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Auditing and Assurance

Student’s Name

Institutional Affiliation

Course Number and Name

Instructor’s Name

Date
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Corporate Report

To: Sadie, Audit Partner

From: [Your Name], Audit Junior

Date: [Date of Submission]

Subject: Audit Engagement with Good Films Limited

Dear Sadie,

I am writing to give you highlights of key issues and risks identified in the

preliminary assessment of Good Films Limited, a potential audit client for Milo & Co LLP.

This report provides an overview of risk-based investigation executed on the financial

statements, business and audit risks, and a critical assessment of the approaches – risk-based

and systems-based. The report comprises an analysis of financial ratios, an estimation of

business risks, assessment of audit risks, and a review of the risk-based method of auditing in

comparison to the system-oriented audit.

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Introduction

Good Films Limited, Jacob Sharpley's brainchild since 2013, unveils its global

streaming facility that gives film and TV series experience. The enterprise is present in over

70 countries a year after its inception, leading to various issues, including legal matters and

rough growth strategies. As a J-level auditor at Milo & Co., auditing their financial health, I

strive to critically assess their financial performance, business risks, and audit considerations.

In the scope of this report, my primary intention is to provide Sadie with practical

information she can use to make her decisions (Geier, 2021). I would assess the company's

financial situation, considering it ended on 31 December 2023.

1. Analytical Review

Key Issues/Risks

Financial Performance Analysis of Film Industry Group

A full-scale analysis of financial results for Good Films Limited for the year ended 31

December 2020 shows mainly some indicators that inform management about the level of

operational efficacy and financial health as well as the company's strategic standing.

Declining Profit Margins

The great disappearance of the gross and operating profit margins from 2022 to 2023

deserves all the attention in the world. The gross profit margin went from 32.7% at the

beginning to 20.7% by the end of the year, whereas the operating margin dropped from -4.3%

to -28.6% during the same period. This realization that the quantities have drastically

diminished implies the existing ineffectiveness and the pricing problem on the company's

part (Piepenburg, 2017).

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It tells that the drop in gross profit margin shows the increase in cost of goods sold

(COS) in the company compared to revenue, mainly from the high production or procurement

cost. Moreover, sizeable operating margin loss means that operating expenditures have

overtaken gross profits, and as a result, the company has been experiencing loss. This is

considering the overwhelming costs of overhead, inefficient resource distribution, and pricing

strategies that do not sufficiently guarantee income collection.

The consequences of a decrease in profit margins look like the overall picture. Not

only do they have an immediate effect on the company's earnings, but there are also questions

in the longer term: the sustainability and competitiveness of the organization. The process of

carving away the profit margins may thus impede the company's capacity to invest in

innovation and other offerings or even cope with a possible economic slump, which could

significantly endanger its future in achieving its goals.

High Debt-to-Equity Ratio

In addition, many analysts would mark the substantially increasing debt-to-equity

ratio as another key financial indicator, from 1.59 in 2022 to 2.93 in 2023. Such a

development constitutes a sign of financial stress and implies that Good Films Limited has

become critically dependent on borrowing to finance its operation and growth plans.

A shortage of equity due to a citizen's capital implies more credit-side financing than

equity-side financing. But alongside the positive role of debt as a tool for funding expansion

or short-term growth opportunities, increased debt relying on debt raising could lead to

creditors' doubts about the company's ability to meet their obligations, especially during

economic downturns and financial troubles.

The probably higher debt-to-equity ratios derive from different reasons: expansion

strategies, various types of investments (e.g., in new technologies or content – notably sports
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rights), or financial results not adequate to cover capital expenditures. To a greater or lesser

extent, all risks will cause a high leverage in the company's activities. Thus, it is essential to

consider the company's possible dangers to its financial stability and investment

attractiveness.

Improved Inventory and Receivables Turnover: While businesses may be confronted

with shrinking earnings and rising debt load problems, an upsurge in inventory and

receivables turnover offers some hope and boosts the industry's general confidence. The

inventory turnover ratio jumped from 7.83 in 2022 to 9.39 in 2023, while the receivables

turnover ratio increased from 8.75 to 17.02 for the same period.

This implies better management of working capital and the timing of spending, such

as converting inventory and receivables into cash. When a higher inventory turnover ratio of

the company is achieved, it implies its stock is sold faster. Ultimately, it lowers the holding

costs and minimizes the risk of being left with old or surplus stock. In addition, a higher

average accounts receivable turnover ratio means that the customers pay the credit not so late,

which helps the liquidity of the company and decreases the credit risk at the same time.

Nevertheless, what needs to be addressed is if such improvements are simply a result

of aggressive sales tactics, like offering discounts or comforting creditors, but the impact

benefits the short-term cash flows only. While temporarily ameliorating liquidity, these

strategies might not be sustainable in the longer term and may put customer loyalty and

producers' profitability at risk (Geier, 2021).

2. Business Risk Analysis

Taking Care of the Compliance, Financial, and Operational risk issues. Good Films

Limited deals with a panoptic of business risks with different dimensions spanning from
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compliance to financial and operational matters, each imposing a threat and putting the

company's economic well-being at risk (Bazley, 2019).

Compliance Risk

The running of the legal battle issued from the unlicensed streaming of a movie before

its release presents a substantial compliance risk for Good Films Limited. The disagreement

can further expose the company to possible legal liabilities like fines and damages but also

threaten the company's reputation and credibility within the industry and among the

subscribers. For instance, a drawn-out litigation process will take management away from the

actual core of the business activities and disrupt the operations and competitive initiatives.

While compliance risk may be more than immediate legal sanctions, it can affect the

company brand negatively and lead to customer loyalty loss. The negative reputation

surrounding the legal disputes can push potential subscribers to use alternative streaming

platforms, drastically affecting revenue growth and strategic market extension efforts

(Piepenburg, 2017). On the other hand, carrying out regulatory audit requirements due to

non-compliance failures could lead to being closely monitored and strict compliance

regulations that would increase administration costs and operational burdens.

Financial Risk

The growth strategy preferred by Good Films Limited involves aggressive strategies

that increase the possibility of financial risk, as the debt-to-equity ratio is high. Although part

of the exquisite strategy would allow the company to penetrate the market and counter the

revenue diversification risk, it will still incur uncertainties in the finances and capital

constraints. The fact that the company's debt financing engine has been supposed to perform

the function of its growth makes one worry about its ability to pay back the loans in the event

of an economic crisis or a wrong turn in the market.

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A high debt-to-equity ratio represents a somewhat weak position of a company in the

case of interest rate increases and credit market runs, and it does ultimately mean more

significant financial problems and cash flow constraints. Therefore, good Films Limited's

economic health may be negatively affected because high debt levels will not allow it to

develop an innovative strategy, acquire quality content, and invest in technology

infrastructures, making it weak on the market terms and stunted in the long run (Putri

Renalita Sutra Tanjung, 2020).

Operational Risk

Good Films Ltd.'s utilization of outdated accounting software, which is not designed

with efficiency in financial reporting in mind, helps to create operational risks to such an

extent that they move beyond simple inefficiencies. Old analog systems may not fit the up-to-

date needs and capacities of business risks, regulations, tax law, e-commerce, or

globalization, which leads to a higher chance for further losses, inaccuracies, and ambiguous

legality of the financial statements. In addition to all the limitations above, relying on legacy

software may limit the coolness of the company and the ability to tactfully make decisions in

case of uncertainties and goodwill issues.

Beyond the financial implications, the operational risk leads to other side effects on

business, such as service quality, customer dissatisfaction, and a lower subscription retention

rate. The inability to fully account for the information could lead to the invalidity of the data.

It may convert its uniformity and reliability, which, dreading the company's stakeholders,

negatively affects the trust in the organization's financial disclosures. Another operational

inefficiency can obstruct internal communications and cooperation, leading to further

complicated coordination issues and organic performance drops (M. Aboalganam et al.,

2024).
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3. Audit Risk Analysis

Risk assessment of the three categories: Autonomous Systems, Human Override

Systems, and Autonomy Triton Systems.

As the auditor for Good Films Limited at the end of the year 2023, I need to identify

and resolve all of the risks related to the financial statements to have high-quality reporting.

We have to deal with essential factors, control activities, detection and adequately provide

audits to counteract the risk of generating a wrong statement and also to assist in reaching

audit objectives in the correct account.

Inherent Risk

Instability grounds of the risk of Good Films Limited are undeniably high for several

reasons. Firstly, lawsuits arising from illegal online movie streaming before the scheduled

release create laws applicable to endorsers who make careless or untrue statements.

Uncertainty and risks of misstating financial statements are increased. Finally, the firm's

uncontrolled growth strategy, linked with its fragile economic condition and high debt-to-

equity ratio, involves dangers such as incorrect revenue recognition, correct valuation for

assets, and completion of the disclosures (Cazzari & Moreira, 2022).

Risk at the core of an enterprise has implications that go beyond a purely financial

aspect—it reaches further to the area of the company's reputation, as well as the trust of its

stakeholders and regulatory compliance. To fight for heightened inherent risk, these

procedural moves must be emphasized, which include input in enormous account balance

testing, management judgment, judgment assessment, and severe legal obligations detection

(Cazzari & Moreira, 2022).

Control Risk
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Good Films Ltd. faces an extra risk in control, mainly related to using outdated

software for its accounting processes and regarding the finance team that is unqualified

professionally. The exposure of dependency on legacy systems results in recording errors in

accuracy and breaches in controls used in inputting financial reports, hence ineffective

controls in running business and conforming to a set acceptable standard.

On the other hand, we do not know whether the finance team is appropriately

qualified; therefore, the questions of specialized knowledge and competence in currency and

portfolio management arise. Insufficient allocation of responsibilities, absence of supervision,

or inadequate tracing may cause a weakness of control in the place and, as a result, a

substantial risk of misrepresentations and the chance of material misstatements in the

financial statements. To manage the higher control risk, focus the audit plan on substantive

testing for financial transactions, evaluation of control design and operating effectiveness,

and consider more proactive or different audit procedures such as compensating controls

where deficiencies are revealed (Chaturvedi et al., 2022).

Detection Risk

As a result of the complexity of the issues and the risk of factual accuracy uncertainty,

the risk of recognition of revenue increases for Good Films Limited. The enterprise, being of

a mixed-income stream model, as opposed to carrying out set contracts and incentives, has

challenges as to the effectiveness of the completeness, accuracy, and timing of the revenue

recognition.

In addition to that, the proliferation of rapid business growth/faster-paced financial

instability may become a great incentive and driving force that managers use as motivation

for aggressive accounting practices and the manipulation of financial statements, which are

all ways that can mask risks of under-detected errors. To ensure effective mitigation of the
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possibility of detection, auditing must combine complex analytical procedures, substantive

testing of revenue forms and balances, and investigating all unusual and significant

accounting estimates and related party transactions (Adom et al., 2023).

Impact on Audit Approach

The complex intrinsic and chance aspects that make the audit process more prone to

errors compel examiners to do profound audit practice involving much scrutiny. Testing the

arithmetical accuracy of the significant account ledgers, evaluating the control structure for

effectiveness and sufficiency, and performing thorough substantive procedures are crucial to

justifying an opinion or hint of doubt.

It is necessary to develop complex analytics and exemplary approaches to audit to

ensure solid identification of material misstatements. By designing audit procedures that aim

at eliminating exact risks and focusing on areas of tremendously higher inherent and control

risks, auditors can improve the effectiveness of their auditing procedures. They can relieve

stakeholders about the integrity and reliability of Good Films Limited's financial statements

(Adom et al., 2023).

4. Risk-Based vs. Systems-Based Audit

Deciding between risk-based and system-based audits is contingent upon particular

factors, such as the nature of risks in the entity and the degree of assurance stakeholders wish

to possess. A risk-based audit strategy could be particularly beneficial for Good Films

Limited since the business stands to be exposed to complex and ever-evolving risk factors.

Risk-Based Audit

A risk-based audit approach targets assurance on the financial statement assertions by

examining the risks to audit significance, which can later be assessed according to the area's
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importance. Firstly, by targeting comprehensive procedures that are explicit of the associated

risks detected during the review, a professional auditor can systematically increase the value

of their audits. At the same time, the effectiveness of the same in offering stakeholder

assurance on financial reporting reliability gets enhanced (Žukauskaitė, 2021).

For Good Films Limited, considering its high reliance on risk factors concerning legal

risks arising from litigation, an aggressive growth strategy, and financial instability, a risk-

based audit approach is preferable. The present legal battle for improper recordings leads to

significant legal uncertainties and obligations that may result in additional liabilities. Auditors

might have to be specific and conclusive in their investigations to rule out possible material

misstatements effectively.

This is akin to the case in which the company's rapid expansion combined with the

elevated debt-to-equity ratio necessitates careful examination and analysis of revenue

recognition, asset valuation, disclosure, and reporting. The adoption of a risk-based audit

method enables auditors to design audit procedures following specific risks and ceilings

rather than accepting the one-size-fits-all approach, and consequently, increasing audit

efficiency and reliability of financial statements is achieved (Chaturvedi et al., 2022).

Risk-based audits direct audit teams to concentrate on the areas of audit risk of

tremendous significance and allocate audit resources accordingly. The performance of risk-

based audits would enable auditors to identify and respond to emerging risks in a timely

proactive manner, thus improving the audit process overall.

Systems-Based Audit

In contrast, a systems-based audit approach emphasizes evaluating internal control

systems and processes, focusing on assessing controls' design and operating effectiveness to

mitigate risks of material misstatements. While systems-based audits provide valuable

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insights into the adequacy and reliability of internal controls, they may not fully capture the

broader spectrum of risks organizations face, particularly in dynamic and evolving business

environments.

Implementing a systems-based auditing approach by Good Films Limited may help

assimilate critical aspects, such as adherence to the financial reporting process, with internal

control processes like revenue recognition, expenditure authorization, and asset control. But,

in the perspective of the risk complexities, which involve a variety of dimensions and may be

too much for a system of audits to handle, a systems-based audit may not be able to mitigate

all inherent risks and control risks (Žukauskaitė, 2021).

Conclusion

In conclusion, it is highly paramount that a strategic audit methodology is employed

as it helps identify a portfolio of issues ranging from legal problems to financial crises and

production inefficiency. The emergent Risk-Based Approach to Audit is the most efficient

coping mechanism for complicated matters. The company gets a better detection of higher

risk areas and adjustment of audit procedures accordingly. This way, it improves the audit's

quality and ensures minimal misstatements are found. This makes the stakeholders raise the

reliability and integrity of the company's financial reporting. In this way, the company not

only faces present challenges but also gets its foothold and is prepared for the success of

future streaming businesses.

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References

Adom, K., Hinson, R. E., Opare Mintah, E., & Obuobisa-Darko, T. (2023). Accounting and

financial statements. Business Administration, 172–200.

https://doi.org/10.4324/9781003458524-8

Bazley, S. (2019). Risk-based financial regulation and compliance officer liability. Financial

Compliance, 137–168. https://doi.org/10.1007/978-3-030-14511-8_6

Cazzari, R. B., & Moreira, G. R. (2022). Uncertainty of claims provisions from the analysis

of financial statements. Revista de Administração Contemporânea, 26(3).

https://doi.org/10.1590/1982-7849rac2022200400.en

Chaturvedi, M., Sharma, S., & Ahmed, G. (2022). Risks of data breaches and mitigating

controls in financial sector. Intelligent Computing Techniques for Smart Energy

Systems, 709–721. https://doi.org/10.1007/978-981-19-0252-9_64

Geier, G., 2021. Managing Profit and Growth.

M. Aboalganam, K., Alzghoul, A., & Alhanatleh, H. (2024). An analysis of service quality

and complaint handling in the Jordanian Healthcare sector: Implications for TQM and

customer retention. Innovative Marketing, 20(1), 51–65.

https://doi.org/10.21511/im.20(1).2024.05
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Piepenburg, C., 2017. Not Yet rated: self-regulation and censorship issues in the US Film

industry. UCLA Ent. L. Rev., 25, p.97.

Putri Renalita Sutra Tanjung. (2020). The effect of return on assets, free cash flow, and debt

to equity ratio on company value. EPRA International Journal of Multidisciplinary

Research (IJMR), 76–84. https://doi.org/10.36713/epra5329

Žukauskaitė, D., 2021. Assessment of the risk of material misstatement in an audit of

financial statements. In Whither our economies-2021: International scientific

conference: conference proceedings: This year, the conference WOE’20 is dedicated

to Strengthening Economic Resilience: Research, Practice, and Policy for successful

Post-Covid-19 Recovery. Vilnius: Mykolas Romeris University, 2021.

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Appendix

Comparison between 2023 and 2022 ratios.

Ratio Formula 2023 2022

Gross Profit GP/Revenue x (1,109,000/5,321,000) x (1,581,000 / 4,835,000)

Margin 100% 100% = 20.8% x 100% = 32.7%

Operating Profit (OP/Sales (-955,000 / 5,321,000) (-208,000 / 4,835,000)

Margin Revenue) x 100% x 100% = -28.7% x 100% = -4.3%

Current Ratio Current Assets / 2,442,300 / 2,087,800 1,663,800 / 1,685,300

Current Liabilities = 1.17 = 0.99

Debt-to-Equity Total Debt/ Total 3,650,100 / 1,960,500 3,799,200 / 3,017,700

Ratio Equity = 1.86 = 1.26

Inventory Cost of Goods £4,212,000/ {(£563,400 £3,254,000/

Turnover Sold / Average + £617,500) / 2} = 7.13 {(£617,500+ £563,400)

Inventory times / 2} = 5.51 times

Receivables Sales Revenue / £5,321,000/ {(£312,300 £4,835,000/

Turnover Average Accounts + £553,000) / 2} = {(£553,000+ £312,300)

Receivable £432,650 = 12.30 times / 2} = 11.17 times