Planning memorandum for the audit partner in Woolworths Limited

Four major business risks of Woolworths

The areas where Woolworths can face difficulty while operating are (1) Strategy and

competition (2) Customer and marketplace (3) Sustainability (4) Legal, regulatory and

governance. These risks can impact the business operations of Woolworths and can cause

harm to the profits of the company. Therefore, the Board and the management along with the

executive must strategies plans to mitigate the business risks so as to run the company

smoothly. Therefore as stated by (Bianchi, 2009) that it is the direction towards knowledge of

the company, compatibility with the local market, innovation and sophistication, business

partnership strategies and senior and top management suggestion related to the expansion and

growth of the business which leads to mitigate the business risks, Woolworths should also

follow such steps to alleviate its business risks.

Strategy and competition: The market in which Woolworths operate is full of competition,

technology disturbances and disruptions, entrance of new players in the similar segment with

larger market capitalization and the ever changing customer tastes, needs and preferences

which are causing obstacles in the course of earning profits for Woolworths. On the other

hand the environment in which Woolworths operates delivers both risks and opportunities

which will impact the business operations and performance of the company as they respond

to the changes.

To mitigate the risks Woolworths Board and the management must receive regular updates

and data related to the progress of the objectives and should provide information diligently

related to the challenges and obstacles on the strategic trend of the business. It is the
responsibility of the delivery office and every employees of the organization to provide

information of the key initiatives and lapses of the strategy implementation. It is the duty of

the group executive committee and the management to evaluate and review with the

customers, suppliers, shareholders and the team members of the company on the sales

propositions, the present trends in the market, the prices charged on various products by the

competitors, innovative marketing activities and promotion strategies. Thus, since the

employees and the management long and short term incentives are dependent on improvising

and successful implementation of these strategies, thus implementing plans to reduce the

strategy and competition risks are extremely important for Woolworths.

Customer and marketplace: The customer in this competitive environment requires getting

personalised, associated and convenient customer services. This also requires Woolworths to

change themselves and evolve their business models to consistently meet the rising

requirement of the customers. The ever-changing and current changes in the customer

behaviour requires for a gamut of changes in the retail segment. There has been growing

demands for online shopping by the customer in the FY 2020 and onwards and hence the

growth of Woolworths remains volatile in the future. Thus as per Childs and Jin (2015), it is

the scale of business operations and diverse product categories which helps in the

internationalization of the retail business.

To mitigate this risk the group-wide customer data and insights are provided to the group

Executive Committee which helps to provide establishing customer experiences and

improving the customer experiences on a consistent basis. Regular monitoring and

supervision of the customer satisfaction is surveyed through feedback from the stores, online

channels, call centers which includes qualitative and quantitative researches. Woolworths

should also emphasize on the policy of listen and learn from the customers. The complaints

and grievances received from the customers should be regularly delivered to the Board and
CEO of the company. This will help Woolworths to analyse the customers’ feedback and

provide them with a more improved solution for the customers.

Sustainability: The ultimate aim of Woolworths is to deliver sustainable value to the

shareholders along with long term growth. The aim of the company is also to reduce the

negative impact on the environment and enhance the reputation of Woolworth as the leading

company in Australia. The operations and supply chain of Woolworths is extremely complex

and are committed towards managing the supply chain and the employees right. There is also

possibility of the business operation may be impacted by the changes in the environment and

temperature rise. The business functions of the company are also impacted by the severe

weather conditions, changes in government policies and customers’ behaviours, needs and

preferences.

To mitigate the risks the Board of Woolworths has provided few strategies for achieving the

sustainable goals by 2020. Woolworths to achieve sustainable development in their

organization has already adopted and is adhering to the policies and recommendations as per

the G20 financial stability board’s task force on climate related financial disclosures. For this

the long term impacts of the climate change have been integrated into the strategic planning

and managing the business risks of the company. There have been investments made by the

company with respect to conservation of energy and every unit in the Woolworths stores.

There have been various programs initiated by the company to address the risks related to

human rights by hiring labour and providing job opportunities in Australian Horticulture

suppliers. The company have partnered with sustainable sourcing of key commodities and

with world wildlife fund to invest and improve the sustainable seafood products.

Legal, regulatory and governance: Woolworths business operations considers various legal

and regulatory business requirements related to employment, product safety, protection of the
consumers, anti-corruption and anti-bribery, liquor laws and gaming and climatic changes.

Thus, Woolworths’s diverse range of products and services provides them with the

opportunity to operate successfully and sustainably. The financial claims, reputation of the

business and the financial position of the company may be impacted due to various litigations

and legal proceedings.

To mitigate such risks there has been a Group compliance framework which provides a range

of procedures, business operation and compliance plans to manage the legal and regulatory

compliances. There has been a code of conduct charter which establishes the principle and

policies which needs to be followed within the organization by its people. There is a team of

specialised legal expert to address various legal issues. There is a legal team to meet the

government and the regulatory bodies to work on the proposed changes to the policy and the

regulatory environment. The risks related to the various litigations are managed effectively

after analysis of the issues carefully by the legal team. Thus, legal issues can impact the

profitability of the company in the form of contingent penalties which needs to be addressed

with concern. As stated by (Dos Santos et al.; 2013) that the governance system followed in

Woolworths is of comprehensible nature and helps to accomplish the business policies and

practices of effectively.

Trend analysis and key ratios

Profit & Loss Statement Jun 30, 2019 Jun 24, 2018 Jun 25, 2017 Jun 26, 2016
Total Revenue 59,984 56,944 55,034 53,664
Growth Rate in Revenue 5% 3% 3%  
Cost of Revenue, Total 42,542 40,235 39,105 38,539
Gross Profit 17,442 16,709 15,929 15,125
Operating Income 2,353 2,548 2,326 1,495
Net Income Before Taxes 2,227 2,394 2,132 1,249
Provision for Income Taxes 668 718 651 486
Net Income After Taxes 1,559 1,676 1,481 763
Growth Rate in Net Income -7% 13% 94%  
The trend of the revenue growth in Woolworth has increased in 2019 by 5% compared to the

previous year while the net income or profits of the company has declined by -7% in 2019

compared to the previous year. Therefore, it can be stated that although the company is

earning revenue in 2019 but it is due to the increase in operating expenses which is reducing

the net income of Woolworths.

Financial Ratios Jun 30, 2019 Jun 24, 2018 Jun 25, 2017 Jun 26, 2016
Leverage        
Interest Burden 0.94 0.93 0.92 0.83
Interest Coverage (times) 17.43 15.17 11.99 5.84
         
Asset Utilization        
Total asset turnover 0.63 0.61 0.59 1.14
Fixed asset turnover 0.59 0.58 0.48 0.80
Inventory turnover 2.50 2.38 2.23 4.23
Days receivables 2.71 2.66 2.80 1.47
         
Liquidity        
Current ratio 0.71 0.78 0.80 0.83
Quick ratio 0.23 0.31 0.33 0.32
Cash ratio 0.25 0.29 0.20 0.21
         
Profitability        
Return on assets 2.49% 2.74% 2.50% 3.18%
Return on equity 3.79% 4.19% 4.11% 4.50%
Return on sales 3.92% 4.47% 4.23% 2.79%

Analysis

The trend in 2019 with respect to the interest burden have slight increased compared to the

previous years and the interest coverage ratio have increased by 15%. This signifies that

Woolworths leverage capacity is performing effectively.

The total turnover ratio, fixed asset turnover ratio and the inventory turnover ratio which

signifies the utilization of assets by the company and generating earnings have significantly

enhanced in 2019 compared to the previous years. Although the day’s receivables have
increase slightly in 2019 compared to the previous year, it is the entire asset utilization

performance which has helped Woolworths to improve their performance.

The current, quick and cash ratio have decreased in 2019 compared to 2018. This is due to

the global slowdown which has impacted the business operations of Woolworths. Hence, this

signifies the short term liquidity of the company is performing at a low level in 2019

compared to the previous years. This issue must be taken into consideration to enhance the

working capital requirement of Woolworths.

The returns from assets, equity and sales have decreased in 2019 compared to the previous

years and have significantly impacted the growth of the company. Proper planning and

strategies must be initiated by the company to enhance the profitability ratios.

Identify and explain which changes in the trend analysis and ratio analysis would

trigger further investigation in the audit for Woolworths

The changes in net income which is reflecting negative as per the trend analysis will need for

further investigations. This is because the company’s net income has declined in 2019

compared to the previous year 2018 by -7%. This was mainly due to the increase in the

operating expenses by 6% in 2019 compared to 2018. In 2019, the rate of increase in

operating expenses was almost double compared to the increase in 2018. The increase in

operating expenses is in the form of increase in selling, general and administrative expenses.

The ratio analysis states the changes where investigation in audit for Woolworths is required

is in the liquidity ratio and profitability ratio. The liquidity ratio signifies the short term

funding ability of the company to run the business operations and repay the short term debts

while the profitability ratio measures the firm’s ability to generate earnings with respect to

the revenue, operating profits and shareholder’s equity over a period of time. In this case both
the ratios are performing poorly for Woolworths and immediate action needs to be

undertaken.

Identify four inherent risks

The four key inherent risks of Woolworth are:

1. Impairment related to the carrying value and the recoverable amount of Woolworths

subsidiary BIG W at $404 million.

2. Onerous lease obligations where the auditors of Woolworths has identified that the

expected future benefits from a leased store has been less than the future contractual

lease payments for that particular store and is not in accordance with the accounting

standards.

3. The IT system of Woolworths forms a vital part for smooth functioning of the

business and for the financial reporting process. Therefore, it forms a key component

for the external audit.

4. The adopting of AASB 16 leases and the impact on the Group’s lease assets and

liabilities to the amount of $12.2 and $14.7 billion respectively from 1st July 2019 will

have significant impact on the Woolworths group financial statement.

Identify a key account and a key related assertion at risk of material misstatement

based on the inherent risks

The key account which gets impacted due to the material misstatement based on the inherent

risks is the impairment asset account. It is the difference between the total carrying cost and

the lower of the market value of the item. The journal entry for recording the impairment of

the asset is debiting a loss or expenses and crediting a profit or assets. The key assertion at

risk identified by the auditors is with respect to the carrying value and the recoverable
amount of Woolworth’s subsidiary BIG W at $404 million. The reason behind the concern

was the trading performance of BIG W has deteriorated recently. As a result there was an

impairment review of BIG W where an impairment cost was recognised in the year 2017 to

the amount of $35.3 million. Whereas the inventory amount held by Woolworths as on June

2017 was $4084.4 million. Thus, Woolworths determined an amount which needs to be

recovered using a value in use model and based on the discounted value of future cash flow

forecasts for three years strategic plan. The forecast of three years discounted cashflow is the

area of focus for the auditor which is the inherent risk of the business for recovering the

amount of loss.

Calculate planning materiality in a $ amount

Impairment of BIG W In million $ 2018 2019 2020 2021 2022

Carrying value 404
Free Cash flows 1212.2 1146 957 852 758
Growth in Cash flow -5% -16% -11%
Impairment Cost 35.3 35.3 35.3 35.3 35.3
Discounted rate @ 10% 0.909 0.826 0.751
Cash Flow after expenses 1177 1111 922 817 723
Discounted cash flow 838 675 543
PV of Cash flow 2056
Carrying value 404
NPV 1652

Although the amount of carrying cost of impairment of assets is $404 million, the free cash

flows of Woolworths are expected to grow at the rates mentioned above. Although the

carrying value is required to be paid in three years but if it is paid within year 2020 still there

will be a positive net present value for Woolworths. But, if the amount is segregated and paid

along with an amount of impairment cost of $35.3 million in the year 2022, there will be a

positive NPV of $1652 million and a huge profitability for the company. The discount rate

that has been assumed for this recovery amount is at the rate of 10%. For calculation of the
cash flows for 2021 and 2022 we have taken the average of the cashflow growth rates from

2018 to 2020.

References

Woolworths Group; 2019 Annual Report; Pg. 133 & 134; pg. 33, 34 & 35;

https://www.woolworthsgroup.com.au/icms_docs/195582_annual-report-2019.pdf

Investing.com; Woolworths Ltd (WOW); https://in.investing.com/equities/woolworths-

limited-cash-flow?period_type=annually

Investopedia; Examples of Inherent Risk;

https://www.investopedia.com/ask/answers/041615/what-are-some-examples-inherent-

risk.asp

WILL KENTON (2020); Business Risk;

https://www.investopedia.com/terms/b/businessrisk.asp#:~:text=Business%20risk%20usually

%20occurs%20in,operational%20risk%2C%20and%20reputational%20risk.

ALICIA TUOVILA (2020); Impaired Asset;

https://www.investopedia.com/terms/i/impairedasset.asp#:~:text=Accounting%20for

%20Impaired%20Assets,credit%20to%20the%20related%20asset.

Suresh Kasanagottu & Sudipto Bhattacharya (2018); A review of metro, target, &

Woolworths global business strategy;

https://www.researchgate.net/publication/326928843_A_review_of_metro_target_woolworth

s_global_business_strategy