Internal Control Evaluation in Sales and Receivables

This assignment focuses on evaluating the effectiveness of internal controls within a company's sales and trade receivables processes. It highlights potential weaknesses, such as management bias towards sales volume and the concentration of receivable-related tasks in a single employee. The assignment suggests specific audit procedures, including re-performance and observation approaches, for testing the identified controls.

Running head: AUDITING AND ASSURANCE
Auditing and assurance
Name of the student
Student ID
Name of the university
Author note

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Table of Contents
Executive summary....................................................................................................................2
Question 1..................................................................................................................................3
(A) Analysis of accounting heads......................................................................................3
(B) Analysis of ratios to assess the business risk...............................................................6
Question 2..................................................................................................................................7
(A) Internal control system................................................................................................7
(B) Weakness in the internal control system with regard to sales and trade receivables 10
Reference..................................................................................................................................11

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Executive summary
GPSA is a company that was incorporated during 1992 and is engaged in the development
and research of medical equipment technologies, distribution and manufacture of medical
equipments and investment of the surplus fund in property market. Their long time auditor
Miller Yates Howarth was approached to report regarding the internal control system of
GPSA, analysis of the major financial ratios with regard to business risk and internal control
system that can be applied to improve the control system and minimise the risk of fraud, error
and misstatement.

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Question 1
(A) Analysis of accounting heads
Account receivable
 Account – accounts receivable is the amount that is receivable by the company with
regard to the delivering of services and goods. The account receivable ratio is
calculated by measuring the net credit sales with the average receivable time.
Therefore, the account associated with the account receivable is the credit sales
account.
 Analysis – it has been analysed from the given case study that all the activities
associated with receivables are performed by the trade receivable clerk only. For
instance, the customer returns the medical equipment, after noting down the reason of
return and completion of documentation, the credit note in favour of the customer is
raised by the trade receivable clerk. Further, the posting of journal as well as receipts
from the debtors are passed on to him, who prepare the bank deposit slip. Therefore
the risk is considered as high.
 Audit risk – as all the activities related to the receivables are performed by the trade
receivable clerk, there exist a risk that the receivable may be misappropriated by the
clerk or the receivables may recorded at lesser amount.
 Steps of audit for reducing risks – to reduce the risks associated with account
receivable of GPSA various activities related with the receivables must be segregated
among various employees

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Current investment
 Accounts – it is the investment that will be converted to cash with the period of 3 to
12 months. It is recorded under the current assets and treated as cash or cash
equivalents. Account associated with this is the investment account.
 Analysis – investments are susceptible to different accounting system under different
accounting system the treatment will also be different, therefore, risk associated with
current investment is at medium level.
 Audit risk – the inherent audit risk that may be associated with the current investment
is that the investment is made without considering the risk and return factor (Cohen,
Krishnamoorthy & Wright, 2017).
 Steps of audit for reducing risks – the return from the investment must be checked
regularly. Further, the past growth trends of the investment shall be evaluated before
investment
Property assets
 Accounts – the accounts involved with the property assets is the fixed asset account
and the depreciation account
 Analysis – if the property assets are not recorded properly or the depreciation is not
provided correctly, it will have great impact on the financial statement. Therefore the
risk associated with the property asset is high (Strecker, Heise & Frank, 2015).
 Audit risk – the auditor may not differentiate the assets that were in use for more than
180 days and less than 180 days during the year if the assets were not recorded
properly.

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 Steps of audit for reducing risks – the asset ledger shall be scrutinized properly to
check the purchase and sales of the property assets. Further, the additions, deletions,
impairment shall be checked properly.
Intangible assets
 Accounts – the accounts that are associated with the intangible assets are goodwill,
any patent or copyright.
 Analysis – the intangible asset must be analysed properly to check its value,
recognition and whether the asset has indefinite period of useful lives or finite period
of useful lives. Therefore, the risk associated with the account is at high level.
 Audit risk – as the intangible assets have no physical existence, the determination of
its fair value is quite difficult. Further, there is difference between the acquisition cost
and fair value of intangible asset.
 Steps of audit for reducing risks – the fair values of the intangible assets shall be
determined by the experts. Further, the control over the procedure of determining the
fair values of the assets.
Research and development capitalisation
 Accounts – as the research of GPSA was not successful therefore the expenses will be
debited to profit and loss account. However, the development expenses will be
capitalized as the development was successful.
 Analysis – there is a thin line between the recognition of research and development
expense as successful and unsuccessful expenses. As the research and development
expenses involved higher amount, improper recognition will lead to high level of risk.

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 Audit risk – the inherent risk associated with the research and development expenses
is that classifying the research as successful or unsuccessful. Further, the amounts
involved in the activities are difficult to measure exactly.
 Steps of audit to reduce risks – the ledger related to the expenses shall be scrutinized
properly. Further, before establishing the product as successful or unsuccessful proper
market research shall be carried out.
(B) Analysis of ratios to assess the business risk
 Return on equity – as the return on equity of the company is in decreasing trend and
from 22.17% in 2015, it fell to 7.19% in 2017, it indicates that the ability of the
company with regard to generate profits from the investment of shareholders is
reducing. Therefore, there is a risk on profitability on the shareholder’s equity
 Return on total asset - as the return on total asset of the company is in decreasing
trend and from 15.52% in 2015, it fell to 4.86% in 2017, it indicates that the earning
before taxes and interest ability of the company with regard to generate profits against
the asset is reducing. Therefore, there is a risk on profitability of the company
(Görener, 2017).
 Net profit margin - as the net profit margin of the company is in decreasing trend and
from 15.52% in 2015, it fell to 4.86% in 2017, it indicates that the earning before
taxes and interest ability of the company with regard to generate profits against the
asset is reducing. Therefore, there is a risk on profitability of the company
 Times interest earned – the times for which the interest earned during the period was
reduced to 1.90 times as compared to 3.51 times in 2016 and 4.10 times in 2015.
Therefore, there is a risk of savings as the company is not able to save sufficient
amount to generate interest income.

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 Days in accounts receivable – as the days in accounts receivable has increased from
53.24 days to 83.07 days over the years from 2015 to 2017, there is a risk of bad-debts
from the receivables.
 Current ratio – through the current ratio of the company is in increasing trend, higher
current ratio that is 1.80 during 2016 indicated the risk of not using the working
capital efficiently by the management.
 Debt to equity ratio – a high debt to equity ratio like more than 1 indicates that the
company is highly leveraged and the company raised more through debt for financing
purpose as compared to equities. Therefore, it will increase the risk associated with
payment to investors as well as creditors as higher debt means higher amount for
interest (Chou, 2015).
Question 2
(A) Internal control system
(a) Effective control
 Payment of bonus - The bonuses that are paid to the management staffs are reviewed
by the shareholders of the company and whenever there is any variance with the
monthly budget, the person responsible is asked to explain the reason of variance
 Password protection - While the new IT system was getting installed, the financial
controller, sales director and the management were actively involves to assess the
success of the system. Further, the application programs were strictly protected with
password to have access to programs (DeFond & Lennox, 2017).
 Allowance of discount - Discount allowed to the valued customers are authorized by
sales director before updating the allowable discounts to the customers.

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 Trade receivable - trade receivables are reconciled with the debtors control account at
the end of closing of each month.
 Aging analysis - Aged analysis for receivables are prepared by the computer at the
end of each month taking into consideration all the invoices that are processed into the
system. The aged analysis is further analysed by the financial controller and the
receivables due for more than 90 days are separated and the trade receivable clerk is
asked to state the reason behind the delay in payment (Martin, Sanders & Scalan,
2014).
 Doubtful debts - While preparing the follow-up plan for doubtful debtors’ balance, in
the instances where the balance is above the prescribed limit, the shipment of further
goods to that particular customer is withheld if a minimum prescribed amount is not
received.
(b) Risk alleviated
 Access to database – Though strict password is applied to control the access on the
programs related to IT functions, the access to the database is not password protected
which in turn will expose the system to unauthorised access
 Manual delivery notes – For despatching the tiles to the customer’s manual notes for
the delivery are raised that exposes the system to intentional or unintentional error
with the delivery amount. Further, the manual system is susceptible to fraud or
misappropriation (Chen et al., 2014).
 Engagement of single person for different activities – All the activities associated with
receivables is performed by the trade receivable clerk only. For instance, the customer
returns the medical equipment, after noting down the reason of return and completion
of documentation, the credit note in favour of the customer is raised by the trade
receivable clerk. Further, the posting of journal as well as receipts from the debtors

9AUDITING AND ASSURANCE
are passed on to him, who prepare the bank deposit slip. Performing all the activities
by the same person exposes to the risk of fraud, error or misappropriation whether
intentionally or unintentionally.
(c)Test of control
Test of control is the audit process for testing the efficiency of internal control system
that is used by the client organization for detecting or preventing the material misstatement.
Based on the test result, the auditor can decide about the level of reliance on the internal
control system of the client. The tests of controls generally are categorized as below –
 Re-performance – under this, a new transaction is initiated to check the internal
control
 Inspection – under this, the associated documents are examined with regard to stamps,
signatures, authorization for checking the control
 Observation – under this, the business procedure in action and the related internal
control systems are analysed (DeFond & Lennox, 2017).
Test of control potential effective control are as follows –
 Payment of bonus - for this, observation approach of control test will be performed
 Password protection – for this, inspection approach of control test will be performed
 Allowance of discount – for this, re-performance approach of control test will be
performed
 Trade receivable – for this, re-performance approach of control test will be
performed

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 Aging analysis - for this, observation and inspection approach of control test will be
performed
 Doubtful debts - for this, re-performance approach of control test will be performed
(B) Weakness in the internal control system with regard to sales and trade
receivables
Sales –
 As the management staffs are paid the bonuses based on the volumes of sales, chances
are there that the volume of the sales will be increases fictitiously
 Manual delivery notes are issued for sales of tiles that are susceptible to error, fraud or
misstatement (Jett et al., 2014).
 Sales journal are prepared on monthly basis, therefore, chances are there that some
manual documents may be misplaced.
Trade receivables –
 The trade receivable clerk alone is responsible for all he receivable related activities
that may lead to intentional or unintentional fraud, error or misstatement
 Trade receivables are reconciled with the bank receipt at the end of each month that is
quite a long time for reconciliation of a major item like receivables.

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Reference
Chen, Y., Smith, A. L., Cao, J., & Xia, W. (2014). Information technology capability, internal
control effectiveness, and audit fees and delays. Journal of Information
Systems, 28(2), 149-180.
Chou, D. C. (2015). Cloud computing risk and audit issues. Computer Standards &
Interfaces, 42, 137-142.
Cohen, J., Krishnamoorthy, G., & Wright, A. (2017). Enterprise risk management and the
financial reporting process: The experiences of audit committee members, CFOs, and
external auditors. Contemporary Accounting Research, 34(2), 1178-1209.
DeFond, M. L., & Lennox, C. S. (2017). Do PCAOB Inspections Improve the Quality of
Internal Control Audits?. Journal of Accounting Research, 55(3), 591-627.
DeFond, M. L., & Lennox, C. S. (2017). Do PCAOB Inspections Improve the Quality of
Internal Control Audits?. Journal of Accounting Research, 55(3), 591-627.
Görener, A. (2017). Risk Based Internal Audit. In Risk Management, Strategic Thinking and
Leadership in the Financial Services Industry (pp. 261-275). Springer International
Publishing.
Jett, J. R., Peek, L. J., Fredericks, L., Jewell, W., Pingleton, W. W., & Robertson, J. F.
(2014). Audit of the autoantibody test, EarlyCDT®-lung, in 1600 patients: an
evaluation of its performance in routine clinical practice. Lung cancer, 83(1), 51-55.
Martin, K., Sanders, E., & Scalan, G. (2014). The potential impact of COSO internal control
integrated framework revision on internal audit structured SOX work
programs. Research in Accounting Regulation, 26(1), 110-117.

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Strecker, S., Heise, D., & Frank, U. (2015). Prolegomena of a modelling method in support of
audit risk assessment-Outline of a domain-specific modelling language for internal
controls and internal control systems. Enterprise Modelling and Information Systems
Architectures, 6(3), 5-24.