Business Risk Areas in A2 Milk Ltd

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

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Executive Summary
The findings of the research state that there are four major business risk areas in A2 Milk Ltd;
they are customer credit risk, market risk, liquidity risk and fair value measurement risk. It is
needed for the auditors to consider these risk areas for the determination of risk of material
misstatements in the financial statements. These areas of business risks include certain areas of
material misstatements in the company.

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Table of Contents
Introduction......................................................................................................................................3
Overview of Client’s Business, Operations and Industry................................................................3
Four Areas of Business Risks..........................................................................................................4
Four Areas of Risk of Material Misstatements................................................................................6
Additional Three Areas of Risk of Material Misstatements............................................................7
Conclusion.......................................................................................................................................9
References......................................................................................................................................10

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Introduction
Auditing is considered as the methodical and systematic process of inspecting as well as
examining the financial statements of the companies in order to make sure that they are free from
material misstatements (Louwers et al., 2015). At the time to perform the audit operations, it is
needed for the auditors to consider analyzing the areas with business risks as these risks can lead
to the risk of material misstatements in the firms’ financial statements. For this reason, the
responsibility of the auditors is to inspect the doubtful areas under these risks along with their
transaction, balances and assertions with the aim to analyze the fact that whether these risks can
lead to material misstatements or not (Knechel & Salterio, 2016). The objective of this report is
the analysis and evaluation of the major areas of business risks of A2 Milk Ltd for finding the
material misstatements in them. For this reason, this report sheds light on the business,
operations and industry of the company for gaining useful insight about the company.
Overview of Client’s Business, Operations and Industry
Business Operations: The A2 Milk Company Limited, commonly known as A2, is an Australian
company listed in ASX 200 and the main business operation of the company involves in
commercialization of intellectual property related to A2 Milk as well as the milk and associated
products like infant formula (thea2milkcompany.com, 2019). The company was established in
the year of 2000 and it is headquarter at Sydney, Australia. A2 Milk Ltd has been to establish a
strong growth in the well established Australian market. The availability of the products of the
company can be seen in six major Australian supermarkets and the company has a grocery value
market share of close to 10 percent (thea2milkcompany.com, 2019). In the year 2013, A2 Milk
Ltd launched a2 Platinum which has become the leading Australian infant formula brand with a

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market share of 32 percent. In the year of 2018, A2 Milk Ltd has continued their strong
investments in all of their brands and the company has spent highest amount for advertising their
brands in both the infant formula and fresh milk categories in the Australian market along with
strong editorial media coverage. In the year 2018, A2 Milk Ltd has registered contiguous growth
with the launch of their new product called a2 Platinum premium stage 4 junior milk drink and
others (thea2milkcompany.com, 2019).
Industry: It needs to be mentioned that A2 Milk Ltd operates in the food processing industry of
Australia. In a declining manufacturing sector in Australia, the food processing industry can be
considered as a standout performer as this industry contributed over $25 billion in value added in
the years 2014 to 2015 (deloitte.com, 2019). Over the last ten years, the average rate of growth
of this particular industry in Australia has been around 8.5 percent. Strong growth is expected
from this industry in the coming years due to growing consumer demand for health and wellness
products, food safety, naturalness and provenance and growing middles class in Asia
(deloitte.com, 2019) Thus, based on the above discussion, it can be said that A2 Milk Ltd
belongs to such an industry that has been able in registering string growth over the years.
Four Areas of Business Risks
It can be seen from the analysis of the 2018 Annual Report of A2 Milk Ltd that the
company is exposed to certain business risks and the following discussion discusses about four
of these risks:
Customer Credit Risk: A2 Milk Ltd is exposed to customer credit risk and the individual
characteristics of the customers have influence on this risk. The majority portion of the sales of
the company is to the major retailers in the presence of recognized credit worthiness and minimal

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default level. Other sales are made on cash on delivery (thea2milkcompany.com, 2019). The
company analyzes the new customers for creditworthiness while considering available credit
ratings, past trading experience, financial position and other factors. The assessment of the
customers is done based on the debtors ageing profile. The company recognizes the provision for
impairment on an assessment of lifetime expected credit loss (Kruppa et al., 2013).
Market Risk: A2 Milk Ltd is also subject to market risk and market risk is the kind of risk that
changes in market price will affect the company’s income or the value of the holdings in the
financial instruments (thea2milkcompany.com, 2019). The business activities of A2 Milk Ltd
expose them primarily to the financial risks of change in the rate of foreign currency exchange to
the NZ dollar. A2 Milk Ltd’s holding of a listed investment is also exposed to the equity price
risk. The management of the company monitors the market risk exposure on an ongoing basis
(Hodrick, 2014).
Liquidity Risk: Liquidity risk can be considered as another major risk to which A2 Milk Ltd is
exposed to. Liquidity risk is considered as the risk that the company will be incapable to meet
their obligations when they fall due (thea2milkcompany.com, 2019). The management of the
company manages this risk by setting a target minimum liquidity level while ensuring the
effective management of ongoing commitments with the respect to the forecast available cash
inflows. For this, A2 Milk Ltd manages a cash reserve for meeting the company’s ongoing
commitments (Dionne, 2013).
Fair Value Measurement Risk: Fair value measurement risk can be considered as another major
business risk of A2 Milk Ltd as the company can be exposed to this risk when there is any kind
of errors in the used methods and assumptions for the estimation of the fair valued of the asset

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and other financial instruments (Ettredge, Xu & Yi, 2014). A2 Milk Ltd follows a particular
process for the measurement of fair values which includes there specific levels
(thea2milkcompany.com, 2019).
Four Areas of Risk of Material Misstatements
The above discussion shows fur specific areas of business risk in A2 Milk Ltd. It needs to
be mentioned that there are certain areas in these risks that can lead to material misstatements in
the financial statements and they are discussed below:
1. It can be seen from the customer credit risk that 36 percent of sales in 2018 were to three
customers which amounted to $332,047 that is 36% of $922,354 (total sales in 2018)
(thea2milkcompany.com, 2019). For this balance, the assertion of Occurrence is at risk
which states that the transactions recognized in the financial statements have occurred
and relate to the company. It implies that A2 Milk Ltd has considered this amount as the
sales where the amount is still receivable. In case one of these three or two of them or all
of them becomes defaulter in paying the sales amount, there will be major material
misstatement in the financial statements of A2 Milk Ltd (Czerney, Schmidt & Thompson,
2014).
2. The next risk states that that the income of A2 Milk Ltd will be affected in case there is
any change in the market price like the change in the rate of foreign currency. $304,351 is
the total comprehensive income of A2 Milk Ltd in 2018 (thea2milkcompany.com, 2019).
The related assertion at risk is completeness which states the recorded transactions have
been recognized in the financial statements. As per this risk, the decrease in the value of

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foreign currencies can decrease the value of the net comprehensive income of A2 Milk
Ltd which can lead to material misstatement in financial statements (Brasel et al., 2016).
3. Liquidity risk is the next risk that depends on the ability of A2 Milk Ltd to pay off their
business obligations. As per 2018 Annual report, $166,749 is the total current liabilities
of the company in 2018 (thea2milkcompany.com, 2019). There can be major material
misstatements in the company’s financial statements in case the company fails to pay off
these current liabilities in proper time. Thus, the related assertion at risk in this case is
Existence which states that the balances of assets, liabilities and equity exist at the end of
the financial period (Johnstone, Gramling & Rittenberg 2013).
4. Fair value measurement risk is due to the errors in the used methods and assumptions to
determine the fair value. A2 Milk Ltd has $186,862 of listed investment which has been
measured at fair value (thea2milkcompany.com, 2019). Significant risk of material
misstatements can be developed in case A2 Milk Ltd has made any mistake in the used
assumptions and methods for the determination of the fair value of this particular asset of
the company. Hence, the assertion at risk in this case is Valuation which states that all the
assets, liabilities and equities have been valued appropriately in the financial statements
(Kochetova-Kozloski, Kozloski & Messier Jr, 2013).
Additional Three Areas of Risk of Material Misstatements
Apart from the above four areas of risk of material misstatements, there are three more
significant areas that can lead to the risk of material misstatements in A2 Milk Ltd and they are
discussed below:

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1. It can be seen from the financial information of A2 Milk Ltd that impairment of the assets
is an area that can lead to material misstatements in the financial statements. As per the
2018 Annual Report of A2 Milk Ltd, the amount of CGU of goodwill for impairment
testing is $10,209 in 2018 (thea2milkcompany.com, 2019). The impairment calculation
of the company is subject to judgments; and the use of certain key assumptions in
discount rates and terminal growth rate can be seen by the company. Due to the presence
of so many assumptions and judgments, it is a significant matter for audit that needs the
testing of material misstatements (Botez, 2015). Thus, the involved assertion at risk is
Valuation which ensures the appropriate valuation of the assets, liabilities and equity.
2. Another major area of material misstatements is the effects of customer discount and
rebates on A2 Milk Ltd’s sales revenue. The company recognizes revenue from sales of
products when the risks and rewards are transferred; and it is recognized net of trade
discounts and volume rebates given to the customers. The amount of sales from selling
the products in A2 Milk Ltd for 2018 is $922,354 (thea2milkcompany.com, 2019).
Hence, it can have material impact on the financial statements of the company in the
presence of complex contractual arrangements with the company’s customers
(Bhattacharjee, Maletta & Moreno, 2015). The audit assertion at risk is Occurrence and
Completeness.
3. The next area that can create the risk of material misstatement is the valuation of
inventory in A2 Milk Ltd. The amount of inventory of the company in 2018 is $64,101
(thea2milkcompany.com, 2019). It can be seen that the valuation of inventory in the
company is subject to key estimates as well as judgments and it depends on the expected
future turnover of inventory held for sale and the expected future selling price of such

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inventory. Hence, the presence of such complex estimates as well as judgments can
create material misstatements in the financial statements. For this reason, the assertions at
risk are Valuation which states that all the assets, liabilities and equities need to be
appropriately valued and Existence which states assets, liability and equity exists at the
period (Ruhnke & Schmidt, 2014).
Conclusion
The above discussion indicates towards the significance of the assessment of business
risks for the companies as it helps in assessing the areas with risks of material misstatements in
the financial statements. It can be seen from the above discussion that A2 Milk Ltd is one of the
leading companies operates in the food processing industry of Australia. The discussion part
about the business risks of A2 Milk Ltd states that the major business risk areas of A2 Milk Ltd
are customer credit, market risk, liquidity and fair value risk. The above discussion also sheds
light on the areas of risks involved in these business risks that can lead to material misstatements
of financial statements; such as customer credit for sales, failure in paying current liabilities,
impairment testing, inventory valuation and others. It is needed for the auditors to consider these
areas for performing the audit procedures.

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References
Bhattacharjee, S., Maletta, M. J., & Moreno, K. K. (2015). The role of account subjectivity and
risk of material misstatement on auditors' internal audit reliance judgments. Accounting
Horizons, 30(2), 225-238.
BOTEZ, D. (2015). Study Regarding the Need to Develop an Audit Risk Model. Audit
financiar, 13(125).
Brasel, K., Doxey, M. M., Grenier, J. H., & Reffett, A. (2016). Risk disclosure preceding
negative outcomes: The effects of reporting critical audit matters on judgments of auditor
liability. The Accounting Review, 91(5), 1345-1362.
Czerney, K., Schmidt, J. J., & Thompson, A. M. (2014). Does auditor explanatory language in
unqualified audit reports indicate increased financial misstatement risk?. The Accounting
Review, 89(6), 2115-2149.
Dionne, G. (2013). Risk management: History, definition, and critique. Risk Management and
Insurance Review, 16(2), 147-166.
Ettredge, M. L., Xu, Y., & Yi, H. S. (2014). Fair value measurements and audit fees: Evidence
from the banking industry. Auditing: A Journal of Practice & Theory, 33(3), 33-58.
Hodrick, R. (2014). The empirical evidence on the efficiency of forward and futures foreign
exchange markets. Routledge.
Johnstone, K., Gramling, A., & Rittenberg, L. E. (2013). Auditing: a risk-based approach to
conducting a quality audit. Cengage learning.

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Knechel, W. R., & Salterio, S. E. (2016). Auditing: Assurance and risk. Routledge.
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