Financial Statement Analysis & Weaknesses

This assignment delves into a company's financial reporting practices, focusing on potential weaknesses in the process. It examines issues related to trade receivables, including the merging of receivables with bank receipts at month-end, and the potential for unintentional mistakes due to officials handling both business receivables and trade receivables. Additionally, the analysis points out concerns regarding sales journals, emphasizing that their monthly production can lead to overlooked errors. The assignment aims to shed light on areas within financial reporting that require attention and improvement.

Running head: AUDITING
Auditing
Name of the Student
Name of the University
Author’s Note

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Executive Summary
GPSA is a business organization established in 1992 and it deals with the research and
development of technologies regarding medical equipment; it also involves in the process of
manufacturing and distributing medical equipments and it invests in the property market. GPSA
approached to the long-term auditor, Miller Yates Howarth for the analysis of control system of
the company along with the analysis of the major financial rations of the company so that the
major business risks can be determined.

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Table of Contents
Answer to Question 1A...................................................................................................................3
Answer to Question 1B....................................................................................................................5
Answer to Question 2A...................................................................................................................7
Answer to Question 2B....................................................................................................................9
References......................................................................................................................................11

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Answer to Question 1A
The evaluation of different accounts is shown below:
Accounts Receivable: Accounts receivable refer to the amount that the business organizations
expect to receive from their debtors as a result of credit sales.
Evaluation: From the case study, it has been seen that the trade receivable official nhas all the
required steps related to accounts receivable. For example, in case of medical instrument return
by the consumer, the respected official drawn credit notes in favor of the customer after
investigating the reasons behind the return and the documentation process. Moreover, officials
sent the related journal postings along with receipts to the bank for the preparation of deposit
slip. Thus, it can be seen that the risk is high.
Audit Risk: The trade relievable has undertaken all the necessary steps related to receivables.
The risk involved in this case is that the trade receivable officials might inflate the receivables in
order to show lesser amount of receivables (Arens, Elder & Mark, 2012).
Audit Steps to Reduce Risk: In order to reduce the accounts receivable risk of GPSA, the
officials must separate out different actions related to the accounts receivable among the staffs.
Investment: Investment refers to a particular amount of money that can be converted into cash
within a period of three to twelve months. Thus, it is considered as cash equivalent.
Evaluation: Business investment use to influence the whole accounting systems of the
companies and this, it needs to be differently treated. Hence, risk related to investments is
medium.

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Audit Risk: Risk in investments arrive when the investments are done without taking into
consideration the related risk factors with it.
Audit Steps to Reduce Risk: It is needed to inspect the return from investments on a regular
basis. Moreover, the investment process, the related investment trends needs to be analyzed.
Property Assets and Resources: The accounts associated with this are considered as fixed
assets and the depreciation related with the fixed assets.
Evaluation: The ineffective registration of fixed assets and ineffective calculation of
depreciation can negatively affect the financial statements of the companies. Thus, the risk is
high associated with property assets and resources (Vona, 2012).
Audit Risk: Audit risk can be arrived in case the accounts do not differentiate the utilization of
resources for more than 180 days and less than 180 days and they do not record this effectively.
Audit Steps to Reduce Risk: It is needed to maintain the ledger of these accounts properly in
order to bring coordination between purchase and sales. In addition, the amount of impairment
also needs to be evaluated.
Intangible Assets: The major accounts related with intangible assets are goodwill, patents,
copyright and others.
Evaluation: The thorough examination of intangible assets is required in order to determine the
value and recognition mode. The definite or indefinite life period of them needs to be
determined. Thus, risk related to these assets is high.

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Audit Risk: It is difficult to ascertain the fair value of intangible assets as they do not have any
physical existence. Apart from this, variance can be seen between the acquirement cost and fair
value of intangible assets (William Jr, Glover & Prawitt, 2016).
Audit Steps to Reduce Risk: The professionals need to determine the fair value of the intangible
assets. Audit risk can be reduced by implementing control over the process to determine the fair
value of the intangible assets.
Capitalization of Firm’s Research and Development: It can be seen that GPSA research
activities were not growing and thus, it is possible that both the profit and loss accounts are
debited.
Evaluation: A very thin gap can be seen between the successful and unsuccessful research.
Ineffective recognition can lead to high risk as the research processes include high amount of
money.
Audit Risk: Inherent audit risks can be seen in case of unsuccessful research processes.
Furthermore, it is difficult to mention the specific amount of money related with the research
process (Ashley-Smith, 2013).
Audit Steps to Reduce Risk: It is needed to properly examine all the ledger accounts related with
these researches. In addition, it is needed to carry out a marker research before involving in any
kinds of research activities.
Answer to Question 1B
The evaluation of major ratios is discussed below:

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Return on Equity: In case of return of equity, a downward trend can be observed in return on
equity of the company as it decreased from 22.7% in 2015 to 7.19% in 2017. It indicates the
decreased capacity of the company to generate profit from investments. Thus, major risks can be
seen in profitability on equity of the company (Hevert, 2013).
Earned Return on Total Assets: In case of return on total assets, a downward trend can also be
observed as it decreased from 15.52% in 2015 to 4.86% in 2017. It indicates that the capacity of
the company to generate income before tax and to gain tax against resources has reduced. Thus,
it is a major risk in the company (Kabajeh, Al Nuaimat & Dahmash, 2012).
Net Profit Margin Analysis: Declining trend can also be seen in the net profit margin of the
company as in dreaded from 17.85% in 2015 to 10.38% in 2017. It shows the reduced capacity
of the company to earn profits and leads to the high risk of profitability. This is one of the major
financial risks of the companies as the company is failing in the generation of higher net profit
(Stahl et al., 2012).
Time Earned Ratio Analysis: The capacity of the company to earn interest has decreased as the
times earned ratio decreased from 4.10 in 2015 to 1.90 in 2017. It leads to the financial risks as
the firm is losing its capacity to earn interest incomes.
Days in Accounts Receivable: It can be seen that there has been an increase in the days in
accounts receivable from 53.24 in 2015 days to 83.07 in 2017. This aspect increases the bad debt
risk of the company for the increase in the chance to not recover the receivables (Michalski,
2013).

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Current Ratio Analysis: A riding trend can be seen in the current ration of the company.
However, it needs to mention that in 2016, the current ratio was 1.80. Thus, the risk of not
utilizing the working capital of the company remains high (Babalola & Abiola, 2013).
Debt to Equity Ratio Analysis: Higher debt to equity ratio that is more than one show the high
leverage of the company and it implies that the company is hugely dependent on long-term debts.
This aspect increases the financial risk of the companies, as the company has to pay higher
amount of money as interest expenses (Palley, 2013).
Answer to Question 2A
The internal control in the system is discussed below:
(a) Effective Control
Bonus Disbursement: Shareholders of the companies can assess the bonus paid to the managers.
The responsible person to prepare budget needs to be asked to explain the reasons for budget
variance (Soudani, 2012).
Password Protection: Passwords helped the form in protecting various applications to restrict
free admittance. It is needed to assess the success of the company’s IT system.
Permitting Discount: In the company, the system is to obtain permission from sales director in
order to provide the customers with various discounts (Soudani, 2012).
Trade Receivable: At the time to close the accounts, the trade receivables are merged with the
debtor accounts.

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Aging Evaluation: After considering the amount of all the invoices, the aged evaluation of
receivables is done with the assistance of computerized systems. Financial controller of the firm
is responsible for this evaluation. The responsible officials for receivable management are asked
to produce the reasons behind the delays in payments.
Doubtful Debt: As a part of the follow up strategy of the company’s doubtful debts, further
shipments to the specific customers are refused in case of the not payment of required minimum
amount (Soudani, 2012).
(b) Risk Alleviated
Admittance to Database: Even in the presence of strong password to access the company’s
specific programs, it can be seen that there is not any password protection of the database of the
firm that increases the risk of unlawful access.
Physical Delivery Notes: Shipping tiles to the customers increases the amount of manual notes.
Increased amount of notes leads to the increase risks in making mistakes in these notes (Chopra
& Sodhi, 2014).
Single Individual Responsible for Diverse Activities: It can be seen in the company that a single
person is responsible for carrying on diverse business operations. A single clerk is responsible
for issuing of credit notes, documentation of reasons, management of trade receivables and many
others. Thus, the chance to make mistakes by the clerk increases (Chopra & Sodhi, 2014).
(c) Test of Control
Test of control is one of the major processes of audit to examine the internal control of
the companies. The classification of test of control is done below:

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Re-performance: As a part of this system, there is the introduction of a new transaction for the
examination of internal control (Numan & Willekens, 2012).
Inspection: In this process, the assessment of important documents is done with the help of
stamps and authorized signatures.
Observation: In this system, all the business processes ate observed and assessed in order to
bring improvements.
The control systems are discussed below:
Bonus Distribution: In order to distribute bonus, internal control system can be used.
Password Protection: In order to protect the passwords, the inspection tactic of control can be
used.
Discount Allowance: In case of the allowance of discounts, the tactic of re-performance can be
used.
Trade Receivable: The performance of re-performance can be used for the management of trade
receivables.
Aging Analysis: Both the tactics of observation and inspection can be used in this regard.
Doubtful Debt: In this situation, the re-performance tactics can be used (Numan & Willekens,
2012).
Answer to Question 2B
The weaknesses in sales and trade receivables are discussed below:

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Sales
 Bonus to the management is provided based on the sales volume of the company. This is
a weakness as the sale s figures can be increased with the help of manipulation.
 Manual declarations for sales can include the chance for mistakes and faults.
 The chance of misplacement on the sales journals cannot be ignored, as they are
produced monthly basis (Skaife, Veenman & Wangerin, 2013).
Trade Receivables
 It can be seen that the trade receivables officials are also responsible for business
receivables. This reason can lead to the unintentional mistakes or errors in the financial
statements. This is a major weakness in trade receivables.
 At the end of every month, the trade receivables are merged with the bank receipts. This
aspect represents an extensive period for the settlement of some of the key items of the
company like receivables (Skaife, Veenman & Wangerin, 2013).

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References
Arens, A. A., Elder, R. J., & Mark, B. (2012). Auditing and assurance services: an integrated
approach. Boston: Prentice Hall.
Ashley-Smith, J. (2013). Risk assessment for object conservation. Routledge.
Babalola, Y. A., & Abiola, F. R. (2013). Financial ratio analysis of firms: A tool for decision
making. International journal of management sciences, 1(4), 132-137.
Chopra, S., & Sodhi, M. S. (2014). Reducing the risk of supply chain disruptions. MIT Sloan
Management Review, 55(3), 73.
Hevert, S. R. B. (2013). Return on Equity.
Kabajeh, M. A. M., Al Nuaimat, S. M. A., & Dahmash, F. N. (2012). The relationship between
the ROA, ROE and ROI ratios with Jordanian insurance public companies market share
prices. International Journal of Humanities and Social Science, 2(11), 115-120.
Michalski, G. (2013). Portfolio management approach in trade credit decision making. arXiv
preprint arXiv:1301.3823.
Numan, W., & Willekens, M. (2012). An empirical test of spatial competition in the audit
market. Journal of Accounting and Economics, 53(1), 450-465.
Palley, T. I. (2013). Financialization: what it is and why it matters. In Financialization (pp. 17-
40). Palgrave Macmillan UK.

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Skaife, H. A., Veenman, D., & Wangerin, D. (2013). Internal control over financial reporting and
managerial rent extraction: Evidence from the profitability of insider trading. Journal of
Accounting and Economics, 55(1), 91-110.
Soudani, S. N. (2012). The usefulness of an accounting information system for effective
organizational performance. International Journal of Economics and Finance, 4(5), 136.
Stahl, F., Heitmann, M., Lehmann, D. R., & Neslin, S. A. (2012). The impact of brand equity on
customer acquisition, retention, and profit margin. Journal of Marketing, 76(4), 44-63.
Vona, L. W. (2012). Fraud risk assessment: building a fraud audit program. John Wiley & Sons.
William Jr, M., Glover, S., & Prawitt, D. (2016). Auditing and assurance services: A systematic
approach. McGraw-Hill Education.