Functioning of Audit Processes in BHP Billiton

This report sheds light on the functioning of the audit processes in BHP Billiton. The auditors of BHP Billiton must assess the financial statements in a manner that the areas that are prone to material misstatements are easily identified. With the help of the materiality concept, an auditor can easily distinguish major misstatements from the minor ones.

AUDITING
2019

BHP Billiton
Executive Summary
This report sheds light on the functioning of the audit processes in BHP Billiton. The auditors
of BHP Billiton must assess the financial statements in a manner that the areas that are prone
to material misstatements are easily identified. With the help of the materiality concept, an
auditor can easily distinguish major misstatements from the minor ones. Material
misstatements have a huge tendency to impacting the decision-making process of the users of
the financial statements. Therefore, an auditor must exercise due focus in tracing the
misstatements in the financial statements of an entity and must also label the same as
intentional or unintentional.
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Contents
Introduction...........................................................................................................................................3
Level of materiality................................................................................................................................3
Notes and disclosures............................................................................................................................4
Financial Statement Analytical Review..................................................................................................6
Cash flow...............................................................................................................................................7
Review of Auditor report.......................................................................................................................8
Conclusion.............................................................................................................................................9
References...........................................................................................................................................10
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BHP Billiton
Introduction
It is the duty of an auditor to minimize or eliminate the presence of material misstatements in
the financials of the company so that the users of the same are not misguided about the
functioning and financial well being of the company. Materiality is a crucial concept and
therefore, an auditor must trace the presence of misstatements in the financials of the
company and must discuss his findings with the management of the same. An auditor must
also evaluate whether the management of BHP Billiton has opted to make necessary
rectifications so as to reduce or eliminate the presence of material misstatements in the
financial statements of the same (BHP Billiton, 2018).
Level of materiality
The auditors must determine materiality on the basis of its qualitative and quantitative
characteristics. An auditor must take an estimated percentage into his due consideration for
evaluating the quantitative characteristics of materiality (Brown, 2013). This estimated
percentage must be charged at an appropriate basis for the ascertainment of the level of
materiality for financial instruments of the company’s annual reports 9 BHP Billiton, 2018).
The auditors must consider the size and nature of the group so as to determine the percentage
that needs to be charged for the ascertainment of the level of materiality. The auditors take
net profit, business inventory, alterations in the accounting policies and accounting methods
for the purpose of evaluating the qualitative characteristics of materiality. The materiality is
performed at various levels. In the first stage, the auditors chose determination of materiality
and in the next stage, all the financial instruments are chosen for the computation of
materiality.
The auditors of BHP Billiton are required to use various materiality bases so as to evaluate
the quantitative characteristics of materiality. This will help the auditors in determining the
actual financial well being of the group. The auditor must consider all the important items
from the Income statement and Balance sheet of an organization so as to evaluate the
different bases for materiality (BHP Billiton, 2018). Total revenue, total sales, net profit
before tax are the significant items from the Income statement that are required to be
considered during the process of materiality determination. The auditor must consider the
total assets of an organization reflected in the balance sheet of the same for the purpose of
materiality determination (Creswell, 2014).
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BHP Billiton
The auditors are required to charge 5% in the process of materiality determination after
evaluating the significant items from the income statement and balance sheet of the company.
Below is the representation of the computation-
Planning Materiality = 5% of the Total Assets
Or, PM= 5% of $111,993 million
Hence, PM= $ 5599.65million
Notes and disclosures
Lease
Leases that are below 12 months (short-term) and low-value are not included under the new
model. All other leases that are long-term and are of high-value will be accounted for in the
new model. The costs pertaining to leases are to be represented as depreciation in the P/L of
the company. It is expected that there will be an impact on the classification and timing of
expenses as contrasted with the current accounting for operating leases which will ultimately
impact the classification between the cash flow from financing activities and cash flow from
operating activities. It is also ascertained that various financial ratios shall also be impacted
such as EBITDA, net debt, gearing, operating cash flows and unit costs (BHP Billiton, 2018).
The company by means of emphasizing more on its contracts and the need for alterations to
be made in the systems and processes has successfully installed its implementation project.
The project is believed to have a major influence on the financial projection of the company
as the procedure for the adoption is still going on. This might altogether enhance the assets
and liabilities of the company (BHP Billiton, 2018).
The current operating leases of the company might continue to act as the main source of
leases under the upcoming standard as well. The company is looking for various options
available for the transition approach that might either include a modified approach or
retrospective approach. BHP Billiton is still assessing the impacts arising out of the transition
approach along with the lease population during the transition.
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BHP Billiton
Contingent Liabilities
The failure of Samarco dam accounted the company to make several accounting judgements
and disclosures that includes the- disclosures pertaining to contingent liabilities of the
company that is concerned with various claims and such other scenarios that highlights such
probable risks for Samarco and BHP which cannot be adequately evaluated, evaluation of the
legal status of the claims made against BHP and Samarco dam along with a proper
accounting treatment, and ascertaining the funding that can be provided by BHP Billiton
Brazil to Samarco along with the quantification of the same to determine if is in accordance
with the Preliminary Agreement, Governance Agreement and Framework Agreement. There
are various reasons as to why the Samarco dam was a key audit matter to BHP (BHP Billiton,
2018). The presence of uncertainty, the in-depth evaluation and thorough analysis required
for the company’s legal claims and obligations and the impact of the potential claims are the
main reasons as to why Samarco was a key audit matter to the company.
Dividend policy
In February 2016, the company opted for a dividend policy that pays off at least about 50%
underlying profits that can be attributed at the end of every financial year. The Board of
directors will determine whether the company is capable of paying more than the minimum
amount of payment as per the Capital Allocation Framework. The company operates mostly
in US dollars. The company pays its dividends in US dollars, New Zealand dollars,
Australian dollars, and UK pounds sterling. However, US dollars are the company’s main
functional currency (BHP Billiton, 2018). The shareholders of the company that are
registered on its main register in the UK along with the ones that are registered on its branch
register that is in South Africa received their dividends in UK pounds sterling.
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BHP Billiton
Financial Statement Analytical Review
The auditor in his audit function follows various techniques. One such technique used by the
auditor is an analytical procedure. In the analytical procedure, the various financial ratios of
the company are not just computed but analyzed as well. The ratios that require the auditor to
follow analytical procedures are current ratios, acid test ratio, profitability ratio, leverage
ratio, asset management ratio, and valuation (Damodaran, 2012). These ratios are used to
determine the liquidity, leverage, profitability and asset management of the company
respectively. Below is the ratio analysis of BHP Billiton from the year 2017 to 2018
Profitability
The GP margin and NP margin has significantly dropped between the years 2017 and 2018.
There are various reasons that contributed to the decrease in the gross profit margin and net
profit margin for the company (Damodaran, 2012). The most significant reasons are the
decrease in the revenues earned by BHP and the failure of the management of the company in
controlling expenses of the same. There was also a huge drop in the return on assets and
return on equity of the company. The return on equity is deemed as the indicators of the
financial well being of the company. The sudden drop in the ratio for the year 2018 in
comparison to 2017 can hamper the functioning and ultimately the existence of the company.
The reason behind this drop can be attributed to the fall in revenue and profits earned by
BHP. To ensure this, an auditor must evaluate the cash and credit sales number so as to
confirm the rightness of the profits presented in the financials of the company (Needles &
Powers, 2013). Then after, the auditor must ensure the viability of expenses through the
application of the vouching procedure. The auditor can also ascertain the expenses by means
of opting for external confirmation (Parrino, R., Kidwell & Bates, 2012).
2017 2018
Return on Equity 10.72% 6.57%
Net Profit Margin 0.156193 0.084901
Gross Profit Margin 55 60
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Gearing
With the help of ratio analysis, it becomes easier for an auditor to determine the fact that if
the company is using equity or debt or both for financing (Peirson et. al, 2015). There is a rise
in the debts of BHP as there is a rise in the debt ratio of the same. BHP Billiton also makes
use of its borrowings as indicated from the rise in the debt to equity ratio of the company.
Therefore, the risks associated with the debt capital of the company needs more focus as the
same needs to be identified and assessed (Madura & Fox, 2011). The auditor must trace the
risks present in the debt capital of BHP and must also determine the rightness of the debts
presented in the financials of the same (Francis, Harrast, Mattingly &Olsen, 2013).
2017 2018
Debt to Equity 1.043469 1.014534
Debt ratio 21 50
Equity Ratio 49 50
Cash flow
2018 2017
Cash inflow from operating activities 18641 16804
Net cash outflow from investing activities --5921 -4161
Net cash inflow from financing activities -10891 -9133
From the cash flow statement, it is noted that the major cash inflow happens from cash flow
from operating activities where the cash flow figure increased from $16804 in 2017 to
$18641 in 2018. Further, the major outflow happened from the division of cash flow from
financing activities where an outflow of $10,891m has been witnessed (BHP Billiton, 2018).
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BHP Billiton
The major receipts of cash came in the form of cash from operations, dividend received,
interest received, and proceeds from liabilities that are interest bearing. On the contrary, the
cash payments we noted mainly in the form of the purchase of PPE, exploration expenditure,
payment of dividend, etc.
The prime investing activities were in the form of the purchase of PPE for which an amount
of $4979m has been paid and payment of exploration expenditure amounted to $874m (BHP
Billiton, 2018).
From the overall cash flow statement analysis, it can be noted that the cash flow of the
company is effectively placed because cash is flowing from operations while cash is
outflowing from the investing and financing department. Hence, there appears danger where
the going concern of the business will be endangered. BHP needs to check that cash flow
from financing activities should be low because a huge expenditure, in that case, will put an
additional burden on the company and hence, lead to lower funds availability (Gowthrope,
2011).
The operating expenses of BHP have increased while the level of profits earned by the same
has dropped. Also, there is a rise in the debt capital of the company which has simultaneously
allowed the debt risks of the company to increase (BHP Billiton, 2018). Therefore, it can be
said that the company’s survival is in danger and in this regards, it is the duty of the
company’s auditor to advice the management of the company in emphasizing more on its
equity share capital and less on the debt structure so as to enhance its profitability and
liquidity.
Review of Auditor report
The audit of BHP has been undertaken by KMPG and from the annual report; it has noted
that the company has not flouted any of the laws. No additional paragraphs have been
provided by the auditor that stress upon the fact that the relevant standard is followed and
adhered to while preparing the report. Thereby, the auditor provides a clean and unqualified
opinion (BHP Billiton, 2018). The relevant rule of Corporation Act 2001 has been followed
while preparing the report.
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BHP Billiton
Conclusion
On an exhaustive study of the company, it can be said that BHP is operating in a profitable
manner and that the results of the company are better in comparison to 2017. Further, the
report stress upon the fact that all regulations have been followed by the auditor and no
manipulation in the company has been observed. Material misstatement can impact the
company’s functioning hence, it is the duty of the auditor to cross-check and verify every
element.
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References
Bauer, R. and Hann, D. (2010). Corporate environmental management and credit risk.
Maastricht University.
BHP Billiton. (2018). BHP 2018 Annual report and accounts. Available from:
https://www.bhp.com/media-and-insights/reports-and-presentations [Accessed 9 May
2019]
Brown, P. (2013). How can we do better?. Accounting Horizons. 27(4), 855–859
Creswell, J. W. (2014). Research design: Qualitative, quantitative, and mixed methods
approaches. Los Angeles, CA: Sage
Damodaran, A. (2012). Investment Valuation. New York: John Wiley & Sons.
Francis, R. N., Harrast, S., Mattingly, J. and Olsen, L. (2013). The relation between
accounting conservatism and corporate social performance: An empirical
investigation. Business and Society Review, 118 (2), p. 193 - 222. Retrieved from:
doi: 10.1111/basr.12008
Gowthrope, C. (2011). Business accounting and finance for non specialists (3rd ed.). South
Western
Madura, R., & Fox, J. (2011). International financial management (2nd ed.). South Western
Market index. (2018) BHP Billiton market index. Retrieved from:
https://www.marketindex.com.au/asx/bhp
Needles, B.E. & Powers, M. (2013) Principles of Financial Accounting. Financial
Accounting Series: Cengage Learning.
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Parrino, R., Kidwell, D., & Bates, T. (2012). Fundamentals of corporate finance. Hoboken,
NJ: Wiley
Peirson, G., Brown, R., Easton, S., Howard, P & Pinder, S. (2015). Business FinanceNorth
Ryde: McGraw-Hill Australia.
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