Audit Plan- GlaxoSmithKline (GSK) Key business and audit risk: In order to make the report more efficient we must identify the key areas of business risk and auditing risk. Business risk can be defined as the risk, which could affect an organization’s ability to achieve its objectives (Gray and Manson, 2007). Audit risk is defined as the risk that the auditor gives an inappropriate audit opinion when the financial statements are materially misstated (Soltani, 2007).
In Gray and Manson (2007)’s book Audit Risk can be split into three separate elements : 1- Inherent risk reflects the auditor’s opinion on the possibility of material misstatement on financial statement. 2- Control risk is the risk that internal control policies and procedures failed to detected or prevented. 3- Detection risk is defined as the likelihood that a material misstatement relating to an assertion will not be detected by the auditor’s substantive testing. One should identify key area of what ? ecause if an auditor looks at each issue to the same extent then resources are spread to thinly and failure to detect material misstatement is more likely. In producing an audit report one is providing an assurance that the financial statement provide a true and fair view on the performance and situation with the entity is facing. Therefore the key areas of business risk will be those that have the potential to have a material effect on the balance sheet or profit statement (Elliott&Elliott, 2008).
This has therefore lead to the conclusion that are as such as sales misstatement, valuation of goodwill, valuation of intangible assets and valuation of PPE being the key areas of potential business risk. Misstatement of assets The reasoning as to why goodwill and the valuation of intangible assets has been included is because GSK have proceeded with a number of takeovers of smaller entities, including the purchase of Stiefel Laboratories Inc (GSK’s annual report, 2009, p. 99).
This could have lead to an error being made in the new calculations for goodwill and intangible asset as both of these have increase considerably in the last period. The purchase of the entities could also lead to misstatement on the balance sheet due to likely differences in the accounting policies of the entities. This could lead to the overvaluation of the assets of the purchased entity or of the undervaluation liabilities that the entity balance sheets (Grant&Visconti, 2006).
There is an inherent business risk in purchasing another entity in that despite being in the same field as the GSK they have their own specialist areas and therefore by purchasing these entities GSK is increasing its specific risk of this area in the industry. Therefore one has to make sure that project growth and turnover from these subsidiary entities is not overstated as this could provide a significant risk of material misstatement in the financial reports.
Also the handling of R&D cost and the future economic benefits which they could bring is an important issue to be reconciled when the entities are purchased. This is a key area for pharmaceutical companies as a misrepresentation of future economic benefits generated could lead to a scandal such as shells misrepresentation of future oil production. Misstatement in Sales It is important to verify sales as it is the main source of income for the entity the sales and has surprisingly doubled its rate of growth on the previous period to 16% and total sales of ? 8,368m. ( GSK’s annual report, 2009, p. 9). Therefore one must verify that this increase in growth has occurred and has not been manufactured in order to enhance the perceived growth of the firm. Particular attention should be taken to that of emerging markets and in particular, the respiratory products which noted a 79% increase for Japan and 21% overall from the emerging markets, this is despite a 13% decline in the USA and only a 9% increase in Europe. (GSK’s annual report, 2009, p. 0) Regarding to Lev (2003) articles, the risk of misstatement of sales can be broken down into three key factors. Firstly, misstatement via the means of non-existent sales or sales which have been realised in the incorrect period. Secondly sales may not be recorded in order to lower sales so provide evidence in further periods of higher growth than is actually correct. Thirdly sales could be incorrectly entered into the system providing incorrect figures. Therefore one would need to verify the sales books, and the controls in place to prevent errors either intentional or unintentional.
Debts The level of debt that a company holds and their ability to repay this debt is an important risk factor for GSK. There is a higher risk for GSK than for some of its competitors, as GSK has a higher leverage than the likes of Pfizer and J&J (Financial Times, 2010). However this in itself can in some cases be more efficient as long as the entity has the cash flow in order to repay these debts. Therefore one has to ensure during the audit that GSK will have sufficient cash flows to meet its repayments for the year.
Cash management Sufficient liquid cash in a company is important to defend against economic uncertainty. A small cash reserve/ cash flow, can be a control and detection risk, which may result profitable projects having to be scrapped or assets sold to increase cash flow Also one has to ensure that the book values for GSK’s debtor and creditors are correct and verified as they make up large sections of the balance sheet and a misstatement of these values would likely have a material effect on the valuation of the entity.
Also one would have to ensure that there are no clauses on the interest payments linked to the leverage that the entity has, as if there were then if the companies leverage was close to this value then one would have to take into account for potential fall in assets causing the interest payment to be increased and therefore effect the entities ability to meet its repayments. Lawsuits As a pharmaceutical company there is a risk of potential side effects of drugs, and the effect on patients treated with the drug.
A successful lawsuit could result in losses for the company in damages, but also from potential product recall reducing sales. This could also have a derogatory effect on intangible assets due to a fall in the perceived trustworthiness of the firm/brand (GSK’s annual report, 2009, p. 169). Example: The most significant of such a lawsuits would be Avandia dropped due to problems in production resulting in patients suffering side-effects, and product being dropped and a lawsuit payout of $750m excluding additional legal costs (Andrew J, 2010).
This example shows the extent of the risk, as it is very difficult to estimate the payouts and effects of these damages lawsuits GSK doesn’t create a provision. However one would have to assess the potential risk of outstanding lawsuits and decide if it is showing a fair value of the firm not to include some form of provision for potential losses from lawsuits Lawsuits may also result from international law, which may stem from the weakness of intellectual property protection (GSK’s annual report, 2009, p. 43) in other countries.
Competition from reengineered products from may create a sizable loss in sales and lowering of barriers of entry into the market. This is a very important issue as patents are what provide the company with the protection required for them to make back the losses they sustain in the research and development. Risk from economy factors There is risk, which affects the entity, which is outside their control, such as the potential risk from the economic downturn. This is due to the fact that governments round the world have had to start austerity measures which for many also include cuts to their healthcare systems.
This will most likely mean that they will purchase less medication and cut some of the more costly drug thus reducing GSK’s sales. If this was on a wide enough basis then this could cause GSK’s sales to be significantly reduced and even cause GSK to produce a loss, and have to sell assets in order to pay off debt. The recession also brings to light the potential risk of foreign currency exchanges, in order to boost their economies leaders may employ an economic strategy aimed at reducing their currencies value.
This could mean that despite recording profits in some regions when it is exchange back into sterling then it may produce a loss for the company. This is a very real risk as there has been criticism of china and the USA deploying such tactics and fears that it might lead to a currency price war, which could be hugely detrimental to GSK’s operation in these regions. Patrick’s last PART !!! – or move it to the last part !! GSK is implementing a major restructuring package including an ERPS (GSK’s annual report, 2009, pp. 10-111). Such restructuring causes a large cost to the firm with no assurance that it will actually work. Such restructuring can also lead to employees to resist the change and as such cause employee morale to fall, causing inefficiency. Such restructuring can also lead to the potential for creative accounting as the company will not wish for such a restructuring to be inefficient so therefore may overstate cost before the restructuring so that there can be a perceived increases in efficiency.
Also the large cost of the restructuring could be potentially underestimated or hidden in order to make the project, seem more cost effective and affirm the decision to go ahead with the project. Materiality Materiality can be defined as information that could affect the user’s decision on the basis of financial statement by its omission or misstatement and provides the threshold in order for auditors to make a right decision on the item in financial statement. (Gray and Manson, 2007, p. 410). There is a firm relationship between materiality and audit risk.
Therefore, it should be considered when planning the timing and nature of audit procedures. Auditors plan to audit the financial statements to provide reasonable assurance that they are free from materiality (APB). On the other hand, internal accountants try to use different techniques to smoothen the company’s profits and costs, and it is because of this materiality detection should be backed by understanding the clients business, its cycle factors, the characteristic of its products, and its, and its reputation to apply professional judgment on the materiality level. Gray and Manson, 2007) Materiality is split into two categories when professionally judged. Firstly, qualitative materiality: which concerns with issues such as whether a certain item should be disclosed by law acts or professional regulations, misleading wordings of policies disclosed, and incorrect classification of items in financial statements. Secondly, quantitative materiality: it is a numerical analysis of comparing the financial statements elements using different methodologies that results in spotting a significant inaccuracy in the elements valuations to the extent of reasonably effecting the decision making of its users.
In relation to quantitative materiality, ISA section 320 states that an auditor must consider materiality ‘at both the overall financial statement level and in relation to individual account balances, classes of transactions, and disclosures’. Furthermore, according to CPA journal (2000) the materiality level should be set based on the size of the entity. For instance, if the size of the entity is less than ? 20000, the materiality level should be set between 2% to 5%.
If there is misstatement or omission on the sale, the general materiality level suggested being set under the following rules: Materiality level (%)Account balance size ($) 2% to 5%Less than ? 20000 1% to 2%? 20000-? 1 million 0. 5% to 1%? 1 million-? 100 million 0. 5%More than ? 100 million In GSK’s financial statement, the turnover figure, which is ? 28,368 million in 2009, constitutes the largest percentage of total revenue, so the auditors should set low materiality level, which is 0. 5%. It also means there is potentially an inherent and control risk.
Moreover, the percentage also can be influenced by the rule of thumb which means that the auditors use their past experience on quantitative approach in order to give an appropriate materiality level and also by other individual factors such as total assets, gross profit, etc. Another factor affecting the materiality level is the key item in the financial statements. For instance, inventory constitutes approximately 40% of GSK’s net assets (? 4,064m out of ? 10,742m). It means that the auditors will put more attention on setting materiality level on inventory.
As a result, the auditors might set from 0. 5% to 1% low materiality level for the inventory. GSKs decline in sales growth rate of a particular medicine could be expected under normal market conditions if its patent expired. However, taking into account the giant brand reputation of this firm among its clients, its less likely that the decline or increase in figures will be substantial under normal circumstances of a particular product for instance. Paxil, for example, is an anti-depressant pills, a leading among the nervous system medicine rang which weights around 20% of sales in its category.
Its patient expired on 2007, and its sales growth dropped by 7% year later and slight increase in 2009 by 2%, but dropped by 42% in 2005. However, the 2004 and 2010 publicized lawsuits and legal costs associated with the addiction problems of Paxil, should partially justify the significant reduction of its profits in 2010. However, in the 2005 financial reporting is not mentioned that the 42% significant decline is only related to competition in 2004 without mentioning the expected effects of major lawsuits. This could, as well, be classified a type of qualitative materiality and should be prevented in 2010 financial report.
Therefore, low materiality level is suggested to be 30% on reduction in Paxils sales for 2010. (GSK’s annual report, 2009). Audit evidence Audit evidence is defined as the appropriateness and sufficiency of information obtained for review of a firm’s financial transactions, internal control practices, and other factors that are required for ‘drawing reasonable conclusion on which to base the audit opinion’. (SAS 400. 1) (FRC, 2005) According to ISA 500, sufficiency is a measure of quantity of audit evidence where higher quantity of audit evidence is required for firms with greater risk of misstatement. Sufficient’ means that in order to achieve the audit goals, enough evidence has to be acquired. Next, ‘appropriate’ contains 2 elements of evidence, which are relevant and reliable. Figure 1: Audit evidence supporting reasonable conclusions. (Gray & Lain, 2008, p 223) For public companies, the external auditors’ opinions both on financial statements and on internal controls are required. These opinions are significantly affected by the sufficiency and appropriateness of evidence gathered during the audit process.
When the firm has solid internal controls the auditors increase the materiality level, which reduces substantive testing. This puts less pressure on external auditors to find more sufficient and appropriate audit evidence (corroborative audit evidence) to justify the reduction in substantive testing and ultimately context their opinion (ISA 500) Examining the nature of audit evidence and its reliability will be through the following audit evidence gathering procedures: 1. Physical examination of tangible assets. Examining the tangible assets (of key medicines inventory like Paxil) and other assets like PPE.
The examination should be by the auditor physically (count by hand) or a specialist agent assigned by the auditing firm record them on electronic or paper format. (Porter, Simon and Hatherly, 2008, p258) However this process does only verify the existence of the asset and not its inherent value or ownership. Therefore it just covers all physical assets but not intangible assets such as goodwill, reputation and especially patent of medicine, which plays an essential role in GSK. 2. External Confirmation. Is a direct response from the third party to the auditors onfirming about specific transaction with GSK. Original receipts confirmation of electronic, paper or other form of format should always be sought. The auditor’s information with its source such as bank statement received from banks. But the information gained from third party maybe not reliable if the source is not well informed. (Porter, Simon and Hatherly, 2008, p 258) 3. Documentation (internal and external). ISA 230 states that ‘the auditor should document matters which are important in providing audit evidence to support the auditor’s opinion and evidence.
When auditing GSK Company, audit evidence should be more reliable if it is in documentary format such as original paper or secured electronic version. This is because during the auditing, the auditors will receive several kind of oral evidence from GSK, which must be backed up by reliable and relevant documents (Gray. I,and Manson. s, 2007). For instance, if the chairman of R&D, Moncef Slaoui, stated that there are no patent’s issues affecting the firm other than those you are informed.
However this oral statement is not really reliable if it is not backed up by the documents obtained from third party (we assumed that all patent documents will be issued by independent third party and auditors can access them). There are many other types of documentations that auditors should rely on after investigating their relevancy and sufficiency such as: (Graham W. Cosserat, Neil Rodda, 2009) 4. Inquiries: Seeking financial and non-financial information from relevant people from and outside the firm (GSK). The inquiries may be formally written or informal oral to the auditor.
For example, the auditor would like to enquire more about evaluating the developments costs as assets of recently problematic medicines like Paxil and Avandia, which where generating large proportion of profits from in its category. These enquiries may need to take some views from the key R&D employees, formal confirmation from the outlet retails managers where the medicines are sold through, and related and original legal documentations taking into account the timings. However, this process is argued to be the least reliable because of the potentially biased misleading statements.
Therefore, a confirmation from independent personal is required. (Porter, Simon, and Hatherly, 2008) 5. Reperformance: it means the independency of the auditor in performing and ensuring the adequacy of internal controls. For example, the external auditor will try to check the security of the accounting system in GSK by himself through dummy transactions/changes. For example, verifying the inability of key organization members to manipulate medicine valuations without being detected either by automated processes or independent employees.
Triggering such frauds/errors is an evidence of the robustness of this particular transaction only. (Porter, Simon, and Hatherly, 2008) 6. Observation: monitoring personnel performing control activities, confirmation of asset sales, or counting inventory for example. However, the evidence from this procedure cannot be confirmed alone because the task could be performed differently while it is observed. Evidence from this procedure should reflect the normal cycle of these activities when performed in terms of timings and workload. Therefore, evidence from other procedures should back these evidences as well. Porter, Simon, and Hatherly, 2008) The above procedures along with assurance from management are critical. However, this assurance alone does not provide sufficient evidence and must be well backed by the previous procedures to confirm the assurance. Also, obtaining large quantities of audit evidence may not help reducing its poor quality. However, differences in evidence nature from the procedures and how they are sourced are key factors to determining their quality. Auditors’s objectives generally include considering future events such as the outcome of potential legal claims .
For example, in the case of GSK, they had an obligation to pay $750 million to settle criminal and civil complaints of selling bad products. This should be an important factor for auditors to consider and evaluate the implication of the firms’ future events. While evidence about the future is usually not easy to obtain, and also associates with doubt, there are ways that can make the future less unclear. Generally, the auditors’ view of future events is often related to their judgment of the reliability of management, which can be proved by the ability of forecasting and controlling the future of the management in the past.
Locations and timing As GSK is a multinational firm it has a number of premises across the globe. It has its main Pharmaceutical operations headquarters in Brentford, UK. It has major R&D sites in the UK, Croatia, France, US, Canada and Belgium, however also has smaller R&D centre’s in India and china (GSK’s annual report, 2009), and it has major manufacturing sites for prescription drugs at several sites in the United Kingdom, France United States; Puerto Rico; Singapore; Ireland;, Poland; , Italy; Romania; Australia.
As well as major manufacturing sites in United Kingdom, Ireland, USA and Kenya, which manufacture OTC products. In total GSK has a presence in over 120 countries across the globe, this therefore makes the logistics of auditing such a company a huge task. Therefore one must ensure that the audit staff required can be mobilized to such locations safely, one must therefore decide based on current location of audit staff how best to spread their resources. Also in the distribution of auditing staff to different area one must also consider whether the appropriate staff are being sent to perform the task.
For example is there an appropriately senior member of staff within the auditing team to perform the task with which they have been set? This is important in order for the auditing to liaise with GSK staff successfully and ensure that the site visits is satisfactory for both parties. The timing of the audit is also important, as one has to consider a number of key event that are required to be performed in order for audit report completed and signed by the set due date. In order to ensure that these dates are kept one has to consider how long each task is likely to take.
Thus base decisions such as the date of the main audit around this timeframe. Other issues such as the date of stock is an important issue as in order to check that the stock given in the statements is valid one should perform the majority of these checks at the end of the year. However it is possible that some of these checks could be performed prior to the end of the year and then reconciled with the companies records, however in these case one must insure that the system in place has been appropriately tested in order to rely on its outputs.
In GSK, the consolidated financial statements are prepared in accordance with the IFRS as adopted by the European Union and also as issued by the International Accounting Standards Board. ( GSK’s annual report, 2009, p91). One also needs to consider the treatment of their accounts in relation to the territories in which they operate i. e. technical advice may be required as to the treatment of GSK’s US operations and whether SOX’s has any jurisdiction and whether it requires certain account treatment, which one would not find in other audits.
The auditing team may also require technical advice with other such clashes in accounting treatment requirements in different territories. As a assessment of the technical advice to the accounting standards applied to GSK, one will have to assess whether one needs additional advice in the following areas, group reorganizations, financing structure and accounting for pension costs. Technical advice may also be required in other areas of the audit, for example with the acquisition of Stiefel Laboratories Inc. hese acquisitions may require the auditing teams to require advice/ clarification on certain issues from specialists within Mergers & Acquisitions. Also as pensions are a very complex issue one may require technical advice on certain aspects of the standards. One will also require expert advice from third party scientists to confirm valuation issues of patents. As well as provide technical advice on the suitability of the control in place in the production of the drugs.
It is also likely that one would require their technical input along with a professional legal opinion as to whether a outstanding lawsuit could be deemed as likely to occur or whether and potential cost which might be involved. One is also likely to need professional IT advice, with dealing with GSK’s computer systems, and whether it would be appropriate for the use of computer assisted auditing software
Reference Andrew J. (2010) GSK finalizes $750m payment over failures downloaded from http://www. ft. com/cms/s/0/8b1213a6-e168-11df-90b7-00144feabdc0. html#axzz16ttIR1u8 as at 25th Nov 2010. Elliott.