our understanding of the entity's business and its industry and environment, its accounting policies and practices, and its financial performance
our assessment of risks of material misstatement relevant to the audit, including error and fraud risks
our audit strategy in response to these risks
Table of Contents
Audit Strategy Decisions
Timing of audit activities
Understanding The Entity
The entity's business and its industry and environment
The entity's accounting policies and practices
The entity's financial performance
Summary of Identified Risks
Identified risks at the financial statement level
Identified inherent risks
I. Audit Strategy Decision
A. Audit risk:
Audit risk is the risk that an 'auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated.' (AU 312.02, SAS 47 AICPA Professional Standards)
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We will determine audit risks which includes 3 main components: inherent risk, control risk and detection risk using the Audit Risk Model (ARM):
Audit risk= inherent risk x control risk x detection risk. (Soltani, 2007: 221)
There is an inverse relationship between audit risk and error detection as Caster et al. (2000: 66) claimed: 'It also follows that the more errors detected, the greater the likelihood that detected error rates will approximately actually error rates in the population, particularly in regard to material errors'.
Materiality and audit risk are interrelated and we consider them at two levels: that of the overall financial statement and in relation to the individual classes of transactions.(Soltani,2007: 229)
B. Materiality levels
The International Federation of Accountants (IFAC) defines 'Materiality' as 'Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.' (IFAC, 2004b, ISA 320:332). The auditor should consider materiality when 'determining the nature, timing and extent of audit procedures and evaluating the effect of misstatement' (Soltani, 2007: 229)
In general, the auditor's materiality judgments are classified into two types: preliminary and final reporting materiality judgment. The preliminary materiality judgment can be set at a lower level than the final reporting in order that it can help increase the possibility of identifying misstatement and lower overall audit risk. 'An auditor shall make a preliminary assessment of materiality to establish an appropriate quantitative materiality level'(ASA 320.12, AUASB).
Auditors usually make the preliminary material judgment base on quantitative approaches which can be categorised into four categories: single rules, variable or size rules, blend or averaging methods and formula methods. We typically use the 'Single Rules' approach, or 'Rules of thumb' - using 'a single financial variable for computing materiality' (McKee et. al, 2000). In accordance with 'the nature and circumstances of the entity include total revenues, gross profit, and other categories of reported income' (AU 312.28, SAS 47 AICPA Professional Standards), sky is a profit-oriented entity; therefore, we determine materiality for planning purpose by reference to profit before tax from continuing operations for the period under audit.
Basis used for determining materiality level
Profit before tax from continuing operations
Amount of the basis used for determining materiality level
Adjusting items (if any):
Adjusted amount of the basis used for determining materiality level
Along with the quantitative approaches, we also take into consideration of qualitative factors which may influence the materiality of individual misstatements to evaluate 'the significance of the misstatement to the particular entity, the pervasiveness of the misstatement and the effect of misstatement on the financial report as a whole.'(ASA 320.21, AUASB) Due to the combination of quantitative and qualitative considerations in materiality judgments, we can identify misstatements of relatively small amounts which may have an effect on the materiality of the financial statements.(AU 312.59, SAS 47 AICPA Professional Standards)
The quantitative level of materiality for planning purposes is commonly determined base on the 5% rule by reference to profit (or loss) before tax from continuing operations. It means that 'reasonable investors would not be influenced in their investment decisions by a fluctuation in net income of 5% or less. Nor would the investors be swayed by a fluctuation or series of fluctuations of less than 5% in income statement line items, as long as the net change was less than 5%.' (Vorhies, 2005) But this approach still encounters with many criticisms from the Securities & Exchange Commission such as 'the misstatement or omission of an item that falls under a 5% threshold is not material in the absence of particularly egregious circumstances, such as self-dealing or misappropriation by senior management' or 'the new statement on materiality will give auditors added leverage when dealing with corporate financial executives' (6). However, 'materiality is not simple calculation and the quantitative analysis is very complex, almost everyone -including Certified Public Account- uses quantitative estimates to identify potential materiality issues.' (Vorhies, 2005)
Always on Time
Marked to Standard
The following table is completed stating the basis used for determining materiality and the determined amount of materiality level
Basis used for determining materiality for planning purposes
% of basis
C. Timing of audit activities
We document all activities as well as the related timing that are relevant for the conduct of the audit as follow:
Audit Committee meeting
1 SEP YEAR 2
Meeting With Sky
15 Sep YEAR 2
Risk Assessment and Planning Meeting
15 Sep YEAR 2
Audit Committee Meeting
15 Oct YEAR 2
Physical Inventory Count
2 Jan YEAR 3
7 Jan YEAR 3
Accounts Receivable Confirmations
7 Jan YEAR 3
Audit Committee Meeting
17 Mar YEAR 3
Important thing on next page !!!
C. Team assignments
We plan and document the role and name of key engagement team members, including KPMG specialists and external experts contracted by a KPMG member firm, and determine their key responsibilities that are unique to this audit. If the names have not yet been determined, we document this fact.
The engagement quality control reviewer, the IFRS reviewing partner, the filing review partner and other reviewing partners, are not considered members of the engagement team. Matters related to such reviewing partners are documented in Section II.D.
(no responsibilities unique to this audit)
Engagement Quality Control Reviewer
(no responsibilities unique to this audit)
(no responsibilities unique to this audit)
Review client's bank covenant compliance; perform procedures using IDEA relating to journal entries and accounts receivable
See attachment II.
See attachment II.
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II. Understanding The Entity
A. The entity's business and its industry and environment
1. The entity's business
a) Legal and Operating Structure
British Sky Broadcasting Group plc ( 'Sky' , the 'Group' or 'the Company') was formed by the merger of Sky Television and British Satellite Broadcasting in 1990. The Company is a dominant provider of satellite television channels in the UK.
At 28 July 2010, about 39% of the Company's shares are held by News UK Nominees Limited, an indirect wholly owned subsidiary of News Corporation - the largest shareholder of Sky. [page43] No major changes have occurred to the Company's legal structure during the current period except for the pending proposal of News Corporation to acquire the remaining 61% of Sky
The Company's Board currently comprises 14 Directors (2 executive and 12 non-executive directors). The Board meet five times during the year to review appropriate strategic, operational and financial matters.
There are also four Boar Committees reporting regularly to the Board on its activities. They are Audit, Remuneration, Corporate Governance & Nominations and The Bigger Picture Committees. No changes have occurred to the Company's operating structure during the period
b) Objectives and Strategies
Management objectives: building larger and profitable business
Increasing overall customer base
Offering low price for customers who want to switch from other service provider to Sky
Selling more products to existing customers
Investing in where customers see values ( standout contents, choices with Sky)
Introducing new ways to bring content to life (3D TV, offer low cost Sky and HD box)
Focusing on operational efficiency
Making cost base more efficient by
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Simplifying processes in the supply chain
Cut cost n back office functions
c) Conduct of operations
Sky operates the leading pay television service primarily in the UK as well as broadband and telephony services. They commission and acquire programming to broadcast on their own channels and supply certain of those channels to other operators for retransmission to their subscribers.
Customers of Sky come from 2 main sources: Direct-to-home (DTH) customers and cable operators' subscribers which were 9.860 million and 4.312 million respectively at the end of June 2010. [page 8]
Sky is currently providing 4 main lines of services including Television, internet access, telephone and online interactive services. At the moment, Television is the most contributing area to the Group's revenue with 95% of the revenue in fiscal year 2010 [page 8]
Due to the heavy reliance of Sky's business on television services, organizations and companies that hold the right of TV content are the main suppliers of Sky. Recently, The Company has acquired certain exclusive DTH rights from Hollywood, independent distributors, and The Premier League Limited which enable it to show movies and live TV programmes on Sky Box Office.
In terms of technology infrastructure, in 2008 the Group acquired Amstrad, who was a major supplier of high definition and PVR set-top boxes. The Group is also under an agreement with DNS, a supplier of smart cards, security development and support services.
The Group employs 16,493 full-time workers, an increase of 1,517 for the previous year.
Each division runs individual recognition programmes to review and evaluate employees' contribution. Employees are entitled to free top-tier home Sky package, on-site gym, free private healthcare and enhanced life insurance.
Long service is highly valued. Therefore, formal recognition was awarded to employees with 10, 15 and 20 years continuous service. In addition, retired employees are assisted with online pension system to help them plan their retirement.
Investments in joint ventures and associates: increased by £14 million to £149 million at 30 June 2010 [page], primarily due to the revaluation of the Group's interests in NGC Network International LLC and NGC Network Latin America LLC due to foreign exchange movements.
Available-for-sale investments: decreased by £79 million to £182 million at 30 June 2010 [page], primarily due to the partial disposal of the Group's investment in ITV, offset by the effect of the increase in the equity share price of ITV.
The Group's long-term funding comes primarily from issued equity and US dollar and sterling-denominated debt.
The Group established a Euro medium term note programme (EMTN Programme) providing a standardised documentation platform to allow for senior debt issuance in the Eurobond markets.
Sky has a £750 million Revolving Credit Facility which was extended another year to 30 July 2013, syndicated across 11 counterparty banks, each with a minimum credit rating of A-. [page]
i) Related parties
Sky conducts business transactions with companies that are part of the News Corporation Group. During the year, the Group supplied programming, telephony, marketing, consultancy services and set-top boxes to News Corporation.
Services purchased from News Corporation include programming, digital equipment, smartcards and encryption services, set-top box technologies, advertising, IT services and rental premises.
The Group also participated in the equity raising, acquiring a further 21,700 shares of the issued share capital of Shine, a limited company that one of the Director of the Group has a controlling interest of, for cash consideration of £19 million. During the year, the Group incurred programming and production costs for television of £6 million from Shine. At 30 June 2010, there were no outstanding amounts due to Shine. [page]
In addition, the Group has engaged in a number of transactions with companies of which some of the Company's Directors are also directors.
j) Litigation & Claims
On 26 January 2010, judgment was given by the Technology and Construction Court ('TCC') regarding to the litigation between EDS and the Group. The litigation related to EDS' former role as a supplier to the Group as part of the Group's customer relationship management project. On 7 June 2010, EDS and the Group fully and finally settled the litigation between them and all related claims for a total amount of £318 million [page]
The Group has recognized £49 million of these payments in investment income on litigation settlement. The balance of £269 million has been recognized in litigation settlement income representing settlement for costs and damages.
On 31 March 2010, Ofcom, the communications regulator, decided to impose the 'WMO Obligations' on Sky which required the Group to offer the Channels to third parties with various minimum qualifying criteria. On 1 June 2010, Sky had presented its appeal against the decision of Ofcom.
2. The entity's industry and environment
a) Industry environment
Intervention of any competitor: on March 2010, Ofcom affirmed that that Sky must wholesale some of its premium channels such as its key sports and movie channels to rival operators at regulated prices to other distributors. This could allow several competitors to challenge Sky in the £4bn pay-TV market, leading to lower consumer prices for Premier League football (ie: it allows BTÂ and the internet service provider Talk Talk to build their own pay TV businesses, possibly at Sky's expense)
Technological: A failure of key suppliers to meet the Group's requirements, , discontinuance of products or services, deterioration in support quality and any occurrence related to economic failure in the industry could have a material adverse affect on the Group's ability to deliver its products and services.
Copy cat: Third parties activities through internet and the lack of internet-specific legislation challenge the Group from protecting its trademark, copyright and other digital technology rights.
b) PESTEL analysis
The peak of global financial crisis in 2008 had affected the financial performance of the industry as a whole and Sky in particular. Not until the end of 2009, when the economy showed slight recovery, did Sky have many remarkable improvements in their business activities. Specifically, the adjusted revenue of the Group grows £539 million and the profit increases by 10% in 2010 [page 7]
In June 2010, News Corporation approached to buy 61% remaining shares of Sky. The proposal which would lead to an unacceptable reduction in media diversity if it was successful has been opposed by major Media organizations. The European Commission's investigation to decide whether it should allow the takeover is still in progress.[ref 1]
Sky has been leading the UK's telecommunication industry in providing HD & 3D television with several channels to customers by continuous technological innovations and by licensing, acquiring and producing a broad range of content. The Company has first step in bringing 3D television to residential customers in the UK and broadcast the world's first live football match in 3D. The Group's key elements to success are complex technology systems and effective customer relationship management
Sky has developed environmental management program and set up Environmental Steering Group to monitor and minimize its bad impacts on environment in long-term basis. The Company also contributes to protecting environment through many projects such as saving 1 billion trees in partnership with WWF. [page]
The Sky's business is greatly influenced by regulations. Therefore, changes in regulations, changes in understanding the existing regulations or failure to acquire the regulatory requirements or licences could unfavourably impede the company from managing and competing efficiently.
B. The entity's accounting policies and practices
Applicable financial reporting framework
The financial statements have been prepared in accordance with 'IFRS' adopted by the European Union, the Companies Act 2006, Article 4 of IAS, and IFRS issued by the International Accounting Standards Board (IASB).
2. Changes to selection and application of accounting policies by the entity
Adopted: IFRS 8 'Operating Segments'
Revised: IAS 1 (2007) 'Presentation of Financial Statement'
IAS 23 (2008) 'Borrowing Costs'
IFRS 3 (2008) 'Business Combinations'
IAS 27 (2008) 'Consolidated and Separate Financial Statements'
Amendment to: IFRS 2 'Share-based Payment - Vesting Conditions and Cancellations'
IFRS 7 'Financial Instruments: Disclosure - Improving Disclosures about Financial Instruments'
IAS 39 'Financial Instruments: Recognition and Measurement - Eligible Hedged Items'
None of the changes above has material impact on our audit of the Company's financial statements.
3. Critical accounting policies
The following have been identified as important accounting policies in the industry:
Impairment of assets
The selection and application of the accounting policies is considered to be acceptable and appropriate for Sky, and it is also consistent with the accounting policies generally used in the industry.
C. The entity's financial performance
Here are some of the key facts and figures about the Group's business at a glance:
Total customers 9,860,000 9,442,000
Operating revenue £5,912 million £5,359 million
Operating expenses £5,085 million £4,546 million
Operating profits £1,096 million £813 million
Profit for year £878 million £259 million
Operating profit margin 19% 15%
Basic earnings per share 50.4 pence 14.9 pence
The Company's revenue is mainly derived from
Retail subscription (DTH customers),
Wholesale fees (Sky Channels),
Advertising on their wholly-owned channels (thirty second commercial),
The provision of services by Easynet (services for public and private sector customers in the UK, Europe, Asia and the US) and
Installation, hardware & servicing (set-top box sales and installation, service calls and warranties).
The Company's operating expenses arises from
Programming (payment for licenses),
Direct networks (supply of broadband and telephony service),
Transmission, technology & fixed networks (cost of satellite transponders),
Subscriber management & supply chain (customer management costs, systems & infrastructure installation costs) and
Administration costs (channel management)
All the figures in 2010 show significant increases compared to those in 2009 proving that Sky's business is on its good run at the moment. The Board also aims to continue this upward trend by holding the rate of growth in operating costs below that of revenue growth. As a result, nothing has come to our attention which indicates that the Company will not continue as a going concern.
III. Risk Assessment
A. Business risks:
B. Audit risks at financial statement level:
In this risk assessment procedure, the auditors shall plan and perform an audit with professional skepticism, maintain questioning mind and a critical assessment of evidence (Jones, 2009). Auditors should keep aside the prior belief that the Group's management is honest. The auditors need to examine carefully the internal and external factors that can influent financial statement's preparing process or create incentives for managers making frauds.
Following the principles above, here are some areas of Group which could create material misstatement.
The 11% increase of Group Revenue is questionable, especially with £483 million (2010) which arises from services provided to other countries. Part of remuneration depends on the Group's performance, especially for Executive Directors. So there are incentives that the Directors are under pressure to provide good statement to please shareholders. Therefore, it's prudent to keep skepticism about Group's revenue and check identities of the revenue.
Impairment of available-for-sale investment and profit on disposal of available-for-sale investment:
The Group earned £115 million on the ITV's disposal. The method of evaluating fair value and impairment losses of investment on ITV should be checked to confirm the profit on disposal.
The Group exposed to UK and US interest rate risk as well as the foreign exchange risk due to the Group's source of finance. There will be huge impact on income and financial position of Group if the violations of both rates are large. The sensitivity analysis on interest rate and foreign exchange rate are based on many assumptions which are subjected to test. The analysis should be use with caution in consideration of interrelationship between various market rates. Although the Group used derivative instruments to hedge those risks, the effectiveness of these should be tested.
The Group's principal source of liquidity is cash generated from operations, combined with access to a £750 million RCF, which expires in July 2013, with the right to request two further one year extensions. The Group is also obligated to operating lease commitments which are subject to renegotiation at the various intervals specified in the leases. The Net Debt: EBITDA ratio has reduced from 1.6:1 in 2009 to 0.9:1 has proved the competence of group's management. However, those ratios should be checked for certainty. Efforts should be made to ensure the good control of finance lease, an off-balance sheet financing method.
The Group is exposed to counterparty default risk amounting to invested cash and cash equivalents and short-term deposits, and the positive fair value of derivative financial assets held. The Group has used many methods to reduce the risks but it is difficult to ensure the risk is low. Moreover, the claims of collecting in advance for digital television subscriptions for over 97% of residential customer base is not easy to track.