JD Sports Fashion – Material Misstatement

1-    Operational Activities of JD Sports Fashion

JD Sports Fashion PLC is a mid- ranked sports fashion, outdoor and athletic wear and footwear retailer company officially situated in the United Kingdom since 1981, and among the leading sportswear retailing company. The business has a large number of outlets throughout various geographical locations, especially in the United Kingdom, Europe, and the international bass visited coupled with a strong online portfolio. JD Sports currently deals in variety of branded tracksuits, footwear; accessories and enumerated brands of apparels and accessories inclusive of Nike, Adidas, Puma, Reebok and JD sports. The customer groups associated with the company are customers who indulge in sports activities, fashionable folks and tourists. The business activity has grown rapidly through acquisitions and partnerships with new investments primarily in Europe, the United States and Asia. JD Sports is aimed to remain on the Sporting and Fashion forefront, always adapting its products and its retail approach.

2-    Concept of Materiality

a)    ISAs & IFRS based n materiality

Materiality is the qualitative aspect by which financial information that could have an impact on the economic decisions of users, if omitted, misrepresented or otherwise provided inaccurately, is evaluated. IFRS define materiality as information that if omitted or misstated would affect the decisions that the users of the financial statements make. It specify that materiality of an item is not only in terms of amount but it is also qualitative in its nature. The concept of materiality is fundamental in auditing under ISAs, particularly in ISA 320 with special regard to planning and performing an audit. This means that it makes auditors to come up with the materiality at both an amount (in monetary terms) and also the nature of a misstatement.

b)   Relevancy of materiality to audit risk

The relationship between materiality and audit risk, is a measure of the chance that the auditor could incorrectly report a material misstatement of the financial statements. Audit risk is comprised of three main components. Inherent Risk, Control Risk and Detection Risk. Inherit Risk arises as a result of factors that are difficult to eliminate such as transactions that are hard to automate, change or deprecated. Control Risk is a risk that a company’s internal controls are inadequate to identify or prevent a material misstatement. Detection Risk has the capability of not identifying a material misstatement existing in the financial statements by the auditor’s procedures.

c)    Calculate Materiality

d)   Examples of Material Items

1. Inventory (Size)

The inventory affects the current profits as incorrect valuations could lead to a material misstatement in inventory valuation, particularly in the case of obsolete, or slow-moving items.

1. Online Sales: (Nature and Size)

Since now people get most of their products online, the amount of money from digital selling platforms is a metric. Misstatement toward occurrence of the improper revenue recognition could jeopardize JD Sports financial status notably, especially on account of complicated discounts, promotions or returns.

1. Goodwill from acquisitions (Nature)

Such goodwill is said to be material because it forms a huge balance that is tested for impairment on an ongoing basis. If wrong assumptions or projections are made then any misstated valuation of goodwill would be deemed material.

1. Trade Payables (Size)

Due to a high proportion of the liability situation, trade payables are considered to be material because they may have an impact on the size and structure of liquidity ratios and cash flow analysis in case of misstating this kind of account.

1. Foreign Exchange Hedging (Nature)

Mistranslation of value or account for these instruments potentially has a significant influence on the company’s profits and loss.

3-    Risk & Response

a)    Inherent risk in accordance with the ISAs with examples

Inherent Risk according to ISAs is a measure of the risk of a misstatement in an assertion about a financial statement that exists before reducing it through ID. It is one of the aspects of the overall audit risk and is established by auditors so as to identify these areas that would warrant more attention. Factor includes complex Financial Transactions, Subjective Judgments, Rapid Industry Changes, High Volume of Transactions & New Accounting Standards

b)   Identify & explain 5 items for higher level of inherent risk.

1. Inventory Valuation:

JD Sports keeps huge stocks as a retailer which is its strength because stock is most valued thing in every retail business. This leaves the fashion industry vulnerable to situations where there is accumulated inventory at the new and lower price, or when the inventory pile remains unsold which leads to overstocking and overvaluation of the inventory.

1. Goodwill and Intangible Assets:

The goodwill from acquisitions is high at JD Sports. There is a need to test goodwill for impairment through estimations that are mainly based on future cash flows.

1. Revenue Recognition:

JD Sports also sell through a variety of channels (physical, online stores and overseas) hence revenue recognition is not so straight forward. This results in increases the risk of misstatements in accounts such as revenues, returns, discounts, and rebates.

1. Foreign Currency Transactions:

A risk that JD Sports exposure to due to its international operation is foreign exchange risks. Unsatisfactory conversion of operations in a foreign currency to GBP might result in overstatements or understatements of financial disclosures.

1. Lease Accounting:

JD Sports has many stores which are leases and are accounted under IFRS 16. This standard involves recognizing lease liabilities and right-of-use assets similar to an operating lease, which also requires judgment to determine lease terms, renewal options and discount rates.

c)    Auditor could choose to respond to this risk

1. Inventory Valuation

Managers would compare registers in an organization and stocks including doing an audit of aging reports while checking historical effects of markdown data with loans more emphatically on sluggish moving stocks and write downs.

1. Goodwill and Intangible Assets:

Auditors would review account holders’ assumptions used in impairment tests, review those assumptions against industry norms, and discuss with other specialists if impairment is being handled correctly.

1. Revenue Recognition:

The auditor would look at the company’s policy for revenue recognition, select a sample of transactions to test and check the right cut-off in respect of sales that should be recognised in which period.

1. Foreign Currency Transactions:

Some of the checks auditors would make include whether there is a coherent policy in place on exchange rates, review of the management’s hedging instruments and compliance with IAS 21.

1. Lease Accounting:

Lease contracts would be checked, assumptions applied in determining the discount rates would be checked, and calculations of lease liabilities and right-of-use assets would also be checked in compliance with IFRS 16 by auditors.

4-    Corporate Governance

1. Analysis of JD Sports Fashion PLC’s Corporate Governance Practices

JD Sports Fashion PLC has taken significant strides to follow measures that shall make it follow corporate governance measures in line with the UK Corporate Governance Code that is meant From the governance perspective. Non-executive directors (NED) and Board of directors is independent of the management employees. Auditing oversight by independent parties is necessary for the following reasons As a result, it reduces objectivity and the risk of misstatements. Also the company has Audit and Risk committee that oversees integrity of reporting system and improvement of internal control. JD Sports also thoroughly disclose relaxation policies for executives, which relates executive compensation to long-term performance, which makes the interest of the managers aligned to those of the shareholders. Nonetheless, specific aspects of the company’s governance practises may contain inherent risks. This is due to the fact that the founder and CEO, Peter Cowgill has been involved in the formulation of decision making over the years. Such centralization of authority brings governance issues, especially on the autonomy of the board and issues to do with conflict of interest.

1. impact on Audit Risk

We expect auditors to supplement the level of analytical procedures by performing additional substantive tests of data and focus greater attention during the evaluation of management’s financial judgments on those areas. They may centre on confirming which controls are independent and assessing the risks around internal control systems to respond to these risks. Therefore despite having an efficient corporate governance model, certain areas namely executive power and past problems with governance call for enhanced scrutiny from the auditors to have accurate financial statements.