This is a solution of Inherent Risks For Wesfamers Limited that describes about Developing business

Inherent Risks For  Wesfamers Limited

Wesfamers Limited is a group of being a diversified conglomerate engaged in eight core business divisions including retail operations (Coles) such as home improvements and office supplies, target, shopping mart (Kmart), insurance, resources sector (coal mining), chemicals, energy and fertilizers sector, industrial and safety products and investment sectors. Keeping in view the veracity of business risks management within industrial perspective of each segment, following are few identified possible inherent risks at the planning phase of audit.

Inherent RisksImplications
1. Wesfarmers’ breach of environmental regulation imposed by the Federal Government of Australia against carbon and greenhouse emissions particularly pertaining to coal mining and chemicals and fertilizer sectors.·        Legal complications leading to fines and penalties

·        Non-disclosure of contingent liabilities in the financial statements

·         Bad reputation and loss of goodwill among the general public

2. Wesfarmers’ significant risk of uncertainty in insurance business causing high claim costs prone to increasing trends in natural disasters, calamities and catastrophes and death rates across worldwide, credit risks and complexity of calculations in actuarial valuation reports subjecting to significant estimation uncertainty.·        Insurance liabilities are not stated accurately in the financial statements.

·        Inability to meet insurance liabilities as and when they fall due

 

3. Wesfarmers’ retail business operational risks including disruption in replenishment of stock (supply chain), theft of stock and risk of embezzlement of cash due to millions of transaction each week in retail outlets. In addition, there is a considerable risk of valuation of the stock leading to overstatement of stock if net realizable value is lower than the cost caused by price fluctuations.·        Revenue from retail business is not giving true and fair view.

·        Frequent stock outs and inefficiency in the operations

·        Loss of physical and financial resources

·        Overstatement of stock of retail segment

 

4. A newly integrated management information system has been implemented in the current year 2012 to effectively monitor the activities of the retail business. However, there is a considerable risk in the effectiveness and efficiency of such system unless examined by our information risk management team.·        Since it is newly incorporated, it is highly prone to errors and omissions thus challenging the reliability of data.

 Inherent risks for Virgin Australia Group of Airlines

Virgin Australia Holdings Limited formerly known as ‘Virgin Blue Holdings Limited’ is primarily engaged in the airline industry both domestic and international. The principal office of the company is situated at 56 Edmondstone Road, Bowen Hills, Queenland 4006. After performing risk assessment procedures, the key identified possible inherent risks at the planning stage of the audit are as follows;

Inherent RisksImplications
1. Virgin Australia Holdings Limited is a highly geared company having 153% debt to equity ratio ($m 1,420.1/929.7) which can be regarded as key business concern. This situation can significantly impair future operating capability.·        Manipulation of financial statements by falsely concealing any significant charges and encumbrances of the loaner because too much gearing inhibits any sort of further investment.

·        Inadequate or misclassifying interest expense to show good returns with intent to reward employees or payment of dividends to shareholders

 

2.  Lack of sufficient working capital to continue operations with a total deficit of $m 559.6 ($m 1,032-1,591.6).·        Inability to meet current liabilities as and when they fall due

·        Manipulation in the current liabilities by understating

3. The fuel supply is integral to the airline industry and any length of time lag for any reason can have a significant operational impact which can consequently result in total loss of revenue and customers’ goodwill at the same time. Accordingly, the rise in fuel costs over the periods has adversely affected the airline industry.·        Significant rise in fuel cost is indicative of the increased pressure to manipulate financial statements to show better earnings by understating or misclassifying fuel expense.
4. All the airline companies in Australia are bound to comply with the rules and regulations imposed by Australian Government’s Civil Aviation Safety Authority (CASA) and have severe legal repercussions in case of non-compliance including the safety and security of its customers and employees. The breach of such regulations can be imminent.·        Legal complications leading to fines and penalties

·        Non-disclosure of contingent liabilities in the financial statements

·         Bad reputation and loss of goodwill among the general public

5. The revenue of Virgin Australia Holdings Limited and airline industry in general in Australia is highly sensitive to fluctuating economic conditions. Any sort of deterioration on the Australian economy would have a material impact on its financial position and financial performance.

·        Creates incentives and pressures towards management to manipulate reported earnings.

·        Falsely concealing or misleading the material information required for the users.

(B) What audit procedures and/or tasks would you have planned to carry out in response to the inherent risks identified by you in 1 above?

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Audit procedures against identified inherent risks at planning stage of audit of Wesfarmers Limited are as follows;

Inherent risksAudit procedures
1. Breach of environmental regulations·        Obtain list of all litigations from the Chief Compliance Officer or other responsible personnel and corroborate it with the Wesfamers’ legal adviser/consultant.

·        Meetings with the Wesfarmers’ legal consultant to clarify whether it is compliant with the environmental regulations or if there is a pending litigation obtain an understanding of the outcome of decision and probable penalty to be imposed on the company.

 

2. Significant risk of uncertainty in insurance business·        Engage an actuarial expert (actuary) independent of the Wesfarmer to cross examine the actuarial reports issued by the Wesfarmers’ actuary including benchmarking data and performing industry analysis to identify unusual trends

·        Read the minutes of the meetings of the Board of Directors to identify whether any unfavorable incidents have occurred which can result in significant claim of the insured entity.

 

3. Retail business operational risks·        Perform a walkthrough test over the point of sales terminal to evaluate whether the retail process is operating effectively

·        Perform a physical cash and stock count at year end on surprised basis to verify existence and completion

·        Benchmark data along with competitors and compare prices to test for the net realizable value to check the correct valuation of retail inventory items

4. Implementation of newly integrated management information system in retail segment·        Employ and use the services of an IT expert independent of Wesfamers particularly specialist in information systems audit to evaluate the consistency, effectiveness and reliability of the reports generated by the system and any exception reports are noted.

Audit procedures against identified inherent risks at planning stage of audit of Virgin Australia Holdings Limited are as follows;

Inherent risksAudit procedures
1. Highly geared 153% debt to equity ratio susceptible to undisclosed charges and encumbrances·        Obtain the list of all financing facilities from the management and seek for external confirmation from the bank in respect of terms and conditions of the facilities, limit of any fixed and floating charge against all classes of assets including letters of credit and bank guarantees and other related covenants.

·        Perform compliance whether the facility is used for the stipulated purpose as mentioned on the agreement.

·        Recalculate the amount of interest and check whether the company is not defaulting towards payments of principal and interest

2. Lack of sufficient working capital to continue operations·        Enhance the nature, timing and extent of substantive testing over current assets and current liabilities
3. Significant increase in fuel costs susceptible to misstatement in fuel expense·        Review the agreement of the company between its fuel supplier to establish whether there are any unusual terms and conditions.

·        Design procedures to verify assertions such as occurrence, completeness, accuracy, classification and cut-off by detailing testing of fuel transactions (vouching) along with test of controls put in place by the company

·        Check for accruals of any unpaid bills at year end and seek for external confirmation with the supplier(s).

4. Possibility of non-compliance with rules and regulations of Civil Aviation Safety Authority (CASA)·        Obtain list of all litigations from the Chief Compliance Officer or other responsible personnel and corroborate it with the company’s legal adviser/consultant.

·        Meetings with the company’s legal consultant to clarify whether it is compliant with the CASA regulations or if there is a pending litigation obtain an understanding of the outcome of decision and probable penalty to be imposed on the company

5. Deterioration in the Australian economy creating pressure for the management to manipulate reported earnings·        Benchmarking and compare the industry wide trends for effects of economy on the business of competitors through ratios analysis

(C) If you had carried out an analytical review on the financial statements of these companies in the planning phase, what areas of concern (high risk or problem areas) or comfort would you have identified? Justify your answer and identify at least three (3) points for each company. (Hint: To answer this part you will need to carry out an analytical review.)

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Answer:

A diagnostic examination have been performed on the financial statements of Wesfarmers Limited for the year ended June 30, 2012 ranging from simple comparison with prior periods to detailed ratios analysis including checking consistency with other relevant financial information with the results as follows;

Results

  • Although the above financial ratios indicate more of kind of satisfactory results with exception of high inventory turnover days. This might indicate that the company takes a long time in replenishing of existing finished goods stock. Possible reasons can be low demand of product which can result in deterioration of stock resulting in overstatement of stock if it had not reduced against its respective net realizable value as inventory is always stated at lower of cost or net realizable value (NRV). Quite possibly that is why sales have only increased by 6% over the year of which might be contributed by inflation factor. So, the key areas of concern are
  • Revenue from sale of goods because it comprises of 96% of the total revenue along with the detailed testing on inventory items
  • Another key area of concern is 850% increase in impairment of goodwill. That happened following the announcement by BlueScope Steel Limited (BlueScope), on 22 August 2011, that it intended to significantly restructure its Port Kembla operations, including a shutdown of its No.6 Blast Furnace at Port Kembla, the Industrial and Safety division’s Coregas business agreed to amend its contract with BlueScope for the supply of industrial gases to its steel operations as a result of the amendments, Coregas has become the primary supplier of industrial gases to BlueScope at the Port Kembla operations, with reduced volumes reflecting the reduced demand from BlueScope under its new operating structure. Given the amendments to this agreement, and having regard to an associated review of the Coregas business, Coregas has recognized an impairment charge against goodwill and plant and equipment of $172 million and $9 million respectively in the year ended 30 June 2012.
  • The total goodwill comprises of 38% of the total assets which is a significant area of concern with regard to its reported amount in the balance sheet. The high amount of impairment as mentioned above is indicative of possible issues that might also exist in the valuation of goodwill. A key focus should be devoted to this area of the financial statements including the reliability, reasonableness and consistency of methods used therein.

Comfort level

  • The only comfort level at the marketing planning phase is its financial stability in terms of its leverage and low debt to equity ratio that comprises of 15% and good interest coverage ratio. Moreover, the interest bearing liabilities have been reduced by 16% which is also a good sign as the company is placing more reliance on equity injection rather than debt borrowing.

A diagnostic examination have been performed on the financial statements of Virgin Holdings Australia Limited for the year ended June 30, 2012 from simple comparisons with prior periods to detailed ratios analysis including checking consistency with other relevant financial information resulted as follows;

Key areas of concern identified

  1. Highly geared debt to equity ratio and low interest coverage ratio calculated above based on the financial statements of 2012. This casts significant doubt about going concern issues in the subsequent years. Interest coverage ratio of 0.9 times indicate that the company would not be able to pay off interest costs with ease. It also shows the company’s potential reliance on borrowings. Hence, at planning phase I as an auditor should devote key attention towards loan financing and all its related covenants.
  2. Poor liquidity position because of inadequate working capital. It is evident from the fact that since average collection period of 9 days is a good sign for cash flow, however, in contrast the company is taking too long to settle its liabilities towards its creditors resulting in negative cash conversion cycle. This might also be indicative of disputes among the creditors for delayed payments and also necessitates the need to check for completeness of provisions booked in the current liabilities.
  3. There has been decrease in value of property, plant and equipment during the financial year 2012 for changes in the airline’s use of certain assets resulted in devaluation and write-down of aircrafts and aeronautical assets totaling $ 18.5 million (2011: nil). A thoroughly analysis and scrutiny is needed to be done to check the basis and reasonableness of such treatment.

(D) What audit procedures and/or tasks would you have planned to carry out in response to the high risks or problem areas identified by you in (C) above? Alternatively, in relation to which area would you have minimized your evidence gathering procedure?

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Answer:

In relation to the high risky problem areas of Wesfarmers Limited identified in above section, I as an auditor hereby planned to do the following audit procedures as follows;

Problem AreasAudit procedures
1. High inventory turnover days and low sales growth·        Inquiries of sales and marketing departments’ personnel about the possible reasons of slight increase in sales and the inventory management departments and supply chain.

·        Obtain list of inventory items along with their aging analysis and perform NRV testing by market survey or through benchmarking competitors’ data.

·        Perform substantive testing on all the processes related to management of inventory of all segments.

2. An 850% increase in impairment with a total of $ 172 million charge for the year·        Evaluation of macroeconomic factors and detailed analysis of the event of amendment of agreement with BlueScope Steel Limited.

·        Recalculate the discount rates

·        Review the financial models prepared management for impairment testing

3. Goodwill revaluation

·        Review the impairment review and discuss with the management

·        Agree goodwill calculation by recalculation

·        Agree the consideration to sales agreement by inspection and involve experts and considering whether asset valuation is on reliable, reasonable and consistent basis.

In relation to the high risky problem areas of Virgin Australia Holdings Limited identified in above section, I as an auditor hereby planned to do the following audit procedures as follows;

Problem AreasAudit procedures
1. Highly geared debt to equity ratio and low interest coverage ratio·        Inquiries of management about the reasons for potential reliance on borrowing and discussion on current critical situation.

·        Obtained all the agreements of financing from management and confirming all the terms and conditions and major covenants mentioned therein with the bank.

·        Obtain written representation from the management about the completeness of information related to financing including declaration of any off the balance sheet arrangements, if any

·        Vouch all the major payments of principal along with interest and checking their accuracy, completeness and cut-off procedures including whether it is meeting such liabilities within stipulated time period.

2. Poor liquidity position because of inadequate working capital. Click Here·        Inquiries with management about current liquidity position and future course of action for remedial measures.

·        Circularizing confirmations to all major creditors to confirm the terms of agreements and outstanding balances at year end.

·        Check for any long outstanding payables that might have resulted in disputes or law suits.

·        Meetings with legal advisor to confirm the adequacy of provisions and contingent liabilities.

3. There has been decrease in value of property, plant and equipment totaling $ 18.5 million

·        Meetings with the management about the reasons for change in use of fixed assets and assessing the reasonableness of such treatment.

·        Engage technical experts e.g. aeronautical engineers for evaluation of physical condition of such assets.

·        Employ a valuation analyst for determination of reliable fair market value and compare it with those written down aircrafts’ costs.

·        Checking the mathematical accuracy of records and documents of such assets by recalculating the depreciation charge from Fixed Assets Register and other relevant supporting documents such as invoices etc.

(E) An Independent Auditor’s Report to the Members has been issued for each company for the financial year ended 30 June 2012:

(a) Identify the type of audit opinion issued by each auditor, and justify your answer.

Wesfarmers LimitedVirgin Australia Holdings Limited
An unmodified opinion has been expressed by the auditors M/s Ernst & YoungAn unmodified opinion has been expressed by the auditors M/s KPMG

 An unmodified opinion means that the auditor has concluded that the financial statements of the entity are giving true and fair view because they have been prepared in accordance with all the material respects that include the applicable financial reporting framework. The applicable financial reporting framework includes Australian Accounting Standards and any other International Accounting Standards being adopted and also includes legal and regulatory requirements such as Corporations Act, 2001.

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(b) Do you agree with the type of opinion issued by the auditor? Why or why not?

Please indicate an alternative audit opinion if you do not agree with the one issued.

Wesfarmers LimitedVirgin Australia Holdings Limited
Yes, I agree with the type of opinion issued by M/s Ernst & Young on the financial statements of Wesfarmers Limited for the year ending 30 June 2012 as the company is growing and there are no significant issues related with the company’s business and no such material misstatement exist in the financial statements.However, I do not agree with the type of opinion expressed by M/s KPMG on the financial statements of Virgin Australia Holdings Limited. Although, the company has earned a profit of $m 22.8 but since it is totally instable in terms of financial leverage and also due to poor liquidity position. The working capital has a deficit of $m 560 which cannot be compensated by the annual profits. Moreover, there are no present signs of improvement. Therefore, the opinion should have been modified.

Alternative Audit Opinion

KPMG should have modified the audit opinion by including an emphasis of matter paragraph after the opinion paragraph to highlight going concern issue that if present circumstances continues to deteriorate it  can significantly impair its future operating capability

 (c) Are there any other matters or events that have taken place after the issue of the audit report that strengthens or weakens the auditor’s opinion?

Wesfarmers LimitedVirgin Australia Holdings Limited
No events have occurred after the issue of audit report. The dividend was declared for a payments date of 28 Sep 2012, but it does not affect the auditor’s opinion and similarly the company has announced the issue of € 650 million EURO bonds on 25 July 2012 and on same day repaid $ 400 million seven year bonds that were issued by Coles on 25 July 2005 but it also does not affect the audit opinion.

As such there are not any events that have taken place after the issue of the audit report that strengthens or weakens the auditor’s opinion. However, 0n 5 July 2012, the Group announced an agreement with Boeing to order 23 Boeing 737 MAX 8 aircraft, the first in Australia. The fuel-efficient aircraft will join the Group’s fleet between 2019 and 2021. The agreement, of which the terms are commercially sensitive and therefore confidential, includes four additional delivery options, ensuring flexibility to respond to market conditions.

To align with its current capacity plan for the next three years, the Group has delayed the delivery of some of its Boeing 737NG aircraft

to after 2016, leaving 31 scheduled deliveries of Boeing 737-800 aircraft between 2013 and 2016. This gives the airline flexibility to develop the appropriate mix of narrow-body and wide-body aircraft. But it does not affect audit opinion.

 (F) In relation to audit committees research and answer the following questions and justify each answer –

 (a) Do the above companies have audit committees?

Wesfarmers LimitedVirgin Australia Holdings Limited
Yes, Wesfamers do have audit committee established by the Board of Directors which comprise of following persons namely;

·        Tony Howarth (Chairman)

·        Bob Every

·        Charles Macek

·        Diane Smith – Gander

·        Vanessa Wallace

Yes, the Board of Directors of Virgin Australia Holdings Limited has established an audit and risk management committee comprising of the following persons namely;

·        Robert Thomas (Chairman)

·        Neil Chatfield

·        Mark Vaile

 (b) Under which section of the annual report would you expect to find information on them?

Wesfarmers LimitedVirgin Australia Holdings Limited
The Audit Committee of Wesfarmers Limited can be found on the Corporate Governance Statement section of the annual report on page # 60 to 61 whereby their composition and responsibilities are duly mentioned.The Audit Committee of Virgin Australia Holdings Limited can be found on the Corporate Governance Statement section of the annual report on page # 44 whereby their composition and responsibilities are duly mentioned.

 (c) Do both companies have the correct composition in relation to audit committees?

Yes, both the companies have the correct composition in relation to audit committees because the ASX Corporate Governance Principles stipulates following criteria for the composition of audit committee as follows;

The Audit Committee must comprise of:

  • only non-executive directors;
  • at least three members;
  • a majority of non-executive directors who are able to exercise independent judgment in their role as a member of the Committee, as determined by the Board;
  • members who are sufficiently financially literate to understand financial statements and general accounting principles, for the purpose of assessing and questioning information presented in Committee meetings; and
  • at least one member who has relevant financial qualifications and experience

(d) In your opinion, are audit committees of benefit to the auditor, the company, the auditing profession and/or society as a whole?

Audit committees play a critical role in ensuring the integrity of a company’s financial reporting and the audit process, including the independence and objectivity of the external auditor. The audit committee also plays a wider role in ensuring that the company has sound internal financial control systems. Overall, a well-functioning audit committee underpins the assurance that the board of directors gives to shareholders in relation to the company’s financial statements and the audit process.

 Part 2

Audit Quality in Australia – A Strategic Review

  1. a) Purpose

This report elaborates the importance of reforms for continual enhancement in the audit process that is integral to the corporate sector which plays a key role in the growth of Australian economy published by the Treasury after a diagnostic review methodology. The primary objective of this report is to inculcate an effective, sound and transparent audit mechanism which provides an independent check on the integrity of the financial statements by promoting the credibility locally as well as in global marketplace and increases the confidence of investors

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  1. b) Scope

In order to achieve such a strategy, the report describes the methodology used in assessing the quality of audit in Australia keeping in view International perspective. It also provides guidelines on quality control procedures to be followed by the professional audit firms. Moreover, it also addresses the role of major stakeholders such as Australian Securities and Investment Commission (ASIC), the Financial Reporting Council (FRS), professional accounting bodies (ICAA and CPA), the Auditing and Assurance Standards Board (AASB), Audit Quality Review Board (AQRB) and other related legal and regulatory agencies. Lastly, it also points out the key findings in relation to Australia’s audit regulation framework of audit quality, review processes followed, audit firms and its liabilities and factors outside the control of auditors.

  1. c) Major Findings

The major findings by the treasury relates to following areas as follows;

  • Australia’s audit regulation framework is in line with International Practice and is functioning effectively
  • Statutory Audit Directives period of five year is deemed to be appropriate as it serves a balance between continuity, the familiarity threat and audit quality unless the same change has been incorporated by Canada, the UK and the US
  • Regulatory bodies such as ASIC, APRA etc continues to monitor future developments resulting from global financial crisis. In addition, other stakeholders should need to take initiatives for improving audit quality
  • ASIC program is in line with best practices of overseas bodies of developed economies and its inspection reports duly identify areas which need improvement including audit documentation
  • The completion of the three-year charter of the Audit Quality Review Board (AQRB) will result in reduction in the firm’s compliance burden
  • A strong ethical culture of honesty and integrity in Australian’s firms is in place.
  • Emphasized particular focus on audit quality through compliance based approach and ASIC’s proactive audit inspection program.
  • Amendment in Corporation Act by incorporating Quality Control Reports as in EU’s Statutory Audit Directive.
  • Audit partners and staff should possess skills and expertise and excellent personal attributes
  • The auditors should exercise professional judgment and must comply with all the accounting standards and legal framework (Corporations Act)
  1. d) The profession’s ICAA and CPA response to the report

The professional bodies ICAA and CPA have duly supported and endorsed the report as they themselves are continually monitoring auditing firms through quality control programs and professional conduct and code of ethics (issued by APESB) including ensuring that their members are compliant with auditing, accounting and assurance standards.

  1. e) Benefits

Yes, certainly this type of report is beneficial to the auditor, the auditing profession and the society as a whole because it not only serves as a basis for improvement in the quality of the audit process but simultaneously it also safeguards the auditor and creates awareness to general public about the possible misconception of the auditor regarding fraud and detection of material misstatement for which the primary responsibility rests with management. For auditors, it specifically prescribes to comply with the requirements of the standards on quality control and annual review of independence check to safeguard their own interest. It will eventually save the auditor from possible repercussions.

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