Piton Drilling and Engineering Services Limited was established in 2001 by Andrew and Cole. The company provides consultancy, engineering, and training services in borehole drilling, power generation, and environmental engineering services under drilling, training, and laboratories divisions. The largest division is drilling, contributing more than 60% of income, while training and laboratory services contribute over 30%.

Piton Drilling & Engineering Services Limited saw an opportunity to combine business operations with Valemu Limited, a small engineering company with three members. Valemu Limited has a strong presence in the riverine areas and commenced operations about two years ago.

The issue of the business combination was brought to the attention of Peter, the Engagement Partner for the audit of Piton Drilling and Engineering Services Limited. He suggested that Andrew and Cole should perform due diligence on the operations of Valemu Limited, regardless of the fact that they are in similar business operations. He explained that this exercise would reduce the risk of failure of the merged entity, as both quantitative and qualitative information would be available about the operations of the entity before deciding on signing the agreement.

The due diligence should cover financial viability and long-term sustainability of the merged entity. Peter made reference to a situation where a large department store was forced to wind down its operations after a business combination when it was discovered that the merged entity was highly indebted to the bank, and most of its assets had been pledged as collateral for loans.

Some staff of your firm have already been assigned to the audit engagement. You informed them that the audit would be delayed because a due diligence exercise is being carried out on the operations of the entity Piton Drilling and Engineering Services Limited intends to merge with. One of the inquisitive staff, who is tired of staying in the office, came up to you with a question: why couldn’t the audit and the due diligence review serve the same purpose?

Required:

(a) Differentiate between due diligence report and external audit report. (3 Marks)

(b) Discuss the items you feel should be investigated or reported on in the due diligence exercise to make it of value to Piton Drilling and Engineering Services Limited. (7 Marks)

(c) Evaluate the benefits of using a professional service firm for the exercise. (3 Marks)

(d) Highlight the format of the due diligence report. (7 Marks)