Security and Control Risks in Great Gifts Inc

Internal control and securities within an organization is of great significance to the overall functioning of the organization. The management must institute effective measures and system within the organization to ensure that the resources are used effectively and carefully to achieve the organizational objectives. Great Gifts Inc. is a corporation that designs and sells inexpensive gifts for all occasions (Burt 2014). Taking into consideration the structure and internal systems of the company a brief explanation about the company and its functioning is provided from the perspective of an auditor.

In a back to back move both CEO and CFO of the company resigned one after the other in 2017 leaving the company exposed to the threat of security and control risk at the highest level of hierarchy within the company. The fact that the new CEO of the company is also the owner of the building in which the company has set up its headquarter is another major security and control issue as it relates to related party transactions. The material weaknesses in the internal control system of new software package installed in the company during 2017 contributes to the increased amount of risk in accounting and financial reporting system of the entity (Hoitash, Hoitash and Johnstone 2011).

Putting the brother in law of CFO of the company in the audit committee is not a standard practice where the company has laid off internal audit manager in a cost cutting measure. This will increase the fraud risk as the audit committee needs to work efficiently to improve the internal control system and securities within an entity thus, only qualified persons shall be allowed to sit in the audit committee. Weaknesses in the new accounting and processing system installed within the company will further increase the risk of fraud (Kabir, Rahman and Su 2017).   

In addition to the above there are few other significant risk factors that can result in material misstatement in the financial statements of the company are listed below:

1. Recognition of income of $200,000 by reversing the impairment loss of 2016 despite no conclusive evidence to support company’s view that it will be able to sale the inventory at normal price is not in conformity with the accounting standards. The risk of material misstatement is very high with the above treatment as the profit of the company will be overstated by such amount (Simeon 2018).       
2. The reduction in the amount of allowance for doubtful debts from 3% to 0.5% in the books of accounts of the company without any supporting reason to do so. Client business risk is increased due to the same. The risk of material misstatement is quite low with the above treatment as the provision will be made and shown in the books of accounts with appropriate notes (Russell 2010).    

• Recognition of $400,000 as revenue in 2017, the shipment of which is expected to take place in 2018 is against the standard accounting practice to recognize revenue in the books of accounts. The financial statements wail be materially misstated as result of the above to increase business risk. The revenue has not been earned thus, the profit of the company is overstated to the tune of $400,000 by the above accounting treatment. The risk associated with the above accounting treatment is very high.  

1. Capitalization of research cost to amortize the same over a 20 years period will also materially affect the financial statements. As per the Accounting standards a maximum period of 10 years shall be used to amortize the deferred research and development cost. The risk of material misstatement in this case is quite low.    

As per the information the two specific account balances of the company from its financial statements which are particularly risky are discussed in specific details below.

Inventory:

The inventory account of the company is specifically at risk since impairment losses recognized in 2016 has been reversed in 2017 by recognizing the amount of impairment loss of $200,000 as income in 2017 without any conclusive evidence to support the accounting treatment. As per the Generally Accepted Accounting Principles (GAAP) impairment loss once recognized shall only be reversed when it is absolutely certain that the terms and conditions on the basis of which impairment loss was recognized is not present anymore.     

Revenue:

The company has recognized $400,000 as revenue in the books of account in 2017 which is to be completed in 2018 is specifically at risk as the amount of revenue is overstated due to the above treatment making the financial statements materially misstated to the tune of such amount. As per GAAP revenue should be recognized in the books of accounts when it is earned and there is absolutely no uncertainty regarding its receipts in the future or has already been received.

Taking into consideration the assertions made above the following steps are recommended for the company:

1. The management should fix the material weaknesses identified in the new accounting and processing system to ensure that the processing of transaction and accounting entries are correctly recorded in the books of accounts.
2. The amount of $400,000 recognized as revenue in 2017 for the sales to be completed in 2018 shall be correctly treated in the books of accounts by reducing the amount of revenue of 2017.

• The Impairment loss of 2016 reversed by recognizing income of $200,000 in 2017 needs to be correctly treated by providing for the amount as impairment loss in the books of account in 2017.        

1. The deferred assets for research and development expenses shall be amortized over a 10 years period instead of 20 years period.
2. The audit committee should have independent and qualified Board members of the company (Tsvetkov 2016).

References

Burt, Ian. 2014. “An Understanding Of The Differences Between Internal And External Auditors In Obtaining Information About Internal Control Weaknesses”. SSRN Electronic Journal 2 (7): 11-37. doi:10.2139/ssrn.2538544.

Hoitash, Rani, Udi Hoitash, and Karla M. Johnstone. 2011. “Internal Control Material Weaknesses And CFO Compensation*”. Contemporary Accounting Research 29 (3): 768-803. doi:10.1111/j.1911-3846.2011.01122.x.

Kabir, Humayun, Asheq Rahman, and Li Su. 2017. “The Association Between Goodwill Impairment Loss And Goodwill Impairment Test-Related Disclosures In Australia”. SSRN Electronic Journal 2 (7): 11-37. doi:10.2139/ssrn.2901397.

Russell, J. P. 2010. The Process Auditing Techniques Guide. 3rd ed. Milwaukee, Wis.: ASQ Quality Press.

Simeon, Edori Daniel. 2018. “Implication Of Choice Of Inventory Valuation Methods On Profit, Tax And Closing Inventory”. Account And Financial Management Journal 03 (07): 2-14. doi:10.31142/afmj/v3i7.05.

Tsvetkov, A. N. 2016. “PARADIGM OF MODERN MANAGEMENT: DEMONSTRATION IN ORGANIZATIONS”. Business Strategies 2 (6): 5. doi:10.17747/2311-7184-2016-6-5.