Five Key Areas of Material Misstatement for Billabong

The provided content discusses the financial performance of Billabong for FY2015 and FY2016, highlighting concerns over trade receivables turnover and inventory management. The analysis suggests that there is a risk of material misstatement in five key areas: revenue reporting, accounts receivables reporting, inventory reporting, intangibles reporting, and provisions reporting. These potential misstatements may be due to the company's poor financial performance, low sales, and inefficient inventory management, which could lead to cash flow issues and short-term liquidity crunches.

AUDITING AND ASSURANCE
Question 3
The objective is to compute the various given ratios and to comment on the same based on
the industry averages.
Current Ratio
Current Ratio = Current Assets/Current Liabilities
Current Ratio (For Billabong FY2015) = (523753000/236768000) = 2.21
Current Ratio (For Billabong FY2016) = (464454000/197932000) = 2.35
From the above computations, it is apparent that the current ratio of the company for both the
years is superior in comparison to the industry average of 2 which augers well for the short
term liquidity of the company (Billabong, 2016). Further, a positive aspect for the company is
the improvement in the current ratio from 2015 to 2016 on account of decreasing current
liabilities whose % decrease exceeded that witnessed for current assets (Arens et. al.,2013).
Debt to Equity Ratio
Debt to equity ratio = Liabilities/ Equity
Debt to equity ratio (For Billabong FY2015) = (522396000/281584000) = 1.86
Debt to equity ratio (For Billabong FY2016) = (484959000/259289000) = 1.87
From the above computations, it is apparent that the debt to equity ratio for the company for
both years is significantly inferior in comparison to the industry average of 1. This is
indicative of the balance sheet being over leveraged especially considering that the business
is still making losses and thereby swelling the already existing retained losses from previous
years. As a result, the total shareholders’ equity also has declined in FY2016 (Billabong,
2016). Going forward, it is essential for the company to generate profits like it did in FY2015
or else it would be difficult to bring down the debt equity ratio. The current value clearly
poses significant solvency risk going ahead (Caanz 2016).
Gross Profit Margin
Gross profit margin = Gross profit/Net Sales

AUDITING AND ASSURANCE
Gross profit margin (For Billabong FY2015) = (1051818000-495308000)/1051818000=
52.9%
Gross profit margin (For Billabong FY2016) = (1100429000-542373000)/1100429000=
50.71%
From the above computations, it is apparent that the gross profit margin for the company is
inferior in comparison to the industry average of 60%. Clearly, there seems to be huge
difference which clearly is a worrisome sign for the company considering the ongoing losses
that it is making. Further, even more cause of concern is that on y-o-y basis, there is a
significant dip in the margins by 225 basis points especially when the margins are already
lower than the industry. This seems to be one of the major contributory reasons for the low
profits after tax and occasional losses like in FY2016 (Billabong, 2016).
Inventory Turnover
Inventory Turnover = Cost of Sales/Average Inventory
Inventory Turnover (For Billabong FY2015) = 495308000/(187125000+180222000)/2 = 2.70
times
Inventory Turnover (For Billabong FY2016) =542373000/(185556000+187125000)/2 = 2.91
times
From the above computation, it is apparent that even though the company has improved the
inventory turnover from FY2015 to FY2016 but still it remains significantly inferior to the
industry average of 4 (Billabong, 2016). This presents a significant business risk for the
company since owing to low inventory turnover the top line growth would be muted.
Coupled with lower profit margins than industry average, this has significant implications for
the business going ahead. It is apparent that the company needs to take drastic measures in
order to enhance sales and prudently manage inventory so as to reduce the associated costs
and also ensure that revenue growth is improved on account of faster turnaround of inventory
(Gay and Simnett, 2012).
Trade Receivables Turnover
Trade Receivables Turnover = Net credit sales/Average net receivables

AUDITING AND ASSURANCE
Trade Receivables Turnover (For Billabong FY2015) =
(0.8*1051818000)/(164504000+153850000)/2 = 5.29 times
Trade Receivables Turnover (For Billabong FY2016) =
(0.8*1100429000)/(171644000+164504000)/2 = 5.24 times
It is noteworthy that the above trade receivables turnover has been computed by taking 80 %
of the sales as credit sales which may be little on the higher side. However, still the
receivables turnover is lower than the industry average of 6 times (Billabong, 2016). Further,
the worrying aspect is that on a y-o-y basis, there seems to a minor deterioration of the
turnover. This may lead to cash flow issues and short term liquidity crunch especially if the
company is not able to recover the outstanding account receivables in a timely manner
(Leung, Coram and Cooper, 2012).
Question 4
The five key areas where material misstatement of financial statements is plausible for
Billabong are as highlighted below.
 Revenue Reporting – It is apparent from the above analysis that inventory turnover
remains a major concern for the company and is highly inferior to the ongoing
industry average. As a result, there is significant risk of misstatement of revenue in
order to boost the top line or sales revenue. This may also be required on account of
the lower gross profit margins which act as a drag on the net profitability. As a result,
growth of revenue becomes vital for the external reporting considering the negative
retained earnings. In the absence of muted or negative revenue growth, possibilities of
turnaround may seem faded (Arens et. al., 2013).
 Accounts Receivables Reporting – Owing to the lower sales, the company might be
tempted to give a large credit period to willing buyers without adequately considering
their credit worthiness. As a result, it is quite possible that the bad debts from the
accounts receivables but may not have been reported. Thus, it is imperative to see the
cashflows where the cash flow from operations is negative as the payment made to
suppliers is higher than the payment received from debtors (Caanz, 2016).

AUDITING AND ASSURANCE
 Inventory Reporting – Considering the nature of business coupled with the low
inventory turnover that reflects at inefficient in inventory management, it might be
possible that the inventory obsolescence may be significant. This does not seem to be
adequately reflected in the financial statements as any write-off in this regard would
further increase the loss for the company which it can ill afford at the present. Hence,
there is a material risk of over reporting of inventory which would serve the twin
purpose of enhancing current ratio and also over-representing the profits in the
income statement (Gay and Simnett, 2012).
 Intangibles Reporting – In the past the company has seen significant write off in
goodwill coupled with amortisation of intangible assets which adversely impacting
the financial health of the company whose impact is visible till now in the form of
retained losses in excess of $ 700 million. Considering the current financial situation
of the company and the operational difficulties that the company is facing, there is a
material risk of the impairment testing on the brands and goodwill not performing in
an appropriate manner since incremental write down of goodwill or amortisation of
brands would further worsen the financial position of the company and raise serious
going concern issues. Hence, it is a critical issue which needs to be paid attention by
the audit team (Leung, Coram and Cooper, 2012).
 Provisions Reporting – The provisions of the company could potentially be materially
misstated as it lacks any allowance foe obsolescence and bad debts which seems
surprisingly to say the least. Considering the business that the company is involved in,
inventory obsolescence is quite prevalent especially when sales are not very robust
leading to lower turnover the present inventory. The consumer preferences are
increasingly becoming more dynamic which makes case for high inventory related
provisions. Additionally, provisions for bad debt also ought to be present based on
historical estimates. However, these are lacking as presenting the same would further
increase the liability and further deteriorate the already below average debt to equity
ratio (Gay and Simnett, 2012).

AUDITING AND ASSURANCE
References
Arens, A., Best, P., Shailer, G. and Fiedler,I. (2013). Auditing, Assurance Services and Ethics
in Australia, 2nd ed., Sydney: Pearson Australia
Billabong (2016), Annual Report 2016, [online] Available at
http://www.billabongbiz.com/phoenix.zhtml?c=154279&p=irol-reportsannual [Retrieved
September 10, 2017]
Caanz, S. (2016), Auditing and Assurance Handbook 2016 Australia, 3rd ed., Sydney: John
Wiley & Sons
Gay,G. and Simnett, R. (2012). Auditing and Assurance Services in Australia, 5th ed., Sydney:
McGraw-Hill Education
Leung, P., Coram, P. and Cooper, B.J. (2012), Modern Auditing and Assurance Services, 4th
ed., New York: John Wiley & Sons