Accounting Theory and Issues: Woolworths Financial Report Analysis

This report presents an analysis of the accounting policies and financial reporting practices of Woolworths Limited, an ASX-listed Australian retail giant. It examines the company's key accounting policies, including its adherence to consolidation principles, historical cost principles, and relevant AASB and IFRS standards. The report assesses the accounting flexibility afforded to management, as well as the company's accounting strategy in comparison to competitors like Wesfarmers. Furthermore, it evaluates the quality of Woolworths' financial disclosures, including its compliance with GAAP principles. The report also identifies potential red flags and assesses the company's adherence to the conceptual accounting framework. The report highlights the company's reward management structure, changes in accounting policies, and the importance of strategic goals for competitive advantage. The analysis draws from Woolworths' annual reports and compares the company to industry peers, providing insights into its financial reporting and accounting practices.

Accounting Theory and Issues
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Executive Summary
The report has been prepared in order to provide an understanding of the accounting
policies in developing the financial reports. The accounting policies and procedures adopted
by Woolworths Limited in developing its financial statements are analyzed in the present
report. It has been examined from the report that the company prepares high quality financial
reports as per the conceptual accounting framework principle. The company has discloses
significant information in its financial reports regarding the accounting policies adopted for
measuring the value of each of its financial elements. There are some issues of concern
discussed as red flags in the report that need to be addressed by the company in future for
enhancing the understandability of its financial reports to users.
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Contents
Introduction................................................................................................................................4
Section 1: Identify Key Accounting Policies.............................................................................4
Section 2: Assess Accounting Flexibility..................................................................................5
Section 3: Evaluate Accounting Strategy...................................................................................6
Section 4: Evaluate the Quality of Disclosure...........................................................................9
Section 5: Identify Potential Red Flags....................................................................................11
Section 6: Compliant With Conceptual Framework................................................................13
Conclusion................................................................................................................................13
References................................................................................................................................15
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Introduction
The financial reports are developed by business entities by taking into consideration
the significant accounting policies and procedures. The accounting policies can be described
as the particular rules and procedures implemented by business entities in development of its
general purpose financial statements (Horngren et al., 2012). In this context, this report
presents an evaluation of the accounting policies and estimates used by an ASX listed
company, that is, Woolworths Limited, an Australian retail giant. The report analyses the
major accounting policies of the company used in developing financial statements. In
addition to this, the comparison of the accounting policies of the company is undertaken with
one of its major competitors for identifying the accounting strategy used by Woolworths for
achieving competitiveness. Also, the issues of concern in the financial reports of the company
are also discussed as red flags in the report. At last, the compliance of the annual disclosures
of the company as per the conceptual accounting framework is evaluated in the report.
Section 1: Identify Key Accounting Policies
The Woolworths Limited develops and published its consolidated financial reports on
the basis of principle of consolidation. As per the principle of consolation, a business entity
needs to develop consolidated statements by integrating the financial information of all its
associated groups of subsidiaries to represent a single economic entity. The consolidated
financial statements are developed by the company in accordance with the Corporations Act
2001, AASB and IFRS standards. The financial facts and figures are presented in Australian
dollars as per the ASIC Class Order 98/100. The company has adopted the use of historical
cost principle for measurement of its financial instruments except sale derivatives financial
assets and some liabilities that are measured at fair value (Woolworths: Annual Report,
2016). The company has applied the relevant AASB standards for disclosing the information
related to its cash flows, operating leases and segment disclosures (Hoffman, 2016).
The company has implemented the required accounting policies in relation to
valuation of inventories, financing costs, trade receivables, derivatives, property, plant and
equipment and other financial instruments. In addition to this, the company has also
implements significant accounting policies for risk management in order to mitigate the risks
arising from its daily operational activities. The major risks identified by the treasury function
of the company are market risk, liquidity and credit risk. The Board of Directors has
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developed written policies in relation to management of the significant risks through the use
of derivatives for hedging the risk. The treasury function holds the responsibility of reporting
the compliance with the risk policies of the overall Group to the board of directors on an
annual basis(Woolworths: Annual Report, 2016).
Section 2: Assess Accounting Flexibility
The accounting managers are provided with some flexibility in selecting the
accounting policies by the Board of Directors as per the corporate goals and objectives. The
fact is supported from the findings of positive theory of accounting (PAT). The PAT theory
have argued that accounting managers should select the accounting policies that helps them
to maximize the value of the firm and thus providing larger returns to the shareholders. Thus,
as per the theory the standard-accounting setting board has provided some discretion to the
management to exercise some flexibility in the accounting policies. The accounting managers
make certain assumptions and estimates in the accounting policies for financial reporting
(Wolk, Dodd and Rozycki, 2012). The annual report of Woolworths Limited has also
provided a description of the accounting estimates of management during development of its
financial statements (Woolworths: Annual Report, 2016). However, the company has
maintained that the estimates, judgments and assumptions are made as per the historical cost
basis that is adjusted as per the current market conditions.
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Source: https://wow2016ar.qreports.com.au/xresources/pdf/wow16ar-full.pdf
The accounting estimates and judgments that have a significant risk of causing
material adjustments are discussed in detail in the notes to financial statements section of the
annual report. The major accounting assumptions are undertaken by the company in
estimating the useful life if its fixed assets, impairment value of non-financial assets, put
options valuation in non-controlling interests, provisions and discontinued operations. The
accounting managers are provided the flexibility in selecting the policies and estimates by the
management for reporting of financial performance of the company. However, the Board of
Directors ensures that flexibility provided to the management in selecting the accounting
policies and estimates do not distort the financial performance in any way. The Board of
Directors has adopted the corporate governance framework for providing standard guidelines
to the managers and employees. The corporate governance principles provide the ethical
policies that the mangers and employees should obey while carrying out their job roles and
responsibilities (Woolworths: Annual Report, 2016). The Board in its corporate governance
framework has also provided the consequences of non-complying with the ethical policies
and procedures for the managers while performing their job roles and responsibilities (Hussey
and Ong, 2017).
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Section 3: Evaluate Accounting Strategy
The accounting strategy developed by a business entity depends on the specific
accounting policies and procedures selected for developing its financial performance. The
accounting strategy depends on the norms of accounting policies selected for competing with
industry peers, incentives policy, changes in policies and estimates for achieving the
corporate aims and objectives. The Woolworths operates in highly competitive retail market
of Australia and thus has many competitors including Wesfarmers Limited, Billabong, Coles
and many others (Woolworths: Annual Report, 2016). The major competitor of the company
is Wesfarmers Limited that is also recognized a supermarket giant in Australian retail sector.
The Wesfarmers is presenting a major challenge in front of Woolworths as it has recently
reported an increase in its sales revenue by about $13.1 billion from its retail outlets (Pierce,
2015).
The Coles, a Wesfarmers company, has also reported an increase of sales to about 4.5
per cent as compared to Woolworths that have reported only rise in its sales of about 0.7 per
cent. Thus, Woolworth’s current faces a large challenge from its competitors and thus need to
implement proper strategies that help it to attain competitive advantage. The Board of
directors of the company is planning to implement a lean retail model in the company for
reducing its operating expenses to about $500 million in the coming two years. The
Wesfarmers have also attained a competitive advantage over Woolworths as it develops its
financial reports in a simple format as compared to Woolworths. This helps Wesfarmers to
achieve the trust and confidence of investors and creditors more in comparison to
Woolworths (Wesfarmers: Annual Report, 2016). Therefore, it can be said that Woolworths
need to develop strategic goals and objectives that helps it in attaining a competitive
advantage (Wesfarmers full-year profit drops 83.3 per cent on $2 billion writedown, 2017).
However, the Woolworths Limited has adopted a proper reward management
structure to drive its long-term growth by providing proper motivation to its key management
personnel (KMP). The reward management structure comprises of short and long-tem
incentive plans provided to its managers fro achieving the company’s strategic objectives and
goals. The incentive plans of the company are based on share-based payments and are
approved from its shareholders in order to promote transparency in the business operations
(Sheridan, 2016). There is flexibility provided by AASB to the business entities in
developing their incentive plans as per the nature of their business operations and goals.
However, the AASB has mandated that such flexibility provided to the company’s
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management should not lead to any manipulation of its financial performance by managers
for their personal benefits. The performance targets are linked with the net profit after tax
(NPAT) and the EBIT (Earnings before Interest and Tax) (Woolworths: Annual Report,
2016). However, the Board of Directors of the company have maintained that linking of
incentives with the profitability does not lead to occurrence of many fraudulent activities
such as manipulating finance data for achieving higher benefits by the managers (Bamberg
and Spremann, 2012). The incentive plans of the company can be depicted as follows:
Source: https://wow2016ar.qreports.com.au/xresources/pdf/wow16ar-full.pdf
Source: https://wow2016ar.qreports.com.au/xresources/pdf/wow16ar-full.pdf
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The company have also adopted the specific change in the accounting policies and
adopted some estimates during development of its financial reports. The comparative
amounts impacted by the change in the accounting policies are adjusted by the company for
each of the prior period. The changes are done in order to improve the relevance and
reliability of finance information for example the company has adopted the use of fair value
in measuring some of its specific assets and liabilities as compared to its previous use of
historic cost principle. The changes in the accounting policies are made by the management
in order to comply with the current AASB and IFRS standards. The company has also made
some estimates in relation to assessing the carrying and recoverable amount of assets.
However, the changes in the policies are estimates are carried out by the company for
carrying out some specific accounting transactions as per its long-term strategic goals and
objectives (Woolworths: Annual Report, 2016).
Section 4: Evaluate the Quality of Disclosure
The company has provided significant details of the specific accounting policies for
identification and measuring of its various financial elements. The notes to financial
statements section of the company have disclosed all the accounting procedures adopted for
developing its consolidated financial reports. The statements representing the accounting
transactions in the financial report of the company have also included footnotes for providing
the relevant accounting policies adopted for their development (Woolworths: Annual Report,
2016).
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Source: https://wow2016ar.qreports.com.au/xresources/pdf/wow16ar-full.pdf
The notes to financial statements section of the annual report of the company are
sufficient for providing an insight into the key performance of the company. The notes are
also consistent with the current performance of the company and the notes have provided
each of the details that have been used in development of the financial reports. The
accounting quality of the disclosures of the company can also be analyzed with the
application of GAAP (Generally Accepted Accounting Principles) standards. The GAAP are
the accounting rules and standards that are used by business entities across the world for
financial reporting. The principles are developed by the FASB for promoting consistency
between the financial reporting of different firms. The development of uniform accounting
standards will help the firms to reduce the chances of occurrence of fraudulent accounting
activities. The basic accounting principles as per GAAP are cost principle, matching principle
and full disclosure. As analyzed from Woolworths Limited, the company has adopted the
GAAP principles and standards during measurement of its major success factors. The
company has adopted the use of historic cost principle for the recognition and measurement
of its different financial elements (Woolworths: Annual Report, 2016). This is done as per the
GAAP principles as Australian entities incorporate the use of historic cost principle for
valuing its different financial instruments. Thus, it can be stated that the adoption of GAAP
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principles by Woolworths have enhanced its disclosures in relation to its key success factors
(Bragg, 2010).
The company has also provided relevant information in relation to its operating
segments in its notes to financial statements section. The major reportable segments as
analyzed from the financial reports of the company are as follows:
 Australian Food and Petrol
 New Zealand Supermarkets
 Endeavour Drinks Group
 BIGW
 Hotels
The reportable segments of Woolworths have been identified as per its internal reports
and these are continuously monitored by the Chief Executive Officer. The review is carried
for allocating the required resources to each of the reporting segment. The different business
units of the company provide different products and services and also are managed distinct
from each other. The financial performance of each of the reporting segments is done on the
basis of comparing their respective EBIT (Earnings before interest and tax). This is done in
accordance with the AASB standards and section 334 of the Corporations Law that directs all
business entities of Australia to report the financial performances of their individual reporting
segments. As such, it can be said that Woolworths Limited is complying effectively with
AASB and Corporations Law principles in developing its financial reports (Woolworths:
Annual Report, 2016). The quality of disclosure provided by the company is also adequate as
the financial reports are prepared on the basis of application of standard accounting principles
and regulations (Walton, 2011). The segment disclosure in the financial reports of the
company can be illustrated as:
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Source: https://wow2016ar.qreports.com.au/xresources/pdf/wow16ar-full.pdf
Section 5: Identify Potential Red Flags
The potential red flags are referred to as the areas of concern for the management that
requires more disclosures in the future financial reports of the company (Gray and Manson,
2007). The company in order to improve its profitability position as compared to the
competitors has discontinued its operations in the home improvement market. The company
has assessed the value of its property assets on the basis of disposal strategy and investment
yields. The values of the assets are determined on the basis of estimation of the management
regarding the net sales to be achieved from discontinuing the operations of home
improvement. The company has included the impairment loss of the assets in the ‘loss from
discontinued operations’ and the carrying amounts of fixed assets are transferred to ‘Assets
held for sale’. As such, these refer to unexplained changes in accounting in the annual
disclosure of the company that requires more disclosure by the management in the future
financial reports (Woolworths: Annual Report, 2016).
The company has also reported a decrease in its inventory value and sales revenue in
comparison to its past financial year of 2015. The inventory had significantly decreased from
$ 4,872.2m to $4,585.5m and the sales figures have reported a decline of $58,812m to
$58,085.7 m in the financial year 2016. The company has also reported a loss of about
$2,347.9m in the financial year 2016. The company financial performance is declining and
thus it needs to significantly provide the reasons for same in its financial reports and the
strategies it is planning to implement for improving the profitability. This is essential for the
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