Principles, Practice And Process Of Auditing: An Analysis Of Cochlear Limited’s Financial Statements

Analytical Procedures

Comparison of Income Statement and Balance Sheet for Last Three Years

Particulars	2016 ($m)	2017 ($m)	2018 ($m) Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper	Change in % from 2016 to 2017	Change in % from 2017 to 2018
Revenue	1,130.6	1,253.8	1,363.7	10.9%	8.8%
Cost of Sales	333.6	358.4	361.2	7.4%	0.8%
Gross Profit	797.0	895.4	1,002.5	12.3%	12.0%
Selling, marketing and general expenses	324.1	347.2	397.0	7.1%	14.3%
Administration Expenses	79.3	85.2	97.4	7.4%	14.3%
Research and Development Expenses	145.1	151.9	167.7	4.7%	10.4%
Other Expenses	–	–	2.2	0.0%	0.0%
Other Income	14.2	4.5	10.2	-68.3%	126.7%
Results from operating activities	262.6	315.6	348.4	20.2%	10.4%
Finance income – interest	0.5	0.7	0.6	40.0%	-14.3%
Finance expense – interest	8.8	7.5	8.5	-14.8%	13.3%
Net finance expense	8.3	6.8	7.9	-18.1%	16.2%
Profit before income tax	254.3	308.8	340.5	21.4%	10.3%
Income Tax Expenses	65.3	85.2	94.7	30.5%	11.2%
Net Profit	188.9	223.6	245.8	18.4%	9.9%
Basic earnings per share (cents)	330.6	389.7	427.3	17.9%	9.6%
Diluted earnings per share (cents)	330.0	389.1	426.7	17.9%	9.7%

Table 1: Comparison of Income Statement

(Source: cochlear.com, 2018)

According to the above table, there are three items that need a thorough investigation; they are Other Income, Finance Income (Interest) and Finance Expenses (Interest). In case of all of these three items, it can be observed that there are some major fluctuations in these amounts in the last three years. For example, there is an increase in finance income of Cochlear Limited in the year 2017 from 2016; but, decrease can again be seen in the year 2018. In case of both other income and finance expenses, decrease can be seen in 2017 from 2016 and increase in 2018. These fluctuations are not healthy for the growth of Cochlear Limited. Investigation of these aspects would helpful in identifying the reasons for these fluctuations (Fazzini, 2018).

Particulars	2016 ($m)	2017 ($m)	2018 ($m)	Change in % from 2016 to 2017	Change in % from 2017 to 2018
Assets
Cash and cash equivalents	75.4	89.5	61.5	18.7%	-31.28%
Trade and other receivables	281.9	292.1	316.7	3.6%	8.42%
Forward exchange contracts	11.4	18.4	3.7	61.4%	-79.89%
Inventories	154.1	160	167.4	3.8%	4.63%
Current tax assets	6.2	7.3	9.6	17.7%	31.51%
Prepayments	13.9	18.6	25.3	33.8%	36.02%
Total Current Assets	543	585.9	584.2	7.9%	-0.29%
Total Current Assets
Other receivables	1.5	0.8	2.1	-46.7%	162.50%
Forward exchange contracts	10.7	7.8	0.4	-27.1%	-94.87%
Property, plant and equipment	86.8	120.1	128.4	38.4%	6.91%
Intangible assets	224.3	340	345.3	51.6%	1.56%
Investments	13.7	15.1	15.8	10.2%	4.64%
Deferred tax assets	77.1	66.6	80.7	-13.6%	21.17%
Total Non-Current Assets	414.3	550.4	572.7	32.9%	4.05%
Total Assets	957.3	1136.3	1156.9	18.7%	1.81%
Liabilities
Trade and other payables	110.3	130.9	140.5	18.7%	7.33%
Forward exchange contracts	12.6	2	13.1	-84.1%	555.00%
Loans and borrowings	3.9	84.7	3.7	2071.8%	-95.63%
Current tax liabilities	13.7	26.3	22.1	92.0%	-15.97%
Employee benefit liabilities	45.4	52.4	57.3	15.4%	9.35%
Provisions	33.6	25	24.5	-25.6%	-2.00%
Deferred revenue	31.2	25.3	26.5	-18.9%	4.74%
Total Current Liabilities	251.1	346.6	287.7	38.0%	-16.99%
Trade and other payables	0	33.9	28.1	0.0%	-17.11%
Forward exchange contracts	3.5	3.2	9.2	-8.6%	187.50%
Loans and borrowings	189.2	134.2	144	-29.1%	7.30%
Employee benefit liabilities	13.7	11	12	-19.7%	9.09%
Provisions	44	54.7	54.4	24.3%	-0.55%
Deferred tax liabilities	7.1	5.8	8.1	-18.3%	39.66%
Deferred revenue	0	3.3	2.6	0.0%	-21.21%
Total Non-Current Liabilities	257.7	246.1	258.4	-4.5%	5.00%
Total Liabilities	508.8	592.7	546.1	16.5%	-7.86%
Net Assets	448.5	543.6	610.8	21.2%	12.36%
Equity
Share Capital	158.9	169.4	173	6.6%	2.13%
Reserves	14.6	12.9	33.8	-11.6%	162.02%
Retained Earnings	304.2	387.1	471.6	27.3%	21.83%
Total Equity	448.5	543.6	610.8	21.2%	12.36%

Table 2: Comparison of Balance Sheet

(Source: cochlear.com, 2018)

It can be seen from the above analysis that two specific items in the balance sheet of Cochlear Limited need to be investigated; they are Cash and Cash Equivalent and Forward Exchange Contracts (Assets). In both of these items, a trend of decrease in value can be seen in 2018 from the last two years. The audit analytical procedures is conducted with the aim to identify the reasons behind the decrease in these items of Cochlear Limited’s balance sheet (Lin et al., 2015). 

Analysis of Ratios for Last Three Years

Profitability Ratios

Particulars	Formula	2016 ($m)	2017 ($m)	2018 ($m)	Change in % from 2016 to 2017	Change in % from 2017 to 2018	Industry Average
Sales		1130.6	1253.8	1363.7
Net Profit		188.9	223.6	245.8
Average Total Assets		916.35	1046.8	1146.6
Average Shareholder’s Equity		401.9	496.05	577.2
Net Profit Ratio	Net Profit/Sale	16.71%	17.83%	18.02%	6.74%	1.07%	21.71
Return on Assets	Net Profit/Average Total Assets	20.61%	21.36%	21.44%	3.62%	0.36%	15.5
Return on Equity	Net Profit/Average Shareholder’s Equity	47.00%	45.08%	42.58%	-4.10%	-5.53%	35.85

Table 3: Profitability Ratios

(Source: cochlear.com, 2018)

Liquidity Ratios

Particulars	Formula	2016 ($m)	2017 ($m)	2018 ($m)	Change in % from 2016 to 2017	Change in % from 2017 to 2018	Industry Average
Total Current Assets		543	585.9	584.2
Total Current Liabilities		251.1	346.6	287.7
Inventories		154.1	160	167.4
Prepaid Expenses		13.9	18.6	25.3
Current Ratio	Current Assets/Current Liabilities	2.16	1.69	2.03	-21.83%	20.12%	2.76
Quick Ratio	Current Assets-Inventories-Prepaid Expenses/Current Liabilities	1.49	1.18	1.36	-21.31%	15.80%	1.68

Table 4: Liquidity Ratios

(Source: cochlear.com, 2018)

Efficiency Ratios

Particulars	Formula	2016 ($m)	2017 ($m)	2018 ($m)	Change in % from 2016 to 2017	Change in % from 2017 to 2018	Industry Average
Sales		1130.6	1253.8	1363.7
Average Total Assets		916.35	1046.8	1146.6
Total Non-Current Assets		414.3	550.4	572.7
Asset Turnover Ratio	Sales/Average Total Assets	1.23	1.20	1.19	-2.92%	-0.70%	0.56
Fixed Assets Turnover Ratio	Sales/Total Non-Current Assets	2.73	2.28	2.38	-16.53%	4.53%	0.58

Table 5: Efficiency Ratios

(Source: cochlear.com, 2018)

Leverage Ratios

Particulars	Formula	2016 ($m)	2017 ($m)	2018 ($m)	Change in % from 2016 to 2017	Change in % from 2017 to 2018	Industry Average
Total Equity		448.5	543.6	610.8
Total Assets		957.3	1136.3	1156.9
Total Liabilities		508.8	592.7	546.1
EBIT		262.6	315.6	348.4
Interest Expenses		8.8	7.5	8.5
Equity Ratio	Total Equity/Total Assets	0.47	0.48	0.53	2.11%	10.36%	1.28
Debt to Equity Ratio	Total Liabilities/Total Equity	1.13	1.09	0.89	-3.89%	-18.00%	0.43
Interest Coverage Ratio	EBIT/Interest Expenses	29.84	42.08	40.99	41.01%	-2.59%	22.82

Table 6: Leverage Ratios

(Source: cochlear.com, 2018)

According to the above analytical procedure of ratio analysis, there are certain ratios that need to be investigated as they are less than the industry average; they are Net Profit Ratio, Current Ratio, Quick Ratio and Equity Ratio (Hilton & Platt, 2013).

It needs to be mentioned that the above-mentioned aspects need to be considered in audit planning as they have effects on the audit procedures. For this reason, the responsibility of the auditor is to conduct thorough investigation on these items with the aim to find out the causes of this financial inconsistency. Most importantly, the auditor needs to put major emphasis on these items for the purpose of audit planning decisions. 

Conclusion

The above analytical procedures of simple comparison and ratio analysis indicate that the auditors of Cochlear Limited is needed to take into consideration the above increase or decrease in the values and ratios for the purpose of audit planning decision.

The following discussion analyzes that inherent risk of material misstatements of Cochlear Limited at financial report level based on five specific parameters:

1. Integrity of Management:It can be observed from the 2018 Annual Report of Cochlear Limited that all the directors in the Board obtain high level of knowledge, experience, skill set and goodwill in the industry. They comply with all the regulations and standards of corporate governance with the aim to eliminate fraudulent and illegal activities in the business operations. In addition, some independent directors are responsible for overseeing the operations of some committees (com, 2018). Thus, it can be said in the presence of all these aspects that inherent risk is low in this case.
2. Management’s Experience, Knowledge and Changes during the Period:It needs to be mentioned that the Board of Directors of Cochlear Limited consists of both executive and non-executive directors. Their details can be seen from the following tables. It can be seen from the below figures that both the executive as well as non-executive directors of the company posses the required skills, knowledge and experience that make them perfect for these positions. It implies that all these aspects are above the satisfying level. Hence, the inherent risk related to this aspect is low for Cochlear Limited (com, 2018).

1. Unusual Pressure on Management:There are some specific responsibilities of the directors of Cochlear Limited.  They are to prepare the financial statements as per the required standards and principles; to implement the required internal control mechanism to eradicate fraud in financial reporting, to assess the ability of the company to continue as a going concern, to develop strategies for the financial as well as other difficulties and others. All these are the normal tasks of the directors and it implies that there is not any unusual pressure on the management. However, the possibility to manipulate cannot be overlooked as directors have all the powers. Thus, this risk can be considered as medium (com, 2018).   
2. Nature of the Entity’s Business:It needs to be mentioned that Cochlear Limited operates in the biotechnology industry of Australia and New Zealand. This industry can be considered as a vibrant one due to the scope of major innovations. The occurrence of major innovation can change the whole situation of the industry. In addition, this industry required huge investments for the purposes Research & Development, introduction of new products and others; and this aspect creates high barrier of entrance for other companies. Due to the presence of all these aspects, the inherent risk can be considered as high (Wilson et al., 2014).
3. Factors Affecting the Industry:There are certain factors that affect the biotechnology industry of Australia; such as level of competition, legislative regulations and rules, innovation and service to the customers. The main aim of the companies operating in this industry is to cater to the needs of the customers with their innovative products and services. For this reason, the presence of immense competition can be seen among the existing companies. In this process, the pricing strategy also plays an integral part as the price of the products and services attracts the attention of large number of customers. The companies are also needed to comply with all the rules and legislations of the government. For all these reasons, the inherent risk can be considered as high (Dodgson, 2018).

Conclusion

It can be seen from the above discussion that in most of the cases the inherent risk is low. However, the auditor of Cochlear Limited is needed to consider the effects of industry nature and factors affecting the industry for audit planning.

Risk of Material Misstatements (Inherent Risk) at the Assertion Level

Cash and Cash Equivalent	Specific Account Balance No.:
a. Explanation of the Reason	The main reason to consider it at significant material misstatement risk is 31.28% decrease in 2018 from 2017. Major fluctuation in both the current and quick ration is another reason.
b. Key Assertions at Risk	After considering the above, the key assertion at risk is cut-off. It is because there is a high probability of incorrect calculation of cash and cash equivalent in the required accounting book (Titera, 2013).
c. Relevant Substantive Audit Procedure	In this case, the relevant substantive audit procedure is to thoroughly check the previous cash receipts and cash payments before the balance date; and then to check the first cash payment after balance date (Groomer & Murthy, 2018).
d. Relevant Internal Control	In this case, the main internal control is to ensure that all cash disbursements are correctly recorded as to the correct account (Badara & Saidin, 2013).

Prepayments	Specific Account Balance No.:
a. Explanation of the Reason	The main reason for considering this at the risk of material misstatements is the continuous increase in this advance payment that is 33.8% from 2016 to 2017 and 36.02% from 2017 to 2018. This is one major reason of low quick ratio that the industry average.
b. Key Assertions at Risk	In this case, the assertion of occurrence at risk because of the fact that there is a chance of fraudulent activity around prepayment (Knechel & Salterio, 2016).
c. Relevant Substantive Audit Procedure	The main substantive audit procedure should be to check all supporting documents related to the prepayments. More specifically, supporting documents like goods received notes, invoice of the suppliers and others need to be checked (Jans, Alles & Vasarhelyi, 2014).
d. Relevant Internal Control	All the above-mentioned supporting documents related to the prepayments needs to be recorded as well as maintained in the correct accounts (Pizzini, Lin & Ziegenfuss, 2014).

Finance Expenses	Specific Account Balance No.:
a. Explanation of the Reason	The main reason for considering finance expenses at the significant risk of material misstatements is the major fluctuation in the values; that is -14.8% from 2016 to 2017 and 13.3% from 2017 to 2018. This aspect leads to the fluctuation in interest coverage ratio and makes it less than the industry average.
b. Key Assertions at Risk	In this aspect, the assertion of cut off is at risk because of the possibility that the transactions related to interest expenses may not be recorded in the same accounting period (van Buuren et al., 2014).
c. Relevant Substantive Audit Procedure	In this case, the most relevant substantive audit procedure is to check all the documents related to this interest expenses so that any error can be identified (Mock & Turner, 2013).
d. Relevant Internal Control	All the documents related to this must be recorded at the correct accounting period (Mock & Turner, 2013).

Conclusion

As per the above discussion, three major accounts are at the risk of material misstatements. The main reasons for considering them as material are the fluctuations in the amount and ratios.

References

Badara, M. A. S., & Saidin, S. Z. (2013). Impact of the effective internal control system on the internal audit effectiveness at local government level. Journal of Social and Development Sciences, 4(1), 16-23.

Cochlear Limited. (2018). 2016 Annual Report. Retrieved 6 November 2018, from https://www.cochlear.com/ebe550d5-d6c2-4b06-a1d2-8f873fb0c345/en_corporate_annualreport2016_2.37mb.pdf?MOD=AJPERES&CONVERT_TO=url&CACHEID=ROOTWORKSPACE-ebe550d5-d6c2-4b06-a1d2-8f873fb0c345-lpSVNkn

Cochlear Limited. (2018). 2017 Annual Report. Retrieved 6 November 2018, from https://www.cochlear.com/b0dffcb0-9826-4c99-9d58-ad7a760bddac/en_corporate_cochlear_annualreport2017_1.78mb.pdf?MOD=AJPERES&CONVERT_TO=url&CACHEID=ROOTWORKSPACE-b0dffcb0-9826-4c99-9d58-ad7a760bddac-lTJByF-

Cochlear Limited. (2018). 2018 Annual Report. Retrieved 6 November 2018, from https://www.cochlear.com/43d56bcc-d510-4a20-ab70-6208fa5af77e/en_annualreport2018_cochlear2018annualreport_5.69mb.pdf?MOD=AJPERES&CONVERT_TO=url&CACHEID=ROOTWORKSPACE-43d56bcc-d510-4a20-ab70-6208fa5af77e-mkRS5RK

Cochlear. (2018). About Cochlear | Cochlear™ AU/NZ About Cochlear | Cochlear™ AU/NZ. Retrieved 6 November 2018, from https://www.cochlear.com/au/about/about-cochlear

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