Assessment of Woolworths Ltd's Earnings Management

This report assesses the earnings management techniques employed by Woolworths Ltd and evaluates its current profitability. It also discusses the motives behind earning management and provides recommendations for the company.

Report

TABLE OF CONTENTS
INTRODUCTION......................................................................................................................3
MAIN BODY.............................................................................................................................3
Assessment of company’s current profitability or earnings..................................................3
Earning management techniques............................................................................................4
Motives behind earning management....................................................................................5
CONCLUSION..........................................................................................................................6
RECOMMENDATIONS...........................................................................................................7
REFERENCES...........................................................................................................................8

INTRODUCTION
In the recent times, business units lay high level of emphasis on undertaking
accounting tools and techniques with the motive to evaluate business performance. With
regards to the firm, earning management is highly significant for the achievement of goals
and getting competitive advantage over others. The present report is based on Woolworths
Ltd which offers wide range of grocery products or services to the customers. It is listed on
recognized stock exchange of Australia (ASX) which focuses on providing customers with
quality services. This report will shed light on the manner in which company managed its
earnings in the past two years.
MAIN BODY
Assessment of company’s current profitability or earnings
In order to assess profitability or earning management aspect of Woolworths Ltd ratio
analysis tool has been applied. Moreover, ratio analysis clearly exhibits profit generated by
the firm from sales. In the context of business unit, earnings are highly important for
managing operations smoothly. Along with this, company can offer suitable returns to the
shareholders when it earns or generates higher profit.
Ratio analysis of Woolworths Ltd for the period of 2018 and 2019 is as follows:
Particulars Formula 2018 2019
Gross profit 16,709 17,442
Operating profit 2548 2,353
Net profit 1,795 2,759
Sales 56,944 59,984
Capital employed
GP ratio Gross profit / sales
revenue * 100
29.34% 29.08%

NP ratio Net profit / sales
revenue * 100
3.2% 4.6%
OP ratio Operating profit /
sales * 100
4.47% 3.92%
The above depicted evaluation shows that, in the period of 2018 and 2019, GP ratio of
the firm was 29.34% & 29.08% respectively. It shows that in both the periods Woolworths
have exerted control on direct expenses. On the contrary to this, in financial year 2019,
operating profit margin of the firm deteriorated from 4.47% to 3.93%. Hence, due to the
incline in indirect expenditure operating profit margin of the firm was decreased over the
period. Annual report of the firm presents that in the accounting period 2019 branch and
administration expenses increased significantly. Further, from evaluation it has assessed that
NP margin of the firm increased from 3.2% to 4.6% at the end of 2019. Referring this, it can
be entailed that business unit has maintained its expenses pertaining to taxation and interest
effectually. Overall assessment clearly presents that Woolworths has employed significant
strategic framework for reducing expenses and thereby generated high profit.
Earning management techniques
Earning management refers to the usage of accounting techniques for the preparation
of financial statements which in turn presents positive view of firm’s financial performance.
There are several earning management techniques which can be undertaken by Woolworths
Ltd. It includes the big bath, cookie jar reserves, big bet on the future, flushing investment
portfolio, operating activities etc. Hence, for fulfilling the purpose of earning management
Woolworths Ltd employs several techniques such as:
Use of derivatives: By doing evaluation it has identified that derivatives offer
opportunity to the firm in relation to managing earnings. In balance sheet, derivatives are
recognized as either assets or liabilities which in turn measured at fair value. With the motive
to managing risk and earnings group of Woolworths Ltd adhere with treasury policy which in
turn approved by company’s BOD. In order to avoids losses due to the fluctuation takes place
in foreign exchange rates company uses derivative instruments for hedging purpose. Hence,

for managing interest rate risk Woolworths LTD focus on undertaking appropriate mix of
fixed and floating aspects (Annual report of Woolworths Ltd, 2019).
Cookie jar reserve technique: On the basis of this technique, business unit is required
to focus on making appropriate estimation about future obligations. In other words, company
must estimate and record events that will be occurred in the near future. However, it is highly
difficult for the firm to make appropriate estimation about future aspects. As per this tool
management team has to select or assess specific amount referring GAAP which in turn
offers opportunity in relation to gaining advantage of earning management (Popular earning
management techniques, 2019). Thus, n Woolworths Ltd can boost earnings by putting
difference, takes place between estimated and actual expenses, into cookie jar.
Big Bath techniques: Sometimes, with the motive to attain success business unit
emphasizes on restructuring aspects. Hence, it may restructure debt, writing down assets,
closing down as operating segment etc. When firm records estimated cost of implementing
change then share price is getting affected negatively. However, share price increases when
change pertaining to restructuring and operational aspects is considered as positive. Annual
report of the company presents that estimation made by Woolworths Ltd differs on the basis
of rent, location, lease exit terms, sublease income etc. Estimations and judgments made by
Woolworths Ltd in relation to Big W and home improvement include high degree of
complexity. In addition to this, it contains high risk regarding material adjustment pertaining
to upcoming time period. Accordingly, estimated changes and judgement of provision
regarding future will be recorded in profitability statement. Thus, Woolworths manage its
earning by adopting the technique of big bath.
Amortization, depreciation and depletion: Woolworth’s td can manage its earnings
through focusing on amortization, depreciation and depletion. In other words, usually, cost of
operating long term assets is written off as an expense during accounting period. Fixed assets
of 2040 millions pertaining to fixed assets includes store refurbishment, supply and It
infrastructure and property development activity. Hence, for income management amount
related to Big W network is partially offset by depreciation and amortization.
Motives behind earning management
Objectives behind using earning management with regards to Woolworths Ltd are
enumerated below:

 Internal targets are recognized as the main aspect due to which Woolworths Ltd
focuses on applying earning management techniques. Usually, company sets its goals
regarding departmental budgeting and makes effort in relation to achieving the same.
With the motive to avoid undesirable aspects and balance it out Woolworths Ltd
employs earning management tools.
 For fulfilling external expectation Woolworths emphasizes on undertaking earning
management tools. Moreover, in the beginning of accounting year, company does
projections about profitability aspect. In this regard, business organization is required
to meet standard profit for meeting the expectations of stakeholders namely
shareholders, other investors etc (Earning management techniques, 2019). Thus, by
applying varied accounting policies and process that applied to financial reporting
company can inflate its earnings.
 In addition to this, income smoothing is another main aspect that assists Woolworths
Ltd in managing earnings. The rationale behind this, potential investors prefer to
invest money in the firm which is growing continuously (Techniques, Motives and
Controls of Earnings Management, 2019). Thus, with the motive to ensure smooth
functioning and income Woolworths Ltd undertakes earning management tools.
 Another motive of Woolworths Ltd behind undertaking earning management tool is to
attract or influence decision making of creditors and investors. Hence, company
presents financial statement in a way that shows overall good performance.
CONCLUSION
By summing up this report, it can be concluded that profitability position of
Woolworths Ltd was good in the both accounting periods. In order to enhance profitability
firm should undertake budgetary control tools which in turn helps in enhancing profitability
by reducing the level of expenses. Besides this, it can be inferred that Woolworth’s td
undertakes several earning management tools for meeting the predetermined goals and
objectives. Further, Woolworths Ltd undertakes earning management techniques with the
motive to meet investor’s expectation and influence decision making of other stakeholders.

RECOMMENDATIONS
 Woolworths Ltd is advised to undertake technique namely ‘Flushing’ the investment
portfolio for the purpose of earning management. Moreover, with the motive to fulfill
goal in relation to profit maximization firms prefer to invest access fund in the shares
of another company. At the time of sale, gain or loss, derived through changes in trade
securities are recognized as operating income. Hence, by selling and writing down
impaired securities firm can manage its earnings effectually.
 Further, company can ensure enough earnings or profitability by taking into account
technique such as ‘Throw out’ a problem child. Accordingly, for increasing income
associated with future Woolworths Ltd should focus on selling subsidiary which is not
performing well. Moreover, as per this technique gain or loss derived through selling
subsidiary is recorded in current period. Along with this, shares of under-performing
subsidiary are distributed to current shareholders as well. Meanwhile, no profit & loss
is reported under the category of spin off.

REFERENCES
Online
Popular earning management techniques. 2019. Online. Available through: <
http://www.swlearning.com/pdfs/chapter/0324223250_2.PDF>.
Earning management techniques. 2019. Online. Available through: <
https://study.com/academy/lesson/earnings-management-definition-techniques-
examples.html>.
Techniques, Motives and Controls of Earnings Management. 2019. Online. Available
through: < http://www.ijtef.org/papers/304-B00010.pdf>.
Annual report of Woolworths Ltd. 2019. Online. Available through: <
https://www.woolworthsgroup.com.au/icms_docs/195582_annual-report-2019.pdf>.