Audit Report: Risk Assessment and Internal Controls for GPSA Limited

This report provides a detailed analysis of the audit of GPSA Limited for the year 2017, focusing on risk assessment and internal controls. The executive summary highlights the high audit and business risks faced by the company due to declining financial performance and increased competition. The report examines key accounts, including accounts receivable, current investments, property assets, and intangible assets, analyzing the rising accounts receivable days and the significance of research and development capitalization. The report identifies audit risks such as manipulation of research and development expenses and potential issues with accounts receivable. It outlines audit steps to mitigate these risks, including verifying controls and applying substantive tests. Business risks, including declining demand and profitability, are also assessed. The report further discusses effective controls implemented by GPSA Limited, such as independent directors and a new IT system, and the risks they alleviate. It also points out weaknesses in internal controls, particularly in sales processes and accounts receivables, and concludes that a focused audit approach is necessary for GPSA Limited due to the high-risk environment. The report references relevant auditing standards and literature.

Running Head: AUDITING THEORY AND PRACTICE
Auditing Theory and Practice

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Executive Summary
The report presented here provides an analysis of the internal controls and audit risk in
relation to the audit of GPSA Limited for the year 2017. The assessment of audit risk and
business risk reveals that the company is bearing high risk. The financial performance of the
company is going down and this year the demand is predicted to be lower due to fierce
competition. From the auditor’s view point, it is essential to assess the risk properly and devise
suitable responses so that appropriate audit opinion could be given on the financial statements of
GPSA Limited.

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Table of Contents
Introduction.................................................................................................................................................4
Question-1A................................................................................................................................................4
Accounts..................................................................................................................................................4
Analysis....................................................................................................................................................4
Audit Risk.................................................................................................................................................5
Audit Steps to Reduce Risk......................................................................................................................6
Question-1B: Business Risks Faced by GPSA Limited...................................................................................6
Question-2A................................................................................................................................................7
Effective Control......................................................................................................................................7
Risk Alleviated.........................................................................................................................................7
Test of Control.........................................................................................................................................8
Question-2B: Weaknesses in Internal Control.............................................................................................8
Conclusion...................................................................................................................................................9
References.................................................................................................................................................10

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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.
Question-1A
Accounts
The five accounts as identified by the audit partner, John Richard being potentially risky
are given as below:
1. Accounts receivables
2. Current Investments
3. Property Assets
4. Intangible Assets
5. Research and Development Capitalization

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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.

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 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).
Question-1B: 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

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solvency risk. Thus, overall it could be evaluated that the business risk of GPSA Limited is high
for the audit of 2017.
Question-2A
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

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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).
Question-2B: 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

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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 company 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.

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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. Auditor’s Response to the Assessed Risk. Retrieved 18 September 2017, from
http://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.