- Determine the level of materiality to be used for the audit of the group accounts for the year ending in 2017. Your answer should include a discussion of the nature of materiality, and a description of what materiality represents in terms of the audit of a set of financial statements, and should discuss the different bases and considerations employed in arriving at materiality. Explain the rationale behind your choice of a certain level of materiality. Provide a quantitative estimate of materiality.
- Review the various draft notes and disclosures accompanying the draft annual report. Highlight those that may have significance to the audit, eg. Contingencies, and outline the audit procedures that you will need to perform.
The partner has requested you to prepare a preliminary analytical review on the information provided by your company. The partner suggests that as a minimum you address key balance sheet and profit and loss ratios over the period 2014 to 2017.
Based on these results and the nature of your company’s business and its markets, outline the apparent trends and changes in these ratios, the key risk areas for the audit and the matters that will have to be addressed in the audit plan. Give examples of relevant assertions and at least one audit procedure for each assertion.
- Review the statement of cash flows. Which category of cash flows provided the majority of cash inflows? Which category had the greatest outflows?
Identify the primary cash receipts and cash payments during the year. What were the main non-cash financial and investing activities? Using the results of questions 2 and 4, evaluate the going concern risk of this company. What audit procedures would you recommend to address this risk.
Review the audit report of the 2017 financial report. What type of opinion was expressed?Are there any additional sections or paragraphs indicating any audit issues? If any, describe the nature of these issues in detail.
Materiality Concepts in Audit
The primary objective of this study is to consider the audit process with the objective of reviewing the materiality that an auditor should consider while identifying any material misstatement in the financial report. The materiality concepts forms the essential scope of audit since it forms the major factor in determining minor and major financial misstatement that should be considered while carrying out the audit work (Arens et al., 2013).
Misstatement of significant nature are assessed depending upon the degree of materiality of item and how it creates an impact on the decision making procedure for the investors together with other estimates that are presented in the financial reports. The present study is based on assessing the materiality of Wesfarmers Ltd that carries on the operations under the Australian stock exchange.
The materiality concept in audit forms the essential scope of audit since the auditors are required to take into the account the material items so that they can understand whether the management has reported the figures accurately. In order to determine the materiality of the business the auditors is required to consider both the qualitative and quantitative aspects (Barr-Pulliam et al., 2017). Under the qualitative materiality aspects, the auditor should consider the significant business items such as net profit, inventory of the business, changes in the accounting method and significant legislations.
While under the qualitative aspects of assessing materiality, the auditor is required to estimate the proportionate change in percentage charged on appropriate bases to understand the level of materiality for different items that are presented in the yearly financial report of a business (Arens et al., 2014). The percentage that is charged to determining the materiality rests on the auditors judgement based on the business size and nature of operations undertaken by a business (Louwers et al., 2015). The auditors calculates the materiality during the early planning stages of audit. With the help such planning the materiality estimates of several different items are calculated. Henceforth, the materiality concept forms the essential element in audit planning process.
Under the quantitative materiality estimations different bases is considered to estimate the materiality planning and performance materiality of a business (Knechel & Salterio, 2016). The different bases that are taken into the consideration is based on the significant items that is presented in the statement of income and statement of financial position of Wesfarmers. Based on the income statement, the bases that would be taken into the consideration are the net profit before income tax, total revenues generated. While based on the statement of financial position the total assets of the company would be considered.
To assess the materiality of Wesfarmers the annual financial report of 2017 is taken into the consideration. Evidences gained from the financial report suggest that Wesfarmers has reported an improved sales revenue from the figures posted in 2016. As a general rule, majority of the company take into the account the items that are highest value as the bases for determining the materiality of the business (Kend et al., 2014).
Quantitative Materiality Estimations for Wesfarmers Ltd
The total assets can be taken into the considerations as the base for computing the materiality planning of Wesfarmers as the company has reported the total assets of $40,115 million for the financial year ended 2017. An estimation of 5% is considered planning the materiality of Wesfarmers. The planning materiality for Wesfarmers is stated below;
Planning Materiality = Total Assets x 5%
Total Assets = $40,115 x 5%
As evident, the materiality planning for the Wesfarmers is considered based on the total assets as the base and 5% as the percent depending upon the auditor’s judgement. Depending upon the planning materiality, the performance materiality for different items is represented below;
Reviewing Draft Notes and Disclosures:
The draft notes and the disclosure that is presented on the yearly report of Wesfarmers also possess significant level of relevance in the audit procedure since the notes section of Wesfarmers provides information relating to treatment and descriptions of items of business (Wesfarmers, 2018). The significant items that are reported under the notes to financial statement of Wesfarmers is stated below;
- Borrowing- Proceeds: Certain number of bank facilities of Wesfarmers were annulled during the accounting year that led to net reduction in the available facilities to approximately $950 million (Wesfarmers, 2018). The left over bank facilities that matured in the financial year were renewed and were stretched for the accounting period stretching from one to three years.
- Borrowings – Repayments: During November 2016, the Australian bonds of worth $500 million matured. The same was repaid by using the current facilities of banks and available amount of cash balances.
- Credit Card Transactions of Coles: Wesfarmers in 2017 derecognized the credit card receivables.
- Business Combinations: During February of 2016, Wesfarmers completely acquired Home Retail Group Plc Holding in Homebase for AUD $665 million. Homebase has its base in United Kingdom and functions as the home improvement and garden retail business in Ireland and UK (Wesfarmers, 2018). As on June 30, 2016 the recognized sum of acquisition accounting balance stood provisional because of the continuous work finalizing and matters related to taxation that may create an impact on the acquisition accounting entries. There were no changes in the provisional fair values of the identified assets that were acquired and the liabilities that were assumed on the date of acquisition from those that were disclosed in the financial statement.
Analytical review of the Financial Statement:
The analytical review of the financial statement is regarded as the tool that are available to the auditor where significant ratios are calculated from the financial report, providing information relating to numerous business aspects (Henderson et al., 2015). The ratios that are calculated includes liquidity, profitability, asset management ratios, leverage ratios and valuation ratios.
The profitability ratios are referred as the class of financial ratios that is used in assessing the ability of the business to generating revenue in respect to its related expenditure (Khan, 2015). Under the profitability ratio the gross profit margin is computed for Wesfarmers. The gross profit margin for Wesfarmers reflects a strong trend over the past four years with gross profit margin standing as high as 32.17 in 2017.
Moving on to net profit margin Wesfarmers has reported a somewhat fluctuating trend as the net profit margin in 2016 declined to 0.62 however gained strength in 2017 to stand at 4.20. The audit should employ the verification process of identifying the expenses incurred in business operations.
The return on assets also represented the fluctuating trend over the past four years as the ratio declined to 1.00 in 2016 however rising in the subsequent year to 7.10. As a verification process the auditor should verify the current assets of Wesfarmers to understand the root cause of such variations. The return on equity though stood strong initially in 2014 however in 2016 the company reported a declining trend in return on equity as the ratio fell as low as 1.77. In the following year of 2017 the ratio increased to as high as 12.00 primarily due to rise in the net income of the business.
The liquidity ratio can be defined as the class of financial metrics that is used to ascertain the debtor’s ability to pay off the present obligations of debt without increasing the external capital (Hoskin et al., 2014). Wesfarmers has maintained a steady trend in current ratio over the past four years with ratio standing stable in 2017 as well. While the quick ratio has reflected a falling trend over the last four years. The quick ratio in 2014 stood 0.48 however in 2017 the ratio has declined to stand 0.30 which may reflect that the company may face problems in meeting its short-term debt obligations.
Reviewing Draft Notes and Disclosures
The auditor should assess the quick assets of Wesfarmers since it reflected a falling trend over the last three years. The net working capital of the business has declined too during the last four years and the same can be considered as the serious matter of concern. Wesfarmers may face the problems of liquidity (Eilifsen et al., 2015). The auditors obligations is to assess the values of the quick and liquid assets in order to make sure that the financial statement reflects a true and fair view of the figures reported.
Turnover or Asset management Ratios:
The asset management ratios represents the measure of assessing the success of firms in administering its assets to generate sufficient amount of sales (Penman, 2016). Inventors of Wesfarmers is regarded as the important item of business and the same can be highly vulnerable to material misstatement. The stock turnover ratio over the last four years as somewhat been stable while the fixed assed turnover has represented a rising trend with the total asset turnover ratio remaining stable all throughout the four year span. The auditor must undertake the verification of inventory records and if required should also perform the physical stock take to correctly value the stocks.
Leverage ratio one of the financial instrument that takes into the considerations the total inflow of capital in the form of debt or evaluating the ability of the company in meeting its financial obligations (Deegan, 2013). The total debt of the company in respect to total assets has relatively been lower while the debt to equity ratio has also remained steady over the course of four years. There is no such major changes in the equity capital however the business relies on the application of debt. The auditor is under obligation of performing the risk test related to debt so that the debt capital of the business is not impacted. Additionally, the auditor should assess whether there is a fair representation of debt capital in financial report.
Valuation ratio can be defined as procedure of assessing the worth of a business. The valuation ratio acts as the tool in determining the investment potential of a company (Soh & Martinov?Bennie, 2018). The price to book value ratio has represented a rising trend which signifies that the Wesfarmers is a worth investment potential. The dividend yield also represents a somewhat fluctuating trend over the last four years. However, the auditor’s obligation lies in assessing the share capital of Wesfarmers that is accumulated by the company.
Section 3: Analysis of Cash Flow Statement:
The cash flow statement represents the inflow and outflow of cash for a business during an accounting year. The cash flow statement helps in portraying the liquidity position of a business (Hoskin et al., 2014). The cash flow statement of Wesfarmers represents the cash flow from operations, investing and financing activities.
The cash flow from operating activities represents the highest inflow of cash with receipts from supplier standing $74,042 million which an improvement over the last year figures of 71,157 (Wesfarmers, 2018). The cash flow from investing activities states that company made payments for property, plant and equipment that stood $1,681 million while also generated a proceeds from the sale of property, plant and equipment. The cash outflow from the financing activities stood as high as $1,994 million with payment of equity dividend standing $1,998.
The principle of going concern is regarded as the fundamental principle in the process of accounting and any factor that creates an impact on the going concern of the business should be reported by the auditor (Cohen & Simnett, 2014). The liquidity position of Wesfarmers represents declining trend as the quick assets has not portrayed a favourable sign. The auditor should advice Wesfarmers in enhancing the position of liquidity by placing more reliance on equity capital rather than emphasising on the debt capital.
Review of Audit Report:
The earnest and young are the auditors of Wesfarmers. According to the auditors opinion the financial report is in compliance with the Corporation Act 2001 (Wesfarmers, 2018). The report provides true and fair view of Wesfarmers consolidated financial situation as the company complies with the Australian Accounting Standards and Corporation Regulation 2001. This implies that the financial report are free from any material misstatement.
The key audit matters for Wesfarmers includes impairment of non-current assets together with the non-current assets (Edgley et al., 2015). The key audit matter of Wesfarmers also includes rebates related to suppliers related to its retail operations and finalization of acquisition of accounting of Homebase.
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