Table of Contents
Evaluating KAM and material misstatement risk for Wesfarmers:
Accounting for demerger of Coles –.
Impairment of non-current assets –.
Rebate to suppliers –.
AASB 16 Leases:
The report strives to focus on the aspect of ASA701 regarding the independent role of the auditors appointed to audit the financial reports of the organisation. In this context, the report would take the relevance of the ASX 100 listed company like Wesfarmers. So the report would go through the annual report of the company for 2019 and evaluate its financial avenues which might lead to material misstatement risks. It would also collaborate on the aspect of auditor’s judgement on important financial transactions that could lead to gross financial misconduct in the business scope of Wesfarmers. It also goes through the concepts that risk Wesfarmers of its going concern identity as per ASA 570. So the report would take relevance of ASA 570 extracting financial data from the recent annual report of Wesfarmers to evaluate its material misstatement risks.
The auditing standard ASA 701 deals with ‘Communicating the Key Audit Matters (KAM) in the Report of the Independent Auditors’. The purpose of the legislation is to communicate effectively with the auditor and reporting the KAM in the auditor’s report (Legislation.gov.au, 2015). The auditor evaluates the matter in context to governance posing their significant attention to corporate governance issues of Wesfarmers. It also facilitates in consideration of the higher risk areas requiring critical analysis and judgement of the auditor. In this regulation, it is the utmost judgement of the auditor about the inclusion of the matter and things that do not need reporting.
ASA 570 is concerned with the Going Concern concept of the organisation stating the responsibility of the auditors upholding and maintaining its going concern entity (Auasb.gov.au, 2015). The going concern in accounting stands for the fact that the financial reports of the company would be prepared in the manner upholding its business flow in the upcoming years as well. So organisations like Wesfarmers would take relevance to the General Purpose Financial Reports (GPFR) for preparing its financial reports unless it decides to liquidate itself. It indicates that the assets and liabilities of Wesfarmers would be recorded as a normal flow of business to be continued in the next year also (Legislation.gov.au, 2019). In this context, the responsibility of the auditors is to ensure that the business has an efficient arrangement to record the financial transactions upholding its going concern accounting approach.
ASA 315 is concerned with the Identification and Assessment of the Risks of Material Misstatement about the responsibility of the auditors to recognise and evaluate such risks expressed through the financial reports. The auditing standard conveys to perform risk evaluation mechanisms to have an understanding of the business and its environment with due consideration of its internal control process (Legislation.gov.au, 2016). The auditor would engage in relevant discussions with the stakeholders to find out the aspects of material misstatement or probability of frauds and risks in the process. He would also go through the internal audit functions to find out the relevance of the auditing process throughout the preparation of the financial records (Diouf & Boiral, 2017). In this regard, the responsibility of the auditor is to locate and evaluate the sorts of risks that could lead to material misstatement and use his judgement to find out the level of risks.
Wesfarmers Limited is the Perth based Australian Conglomerate Company having diversified business interests in fertilisers, coal mining, chemicals, and industrial and safety products across Australia and New Zealand. It is the biggest company in terms of revenue earning worth $66 billion in 2016 surpassing BHP and Woolworths Limited (Our businesses, 2020). The leading retail conglomerate is the biggest Australian employer recruiting around 220,000 staff and listed in the Australian Securities Exchange, a component of the ASX Top 100 listed companies.
The instance of Wesfarmers is taken to evaluate its KAM and incidence of material misstatement risk from the company’s latest annual report of 2019. Ernst & Young (EY) shouldered the auditing task of Wesfarmers and was responsible for evaluating the KAM. It required important judgements on various changes that affected the company such as its demerger with Coles (Legislation.gov.au, 2019). So it was the task of the auditor to see that the auditing standards concerning the business dealings have been well-maintained throughout the process.
KAM in the auditing process of the organisation requires effective judgments on part of the auditor. This is because it shows the level of discretion applied by the auditors to determine the material misstatement risk that the organisation is vulnerable to considering the audit process and opinion on such issues. Accordingly, the KAM for Wesfarmers are as follows:
1. Accounting for demerger of Coles –
Wesfarmers demerged with Coles Group Limited in November 2018 which led the organisation to retain its 15% controlling interest. Based on Discontinued Operations, Wesfarmers realised a gain of $2.26 billion post-tax revenue due to the demerger (Ato.gov.au, 2019). So there lies plausible instance of a material misstatement by Wesfarmers requiring the effective judgement of the auditors on the matter due to gain of a huge financial amount. Again, Wesfarmers being a leading player in the market poses due influence on Coles which ought to be determined by the auditors. It requires effective judgement by the auditor as Wesfarmers possess an ownership interest on Coles holding equity stakes worth $2.7 billion as on 30th June 2019.
Response of the auditors regarding KAM:
The auditor would go through the vivid details of the demerger process of Wesfarmers and Coles to understand the terms and conditions regarding such business dealings. The auditor is required to see the determination process of the gains of Wesfarmers and its influence on Coles during the last financial year when the demerger took place (Hay, et al., 2017).
The auditor also plays a distinctive role in determining the demerger value and tallying with the actual gain by the company. In this context, the auditor needs to see whether the book value or fair value of the firm has been considered along with the carrying worth of the business on the demerger date (Ulrich & Blouch, 2018). The auditor would also evaluate the transaction expenses incurred for the purpose as it has higher instances of material misstatement in the process.
The assessment process of the assets and liabilities of the organisation during the demerger process is also subjected to the wide discretion of the auditors. It is up to the auditors to evaluate the correct mechanism of operating outcome recorded on the demerger process keeping aside instances of foul play.
The tax implications of the demerger are to be evaluated by a tax specialist for the purpose of the demerger. In this regard, the auditor could seek help from an external source having the requisite tax expertise enabling the auditors to understand its implications during demerger (Ato.gov.au, 2019).
The equity valuation of Coles is also significant for the auditors which ought to be in alignment with the profits and reserves held by the company during its demerger (Groomer & Murthy, 2018). In this context, the auditors go through the audited financial reports of Coles as well to find out any sort of misleading information in its due process. The aspect of assets impairment with respect to the market worth of the company and its accounting practices also needs to be evaluated to ensure that proper auditing standards were abided for the purpose. So the auditor has to go through the disclosures of the financial reports ensuring that it has been contemplated by both the Wesfarmers and Coles as per the Australian Accounting Standards.
2. Impairment of non-current assets –
It is a significant aspect for the audit team to ascertain the worth of the recoverable values of property, plant, and equipment (PPE), along with goodwill, and other intangible resources held by the company. It is the responsibility of the auditors to assess the impairment process for goodwill and other intangibles in tune with the Australian Accounting Standards (Bond, et al., 2016). This kind of evaluation is required because impairment determination is a complicated matter and the auditors are required to apply suitable judgement and various modelling range to ascertain those values. The decision-making of the auditors ought to be in alignment with the prevailing market conditions and sustainability of Wesfarmers in the upcoming future as well (Zhuang, 2016). So the auditor has to apply effective judgment and guesses while determining the cash-generating units (CGUs) of Wesfarmers extracted from its Industrial and Safety items.
Response of the auditors regarding KAM:
The auditors undertook an evaluation approach for the purpose of assessing the CGUs. It is also applicable for the projection of items like the organisational growth, cash flows, rate of discounts, relative valuation of industrial multiples, and various market instances. The auditors in this context, take assistance from the valuation specialist to determine the key inputs of business related to impairment tests of the non-current assets for Wesfarmers (Dlamini, et al., 2017). In this way, the discount rates, terminal rate of growth, long-term inflation and growth prospects, and industrial valuation multiples would be determined. The auditors take due relevance of the financial disclosures available in the financial report for impairing its non-current resources serving the purpose of testing, sensitivity analysis, and crucial expectations (Ulrich & Blouch, 2018).
3. Rebate to suppliers –
The kinds of rebate received by the companies like Wesfarmers for its retail operations are to be adjudged efficiently. It is because the retailer has impeccable scope to exploit the figures for serving its narrow purpose (Messier & Schmidt, 2018). Accordingly, the auditors need to adjudge the commercial terms and conditions of each of the rebates that Wesfarmers received in the business process. The sort of rebate received by Wesfarmers is required to be determined by the auditors and its treatment while consideration of the carrying worth of the inventories for recording in the income statement. The identification and determination of the rebates ought to be in tune with the Australian Accounting Standards and its internal control expertise to guide in a suitable direction.
Response of the auditors regarding KAM:
As per the KAM mechanism, the auditors goes through the detailing of the suppliers’ terms and conditions with Wesfarmers to understand the agreement that unfolded between the parties. The phenomenon would enable the auditors to understand the dealings between Wesfarmers and its suppliers and note foul play, if any (Wang & Fargher, 2017). They would also refer to the internal control scenario prevalent in the organisational scenario of the retailer effective for identification and determination of such rebates offered to it. So the auditor undertake relative comparison of different kinds of rebate mechanism for the last year with consideration of factors like aging analysis of assets, identification of material variances to solve the matter at its best.
The auditor for the purpose of sampling considers a particular suppliers’ dealing going through its documentation for testing as applicable to identify and determine such items for the last financial year (Legislation.gov.au, 2015). For the purpose, a sampling of material new contracts are used by the auditors and evaluated its stance before and after preparation of the financial statements to see its effective treatment as per the auditing requirements. The auditors also consulted with the legal practitioners regarding usage of the suppliers’ contracts in tune with the acceptable terms and conditions of Wesfarmers. The auditor also sought explanation of the supply chain managers and procurement staff in this matter to find out if Wesfarmers are resorting to any sort of unfair business practices in the process (Diouf & Boiral, 2017).
4. AASB 16 Leases:
As per the Australian Accounting Standard, it is obligatory for the listed organisations like Wesfarmers to adopt the new leasing standards – AASB 16 Leases. This particular change in the accounting deliverance impacts the financials of the company considering its estimates and critical assumptions (Treasury.gov.au, 2020). This would be in terms of the leasing terms having extension options, solicitation of applied actions, exercise of incremental borrowing rates, and approximation of exclusive rates for non-lease factors.
Response of the auditors regarding KAM:
To ascertain the appropriate exercise of AASB 16, the auditors evaluated the determination process of the anticipation of auditing standards. Therefore, the auditors took relevance of the determination process of Wesfarmers through their judgement on the matter utilising the disclosures owing to AASB 16 in accordance with the accounting principles (Messier & Schmidt, 2018). The auditors also resorted to test sample lease contracts to see the application of Wesfarmers in terms of right-of-use resources and lease liabilities. It is to determine its tuning with the materiality concept with relevance to the contract conditions, accounting standards obligation (Wang & Fargher, 2017). This sort of arrangement are complying with the fixed and variable aspects of the leasing terms.
The auditors to ensure proficiency of the system also appraised the materiality of the lease conditions. They also ran discussions on the leasing agreements with the divisional property management team of Wesfarmers. It facilitated the audit team to have better understandings of the approximate lease terms and conditions along with the rats of the non-lease components (Diouf & Boiral, 2017). The auditors to ensure fairness on the matter shared data of the non-lease components to tally it with the third-party yardsticks as published by independent authorities. In this regard, the auditor consulted with the external debt and capital advisory specialists and actuary specialists to ensure fairness of the determination process of Wesfarmers (Hay, et al., 2017). For this, the auditors also considered the rates of incremental borrowings and the discount rates exercised for the future lease payments in tune with its present worth. The financial disclosures in the financial report of Wesfarmers are worthy to mention for ensuring clarity of the determination process.
The report shows that the auditor in the business process of Wesfarmers got adequate liberty to adjudge the financial reports and ensure its accuracy in tune with the KAM. The auditors went to a great length like matching the figures with the external benchmark, consultation with independent experts to have their perception on the matter. So in the business scenario of Wesfarmers, the auditors applied a range of tests, judgement, and assumptions to ensure that the accounting and auditing standards are well-maintained. This phenomenon would encourage the stakeholders to continue their investment with the retailer and encourage new investors to consider Wesfarmers for the purpose. The auditor considered the various KAM like demerger with Coles, leasing arrangements, impairment of non-current assets, and rebates offered by the suppliers which are plausible avenues of material misstatement. The auditors considered last year’s figure along with approximation for the future upholding its going concern concept. The report bears the testimony that Wesfarmers maintain a well-controlled business scenario in its process and the auditors also backed such claim through their evaluation.
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