Question

General Practice (GP) is a not-for-profit organization that operates a nursing home in Toronto, Ontario. You are auditing the revenue and receivables at GP. The nursing home has a reputation for delivering excellent patient services, but its accounting department is understaffed and does not have time for internal verification or other accuracy checks. Your assessment of controls over cash receipts indicates that there are effective management supervision and monitoring procedures in place, and you have found no indication of fraud risk, but past audits have found misstatements in recording the patient invoices and accounts receivable. In confirming the accounts receivable from patients in past audits, you have had a very low response rate. Furthermore, those patients who did respond did not appear to know what information they were being asked to provide or what their correct outstanding balance actually was. You have had the same experience in confirming receivables at other nursing homes. The nursing home has a large bank loan payable, which is up for renewal two months after year-end. The bank’s loan officer has told management the bank’s head office may not approve a renewal. The bank is concerned about its exposure to not-for-profit nursing homes because many new government- funded nursing homes are expected to open over the new few years. These new long-term care facilities will be more modern and will be located closer to many large hospitals than GP.

Required:

1. Identify the business risks in GP.

2. Assess the risk of material misstatement at the overall financial statement level. Identify the inherent and control risk factors in the organization to support your assessment.

3. In the audit of the revenues, explain the overall audit approach you would use to obtain sufficient appropriate evidence in this situation. Give clear reasons for the mix of control and substantive work you would plan to do. Describe the substantive tests you would perform to audit the revenue transactions in this organization. Be specific and show how the tests tie in to the relevant assertions.

Answer 1

The business risk in GP:

The business risk in GP is that the organization is under staffed and as a result of that the accounting and other important book keeping functions of not for profit organization are hampered. In fact there is significant risk of fraud being committed by showing excess receivable amount or collecting receivables by staffs without recording the same in the books of accounts.   

Risk of material misstatement and inherent and control risk factors:

The account receivable balances are yet to be confirmed by the patients. There is significant amount of risk that the actual account receivable balances are lower than that showed in the books of accounts. Thus, there is a risk of window dressing the financial statements by the staffs and management of the organization.

Inherent risk:

The inherent risk is that not all the patients of the hospital will be aware of the balances due from them thus, it would be significantly difficult job to reconcile the account receivable balances. Thus, despite using appropriate auditing measures to verify the account receivable balances there would be significant risk of accounts receivables not reflecting the actual amount receivable from patients.         

Control risk:

The staffs in the hospital are not adequate to do various accounting jobs in the organization. There is high risk that not enough controls are there to prepare the books of accounts correctly by recording all the transactions promptly.

Overall audit approach:

Analytical procedures on different items of financial statements would help the auditors to identify the possible areas where fraud or manipulations could have been committed. Based on the findings of the analytical procedures necessary substantive procedures should be designed to conduct the audit effectively. The books of accounts shall be verified to check whether the financial statements have been prepared properly from the balances of books of accounts. External confirmations shall be used to verify the account receivable balances showed in the financial statements. The expenditures shall be verified with the document and vouchers. The internal controls shall be tested to take a decision as to the extent of reliance the auditors can place on the books of accounts prepared by the management along with the management representations.