Research And Development Capitalization: Audit Risks And Steps To Reduce Them

Audit Risk

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 30^th 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).

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:

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

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).

Accounts Receivables

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).

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).

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). 

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).

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).

Current Investments

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).

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 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. 

 Refer to detection of business risks, following ratios are to be considered:

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.

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

Property Assets

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 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.

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 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.

References:

Aafp. (2016). Evaluating Your Practice’s Revenue Cycle: Days in Accounts Receivable. Retrieved September 16, 2017, from Aafp: https://www.aafp.org/practice-management/administration/finances/days-ar.html

Aasb. (2014, December). Financial Instruments. Retrieved September 17, 2017, from Aasb: https://www.aasb.gov.au/admin/file/content105/c9/AASB9_12-14.pdf

Aasb. (2015, October 22). Intangible Assets . Retrieved September 17, 2017, from Aasb: https://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: https://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: https://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: https://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: https://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: https://www.auasb.gov.au/admin/file/content102/c3/Nov13_Compiled_Auditing_Standard_ASA_240.pdf

Auasb. (2006, April). Auditing Standard ASA 545 Auditing Fair Value Measurements and Disclosures. Retrieved September 16, 2017, from Auasb: https://www.auasb.gov.au/admin/file/content102/c3/ASA_545_28-04-06.pdf

Financeformulas. (2015). Days in Inventory. Retrieved September 16, 2017, from Financeformulas: https://financeformulas.net/Days-in-Inventory.html

Myaccountingcourse. (2016). Current Ratio. Retrieved September 16, 2017, from Myaccountingcourse: https://www.myaccountingcourse.com/financial-ratios/current-ratio

Myaccountingcourse. (2016). Return on Assets Ratio – ROA. Retrieved September 16, 2017, from Myaccountingcourse: https://www.myaccountingcourse.com/financial-ratios/return-on-assets

Myaccountingcourse. (2016). Return on Equity Ratio. Retrieved September 16, 2017, from Myaccountingcourse: https://www.myaccountingcourse.com/financial-ratios/return-on-equity

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