CQUniversity ACCT20075 Auditing and Ethics Report: FMG Analysis 2018

This report, prepared for CQUniversity's ACCT20075 course, analyzes the auditing and ethics of Fortescue Metals Group (FMG). It begins by establishing materiality, outlining audit procedures for significant events like contingent liabilities and capital commitments. The report then delves into ratio calculations, interpreting trends in profitability, liquidity, and solvency to identify key risk areas, such as decreasing profitability and cash management issues. Furthermore, it examines cash flow activities, highlighting the significant cash outflow in 2018, and assesses the company's going concern status. The report concludes with an overview of audit opinions based on the financial analysis conducted, offering a comprehensive view of FMG's financial health and compliance with auditing standards.

AUDITING AND ETHICS
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Contents
Introduction................................................................................................................................3
Section 1.....................................................................................................................................4
Materiality of financial statements.........................................................................................4
Outline of audit procedures for significant events.................................................................4
Section 2.....................................................................................................................................6
Ratio Calculation....................................................................................................................6
Analysis and interpretation.....................................................................................................6
Section 3.....................................................................................................................................9
Cash flow activities................................................................................................................9
Going concern......................................................................................................................10
Audit opinion........................................................................................................................10
Conclusion................................................................................................................................11
References................................................................................................................................12
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Introduction
There are legal foundations on the business organization to conduct audit under the
supervision of registered auditor at the end of every financial year with regard to financial
data provided in financial statements. Importance of auditing in a banking organization
increases as the general public and government organizations have a significant interest in the
performance of these organization (Cohen & Simnett, 2014). Mismanagement or fraud on
part of banking organization can impact the whole economy. In addition to that importance of
auditing also increases as it identifies risk management in internal control measures applied
by the organization. Therefore it can be said that with the help of identifying deficiencies,
management of the company can improve internal operations. Different aspects of auditing
and internal control will be discussed in this report by considering the business operations of
the Fortescue Metals Group.
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Section 1
The materiality of financial statements
It is very important for an auditor to identify the level of materiality before starting the
process of audit. This type of materiality helps auditors to understand the level at which a
particular error omission can be considered as material in the decision-making process of
stakeholders. Audit materiality can be defined as a threshold limit up to which all the errors
and omissions are considered as not having any impact on the decision making the process of
stakeholder (Edgley, 2014).
There are various methods that can be used for calculation of audit materiality i.e. on the
basis of total assets, total revenue, total net profit, etc. In the case of Fortescue Metals Group,
audit materiality will be calculated on the basis of total revenue generated by the organization
in the last financial year i.e. 2018. Here total revenue is selected for calculation of materiality
rather than total assets or total profits (Cox, Dayanandan & Donker, 2014). This is due to the
fact that business organization is operating in a very competitive market and revenue
generated by business organization indicates the popularity of product and services in a
dynamic environment.
Audit materiality= Total sales* 0.5%
= $6,887 million* 0.5%
= $ 34.435 million
On the basis of this calculation, it can be said that if the total amount of errors and omissions
in auditing of this organization increases beyond $34.435 million then it should be considered
as material.
Outline of audit procedures for significant events
There are various events in business organization presented in notes to accounts that can have
a significant impact on financial performance and productivity of the business organization. It
is important to consider these events separately as they are not presented in financial
statements but still impacts business operations is significant. Following are some of these
events along with audit procedure that will help in identifying accuracy and impact on
business operations-
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Contingent liabilities
These are the liabilities that have not impacted business operations in the latest financial year
under consideration but its impact in future can be significant (Cao, Chychyla & Stewart,
2015).
Fortescue has been operating in offices and other premises that are on lease and these leases
will expire in next one to three financial years. It is important for an organization to make
sure that business organization has fixed the place of operation at all the time as non-
availability of such premises can have a significant negative impact on a business
organization due to disturbance of day-to-day operations.
Auditor of the company should identify whether management of the company has made
sufficient arrangements to renew the lease agreement or arrange a new place for business
operations. In case of management has arranged for a place for business operation, the auditor
should evaluate whether the organization has prepared sufficiently to plans to make sure that
a transition of officers has no impact on day to day operations (Koren, Kosi & Valentincic,
2014).
Capital commitments- Management of the organization is in contractual liability for
construction of iron ore carriers worth $43 million in the next financial year i.e. 2019. This
type of capital expenditure will have a significant impact on the financial and liquidity
position of the company (Lewis, Neiberline & Steinhoff, 2014). Auditor of the organization is
required to identify whether sufficient sources of finance are arranged by a business
organization to make sure that such capital commitment will be met.
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Section 2
Ratio Calculation
Ratio analysis can be an effective tool for identifying deficiencies of business operations by
an auditor. Increasing or decreasing trend of ratios in last five financial years will help in
identifying whether management is using assets of the company in an effective manner for
the generation of profits (Weil, Schipper & Francis, 2013). Following is a statement that
shows efficiency, profitability, solvency and liquidity ratios-
Particulars 2015 2016 2017 2018
Net profit ratio 3.70% 13.89% 24.78% 12.97%
Return on equity 4.63% 12.56% 22.73% 9.22%
Return on asset 1.59% 4.92% 10.69% 4.85%
Current ratio 2.09 1.48 1.18 1.33
Debt to equity
ratio
1.25 0.80 0.45 0.40
Operating Cash
Flow Growth (%)
-60.01 53.48 35.92 -60.85
Analysis and interpretation
Net profit ratio- This ratio helps in ensuring that the profitability of the organization is
analysed in an effective manner and compared with the previous financial year. Net profit
ratio of this organization has decreased by 50% in 2018 as compared to 2017. On the basis of
this analysis, it can be said that the financial performance of this organization in the current
financial year has not been very positive. There are some deficiencies that are affecting the
profit generation capabilities of the organization.
Return on equity ratio also helps in identifying profitability and it is focused on returns
provided by a business organization to its equity shareholder on their investment. Return on
equity ratio has also decreased in the current financial year as compared to 2018 which shows
ineffective profit generation capabilities of the organization (Robinson, Henry, Pirie &
Broihahn, 2015).
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Identification of capabilities of using total assets for generation of profit by using effective
and efficient management practices can be identified with the help of return on total asset
ratio. On the basis of calculation done in the above section, it can be said that the return on
asset ratio of the organization has also decreased by more than 50% during 2018. This is due
to the fact that management has not been able to generate effective profits in 2018.
The current ratio helps in identifying the liquidity position of the company in the market by
comparing total current assets and current liabilities. It can be said that management of the
company has sufficient current assets for payment of current liabilities in 2018 as the current
ratio is more than 1 (Brigham, Ehrhardt, Nason & Gessaroli, 2016). The liquidity position of
a business organization with a current ratio of 1 is considered to be average as the optimum
current ratio is 2:1 which was achieved by this organization in 2015.
Debt equity ratio- debt-equity ratio shows the efficiency of capital structure in a particular
organization. Debt to equity ratio of Fortescue Metals Group is decreasing on a constant basis
from 2015 to 2018. It has decreased from 1.25 in 2015 0.40 in 2018 which shows that
business organization is becoming more equity intrinsic which will result in mismanagement
due to interference from different stakeholders (Edwards, 2013).
Operating cash flow growth ratio helps in identifying the efficiency of the cash management
practices undertaken by a business organization. A business organization is considered to be
effective and efficient if the total of cash generated from the operational activity is increasing
on a yearly basis. This has not been the case for Fortescue Metals Group as the real growth
rate of operating cash flow is decreasing (Easton & Sommers, 2018). In the financial year,
2018 total cash generated from operating activities has decreased by 60.85%. It clearly shows
that management of the financial position and standing of the organization is not very
effective in the market.
On an overall analysis, it can be said that the profitability of the organization is the main root
cause for the current financial position of Fortescue Metals Group. Internal and external
analysis should be conducted by the auditor of the company. If the profitability of other
organizations operating in this industry is also decreased as compared to 2017 when it can be
said that there are market factors that affecting profitability (Brooks and Mukherjee, 2013).
On the other hand if operating profitability of other organization in stronger than there is a
deficiency in internal management practices of Fortescue Metals Group.
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Key risk areas
Decreasing profitability- overall profitability is decreasing on a regular basis therefore
management operation can be considered as key risk area in this scenarios. Auditor is
required to communicate with management regarding the basic deficiencies in the
management operations that are resulting in this decreased profitability.
Cash management- Cash is always very vulnerable to fraud, error or mistake and in given
scenario cash flow from operations are fluctuating significantly over the previous 5 years,
therefore cash is also a key area that required auditor’s attention. Auditor is required to
evaluate the policies that are used by management to manage cash and whether these policies
are actually followed by the management or not.
Section 3
Cash flow activities
Total cash outflow of Fortescue Metals Group in the year 2018 has been $961 million as
compared to total cash inflow of $259 million in the year 2017. It clearly shows that cash
management practices in the year 2018 have not been very effective as compared to 2017. In
addition to the two main problems of this organization is cash flow from operating activities
at it has decreased by 63% in 2018.
The main contributor that resulted in a cash outflow of $961 million in the year 2018 has
been cash outflow from financing activities. Total cash outflow from financing activities in
2018 is $1626 million. Primary activities in cash flow from financing activities are repayment
of borrowings and financial lease, the dividend paid, finance cost paid and purchase of shares
by employees share trust (Bhandari & Iyer, 2013). The outflow of this organization in 2018
has increased significantly due to the repayment of borrowing and financial analysis and this
type of business activities does not occur yearly basis but the management of the company
should focus on cash flow from operating activity. It is important that cash flow from
operating activities increases over the period of time.
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Other than financing activities following are some of the critical cash receipts and cash
payments are undertaken by the business organization in 2018-
Payments-
Purchase of property plant equipment
Purchase of financial assets
Payment made to suppliers and employees
Interest paid
Income Tax Paid
Receipts-
Cash generated from operations
Cash received from customers in exchange of products and services
Proceeds from disposal of fixed assets i.e. plant and machinery (Kroes & Manikas, 2014)
There were no non cash financial and investing activities in the financial year ending 2018 in
accordance with the financial accounts and noted to accounts issues by management.
Going concern
Cash flow activities of the organization it can be said that business operation is undertaken by
the Organization on a regular basis irrespective of the fact that it has decreased in the current
financial year. On the basis of frequent business activities, it can be said that there are no
probable chances of dissolution of this organization in the near future, therefore, there is no
risk of going concern for Fortescue Metals Group.
Following are the procedures that will help in identifying Going Concern risk in a particular
business organization-
 Non-payment to of interest and principal amount on borrowings and loans from
financial institutions for a long period of time.
 Decrease in total revenue of a business organization at a significant rate.
 Constant selling of fixed asset, plants, and machinery to generate cash inflows.
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 An increasing amount of debt component in the organization's capital structure
(William Jr, Glover & Prawitt, 2016). Increase in stock turnover ratios and non-
payment of salary and commission to employees.
Audit opinion
Audit opinion can be defined as the opening provided by the statutory auditor on financial
statements are prepared by a business organization. It is important that the audit opinion
provided by the auditor is unbiased. All the principles of the code of ethics and professional
behaviour should be followed while providing opinion on financial statements.
Auditor for the year 2018 has been undertaken by PricewaterhouseCoopers which is one of
the most reputed to audit firms in the world. Auditor of this organization has stated that true
and fair view of the financial position of the organization is depicted in financial statements
(Knechel and Salterio, 2016). There are no additional paragraphs or sections included by the
auditor in relation to audit issues.
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Conclusion
An overall analysis it can be concluded that the financial position of this organization has not
been very effective in 2018 where is the financial position was better in the year 2017.
Different aspects of auditing are considered before making this conclusion such as cash flow
analysis, going concern analysis, ratio analysis, etc. in addition to that audit opinion provided
by the auditor of the organization is also considered while evaluating the financial position of
the company.
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References
Bhandari, S. B., & Iyer, R. (2013). Predicting business failure using cash flow statement
based measures. Managerial Finance, 39(7), 667-676.
Brigham, E. F., Ehrhardt, M. C., Nason, R. R., & Gessaroli, J. (2016). Financial Managment:
Theory and Practice, Canadian Edition. Nelson Education.
Brooks, R., & Mukherjee, A. K. (2013). Financial management: core concepts. Pearson.
Cao, M., Chychyla, R., & Stewart, T. (2015). Big Data analytics in financial statement
audits. Accounting Horizons, 29(2), 423-429.
Cohen, J. R., & Simnett, R. (2014). CSR and assurance services: A research
agenda. Auditing: A Journal of Practice & Theory, 34(1), 59-74.
Cox, R. A., Dayanandan, A., & Donker, H. (2014). Materiality disclosure and litigation risks:
A Canadian perspective. International Journal of Disclosure and Governance, 11(3),
284-298.
Easton, M., & Sommers, Z. (2018). Financial Statement Analysis & Valuation, 5e.
Edgley, C. (2014). A genealogy of accounting materiality. Critical Perspectives on
Accounting, 25(3), 255-271.
Edwards, J. R. (2013). A History of Financial Accounting (RLE Accounting). Routledge.
Knechel, W.R. and Salterio, S.E., 2016. Auditing: Assurance and risk. Routledge.
Koren, J., Kosi, U., & Valentincic, A. (2014). Does Financial Statement Audit Reduce the
Cost of Debt of Private Firms? Available at SSRN 2373987.
Kroes, J. R., & Manikas, A. S. (2014). Cash flow management and manufacturing firm
financial performance: A longitudinal perspective. International Journal of
Production Economics, 148, 37-50.
Lewis, A. C., Neiberline, C., & Steinhoff, J. C. (2014). DIGITAL AUDITING: Modernizing
the Government Financial Statement Audit Approach. Journal of Government
financial management, 63(1).
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Robinson, T. R., Henry, E., Pirie, W. L., & Broihahn, M. A. (2015). International financial
statement analysis. John Wiley & Sons.
Weil, R. L., Schipper, K., & Francis, J. (2013). Financial accounting: an introduction to
concepts, methods and uses. Cengage Learning.
William Jr, M., Glover, S., & Prawitt, D. (2016). Auditing and assurance services: A
systematic approach. McGraw-Hill Education.
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Appendix
Financial year 2015 and 2016
Profit and loss account
Balance sheet
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15

Financial year 2017 and 2018
Profit and loss account
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Balance sheet
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