Evaluation Of Accounting Policies And Estimates Used By Woolworths Limited In Essay.

Accounting Policies of Woolworths Limited

Question:

Discuss about the Accounting Policies and Procedures adopted by Woolworths Limited.

The financial reports are developed by business entities by taking into consideration the significant accounting policies and procedures. The accounting policies can be described as the particular rules and procedures implemented by business entities in development of its general purpose financial statements (Horngren et al., 2012). In this context, this report presents an evaluation of the accounting policies and estimates used by an ASX listed company, that is, Woolworths Limited, an Australian retail giant. The report analyses the major accounting policies of the company used in developing financial statements. In addition to this, the comparison of the accounting policies of the company is undertaken with one of its major competitors for identifying the accounting strategy used by Woolworths for achieving competitiveness. Also, the issues of concern in the financial reports of the company are also discussed as red flags in the report. At last, the compliance of the annual disclosures of the company as per the conceptual accounting framework is evaluated in the report.

The Woolworths Limited develops and published its consolidated financial reports on the basis of principle of consolidation. As per the principle of consolation, a business entity needs to develop consolidated statements by integrating the financial information of all its associated groups of subsidiaries to represent a single economic entity. The consolidated financial statements are developed by the company in accordance with the Corporations Act 2001, AASB and IFRS standards. The financial facts and figures are presented in Australian dollars as per the ASIC Class Order 98/100. The company has adopted the use of historical cost principle for measurement of its financial instruments except sale derivatives financial assets and some liabilities that are measured at fair value (Woolworths: Annual Report, 2016). The company has applied the relevant AASB standards for disclosing the information related to its cash flows, operating leases and segment disclosures (Hoffman, 2016). 

The company has implemented the required accounting policies in relation to valuation of inventories, financing costs, trade receivables, derivatives, property, plant and equipment and other financial instruments.  In addition to this, the company has also implements significant accounting policies for risk management in order to mitigate the risks arising from its daily operational activities. The major risks identified by the treasury function of the company are market risk, liquidity and credit risk. The Board of Directors has developed written policies in relation to management of the significant risks through the use of derivatives for hedging the risk. The treasury function holds the responsibility of reporting the compliance with the risk policies of the overall Group to the board of directors on an annual basis(Woolworths: Annual Report, 2016).

Risk Management and Flexibility in Accounting Policies of Woolworths Limited

The accounting managers are provided with some flexibility in selecting the accounting policies by the Board of Directors as per the corporate goals and objectives. The fact is supported from the findings of positive theory of accounting (PAT). The PAT  theory have argued that accounting managers should select the accounting policies that helps them to maximize the value of the firm and thus providing larger returns to the shareholders. Thus, as per the theory the standard-accounting setting board has provided some discretion to the management to exercise some flexibility in the accounting policies. The accounting managers make certain assumptions and estimates in the accounting policies for financial reporting (Wolk, Dodd and Rozycki, 2012). The annual report of Woolworths Limited has also provided a description of the accounting estimates of management during development of its financial statements (Woolworths: Annual Report, 2016). However, the company has maintained that the estimates, judgments and assumptions are made as per the historical cost basis that is adjusted as per the current market conditions.

 

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The accounting estimates and judgments that have a significant risk of causing material adjustments are discussed in detail in the notes to financial statements section of the annual report. The major accounting assumptions are undertaken by the company in estimating the useful life if its fixed assets,  impairment value of non-financial assets, put options valuation in non-controlling interests, provisions and discontinued operations. The accounting managers are provided the flexibility in selecting the policies and estimates by the management for reporting of financial performance of the company. However, the Board of Directors ensures that flexibility provided to the management in selecting the accounting policies and estimates do not distort the financial performance in any way. The Board of Directors has adopted the corporate governance framework for providing standard guidelines to the managers and employees. The corporate governance principles provide the ethical policies that the mangers and employees should obey while carrying out their job roles and responsibilities (Woolworths: Annual Report, 2016). The Board in its corporate governance framework has also provided the consequences of non-complying with the ethical policies and procedures for the managers while performing their job roles and responsibilities (Hussey and Ong, 2017).

The accounting strategy developed by a business entity depends on the specific accounting policies and procedures selected for developing its financial performance. The accounting strategy depends on the norms of accounting policies selected for competing with industry peers, incentives policy, changes in policies and estimates for achieving the corporate aims and objectives. The Woolworths operates in highly competitive retail market of Australia and thus has many competitors including Wesfarmers Limited, Billabong, Coles and many others (Woolworths: Annual Report, 2016). The major competitor of the company is Wesfarmers Limited that is also recognized a supermarket giant in Australian retail sector. The Wesfarmers is presenting a major challenge in front of Woolworths as it has recently reported an increase in its sales revenue by about $13.1 billion from its retail outlets (Pierce, 2015).

Comparison of Accounting Policies with Woolworths' Competitor

The Coles, a Wesfarmers company, has also reported an increase of sales to about 4.5 per cent as compared to Woolworths that have reported only rise in its sales of about 0.7 per cent. Thus, Woolworth’s current faces a large challenge from its competitors and thus need to implement proper strategies that help it to attain competitive advantage. The Board of directors of the company is planning to implement a lean retail model in the company for reducing its operating expenses to about $500 million in the coming two years. The Wesfarmers have also attained a competitive advantage over Woolworths as it develops its financial reports in a simple format as compared to Woolworths. This helps Wesfarmers to achieve the trust and confidence of investors and creditors more in comparison to Woolworths (Wesfarmers: Annual Report, 2016). Therefore, it can be said that Woolworths need to develop strategic goals and objectives that helps it in attaining a competitive advantage (Wesfarmers full-year profit drops 83.3 per cent on $2 billion writedown, 2017).

However, the Woolworths Limited has adopted a proper reward management structure to drive its long-term growth by providing proper motivation to its key management personnel (KMP). The reward management structure comprises of short and long-tem incentive plans provided to its managers fro achieving the company’s strategic objectives and goals. The incentive plans of the company are based on share-based payments and are approved from its shareholders in order to promote transparency in the business operations (Sheridan, 2016). There is flexibility provided by AASB to the business entities in developing their incentive plans as per the nature of their business operations and goals. However, the AASB has mandated that such flexibility provided to the company’s management should not lead to any manipulation of its financial performance by managers for their personal benefits. The performance targets are linked with the net profit after tax (NPAT) and the EBIT (Earnings before Interest and Tax) (Woolworths: Annual Report, 2016). However, the Board of Directors of the company have maintained that linking of incentives with the profitability does not lead to occurrence of many fraudulent activities such as manipulating finance data for achieving higher benefits by the managers (Bamberg and Spremann, 2012). The incentive plans of the company can be depicted as follows:

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Source: https://wow2016ar.qreports.com.au/xresources/pdf/wow16ar-full.pdf

The company have also adopted the specific change in the accounting policies and adopted some estimates during development of its financial reports. The comparative amounts impacted by the change in the accounting policies are adjusted by the company for each of the prior period. The changes are done in order to improve the relevance and reliability of finance information for example the company has adopted the use of fair value in measuring some of its specific assets and liabilities as compared to its previous use of historic cost principle. The changes in the accounting policies are made by the management in order to comply with the current AASB and IFRS standards. The company has also made some estimates in relation to assessing the carrying and recoverable amount of assets. However, the changes in the policies are estimates are carried out by the company for carrying out some specific accounting transactions as per its long-term strategic goals and objectives (Woolworths: Annual Report, 2016).

Issues of Concern in Financial Reports of Woolworths Limited

The company has provided significant details of the specific accounting policies for identification and measuring of its various financial elements. The notes to financial statements section of the company have disclosed all the accounting procedures adopted for developing its consolidated financial reports. The statements representing the accounting transactions in the financial report of the company have also included footnotes for providing the relevant accounting policies adopted for their development (Woolworths: Annual Report, 2016).

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The notes to financial statements section of the annual report of the company are sufficient for providing an insight into the key performance of the company. The notes are also consistent with the current performance of the company and the notes have provided each of the details that have been used in development of the financial reports. The accounting quality of the disclosures of the company can also be analyzed with the application of GAAP (Generally Accepted Accounting Principles) standards.  The GAAP are the accounting rules and standards that are used by business entities across the world for financial reporting. The principles are developed by the FASB for promoting consistency between the financial reporting of different firms. The development of uniform accounting standards will help the firms to reduce the chances of occurrence of fraudulent accounting activities. The basic accounting principles as per GAAP are cost principle, matching principle and full disclosure. As analyzed from Woolworths Limited, the company has adopted the GAAP principles and standards during measurement of its major success factors. The company has adopted the use of historic cost principle for the recognition and measurement of its different financial elements (Woolworths: Annual Report, 2016). This is done as per the GAAP principles as Australian entities incorporate the use of historic cost principle for valuing its different financial instruments. Thus, it can be stated that the adoption of GAAP principles by Woolworths have enhanced its disclosures in relation to its key success factors (Bragg, 2010).

The company has also provided relevant information in relation to its operating segments in its notes to financial statements section. The major reportable segments as analyzed from the financial reports of the company are as follows:

• Australian Food and Petrol
• New Zealand Supermarkets
• Endeavour Drinks Group
• BIGW
• Hotels

The reportable segments of Woolworths have been identified as per its internal reports and these are continuously monitored by the Chief Executive Officer. The review is carried for allocating the required resources to each of the reporting segment. The different business units of the company provide different products and services and also are managed distinct from each other. The financial performance of each of the reporting segments is done on the basis of comparing their respective EBIT (Earnings before interest and tax). This is done in accordance with the AASB standards and section 334 of the Corporations Law that directs all business entities of Australia to report the financial performances of their individual reporting segments. As such, it can be said that Woolworths Limited is complying effectively with AASB and Corporations Law principles in developing its financial reports (Woolworths: Annual Report, 2016). The quality of disclosure provided by the company is also adequate as the financial reports are prepared on the basis of application of standard accounting principles and regulations (Walton, 2011). The segment disclosure in the financial reports of the company can be illustrated as:

Compliance of Annual Disclosures of Woolworths Limited as per Conceptual Accounting Framework

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The potential red flags are referred to as the areas of concern for the management that requires more disclosures in the future financial reports of the company (Gray and Manson, 2007). The company in order to improve its profitability position as compared to the competitors has discontinued its operations in the home improvement market. The company has assessed the value of its property assets on the basis of disposal strategy and investment yields. The values of the assets are determined on the basis of estimation of the management regarding the net sales to be achieved from discontinuing the operations of home improvement.  The company has included the impairment loss of the assets in the ‘loss from discontinued operations’ and the carrying amounts of fixed assets are transferred to ‘Assets held for sale’. As such, these refer to unexplained changes in accounting in the annual disclosure of the company that requires more disclosure by the management in the future financial reports (Woolworths: Annual Report, 2016).

The company has also reported a decrease in its inventory value and sales revenue in comparison to its past financial year of 2015. The inventory had significantly decreased from $ 4,872.2m to $4,585.5m and the sales figures have reported a decline of $58,812m to $58,085.7 m in the financial year 2016. The company has also reported a loss of about $2,347.9m in the financial year 2016. The company financial performance is declining and thus it needs to significantly provide the reasons for same in its financial reports and the strategies it is planning to implement for improving the profitability. This is essential for the company to maintain the trust and confidence of its present and potential investors. The main reason for the loss reported in the financial year of the company is due its discontinued operations from the home improvement market (Henderson et al., 2015). The comprehensive loss from the discontinued operations as reported in the income statement of the company is $3,191.9m (Woolworths: Annual Report, 2016). The company has also reported cash inflows from the sale of its items of property, plant and equipment to about $722m in the accounting period of 2016.

Source:  https://wow2016ar.qreports.com.au/xresources/pdf/wow16ar-full.pdf

However, the notes to financial statement of the company have not stated any reason for large asset write-offs by the company. The reduction in the value of fixed assets of the company reported as asset write-offs is recorded in the statement of cash flows of the company. The company in order to enhance the understandability of its financial information should provide more information about its asset write-offs it in its financial reports (Mintz, 2013).

The conceptual accounting framework has been developed by the IASB for improving the quality of financial reporting. The major principles as identified by IASB of conceptual accounting framework are relevance, reliability, faithful presentation and understandability. Thus, financial information should be according to these qualitative characteristics for meeting the needs and expectations of the end-users of financial reports (Pietra, McLeay and Ronen, 2013). The Woolworths Limited has provided financial information in its annual disclosures as per the qualitative characteristics of conceptual accounting framework. The financial information presented is relevant, reliable and also complete in all aspects. The company however needs to enhance the understandability of its financial reports by developing its general purpose financial statements in an easy format. The quality of the financial reports is also significantly influenced by the political factors that the company faces while operating its business in different countries (Kenny, 2009).

The Woolworths Limited is operating on a global level and therefore needs to develop its financial reports in a way for meeting he expectations of its diverse users across the world. As such, the company is complying with the IFRS standards as stated in its annual reports in order to meet its corporate goals of diversification and expansion. The company is also making some voluntarily disclosures for improving its competiveness on a global platform in its annual reports. For example, the company has presented detailed information regarding its trading performance in its annual report that is not required under AASB standards. This is done by the company voluntarily for improving its global competiveness and thus driving its sustainable growth in the foreign markets. The company making such voluntarily disclosures will be bale to achieve its long-term goals of attaining global competitiveness and thus achieving a recognized brand name in the global market of Australia (Woolworths: Annual Report, 2016). Thus, the selection of such accounting policies and disclosures will help the company for improving the reliability and transparency in the business operations and thus achieving the trust of foreign investors (Jensen, 2001).

Conclusion

It can be inferred from the overall discussion held in the report that accounting policies and procedures plays a significant role in depicting the actual financial performance of a business entity. The flexibility provided to the managers in selection of particular accounting policies can also lead to manipulation of accounting activities. Thus, as such it is important for the Board of directors to review the discretion power of the management for ascertaining that the authority provided to them is not used for achieving any personal gains. The analysis of annual disclosure of Woolworths Limited has revealed that the company has effectively followed the relevant AASB and Corporations Law standards for developing its financial reports. However, there are some areas of concern identified in its financial reports that needs more disclosures by the management for improving the understandability of its general purpose financial statements

References

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