Metcash: Relevant Background Information

Describe about the Advanced Auditing and Assurance for Legal Operations Environment.

For the purpose of meeting to be conducted to plan the audit of Metcash group, the relevant information pertaining to the operations and legal environment has been gathered as under:  

It is essential for the auditor to have a thorough understanding of the operations and the environment in which the company operates (Coleman, 2015). In the context of this it has been identified that the major operations of Metcash comprises of wholesale distribution, merchandising, and marketing of the grocery, liquor, and hardware items. The company operates mainly in Australia and New Zealand, while, the products are also exported to the other parts of the world such as Central Pacific, China, and Hong Kong. Accounting for 68% of the total revenues, the Food and Grocery is the most revenue generating segment of the company (Metcash, 2015). The major brands sold by the company through different segments are IGA, Cellarbrations, Bottel-O, and Mitre 10. Further, it is interesting to note that the company has a huge customer base, which is evident from the fact that it serves 2500 grocery stores, 12000 pubs, and more than 800 outlets. The company is expanding the operations for which a four expansion program initiated in the year 2014 is under process (Metcash, 2015).  

The understanding of the laws and regulations that the entity has to comply with is the most crucial aspect of auditing (Pickett, 2006). The laws and regulations not only govern the preparation and presentation of the financial statements, but also govern the operations of the company. In the current case of Metcash group, the most crucial laws and regulations which affect the operational aspect of the group have been identified as Environment Protection and Biodiversity Conservation Act 1999 and Australian Consumer Law (Australian Government, 2016). The Environment Protection and Biodiversity Conservation Act provides for safeguard of the environment from the hazards emanating from the company’s operations.

Further, there are other laws and regulations, which are also crucial for the auditor’s consideration while conducting audit of the group. Those laws and regulations involve product safety standards, competition laws, and foreign exchange regulations (Australian Government, 2016). It is important to note that the group has operations of export and import with the countries outside Australia, thus, the foreign exchange laws will have to be complied with.

Metcash operates in the highly competitive environment. The primary competitors of Metcash have been identified as Woolworths Ltd, Coles Group Ltd, and ALDI Gmbh & Co. KG Essen. In the grocery segment, Metcash is receiving a tough competition from Woolworth Ltd, while, Coles group and ALDI also are big threat to the overall business of the company (Hoovers.com, 2016).  

Operations

Consideration of the business risk factor is critical for the auditor not only at the planning stage, but throughout the auditing process. The auditor should be alert to the event and transactions, which causes significant risk to the business of the company (ASA 315, 2013). With regard to the current case of Metcash Ltd, five crucial risk factors have been identified as under:

The competition in Australia in the merchandise business is getting stiffer day by day. The increased competition is one of the biggest is factor for the business of Metcash group. This is because the company may lose business in the upcoming years, which may threaten its very survival (Metcash, 2015).

Metcash group is engaged in the import and exports apart from selling the merchandise in Australia. The import and export always carry the risk of foreign exchange; however, the group has low foreign exchange exposure presently (Metcash, 2015).

There have been observed a decline in the financial wealth of the individual retailers, which may affect the revenues of the group adversely. The retailers are slow to order goods to the group, which may create lags in the group’s revenues in the upcoming years (Metcash, 2015).

The group has written off impairment loss on the intangibles in the books of accounts in the year 2015, due which the financial performance has gone negative. There is a risk that few more assets requiring impairment may be hidden (Metcash, 2015).      

The group has to comply with various laws and regulations, which includes consumer safety and environmental regulations as crucial ones. Thus, there is a risk that the company may skip in adequately complying with all the requirements (Metcash, 2015).   

The auditor should maintain professional skepticism and remain alert to the accounts which may be misappropriated or falsified by the management (Bagshaw, 2013). In the case of Metcash Ltd following four types of accounts have been identified as susceptible to misappropriations:

Revenues:

The revenue account is the most susceptible to misappropriations and fraudulent financial reporting for the Metcash group. This is because the market conditions are adverse and affecting the revenues of the group unfavorably. The demand is low and the competition is stiff, which may create pressure on the management to manipulate the figure of the revenues to show good financial performance to the shareholders. Thus, it is quite probable that the management may manipulate the revenue account to show enhanced revenues and claim better performance than the competitors (Bagshaw, 2013).

Applicable Laws and Regulations

The account receivables account is directly linked with the revenue account. Thus, if the management manipulates revenue account, the accounts receivables will automatically stand manipulated. The fake sales can not be shown in cash; therefore, it is obvious that it would be routed through receivables account (Bagshaw, 2013).

The cash is the most susceptible asset in every organization (Bagshaw, 2013). There are greater chances that the management may manipulate the cash account along with manipulating expenditure account by showing fake payments. The management may siphon the funds of the business by manipulating the cash account and expenditure account. Further, the cash can also be manipulated through others means apart from showing fake expenditures. The management may use the cash collected from the receivables for own purpose without passing entry in the books of accounts.

Inventory is sensitive to manipulation and misappropriation in every business, but in merchandise business this gets even more critical (Bagshaw, 2013). Large quantities of inventory and numerous items make it very difficult for the top management to design suitable controls to stop misappropriation. In the case of Metcash group, it has been observed that the goods are supplied to various retails stores from the warehouses of the company. Thus, it is possible that the goods may be misappropriated from the warehouse by the lower level staff that is engaged in handing and storing.                        

It is within the duties of the auditor to indentify and assess the risk of material misstatement in the financial statements. For this purpose, the auditor is required to take a thorough understanding of the entity and its control environment (ASA 315, 2013). The corporate governance plays a crucial role in designing an adequate control environment which could be relied upon by the auditor. Therefore, the auditor needs to pay particular attention to the governance mechanism of the entity while assessing the effectiveness of the control environment (ASA 315, 2013).    

Metcash group has in place a strong governance mechanism that appears to be effective in mentoring and managing the risk of material misstatement in the financial statements. The group has formed its own governance principles and compliance with those principles was observed from the plain reading of the annual report of the year 2015 (Metcash, 2015). For the purpose of good corporate governance, the board of Metcash lays down solid foundation for the oversight of the state of affairs. This involves ensuring proper and systematic delegation of the duties, evaluation of the senior management performance, and transparent reporting (Metcash, 2015).

Primary Competitors

The analysis of the five crucial factors for the assessment of the control environment in respect of Metcash is given as under:

This is the first thing which an auditor would look when assessing the effectiveness of the control environment. In the absence of an integrated management, the adequacy of the control environment can not be assured (Institute of Internal Auditors, 2011). In the case of Metcash, it has been observed that the senior management of the company comprises vastly experienced people who are attached with the company for years. Further, it has also been observed that the composition of the board has been kept balanced by having sufficient number of independent directors.    

The approach or philosophy of the management counts a lot in effectively managing the risk (Institute of Internal Auditors, 2011). In the case of Metcash, the philosophy of the management may not be modern as the most of the board of directors are old aged. However, they are experienced and capable to handle the critical situations more effectively than the young age directors.     

This implies the model which the company follows to achieve its objectives (Institute of Internal Auditors, 2011). The organizational structure of Metcash appears to be satisfactory. There is a board that takes part in day to day management of the business affairs. The roles and responsibilities of the middle level and lower level management seem to be adequately defined.     

In order to make the governance mechanism even stronger, the group has established various committees namely remuneration committee, nomination committee, and audit committee.    

The evaluation of the competency of the personnel is critical aspect in assessing the effectiveness of the control environment (Institute of Internal Auditors, 2011). In the case of Metcash, it has been observed that the company employs over 6000 employees. Further, the board asserts that the most of the personnel working for the group are highly qualified and professionally competent.    

Therefore, based on the above discussed factors, it could be articulated that the control environment of the company is reliable. However, it is recommended that the auditor personally conducts test checks on the internal processes and procedures while assessing the effectiveness of the control environment of Metcash.

The acquisition of the business is a big event that involves exchange of the resources between two concerns. In the acquisition of a business, the acquiring company pays cash or shares in consideration of receipt of the net assets to the target company. Thus, the crucial point which comes out for the auditor’s attention is that the transactions for business acquisition happens at a large scale, which not affect the current financial position, but may also affect the future outlook of the financial performance and position (Pwc.com, 2012). Further, one more point that the auditor needs to keep in mind is that the process of acquisition is time consuming. It may take years in finalizing the acquisition deals. Thus, the auditor should ensure that the books of accounts have been adjusted for the effect of acquisition in the period in which these should have been (Pwc.com, 2012).         

In the current case, Metcash group is considering acquisition of the timber and hardware business of Woolworth for $250 million. Although, the acquisition has not been finalized yet, but the auditor’s plan will be needed to be modified to take the matter of acquisition into consideration. Thus, in respect of this proposed acquisition of the business, the auditor’s plan should include discussion with the board of directors. The discussion should include the point such as terms and conditions of the acquisition, impact on the shareholder’s worth, and impact on the financial performance of the group as a whole. 

Further, the auditor should also discuss the expected date of acquisition. The date of acquisition is important because if the business is acquired between the date of balance sheet and the approval of the financial statements by the board, the auditor may be required to make certain disclosures in the audit report in respect of the acquisition.

References

ASA 315. 2013. Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment. [Online]. Available at:   https://www.auasb.gov.au/admin/file/content102/c3/Nov13_Compiled_Auditing_Standard_ASA_315.pdf [Accessed on: 04 October 2016].

Australian Government. 2016. Australian business and environment laws. [Online]. Available at: https://www.austrade.gov.au/International/Invest/Guide-to-investing/Running-a-business/Understanding-Australian-business-regulation/Australian-business-and-environment-laws [Accessed on: 04 October 2016].  

Australian Government. 2016. Department of Environment and Energy. [Online]. Available at: https://www.environment.gov.au/about-us/legislation [Accessed on: 04 October 2016].  

Bagshaw, K. 2013. Audit and Assurance Essentials: For Professional Accountancy Exams. John Wiley & Sons.

Coleman, L.B. 2015. Advanced Quality Auditing: an Auditor’s Review of Risk Management, Lean Improvement, and Data Analysis. ASQ Quality Press.

Hoovers.com. 2016. Metcash Ltd competition. [Online]. Available at: https://www.hoovers.com/company-information/cs/competition.metcash_limited.3691f573f8f5ef59.html [Accessed on: 04 October 2016].

Institute of Internal Auditors. 2011. Auditing the Control Environment. [Online]. Available at:     https://www.iia.org.uk/media/97410/Auditing%20the%20control%20environment.pdf [Accessed on: 04 October 2016].

Metcash. 2015. Annual Report. [Online]. Available at: https://www.metcash.com/wp-content/uploads/Metcash-Limited-Annual-Report-2015.pdf [Accessed on: 04 October 2016].  

Pickett, K.H.S. 2006. Audit Planning: A Risk-Based Approach. John Wiley & Sons.

Pwc.com. 2012. Emerging Risks and the Impact on Your Audit Plan. [Online]. Available at: https://chapters.theiia.org/san-francisco/Documents/IIA_Luncheon___Emerging_Risk_impact_on_Audit_Plan.pdf [Accessed on: 04 October 2016].