In: Accounting
Biotech Limited
Financial year end 30 June 2020
You are an auditor in Smit & Chandra, a mid-tier audit firm. Your firm is the incumbent auditor on Biotech Ltd, a pharmaceutical company. Since the previous audit, the company has listed on the Australian Securities Exchange which means the company has to meet additional reporting regulations. Due to rapid growth, Biotech Ltd is financially stretched and its accounting systems are struggling to cope with the growth in the business. You recently read an article in the Australian Financial Review, which stated that Biotech Ltd is currently under investigation by the Australian Taxation Office (ATO) for alleged failure to pay the appropriate amount of Pay As You Go (PAYG) tax on their payroll.
Biotech Ltd is a pharmaceutical company, developing drugs to be licensed for use around the world. Products include medicines such as tablets, medical gels and creams. The market is very competitive, encouraging rapid product innovation. New products are continually in development and improvements are made to existing formulations. Drugs must meet very stringent regulatory requirements prior to being licensed for production and sale. You are aware that during the 2020 financial year, Biotech Ltd lost several customer contracts to overseas competitors.
Biotech Ltd approached its bank during the year to extend its borrowing facilities. An extension of $20 million was sought to its existing loan to support the on-going development of new drugs. The long-term borrowings are subject to debt covenants in which the company must maintain a current ratio of 3.5:1.
In addition, the company asked the bank to make cash of $5 million available if an existing court case against the company is successful. The court case is being brought by an individual who suffered severe side effects when participating in a clinical trial in 2016.
On 8 June 2020, the Company announced to the market it had been the victim of a cyber-security incident that resulted in supplier and customer details being disclosed on the dark web. The Company is assessing the costs of the incident and the subsequent reduction in revenue. The Company expects this to have a material impact on future earnings.
In December 2019, the internal audit department of Biotech Ltd performed a review of the operation of controls over processing of overtime payments in the Payroll department. It was found that the company’s specified internal control procedures in relation to the processing of overtime payments were not followed.
Below are some results of the analytical review procedures performed by the Senior Auditor (David) during the planning stage:
Sales 12.5% decrease since prior year
Net profit after tax 20% decrease since prior year
Accounts payable 15% decrease since prior year
Cash at Bank 16% increase since prior year
Accounts receivable 18% increase since prior year
Inventories 6% increase since prior year
Current ratio: 3.6:1
Debt to Equity ratio: 0.6
Minutes from the Audit Planning meeting with Simon Jones (Finance Director of Biotech Ltd) held on 30th April 2020:
Due to the current government restrictions, the planning meeting with Simon Jones was held via Zoom. In attendance at the meeting was the Audit Partner (Michael), the Audit Manager (Amanda) and the Audit Senior (David).
The following key items were discussed during the meeting:
The Audit Team
The audit team consists of 4 people. The partner is Michael. He has been the audit partner on the Biotech Ltd audit for 6 years. The audit manager is Amanda. This is Amanda’s first time on the Biotech Ltd audit. David is the audit senior and is responsible for the initial audit planning. David has recently completed the Graduate Diploma of Chartered Accounting. David has just been offered a well-paying accountant position at Biotech but he has not yet decided whether to accept the position. The graduate on the audit is Audrey. Audrey’s friend is the receptionist at Biotech Ltd. The receptionist has no accounting knowledge and has no involvement with the recording or processing of accounting transactions.
Accounts Receivable / Sales Accounting Cycle and Internal Control System
At the end of each month, the sales manager determines the amount of products required to meet sales demand for the following month based on sales orders received. He reviews the sales orders received from customers and then prepares the pre-numbered inventory requisition forms, which he then sends to the warehouse managers so that they can prepare the goods for delivery. One copy of the sales order and inventory requisition form is sent to the warehouse, one copy is sent to the accounts receivable department and one copy is filed in the sales department.
The warehouse prepares the goods for delivery to the customers and generates the delivery document. When the goods have been delivered, the signed delivery document, which includes the delivery details, is forwarded to the accounts receivable department. The other copy is filed in the warehouse. The accounts receivable clerk matches the signed delivery document with the sales order and inventory requisition form. Once satisfied that all of the details agree, the clerk generates the sales invoice. Once generated, the clerk does another check to ensure that all details per the sales invoice agrees to the delivery document and sales order. Once satisfied, she writes “checked” on the sales invoice and sends it to the customer. At the end of every week, a different clerk in the Accounts Receivable team reviews the bank statements for receipt of payments from customers and performs a reconciliation against the sales invoices. Once a customer has paid the sales invoice, the clerk stamps “received” on the sales invoice and files that along with all the other documents in date order.
The walk-through of the accounts receivable/sales cycle confirmed that the accounting and internal control system was working as documented above.
Test of control:
As part of the audit, Audrey tested the controls over the accounts receivable system. She selected a sample of twenty sales transactions and tested the control that all details had been checked. Out of the 20 sales transactions that were selected for testing, 5 sales invoices in the sample did not have the word “checked” written on them. When documenting the results of the test performed, Audrey concluded that the internal control did not operate effectively and consistently throughout the year but that no further audit work is required.
Substantive test
In order to test the occurrence of the sales transactions, Audrey selected a sample of sales invoices and traced them to the General Ledger to test that they were properly recorded.
Subsequent events not previously mentioned
What is the independence of the audit team?
Answer:
Auditor independence refers to the independence of the internal auditor or of the external auditor from parties that may have a financial interest in the business being audited. Independence requires integrity and an objective approach to the audit process. The concept requires the auditor to carry out his or her work freely and in an objective manner.
Independence of audit team basically means that the audiors are able to perform their audit in a proper manner, also without any bias and auditor should be free to express their opinion i.e. whether the financial information given by the company is true and fair or not. Moreover their should be no coercion from the management of the organisation on auditor or on the audit team. The audit team should also be trained to be independent as they are the one who collects the evidences which are base for forming an audit opinion.
The Independence of audit team means that they are in a position to perform their audit procedures without any bias as instructed to them by their Audit Senior or Audit Manager. The Audit Senior should ensure that those people are selected in the audit team who are not related to the client whether directly or indirectly. In the above given case Audrey's friend is the receptionist at Biotech ltd even though the receptionist is not aware of finance and accounting but still theire is a chance that mistake done by receptionist may not be pointed out by Audrey's as he is his friend, this will effect the independence of the audit team.
The Independence of audit team is of utmost importance as they are the one who collects the evidences and interact with the management of auditee which act as an base for forming an audit opinion.