Audit Planning Considerations for AGL Energy Limited and Qantas Airways Limited
TO: The Engagement Partner
FROM: Engagement Team Lead of AGL and Qantas
DATE: April 25, 2020
SUBJECT: Audit Planning Memorandum – Identification of key risk areas and suggested audit strategy
Dear Sir,
The management of AGL Energy Limited (“AGL”) and Qantas Airways Limited (“Qantas”) will present the annual financial statements before their respective Boards in 3 weeks’ time. Our engagement needs to be conducted and performed before the end of third week for timely availability of audited accounts for the management to take informed decisions. Realizing this fact, the engagement team responsible for conducting the audit of two entities have assisted me in identifying the key areas that require special audit consideration and also identified controls that are most relevant to the true and fair preparation and presentation of financial statements. In the following paragraphs we set forth our findings for your attention and further guidance, so that audit engagement is performed in accordance with Australian Standards on Auditing (ASAs) in an efficient and effective manner.
Identification of Inherent Risks
AGL
AGL owns Australia’s one of the oldest integrated energy generation portfolio with a capacity of over 10,413 MW. It market share is around 20% of the Australia’s National Electricity Market (AGL Energy, 2020). Based on the initial understanding of the company and the environment in which it operates, following inherent risks are identified in its operations (ASA 315, 2016):
- As at June 30, 2019 the Company has reported $898 million of unbilled revenue (included in trade and other receivables). This effectively represents the electricity and gas supplied to customers between the date of last bill and the reporting date (June 30, 2019). Besides, the company has also recognized the related costs of $400 million as reported in Note 17 of the accounts. Reporting of these figures is based on estimates and management judgments are also made in determining the estimated electricity and gas consumption between these dates. Therefore, this warrants special audit attention (ASA 520).
- During the year the company has expanded $141 million on the upgradation of its enterprise resource planning and management information systems. Implementation of the new IT system combined with the already complex MIS appears to be a key aspect because these systems are critical to the integrity of the financial reporting process (ASA 315).
- The company has huge amounts of financial instruments recorded in its accounts ($798 million of current financial assets, and $590 million of non-current). This is because the company enters into signification long-term derivative financial instruments to hedge its exposure to variability in energy prices, interest rates and forex rates. This presents a key risk in financial statements (AASB 9 – Financial Instruments).
Qantas
Founded back in 1920, Qantas proudly defines itself as the “Australia’s largest domestic and international airline”. It’s business is the transportation of customers through various regional, domestic and international air flights. It operates through two airline brands, namely: Qantas and Jetstar. Following inherent risks are identified based on the initial understanding of the business and prior year audits:
- (i) Being and airline service provider, majority of the assets comprise of aircrafts and carriers. These may be subject to impairment and their regular maintenance and running expenditure are usually biggest hit to profit. Hence, being a key to operational efficiency this is a key risk area (ASA 330).
- (ii) The company provides frequent flyer miles to its customers, and recognition of frequent flyer revenue requires high level of management judgments and assumptions as to the deferment of Unredeemed Frequent Flyer revenue. There is a risk that the same might not be recognized in accordance with the new AASB 15 Revenue from Contracts with Customers.
- (iii) The company hedges the risk of commodity prices and foreign currency through cash flow hedges. These in turn require estimation of the fair value of options, swaps and cross-currency at several dates and are therefore prone to errors (ASA 200).
Audit procedures in response to inherent risks identified
AGL
- (i) Procedures to address the risk identified in unbilled revenue includes:
- Obtaining an understanding of the system in place to capture, estimate, record and ultimately account for such revenue;
- Obtaining the estimates of volume, customer pricing and distribution tariff rates and challenging the assumptions used by the management in forming these estimates;
- Comparing the consumption data with historic and currently available data;
- Using the work of a data analytics specialists (ASA 520).
- Subject Code and Name ACCT6006 Auditing Theory and Practice(ii) Procedures to address risks relating to IT systems include:
- Understanding how the systems contribute to the risk management and financial reporting process of the company;
- Testing the design and implementation process of the key processes that are relevant and of utmost importance to the financial reporting;
- Inquiring about any incidents or exceptions that may be identified by the management and investigating the reasons therefor;
- Walkthrough tests should also be performed to check how AASB 15 recognition criteria is satisfied (ASA 330, 2016).
- (iii) Determine whether derivative financial instruments have been correctly recognized and measured using the principles defined under the new AASB 9 Financial Instruments (AASB, 2018) including whether any fair value adjustments and impairments have been adequately recorded.
Qantas
- (i) Risk of unrecorded impairment and expenses can be mitigated by obtaining from management a summary cash flows from each aircraft expected for the year and checking if the recoverable amount is lower than the carrying value of the planes (AASB 136).
- (ii) Obtain and understanding of the key inputs in the frequent flyer miles and its redemption and test the integrity of the calculation. Using the internal data available, estimate the stand-alone selling price of the Qantas Points (frequent flyer miles available to customers) and the probability estimates compared with past history of redemption of points.
- (iii) Same as (iii) in paragraph 2.1 above.
Analytical review of the financial statements with the purpose of identifying areas of concern or comfort
AGL Analytical Reviews
|
|
|
2019 ($m) |
2018 ($m) |
% change |
% of total |
|
Trade and other receivables |
1,703 |
1,775 |
-4.1% |
11.5% |
|
|
Inventories |
388 |
370 |
4.9% |
2.6% |
|
|
Other current financial assets |
798 |
600 |
33.0% |
5.4% |
|
|
Cash and cash equivalents |
115 |
463 |
100.0% |
0.8% |
|
|
Property, plant and equipment |
6,588 |
6,757 |
-2.5% |
44.5% |
|
|
Intangible assets |
3,740 |
3,271 |
14.3% |
25.2% |
|
|
Total Assets |
14,821 |
14,633 |
1.3% |
100.0% |
|
|
Trade and other payables |
1,556 |
1,579 |
-1.5% |
24.4% |
|
|
Other current financial liabilities |
632 |
394 |
60.4% |
9.9% |
|
|
Borrowings |
2,850 |
2,963 |
-3.8% |
44.6% |
|
|
Deferred tax liabilities |
97 |
– |
100.0% |
1.5% |
|
|
Total liabilities |
6,383 |
6,332 |
0.8% |
100.0% |
|
|
|
|
2019 ($m) |
2018 ($m) |
% change |
% of revenue |
|
Revenue |
13,246 |
12,816 |
3.4% |
100.0% |
|
|
Cost of sales |
9,440 |
9,070 |
4.1% |
71.3% |
|
|
Employee benefits expenses |
604 |
651 |
-7.2% |
4.6% |
|
|
Loss/(gain) on fair value of financial instruments |
198 |
(803) |
-124.7% |
1.5% |
|
|
Depreciation and amortization |
625 |
568 |
10.0% |
4.7% |
|
|
Finance costs |
203 |
230 |
-11.7% |
1.5% |
|
|
Income tax expense |
374 |
662 |
-43.5% |
2.8% |
|
|
PBT |
1,279 |
2,244 |
-43.0% |
9.7% |
|
Areas of Concern
- (i) Current financial assets and liabilities definitely represent a major risk as each of them have increased by 33% and 60% when compared with the last year. Further, both of these figures are material being 5% and 4% of total assets (ASA 320).
- (ii) Employee benefits expense have reduced during the year by 7.2% for no reason. Normally salary and benefit increase during the year and there is also evidence of “launching additional employee benefits” as well as enhanced expenditure on training and development of employees, yet the expense seem to have been reduced.
- Loss/(gain) on fair value of financial instruments has changed from loss last year of $803 million to gain in the current year of $198 million, suggesting a change of almost 125% during the year. This represent a major risk as described in the last section (ASA 200).
Areas of Comfort
- (i) Trade receivables have increased by 4% which is consistent with the increase in revenue of around 3.4%.
- (ii) Property, plant and equipment have reduced by 2.5% which seems consistent with the additions and depreciation during the year.
- GP margin has remained somewhat consistent going down from 29.23% last year to 28.73% in the current year (ASA 520).
