Audit of A2 Milk Ltd: Business Risk Areas and Material Misstatement Risks

This report analyzes the major business risks of A2 Milk Ltd and evaluates the scope of material misstatements. It also undertakes the analysis of the business operations and industry of A2 Milk Ltd.

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

1AUDIT
Executive Summary
As per the major findings of the study, customer credit, market risk, liquidity and fair value risk
are the four inherent risk areas in the operations of A2 Milk Ltd. The presence of these inherent
risk s can create material impacts on the income statement, balance sheet and other financial
statements of the company. Hence, it is needed for the auditor to consider these risk areas along
with the involved assertions.

2AUDIT
Table of Contents
Introduction......................................................................................................................................3
Business, Operations and Industry of A2 Milk Ltd.........................................................................3
Business and Operations..............................................................................................................3
Industry........................................................................................................................................4
Business Risk Areas........................................................................................................................4
Material Misstatement Risks...........................................................................................................6
Additional Material Misstatement Risks.........................................................................................8
Conclusion.......................................................................................................................................9
References......................................................................................................................................10

3AUDIT
Introduction
Auditing is considered as such a profession where the responsibility of the auditors is to
inspect as well as analyze the accounting records and financial statements of the clients in order
to ascertain whether there is any material misstatements in them or not (Louwers et al., 2015).
While carrying out the audit procedures, the auditors of the companies must ensure the analysis
of the business risk areas as these have the ability to materially misstate the financial statements.
Due to this, it is the utmost responsibility of the auditors to ensure the inspection of the business
areas with severe doubts; specifically, the auditors are needed to ensure the examination of the
specific accounting truncations with correct balances along with the assertions used by the
management so that they can ensure about the presence of material misstatements in the financial
statements due to these (Knechel & Salterio, 2016). The main aim of this report can be found in
analyzing as well as evaluating the major business risks of A2 Milk Ltd with the aim to analyze
the scope of material misstatements. This report also undertakes the analysis of the business
operations and industry of A2 Milk Ltd.
Business, Operations and Industry of A2 Milk Ltd
Business and Operations
A2 Milk Ltd is an Australian company and it is commonly known as A2. The company is
enlisted under Australian Securities Exchange (ASX). A2 Milk Ltd commenced their business
operations in the year of 2000 and the headquarter of the company is at Sydney, Australia
(thea2milkcompany.com, 2019). The primary business operations of A2 Milk Ltd are to
commercialize the intellectual property associated to A2 Milk and other relevant products such

4AUDIT
as infant formula and others. Over the years, effective business growth of A2 Milk Ltd can be
seen in the Australian market (thea2milkcompany.com, 2019). It needs to be mentioned that the
company sells their products through the six major supermarkets of Australia; and 10% is the
grocery value market share of A2 Milk Ltd. In 2013, A2 Milk Ltd introduced a2 Platinum and
this product became the most important infant formula brand in Australia in the presence of 32%
market share (thea2milkcompany.com, 2019). In 2018, the company ensured large amount of
investment in their leading brands; and for ensuring this, A2 Milk Ltd ensured spending large
amount of money for the advertisement of their leading brands in the fresh milk categories and
infant formula in the market of Australia. In 2018, the company introduced their new product
named a2 Platinum stage 4 junior milk drink for ensuring their permanent growth
(thea2milkcompany.com, 2019).
Industry
The business operation of A2 Milk Ltd can be seen in the Australian food processing
industry. When the Australian manufacturing industry has been in a decline, the food processing
industry of this country can be regarded as a prominent performer with the contribution of more
than $25 billion in the years 2014 to 2015. The average growth rate of this industry over the past
ten years has been 8.5% and it is expected that this industry will perform well in the coming
years in the presence of increased customer demand for health care products, safety of food
genuineness, attribution and growth in middle class families in Asia. It needs to be mentioned
that the growth of A2 Milk Ltd has been a major contributor to this industry.

5AUDIT
Business Risk Areas
The 2018 Annual Report of A2 Milk Ltd indicates that the company faces certain
business risks while operating and they are discussed below:
Customer Credit Risk
A2 Milk Ltd has to face risk of customer credit and the main influencer of this inherent
risk is the customer characteristics. The bulk portion of the sales of the company comes from the
large retailers in the existence of effective credit merit along with the minimum level of default;
cash on delivery is used for the rest of the sales (thea2milkcompany.com, 2019). A2 Milk Ltd
has a mechanism for evaluating the credit merit of the new customers by taking into account
available credit rating, previous business experience, financial stability and financial position.
The company uses debtors ageing profile for assessing the customers. Provision for impairment
is ascertained on the assessment of the lifetime expected credit loss (Ruhnke & Schmidt, 2014).
Market Risk
A2 Milk Ltd has to face market risk and this is considered as the kind of inherent risk that
is influenced by the market price change as it affects company’s income and the value of the
financial instruments that the company has been holding (thea2milkcompany.com, 2019). The
business operations of the company are the main reason for which the company faces the
financial risk in foreign exchange currency rate to the NZ dollar. After that, the investments that
the company has been holding also have to face market risk in the form of equity price risk
(Coetzee & Lubbe, 2014).
Liquidity Risk

6AUDIT
A2 Milk Ltd also has to face liquidity risk that is another inherent risk of the company.
This risk can be regarded as the specific risk that the company will be unable to fulfill the
business obligations at the time of due (thea2milkcompany.com, 2019). The strategy of the
management of A2 Milk Ltd to tackle this risk is to set a aim level of minimum liquidity that
effective manage the company’s continuing commitments in relation to the available cash
inflows. In addition, the management of ensures the managing a cash reserve to meet the
ongoing commitments (Botez, 2015).
Fair Value Measurement Risk
Another major inherent risk that A2 Milk Ltd faces is the fair value measurement risk.
The business operations of A2 Milk Ltd face this risk in the presence of any dispute in the used
assumptions and methods during the ascertainment of the assets’ and liabilities’ fair value. This
risk can lead to material misstatements in the financial statements (Griffiths, 2016).
Material Misstatement Risks
The above-discussed areas of business risks can materially misstate the financial
statements of A2 Milk Ltd and these are discussed in the following:
1st Risk: Information provide in the customer credit risk indicates towards the fact that 36% sales
of A2 Milk Ltd in 2018 were to three major customers and the value is $332,047 that is 36% of
$922,354 (total sales in 2018) (thea2milkcompany.com, 2019). In this particular case, the
assertion at risk is occurrence as this assertion says that there is occurrence of the transactions
recorded in the financial statements. This aspect helps in showing the fact that the company is
yet to receive the sales value, but they have recorded the sales. In case of the default of these

7AUDIT
three customers or one of them or two of them to pay the sales amount, income statement of A2
Milk Ltd will be materially misstated (Contessotto & Moroney, 2014).
2nd Risk: As per the condition of this second risk, any fluctuation in the market price such as the
change in foreign currency exchange rate can affect the company’s income. As per 2018 Annual
Report of A2 Milk Ltd, total comprehensive income of the company is $304,351
(thea2milkcompany.com, 2019). The assertion at risk in here is completeness as it states that the
companies need to recognize the recorded transactions in the financial report. This risk states that
the total comprehensive income of A2 Milk Ltd can be decrease due to the fall in the value of
foreign currency. This particular aspect can materially misstate the company’s income statement
(Johnstone, Gramling & Rittenberg, 2013).
3rd Risk: The next risk is the liquidity risk and the occurrence of this risk is based on A2 Milk
Ltd’ capability to paying the business requirements. 2018 Annual Report of A2 Milk Ltd states
that the total current liability of the firm is $166,749 (thea2milkcompany.com, 2019). In case the
company is not able in paying off their current liabilities, there can be huge material
misstatement in the company’s balance sheet. Hence, existence can be considered as the relevant
assertion at risk in here as it stays that the assets, liabilities and equity in the balance sheet must
have existence at the end of the financial year of the companies (Hematfar & Hemmati 2013).
4th Risk: A2 Milk Ltd faces risk of fair value measurement in the presence of any dispute in the
process of fair value measurement of the assets and liabilities. As per the 2018 Annual Report of
A2 Milk Ltd, the company has listed investment worth $186,862 that has been measured at fair
value (thea2milkcompany.com, 2019). There can be the creation of major risk of material
misstatements in the balance sheet of the company in case there is any error or dispute from the

8AUDIT
side of the company’s management in the fair value measurement of these investments. Thus, the
assertion at risk in this case is valuation as it states that the company has done the correct
valuation of all of their assets, liabilities and equity in the appropriate financial statements
(Demartini & Trucco, 2016).
Additional Material Misstatement Risks
The additional risks of material misstatements are discussed below:
1st Risk: According to the 2018 Annual Report of A2 Milk Ltd that the area of asset impairment
needs significant judgments and assumptions which can lead to material misstatement of
financial statements. $10,209 is the CGU for goodwill impairment testing of the company in
2018 (thea2milkcompany.com, 2019). The management of the company has used certain
judgments, assumptions, terminal growth rate and discount rate for this purpose. The risk of
material misstatements increases in the presence of these assumptions and judgments. Thus, the
assertion at risk is valuation as it states the correct assessment of assets and liabilities (Reding et
al., 2013).
2nd Risk: The impact of customer discount as well as rebates on sales in A2 Milk Ltd can have
material impact on the company’s financial statements. The recognition of revenue in A2 Milk
Ltd is done from product sales after the transfer of associated risks and rewards; and the
company recognizes net of trade discount and volume rebate provided to their customers. The
sales amount of A2 Milk Ltd from the product sales in 2018 is $922,354
(thea2milkcompany.com, 2019). For this reason, this can materially misstate the income
statement of the company including other financial statements due to the difficult contractual

9AUDIT
arrangement with the customers of A2 Milk Ltd. Hence, the assertions at risk in this situation are
completeness as well as occurrence (Byrnes et al., 2018).
3rd Risk: The inventory valuation process of A2 Milk Ltd can contribute to material
misstatements. As per 2018 Annual Report, the amount of inventory of A2 Milk Ltd in 2018 is
$64,101 (thea2milkcompany.com, 2019). It can be observed that the management of A2 Milk
Ltd has used certain key judgments and estimates for the valuation of inventory and the
dependency of the same can be seen in expected future outcome of inventory held for sale along
with the expected future selling price of the same. There is increased possibility of material
misstatements in the financial statements of A2 Milk Ltd as there are these complex judgments
as well as accounting estimates. Thus, the assertion at risk is valuation as it implies that the
valuation of all assets, liabilities and equity needs t o be done in appropriate manner (Hay,
Knechel & Willekens, 2014).
Conclusion
It can be seen from the above discussion that there is major importance of the assessment
of the business risk areas of the companies with the aim to make the assessment of the material
misstatements in the financial statements. According to the above discussion, A2 Milk Ltd has
been able in registering effective business growth over the years in the Australian food
processing industry. The above discussion also indicates towards the presence of four areas of
inherent risk in the business operations of A2 Milk Ltd; they are customer credit risk, market
risk, liquidity and fair value risk. The above discussion sheds light on the fact that these inherent
business risk areas can materially misstate the financial statements of the companies. Thus, the
auditors are needed to consider these risk areas in the audit procedures.

10AUDIT

11AUDIT
References
BOTEZ, D. (2015). Study Regarding the Need to Develop an Audit Risk Model. Audit
financiar, 13(125).
Byrnes, P. E., Al-Awadhi, A., Gullvist, B., Brown-Liburd, H., Teeter, R., Warren Jr, J. D., &
Vasarhelyi, M. (2018). Evolution of Auditing: From the Traditional Approach to the
Future Audit 1. In Continuous Auditing: Theory and Application (pp. 285-297). Emerald
Publishing Limited.
Coetzee, P., & Lubbe, D. (2014). Improving the efficiency and effectiveness of risk‐based
internal audit engagements. International Journal of Auditing, 18(2), 115-125.
Contessotto, C., & Moroney, R. (2014). The association between audit committee effectiveness
and audit risk. Accounting & Finance, 54(2), 393-418.
Demartini, C., & Trucco, S. (2016). Does intellectual capital disclosure matter for audit risk?
evidence from the UK and Italy. Sustainability, 8(9), 867.
Griffiths, P. (2016). Risk-based auditing. Routledge.
Hay, D., Knechel, W. R., & Willekens, M. (Eds.). (2014). The Routledge companion to auditing.
Routledge.
Hematfar, M., & Hemmati, M. (2013). A comparison of risk-based and traditional auditing and
their effect on the quality of audit reports. International Research Journal of Applied and
Basic Sciences, 4(8), 2088-2091.

12AUDIT
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.
Louwers, T. J., Ramsay, R. J., Sinason, D. H., Strawser, J. R., & Thibodeau, J. C.
(2015). Auditing & assurance services. McGraw-Hill Education.
Our businesses - The a2 Milk Company. (2019). The a2 Milk Company. Retrieved 29 January
2019, from https://thea2milkcompany.com/about-us/our-businesses/
Reding, K. F., Sobel, P. J., Anderson, U. L., Head, M. J., Ramamoorti, S., Salamasick, M., &
Riddle, C. (2013). Internal Auditing: Assurance & Advisory Services. Institute of Internal
Auditors, The IIA Research Foundation.
Ruhnke, K., & Schmidt, M. (2014). Misstatements in financial statements: The relationship
between inherent and control risk factors and audit adjustments. Auditing: A Journal of
Practice & Theory, 33(4), 247-269.
The two-speed food processing industry in Australia | Deloitte Australia | Consumer & Industrial
Products, Agribusiness. (2019). Deloitte Australia. Retrieved 29 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 29 January 2019, from
https://thea2milkcompany.com/wp-content/uploads/A2M-Annual-Report-FY18.pdf