Audit Report: Identifying Business Risks and Material Misstatements in A2 Milk Ltd

In this report we will discuss about audit and below are the summaries point:- This report analyzes the business risks of A2 Milk Ltd, including fair value measurement, market risk, liquidity risk, and customer credit risk. The auditors examine the inherent business risks to identify potential material misstatements in the financial statements. A2 Milk Ltd is an Australian company focused on commercializing A2 Milk and other related products, operating in the grocery industry with a 10% market share.  

Running head: AUDIT
Audit
Name of the Student
Name of the University
Author’s Note

1AUDIT
Executive Summary
This report analyzes the business of A2 Milk Ltd with the aim to find the business risk areas. As
per the findings, the major inherent business risks are risk associated with fair value
measurement, market risk, liquidity risk and customer credit risk. Risk of material misstatements
can be developed from these inherent risks.

2AUDIT
Table of Contents
Introduction......................................................................................................................................3
Business, Operations and Industry..................................................................................................3
Business Operations.....................................................................................................................3
Industry........................................................................................................................................4
Areas of Business Risks...................................................................................................................4
Areas of Risk of Material Misstatements........................................................................................6
Further Risks of Material Misstatements.........................................................................................8
Conclusion.......................................................................................................................................9
References......................................................................................................................................10

3AUDIT
Introduction
Auditing is considered as the process to inspect and examine the financial statements of
the companies with the aim to makes sure that they are free from material misstatements
(Persellin, Schmidt & Wilkins, 2014). At the time to search for the material misstatements in the
financial statements, the need for the auditors is to carefully examine as well as inspect the
inherent business risks of the companies due to the fact that they can lead to material
misstatements in the financial statements. For this reason, the auditors are needed to ensure the
examination of the balances of the doubtful accounts along with the underlying assumptions
associated with them with the aim to identify the material impact of them on the company’s
financial results (Tritschler, 2013). This report undertakes the analysis of the areas of business of
A2 Milk Ltd with inherent risks that can lead to the material misstatements in the company’s
financial statements. After that, this report involves in the identification of the major areas with
the risk of material misstatements in the financial statements.
Business, Operations and Industry
Business Operations
A2 Milk Ltd is considered as a major Australian companies and the name of the company
can be found in ASX. The company was established in the year of 2000 and it is headquartered
at Sydney, Australia (thea2milkcompany.com, 2019). The main business operation of A2 Milk
Ltd can be seen in commercializing the intellectual property associated with A2 Milk and other
products in the same category. It needs to be mentioned that the products of A2 Milk Ltd are
available in the six large supermarkets of Australia. A2 Milk Ltd has a market share of 10 per

4AUDIT
cent in terms of the grocer value products (thea2milkcompany.com, 2019). In the year 2013, a2
Platinum was launched by A2 Milk Ltd and this particular product of the company has become
the chief infant formula brand in Australia in the presence of the market share of 32 per cent
(thea2milkcompany.com, 2019). After that, in the year 2018, A2 Milk Ltd has ensured huge
amount for the development of all of their products; at the same time, the company has also
increased their investment for the purpose of advertising of their products in both of the
categories of infant formula as well as fresh milk in the Australian market. In addition, A2 Milk
Ltd has been able in registering strong growth for their new product called a2 Platinum Premium
stage 4 milk drink for the juniors and others (thea2milkcompany.com, 2019).
Industry
A2 Milk Ltd has their business operations in the food processing industry of Australia.
This particular Australian industry has been a standout performer in Australia when the
manufacturing industry of Australia has registered low growth in the same period. $25 billion is
the contribution of this industry to the Australian economy (deloitte.com, 2019). The average
growth rate of the food processing industry of Australia over the last ten years is 8.5 per cent and
the forecast states that this growth will be continued in this industry in the presence of increased
demand for the health products, natural food, and safety of foods along with the major growth in
the middle class families in Asia. The major growth of the business of A2 Milk Ltd is one major
contributor towards the growth of this industry (deloitte.com, 2019).
Areas of Business Risks
The following discussion shows the four areas of business risk of A2 Milk Ltd that the
company is exposed to:

5AUDIT
Risk of Fair Value Measurement: The risk related to the fair value measurement of A2 Milk
Ltd is a major inherent risk that the company is exposed to (Cannon & Bedard, 2016). The
development of this specific inherent risk can be seen due to the presence of any kind of mistake
or error in the process to estimate the fair value of the assets along with the other financial
instruments. The management of A2 Milk Ltd uses three specific steps to measure the fair value
(thea2milkcompany.com, 2019).
Liquidity Risk: Another major inherent risk of A2 Milk Ltd is the liquidity risk as the
development of this risk can be seen in the presence of the inability of the company to meet their
business obligations (thea2milkcompany.com, 2019). The management of A2 Milk Ltd handles
this risk by ensuring the presence of a target minimum level of liquidity along with appropriately
manage the present business commitments by considering the predicted cash inflows. The
presence of a cash reserve can be seen in the company to fulfill the present business
commitments (García Blandón & Argilés Bosch, 2013).
Market Risk: Another crucial inherent risk of the business operation of A2 Milk Ltd is the
market risk and the presence of this risk affects the income as well as value of financial
instruments of A2 Milk Ltd with the change in market price (thea2milkcompany.com, 2019). A2
Milk Ltd faces this risk because of the nature of their business activities as there is change in the
foreign currency exchange rate. After that, certain investments of the company also faces this
risk (Griffiths, 2016). Thus, the management of A2 Milk Ltd ensures the ongoing basis
management of this particular risk.
Customer Credit Risk: Customer credit risk is one of the major inherent risk faced by A2 Milk
Ltd and the development of this risk largely depends on the customer characteristics of the

6AUDIT
company (thea2milkcompany.com, 2019). Top retailers of Australia accounts for the majority of
the sales of the company where the company examines the retailer’s credit worthiness and level
of default; and the rest of the sales is made on cash basis. For this reason, A2 Milk Ltd ensures
the examination and evaluation of the credit worthiness of the new clients with the help of
examining past credit record, past trading experience, financial position and others (Groomer &
Murthy, 2018).
Areas of Risk of Material Misstatements
It needs to be mentioned that the areas of inherent risks can lead to material
misstatements in the financial statements of A2 Milk Ltd and they are discussed below:
First Risk: This particular risk occurs in the presence of any dispute in the fair value
measurement process of A2 Milk Ltd. 2018 Annual Report of A2 Milk Ltd indicates towards the
presence of listed investments worth $186,862 that have been measured based on fair value
(thea2milkcompany.com, 2019). There can be the development of major amount of the risk of
material misstatements in case the responsible personnel makes any mistake or error while using
the methods and applying the assumptions for measuring the fair value of these investments
(Lobo & Zhao, 2013). For this risk, the assertion of valuation is at risk as this assertion puts the
obligation on the companies to ensure the correct valuation of assets, liabilities and equity in the
financial statements.
Second Risk: The ability of A2 Milk Ltd to repay the obligation leads to the liquidity risk. 2018
Annual Report of the company indicates that $166,749 is the total current liabilities of A2 Milk
Ltd in 2018 (thea2milkcompany.com, 2019). In case the company fails in the payment of these
current liabilities or the majority potion of this current inabilities, there can be creation of the risk

7AUDIT
of material misstatements in the company’s financial statements. In this scenario, the assertion of
existence is at the risk as this assertion denotes that the values of assets, liabilities and equity
have their existence in the company’s financial statements (Ettredge, Fuerherm & Li, 2014).
Third Risk: A2 Milk Ltd is exposed to the market risk when the income of the company is
affected with the change in the price in the market. 2018 Annual Report of A2 Milk Ltd indicates
towards the fact that the total comprehensive income of the company in 2018 is $304,351
(thea2milkcompany.com, 2019). In this position, in case the value of the currency decreases in
the market, it will lead to the decrease in the total comprehensive income of the company; hence,
there will be the creation in material misstatements in the income statements of A2 Milk Ltd due
to the presence of these aspects. In this case, the relevant assertion of completeness is at the risk
which denotes that the company has recognized the recorded transactions in the relevant
financial statements (Knechel & Salterio, 2016).
Fourth Risk: The occurrence of customer credit risk largely depends on the characteristics of
the customers. As per the 2018 Annual Report of A2 Milk Ltd, three specific customers were
accountable for the 36 per cent sales of the company that is $332,047 (36% × $922,354 Sales of
2018) (thea2milkcompany.com, 2019). As the majority portion of the sales of the company is
made on credit basis, the company is yet to receive this amount from these three customers. In
this situation, there can be the development of material misstatements in the income statement in
case these customers fails in their due payment in time. Thus, the assertion of occurrence is at
risk which denotes the occurrence of the transactions recorded in the financial statements
(Lennox & Li, 2014).

8AUDIT
Further Risks of Material Misstatements
The presence of certain more areas can be seen that can lead to material misstatements in
the financial statements of A2 Milk Ltd and they are discussed below:
First Risk: Valuation of inventory in A2 Milk Ltd can create material misstatements in the
company’s balance sheet. 2018 Annual Report of the company indicates that $64,101 is the
amount of inventory in 2018 (thea2milkcompany.com, 2019). After that, the management of A2
Milk Ltd has used certain key estimates and accounting judgments for inventory valuation; and
the predictable future inventory turnover and for sale along with the predicted future selling price
is included in this valuation. Thus, the presence of material misstatements can be there due to the
use of these complex judgments as well as estimates. Thus, the assertions of valuation and
existence can be considered at risk as they denote the correct valuation and existence of the
assets and liabilities in the financial statements (Johnstone, Gramling & Rittenberg, 2013).
Second Risk: After that, the presence of rebate and customer discount from the sale of A2 Milk
Ltd can lead to material misstatements. In A2 Milk Ltd, at the time of the transfer of the reward
and risk to the buyers, revenue is recognized at net of trade discount and rebates to the
customers. $922,354 is the sales from the customers of A2 Milk Ltd in 2018
(thea2milkcompany.com, 2019). Thus, the presence of this difficult arrangement around trade
discount and rebates can lead to the material misstatements in the income statement. The
assertions of occurrence and completes are at risk (DeFond, Lim & Zang, 2015).
Third Risk: Lastly, the impairment testing and charging mechanism of A2 Milk Ltd can
contribute towards the development of material misstatements. 2018 Annual Report of A2 Milk
Ltd indicates that $10,209 is the cost-generating unit of goodwill for impairment

9AUDIT
(thea2milkcompany.com, 2019). The management of A2 Milk Ltd has used certain accounting
judgments as well as key accounting assumptions for the purpose of impairment calculation such
as rate of growth, discount rate and others. There can be material misstatements in the financial
statements of A2 Milk Ltd as the management has used these complex assumptions and
estimates (Mostafa Mohamed & Hussien Habib, 2013). Thus, the assertion of valuation can be
considered at the risk in this case.
Conclusion
One significant aspect that can be observed from the above discussion is that it is
necessary for the auditors of the companies to mandatorily analyze and evaluate the business risk
areas in the presence of the fact that these inherent business risks can create material
misstatements in the financial reports of the firms. As per the above discussion, the major
inherent business risks of A2 Milk Ltd are risk associated with fair value measurement, market
risk, liquidity risk and customer credit risk. It can also be seen from the above discussion that
these inherent risks can be developed in material misstatements in financial statements in the
presence of complex business arrangements, use of difficult accounting estimates, judgments and
others. For this reason, it is needed for the auditors to consider these risks in their audit
programs.

10AUDIT
References
Cannon, N. H., & Bedard, J. C. (2016). Auditing challenging fair value measurements: Evidence
from the field. The Accounting Review, 92(4), 81-114.
DeFond, M. L., Lim, C. Y., & Zang, Y. (2015). Client conservatism and auditor-client
contracting. The Accounting Review, 91(1), 69-98.
Ettredge, M., Fuerherm, E. E., & Li, C. (2014). Fee pressure and audit quality. Accounting,
Organizations and Society, 39(4), 247-263.
García Blandón, J., & Argilés Bosch, J. M. (2013). Audit tenure and audit Qualifications in a low
litigation risk setting: An analysis of the Spanish market. Estudios de Economía, 40(2),
133-156.
Griffiths, P. (2016). Risk-based auditing. Routledge.
Groomer, S. M., & Murthy, U. S. (2018). Continuous auditing of database applications: An
embedded audit module approach. In Continuous Auditing: Theory and Application (pp.
105-124). Emerald Publishing Limited.
Johnstone, K., Gramling, A., & Rittenberg, L. E. (2013). Auditing: a risk-based approach to
conducting a quality audit. Cengage learning.
Knechel, W. R., & Salterio, S. E. (2016). Auditing: Assurance and risk. Routledge.
Lennox, C., & Li, B. (2014). Accounting misstatements following lawsuits against
auditors. Journal of Accounting and Economics, 57(1), 58-75.

11AUDIT
Lobo, G. J., & Zhao, Y. (2013). Relation between audit effort and financial report misstatements:
Evidence from quarterly and annual restatements. The Accounting Review, 88(4), 1385-
1412.
Mostafa Mohamed, D., & Hussien Habib, M. (2013). Auditor independence, audit quality and
the mandatory auditor rotation in Egypt. Education, Business and Society: Contemporary
Middle Eastern Issues, 6(2), 116-144.
Our businesses - The a2 Milk Company. (2019). The a2 Milk Company. Retrieved 22 January
2019, from https://thea2milkcompany.com/about-us/our-businesses/
Persellin, J., Schmidt, J., & Wilkins, M. S. (2014). Auditor perceptions of audit workloads, audit
quality, and the auditing profession.
The two-speed food processing industry in Australia | Deloitte Australia | Consumer & Industrial
Products, Agribusiness. (2019). Deloitte Australia. Retrieved 22 January 2019, from
https://www2.deloitte.com/au/en/pages/consumer-industrial-products/articles/two-speed-
food-processing-industry.html
Thea2milkcompany.com. (2019). 2018 Annual Report. Retrieved 22 January 2019, from
https://thea2milkcompany.com/wp-content/uploads/A2M-Annual-Report-FY18.pdf
Tritschler, J. (2013). Audit quality: Association between published reporting errors and audit
firm characteristics. Springer Science & Business Media.