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Question 1A

Background

You are a manager in the audit division at Miller Yates Howarth (MYH), an accounting firm with offices throughout the major regional centres of NSW and Queensland. Although a medium sized firm by national standards, MYH is the second largest regional accounting firm in Australia. Most of MYH’s audit clients are in the agriculture, mining, manufacturing and property industries. All of those industries are currently under pressure, either from a downturn in commodity prices or fierce competition from overseas competitors.

You are gathering information in order to prepare the audit plan of GPSA Limited for the year ended 30 June 2017. Along with Morgan Fertilisers, GPSA is one of MYH’s most significant and longstanding clients. The following information has been gathered to date.

Principal activities of GPSA 
• research and development of technologies relating to medical equipment;
• manufacture and distribution of medical equipment;
• investment of surplus funds; and
• investment in the property market.

GPSA was incorporated in 1992 and has operated successfully and profitably since that date. In the last few years it has branched out into the property market, acquiring a number of commercial properties which are let mainly to medical practitioners.

The directors of GPSA are:
• Mr. John Stanton, Chairman
• Ms Jane Quade, Chief Executive Officer
• Mr. Joe Quade
• Dr Barry Jones
• Dr Beryl Yeo

Doctors Jones and Yeo are independent non-executive directors and have been directors since 2003. The other three executive directors have been employed by the company since its incorporation and have considerable experience in the industry. Mr Stanton controls a number of private companies.

In prior years MYH placed reliance on internal controls based on satisfactory results of extensive tests of control. Recent discussions with the client have revealed no changes in the system of internal control since last year. The company does not have an internal audit function.

In February 2016, research activities relating to a new laser surgery device commenced. Significant costs were incurred in relation to this research. In April 2017 a competitor announced that it had successfully developed and patented a similar device. In order to finance the research activities noted above the company borrowed from its bankers an additional $5 million during the year. The loan agreement contains a covenant to the effect that should the company's debt to equity ratio (measured as total liabilities: shareholders' equity) increase above 1.2:1.0 at any time, the bankers have the right to demand immediate repayment.

Throughout the 2017 financial year, the property market has been in decline. The end of financial year audit is scheduled to start on 1 August 2017 and should take about two weeks to complete. The client completed a stock count on 30 June 2017. The directors require the signed audited final financial report by 28 August 2017.

Your audit partner, John Richards, has approached you and advised that there are several areas he is concerned about and he wants to you to report back to him about these areas before you complete your audit program. These areas and accounts are:
• Accounts receivable
• Current investments
• Property assets
• Intangible assets
• Research and development capitalisation

Question 1B

Ratios extracted from an unaudited set of financial reports at 30 June 2017 together with audited comparatives for the year ended 30 June 2016 and 2015 are set out below for your review. 

Ratio

2017 (Unaudited)

2016 (Audited)

2015 (Audited)

Return on equity %

7.19

18.61

22.17

Return on total assets %

4.86

13.7

15.52

Gross margin %

31.76

30.00

24.94

Net profit margin %

10.38

20.27

17.85

Times interest earned

1.90

3.51

4.10

Days in inventory

166.53

127.89

115.85

Days in accounts receivable

83.07

60.65

53.24

Current ratio : 1

1.80

1.54

1.66

Quick asset ratio : 1

0.89

0.78

0.82

Debt to equity ratio : 1

1.11

1.02

1.04

The financial controller at GPSA has been refining the system of internal controls and informs you, at the planning stage of the current year's audit, that he has put together an internal control manual for the company. He has stated that this manual will create greater awareness of controls in the company, particularly with management which, in the past, has not been overly conscious of the need to implement and enforce effective internal controls.

Management staff receive bonuses based on certain agreed-upon target ratios which include measures such as targeted monthly sales volumes, variance of actual to budget departmental overheads and profit before interest and tax. The major shareholder takes an active interest in the performance of the company and is quick to request explanations on variances from the agreed-upon monthly budgets.

Two years ago, the company devoted significant time and resources to the development and implementation of a new IT system. All teething problems associated with the implementation phase have now been resolved, and the financial controller is satisfied that the automated controls in place are assisting in producing accurate and complete accounting records. The sales director also looks after the IT function as the position is not regarded by management as being a full-time job. Once application programs have been tested, strict password control exists over access to the programs. Passwords are not required for access to databases.

To assist in the planning for the current year's audit engagement, you extracted the following information from a review of the systems notes in the permanent file and perusal of the new internal control manual:

  1. manual delivery notes for dispatch of tiles to customers are raised by the dispatch department from the sales order form. Where a delivery is only partially filled, the delivery note is marked 'hold for invoice' and placed on the incomplete deliveries file. At month end, the supervisor of the dispatch department is responsible for follow-up of the reasons why incomplete deliveries have been outstanding for greater than 30 days.
  2. returns of medical equipment by customers due to inferior quality, incorrect specifications or oversupply are received by the dispatch department where staff are required to check quantity and condition of the returned tiles. Details noted by the dispatch personnel, including the reason for the return, are recorded on a ‘goods returned’ note. Once completed, this document is passed on to the trade receivables clerk who raises a credit note and sends it to the customer.
  3. once a delivery has occurred, the office copy manual delivery note is forwarded to the trade receivables clerk who is responsible for generating an invoice on the computer system. An invoice is raised by inputting the total quantity delivered (Note: this could be a number of partial deliveries) and the stock code which is also recorded on the delivery note. The computer then automatically retrieves the stock code price from the selling price master file. Posting to the debtors account occurs automatically once the trade receivables clerk has performed a screen check on the accuracy of the input of delivery details.
  4. for valued customers, discounts are applied in accordance with the company's volume rating system. The trade receivables clerk is responsible for updating the individual customer volume ratings every six months after preparing the 'sales volume analysis by customer' report. This report is authorised by the sales director prior to updating the customer discounts.
  5. a sales journal summarising all sales invoices is prepared monthly by the computer system. This journal is then used by the trade receivables clerk for posting to the general ledger.
  6. receipts from debtors are passed on to the trade receivables clerk after having been opened by the mail room. The trade receivables clerk lists all receipts from the debtors and then prepares a bank deposit slip. The list prepared by the trade receivables clerk is used to enter the debtors’ payments on the computer system. The batch total of postings to the individual debtors’ accounts is balanced to the bank deposit slip before processing occurs on the system. At each month end, the trade receivables clerk prepares a reconciliation of the trade receivables ledger to the debtors control account in the general ledger.
  7. the computer generates an aged analysis at month end based upon all invoices that have been processed onto the system for the period up until the last day of the month.
  8. the financial controller obtains the latest trade receivables aged analysis at the end of each month and reviews all amounts outstanding for longer than 90 days. The trade receivables clerk is required to detail reasons for delays in payment by long outstanding debtors and the financial controller discusses items of concern with the clerk.
  9. usually an action plan is agreed for follow-up; this may include involvement of debt collectors or the issuing of writs. Where necessary the financial controller records details of amounts that should be provided for as doubtful debtors. Whilst performing this re view, the financial controller notes the level of individual debtors’ balances and, in instances where he is uncomfortable with the level of this balance, he instructs the dispatch area to withhold any shipments until a minimum prescribed payment is received.

John Richards your partner on the audit has mentioned to you that, in the past, a substantive approach had been adopted for the audit of GPSA. He now feels that, with the improvements that the client claims to have made to the systems of internal control, an opportunity exists to place reliance on the internal controls and therefore reduce the extent of substantive work.

Write a report, to your managing partner that addresses the questions below. Where indicated, use the required format to answer that question.

Analyse the ratios and additional information associated with the five accounts listed by your audit partner, John Richards. Identify the potential audit risks and any particular audit steps that need to be undertaken to reduce audit risk. 
Answer this question using the following headings:
(a) Account (b) Analysis (c) Audit risk (d) Audit steps to reduce risk

Analyse the ratios and additional information to outline business risks that GPSA faces.

Identify the internal controls in the system that are potentially effective, the risk that the control could alleviate and one test of control for each of the identified potentially effective controls.
Answer this question using the following headings:
(a) Effective control (b) Risk alleviated (c) Test of control

List and justify the weaknesses in internal control for sales and trade receivables.

Question 1A

Auditing firm Miller Yates and Howarth is engaged in the preparation of audit plan. One of the most outstanding and significant clients of  MYH is GPSA for which accounting records are audited.  Internal control of organizations are placed great reliance by the auditing firm derived from extensive test control. There are several area of concerns related to some accounts of organization in preparation of audit plan. Analysis of ratio has been done that helps in evaluation of the effectiveness of internal control systems (Bik et al., 2017).

Accounts-

The five types of accounts that is a concern for the auditors of GPSA while carrying out audit plan includes accounts receivables, current investment, property assets, intangible assets and research and development capitalization. The audit partner of organization is concerned about these areas of accounts prior to conducting the audit program (Pitt, 2014).

The reconciliation of trade receivable ledger in the general ledger to the debtor control account is to be done by trade receivable clerk. All the receipt from debtors and preparation of bank slip is done by clerk. Payments made to debtors are recorded in the computer system as debtor payment. Current investment is made by GPSA relating to research activities for the commencement of new laser surgery device. Research activities of organization are financed by borrowing loan of amount of $ 5 million during a year. In addition to this, GPSA has branched out in the property market and acquired a number of properties relating to medical practitioners. They have made investment in property market and there has been decline in property value in recent years. However, they are susceptible to such investments due to bearish property market. GPSA has other principal activities of being involved in research developmental activities in technologies relating to medical equipment. For enabling the borrowing of loan amount to make investment in research and development activities, bankers requires GPSA to maintain debt to equity ratio around 1.2:1. An increase in ration above this level would lead to make repayment of bank loan. When looking at the audited value of debt to equity ratio, it can be seen than GPSA is near the banker’s criteria ratio maintenance. It can be seen that time taken by organization to collect receivables form customer has increased that reflects that organization might have lenient credit policy criteria (Quick, 2014).

Analysis of audit risk is essential part of audit plan and there are several risks associated while carrying out audit. Analysis of risk is carried out for evaluating, identifying and prioritizing the risks associated with the management of all the accounts mentioned above. When looking at recording of trade receivables value that is done by trade receivable clerk, it is certainly possible that management might not be efficient in keeping the tracks of such record. Investment made in the implementation of new information technology system and the function of information technology in organization is looked after by sales director. However, the sales director duties toward information technology function are not regarded as full time job by organization’s management. Risk is associated because there is no proper segregation of duties and this might manipulate data (Boone et al., 2017). There are several risk associated with accounts receivables as there can be improper reconciliation of accounts receivables into the general ledger account. Measures of collecting receivables might be ineffective. While making investigation into the property investment made by organization, is susceptible to the fact that organization can engaged in fluctuating or inflating the value of their investment made in property market because of decline.

Question 1B

Stakeholders of organization should be well informed about the duration of audit risks and audit engagement should be conducted in accordance with International standards on auditing.

The business risk faced by GPSA can be outlined by analysing the information of ratio. Some of the enquires are required to be done by auditors that form an essential part of audit plan.

  • Risk of material misstatement relating to all the accounts can be identified by making enquiries to management that requires enquiries of financial and non financial data.
  • Analytical procedures are required to be performed by auditor for identifying plausible relationship between several accounts.
  • Risk of transactions in normal course of operations relating to accounts receivable are assessed and identified.
  • Inspection and observation process are collaborated with management and other reporting authority within organization.

The business risk of organization can be outlined by evaluating the ratio analysis. The tool of ratio analysis helps in explaining the relationship between widely used analytical procedures and relevant items of financial information. In order to derive at audit evidence and deriving at audit relevance, auditors make the comparison of ratios. When looking at the audited financial ratios, debt to equity ratios has decreased inn year 2015 to 1.02 from 1.04 in year 2014 respectively. For unaudited ratio, debt to equity ratio has increased considerably to 1.11. This is indicative of the fact that the proportion of debt in relation to equity has increased. Number of days required to collect receivables has increased considerably as depicted from unaudited financial ratio. Return on total assets has declined significantly from 13.7% in year 2015 to 4.86% in year 2016.  This is indicative of the fact that total assets have not been efficiently utilised in the current year (De Santis, 2016). Current ratio has also reduced from 1.66 in year 2015 to 1.54 in year 2016 respectively. The unaudited financial ratio depicts that current ratio stand at 1.80. Increase in current ratio shows that organization is capable of meeting its short term obligations using current ratio. Looking at return on equity, it can be seen that, ratio has been significantly falling return to shareholders is declining.

The internal control system of GPSA is effective and there has not been any change is the control system for the last few years. There is no internal audit function and the system of internal control is being refined at the planning stage of conducting audit. The sales invoices are properly documented as there are proper procedures for deciding of data related to sakes made. If there is any manual delivery made, dispatch department raises the sales order and in event of incomplete deliveries, it is essential to have proper follow up.

The quality and conditions of medical equipments returned by customers are properly checked by the staff of dispatch department. There is proper procedures related to trade receivables follow up. In order to achieve the objective of sales system for reviewing the procedures of internal control procedures, some of relevant aspects are required to be examined and this involves organizational control, segregation of duties, authorization, physical control and accounting control (Gendron & Power, 2015).

The effective internal control system could help in alleviating the risk that might arise in organization. Implementation of effective measures would helps in eliminating the risks that may arise from the manual recording of data and invoices. Recording of trade receivable data are done by trade receivable clerk and he is responsible for posting the same into ledger accounts (Zadek et al., 2013). If organization has effective internal control, system then there can be reduced risks arising from recording of accounting transactions. It is certainly possible that the trade receivable slip by trade receivable clerk might have some defect as there can be manipulation or improper recording of list of debtors in preparing the slip. The individual customer volume rating is updated manually by trade receivable clerk and sale director is responsible for authorizing the report. All the possible risks associated with accounting and transactions recording of data would be alleviated by the effective control system of organization. Thus is so because it helps in facilitating efficient and effective operations as it becomes easy to respond appropriately to operations, finance and compliance of business. Quality of external and internal control of reporting is ensured by maintenance of processes and proper records that helps in generating relevant timely and reliable information within and outside the organization (Davies & Goddard, 2017).

Organizational control

Written procedures should be there for granting credit to customers and receiving orders and recoding of sales amount.

Physical control

The documents related to sales order should have physical control and their should be numbering of re order sales forms. The monitoring of condition and quantity of goods supplied should be done.

Sales invoices and delivery notes should be pre numbered. Notes related to service performance and goods delivery notes should be pre numbered.

Segregation of duties

Different members of sales team should be involve in different aspects of the process of sales. There should not be any involvement of sales team members in some other functional areas such as information technology department as this cam lead to some potential risks to internal system. Moreover, if looking within the same department, there needs to be segregation, for instance, same staff should not be involved in raising invoices and dispatching the good to customers (Earley, 2015).

Accounting

There should be proper accounting of all the transactions and recording of data relating to customer and sales invoices. Quotation of prices should be correct and calculation of discounts should be done appropriately.

Authorization

Proper authorization should be involved in change of any customer database and changes made to credit limit must be properly authorized.

Weakness identified in the internal control for trade receivables and sales of GPSA:

Question 2A

The objective of trade receivables and sales system involves efficient and prompt recording of customer orders. Recording of sales transactions are appropriate and prompt and payment of invoices are made in accordance with organization’s trading terms.

  • Trade receivable clerk is responsible for auctioning all aspects of invoice generation. He is further responsible for preparing the sales volume analysis along with updating the volume rating of individual customers. They should not be integral to handle all the aspects of recording invoices and sales system. Such functions should be managed and controlled by employee who is independent of recording transactions and performing the analysis relating sales and purchase.
  • Sales bonuses are paid to employees against their targeted monthly sales volume and target ratios and there is high risk of part of management making bonus payments in event of inadequate sales transactions (Broberg, 2013).
  • As depicted from the case study that financial controller is concerned about the balance of doubtful debtors and there is no prescribed payment received from customers that should be withhold. Since clerk is responsible for handling all matters relating to trade receivables, there is increased risk that there will be bad debts and doubtful debts. In this regard, they would have conflict of interest in minimizing the doubtful debts and maximising the sales volume.
  • Since there is no internal audit function of GPSA, there exists weakness in recording of sales transactions in the account department (Griffin & Wright, 2015). In regard to this, there is increase risk that the accounting record of company will be inaccurate and inadequate relating to sales transactions.

Conclusion:

The given case study depicts the internal control system of GPSA that is actively engaged in development of technologies relating to medical equipment. It has been ascertained for the analysis of the given case that the internal control system of organization is somewhat effective. However, there are some risks associated with the trade receivable and sales system that can be mitigated by the effective implementation of audit plan. Investigations have been carried out manly in five accounts listed by audit partner of organization. Furthermore, the test of control is also employed for effective implementing of internal control so that they are able to address the concern area.

References:

Bik, O., Hooghiemstra, R., Bishop, C. C., DeZoort, F. T., Hermanson, D. R., Officers’Judgments, F., ... & Glover, S. M. (2017). Auditing: A Journal of Practice & Theory A Publication of the Auditing Section of the American Accounting Association.

Boone, J. P., Khurana, I. K., Raman, K. K., Chen, L. H., Chung, H. H. S., Peters, G. F., ... & Truong, C. (2017). Auditing: A Journal of Practice & Theory A Publication of the Auditing Section of the American Accounting Association.

Broberg, P. (2013). The auditor at work: A study of auditor practice in Big 4 audit firms (Doctoral dissertation, Department of Business Administration, School of Economics and Management, Lund University).

Curtis, E., Humphrey, C., & Turley, W. S. (2016). Standards of innovation in auditing. Auditing: A Journal of Practice & Theory, 35(3), 75-98.

Davies, J., & Goddard, J. (2017, July). Peri-operative delirium quality improvement project: auditing best practice. In ANAESTHESIA (Vol. 72, pp. 76-76). 111 RIVER ST, HOBOKEN 07030-5774, NJ USA: WILEY.

De Santis, F. (2016). Auditing Standard Change and Auditors' Everyday Practice: A Field Study. International Business Research, 9(12), 41.

Earley, C. E. (2015). Data analytics in auditing: Opportunities and challenges. Business Horizons, 58(5), 493-500.

Gendron, Y., & Power, M. K. (2015). Research forum on qualitative research in auditing. AUDITING: A Journal of Practice & Theory, 34(2), 1-2.

Griffin, P. A., & Wright, A. M. (2015). Commentaries on Big Data's importance for accounting and auditing. Accounting Horizons, 29(2), 377-379.

Kogan, A., Alles, M. G., Vasarhelyi, M. A., & Wu, J. (2014). Design and evaluation of a continuous data level auditing system. Auditing: A Journal of Practice & Theory, 33(4), 221-245.

Kumar, R., & Sharma, V. (2015). Auditing: Principles and practice. PHI Learning Pvt. Ltd..

Nichols, O., Coleman, M., Jones, D. R., Unger, C. J., Donato, D., Pattenden, C., ... & Brown, G. (2016). Evaluating performance: Monitoring and auditing: Leading Practice Sustainable Development Program for the Mining Industry.

Persellin, J., Schmidt, J. J., & Wilkins, M. S. (2015). Auditor perceptions of audit workloads, audit quality, and the auditing profession.

Pitt, S. A. (2014). International standards for the professional practice of internal auditing.

Quick, R. (2014). [Besprechungen von Aufsätzen] Billings, Anthony B./Gao, Xinghua/Jia, Yonghong: CEO and CFO Equity Incentives and the Pricing of Audit Services, Auditing: A Journal of Practice & Theory, May 2014 (No. 67563). Darmstadt Technical University, Department of Business Administration, Economics and Law, Institute for Business Studies (BWL).

Zadek, S., Evans, R., & Pruzan, P. (2013). Building corporate accountability: Emerging practice in social and ethical accounting and auditing. Routledge.

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My Assignment Help. (2021). Audit Plan For GPSA Limited 2017: Potential Risks, Business Risks, Internal Controls, Weaknesses, And Essay.. Retrieved from https://myassignmenthelp.com/free-samples/acg31-auditing-theory-and-practice/a-case-of-miller-yates-howarth.html.

"Audit Plan For GPSA Limited 2017: Potential Risks, Business Risks, Internal Controls, Weaknesses, And Essay.." My Assignment Help, 2021, https://myassignmenthelp.com/free-samples/acg31-auditing-theory-and-practice/a-case-of-miller-yates-howarth.html.

My Assignment Help (2021) Audit Plan For GPSA Limited 2017: Potential Risks, Business Risks, Internal Controls, Weaknesses, And Essay. [Online]. Available from: https://myassignmenthelp.com/free-samples/acg31-auditing-theory-and-practice/a-case-of-miller-yates-howarth.html
[Accessed 28 March 2024].

My Assignment Help. 'Audit Plan For GPSA Limited 2017: Potential Risks, Business Risks, Internal Controls, Weaknesses, And Essay.' (My Assignment Help, 2021) <https://myassignmenthelp.com/free-samples/acg31-auditing-theory-and-practice/a-case-of-miller-yates-howarth.html> accessed 28 March 2024.

My Assignment Help. Audit Plan For GPSA Limited 2017: Potential Risks, Business Risks, Internal Controls, Weaknesses, And Essay. [Internet]. My Assignment Help. 2021 [cited 28 March 2024]. Available from: https://myassignmenthelp.com/free-samples/acg31-auditing-theory-and-practice/a-case-of-miller-yates-howarth.html.

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