Analyzing Financial Statements

This assignment focuses on analyzing financial statements using relevant accounting standards (AASB) and auditing guidelines (ASA). You'll need to understand concepts like intangible assets, property, plant & equipment, and fair value measurements. The analysis involves applying various financial ratios, including ROA, ROE, and the current ratio, to evaluate a company's financial health and performance. Understanding audit risk models and the auditor's responsibilities related to fraud is also crucial for this assignment.

Audit Planning and Internal Control- A
Case STUDY
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Executive Summary
This management report is made for the audit partner of MYH John Richards to highlight
different domains of financial information to make the next audit plan for year ended on 30th
June, 2017. The client of MYH is GPSA who are engaged in different activities in the fields of
research and development of technologies related to medical equipments, production and
distribution of medical equipments, investment of surplus fund and investment in the property
market. Main concern for the audit planning is to find out the areas related to audit risks,
business risks and the implementation of tighter internal control. For this purpose my partner,
John Richards had asked for a management report on different areas of financial information like
accounts receivables, current investments property assets, intangible assets and capitalization of
research and development process. The financial controller has implemented some new IT
application for the company earlier which has taken shape with the staffs and now it runs
smoothly. Main objective of this report is to analyze different financial ratios as retrieved from
the financial report of the company for the last three years. The financial reports to be considered
has the credential of audited status for last two years- 2015 and 2016, while for 2017 the
financial ratios are of unaudited status. By analyzing those financial ratios, the present financial
condition of the company will be projected on the core areas of derivation of audit risks, business
risks and enhanced level of internal control to make the financial activities of the company more
professional and full proof.
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Table of Contents
Introduction.................................................................................................................................................4
Audit Risk.....................................................................................................................................................4
Accounts Receivables..............................................................................................................................4
Current investments................................................................................................................................5
Property assets........................................................................................................................................6
Intangible assets......................................................................................................................................7
Research and development capitalization...............................................................................................8
Business risk................................................................................................................................................8
Return on equity (ROE)............................................................................................................................9
Times interest earned..............................................................................................................................9
Current ratio............................................................................................................................................9
Debt to equity ratio...............................................................................................................................10
Potential Internal Controls........................................................................................................................10
Weaknesses in Internal Control for Sales and Trade Receivables..............................................................12
Conclusion.................................................................................................................................................12
References:................................................................................................................................................14
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Introduction
GPSA is engaged in different level of business with good profit. This report is meant for
detection of audit risks as per financial ratio analysis of the company by MYH, the audit firm of
GPSA. Before starting the audit, audit plan is required and this is to be made with the
consultation of Audit partner, Mr. Richards. As per his requirement, this management report is
made to highlight five accounting heads namely accounts receivables, current investments,
intangible assets, property assets, research and development capitalization. The report will
consist of discussion of audit risks of these five heads, relevant business risks as per ratio
analysis, general internal control for good business practice and internal control for sales and
receivables for GPSA (Myaccountingcourse, 2016). This report is required prior to proceeding
of audit plan for the financial year ended on 30th June 2017. The audit report of the company is to
be submitted to the Board at the end of August 2017. The audit report will obviously contain the
auditing process with the finalization of accounts along with the proposed internal control to be
implemented in order to make the business sustainable in long run (Myaccountingcourse, 2016).
Audit Risk
The audit risks for the company are to be detected are of the following heads with proper ratio
analysis, audit risk detection and steps to reduce audit risk:
Accounts Receivables
Ratio Analysis- As per days in accounts receivable ratio, the receivable ageing is getting
increased in respect of average turnover. The trend of this ratio for the company is observed as
upward which depicts that the blockage of blockage of working capital is there through this
loophole. The company has latest trend of 83 days of 2017 as days on accounts receivable. It
means that the company can recover receivable beyond 83 days which is to be justified by the
company policy of credit sales
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Audit Risks- As per Audit risk classification, this is a Control risk. This trend is tending towards
accounts receivable ageing to 90 days which is not good for the business. If the trend is
continuing, the amount of doubtful debts can be increased and the profit of the company will be
drained out. It is to be controlled with some measures of internal control within GPSA to ensure
reduction of ageing of accounts receivable gradually to the objective of attaining 65 days on
order to increase the good debts and reduce the tendency to doubtful debts of the accounts
receivables (Financeformulas, 2015).
Audit Steps to reduce risks- To reduce audit risks for GPSA, the company should follow AASB
Standard 9 – Financial Instruments – Accounts Receivables (Aasb, 2014).
MYH should follow ASA 240 with the following steps to be taken to reduce risk:
 to find out the real sales justified by dispatch of items;
 to have proper exercise on ageing analysis of the receivables for
identification of doubtful debts;
 proper verification of credit sales by the agreement of the company
and the customers to comply with the agreed terms of payments;
 to ensure that returned goods are to be taken back into stock through
credit notes;
 Cash sales, if any, is to be differentiated from credit sales (Auasb,
2006).
Current investments
Ratio Analysis- This financial component is derived from Quick Ratio and Current Ratio. As
current investments are component of current assets, it contributes to those ratios. Current ratio
of GPSA is found >1, which means current assets are > current liabilities. But the Quick ratio of
GPSA is featuring <1, which means components of current assets like cash, cash equivalent,
current investments and receivables are less than current liabilities for GPSA. Thos is ideal and
good sign for the organization so far liquidity of the company is concerned (Aafp, 2016).
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Audit Risks- As per Audit Risk classification, this is a Detection Risk. The risk is demanding
proper detection of financial instruments in the form of current investments. This is to be ensured
my MYH because failure of proper detection of current investment of GPSA with the salient
features of those investments. This is to be done to ensure as its real identity as a component of
current assets. GPSA should comply with AASB Standard 9 for the accounting treatment of
those current investments (Aasb, 2014).
Audit Steps to reduce risks- Following steps are to be taken for reduction of this risk as per the
guideline provided by ASA 545 by MYH to ensure Fair value measurement and subsequent
disclosure:
 verification of proper documentation of current investments,
 proper listing of the current investments with the date of maturity
and the amount to be repaid after the maturity,
 Identification of any mortgage against those investments with the
detection of risk (Auasb, 2006).
Property assets
Ratio Analysis- Property assets are part of long-term assets and are derivable from the
consolidated financial statement of the company. It is always observed that the valuation of such
assets can be made from Return on total assets ratio. The consideration of total assets are done by
(opening value + closing value of assets)/2. Through the schedule of total assets with opening
and closing values of assets, property assets can be derived.
Audit Risks- Applicable type of audit risk for this component of financial instrument is detection
risk. Proper evaluation of property assets are to be made with the opening and closing value to
derive the addition during the year with consideration of anticipated depreciation or appreciation
of value of those assets. GPSA should follow AASB Standard 116- Property, Plant and Assets to
ensure proper treatment of those property assets which are with the company (Aasb, 2014).
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Audit steps to reduce risks- As these types of assets are generating revenue in the form of
revenue other than turnover as specified by the company operation of renting those to medical
practitioners, proper verification of rent agreements is to be done to assess the revenue earned
from those assets (Auasb, 2006). Moreover the valuation of the assets as per standard norms is to
be verified with effective guidance of AASB through AASB 15- revenue from contract with
customers. MYH should ensure the auditing procedure of these assets as per ASA Standard 240
and 545 for fair value measurement with subsequent disclosure (Auasb, 2013).
Intangible assets
Ratio Analysis- It is not possible to identify the component of intangible assets from the given
ratio analysis, but as it is a component of total assets, ROA is to be considered for deriving the
same with schedule of intangible assets of the company.
Audit risks- The identified audit risk related to this component is inherent risk. There may be
some material misstatement related to the valuation of these assets. GPSA should follow the
guideline of AASB Standard 138 meant for treatment of Intangible Assets (Aasb, 2015).
Audit steps to reduce risks- To ensure mitigation of audit risks, auditor should follow the
guideline of ASA 545 for valuation of intangible assets as this standard demands fair value
measurement of the intangible assets with subsequent disclosure (Auasb, 2006).
Research and development capitalization
Ratio Analysis- GPSA has taken loan for $ 5 million during this year for research and
development. The banker had put the criterion of debt to equity ratio should be below 1.2;
otherwise the bank may recover the loan amount at any time. The company is positioned at 1.11
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so far debt-equity ratio is concerned and the situation is posing threat to the company
(Accounting-simplified, 2016).
Audit Risks- The audit risk related to this is detection risk as the evaluation of the research and
development process has to ensure its worth; otherwise the company will lose its credential to
the shareholders. The company should follow accounting treatment as fixed in the AASB
Complied standard AASB 138 related to intangible assets as this item is considered as such as
per accounting standard.
Audit steps to reduce risks- To ensure reduction of audit risk, the auditor has to follow ASA 545
Application 25 for fair value measurement followed by proper disclosure.
Business risk
Refer to detection of business risks, following ratios are to be considered:
Ratio 2017
(Unaudited)
2016
(Audited)
2015
(Audited
)
Average Risk
detected
Return
on equity
%
7.19 18.61 22.17
15.99
Business
risk
Times
interest
earned
1.9 3.51 4.1
3.17
Business
risk
Current
ratio : 1
1.8 1.54 1.66
1.67
Business
risk
Debt to
equity
ratio : 1
1.11 1.02 1.04
1.06
Business
risk
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Return on equity (ROE)
ROE of GPSA is decreasing in steady rate during 2015 to 2017. As the components of
calculation of ROE are net income and average assets, it is observed that the rate of deployment
of net income for acquisition of assets are getting declined which pose risk to the business.
Times interest earned
This ratio is derived from EBIT/ interest expenses. As the company had taken fresh loan from
bankers for their research and development, interest expenses increased which makes the ratio of
2017 at 1.9. Moreover as one of the competitors had announced their achievement for same
machinery with subsequent patent, this investment causes great risk to the business
Current ratio
Current ratio shows the strength of the company so far its financial liquidity is concerned. As the
present ratio stands at 1.8, it depicts that the current assets are 1.8 times than current liabilities.
The current assets include inventories which are consisting of good and obsolete inventories also.
Moreover, the accounts receivable is also a component of current assets which contains doubtful
debts as the company has days in accounts receivable of 83 days. Most of the customers are of
credit sales with specific terms and conditions and thus recovery of such receivable in full is
problematic for the company (Myaccountingcourse, 2016).
Debt to equity ratio
Debt to equity ratio shows 1.11 in 2017. This is due to the new introduction of loan by bankers
for the research and development of the company. Due to the standing agreement of the bank, if
this ratio reaches 1.2, the bank will immediate recover the money from the company. Hence this
ration is posing business risk and to be controlled with justified decision by Board.
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Potential Internal Controls
Effectiv
e
Control
Risks alleviated Test of Control
Sales To ascertain real sales which is defined with
shipment and recovery through payment
At month end, physical stock
verification after sales takes
place with all sales invoices
to be dispatched with item-
wise identification.
Manual
delivery
notes
To be replaced by system generated delivery notes
to be connected with invoice generation.
At month-end, the pending
delivery notes are to be
segregated with goods to
identify real inventory to be
checked with physical
inventory.
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Sales
Return
Good return note is to be raised after physical
verification of the goods returned from customers
with specific reason. The same is to be noted in the
system through creating credit note for giving
credit impact to accounts receivable.
Proper technical person is to
be deployed to check the
reason for goods return to be
authenticated by him for
further action.
Trade
discount
s
This is applicable as per agreement with valued
customers. The specified target is to be monitored
for subsequent credit for the customers with
authentication from sales head.
A practice to ensure genuine
sales with proper payment for
calculating eligible sales for
discounts on regular basis as
per cycle specified.
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Weaknesses in Internal Control for Sales and Trade Receivables
Basic weaknesses found in internal control:
For Sales:
 Lack of priority for generating genuine sales
 Non compliance of strict dispatch schedule
 Lack of control in goods return system
 Inventory management
 Lack of proper control to stop fictitious sales by sales team
For Trade Receivables:
 Most of the sales are credit sales
 Recovery of receivables are not strictly maintained as per payment terms
 Receivables ageing analysis is getting high with more blockage of working capital
 Regular follow up of receivables are not done on routine basis
 Sales made are not followed up for steady payment practice
Conclusion
With the above report, I will conclude that different financial areas of business of GPSA needs
to be taken under the scanner in the form of accounts receivables, sales, property assets,
intangible assets and capitalization of research and development. The financial ratios of the
company are the basic resources for this primary management report related to auditing with
basic objective of detection of audit risks and subsequent steps to avoid audit risks, detection of
business risks of the company, prescribed internal control in different areas with the basic
weaknesses of internal control in the areas of trades receivables and sales. This report has
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emphasized on the applicable AASB standards for different fields of audit risk with the
recommendation of ASA standards to follow. The business risks are detected in potential areas
of activities and had been discussed in detail. Other parts like internal control and weakness in
internal control for sales accounts receivables are also emphasized as per the status of GPSA.
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References:
Aafp. (2016). Evaluating Your Practice’s Revenue Cycle: Days in Accounts Receivable. Retrieved
September 16, 2017, from Aafp:
http://www.aafp.org/practice-management/administration/finances/days-ar.html
Aasb. (2014, December). Financial Instruments. Retrieved September 17, 2017, from Aasb:
http://www.aasb.gov.au/admin/file/content105/c9/AASB9_12-14.pdf
Aasb. (2015, October 22). Intangible Assets . Retrieved September 17, 2017, from Aasb:
http://www.aasb.gov.au/admin/file/content105/c9/AASB138_08-15_COMPoct15_01-18.pdf
Aasb. (2014, June 04). Property, Plant and Equipment. Retrieved September 17, 2017, from Aasb:
http://www.aasb.gov.au/admin/file/content105/c9/AASB116_07-04_COMPjun14_07-14.pdf
Accounting-simplified. (2016). Audit Risk Model. Retrieved September 16, 2017, from Accounting-
simplified: http://accounting-simplified.com/audit/risk-assessment/audit-risk.html
Auasb. (2006, April 28). Auditing Fair Value Measurements and Disclosures. Retrieved September
17, 2017, from Auasb: http://www.auasb.gov.au/admin/file/content102/c3/ASA_545_28-04-
06.pdf
Auasb. (2006, April 18). Auditing Standard ASA 240 . Retrieved September 17, 2017, from Auasb:
http://www.auasb.gov.au/admin/file/content102/c3/ASA_240_28-04-06.pdf
Auasb. (2013, November). Auditing Standard ASA 240 The Auditor's Responsibilities Relating to
Fraud in an Audit of a Financial Report . Retrieved September 17, 2017, from Auasb:
http://www.auasb.gov.au/admin/file/content102/c3/Nov13_Compiled_Auditing_Standard_AS
A_240.pdf
Auasb. (2006, April). Auditing Standard ASA 545 Auditing Fair Value Measurements and
Disclosures. Retrieved September 16, 2017, from Auasb:
http://www.auasb.gov.au/admin/file/content102/c3/ASA_545_28-04-06.pdf
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Financeformulas. (2015). Days in Inventory. Retrieved September 16, 2017, from Financeformulas:
http://financeformulas.net/Days-in-Inventory.html
Myaccountingcourse. (2016). Current Ratio. Retrieved September 16, 2017, from
Myaccountingcourse: http://www.myaccountingcourse.com/financial-ratios/current-ratio
Myaccountingcourse. (2016). Return on Assets Ratio - ROA. Retrieved September 16, 2017, from
Myaccountingcourse: http://www.myaccountingcourse.com/financial-ratios/return-on-assets
Myaccountingcourse. (2016). Return on Equity Ratio. Retrieved September 16, 2017, from
Myaccountingcourse: http://www.myaccountingcourse.com/financial-ratios/return-on-equity
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