In prior years MKM placed reliance on internal controls based on satisfactory results of extensive tests of control. Recent discussions with the client have revealed no changes in the system of internal control since last year. The company does not have an internal audit function. In January 2021, research activities relating to a new knee replacement device commenced. Significant costs were incurred in relation to this research. In April 2022 a competitor announced that it had successfully developed and patented a similar device. In order to finance the research activities noted above the company borrowed from its bankers an additional $6 million during the year. The loan agreement contains a covenant to the effect that should the company's debt to equity ratio (measured as total liabilities: shareholders' equity) increase above 1.2:1.0 at any time, the bankers have the right to demand immediate repayment. Throughout the 2022 financial year, the property market has been in decline. The end of financial year audit is scheduled to start on 1 August 2022 and should take about two weeks to complete. The client completed a stock count on 30 June 2022. The directors require the signed audited final financial report by 28 August 2022. Your audit partner, Megan Mulia, has approached you and advised that there are several areas they are concerned about and wants you to report back to her about these areas before you complete your audit program. These areas and accounts are: Accounts receivable Current investments Property assets Intangible assets Research and development capitalisation Ratios extracted from an unaudited set of financial reports at 30 June 2022 together with audited comparatives for the year ended 30 June 2021 and 2020 are set out below for your review. 5.30 Ratio 2022 (Unaudited) 2021 (Audited) 2020 (Audited) Return on equity % 9.12 20.12 25.17 Return on total 15.70 16.20 assets % Gross margin % 32.96 29.00 25.20 Net profit margin % 11.20 21.20 16.95 Times interest 1.85 3.42 4.01 earned Days in inventory 157.23 125.20 113.20 Days in 83.25 59.25 51.25 accounts receivable Current ratio : 1 1.76 1.51 1.63 Quick asset ratio : 1 0.86 Debt to equity ratio: 1.12 0.75 0.81 1.02 1.06 1 Internal controls The financial controller at DB Limited has been refining the system of internal controls and informs you, at the planning stage of the current year's audit, that he has put together an internal control manual for the company. She has stated that this manual will create greater awareness of controls in the company, particularly with management which, in the past, has not been overly conscious of the need to implement and enforce effective internal controls. Management staff receive bonuses based on certain agreed-upon target ratios which include measures such as targeted monthly sales volumes, variance of actual to budget departmental overheads and profit before interest and tax. The major shareholder takes an active interest in the performance of the company and is quick to request explanations on variances from the agreed-upon monthly budgets. Two years ago, the company devoted significant time and resources to the development and implementation of a new IT system. All teething problems associated with the implementation phase have now been resolved, and the financial controller is satisfied that the automated controls in place are assisting in producing accurate and complete accounting records. The sales director also looks after the IT function as the position is not regarded by management as being a full-time job. Once application programs have been tested, strict password control exists over access to the programs. Passwords are not required for access to databases. To assist in the planning for the current year's audit engagement, you extracted the following information from a review of the systems notes in the permanent file and perusal of the new internal control manual: 1. manual delivery notes for dispatch of medical equipment to customers are raised by the dispatch department from the sales order form. Where a delivery is only partially filled, the delivery note is marked 'hold for invoice' and placed on the incomplete deliveries file. At month end, the supervisor of the dispatch department is responsible for follow-up of the reasons why incomplete deliveries have been outstanding for greater than 30 days. 2. returns of medical equipment by customers due to inferior quality, incorrect specifications or oversupply are received by the dispatch department where staff are required to check quantity and condition of the returned tiles. Details noted by the dispatch personnel, including the reason for the return, are recorded on a 'goods returned' note. Once completed, this document is passed on to the trade receivables