases will see a significant increase in demand as Air Products continues to serve the rapidly expanding healthcare system (American Hospital Association). Increase in Population Age: 29 Additionally, a shift towards a lifestyle that focuses on convenience and timeliness has impacted the food and beverage industry, especially in the United States. There is higher demand for prepackaged and ready-to-cook foods. Packaging, cooling, and freezing processes serviced by Air Products are essential to this modern food industry. Foods must be adequately stored and transported, requiring gases and equipment that the company provides. These products are used to extend shelf life and quality (airproducts.com). The pie chart below portrays the percentage of Air Products sales that each industry makes up. It is expected that the healthcare industry and food industry percentages will increase because of continued social shifts. 30 Primary Competitors To be competitive, Air Products focuses primarily on the price and reliable supply of their products to customers. According to Hoovers' online database, their top competitors are Airgas, Praxair, and The Linde Group. With annual sales and net profit margin figures that are comparable, these four companies face intense competition. Air Products ranks first in net profit margin and a close third in sales. Beating the industry's median net profit margin by over 9%, Air Products performs very well when compared to the rest of the industry. Although not one of the largest companies in the industry, Air Products remains strongly competitive with its primary opponents (Hoovers). Company Air Products Airgas Praxair The Linde Group Industry Median 31 Annual Sales $10.08B $4.25B $10.12B $12.87B -- Net Profit Margin 11.90% 6.24% 11.81% -2.53% Market Capitalization $19.04B $5.29B $32.04B -$9.39B Data from: Hoovers' Database Airgas is one of the United States' largest distributors in the Chemical Wholesalers industry; specializing in industrial, medical and specialty gases, and hard goods. They are also a primary producer of atmospheric gases, carbon dioxide, dry ice, and nitrous oxide. Like Air Products, they import products from, and export products to, foreign nations (airgas.com). Air Products has significantly greater sales and net profit margin figures than Airgas. Praxair is another distributor in the Chemical Wholesalers industry with financial statistics very similar to those of Air Products. The company supplies atmospheric, medical, and process and specialty gases to the U.S. and Canada (praxair.com). The Linde Group, a German company in the Industrial Chemical Manufacturing industry, is the world's largest producer of industrial and medical gases. Linde is most similar to Air Products and is one of the company's biggest international competitors (Company Profile - About Linde). Turnover of Personnel The personnel turnover, which measures the rate at which an employer loses or gains employees, is quite indicative of the conditions at that company, and it can therefore be an important figure to consider. A high turnover is an indication of a shorter term of employment and can be more risky for the business because it leaves the company with costs of searching, training, and transitioning new employees. Also, a high turnover results in a negative image of the company because it allows for an increased opportunity for fraudulent reporting. A low turnover rate is 32 seen as a beneficial trait, because it signifies that employees are satisfied in the work environment and are performing up to the company standards (Murlin). Over the past five years, Air Products' personnel turnover has been fairly consistent. The following chart shows the number of employees and the personnel turnover rate for the years 2007-2011. Year 200 7 200 8 200 9 201 0 2011 Number of Employees 22,100 Personnel Turnover Rate 21,100 (4.5%) 18,900 (10.4%) 18,300 (3.2%) 18,900 3.3% 6.7% Data from: Hoovers' APCI Profile The low turnover rate directly correlates to employee satisfaction. Air Products' relatively high turnover rate in 2008 and 2009 was the result of the severe recession experienced in the United States and abroad during that period. The company provides many benefit plans to the employees. Such benefits include: retirement pension plans, medical coverage, life insurance, and disability insurance (airproducts.com). Ease of Entry into the Industry 33 The ease of entry of new competitors into an industry is influenced by the market power by existing leaders in the industry. Other factors that influence the entry are the size of the new company and their strategies for growth once they have entered into the market. A major barrier to entry in the chemical industry is its costs. A new company requires funds for expenditures such as research, development, licensing, technological machinery and equipment, and advertising. Because of these major cost barriers, it is relatively difficult for a business to enter the chemicals market. The chemicals market mirrors other industries, including oil, gas, and even pharmaceutical companies. Thus, companies in these markets have been able to expand into chemicals. Overall, unless a company has the necessary funds and a sufficient understanding of the industry, it can be quite difficult to enter the market for chemicals. Integrity Air Products has a website for integrity reporting called \"IntegrityLine.\" To eliminate any independence issues, IntegrityLine is administered by a third party, called Global Compliance. If an employee or third party is facing an ethical dilemma or needs assistance on how to handle a situation, IntegrityLine can help. The website protects one's anonymity and will aid Air Products in investigations into filed complaints. Upon entering information about the location of the issue, one can follow up on a report, or file a new one, on issues such as: work environment and employment; environment, health and safety issues; misuse of company assets or information; and financial and business integrity. Also accessible from IntegrityLine is Air Products' Code of Ethical Conduct (airproducts.com). 34 In their Code of Conduct, Air Products states that it is imperative that the company maintains the highest level of ethics in all business they conduct. This corresponds to complying with all laws, standards, policies, and procedures. Air Products prides themselves on doing the \"right,\" or fair and honest thing, although at times the \"right\" answer is not always black or white. The company affirms that an employee is only responsible for his or her own ethical actions and encourages employees to report actions that conflict with conformities of good faith. Air Products enforces a strict non-retaliation policy for those who step forward to report violations. The company has a low tolerance for those who do not comply with such standards. Employees who fail to comply are immediately subject to termination and in more serious cases, pursued for criminal prosecution or legal action. Correlating with this, management may be subject to the same terms if they fail to address violations by their subsidiaries (airproducts.com) Because Air Products is a multinational company, it can sometimes be difficult to assess whether compliance with the laws, standards, policies, and procedures are being executed with integrity. When conflicts arise, Air Products suggests consulting with the local manager or contacting the Law Department (airproducts.com). After additional research, it was uncovered that in 2010, the EPA identified areas where Air Products violated codes under the Resource Conservation and Recovery Act. Such violations included: failure to make a hazardous waste determination for the sulfuric acid, shipment of sulfuric waste to unauthorized facilities, failure to perform a land-disposal determination, failure to label hazardous waste containing spent carbon, and several other violations. Air Products agreed to pay approximately $1.5 million for the penalties and to resolve their misuses (U.S. 35 Environmental Protection Agency). The previously mentioned violations contradict the statements shown in the Company's Code of Ethics on integrity. However, Air Products appeared to comply with all measures and took responsibility for their actions. With their compliance, Air Products is determined to be a relatively honorable company that demonstrates a commitment to integrity and morality. Agenda Growth is one of the main goals to reach for 2015. In order to grow to the ideal target, Air Products must continue to develop factors of improvement that result in the expansion of the market and increased productivity. They plan to grow the company through increasing energy demand, focusing on environmental protection efforts, integrating digital revolution, and competing in emerging markets (Air Products Annual Report 2011, page IV). Attaining disproportionate growth in developing regions is a main focus for Air Products, and they intend to have considerable expansion in China. However, entering a new, developing market is subject to greater risks than those in a well-established country. If market fluctuations occur in such regions, growth would not stimulate to ideal levels and negative results would unfold. Successful growth will depend upon effectively managing and adapting to the risks that develop from tapping into an emerging economy. In addition to the expansion into emerging markets, marginal returns are expected to increase from the tightening of productivity (Air Products Annual Report 2011, page IV). However, this 36 directly correlates to reducing operating costs. Seeing how Air Products involves cost factors that are uncontrollable to the internal business, the company must determine alternative plans to control operating efficiency. Stated from the company's 10-K report, they assert that, \"If we are not able to identify and complete initiatives designed to control or reduce costs and increase operating efficiency, or the cost savings initiatives we have implemented to date, or any future cost-savings initiatives, do not generate expected cost savings, our financial results could be adversely impacted\" (Air Products Annual Report 2011, page 11). Moreover, Air Products plans to increase innovation and integration of the business (Air Products Annual Report 2011, page IV). Reducing costs of major processes is a main concern of the company, and has been the basis for improvement for many years. They strive to introduce more applications into the chemical field and develop more products in the materials sector. Based upon cost management, productivity focus, and efficient project backlog, Air Products anticipates capital spending will increase 20-40% over the 2011 statistics (Air Products Annual Report 2011, page IV). Most of this increased spending is planned to be a result of projects constructed by the company's on-site business model. They continue to strive for opportunities that lend themselves to high growth, emerging markets. Air Products states that winning in energy, environmental and emerging markets is at the top of their Strategy for Success. In their Annual Report, Air Products states that, \"The global energy, environmental and emerging market trends will accelerate the growth of our business. We continue to build on our strong market positions, helping our customers improve the 37 productivity, efficiency, and sustainability of their businesses.\" (2011 Annual Report, page III). Air Products plans to win by constructing a new pipeline, tightening resources in China, and bringing innovative sustainable solutions into civil engineering, personal care, coatings, inks, and adhesive markets. Next on their Strategy for Success is Executing on Innovation, Integration, and Improvement. To drive cost leadership and increase market competitiveness, Air Products focuses on actions that drive the three components. Innovation has been a cornerstone of the company for years. They continue to find new ways to reduce air separation and develop innovative hydrogen plants (2011 Annual Report, page IV). Following innovation, integration generates efficiency and is the key factor of success in the industrial gas business. Lastly, Air Products uses Continuous Improvement (CI) tools to facilitate productivity (2011 Annual Report, page IV). On Air Products' final step for success, they place focus on delivering revenue, margins, and returns. For 2012, expectations of capital spending plan to rise from $1.9 to $2.2 billion with the introduction and upkeep on projects. An example of this is Air Products' recent equity affiliate investment in Saudi Arabia (2011 Annual Report, page IV). 38 SWOT Analysis A SWOT analysis is a tool used by auditors to help asses a company's standing in relation to its competitors. The acronym SWOT stands for strengths, weaknesses, opportunities, and threats. Strengths and weaknesses portray internal mechanisms of the company, while opportunities and threats represent external factors. The implementation of a SWOT analysis improves the auditor's knowledge on factors that will affect their internal controls, as well as external forces. Air Products SWOT Analysis Strengths Wide customer base Diversified geographic presence Steady growth in revenue & operating profit Chemical development competencies Opportunities Acquisitions Expansion in Europe, Russia, China, & Japan Contracts with Exxon Mobil Weaknesses Litigations Uniqueness Threats Strong competition Risks associated with international business Impact of natural disasters Economic or industry downturns (Air Products & Chemicals [SWOT Analysis]) Strengths One of Air Products major strengths is its wide customer base. Currently, Air Products serves customers across a broad range of industries. This includes food and beverage, health care, energy, transportation, and semiconductors. Having a wide base of customers helps to ensure 39 continual business and creates a larger target market. Additionally, Air Products operates in more than forty countries, diversifying their geographical presence. The company has continually shown a constant revenue growth in these domestic and foreign markets. Weaknesses In February of 2011, Air Products launched a public tender offer for all outstanding shares of Airgas stock. Priced at $70 per share, Airgas believed that the shares were worth at least $78. This led to litigation between Airgas and Air Products. Litigation and lawsuits shed a negative light on a company and could be seen as an attempt to reduce competition by customers and investors. Air Products has experienced lawsuits, like the one above, and lawsuits dealing with environmental concerns of the products they produce. Also, the lack of uniqueness between Air Products and its competitors is troublesome because it heightens the risk of competitors mimicking Air Products' products. Opportunities Because Air Products is such a large company, they possess the financial ability to acquire smaller companies, which is one of their greatest opportunities. Acquisitions help to grow the company and provide more venues to raise capital. Recently, Air Products entered into an agreement to acquire all of the interest in DuPont Air Products NanoMaterials LLC, which is the two companies' 50-50 joint venture. Currently, Air Products has contracted with Exxon Mobil on several issues and they have recently integrated a plant with Exxon, which saves energy and reduces carbon dioxide emissions. Since Exxon is such a widespread and prominent oil provider, 40 Air Products should continue to pursue the company to contract in other areas in order to secure business ventures. Threats One of Air Products' major threats is the risk involved with managing international business. Conducting business in other countries can be a difficult task because of laws and regulations that are not enforceable or active in the United States. Violating such laws creates a threat of lawsuits and financial burdens. Another threat deals with the uncertainty of natural disasters and their potential impact on Air Products' facilities. Natural disasters are unforeseen complications that would damage the business considerably. In addition, a third major threat is the unpredictability of economic conditions. If the economy begins to take a downturn, sales and revenue will likewise decline. The latter two threats are those that are unforeseen and therefore, are not preventable by the company. Porters Five Forces Model In 1979, Michael Porter constructed a framework of examination for analysis of industries and business strategies. The model, which he named the \"Five Forces Model,\" examines five different forces that determine the competitive powers and attractiveness of profitability in the examined market. The model is a combination of external and internal threats. On the following page is Porter's Five Forces Model diagram and a discussion on how these factors influence Air Products. 41 Threat of New Entrants The chemicals industry is global, complex, and has relatively few suppliers. The existing suppliers are large, reputable companies. In order to find opportunities in the chemical market, it is important to find a niche. Many customers have brand loyalty to their current chemical provider, so it is essential that a niche be established. Because there are high start-up costs for a chemical industry company, the barriers to entry are higher compared to many other industries, thus there is a lower threat of new entrants (Miller). 42 Bargaining Power of Suppliers The bargaining power of suppliers in the chemicals industry is relatively high due to the fact that the supply industry of chemicals is dominated by a few large firms. Also, there are few substitutes for chemicals, so the suppliers can charge higher prices. Therefore, suppliers in the chemical field have a higher bargaining power than in fields such as pharmaceuticals or textiles (Miller). Bargaining Power of Buyers The bargaining power of customers in the chemical industry is typically lower. The industry is dominated by a few large competitors. Each competitor has a lower bargaining power because the suppliers could, simply, sell to another competitor. Also, since there is limited substitution of chemicals, this lowers the companies' bargaining power further. Furthermore, the customers that seek business in the chemical field are typically ones that have an inelastic need for the products. Consequently, this assigns more power to the seller and less to the buyer (Schindel). Threat of Substitutes In the chemicals industry, there is a low threat of substitutes. However, for businesses that use these chemicals, new ideas have been formulated and the technology and chemical fields have been rapidly changing. Such opportunities for newer and alternative products have greatly increased and leave room for a subtle threat. Additionally, because customers have an infinite accessibility to computers and online databases, they have the ability to become educated about 43 certain alternative sources. These forces exhibit a higher threat of substitution. However, chemicals and gasses are extremely difficult to innovate and require a great deal of time and money. For this reason, many substitutes do not present themselves frequently in the chemical industry. Rivalry among Competition The Industrial Chemical Manufacturing industry retains a smaller amount of competitive firms, not including online businesses. Because there are fewer large companies to compete with, the competition remains stable. Also, not every company involved in the chemical industry provides identical products and services. For example, Air Products is the only integrated gases and chemicals company in the world. They provide their products and services to such a wide range of other industries, making competition with the company relatively difficult. In relation to businesses conducted via the Internet, there has been an increasing number of chemical companies emerging in the online sector (Bierma). Because of this, competition in the e-world of chemicals may become more intense in the future. Accounting and Governance Risk Accounting and Governance risk is a measurement of the reliability of a company's reporting and governance applications. The main goal is to predict any irregularities in the financial statements and to foresee any governance issues. The focal point of AGR is based primarily 44 upon identifying situations that are correlated with fraud, and transforming those into quantifiable results for stakeholders in the company. The rating scale is based on a number scale of one to one hundred, with a score o