Why Auditing & Assurance Services Are Required?

Industry analysis

Why Auditing & Assurance Services Are Required?

Auditors are required to analyse degree of assurance on the financial statement, operations of business entity and other environmental factors that affect business organization. It is the duty of auditor to identify, analyse and evaluate various types of risk that business organisation may or may not have. In this industry report, analysis of Australian retail industry has been undertaken. Retail industry of Australia covers all sort of environmental factors and there are various business firms that are operating in the same industry. Analysis of the industry is the prime requirement of initiating audit and assurance service. Level of and types of inherent risks, that industry has an impact business entities has been analysed in this report. Myer Pty Ltd is the business organisation that has been taken for the analysis in this report. Analysis of Myer Pty Ltd includes health and financial check up for the purpose of audit and assurance services has been conducted. Ratio analysis has been used for the purpose of analysing inherent risk present in Myer Pty Ltd’s financial and operational functions.

Consumer goods retailing industry is the industry that has been examined and assessed. There are various factors and situation that are present in the industry and make industry complex. Retail sector in Australia has been growing at great phase and integration of e-commerce and retail business industry has resulted in rising growth graphs. Retail industry in Australia has shown great amount of growth and development in recent past years. Internet retailing is the emerging trend in the Australian retail industry or sector. It has been reported that, sales through online or internet has outperformed store based sales. On the other hand, Australian retail industry also shown low level of growth rate for its participants i.e. business organisations (Grimm & Blazovich, 2016). Australian retail industry has been impacted from both macro economic factors and micro environmental factors. But technological environmental factor in terms of developments taken place in information technology has impacted retail industry or in other words supported Australian retail industry to a great level. At micro environmental level, less entry barriers and high level of competition is the key element of Australian retail industry.

Myer Pty ltd is engaged in business operations of retailing of consumer goods or products. Myer Pty ltd is one of the largest departmental chains operating business in Australia and covered most of the part of Australia. Myer Pty ltd has been in the business of retailing products like clothing’s, footwear, accessories, cosmetics, electrical appliances, furniture, beddings, books, stationeries, etc. There is vast range of business products that Myer Pty ltd operates. Myer Pty ltd is the product of disinvestment strategy of Coles Group and later on purchased by Wesfarmers limited. But after few years, Myer Pty ltd has been emerged as separate legal entity. Myer Pty ltd has been conducting business operations in many location of Australia i.e. Queensland, Tasmania, Victoria and New South Wales, and has been able to reach its customers very effectively. With the growing demand of e-commerce, Myer Pty ltd has also developed e-shopping site for their customers (Myer Pty Ltd Annual Report, 2016). In 2011, Myer Pty ltd has launched their online website or e-commerce platform for their customers to interact and shop from there.  

Company brief

Ratio analysis is the technique that is used to analyse and evaluate state of financial position and financial performance of the business organisation. There are four major types of ratios categories that are used to analyse and evaluate inherent risk present in the business operations. For the purpose of ratio analysis of Myer Pty Ltd, financial statements i.e. income statement,  statement of financial position, cash flow statement and statement showing change in equity has been used and analysed (Karanovic, Bogdan & Baresa, 2010). Following are different type of ratios that are used in identifying inherent risk in business operations of Myer Pty Ltd:

Current ratio = Current assets ÷ Current liabilities

2016 = 479,738 / 520,585 = 0.92 times

2015 = 480,804 / 481,389 = 0.999 times

Quick ratio = Quick asset ÷ Current liabilities

Quick asset = Current assets – (Inventories + prepaid expenses)

2016 = $ 479,738 – ($ 396,297 + $ 8,939) / $ 520,585

 2016 = $ 74,502 / $ 520,585 = 0.143 times

2015 = $ 480,804 – ($ 381,907 + $ 16,780) / $ 481,389

2015 = $ 82,117 / $ 481,389 = 0.171 times

Particulars	2016	2015
Current ratio	0.92 times	0.99 times
Quick ratio	0.143 times	0.171 times

Liquidity ratio is used to analyse liquidity position and working capital management capabilities of the business organisation. Before starting of audit planning and procedure, it is very much important for the auditor to analyse liquidity of the business organisation. If liquidity position is good then is less possibility of material misstatement in financial statements of the business organisation. In case of Myer Pty Ltd, liquidity in business operations has reveal less efficiency and management or Myer Pty Ltd is available with fewer current assets to pay off current obligations. With the help of liquidity ratio, assessment of working capital management can be done and limiting factors can be identified (Oke & Gopalakrishnan, 2009).

For this purpose, we have used current ratio and quick ratio. Current ratio analysis is taken between current assets and current liabilities. Current ratio of Myer Pty ltd reflects weak liquidity position and less effective working capital management. In both the years, Myer Pty ltd has not able to maintain adequate level of current assets or liquidity to pay off current obligations. On the other hand, quick ratio has been used to analyse deeper working capital position. Results of quick ratio are adverse in terms of actual cash and cash equivalents available for current obligation. Therefore this shows inheres risk of liquidity that Myer Pty ltd possess or has in its working capital.

Analysis of Myer Pty Ltd

In order to analyse profitability of the Myer Pty ltd or in other words financial performance of Myer Pty ltd can be analysed with the help of profitability ratios. Profitability ratio is effective tool to analyse inherent risk present in the profit earning capacity of the business organisation. There are 3 major types of profitability ratio i.e. gross profit ratio, net profit ratio and asset turnover ratio. All these ratios are used to analyse profit earning ability and trend in the same. In case of Myer Pty Ltd, their net profit earning capacity is at adverse side. This has hinted towards, inherent risk of inability of generating profits and in cost / expenses management of the Myer Pty Ltd. In both the years, their net profit margin is under 3 % and this has been proved to be adverse condition for Myer Pty Ltd. In this case, there will be financial inherent risk that auditor has to manage or mitigate (Wahlen & Wieland, 2011).

Business organisation is required to maintain adequate level of profitability in order to attract more investors and stakeholders in the business operations. Net profit margin has been at decline side and this can be because of overstatement of expenses or cost. According to industry in which Myer Pty Ltd operates, profitability is at higher side. Therefore this can be inherent risk that shall be considered during audit planning.

Gross profit margin = Gross profit ÷ Sales x 100

2016 = $ 1,274,291 / $ 2,679,015 x 100 = 47.57 %

2015 = $ 1,290,392 / $ 2,694,473 x 100 = 47.89 %

Net profit margin = Net profit ÷ Sales x 100

2016 = $ 60,543 / $ 2,679,015 x 100 = 2.26 %

2015 = $ 29,826 / $ 2,694,473 x 100 = 1.11 %

Asset turnover ratio = Total assets ÷ Sales x 100

2016 = $ 1,867,898 / $ 2,679,015 x 100 = 69.72 %

2015 = $ 1,886,548 / $ 2,694,473 x 100 = 70 %

Particulars	2016	2015
Gross profit margin	47.57 %	47.89 %
Net profit margin	2.26 %	1.11 %
Asset turnover ratio	69.72 %	70 %

Solvency in the business organisation is the state of maintaining and having control over business organisation. Solvency ratios are used for the purpose of risk assessment of the Myer Pty Ltd therefore these ratios are important to be considered here. In case of Myer Pty Ltd, debt / equity ratio suggest level or propos ate of debt and equity used in the supporting business operations of the Myer Pty Ltd. Debt / equity ratio identifies inherent risk in capital structure of the business organization. Debt to equity ratio reflects that in 2016, Myer Pty Ltd has under-utilised its debt capabilities and in 2015 Myer Pty Ltd has over-utilised its debt capacity. This denotes significant inherent risk in Myer Pty Ltd’s capital structure (Wahlen & Wieland, 2011). Financial leverage has been used for the purpose of analysing risk in using long term liabilities or debt as compared to equity i.e. internal fund. In order to analyse inherent risk involve in business operations of Myer Pty Ltd and for the assessment of risk in repayment, interest coverage ratio has been used. Interest coverage ratio shows fluctuation of in 2015 and 2016 years and therefore there is possibility of financial risk.

Ratio analysis

Debt / equity ratio = Total Debt ÷ Total equity

2016 = $ 760,133/ $ 1,107,765 = 0.686 times

2015 = $ 1,023,532 / $ 863,016 = 1.22 times

Financial leverage = Long terms liabilities ÷ Total equity

2016 = $ 239,548 / $ 1,107,765 = 0.089 times

2015 = $ 542,143 / $ 863,016 = 0.628 times

Interest coverage ratio = Interest expenses ÷ Earnings before interest and taxes

2016 = $ 95,236 / $ 15,447 = 6.17 times

2015 = $ 71,769 / $ 23,488= 3.06 times

Particulars	2016	2015
Debt / equity ratio	0.686 times	1.22 times
Financial leverage	0.089 times	0.628 times
Interest coverage ratio	6.17 times	3.06 times

Efficiency ratio has been used for the purpose of analysed risk involved in activities that Myer Pty Ltd undertakes in normal course of business. Receivables turnover, inventory turnover and cash conversion cycle has been used making assessment of risk involve in business operations of Myer Pty Ltd. Efficiency ratio of Myer Pty Ltd revels that there is risk involve in operational capacity or activities of Myer Pty Ltd. Cash conversion cycle is used to analyse period of time within which cash is cycled by the business entity. In other words, in the year 2016 their cash conversion cycle has been increased and this has impacted their liquidity position. Working capital management risk has been evolved in this case and hence leads to higher inherent audit risk. Receivables period is the reflection of the higher inherent risk as it is at higher side.

Receivables turnover = Credit sales during the month ÷ accounts receivables

2016 = $ 2,679,015 / $ 30,490 = 180.90 days

2015 = $ 2,694,473 / $ 14,894 = 180.90 days

Inventory turnover = Cost of goods sold ÷ Inventory

2016 = $ 1,527,552 ÷ 396,297 = 3.85 days

2015 = $ 1,495,382 / 381,907 = 3.92 days

Cash conversion cycle = Days sales outstanding + Inventory days – Payable period

2016 = Days sales outstanding (2.79 days) + Inventory days (92.97 days) – Payable period (45.43 days) = 50.34 days

2015 = Days sales outstanding (2 days) + Inventory days (92.59 days) – Payable period (48.23 days) = 46.36 days

Particulars	2016	2015
Receivables turnover	87.86 days	180.90 days
Inventory turnover	3.85 days	3.92 days
Cash conversion cycle	50.34 days	46.36 days

Return on equity = Net profit margin x Total asset turnover x Financial leverage

2016 = Net profit margin (2.26 %) x Total asset turnover (69.72 %) x Financial leverage (2.18)

2016 = 0.0226 x 0.6972 x 2.18 = 3.44 %

2015 = Net profit margin (1.11 %) x Total asset turnover (70 %) x Financial leverage (1.69)

Liquidity ratio

2015 = 0.0111 x 0.70 x 1.69 = 1.31 %

In order to observe earning for shareholders, return on equity is used to analyse the same. Equity shareholders are concerned about return on equity share capital or on their investments. DuPont analysis examines return on equity on extended basis. DuPont analysis is used to analyse return on equity that business organisation has earned and provided basis of decision making to the investors. DuPont analysis undertakes financial leverage, net profit ratio and total asset turnover ratio into account in calculation and decision-making process. In present case of  Myer Pty ltd, DuPont analysis has shown average return for equity shareholders.

Statement showing vertical analyses of income statement of Myer Pty Ltd for the year ended 2015 and 2016:

Particulars	2016	2015	change (amount)	change %
Sales Revenue	$ 2,640,154	$ 2,654,351	$ -14,197	-0.53%
Operating revenue	$ 161,689	$ 131,423	$ -30,266	-23.03%
Cost of goods sold (COGS)	$ -1,527,552	$ -1,495,382	$ 32,170	-2.15%
Operating or Gross Profit	$ 1,274,291	$ 1,290,392	$ 16,101	1.25%
Income (Other)	$ 71	$ 108	$ 37	34.26%
Selling-expenses	$ -842,217	$ -828,906	$ 13,311	-1.61%
Administration-expenses	$ -318,039	$ -328,138	$ -10,099	3.08%
Equity accounted associate	$ -620	$ 0	$ 620	620.00%
Strategic review expenses	$ -18,250	$ -61,687	$ -43,437	70.42%
EBIT (Earnings before Interest and Tax)	$ 95,236	$ 71,769	$ -23,467	-32.70%
Finance revenue	$ 906	$ 753	$ -153	-20.32%
Finance costs	$ -15,447	$ -23,488	$ -8,041	34.23%
Net finance costs	$ -23,488	$ -22,735	$ 753	-3.31%
Profit before income tax	$ 80,695	$ 49,034	$ -31,661	-64.57%
Income tax expense	$ -20,152	$ -19,208	$ 944	-4.91%
Profit for the period	$ 60,543	$ 29,826	$ -30,717	-102.99%

(Bisogno, Santis & Tommasetti, 2015)

Particulars	2016	Percent	2015	Percent	Change (amount)	Change in %
ASSETS
Current assets
Cash and cash equivalents	$ 45,207	2.42 %	$ 53,323	2.83 %	$ -8,116	-15.22 %
Trade receivables and prepayments	$ 37,883	2.03 %	$ 30,363	1.61 %	$ 7,520	24.77 %
Inventories	$ 396,297	21.22 %	$ 381,907	20.24 %	$ 14,390	3.77 %
Derivative instruments	$ 351	0.09 %	$ 15,211	0.81 %	$ -14,860	-97.69 %
Total current assets	$ 479,738	25.68 %	$ 480,804	25.49 %	$ -1,066	-0.22 %
Non-current assets
Property, plant and equipment	$ 445,379	23.84 %	$ 469,006	24.86 %	$ -23,627	-5.04 %
Intangible assets	$ 904,171	48.41 %	$ 916,108	48.56 %	$ -11,937	-1.30 %
Deferred tax assets	$ 27,056	1.45 %	$ 18,016	0.95 %	$ 9,040	50.18 %
Derivative financial instruments	$ 80	0.004 %	$ 0		$ 80	80 %
Investment in associate	$ 9,203	0.49 %	$ 0		$ 9,203	9230 %
Other non-current assets	$ 2,271	0.12 %	$ 2,614	0.14 %	$ -343	-13.12 %
Total non-current assets	$ 1,388,160	74.32 %	$ 1,405,744	74.51 %	$ -17,584	-1.25 %
Total assets	$ 1,867,898	100 %	$ 1,886,548	100 %	$ -18,650	-0.99 %
LIABILITIES
Current liabilities
Trade and other payables	$ 400,590	52.70 %	$ 387,182	37.83 %	$ 13,408	3.46 %
Provisions	$ 94,228	12.40 %	$ 85,728	8.38 %	$ 8,500	9.92 %
Deferred income	$ 10,812	1.42 %	$ 6,997	0.68 %	$ 3,815	54.52 %
Current tax liabilities	$ 7,033	0.93 %	$ 512	0.05 %	$ 6,521	1273.63 %
Derivative financial instruments	$ 7,127	0.94 %	$ 99	0.01 %	$ 7,028	7098.99 %
Other liabilities	$ 795	0.10 %	$ 871	0.09 %	$ -76	-8.73 %
Total current liabilities	$ 520,585	68.49 %	$ 481,389	47.03 %	$ 39,196	8.14 %
Non-current liabilities
Borrowings	$ 147,273	19.37 %	$ 441,179	43.10 %	$ -293,906	-66.62 %
Provisions	$ 19,754	2.60 %	$ 21,198	2.07 %	$ -1,444	-6.81 %
Deferred income	$ 69,702	9.17 %	$ 75,112	7.34 %	$ -5,410	-7.20 %
Derivative financial instruments	$ 2,819	0.37 %	$ 4,654	0.45 %	$ -1,835	-39.43 %
Total non-current liabilities	$ 239,548	31.51 %	$ 542,143	52.97 %	$ -302,595	-55.81 %
Total liabilities	$ 760,133	100 %	$ 1,023,532	100 %	$ -263,399	-25.73 %
Net assets	$ 1,107,765		$ 863,016		$ 244,749	28.36 %
EQUITY					0
Contributed equity	$ 739,338	66.74 %	$ 524,755	60.80 %	$ 214,583	40.89 %
Retained earnings	$ 379,483	34.26 %	$ 335,366	38.86 %	$ 44,117	13.15 %
Reserves	$ -11,056	-1.00 %	$ 2,895	0.34 %	$ -13,951	-481.90 %
Total equity	$ 1,107,765	100 %	$ 863,016	100 %	$ 244,749	28.36 %

(Aggarwal & Gupta, 2016)

Particulars	2016	2015	change (amount)
Cash flows from operating activities
Receipts from customers	$ 3,101,149	$ 3,096,099	$ 5,050
Payments to suppliers and employees	$ -2,915,467	$ -2,946,252	$ 30,785
Interest paid	$ -15,894	$ -22,601	$ 6,707
Tax paid	$ -20,369	$ -30,439	$ 10,070
Net cash inflow from operating activities	$ 149,490	$ 96,915	$ 52,575
Cash flows from investing activities
Payments for property, plant and equipment	$ -40,479	$ -63,099	$ 22,620
Payments for intangible assets	$ -11,891	$ -17,276	$ 5,385
Net cash outflow from investing activities	$ -58,251	$ -62,350	$ 4,099
Cash flows from financing activities
Repayment of borrowings net of transaction costs	$ -295,000	$ 17,927	$ -312,927
Proceeds from the issue of shares, net of transaction costs	$ 212,011	$ 23	$ 211,988
Dividends paid to equity holders of the parent	$ -16,426	$ -73,211	$ 56,785
Net cash outflow from financing activities	$ -99,355	$ -54,806	$ -44,549
Cash and cash equivalents at end of period	$ 45,207	$ 53,323	$ -8,116

(Deo, 2016)

From the analysis of financial statements of Myer Pty ltd inherent risk has been identified in this section. Following are some inherent risk of Myer Pty ltd:

Business risk (operational risk): One of the major risks of Myer Pty ltd which prevails in the business operations of Myer Pty ltd can be termed as business risk. It can be observed from the analysis of statements of cash flows of 2015 and 2016 that management of Myer Pty ltd are not able to generate higher cash flows from operating activities or from business operations (Chaffai & Dietsch, 2015). Since Myer Pty ltd is operating their business operations in retail industry and to be more specific in consumer goods sector, therefore business operation management plays important role. As liquidity ratio also suggest, inefficient working capital management of Myer Pty ltd can lead to operational failure (Daniel, 2014).

Financial risk (profitability): Second important factor that lea towards inherent risk in the business operations of Myer Pty ltd is of financial risk that Myer Pty ltd has been facing. From the ratio analysis and trend analysis undertaken for the period of last two financial years, this has been proved that Myer Pty ltd has low level of profitability. As compared to industry standards and profitability of competitors, Myer Pty ltd has been facing serious issue of low profitability (El-Dalabeeh, 2013). Deeper analysis of profitability and cost structure of the Myer Pty ltd is required to be undertaken during the audit procedure. In case of Myer Pty ltd, inherent risk is mainly associated with cost structure and expenses administration therefore these two aspects shall be checked thoroughly.

Profitability ratio

Rapid change in inventory: As Myer Pty ltd has been operating their business operations consumer goods retail industry therefore inventory level is ever changing. From the analysis of financial statement or financial position of Myer Pty ltd, it has been analysed that Myer Pty ltd has invested significant amount in inventory (Gomaa & Shaw, 2011). Inventories are major current asset of Myer Pty ltd; therefore this requires systematic analysis during audit. Significant investment in rapid changing inventory or obsolete inventory has posed significant inherent risk.

Conclusion

From the research conducted on Myer Pty Ltd, it can be conclude that Myer Pty Ltd has been operating business in retail industry. From the analysis of financial statements of Myer Pty Ltd, it has been observed that management is not able to manage business operations effectively. Ratio analysis has been used in the process of analysing performance of Myer Pty Ltd in different sections of business. Profitability level has been at adverse side which is supported by profitability ratios (gross and net profit ratios). On the other hand, solvency management in capital structure has also possessed inherent risk. As capital structure of Myer Pty Ltd has not reflected optimum level or many issues related to debt management needs to be undertaken during the audit procedure. After analysis of financial statement of past two years i.e. 2015 and 2016, some possible inherent risk that shall be considered during audit procedure has been identified. Business risk, profitability risk and inventory management risk are some inherent risk factor that shall be undertaken or considered at the time of audit.

References

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