Answers:
Introduction
The report deals with audit planning of TCW, one of the major client of MYH in Australia of the year ended 30th June 2018. TCW has been primarily dealing in the growing grapes for production of wines and then distribution of the same, beef cattle production on surplus lands and investing in the surplus lands (Bromwich & Scapens, 2016). Due to less rainfall in the past few years, the land has been rendered unsuitable of grape production and hence being used for cattle production. In addition, the average temperatures have increased by 2%, which has affected the production of sparkling wine, and hence the company is planning to invest in new lands in cooler climates. Wagyu Selling Group (WSG) is the one who is selling and marketing the beef produced by TCW since TCW has significant stake in WSG (Alexander, 2016).
The various ratios of the company over the past 3 years has been analysed and also the internal control in areas of ordering, purchasing, goods receipt, payment to creditors, invoice verification, service invoicing, etc. all have been checked and commented upon in the below case study.
Analysis and discussion
The ratio analysis, the potential audit risk and the audit steps that are needed to be undertaken to reduce the risk are shown below in the workings:
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Account
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Analysis
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Audit Risk
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Audit steps to reduce risks
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Accounts Receivable
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IN the case of the given company, we can see that the receivable days has been more or less constant in the wine business near to 50 days which is much above the ideal industry trend of 30 days. On the other hand, for the beef business, it has been even adverse as it has fallen from 24 days on 2016 to 57 days in 2018 and this shows that the company is getting struck with the receivables off late (Chron, 2017).
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Since the receivables days has been increasing ever so rapidly in both the cases, it poses both the business as well as the audit risk. It needs to be checked if the receivables are being appropriately recorded by the entity and what is the main reason for the non collection of the receivables. Is there a need to provide for the bad and doubtful debts by the company in the books of accounts?
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The audit steps which needs to be taken in this regard is to check and reconcile both the debtors and sales ledger, what are the polices and measures being adopted by the company for the collection of the debtors. The auditor should also ask for balance confirmation statement from the debtors and what is the method or valuation and reporting of debtors in the books along with the amount to be provided for bad debt in books.
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Current Investments
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In case the return on the assets is being analysed, we can see that again there is a sharp decline in the return on equity which has fallen from 17.5% in 2017 to 10.80% in 2018. Furthermore, the net profit margin as well as the gross profit margin has also declined to 14.38% from 17.85% and to 24.5% from 31.76% respectively (Farmer, 2018).
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The decline in the profits of the company is indicative of the fact that the efficiency of operations has been decreasing and is thus posing the risk on the investment being made by the investors in the company. It needs to checked if the costs are increasing or the sales has declined or is it that the company is not being able to generate good margins.
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Since the efficiency and profitability ratios is on the decreasing side, it needs to be checked what are the major cost and other reasons attributable to the decrease in profitability and whether or not the same has been approved by the management. It also needs to be checked if all the present period costs have been booked in the present period and has not been shifted to the future years.
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Property Assets
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When the return on assets is being evaluated, we can see that the same has declined for wine production assets from 16.2% in 2016 to 12.2% in 2018 and in case of the beef production assets, it has been as low as 1.67% in 2018 and was negative in the previous years.
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The continuous decrease in the return on assets is an indication that the property is not reaping the expected benefits and it poses a risk on the existence of the business and thus the going concern assumption of the client needs to be checked as it is a huge business risk (Werner, 2017).
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The auditors may make use of an expert here for the audit purpose to determine what is wrong with the productive assets and why the returns are declining. Is it because of natural reasons or market pressure or the wrong accounting policies being followed by the company? The depreciation policy of the company also needs to be verified here.
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Marketing expenses
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In case the ratio of marketing expenses as a percentage of the S&A expenses is being analysed, we can see a sharp increase from 15.2% to 23.67% over the years.
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This is again one of the major risks for the business and needs to be seen if which are the expense heads under which the amount is increasing and whether the same has been accounted properly. IF the amount of increase is justified, then why the increase in productivity and profitability cannot be seen.
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The risk of increase in marketing expenses can be evaluated by checking the big ticket line items and whether or not the same was approved by management and what was the basis of approval. The accounting of the cost also needs to be verified by the auditor if the present year cost has not be shifted to the future years or vice versa (Trieu, 2017).
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On analysing the other ratios of the company, following business risk can be seen to TCW, which have been enlisted below:
- Current Ratio and Quick Ratio: Both of these are liquidity ratios and shows the ability of the company to pay off the short term debts on time using the current assets like stock, debtors, cash and prepaid expenses, etc. For TCW, the ratio has been 2.80 and 1.18 respectively for the year 2018 and it is well above the industry trend and therefore, it shows that the company has a good liquidity position but there is also a flip side to it and the auditor needs to check if the resources like cash and other current assets are being adequately utilised as the company is losing out of the opportunity cost(Choy, 2018).
- Debt to equity ratio: This ratio is the measure of the proportion of debt and equity in the company’s overall capital. Since debt comes at low cost, therefore, more the debt, lesser the weighted average cost of capital and high risk of non-repayment. The ideal scenario for this ratio is 2: 1 maximum whereas TCW is having the debt equity ratio of 0.54 which is well within the limits but is poses the risk that the company is not making use of leveraging and increasing the returns for the shareholders(Dichev, 2017).
- Time’s interest earned: This shows the company ability to pay of the interest on debt capital from the profits earned. More the ratio, more the credibility of the company to pay off debt. But in the given case, the same has been decreasing over the year and is 6.67 times which is much below the industry trend of 10-12 times and thus is a business risk.
- Days in inventory: This shows how much time the company is taking to liquidate the inventory from the time it is manufactured. Lesser it is, better for the company. For TCW, the same has been decreasing from 460 days in 2016 to 367 days in 2018 but is still way above the industry trend and thus needs to be well analysed(Das, 2017).
TCW has a number of internal controls which are active in the company and which have been effective in alleviating a number of risks as well. Test of control for each one of them has been shown below:
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Effective control
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Risk alleviated
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Test of control
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Post the implementation and resolving all the issues in the IT systems, it is being managed and monitored by the management accountant and is secured through passwords (Raiborn, Butler, & Martin, 2016).
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As the IT system forms one of the integral parts of the company’s database and accounting, authorizations to the programs and data base should be restricted through the password. In case the same would not have been there, then the database can be destroyed or changed, etc. and this may have severe financial impact and thus the password management alleviates this risk.
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The test of control can be done by checking the authorizations of the employees other than from finance team to the IT system. Also, some big ticket line items can be checked to see who has passed the entry, with what supporting and whether the same was approved (Jefferson, 2017).
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The 2nd internal control is the value limit for ordering which is based on approvals. The section managers are authorised to order up to $10000, post which it will require approvals of management accountant, CEO and Board of Directors based on the approval.
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This process of approval based ordering that none of the section managers make untheorized use of the power and 4 eye principle is also being followed. This would also ensure proper control on the inventory balances (Belton, 2017).
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This can be checked directly in the order booking computer system as to whether proper approvals are there in place or not and each of the orders has been recorded in system.
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The entire process of placing of the orders, receipt of goods, punching the invoices in the register, reconciling the quantities, invoice verification and vendor payment is a comprehensive process (Bizfluent, 2017).
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The overall process is comprehensive and alleviates the risk that the false invoices would be accounted in system and since the physical order receipt and the invoice is being verified, it ensures that false delivery will also not be accounted.
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One of the processes to check this is reconciling the order copies and the invoices in the system and whether each one of them is signed and duly vetted.
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However, the company entails a robust internal control process in many areas, but there are still some inefficiencies in the purchases and accounts payable department, which has been enlisted below:
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Weaknesses
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Justification
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The central supplier master file is being maintained by the accounts clerk but any changes to the same is being finally approved by the management accountant beyond which no checking is being done (Saeidi, 2012).
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The approval procedure is manual in the case of TCW and any changes or alteration is only being approved by management accountant, there is no double check or 4 eye principle being followed here and in case unapproved supplier is entered or approved supplier is deleted, nobody would come aware of the same. This is a huge business risk.
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The payment file is again being approved finally by management accountant and the ABA file is also uploaded by him in bank portal post which the payment is released (Kuhn & Morris, 2016).
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This can lead to a huge danger to the entity as there is no double check and the management accountant has the power to approve and upload the unauthorised payments, thus there should segregation of duty in order to avoid this business risk and cash risk.
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As soon as the management accountant checks and uploads the file on the bank portal, it is assumed that the same has been paid without any proper acknowledgement or reference number (Linden & Freeman, 2017).
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This can lead to a number of reconciliation issues with the customer and vendors in the long run as there is no proper evidence for accounting of the payment entry in books, therefore, in order to avoid this risk, proper acknowledgement or reference number should be asked from the bank (Heminway, 2017).
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There is no upper or lower limit being set for the stock ordering purposes for wine, grape and beef section managers and hence they have the authority to make order below $10000 a number of times (Gooley, 2016).
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It poses a risk that the section managers can order the stock multiple times even if it is not required and hence to control this, minimum and maximum stock levels should be defined.
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References
Alexander, F. (2016). The Changing Face of Accountability. The Journal of Higher Education, 71(4), 411-431.
Belton, P. (2017). Competitive Strategy: Creating and Sustaining Superior Performance. London: Macat International ltd.
Bizfluent. (2017). Advantages & Disadvantages of Internal Control. Retrieved december 07, 2017, from https://bizfluent.com/info-8064250-advantages-disadvantages-internal-control.html
Bromwich, M., & Scapens, R. (2016). Management Accounting Research: 25 years on. Management Accounting Research, 31(1), 1-9.
Choy, Y. K. (2018). Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview Analysis. Ecological Economics, 145. Retrieved from https://doi.org/10.1016/j.ecolecon.2017.08.005
Chron. (2017). five-common-features-internal-control-system-business. Retrieved december 07, 2017, from https://smallbusiness.chron.com/five-common-features-internal-control-system-business-430.html
Das, P. (2017). Financing Pattern and Utilization of Fixed Assets - A Study. Asian Journal of Social Science Studies, 2(2), 10-17.
Dichev, I. (2017). On the conceptual foundations of financial reporting. Accounting and Business Research, 47(6), 617-632. Retrieved from https://doi.org/10.1080/00014788.2017.1299620
Farmer, Y. (2018). Ethical Decision Making and Reputation Management in Public Relations. Journal of Media Ethics, 33(1), 1-12.
Gooley, J. (2016). Principles of Australian Contract Law. Australia: Lexis Nexis.
Heminway, J. (2017). Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and Organic Documents. SSRN, 1-35.
Jefferson, M. (2017). Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland . Technological Forecasting and Social Change, 353-354.
Kuhn, J., & Morris, B. (2016). IT internal control weaknesses and the market value of firms. Journal of Enterprise Information Management, 30(6).
Linden, B., & Freeman, R. (2017). Profit and Other Values: Thick Evaluation in Decision Making. Business Ethics Quarterly, 27(3), 353-379. Retrieved from https://doi.org/10.1017/beq.2017.1
Raiborn, C., Butler, J., & Martin, K. (2016). The internal audit function: A prerequisite for Good Governance. Journal of Corporate Accounting and Finance, 28(2), 10-21.
Saeidi, F. (2012). Audit expectations gap and corporate fraud: Empirical evidence from Iran. African Journal of Business Management, 6(23), 7031-41. Retrieved from search.proquest.com
Trieu, V. (2017). Getting value from Business Intelligence systems: A review and research agenda. Decision Support Systems, 93, 111-124.
Werner, M. (2017). Financial process mining - Accounting data structure dependent control flow inference. International Journal of Accounting Information Systems, 25, 57-80.
