Risk and Audit of GPSA Limited Samples †MyAssignmenthelp.com

Question: Discuss about the Risk and Audit of GPSA Limited. Answer: Introduction Auditing is the process being undertaken by the certified accountant for the purpose of verifying the books of accounts of a business entity for a particular financial year. The auditing involves risk assessment as the major element (Leung, Coram, Cooper, 2012). The auditor needs to assess the risk of manipulations in the financial statements before commencing the actual verification of the books and records of the entity. In this context, a report has been prepared here that deals with the risk assessment in relation to the audit of GPSA Limited which engages in the research and development activities and investment in properties. The report provides overview of the application of risk assessment tools and techniques such as test of controls and ratio analysis. Further, discussion on the audit steps required to reduce the audit risk has also been provided in this report. Accounts The five accounts as identified by the audit partner, John Richard being potentially risky are given as below: Accounts receivables Current Investments Property Assets Intangible Assets Research and Development Capitalization Analysis The days in accounts receivables have been observed to be rising over the period of three years. In the year 2015, the accounts receivable days were 53 which increased to 61 in 2016 and then further increased to 83 in the year 2017. The increase in the accounts receivable days has been significant in three years, which certain raise concerns of the auditor. Current investment account shows the investments held by the company for disposal in the short term. Current investment forms part of current assets. The current ratio of the company has been observed to be increasing from 1.66 times in 2015 to 1.80 times in 2017. The company makes investment in the properties which are shown under the property assets account. Intangible assets and research and development capitalization accounts are the most crucial for the auditor because these comprise the main business activities of the company. In the year 2016, the company incurred a huge sum on the research of new laser surgery device which one of its competitors has already developed and patented, the expected revenues from this device may be adversely affected. Further, as per the loan covenants the company will be under obligation to pay the loan on demand if the debt to equity ratio goes increases above 1.2:1 (AICPA, 2016). Audit Risk Audit risk is the risk that the auditor would make incorrect audit opinion in regards to accounts examined because the fraud and error remain undetected (Griffiths, 2016). The auditor tries to reduce the audit risk by adopting the test of controls and substantive procedures. In the case of GPSA Limited, the main audit risks have been identified as below: The capitalization of research and development expenses may be manipulated. The accounts receivable might include bad and irrecoverable debt. The company might try to increase the equity to keep the debt equity ratio within the limits specified in the loan covenant. Audit Steps to Reduce Risk The auditor should verify the controls over the accounts receivables and apply extensive checking on the receivable accounts outstanding for more than a considerable period of time. Verify the capitalization in the research and development account and the expected cash flows from the device developed. Apply substantive tests over the equity accounts to verify (ISA 330, 2009). Business Risks Faced by GPSA Limited Business risk implies the possibility of loss that the company may incur due to adverse business conditions. The auditor should strive to find out the events that gives rise to substantial business risk (Reuvid, 2014). In the case of GPSA Limited, it has been observed that the company is facing downfall in the demand in market due to increased competition. The manufacturing and property industry in Australia is under pressure to improve the margins. The return on equity of GPSA Limited is down from 22.17% in 2015 to 7.19% in 2017. Further, the return on total assets is down from 15.52% in 2015 to 4.86% in 2017 and net margin has decrease from 17.85% in 2015 to 10.38% in 2017. The downfall in the key profitability ratio clearly indicates that the company is bearing high business risk and it may incur losses. Further, the debt to equity ratio has also increased from 1.04 times in 2015 to 1.11 times in 2017. If the debt to equity ratio hits the limit as per loan covenant of 1.20 times, the company would incur solvency risk. Thus, overall it could be evaluated that the business risk of GPSA Limited is high for the audit of 2017. Effective Control Some of the potentially effective controls that GPSA Limited has are discussed as below: The company has two non-executive independent directors out of total five on the board. The company has implemented a new IT system for the record maintenance. The access to records is password protected (Graham, 2015). The major shareholders take active part in the management of affairs, particularly related to the managerial bonus and remunerations. Budgeting system is there in place through which company specifies the targets to be achieved in the coming period (Graham, 2015). Risk Alleviated The risks alleviated by the above mentioned controls of GPSA Limited are given as below: It is essential to have independent directors on the board to alleviate the risk of losing governance in the organization. Thus, GPSA Limited, by having two independent directors on the board, alleviates the risk of non-governance in the company (Graham, 2015). The new IT system implemented by the company would alleviate the risk of errors in recoding the transactions and maintaining records. Password protection provides safeguard against the risk of unauthorized access to the accounting records. The involvement of shareholders in the management of affairs reduces the risk of management manipulating the financial statements for personal benefit. Preparing budgets and targets for the future performance helps in tightening controls over the activities of the personnel. The risk of non-performance is reduced to a great extent (Graham, 2015). Test of Control One test of control for the above discussed potentially effective controls is prescribed as below: Inspection of board meeting minutes and resolutions. Test of transactions recorded by the new IT system and verification of the security measures. Verifying the resolution passed and approvals given by the shareholders for the managerial bonus. Verifying the variance report to check that budgetary system is working properly (Graham, 2015). Weaknesses in Internal Control The internal controls laid by GPSA Limited over the sales processes and accounts receivables seem to be sufficiently good but there are certain weaknesses which if the company overcomes would help it to reduce the risk of fraud or error. In the case of incomplete deliveries, the responsibility to probe into the reasons should be assigned to officer other than the dispatch supervisor. Thus, the segregation of the duties does not seem to be proper in relation to delivery of goods and follow ups. The incomplete deliveries should be signed off by the appropriate authority. In the same way, the return of sold material is also not under the watch of proper authority. The sales return should be approved by the sales manager rather than the supervisor of dispatch department. Further, the company does not take confirmation of the material delivered to the customer. In regard to trade receivables, it has been observed that the company does not have a system of account reconciliation. The compa ny does not take balance confirmation from the trade receivables on regular basis which is a significant loophole in the system (Whittington, 2015). Conclusion From the discussion in the report, it could be concluded that the audit of GPSA Limited for the year 2017 should be with more focus and planning because the company is bearing high risk. Further, there has been a change in the internal control system due to implementation of the new IT system. Thus, the auditor needs to go through testing of controls in detail this year. References AICPA. 2016. Audit Guide: Analytical Procedures. John Wiley Sons. Graham, L. 2015. Internal Control Audit and Compliance: Documentation and Testing Under the New COSO Framework. John Wiley Sons. Griffiths, P. 2016. Risk-Based Auditing. CRC Press. ISA 330. 2009. Auditors Response to the Assessed Risk. Retrieved 18 September 2017, from https://www.ifac.org/system/files/downloads/a019-2010-iaasb-handbook-isa-330.pdf Leung, P., Coram, P., Cooper, B.J. 2012. Modern Auditing and Assurance Services, Google eBook. John Wiley Sons. Reuvid, J. 2014. Managing Business Risk: A Practical Guide to Protecting Your Business. Kogan Page Publishers. Whittington, O.R. 2015. Wiley CPAexcel Exam Review 2015 Study Guide (January): Auditing and Attestation. John Wiley Sons.