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BUSINESS RISK ANALYSIS FOR WESFARMERS LIMITED

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Business risk analysis for Wesfarmers Limited

Executive summary

Risk analysis is the process through which an organization identifies potential problems within the business that can undermine key projects or initiatives and then be able to manage them in the most appropriate manner (PWC, 2016). Business risk analysis is key when preparing an audit strategy for any organization for purposes of inclusion in the audit report. It is one of the major steps involved in conducting an audit for an organization and then preparing an audit report. This paper prepares a broad audit strategy for Wesfarmers, which is ASX listed company. Various aspects on the company will be considered when preparing the broad audit strategy, including the company’s profile, size, main products, segments, corporate governance issues, business success factors, accounting issues, legal matters, financial strength of the company, trends in performance, sources of capital, comparison with other companies in the same or different industries, among other factors. All these factors, together with other aspects will be discussed in this report as well as how they affect the financial statement assertions during the process of auditing.

Internal information

Before conducting any form of audit and preparing the audit report, it is very critical for the auditors to be aware of the company’s profile, its major products, size in terms of assets, sales and employees, segments or locations if any, associates, corporate governance issues among others (PWC, 2016).

Overview of the company

Wesfarmers was founded back in 1914 as a farmers’ cooperative and since then, it has grown one of the largest listed companies in Australia. As at 1914, it was involved in providing services and agricultural merchandise to the rural community in Western Australia. However, since the 1950, Wesfarmers started diversifying its business with the introduction of the business of distributing liquefied petroleum gas (Wesfarmers, 2016). In 1984, it introduced the business of producing and distributing fertilizers, coal mining in 1989, insurance business in 1991, and hardware in 1994, and introduced the business of supplying home improvement products, building, safety and industrial products in 2001. In 2008, Wesfarmers got in the retail sector fully. As a result of the diversification process, Wesfarmers is now a leading public company in various businesses not only in Australia, but in New Zealand as well. This is a very crucial information when it comes to conducting an audit of the business as the auditor are aware of where the company has originated from and how the various segments have been started (Wesfarmers 2016).

Primary products

Wesfarmers business currently has two major divisions or segments and these are: the retail segment and the industrial sector (Kassem & Higson, A, 2012).The retail sector comprises of four division namely; Coles (food, convenience retailer and liquor), Home Improvement as well as Office Supplies, Target (clothing and housewares), and Kmart (automotive service retailer and a departmental store). The Industrial and other Businesses segment comprises of five division namely; Resources (coal mining), Insurance, Chemicals, Energy and Fertilizers, Safety and Industrial, as well as other products and services that serve this industry (Wesfarmers, 2016).

Company size

Wesfarmers is one of the largest public listed company in Australia with around 220,000 employees distributed across all its segments. Also, the company has a shareholder base of around 530,000. In terms of revenues, the company reported a total revenue of $62 billion in 2015, including sales and other types of revenues. Also, during the same financial year (2015), operating income was A$3.76 billion, profit, A$ 2.44 billion and total assets reported at A$40.40 billion (Wesfarmers, 2016).

Locations/segments

Wesfarmers divides its operations into various segments as follows:

This includes supermarkets, convenience stores, office supplies and hardware. The brands in this include: Coles, that deals with retailing of groceries and other household consumable (Murphy, PR & Free, 2015). This division is located in over 2300 locations in Australia and New Zealand and is also present online through Cokes Online; Kmart, a retailer of general merchandise such as entertainment and other home consumables; Target, which comprises of the Target and Target Country brands that deal in homewares, apparel and other merchandise such as electricals and toys; and lastly, the Home Improvement and Office Supplies division (IBISWorld 2016).

Resources

This division deals mainly with coal producing and has various mining operations in Australia. Division here include the Curragh mine in Queensland as well as a 40% interest in Bengalla mine in New South Wales (IBISWorld 2016).

Chemicals, energy and fertilizers

This segment is involved in supplying chemicals and fertilizers to the agricultural, mining and industrial sectors. Businesses in this segment include: SABP, Australian Vinyls, 75% interest in Australian Gold Reagents, and a 50% interest in Queensland Nitrates (IBISWorld 2016).

Industrial and safety

This segment is involved in supplying repair, maintenance, operating, and safety and packaging products to the industry as well as to the public sector. Businesses in this segment include Blackwoods, Protector Alsafe, NZ Safety, Workwear Group, GotStock, Greencap, Coregas, Bullivants and Total Fasteners (IBISWorld 2016).

Other segments

Wesfarmers holds 50% interest in Gresham Partners and Gresham Equity Fund, a provider of investment banking services as well as corporate advisory services. Also, Wesfarmers has 50% interest in SawmillerWestpine industries (IBISWorld 2016).

Corporate governance issues

The Wesfarmers Board advocates strongly for corporate good governance and is committed to giving a satisfactory return to its shareholders and at the same time fulfil its obligations of corporate governance at the interests of the company and its stakeholders. In regard to this, the company complies with the ASX Corporate Governance Council’s Corporate Governance Principles and Recommendations. This compliance means that Wesfarmers board is very keen when it comes to the interest of the company, shareholders as well as the community (Wesfarmers 2016).

Circumstantial information

Business success factors

No one can say that Wesfarmers has had the best conditions for doing business, however, various factors can be termed as the reasons why the business has undergone a highly substantial growth since its inception in 1914. Wesfarmers was started as a farmers’ cooperative, but after operating for a while, it considered diversifying its business and this is majorly the reason why the company is the largest in Australia. Wesfarmers received revenues from the many segments it operates in, some of which bring huge profits for the company. These segments are: The retail sector comprises of four division namely; Coles, Home Improvement as well as Office Supplies, Target, and Kmart (automotive service retailer and a departmental store). The Industrial and other Businesses segment comprises of five division namely; Resources (coal mining), Insurance, Chemicals, Energy and Fertilizers, Safety and Industrial, as well as other products and services that serve this industry (Wesfarmers, 2016).

Another business success factor at Wesfarmers is the fact that the company has had a good history of successful acquisitions. In the business world, acquisitions are termed as a risky business whereby it is hard for a big company to create value from acquisition. However, Wesfarmers has beaten the odds and has successfully acquired various business including the $19 billion Coles buyout. Other businesses acquired by Wesfarmers include: Bunnings, Howard Smith and Westerns Collieries. Also, having a highly qualified team of workforce has also been a success factor at the company(Richards 2016).

Key economic factors about company’s industry

Various economic factors affect the industry in which the company belongs, which are the retail and industrial sectors. These factors may include: currency exchange rates, taxation, levels of consumer confidence, consumer income, and inflation among others. For example, the level of consumer confidence in a business affects its profitability in the long run (Wesfarmers, 2016). Customers have varying levels of confidence for business in the same industry and this determines the level of customer loyalty. Also, levels of consumer incomes affects the business. Increased consumer incomes means that more customers will spend on the company’s products and this increases the profitability.

Notable accounting issues

The retail industry has substantially grown in the Australian market and this does not go without various issues in accounting (Wesfarmers, 2016). The rapid growth of the industry under which Wesfarmers operates in can be traced to the underlying economic growth in Australia and New Zealand, expansion of population, increased wealth of individual customers as well as rapid constructions of infrastructure. Notable accounting issues that arise in these two industries include revenue and assets recognition, inventory among others.

Legal and regulatory matters

There are various legal and regulatory matters that govern Wesfarmers within the retail and industrial sectors, based on the company’s corporate governance statement. One of the regulatory matters that arise include integrity in financial reporting, unfair competition, and the use of false information on products among others.

The company’s position

This section analyses the position of the company in terms of its financial strength, sources of capital, trends in performance in the recent years, quality of earnings, responses of the media or the market to the company news, ratio analysis as well as comparing the company with the rest of the industry (Richards 2016).

Financial strength

Wesfarmers is a diversified company with many operations in hardware, office supplies, petrol, discount operations, coal mining, and insurance among other. All these operations yield revenues that when included together create a very strong company in terms of financial strength. In terms of the company’s financials, figures indicate that it is in a relatively good level. For example, the total revenues for the company grew from $58 billion in 2012 to $64 billion in 2015 (Wesfarmers, 2016). When it comes to the assets part of it, the company has not enjoyed a substantial growth, however, it has been able to maintain its assets between $40 billion to $43 billion since the financial year 2012. These numbers indicate that the company’s financial strength is strong when compared with other big ASX public companies such as the Woolworths, whose assets range between $21 billion to $25 billion between the years 2013 to 2015.

Performance trends

Since its inception in 1914, Wesfarmers limited has enjoyed a substantial growth in numbers in almost all aspects including customer numbers, assets, sales revenues, number of new segments, earnings per share, among others. For instance, since 2012, the company has enjoyed a 7.9% growth in Earnings per share (Wesfarmers, 2016).The company’s vison has been centered on delivering shareholder value through innovation, initiative and growth. The company’s total revenues for the company grew from $58 billion in 2012 to $64 billion in 2015.operating profits after income tax has also grown from $1.9 billion in 2012 to around $2.4 billion in 2015.

Sources of capital

Majorly, Wesfarmers obtains its capital from shareholders who have financed the after it was listed as a public company in the ASX. Before this, members of the Wesfarmers Cooperative society used to finance it(Richards 2016).As indicated above, the company values its shareholders very much and everything done at the company is done in the perspective of increasing shareholder value. Since 2012, the company has seen its earnings per share grow by 7.9% and this continues to attract more shareholders who are majorly the financiers. Its big earnings per share continues to attract more shareholders who are ensured of the security by the virtue that the company is very large in terms of numbers(Richards 2016).

Quality of earnings

The growth of earnings from certain segments making up the Wesfarmers limited, such as Coles and Bunnings, which is a home improvement business, have contributed to the huge lifts in profits at the company. Quality earnings by the company also mean quality earnings by the shareholders, who are basically the business financiers.

Corporate responsibility

Wesfarmers is among the leading companies in Australia and as per its size, it is highly committed to sustainability improvement of the business as well as for the stakeholders. The company’s strong economic, social and environmental performance is central to its objective, which is to provide value to shareholders, employees, suppliers, customers as well as partners within the community (Richards 2016). The company gets involved in various corporate social responsibility (CSR) activities, which paly a big role in enhancing loyalty from the society. In its CSR activities, the company focuses on efforts towards improving the livelihoods of people, efficient energy management, investment in the community, carbon reduction as well as contributing positively to the environment.

Growth strategy

The company’s growth strategy has been based on increasing the number of segments as well as opening up new businesses in new locations. A number of successful acquisitions and opening up of new sections or segments within Australia and New Zealand has seen the company emerge the top in terms of size, ahead of companies such as the Woolworths limited. Since 2007, the company began investing in the retail industry with various kinds of products such as foods, liquor, petrol, software, home building, clothing, stationery, automobile, and other similar services. The retail sector has been a growth strategy by the company and has enjoyed increased profits from these businesses (Richards 2016).

Also, Wesfarmers relies much on their customer’s loyalty and have thus been focusing on satisfying customers with the best quality products and services, convenience, variety as well as suitability in price. Also, Wesfarmers relies much on the skills and experience from its talented team of employees within the sound governance system.

Broad audit strategy

High risk areas for the business

For purposes of audit, it is critical for the auditor(s) to specify and differentiate between high risk areas and low risk areas within the business (Richards 2016). Some of the high risk areas are the insurance segment as a result of high claim costs due to the existence of natural calamities and disasters which have become prone, coal mining as a result of greenhouse emissions and carbon, retail business operational risks, as well as the management information system which was started in the year 2012 and has been prone to errors and omissions (Bentley, Omer & Sharp 2013).

Low risk areas for the business

The Wesfarmers limited has 8 major divisions, namely; Coles, Target, Kmart, Home improvement and Office Supplies, Insurance, Chemicals, Industrial and Safety, Energy and Fertilizers. Among these the low risk areas can be named as follows: home improvement and office supplies, Target and Kmart.

How risks are reflected in the financial statements

A company’s annual reports, such as the balance sheet which shows the company’s assets and liabilities, are affected by business risks in one way or another (Richards 2016). Though the risk may not be evident to the untrained, risk affects various line items in the statement of financial position. Only trained auditors can have the ability to see risks from the financial statements. Some of the risks are immediate, quantifiable and can be recorded directly into the financial statements such as the balance sheet. Others are long-term and can only be reflected in the footnotes part. What is important is that accountants should be made aware of these risks and ensure that they are properly recorded. Some of these risks to be reflected in the balance sheet include: accounting for doubtful accounts, interest expense, contingencies and other factors that affect future balance sheet (Healy & Palepu 2012; Van Deventer et al., 2013).

Higher financial risk leads to a higher interest rate on borrowing money and this leads to a higher interest expense in the balance sheet. As per this perspective, Wesfarmers is a low-risk company as it has very little debt and has stable revenues. Selling goods on credit also creates the possibility of doubtful accounts and this is a form of business risk that should be reflected in the financial statements (Van Deventer et al., 2013).

Whether appropriate to reduce assessed control risk

In an organization, there will always be some control risk on the financial statements as a result of inherent limitations in the accounting and internal control systems within the company (Richards 2016). Control risk assessment refers to the process in which the effectiveness of the company’s accounting and internal control systems are evaluated so as to detect, prevent or correct material misstatements. Thus, for Wesfarmers, it is always appropriate to reduce assessed control risk through performing preliminary assessment of the control risk for both the accounting and internal control systems. This will help reduce the chances of occurrence of any form of control risk in the financial statements (Rausand 2013).

The Fraud Triangle and the Fraud Scale

The Fraud triangle is basically a model that explains the reasons that cause someone to commit fraud within an organization (Kassem& Higson 2012). Three major factors are believed to cause someone commit occupational fraud and these are: perceived financial need, perceived opportunity as well as rationalization. There are very important and trusted people in the company, but when the same people have the above perceptions, then chances are that they may violate their trust (Kassem& Higson 2012). Such very important people in the company that are highly trusted but the existence of such perceptions may cause them commit occupational fraud are the accountants, especially the chief accountant and the general manager or the chief executive officer. The fraud scale model was developed as an alternative to the Fraud triangle and places its emphasis on a person’s integrity rather than on rationalization. These two models operate the same and ate used to analyze the integrity of a person in an organization as per the level of trust from the shareholders. The financiers of the Wesfarmers limited have confidence and trust in the company’s top management and as well as in the finance section, and the existence of any of the perceptions, can lead to an occupational fraud (Murphy & Free 2015; Boyle 2015 et al., 2015).

Conclusion

Fraud in an organization commonly involves various activities by people who were initially trusted within the organization. These activities may include theft, corruption, and embezzlement of funds, money laundering, extortion and bribery. This report brings out various factors and concepts that are involved in business risk analysis, essential for auditors when preparing a broad audit strategy for inclusion in the audit report (Bentley, Omer & Sharp, 2013). Business risk analysis involves analyzing the entire company from its history, company size, segments, financial strength, performance trends, key people in the company, among other aspects as discussed in this report. Before conducting an audit as well as preparing the audit plan, it is important for the auditors to have an adequate knowledge of the company, especially its account and internal control systems as audit evidence is obtained from such knowledge. Business risk analysis is very essential for an auditor before he or she conducts any form of audit. The contents of this report can provide adequate knowledge to the auditor on the company, its high and low risk areas, nature of accounting and internal control systems, key people for the company among other important aspects required by the auditors (Bell et al., 2001).

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