Wesfarmers Financial Reporting Analysis

This assignment requires an analysis of Wesfarmers' financial reports. The task is to identify areas within the reports that lack sufficient disclosure by management, hindering the understanding of the general purpose financial statements. The analysis should draw upon accounting principles and theories, particularly those related to agency theory, information asymmetry, and the conceptual framework of financial reporting.

Accounting Theory and Issues
1

Executive Summary
The report has been prepared in order to provide an understanding of the accounting
policies in developing the financial reports. The accounting policies and procedures adopted
by Woolworths Limited in developing its financial statements are analyzed in the present
report. It has been examined from the report that the company prepares high quality financial
reports as per the conceptual accounting framework principle. The company has discloses
significant information in its financial reports regarding the accounting policies adopted for
measuring the value of each of its financial elements. There are some issues of concern
discussed as red flags in the report that need to be addressed by the company in future for
enhancing the understandability of its financial reports to users.
2

Contents
Introduction................................................................................................................................4
Section 1: Identify Key Accounting Policies.............................................................................4
Section 2: Assess Accounting Flexibility..................................................................................5
Section 3: Evaluate Accounting Strategy...................................................................................6
Section 4: Evaluate the Quality of Disclosure...........................................................................9
Section 5: Identify Potential Red Flags....................................................................................11
Section 6: Compliant With Conceptual Framework................................................................13
Conclusion................................................................................................................................13
References................................................................................................................................15
3

Introduction
The financial reports are developed by business entities by taking into consideration
the significant accounting policies and procedures. The accounting policies can be described
as the particular rules and procedures implemented by business entities in development of its
general purpose financial statements (Horngren et al., 2012). In this context, this report
presents an evaluation of the accounting policies and estimates used by an ASX listed
company, that is, Woolworths Limited, an Australian retail giant. The report analyses the
major accounting policies of the company used in developing financial statements. In
addition to this, the comparison of the accounting policies of the company is undertaken with
one of its major competitors for identifying the accounting strategy used by Woolworths for
achieving competitiveness. Also, the issues of concern in the financial reports of the company
are also discussed as red flags in the report. At last, the compliance of the annual disclosures
of the company as per the conceptual accounting framework is evaluated in the report.
Section 1: Identify Key Accounting Policies
The Woolworths Limited develops and published its consolidated financial reports on
the basis of principle of consolidation. As per the principle of consolation, a business entity
needs to develop consolidated statements by integrating the financial information of all its
associated groups of subsidiaries to represent a single economic entity. The consolidated
financial statements are developed by the company in accordance with the Corporations Act
2001, AASB and IFRS standards. The financial facts and figures are presented in Australian
dollars as per the ASIC Class Order 98/100. The company has adopted the use of historical
cost principle for measurement of its financial instruments except sale derivatives financial
assets and some liabilities that are measured at fair value (Woolworths: Annual Report,
2016). The company has applied the relevant AASB standards for disclosing the information
related to its cash flows, operating leases and segment disclosures (Hoffman, 2016).
The company has implemented the required accounting policies in relation to
valuation of inventories, financing costs, trade receivables, derivatives, property, plant and
equipment and other financial instruments. In addition to this, the company has also
implements significant accounting policies for risk management in order to mitigate the risks
arising from its daily operational activities. The major risks identified by the treasury function
of the company are market risk, liquidity and credit risk. The Board of Directors has
4

developed written policies in relation to management of the significant risks through the use
of derivatives for hedging the risk. The treasury function holds the responsibility of reporting
the compliance with the risk policies of the overall Group to the board of directors on an
annual basis(Woolworths: Annual Report, 2016).
Section 2: Assess Accounting Flexibility
The accounting managers are provided with some flexibility in selecting the
accounting policies by the Board of Directors as per the corporate goals and objectives. The
fact is supported from the findings of positive theory of accounting (PAT). The PAT theory
have argued that accounting managers should select the accounting policies that helps them
to maximize the value of the firm and thus providing larger returns to the shareholders. Thus,
as per the theory the standard-accounting setting board has provided some discretion to the
management to exercise some flexibility in the accounting policies. The accounting managers
make certain assumptions and estimates in the accounting policies for financial reporting
(Wolk, Dodd and Rozycki, 2012). The annual report of Woolworths Limited has also
provided a description of the accounting estimates of management during development of its
financial statements (Woolworths: Annual Report, 2016). However, the company has
maintained that the estimates, judgments and assumptions are made as per the historical cost
basis that is adjusted as per the current market conditions.
5

Source: https://wow2016ar.qreports.com.au/xresources/pdf/wow16ar-full.pdf
The accounting estimates and judgments that have a significant risk of causing
material adjustments are discussed in detail in the notes to financial statements section of the
annual report. The major accounting assumptions are undertaken by the company in
estimating the useful life if its fixed assets, impairment value of non-financial assets, put
options valuation in non-controlling interests, provisions and discontinued operations. The
accounting managers are provided the flexibility in selecting the policies and estimates by the
management for reporting of financial performance of the company. However, the Board of
Directors ensures that flexibility provided to the management in selecting the accounting
policies and estimates do not distort the financial performance in any way. The Board of
Directors has adopted the corporate governance framework for providing standard guidelines
to the managers and employees. The corporate governance principles provide the ethical
policies that the mangers and employees should obey while carrying out their job roles and
responsibilities (Woolworths: Annual Report, 2016). The Board in its corporate governance
framework has also provided the consequences of non-complying with the ethical policies
and procedures for the managers while performing their job roles and responsibilities (Hussey
and Ong, 2017).
6

Section 3: Evaluate Accounting Strategy
The accounting strategy developed by a business entity depends on the specific
accounting policies and procedures selected for developing its financial performance. The
accounting strategy depends on the norms of accounting policies selected for competing with
industry peers, incentives policy, changes in policies and estimates for achieving the
corporate aims and objectives. The Woolworths operates in highly competitive retail market
of Australia and thus has many competitors including Wesfarmers Limited, Billabong, Coles
and many others (Woolworths: Annual Report, 2016). The major competitor of the company
is Wesfarmers Limited that is also recognized a supermarket giant in Australian retail sector.
The Wesfarmers is presenting a major challenge in front of Woolworths as it has recently
reported an increase in its sales revenue by about $13.1 billion from its retail outlets (Pierce,
2015).
The Coles, a Wesfarmers company, has also reported an increase of sales to about 4.5
per cent as compared to Woolworths that have reported only rise in its sales of about 0.7 per
cent. Thus, Woolworth’s current faces a large challenge from its competitors and thus need to
implement proper strategies that help it to attain competitive advantage. The Board of
directors of the company is planning to implement a lean retail model in the company for
reducing its operating expenses to about $500 million in the coming two years. The
Wesfarmers have also attained a competitive advantage over Woolworths as it develops its
financial reports in a simple format as compared to Woolworths. This helps Wesfarmers to
achieve the trust and confidence of investors and creditors more in comparison to
Woolworths (Wesfarmers: Annual Report, 2016). Therefore, it can be said that Woolworths
need to develop strategic goals and objectives that helps it in attaining a competitive
advantage (Wesfarmers full-year profit drops 83.3 per cent on $2 billion writedown, 2017).
However, the Woolworths Limited has adopted a proper reward management
structure to drive its long-term growth by providing proper motivation to its key management
personnel (KMP). The reward management structure comprises of short and long-tem
incentive plans provided to its managers fro achieving the company’s strategic objectives and
goals. The incentive plans of the company are based on share-based payments and are
approved from its shareholders in order to promote transparency in the business operations
(Sheridan, 2016). There is flexibility provided by AASB to the business entities in
developing their incentive plans as per the nature of their business operations and goals.
However, the AASB has mandated that such flexibility provided to the company’s
7

management should not lead to any manipulation of its financial performance by managers
for their personal benefits. The performance targets are linked with the net profit after tax
(NPAT) and the EBIT (Earnings before Interest and Tax) (Woolworths: Annual Report,
2016). However, the Board of Directors of the company have maintained that linking of
incentives with the profitability does not lead to occurrence of many fraudulent activities
such as manipulating finance data for achieving higher benefits by the managers (Bamberg
and Spremann, 2012). The incentive plans of the company can be depicted as follows:
Source: https://wow2016ar.qreports.com.au/xresources/pdf/wow16ar-full.pdf
Source: https://wow2016ar.qreports.com.au/xresources/pdf/wow16ar-full.pdf
8

The company have also adopted the specific change in the accounting policies and
adopted some estimates during development of its financial reports. The comparative
amounts impacted by the change in the accounting policies are adjusted by the company for
each of the prior period. The changes are done in order to improve the relevance and
reliability of finance information for example the company has adopted the use of fair value
in measuring some of its specific assets and liabilities as compared to its previous use of
historic cost principle. The changes in the accounting policies are made by the management
in order to comply with the current AASB and IFRS standards. The company has also made
some estimates in relation to assessing the carrying and recoverable amount of assets.
However, the changes in the policies are estimates are carried out by the company for
carrying out some specific accounting transactions as per its long-term strategic goals and
objectives (Woolworths: Annual Report, 2016).
Section 4: Evaluate the Quality of Disclosure
The company has provided significant details of the specific accounting policies for
identification and measuring of its various financial elements. The notes to financial
statements section of the company have disclosed all the accounting procedures adopted for
developing its consolidated financial reports. The statements representing the accounting
transactions in the financial report of the company have also included footnotes for providing
the relevant accounting policies adopted for their development (Woolworths: Annual Report,
2016).
9

Source: https://wow2016ar.qreports.com.au/xresources/pdf/wow16ar-full.pdf
The notes to financial statements section of the annual report of the company are
sufficient for providing an insight into the key performance of the company. The notes are
also consistent with the current performance of the company and the notes have provided
each of the details that have been used in development of the financial reports. The
accounting quality of the disclosures of the company can also be analyzed with the
application of GAAP (Generally Accepted Accounting Principles) standards. The GAAP are
the accounting rules and standards that are used by business entities across the world for
financial reporting. The principles are developed by the FASB for promoting consistency
between the financial reporting of different firms. The development of uniform accounting
standards will help the firms to reduce the chances of occurrence of fraudulent accounting
activities. The basic accounting principles as per GAAP are cost principle, matching principle
and full disclosure. As analyzed from Woolworths Limited, the company has adopted the
GAAP principles and standards during measurement of its major success factors. The
company has adopted the use of historic cost principle for the recognition and measurement
of its different financial elements (Woolworths: Annual Report, 2016). This is done as per the
GAAP principles as Australian entities incorporate the use of historic cost principle for
valuing its different financial instruments. Thus, it can be stated that the adoption of GAAP
10

principles by Woolworths have enhanced its disclosures in relation to its key success factors
(Bragg, 2010).
The company has also provided relevant information in relation to its operating
segments in its notes to financial statements section. The major reportable segments as
analyzed from the financial reports of the company are as follows:
 Australian Food and Petrol
 New Zealand Supermarkets
 Endeavour Drinks Group
 BIGW
 Hotels
The reportable segments of Woolworths have been identified as per its internal reports
and these are continuously monitored by the Chief Executive Officer. The review is carried
for allocating the required resources to each of the reporting segment. The different business
units of the company provide different products and services and also are managed distinct
from each other. The financial performance of each of the reporting segments is done on the
basis of comparing their respective EBIT (Earnings before interest and tax). This is done in
accordance with the AASB standards and section 334 of the Corporations Law that directs all
business entities of Australia to report the financial performances of their individual reporting
segments. As such, it can be said that Woolworths Limited is complying effectively with
AASB and Corporations Law principles in developing its financial reports (Woolworths:
Annual Report, 2016). The quality of disclosure provided by the company is also adequate as
the financial reports are prepared on the basis of application of standard accounting principles
and regulations (Walton, 2011). The segment disclosure in the financial reports of the
company can be illustrated as:
11

Source: https://wow2016ar.qreports.com.au/xresources/pdf/wow16ar-full.pdf
Section 5: Identify Potential Red Flags
The potential red flags are referred to as the areas of concern for the management that
requires more disclosures in the future financial reports of the company (Gray and Manson,
2007). The company in order to improve its profitability position as compared to the
competitors has discontinued its operations in the home improvement market. The company
has assessed the value of its property assets on the basis of disposal strategy and investment
yields. The values of the assets are determined on the basis of estimation of the management
regarding the net sales to be achieved from discontinuing the operations of home
improvement. The company has included the impairment loss of the assets in the ‘loss from
discontinued operations’ and the carrying amounts of fixed assets are transferred to ‘Assets
held for sale’. As such, these refer to unexplained changes in accounting in the annual
disclosure of the company that requires more disclosure by the management in the future
financial reports (Woolworths: Annual Report, 2016).
The company has also reported a decrease in its inventory value and sales revenue in
comparison to its past financial year of 2015. The inventory had significantly decreased from
$ 4,872.2m to $4,585.5m and the sales figures have reported a decline of $58,812m to
$58,085.7 m in the financial year 2016. The company has also reported a loss of about
$2,347.9m in the financial year 2016. The company financial performance is declining and
thus it needs to significantly provide the reasons for same in its financial reports and the
strategies it is planning to implement for improving the profitability. This is essential for the
12

company to maintain the trust and confidence of its present and potential investors. The main
reason for the loss reported in the financial year of the company is due its discontinued
operations from the home improvement market (Henderson et al., 2015). The comprehensive
loss from the discontinued operations as reported in the income statement of the company is
$3,191.9m (Woolworths: Annual Report, 2016). The company has also reported cash inflows
from the sale of its items of property, plant and equipment to about $722m in the accounting
period of 2016.
Source: https://wow2016ar.qreports.com.au/xresources/pdf/wow16ar-full.pdf
However, the notes to financial statement of the company have not stated any reason for
large asset write-offs by the company. The reduction in the value of fixed assets of the
company reported as asset write-offs is recorded in the statement of cash flows of the
company. The company in order to enhance the understandability of its financial information
should provide more information about its asset write-offs it in its financial reports (Mintz,
2013).
Section 6: Compliant With Conceptual Framework
The conceptual accounting framework has been developed by the IASB for improving
the quality of financial reporting. The major principles as identified by IASB of conceptual
accounting framework are relevance, reliability, faithful presentation and understandability.
Thus, financial information should be according to these qualitative characteristics for
meeting the needs and expectations of the end-users of financial reports (Pietra, McLeay and
13

Ronen, 2013). The Woolworths Limited has provided financial information in its annual
disclosures as per the qualitative characteristics of conceptual accounting framework. The
financial information presented is relevant, reliable and also complete in all aspects. The
company however needs to enhance the understandability of its financial reports by
developing its general purpose financial statements in an easy format. The quality of the
financial reports is also significantly influenced by the political factors that the company
faces while operating its business in different countries (Kenny, 2009).
The Woolworths Limited is operating on a global level and therefore needs to develop its
financial reports in a way for meeting he expectations of its diverse users across the world.
As such, the company is complying with the IFRS standards as stated in its annual reports in
order to meet its corporate goals of diversification and expansion. The company is also
making some voluntarily disclosures for improving its competiveness on a global platform in
its annual reports. For example, the company has presented detailed information regarding its
trading performance in its annual report that is not required under AASB standards. This is
done by the company voluntarily for improving its global competiveness and thus driving its
sustainable growth in the foreign markets. The company making such voluntarily disclosures
will be bale to achieve its long-term goals of attaining global competitiveness and thus
achieving a recognized brand name in the global market of Australia (Woolworths: Annual
Report, 2016). Thus, the selection of such accounting policies and disclosures will help the
company for improving the reliability and transparency in the business operations and thus
achieving the trust of foreign investors (Jensen, 2001).
Conclusion
It can be inferred from the overall discussion held in the report that accounting
policies and procedures plays a significant role in depicting the actual financial performance
of a business entity. The flexibility provided to the managers in selection of particular
accounting policies can also lead to manipulation of accounting activities. Thus, as such it is
important for the Board of directors to review the discretion power of the management for
ascertaining that the authority provided to them is not used for achieving any personal gains.
The analysis of annual disclosure of Woolworths Limited has revealed that the company has
effectively followed the relevant AASB and Corporations Law standards for developing its
financial reports. However, there are some areas of concern identified in its financial reports
14

that needs more disclosures by the management for improving the understandability of its
general purpose financial statements.
15

References
Bamberg, G. and Spremann, K. 2012. Agency Theory, Information, and Incentives. Springer
Science & Business Media.
Bragg, S. 2010. Wiley GAAP: Interpretation and Application of Generally Accepted
Accounting Principles 2011. John Wiley & Sons.
Gray, I. and Manson, S. 2007. The Audit Process: Principles, Practice and Cases. Cengage
Learning EMEA.
Henderson, S. et al. 2015. Issues in Financial Accounting. Pearson Higher Education AU.
Hoffman, C.W. 2016. Revising the Conceptual Framework of the International Standards:
IASB Proposals Met with Support and Skepticism. World Journal of Business and
Management 2 (1), pp. 1-32.
Horngren, C. et al. 2012. Financial Accounting. Pearson Higher Education AU.
Hussey, R. and Ong, A. 2017. Corporate Financial Reporting. Springer.
Jensen, M.C. 2001. Foundations of Organizational Strategy. Harvard University Press.
Kenny, G. 2009. Diversification Strategy: How to Grow a Business by Diversifying
Successfully. Kogan Page Publishers.
Mintz, S. 2013. Accounting for the Public Interest: Perspectives on Accountability,
Professionalism and Role in Society. Springer Science & Business Media.
Pierce, F. 2015. Wesfarmers vs. Woolworths: which has the upper hand? [Online]. Available
at: http://www.businessreviewaustralia.com/finance/1639/Wesfarmers-vs-Woolworths:-
which-has-the-upper-hand [Accessed on: 5 October 2017].
Pietra, R., McLeay, S and Ronen, J. 2013. Accounting and Regulation: New Insights on
Governance, Markets and Institutions. Springer Science & Business Media.
Sheridan, T. 2016. Managerial Fraud: Executive Impression Management, Beyond Red
Flags. Routledge.
16

Walton, P. 2011. A Global History of Accounting, Financial Reporting and Public Policy:
Asia and Oceania. Emerald Group Publishing.
Wesfarmers full-year profit drops 83.3 per cent on $2 billion writedown. 2017. [Online].
Available at: http://www.news.com.au/finance/business/retail/wesfarmers-fullyear-profit-
drops-833-per-cent-on-2-billion-writedown/news-story/
ca70aa1e16fbe1824a5376a975a0d387 [Accessed on: 5 October 2017].
Wesfarmers: Annual Report. 2016. [Online]. Available at:
https://www.wesfarmers.com.au/docs/default-source/reports/2016-annual-report.pdf?
sfvrsn=4 [Accessed on: 5 October, 2017].
Wolk, H.I., Dodd, J.L. and Rozycki, J.J. 2012. Accounting Theory: Conceptual Issues in a
Political and Economic Environment. SAGE.
Woolworths: Annual Report. 2016. [Online]. Available at:
http://www.woolworthsholdings.co.za/downloads/2016/WHL-Integrated-Report-2016.pdf
[Accessed on: 5 October, 2017].
17