Analysis of South32 Ltd's Financial Structure and Audit Plan

This assignment analyses the financial structure of South32 Ltd based on its annual report for 2017. It includes a discussion on materiality, preliminary analytical review, and review of the cash flow statement. The audit plan is also discussed.

Finance Assignment

1
By student name
Professor
University
Date: 25 April 2018.
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Executive Summary
The given assignment has been completed with the help of Annual Report of the company. The
company, which is analysed here, is South32 Ltd, which is one of the listed companies on the
Australian Stock Exchange. The company’s financial structure is examined based on annual
relating to the year 2017. The analysis has been done on the concept of materiality and how the
same has been determined for the given company by the auditors, what is the concept of
materiality and what is the quantitative estimate for the given company. What are the different
standard to identify and assess the level of materiality. The various kind of notes and disclosure
attached with annual report has been studied and gave opinion on it in annual report. Apart from
all this preliminary analytical review has been analysed with the help of profit & loss account
and balance sheet of the company and based on various ratios. To establish an effective audit
plan the company has been also considering relevant assertion and risk assessment audit
procedure. In the 3rd section of the annual report, the cash flow statement of company has been
inspected to determine the what are the major cash receipt and payment items, what are the
major non cash item and their effect on financial statement and other significant financing and
investing activity. In addition to all this, the fundamental assumption of going concern
assumption has also been checked and audit report of company has been analysed to determine
major issue, if any.
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Contents
Section 1: Materiality concern of the entity................................................................................................4
Section 2: Preliminary analytical review of the company............................................................................6
Section 3: Review of the cash flow statement of the company...................................................................9
References.................................................................................................................................................11
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Section 1: Materiality concern of the entity
Materiality is a subject of professional judgement, which is provided in ASA 320 “Materiality in
Planning and Performance an Audit”. For the effective and efficient planning and performance of
audit, materiality is very critical factor. The material misstatement, significant error and omission
which either individually or in aggregate are considered material if it expected to influence the
economic and financial decision of the user of financial statement. Materiality also includes
omission expected to affect the financial decision, size and nature of material misstatement and
surrounding circumstances and common financial and economic information (Belton, 2017).
Materiality is a concept, which may change from the prospect of entity-to-entity, individual to
individual. Materiality can be subjective and depends upon the size of company. Like in case of
small company, an amount of $ 40,000 may be material but in case of large listed company, the
amount of $ 40,000 may not be material for decision-making purpose. It is applicable for both
quantitative as well as qualitative values (Alexander, 2016). As per ASA 320 and IASB, some
percentage is often applied to a chosen benchmark as a starting point in determining materiality
for the financial statement as a whole. Like 0.5% to 1% of sales revenue, 2-5% of the
shareholders equity, 5-10% of net profit of the entity, 1-2% of the total assets of the company or
the gross profit being made by the entity.
(in $ Mn.)
South32 Ltd
Quantitative estimate of materiality
Criterion Base
Amoun
t Materiality level/range
0.5% to 1% of gross revenue
Gross
Revenue 7,225 36.13 to 72.25
1% to 2% of the total assets Total Assets 14,743 73.72 to 147.43
1% to 2% of the gross profit Gross Profit 1,795 8.98 to 17.95
2% - 5% of the shareholders's equity Equity 10,235 51.18 to 102.35
5% to 10% of the net profit Net profit 1,231 6.16 to 12.31
The company which has been selected here is South 32 Ltd (ASX: S32) which is listed on
Australian Stock Exchange and London Stock Exchange and deals in mining and metal industry.
It has spun out of BHP Billiton in the year 2015 and is a producer of alumina, silver, zinc,
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manganese, nickel, coking coal, lead, aluminium and thermal coal. It has a number of reserves.
The quantitative materiality has been defined and estimated using the above-mentioned criteria.
Here, the materiality can be taken to be in between the range of $ 6.16 Mn to $ 17.95 Mn. This is
an ideal range and has been taken out using the net profit and gross profit’s lower limit and the
upper limit respectively (Erik & Jan, 2017). This will help the auditor in checking all the material
line items and planning of the audit.
The draft notes and disclosures with respect to the company have been studied and it is seen that
the company has given the basis of all the management estimates and the judgement and has also
given all the material disclosures in the notes to financial statements. The auditors will have to
employ the substantive as well as the analytical audit procedures in order to give and opinion on
the financial statements (Grenier, 2017).
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Section 2: Preliminary analytical review of the company
For the evaluation of financial statement and financial and non-financial data, auditors can
applied different procedure, which are substantive test, and the analytical review procedures.
Substantive test involve the vouching the incomes and expenses items and verification involve
valuation of assets and liabilities, major change in financial values, completeness of financial
statement and inclusion of all major financial statement which effect the decision of financial
users (Choy, 2018). If on the basis of information obtained through substantive measures, he
performs preliminary analytical procedures, which includes determine the suitability of particular
substantive analytical procedure, Evaluation of relevance of data, develop an expectation of
recorded amount of ratios, find the difference of recorded value and expected value and
investigation the result of analytical procedure, understanding the business environment, trend
analysis and ration analysis and many others. Here in the given assignment, the preliminary
analytical review is done with the help of basic ratios which we have derive from balance sheet
and profit and loss account and examine the same trend over the period 2014 to 2017 (Das,
2017).
South32 Ltd
Ratio Analysis
Particulars 2015 2016 2017
Efficiency Ratios
Return on capital -1.00% 13.00% 13.00%
Return on Equity -1.80% 12.00% 12.90%
Pay-out Ratio -32.00% 44.00% 51.00%
Profitability Ratios
Operating Margin Ratio 12.70% 36.20% 33.30%
Net Profit Ratio -27.16% 17.40% 17.64%
Liquidity Ratios
Current Ratio 196% 248% 290%
Cash Ratio 9% 18% 20%
Capital Ratios
Debt Equity Ratio 27% 27% 26%
Debt to Total Assets Ratio 19% 19% 18%
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The ratio analysis has been done from 4 perspective. From the above table, we can see that in
terms of efficiency ratios, the company has improved a great deal and the return of capital and
the return on equity with which the shareholders are concerned has moved from negative to
positive over 3 years (Farmer, 2018). In addition, the payout ratio was -32% in 2015 where in
2017, it increased to 51% in 2017, which goes on to show that the company is meeting the
expectations of the shareholders. In terms of profitability ratios, the net profit ratio has improved
considerably and the company, which was in loss in the year 2015, is now earning at the rate of
17.64%. Similarly, the operating margin ratio has improved from 12% to 33%, which goes on to
say that the company has reduced costs and has improved on the business front. The company
also enjoys a healthy current ratio and the liquid ratio and is well above the industry trend. This
shows that the company would be able to pay off its short-term liabilities as it has enough of
current assets (Werner, 2017). Finally, the company also has enjoy a good debt equity ratio,
which is well within the control. It has fairly remained constant over the past 3 years at 27% and
it shows that the company is mostly using equity capital and gas a cushion to use debt capital in
the coming future, which comes at lower cost of capital.
Audit assertion are representations and claims, which are being made by the management that
the preparation and presentation of the financial statements has been done correctly and
appropriately in the annual report. It shows that the management has handled all the risks in the
company well. Audit risk is the risk of non-identification of the material misstatement, errors and
omission even when the audit is carried out, it can be detective risk, control risk or inherent risk.
Some of them are highlighted below along with the audit measures, which are required to be
undertaken (Trieu, 2017).
Sl
No.
Key risk areas Relevant assertion Audit procedure
1 Huge
fluctuations in
the commodity
prices, interest
rate, exchange
rate and the
global economy
as a whole
As per the management, they are
mitigating this risk through the
quality of operations and
commitment to the strong
balance sheet, it also deals in
multiple currencies so there is no
major risk and it also
continuously monitors the
market for changes, if any.
This risk can be audited and
checked by analysing the impact
of the different currencies in
which the company has been
dealing over the past years and
what could have been the impact
in case the currencies would have
been hedged.
2 Counterparty As per the team, they use quality The health of the debtors needs to
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default risk from
the commercial,
government and
other
institutional
customers
control measures and the credit
ratings to manage and set the
counterparty limits. Also, they
have an insurance program,
which mitigates the financial
consequences based on cost and
availability.
be analysed, balance
confirmation, ageing of the
customers and then the decision
needs to be taken if the provision
for bad and doubtful debt needs
to be carried in the books.
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Section 3: Review of the cash flow statement of the company
Given below is the screenshot of the cash flow statement of the company.
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From the given Cash flow statement, we can see that the majority of cash inflow are generated
from operations in which the company deals amounting to $ 1,963 million, proceeds from
financial assets amounting to $ 344 million and from dividend received from equity accounted
investment amounting to $313 million (Saeidi, 2012). Because of that, it is concluded that the
major cash inflow for the company is coming from the company’s own business operation that is
operating activity. In case of cash outflow, the investing and financing activity of company
reported for the same. In case of investing activity the major area where the amount of cash
outflow is quantities is purchase of property, plant and equipment amounting to $ 316 million
and from investment in financial assets amounting to $ 331 million whereas in terms of financing
activity, major cash outflow was there in buy back of shares amounting to $ 244million, dividend
paid to shareholders amounting to $ 211 million (Linden & Freeman, 2017).
From the study of the cash flow statement of the entity in the above para, we have discussed the
principle items and activity of cash inflow and cash outflow like dividend received, dividend
payment purchase of plant, property etc. (Goldmann, 2016). In cash of non-cash financial and
investing activity except for amortization of the intangible and tangible assets. Here in case of
this company as the company had declared dividend of $ 143 Mn so, it would account for non-
cash financial activity.
From the above analysis, it can be concluded that the company has fulfilled the going concern
assumption in the preparation of financial statement. As per the auditor’s report by KPMG, it can
be seen that the company has prepared and presented the financial information as per the
Australian Accounting Standards and the Corporation Act, 2001 and has thereby the met all the
relevant criterias (Kim, Schmidgall, & Damitio, 2017). The auditors’ has given a clear opinion
on the financial statements mentioning it to be showing true and fair view. However, the auditors
have shown few key audit matters for which they had to take in additional measures for
addressing the same and forming an opinion thereon. These issues include asset valuation
including PPE and the intangible assets, closure and rehabilitation provision which was carried in
the books for $ 1565 Mn and the tax matters which included assumptions made by the
management in classifying and quantifying the provisions and contingent liabilities (Sithole,
Chandler, Abeysekera, & Paas, 2017).
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References
Alexander, F. (2016). The Changing Face of Accountability. The Journal of Higher Education, 71(4), 411-
431.
Belton, P. (2017). Competitive Strategy: Creating and Sustaining Superior Performance. London: Macat
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Choy, Y. K. (2018). Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview
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Das, P. (2017). Financing Pattern and Utilization of Fixed Assets - A Study. Asian Journal of Social Science
Studies, 2(2), 10-17.
Erik, H., & Jan, B. (2017). Supply chain management and activity-based costing: Current status and
directions for the future. International Journal of Physical Distribution & Logistics Management,
47(8), 712-735.
Farmer, Y. (2018). Ethical Decision Making and Reputation Management in Public Relations. Journal of
Media Ethics, 1-12.
Goldmann, K. (2016). Financial Liquidity and Profitability Management in Practice of Polish Business.
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Grenier, J. (2017). Encouraging Professional Skepticism in the Industry Specialization Era. Journal of
Business Ethics, 142(2), 241-256.
Kim, M., Schmidgall, R., & Damitio, J. (2017). Key Managerial Accounting Skills for Lodging Industry
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Linden, B., & Freeman, R. (2017). Profit and Other Values: Thick Evaluation in Decision Making. Business
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Saeidi, F. (2012). Audit expectations gap and corporate fraud: Empirical evidence from Iran. African
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Sithole, S., Chandler, P., Abeysekera, I., & Paas, F. (2017). Benefits of guided self-management of
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Werner, M. (2017). Financial process mining - Accounting data structure dependent control flow
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