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1.       Areas of operations

BCL is one of the major market players in Australian dairy industry that specializes in the production of natural and processed and cheese, butter and rich cream products. It was formed in 1899 and its manufacturing facilities are located in Bega, New South Wales and Strathmerton in Victoria (Australian Business Review, 2017). BCL is listed on the Australian Stock Exchange (Asx.com.au, 2019) and follows the acquisition model for expansion of its operations across the globe, with major acquisitions of brands like Vegemite and Kraft in the past, and acquisition of companies like Tatura Milk in the past and Koroit production facility in the current year. By exporting its products to over 70 different countries across the globe, the Company claims to sell 1 million packets of cheese every day (Bega Cheese Ltd, 2016). These sales account for 40-50% of BCL’s revenue. Besides selling its products under various brand names, BCL also caters to the needs of other local manufacturers by supplying bulk quantities under contracts to be sold under other brand names (Bega Bionutrients, 2016).

BCL’s revenue from the two major products is depicted using the following pie chart (with data extracted from Segment reporting note in financial statements):

 

2.       Laws and regulations affecting BCL’s operations

Besides being subject to reporting requirements under various local and international laws, BCL being engaged in operating various dairy farms and food processing facility has to comply with laws and regulation applicable on the dairy and farming industry. Some of these regulations are listed below:

  • Australian Animal Welfare Standards and Guidelines having regulation relating to fair treatment of animals and land transportation of livestock, and cattle farmer
  • The Foods Standards Code – FSANZ standards
  • Export Control (Prescribed Goods – General) Order 2005
  • Exports Control Act 1982
  • FSANZ Product Recall Protocol under which company needs to have a working recall system complying the requirements
  • Environment protection, occupational health and safety laws

 

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Adoption of the acquisition model of growth by BCL has resulted in purchase of several small and big brand names in the industry. The company also frequently undertake joint ventures within its industry. This has resulted accumulation of goodwill and intangible assets in its financial statements which might be overvalued. Further, the group operating in the food and agriculture industry has to account for its biological assets in accordance with IAS 41 and carry its inventory at fair value less cost to sell in accordance with that accounting standard. Since, these are subjective areas and often requires management of the entity to exercise judgment and are also subject to significant estimation uncertainty, the report identifies these two areas as highly risky and prone to misstatement due to the inherent degree of variability within their account balances.

 

 

Besides, the group has several transactions with related parties which are also inherently risky as transactions with related party could be undertaken on non-arm’s length basis resulting in the entity being unable to realize full value of its resources. Besides these transactions re to be eliminated for the purpose of consolidation procedures under IFRS 10 Consolidated Financial Statements. These procedures and he resulting adjustments are often complex and require the entity to apply considerable judgment and skill, and therefore could be prone to error. The following paragraphs of the report discuss these identified issues in detail.

 

4.       Goodwill and other acquired Intangible Assets

4.1       Explanation of the identified audit risk

A horizontal analysis of the breakup of intangible assets as disclosed in the available financial statements reveal the following:

 Figures in AUD thousands 2019 2018 Difference % change
Brands       140,405 140,405                  – 0%
Water rights            5,601 5,601                  – 0%
Headwork utilities rights               956 956                  – 0%
Gene pool            1,467 0            1,467 100%
Software          51,185 35,055          16,130 46%
Goodwill       335,533 229,446       106,087 46%
Total Intangibles       535,147       411,463       123,684 30%

 

Overall intangibles have increased during the current year by 30% at $123,684,000. Total intangibles amount to $535 million which is 36% of the assets employed by the company and therefore highly material account balance.

Goodwill and indefinite useful life assets are to be tested for impairment at least annually, and the results could indicate that these assets cannot fetch an amount equal to their carrying amount, and therefore need to be written down. Additions to software also amount to $20.7 million and is individually material to financial statements. Considering the company has been making major investments in the new enterprise resource planning (ERP) software since 2017, the utility and benefit of these additions should be inquired and evaluated against the management’s assertions. Intangibles therefore represent a major audit risk and would rightly deserve our major audit consideration.

Amount of $1.47 million recognized in the current year in respect of Gene Pool (as shown in table above) represents a seed research and development program of a subsidiary company – Peanut Company of Australia. It represents cost of R&D for the purpose of improving the desirable attributes of the peanut seeds varieties for optimum commercial production and grower’s successful varieties. This needs to be evaluated as per paragraph 58 of IAS 38 Intangible Assets so that only those expenditures on research are capitalized for which future benefits and commercial viability can be practically demonstrated and proved.

4.2       Potential impact on the financial statements

The level of management judgement involved in the valuation models is high and requires forecasting of future cash flows, growth rate of the operations, and determining the appropriate discount to be used. The amounts recognized in financial statements in respect of intangible assets and particularly for goodwill could therefore be overstated (materially).

 

4.3       Audit procedures and the related assertions to address the identified risks

The addition to goodwill as discussed above pertains to Koroit facility that has been acquired by BCL during the year. Koroit facilities generates cash inflows for the Company independent of its other operations and segments, hence it is a cash generating unit (CGU) that is accountable for good of over $106 million. The management has tested the CGU for impairment by calculating the net present value of cash inflows and outflows that it expects to incur from Koroit CGU over the next many years. Management has made the following subjective judgments in concluding that the goodwill has not been impaired at the close of financial year:

  • 5% growth rate for the products generated over the foreseeable future
  • 5 discount rate can be achieved
  • Sale of other products do not undermine the sale of Koroit products
  • Supply of Lactoferrin (which is an essential ingredient in dairy products) can be obtained

 

The use of incorrect assumption could result in over-optimistic valuation of the CGU, which will lead to avoidance of impairment recognition and consequently overstated profits. Following audit procedures would address this risk.

  1. Testing of management’s assumptions in valuation of CGU in line with market conditions to concluding whether they are relevant and correct in accordance with our understanding of the Company and its environment. An expert valuer can be employed if required by us;
  2. Performance of analytical procedures to predict the impact of acquisition of Koroit CGU on the company’s key performance indicators (KPIs) to predict the change in revenue and then comparing it with actual revenue to ascertain whether the expected increase has materialized over the period as per draft unaudited accounts;
  3. Comparing the forecasts used in the valuation with the budgets approved by the Company’s Board of Directors;
  4. Performing a sensitivity analysis of the calculations by varying key variables using a range of possible rates / outcomes, then determining which one is the most expected scenario (Jackson & Stent, 2015);
  5. Checking the mathematical accuracy of the calculations given by management and consider whether any variable / event / possibility has been ignored in the present value of net cash inflows;
  6. Reading the minutes of the BOD meeting to identify any fluctuations in the budgeted / expected cash inflows / outflows or deviations from initial expectations.