Materiality Determination and Audit Scope
The main aim of this assignment is to gain understanding about the audit procedures of Woodside Petroleum Limited (WPL) in order to review the materiality that the auditors are needed to consider in the detection of material misstatements in the financial reports. Materiality is a crucial concept for audit scope and helps the auditors in considering the fact that which misstatements are major and which misstatements are minor as they can have significant effects on the company financials (Legoria, Melendrez & Reynolds, 2013). The auditors judge the significant missstements based on the level of materiality and the process as well as level of impact of these aspects on the decision-making process of the investors and others users of the financial reports. WPL is one of the leading energy companies having operation in the Australian regions (Woodside.com.au, 2018).
Materiality is a major fundamental concept of auditing as it is needed for the auditors to take into account the material aspects and whether the managements of the companies have correctly reported them or not. In order to set the materiality level of business, the auditors are needed to apply their materiality judgment. The auditors of the companies consider both the qualitative and quantitative characteristics as the basis for determining materiality (Christensen, Glover & Wood, 2013). Under the qualitative dimension of materiality, the auditors consider the factor like business inventory, net profit, changes in the accounting methods along with major accounting policies. Under the dimension of quantitative aspect of materiality, the auditors take into consideration the estimated percentage that needs to be charged at appropriate basis for the determination of level of materiality for financial items of the annual reports of the companies. It depends on the judgment of the auditors to consider the percentage that needs to be charged for the determination of materiality level; and the auditors are needed to consider the size as well as nature of the business organizations. In the initial stage of audit planning, the auditors consider the computation of materiality; after that, the auditors consider the computation of materiality of different financial items after the materiality determination in the initial stage (Eilifsen & Messier Jr, 2014). Thus, the above discussion indicates towards the importance of materiality computation in the auditing process.
Under the estimation of materiality in quantitative basis, the auditors need to consider different materiality base for the planning of materiality and the materiality of business performance. At the time to consider different bases for materiality, the auditors are needed to take into consideration significant items from the Profit or Loss statement as well as balance sheet of the entities (Ruhnke & Schmidt, 2014). According to the Profit or Loss statement, the considered bases for materiality determination are net profit before tax, total revenue and total sales or revenue. In the balance sheet, the considered base for materiality is total assets of the businesses (Ruhnke, Pronobis & Michel, 2014).
The 2017 Annual Report of WPL is taken into consideration in order to estimate the materiality level of the business for the year of 2017. It can be seen from the 2017 Annual Report of WPL that there has been major drop in the operating revenue of the company. At the time of the determination of the level of materiality, the common practice is to consider the highest value as the base for the determination of materiality (Edgley, 2014). In case of WPL, the total asset of the company is considered as the base of materiality determination and the value of total asset in 2017 Consolidated Statement of Financial Position is $25,401 million (Woodside.com.au, 2018). After that, 5% is considered as he percentage that needs to be charged for the purpose of materiality determination. The computation can be seen in below:
Draft Notes and Disclosure Review
Planning Materiality = 5% of the Total Assets
= 5% of $25,401 million = $ 1,270.05 million
The draft notes and the disclosures in the 2017 Annual Report of WPL have major importance in the audit procedures of the company as it includes certain accounting treatments along with explanations of some crucial aspects of the financial statements. The following are some significant items in the drafts that can have impact on the audit process of WPL:
Leases: It can be seen from the notes of leases that the company has segregated their leases between finance leases and operating leases as per the regulation of AASB 117 Leases. However, from the year 2018, the companies are needed to comply with the new lease standers AASB 16 Leases that will eliminate the segregation of leases as operating and finance leases. For this reason, the auditors can check lease balances of WPL for finding any manipulation (Woodside.com.au, 2018).
Contingent Liabilities: Contingent liability is a part of the financial activities of WPL that is full of uncertainty; and there is not any accounting base for the determination of the contingent liabilities. 2017 Annual Report of WPL states that US$66 million is the amount of contingent liabilities of WPL in 2017. Due to uncertainty, the auditors can look into this matter to get the confirmation (Woodside.com.au, 2018).
Dividend: WPL has provide the break-up of the payment of dividend for the year 2017 and the company declares dividend based on their business profitability. This particular aspect creates scope for the presence of manipulation or fraud in the dividend payment and declaration. For this reason, the auditors of WPL can consider reviewing the dividend payment of WPL (Woodside.com.au, 2018).
At the time to conduct the audit operations, the auditors adopt the technique of analytical review that includes the computation as well as analysis of major financial ratios from different business dimensions, In case of WPL, the considered rations cover the areas like liquidity, profitability, asset management, leverage and valuation. The following discussion shows the analysis of the ratios of WPL for four years from 2014 to 2017:
| Woodside Petroleum Limited (WPL) | ||||
| Liquidity Ratios | ||||
| Particulars | 2014 ($m) | 2015 ($m) | 2016 ($m) | 2017 ($m) |
| Current Assets | 4,042 | 1,079 | 900 | 1,013 |
| Current Liabilities | 1,941 | 1,304 | 963 | 1,088 |
| Current Ratio | 2.08 | 0.83 | 0.93 | 0.93 |
| Particulars | 2014 ($m) | 2015 ($m) | 2016 ($m) | 2017 ($m) |
| Total Current Assets | 4,042 | 1,079 | 900 | 1,013 |
| Less: Inventories | 247 | 170 | 149 | 186 |
| Quick Assets | 3,795 | 909 | 751 | 827 |
| Current Liabilities | 1,941 | 1,304 | 963 | 1,088 |
| Quick Ratios | 1.96 | 0.70 | 0.78 | 0.76 |
| Particulars | 2014 ($m) | 2015 ($m) | 2016 ($m) | 2017 ($m) |
| Current Assets | 4,042 | 1,079 | 900 | 1,013 |
| Less: Current Liabilities | 1,941 | 1,304 | 963 | 1,088 |
| Net Working Capital | 2,101 | -225 | -63 | -75 |
The major liquidity ratios of WPL are current ratio, quick ratio and working capital. Major decrease in the current ratio of the company can be seen over the year that is 2.08 in 2014 to 0.93 in 2017. It indicates towards the fall in the liquidity position of the company. Thus, the auditor of WPL is needed to consider the application of verification procedure for verifying the value of the current assets and liabilities. Similarly, there is also decrease in the quick ratio of WPL that is also related to the liquidity position of WPL. Moreover, the auditor is needed to consider the massive decrease in net working capital of WPL as it can lead to major liquidity risk. Hence, the auditor can verify the value of the current assets and liabilities for ensuring true and fair view (Van Den End & Kruidhof, 2013).
| Profitability Ratios | ||||
| Particulars | 2014 ($m) | 2015 ($m) | 2016 ($m) | 2017 ($m) |
| Gross Profit | 4,552 | 1,957 | 1,841 | 1,945 |
| Sales | 7,435 | 5,030 | 4,075 | 3,908 |
| Gross Profit Margins | 61.22 | 38.91 | 45.18 | 49.77 |
| Net Profit | 2,516 | 113 | 973 | 1,120 |
| Sales | 7,435 | 5,030 | 4,075 | 3,908 |
| Net Profit Margin | 33.84 | 2.25 | 23.88 | 28.66 |
| Net Income | 2,516 | 113 | 973 | 1,120 |
| Average Assets | 23,926 | 23961 | 24296 | 25077 |
| Return on Assets | 10.52 | 0.47 | 4.00 | 4.47 |
| Net Income | 2,516 | 113 | 973 | 1,120 |
| Shareholders Equity | 16,659 | 15,025 | 15,662 | 15,880 |
| Return on Equity | 15.10 | 0.75 | 6.21 | 7.05 |
Financial Statement Analytical Review
The above table shows that there is decrease in both the gross profit margin and net profit margin from 2014 to 2017. The main reason or the decrease in these profit margins is the decrease in the revenue of WPL and the management of WPL does not have control on the expenses. Return on assets and return on equity are the indicators of financial performance and both these ratios registered drop in 2017 as compared to 2014. Decrease in revenue and profit can be the reason of this. For this reason, the auditor needs to consider checking both the cash and credit sales figures in order to ensure that the profit is not understated. After that, the auditor is needed to consider applying the vouching procedure for checking the viability of expenses. Moreover, the auditors can use external confirmation in order to determine the expenses (Ogiela & Ogiela, 2014).
| Asset Management Ratios | ||||
| Particulars | 2014 ($m) | 2015 ($m) | 2016 ($m) | 2017 ($m) |
| Cost of goods sold | 2,883 | 3,073 | 2,234 | 1,963 |
| Average Inventory | 219.5 | 208.5 | 159.5 | 167.5 |
| Stock Turnover | 13.13 | 14.74 | 14.01 | 11.72 |
| Particulars | 2014 ($m) | 2015 ($m) | 2016 ($m) | 2017 ($m) |
| Sales | 7,435 | 5,030 | 4,075 | 3,908 |
| Average Net Fixed Assets | 20457.5 | 21400 | 23306.5 | 24120.5 |
| Fixed Asset Turnover | 0.36 | 0.24 | 0.17 | 0.16 |
| Particulars | 2014 ($m) | 2015 ($m) | 2016 ($m) | 2017 ($m) |
| Sales | 7,435 | 5,030 | 4,075 | 3,908 |
| Average Total Assets | 23,926 | 23961 | 24296 | 25077 |
| Total Asset Turnover | 0.31 | 0.21 | 0.17 | 0.16 |
The above table shows decrease in the ratios of stock turnover, fixed asset turnover and total asset turnover. The auditor is needed to consider the business inventories of WPL due to their vulnerability to material misstatements. Moreover, the assets of the company are also prone to material missstements. Hence, the auditor of WPL needs to consider the physical count of inventory for verifying the amount of inventory. At the same time, the auditor is needed to consider the verification of the assets in order to ascertain whether the management of WPL has adopted the appropriate asset valuation method (Malkiel, 2013).
| Leverage Ratios | ||||
| Particulars | 2014 ($m) | 2015 ($m) | 2016 ($m) | 2017 ($m) |
| Total Debt | 5,482 | 7,510 | 8,128 | 8,433 |
| Total Assets | 24,082 | 23,839 | 24,753 | 25,401 |
| Debt Ratio | 0.23 | 0.32 | 0.33 | 0.33 |
| Particulars | 2014 ($m) | 2015 ($m) | 2016 ($m) | 2017 ($m) |
| Long Term Debt | 1,957 | 4,364 | 4,897 | 4,989 |
| Total Equity | 16,659 | 15,025 | 15,662 | 15,880 |
| Debt – Equity Ratio | 0.12 | 0.29 | 0.31 | 0.31 |
| Particulars | 2014 ($m) | 2015 ($m) | 2016 ($m) | 2017 ($m) |
| Net Debt | 5,482 | 7,510 | 8,128 | 8,433 |
| Total Equity | 16,659 | 15,025 | 15,662 | 15,880 |
| Total Capital | 22,141 | 22,535 | 23,790 | 24,313 |
| Gearing Ratio | 25% | 33% | 34% | 35% |
The analysis of this ratios help the auditors to gain understanding whether WPL is using debt or equity or both for financing. The above table shows increase in the debt ratio for WPL that indicates the increase in debt or term loans in the debt structure. At the same time, increase in debt-to-equity ratio also indicates the use of borrowings by WPL. Thus, the auditor of WPL needs to involve himself/herself in assessing the risk associated with debt capital. In addition, the auditor is needed to verify whether the debts are correctly stated in the financial statements or not (Kiema & Jokivuolle, 2014).
| Valuation Ratios | ||||
| Particulars | 2014 ($m) | 2015 ($m) | 2016 ($m) | 2017 ($m) |
| Market Price per share | 37.51 | 28.34 | 30.75 | 32.65 |
| Earnings per Share | 293.4 | 3.2 | 104 | 121.8 |
| Price / Earnings ratio | 0.13 | 8.86 | 0.30 | 0.27 |
| Particulars | 2014 ($m) | 2015 ($m) | 2016 ($m) | 2017 ($m) |
| Dividend per Share | 2.55 | 1.09 | 0.83 | 0.98 |
| Market Price per share | 37.51 | 28.34 | 30.75 | 32.65 |
| Dividend Yield | 6.80 | 3.85 | 2.70 | 3.00 |
It can be seen from the above table that there is increase in price earnings ratio in 2017 as compared to 2014 that indicates the development of the business of WPL. However, decrease can be seen in the dividend yield of the company. Hence, the auditor is needed to verify both the earnings per share and dividend payment of the company in order to find any kind of manipulation in them (Brooks & Mukherjee, 2013).
It can be seen from the 2017 Annual Report of WPL that the cash flow from operating activities has generated the greatest cash inflow in 2017 that is $2400 million. At the same time, the cash flow from investing activities has the greatest cash outflow that is ($1568 million) in 2017 (Woodside.com.au, 2018). As per the cash flow statement, the primary cash receipts are interest received and dividends received and PRRT received. The primary cash payments during the year are purchase of share, payment of income tax and payment for restoration. As per 2017 Annual Report of WPL, the main non-cash financial and investing activities are payment for capital and exploration expenditures, borrowing costs, proceeds from borrowings, repayment of borrowings, payment of dividend, contributions to non-controlling interest and others (Woodside.com.au, 2018).
Key Audit Concerns and Procedures
The going concern assumption is considered as a fundamental principle for the businesses and it is needed for the auditor of WPL to report any factor that can affect the going concern status of the business of WPL. The analysis of the liquidity position of WPL states that there is major decrease in the liquidity rations of WPL and it is a negative sign for the company (Blay & Geiger, 2013). Moreover, there is fall in the level of profit of the company along with the increase in the operating expenses. At the same time, there is increase in the debt risk of WPL due to the increase in debt capital in the capital structure. All these negative aspects indicates towards the fact that the going concern status of WPL can be in danger due to drop in some of the major financial parameters. For this reason, it is needed for the auditor of WPL to provide the company with the advices for bringing improvements in the liquidity and profitability position and to put more reliance on the equity share capital in the debt structure (Sundgren & Svanström, 2014).
It can be seen from the 2017 Annual Report of WPL that Ernst & Young (EY) was the audit partner of WPL for the year 2017. After the examination of the financial statements of WPL, EY has provided the opinion that the financial statements of the company provided the true and fair view of the financial position of their business. Moreover, EY has also provided the opinion that WPL has conducted their accounting operations by complying with the principles of Australian Accounting Standards and the Corporations Regulations 2001 (Woodside.com.au, 2018).
In the audit report of WPL, EY has mentioned about two audit issues that they have considered as the Key Audit Matters. The first issue is related to the impairment of non-current assets and the auditor has used the assessment evaluation process to reduce them. The next issue is related to the accounting for petroleum resources rent tax assets and EY has used the application of judgment for reducing this risk (Woodside.com.au, 2018).
References
Blay, A. D., & Geiger, M. A. (2013). Auditor fees and auditor independence: Evidence from going concern reporting decisions. Contemporary Accounting Research, 30(2), 579-606.
Brooks, R., & Mukherjee, A. K. (2013). Financial management: core concepts. Pearson.
Christensen, B. E., Glover, S. M., & Wood, D. A. (2013). Extreme estimation uncertainty and audit assurance. Current Issues in Auditing, 7(1), P36-P42.
Edgley, C. (2014). A genealogy of accounting materiality. Critical Perspectives on Accounting, 25(3), 255-271.
Eilifsen, A., & Messier Jr, W. F. (2014). Materiality guidance of the major public accounting firms. Auditing: A Journal of Practice & Theory, 34(2), 3-26.
Kiema, I., & Jokivuolle, E. (2014). Does a leverage ratio requirement increase bank stability?. Journal of Banking & Finance, 39, 240-254.
Legoria, J., Melendrez, K. D., & Reynolds, J. K. (2013). Qualitative audit materiality and earnings management. Review of Accounting Studies, 18(2), 414-442.
Malkiel, B. G. (2013). Asset management fees and the growth of finance. Journal of Economic Perspectives, 27(2), 97-108.
Ogiela, L., & Ogiela, M. R. (2014, September). Data mining and semantic inference in cognitive systems. In Intelligent Networking and Collaborative Systems (INCoS), 2014 International Conference on (pp. 257-261). IEEE.
Ruhnke, K., & Schmidt, M. (2014). Misstatements in financial statements: The relationship between inherent and control risk factors and audit adjustments. Auditing: A Journal of Practice & Theory, 33(4), 247-269.
Ruhnke, K., Pronobis, P., & Michel, M. (2014). Audit materiality disclosures and credit lending decisions.
Sundgren, S., & Svanström, T. (2014). Auditor?in?charge characteristics and going?concern reporting. Contemporary Accounting Research, 31(2), 531-550.
Van Den End, J. W., & Kruidhof, M. (2013). Modelling the liquidity ratio as macroprudential instrument. Journal of Banking Regulation, 14(2), 91-106.
Woodside. (2018). Annual Report 2014. Retrieved 30 August 2018, from https://www.woodside.com.au/Investors-Media/announcements/Documents/18.02.2015%202014%20Annual%20Report.pdf
Woodside. (2018). Annual Report 2015. Retrieved 30 August 2018, from https://www.woodside.com.au/Investors-Media/announcements/Documents/17.02.2016%202015%20Annual%20Report.PDF
Woodside. (2018). Annual Report 2017. Retrieved 30 August 2018, from https://woodsideannouncements.app.woodside/14.02.2018+Annual+Report+2017.pdf
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