Ian - Chapter 3

11.) Find three annual reports and make a list of the Key Audit Matters reported in the audit
report. From the following list, what do you think would be the top five KAMs reported in 2017?
Why?

KAMs Topic SMC Jollibee Nestle Total

Impairment of goodwill and intangibles 1 1 1 3
Taxation 1 1 2
Provisions 1 1
Revenue recognition 1 1
Acquisition 1 1

KAMs Topic Observation

Impairment of  The most common KAM relates to carrying value assessments or
goodwill and impairment of Goodwill and Intangibles.
intangibles  Common reasons cited as driving the greater auditor attention include
the significance of the balances, the requirement to test goodwill
annually for impairment, and the significant judgment associated with
forward-looking estimations in valuation models. These assessments
can be particularly challenging in sectors experiencing constrained
economic conditions.
Taxation  The identification and valuation of uncertain tax positions is a key
audit matter because of the significant level of judgment and
expertise required to interpret tax legislation and the related
estimation uncertainty.
 The recognition of deferred tax assets is significant to audit because
the assessment process is complex and judgmental, and is based on
assumptions that are affected by expected future market or economic
conditions and the expected future performance as well as
management’s plans and strategies of the relevant taxable entities,
including the Parent Company and certain subsidiaries.
Provisions  This matter is significant to audit because the determination of
whether any provision should be recognized and the estimation of the
potential liability resulting from these assessments require significant
judgment by management.
 The inherent uncertainty over the outcome of these matters is brought
about by the differences in the interpretation and implementation of
the relevant laws and rulings.
Revenue  Revenue is an important measure used to evaluate the performance
recognition of the Group and is generated from various sources.
 It is reasonable to expect auditors will choose to focus procedures on
gathering evidence regarding its accuracy.
Acquisition  The purchase price allocation in 2020 is considered to be a key audit
matter because it requires significant management judgment and
estimation in identifying the underlying acquired assets and liabilities
and in determining their fair values, specifically the acquired property
and equipment, trademark and other intangible assets.
 1.) San Miguel Corporation 2021 Annual Report

Key Audit Matters

 Revenue recognition
 Valuation of Goodwill
 Valuation of Other Intangible Assets

Key Audit Matters

Key audit matters are those matters that, in our professional judgment, were of most
significance in our audit of the consolidated financial statements of the current period. These
matters were addressed in the context of our audit of the consolidated financial statements as a
whole, and in forming our opinion thereon, and we do not provide a separate opinion on these
matters.
Revenue recognition (P941,193 million).
Refer to Notes 6, 25 and 33 of the consolidated financial statements.
The risk
Revenue is an important measure used to evaluate the performance of the Group and is
generated from various sources. It is accounted for when control of the goods or services is
transferred to the customer over time or at a point in time, at an amount that reflects the
consideration to which the Group expects to be entitled in exchange for those goods or
services. While revenue recognition and measurement are not complex for the Group, revenues
may be inappropriately recognized in order to improve business results and achieve revenue
growth in line with the objectives of the Group, thus increasing the risk of material misstatement.
Our response
We performed the following audit procedures, among others, on revenue recognition:

 We evaluated and assessed the revenue recognition policies in accordance with PFRS
15, Revenue from Contracts with Customers.
 We evaluated and assessed the design and operating effectiveness of the key controls
over the revenue process.
 We involved our information technology specialists, as applicable, to assist in the audit
of automated controls, including interface controls among different information
technology applications for the evaluation of the design and operating effectiveness of
controls over the recording of revenue transactions.
 We vouched, on a sampling basis, sales transactions to supporting documentation such
as sales invoices and delivery documents to ascertain that the revenue recognition
criteria are met.
 We tested, on a sampling basis, sales transactions for the last month of the financial
year and also the first month of the following financial year to supporting documentation
such as sales invoices and delivery documents to assess whether these transactions are
recorded in the appropriate financial year.
  We tested, on a sampling basis, journal entries posted to revenue accounts to identify
unusual or irregular items.
 We tested, on a sampling basis, credit notes issued after the financial year, to identify
and assess any credit notes that relate to sales transactions recognized during the
financial year.

Valuation of Goodwill (P130,081 million).

Refer to Notes 4, 5, 17 and 38 of the consolidated financial statements.
The risk
The Group has embarked on a diversification strategy and has expanded into new businesses
through a number of acquisitions and investments resulting in the recognition of a significant
amount of goodwill. The goodwill of the acquired businesses is reviewed annually to evaluate
whether events or changes in circumstances affect the recoverability of the Group's
investments.
The methods used in the annual impairment test of goodwill are complex and judgmental in
nature, utilizing assumptions on future market and/or economic conditions. The assumptions
used include future cash flow projections, growth rates, discount rates and sensitivity analyses,
with a greater focus on more recent trends and current market interest rates, and less reliance
on historical trends.
Our response
We performed the following audit procedures, among others, on the valuation of goodwill:

 We assessed management’s determination of the recoverable amounts based on fair

value less costs to sell or a valuation using cash flow projections (value in use) covering
a five-year period based on long range plans approved by management. Cash flows
beyond the five-year period are extrapolated using a constant growth rate determined for
each individual cash-generating unit.
 We tested the reasonableness of the discounted cash flow model by comparing the
Group’s assumptions to externally derived data such as relevant industry information,
projected economic growth, inflation and discount rates. Our own valuation specialist
assisted us in evaluating the models used and assumptions applied.
 We performed our own sensitivity analyses on the key assumptions used in the models.

Valuation of Other Intangible Assets (P190,979 million).

Refer to Notes 4, 5 and 17 of the consolidated financial statements.
The risk
The methods used in the annual impairment test for other intangible assets with indefinite useful
lives and tests of impairment indicators for other intangible assets with finite useful lives are
complex and judgmental in nature, utilizing assumptions on future market and/or economic
conditions. These assumptions include future cash flow projections, growth rates, discount rates
and sensitivity analyses, with a greater focus on more recent trends and current market interest
rates, and less reliance on historical trends.
Our response
We performed the following audit procedures, among others, on the valuation of other intangible
assets:

 We evaluated and assessed management’s methodology in identifying any potential

indicators of impairment.
 We assessed management’s determination of the recoverable amounts based on a
valuation using cash flow projections (value in use) covering a five-year period based on
long range plans approved by management. Cash flows beyond the five-year period are
extrapolated using a constant growth rate determined for each individual cash-
generating unit.
 We tested the reasonableness of the discounted cash flow model by comparing the
Group’s assumptions to externally derived data such as relevant industry information,
projected economic growth, inflation and discount rates. Our own valuation specialist
assisted us in evaluating the models used and assumptions applied.
 We performed our own sensitivity analyses on the key assumptions used in the models.

2. Jollibee 2020 Annual Report

Key Audit Matters

 Finalization of Purchase Price Allocation

 Recoverability of Goodwill and Trademarks with Indefinite Life
 Provisions and Contingencies
 Recognition of Deferred Income Tax Assets
 Impairment Assessment of Property, Plant and Equipment, Right-of-Use Assets and
Accounting for Pre-termination of Leases

Key Audit Matters

Key audit matters are those matters that, in our professional judgment, were of most
significance in our audit of the consolidated financial statements of the current period.
These matters were addressed in the context of our audit of the consolidated financial
statements as a whole, and in forming our opinion thereon, and we do not provide a separate
opinion on these matters. For each matter below, our description of how our audit addressed
the matter is provided in that context.
We have fulfilled the responsibilities described in the Auditor’s Responsibilities for the Audit of
the Consolidated Financial Statements section of our report, including in relation to these
matters. Accordingly, our audit included the performance of procedures designed to respond to
our assessment of the risks of material misstatement of the consolidated financial statements.
The results of our audit procedures, including the procedures performed to address the matters
below, provide the basis for our audit opinion on the accompanying consolidated financial
statements.

Acquisition of The Coffee Bean & Tea Leaf (CBTL) – Finalization of Purchase Price
Allocation
On September 24, 2019, the JFC Group, through its 80%-owned subsidiary, Super Magnificent
Coffee Company Hungary Kft., acquired 100% interest over The Coffee Bean & Tea Leaf
(CBTL). In 2019, the purchase price allocation was determined on a provisional basis. PFRS 3,
Business Combination, provides for a measurement period of one year from the date of
acquisition wherein the acquirer may adjust provisional amounts.
We considered the finalization of the purchase price allocation in 2020 to be a key audit matter
because it requires significant management judgment and estimation in identifying the
underlying acquired assets and liabilities and in determining their fair values, specifically the
acquired property and equipment, trademark and other intangible assets. The 2019
consolidated statement of comprehensive income was restated to reflect the gain on bargain
purchase recognized which amounted to P4,255.3 million. The disclosures in relation to the
acquisition of CBTL are included in Notes 4 and 11 to the consolidated financial statements.

Audit Response
We reviewed the final purchase price allocation and obtained an understanding of the nature
and underlying support for the changes from the provisional amounts. We evaluated the
competence, capabilities and objectivity of the independent appraiser who prepared the
appraisal report for the property and equipment and the external valuation specialist who valued
the trademark and other intangible assets by considering their qualifications, relevant
experience and reporting responsibilities. We involved our internal specialist in the review of the
methodologies and assumptions used in arriving at the fair values of the property and
equipment, trademark and other intangible assets. We compared the key assumptions used
such as the cost indices and trends, and adjustment factors by reference to relevant market
data for the valuation of property and equipment. We also compared the key assumptions used
in the valuation of trademark and other intangible assets such as revenue growth rate, long-term
growth rate and royalty rate by reference to existing contractual terms, historical trends and
relevant external information. We tested the parameters used in determining the discount rate
against market data. We reviewed the adequacy of the disclosures in the consolidated financial
statements.

Recoverability of Goodwill and Trademarks with Indefinite Life

Under Philippine Accounting Standard (PAS) 36, Impairment of Assets, the JFC Group is
required to annually test the amount of goodwill and trademark with indefinite life for impairment.
This annual impairment test was significant to our audit because the balance of goodwill and
trademark with indefinite life amounting to P14,097.3 million and P35,048.0 million as at
December 31, 2020, respectively, are material to the consolidated financial statements.
In addition, management’s assessment process is complex and highly judgmental and is based
on assumptions, specifically discount rate, which is applied to the cash flows, net sales
forecasts, long-term revenue growth rate, and EBITDA which are affected by expected future
market or economic conditions, particularly those in the Philippines, the People’s Republic of
China, Vietnam and the United States of America. These assumptions are also subject to higher
level of estimation uncertainty due to the current economic conditions which have been
impacted by the coronavirus pandemic.
The JFC Group’s disclosures about goodwill and trademarks with indefinite life are included in
Note 14, which specifically explains that small changes in the key assumptions used could give
rise to an impairment of the goodwill balance in the future.
Audit Response
We involved our internal specialist in evaluating the methodologies and the assumptions used in
determining the recoverable amounts of the cash-generating units (CGUs) for goodwill and the
trademarks with indefinite life. These assumptions include the discount rate, net sales forecasts,
long-term revenue growth rate and EBITDA. We compared the key assumptions used, such as
forecasted long-term revenue growth rate, forecasted net sales and EBITDA against the
historical data of the CGUs and inquired from management and operations personnel about the
plans to support the forecast, taking into consideration the impact associated with coronavirus
pandemic.
Furthermore, we tested the parameters used in the determination of discount rate against
market data. We reviewed the weighted average cost of capital (WACC) used in the impairment
test by comparing it with the WACC of comparable companies where the CGUs operate. We
also reviewed the JFC Group’s disclosures about those assumptions to which the outcome of
the impairment test is most sensitive, specifically those that have the most significant effect on
the determination of the recoverable amount of goodwill and trademarks with indefinite life.

Provisions and Contingencies

The JFC Group is involved in litigations, claims and disputes, and regulatory assessments
which are normal to its business. This matter is significant to our audit because the
determination of whether any provision should be recognized and the estimation of the potential
liability resulting from these assessments require significant judgment by management. The
inherent uncertainty over the outcome of these matters is brought about by the differences in
the interpretation and implementation of the relevant laws and rulings.
The JFC Group’s disclosures about provisions and contingencies are included in Notes 17 and
30 to the consolidated financial statements.
Audit Response
We involved our internal specialist in the evaluation of management’s assessment on whether
any provisions for contingencies should be recognized, and the estimation of such amount. We
discussed with management the status of the litigations, claims and disputes, and assessments.
In addition, we read correspondences with the relevant government agencies, and any relevant
laws and rulings on similar matters, and obtained replies from third party legal counsels. We
evaluated the position of the JFC Group by considering the relevant laws, rulings and
jurisprudence.

Recognition of Deferred Income Tax Assets

The Parent Company and certain subsidiaries (foreign and local) have recognized deferred tax
assets amounting to P15,463.9 million as at December 31, 2020. Of that amount, around 21%
relates to net operating loss carryover and excess minimum corporate income tax over regular
corporate income tax. Management evaluated the recognition of these deferred tax assets
based on the forecasted taxable income taking into account the period in which the deductible
temporary differences can be claimed in the Philippines, the People’s Republic of China and the
United States of America. The recognition of deferred tax assets is significant to our audit
because the assessment process is complex and judgmental, and is based on assumptions that
are affected by expected future market or economic conditions and the expected future
performance as well as management’s plans and strategies of the relevant taxable entities,
including the Parent Company and certain subsidiaries. The estimation uncertainty increased as
a result of the effect of coronavirus pandemic on the macroeconomic factors used in developing
the assumptions.
The disclosures in relation to deferred income taxes are included in Note 24 to the consolidated
financial statements.

Audit Response
We updated our understanding of the Parent Company and its subsidiaries’ deferred income tax
calculation process and, together with our internal specialist, the applicable tax rules and
regulations. We reviewed management’s assessment on the availability of future taxable
income with reference to financial forecasts and tax strategies. We evaluated management’s
forecast by comparing the forecasts of future taxable income against approved budgets,
historical performance of the relevant entities like past revenue growth rates and with relevant
external market information such as inflation, taking into consideration the impact associated
with coronavirus pandemic. We also reviewed the timing of the reversal of future taxable and
deductible temporary differences.

Impairment Assessment of Property, Plant and Equipment, Right-of-Use Assets and

Accounting for Pre-termination of Leases
The JFC Group’s store operations were impacted by the coronavirus pandemic and certain
stores incurred losses in the current financial year. The JFC Group has embarked on a business
transformation initiative to rationalize these losing or nonperforming stores, including its store
network and supply chain facilities. Accordingly, certain stores have been permanently closed
and the underlying lease agreements have been pre-terminated in 2020, while certain stores
were planned to be closed in 2021. Management has identified these as impairment indicators
and has performed impairment assessment on its property, plant and equipment and right-of-
use assets and has identified the related lease pre-termination costs, if any. In 2020, the JFC
Group recognized loss on retirements and disposals of property, plant and equipment of
P1,489.2 million, lease pre-termination costs of P488.7 million and impairment loss of P661.4
million and P1,185.5 million on its right-of-use assets and property, plant and equipment,
respectively. Due to the judgments involved in the impairment assessment, the number of
stores affected and the significant amounts involved, we consider this to be a key audit matter.
The disclosures in relation to impairment assessment of property, plant and equipment, right-of-
use assets and the accounting for pre-termination of leases are included in Notes 12 and 29 to
the consolidated financial statements.
Audit Response
As part of our audit, we obtained an understanding of management’s impairment assessment
process, including the evaluation of the impact of coronavirus pandemic on its store network,
the performance of the stores and the identification of impairment indicators, if any, on the JFC
Group’s property, plant and equipment and right-of-use assets. We obtained an understanding
of the number of stores involved in the permanent or planned closures, their locations, the terms
and conditions of the underlying lease agreements and management’s basis of the
determination of the recoverable amount. On a sample basis, we traced the net book values of
the property, plant and equipment and right-of-use assets of the affected stores to the JFC
Group’s asset register. On a test basis, we also traced the lease pre-termination costs to the
terms and conditions of the lease contracts. We test computed the JFC Group’s computation of
the loss on retirements and disposals and the impairment loss and lease pre-termination costs
recognized. We reviewed the adequacy of the disclosures in the consolidated financial
statements.

3. Nestle 2020 Annual Report

Key Audit Matters

 Measurement of sales
 Goodwill and indefinite life intangible assets
 Completeness and valuation of uncertain tax positions

Key Audit Matters

Key audit matters are those matters that, in our professional judgment, were of most
significance in our audit of the consolidated financial statements of the current period. These
matters were addressed in the context of our audit of the consolidated financial statements as a
whole, and in forming our opinion thereon, and we do not provide a separate opinion on these
matters. For each matter below, our description of how our audit addressed the matter is
provided in that context. We have fulfilled the responsibilities described in the Auditor’s
responsibility section of our report, including in relation to these matters. Accordingly, our audit
included the performance of procedures designed to respond to our assessment of the risks of
material misstatement of the consolidated financial statements. The results of our audit
procedures, including the procedures performed to address the matters below, provide the basis
for our audit opinion on the accompanying consolidated financial statements.
Measurement of sales as it relates to trade spend
As described in Note 3 of the consolidated financial statements, sales are recognized when
control of the goods has transferred to the customer, which is mainly upon arrival at the
customer. Revenue is measured as the amount of consideration that the NHI Group expects to
receive after deduction of returns, sales taxes, pricing allowances, other trade discounts, and
couponing and price promotions to consumers. The level of discounts, allowances, and
promotional rebates (collectively ‘trade spend’) are estimated and recognized as a deduction
from revenue.
The risk of sales being misstated, through error, misinterpretation or misapplication of
accounting standards and policies or intentional manipulation, may result from the pressure that
management may feel to achieve performance targets. The nature of the misstatements may
include bias in estimates, unrecorded accruals, or the misclassification of trade spend in the
consolidated income statement.
We deemed the measurement of trade spend to be a key audit matter due to the materiality and
complexity in estimating the amount of trade spend that is ultimately claimed. Management
estimates the level of trade spend using judgments based on historical experience and the
specific terms of the agreements with the customers. The estimates require the use of
assumptions that are complex, given the diversity of trade spend arrangements and the
uncertainty related to future outcomes. There is a risk that discounts, allowances, and
promotional rebates to consumers are not properly measured or classified at the reporting date,
resulting in a misstatement of sales.
How our audit addressed the key audit matter?
We assessed the NHI Group’s revenue recognition accounting policies, including the
recognition and classification criteria for trade spend. We evaluated monthly trends of trade
spend. We performed a predictive analysis focused on trade spend as a percentage of sales by
month, and by customer. For a sample of trade spend, we considered if those items were
properly classified with reference to the NHI Group’s accounting policies.
For a sample of trade spend arrangements, we reconciled key inputs and assumptions used in
the estimates with internal and external sources of information, such as the contracts with the
relevant customers or other third-party support. We recalculated the accrual and income
statement amounts to test mathematical accuracy.
We considered the aging of trade spend accruals based on our understanding of the average
lead time for settlement. We reviewed the NHI Group’s lookback analysis over the prior year
end accrual balance and assessed the accuracy at which the NHI Group determined their
accruals. We tested payments made to customers after the reporting date to assess the
completeness of accruals and assessed whether recorded in the correct period.
We assessed the adequacy of the disclosures provided in Note 3 of the consolidated financial
statements in relation to the relevant accounting standards.
Carrying value of goodwill and indefinite life intangible assets
As described in Note 9 of the consolidated financial statements, the NHI Group has $15.2 billion
of goodwill and $4.2 billion of indefinite life intangibles assets. For all cash generating units
(CGUs), goodwill and indefinite life intangibles are tested for impairment at least annually and
when there is an indication of impairment. The impairment test is performed by comparing the
carrying value of the assets of these CGUs with their recoverable amount.
There were no goodwill or indefinite life intangible impairment charges recognized in the year
ended December 31, 2020 based on the NHI Group’s recoverability assessment.
The recoverability of goodwill and indefinite life intangible assets is assessed using forecasted
financial information within a discounted cash flow model. The assumptions used in the
impairment tests, including projected cash flows, discount rates, and terminal growth rates, as
well as allocation of assets to CGUs, are subject to management judgment.

How our audit addressed the key audit matter?

We assessed whether the determination of CGUs, and whether the allocation of assets to
CGUs, was appropriate. We obtained an understanding of the current macro-economic
environment, the impact of COVID-19 on forecasted financial information and the outlook for a
sample of CGUs through external market data and discussions with selected stakeholders
within the NHI Group. We compared the forecasted cash flows with historical data. Where the
forecasted cash flows differed from our expectations given the current environment and
historical data, we obtained supporting explanations. We assessed assumptions in comparison
to external market data. We performed sensitivity analyses around the key assumptions such as
projected cash flows, discount rates, and terminal growth rates.
With the assistance of our valuation specialists we assessed the appropriateness of key
assumptions, including discount rates and terminal growth rates, including independently
deriving a range of discount rates and terminal growth rates, and we recalculated the
recoverable amount determined by management. Further, we assessed the appropriateness of
the methodology used and the consistent application thereof to the CGUs tested.
We assessed the adequacy of the disclosure provided in Note 9 of the consolidated financial
statements in relation to the relevant accounting standards.

Completeness and valuation of uncertain tax positions

As described in Note 13 of the consolidated financial statements, the taxes and fiscal risks
recognized in the consolidated financial statements reflect NHI Group management’s best
estimate of the outcome based on the facts known at the balance sheet date. These facts may
include, but are not limited to, changes in tax laws and interpretations thereof in the United
States. NHI Group is regularly subject to examination and audits by tax authorities, including the
United States Internal Revenue Services. Certain matters involving transactions with other
Nestlé S.A. affiliates, including royalty arrangements, financing arrangements, other transaction-
related matters give rise to uncertain tax positions, and the related transfer pricing impacts.
These uncertain tax positions inherently result in the application of management judgment in
ascertaining reasonable estimates, which may lead to liabilities for uncertain tax positions being
understated or overstated.
The identification and valuation of uncertain tax positions is a key audit matter because of the
significant level of judgment and expertise required to interpret tax legislation and the related
estimation uncertainty.
How our audit addressed the key audit matter?
We assessed the application of the relevant standards, including but not limited to IFRIC 23,
Uncertainty over Income Tax Treatments, in the accounting for uncertain tax positions.
We obtained an understanding of the uncertain tax positions arising from the transactions with
other Nestlé S.A. affiliates, and we assessed the potential outcome of investigations by the
authorities and whether uncertain tax positions are complete and reasonably measured.
Our tax specialists, including transfer pricing specialists, considered impacts of changes in tax
legislation or business operations in the identification, measurement and recognition of
uncertain tax positions. We reviewed available information related to significant on-going tax
audits. We reviewed the recognized and unrecognized positions in comparison to tax audits’
outcomes, when available, and gained an understanding if there were any deviations in
outcome compared to amounts recognized. The significant intercompany transfer pricing
models were assessed for compliance with, among other things, applicable laws, regulations
and transfer guidance and we evaluated management’s judgments regarding tax risks.
We assessed the adequacy of the disclosure provided in Note 13 of the consolidated financial
statements in relation to the relevant accounting standards.

Sources:
https://www.sanmiguel.com.ph/annual-reports
https://www.jollibee.com.ph/investors/fiscal-reports/annual-reports/
https://www.nestle.com/sites/default/files/2021-04/nestle-holdings-inc-financial-statements-
2020.pdf
https://assets.kpmg/content/dam/kpmg/au/pdf/2017/key-audit-matters-auditor-report-28-march-
2017.pdf