Macro Appliances Inherent Risk Assessment Case Study

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Accurate Auditing, Inc.78243 BrownsvilleTX 987-210-1892Date: May 2, 2019To: Arely Davies, Partner in ChargeFrom: Peter Rogers, Senior Staff AuditorSubject: Client Acceptance ReportOn May 4, 2019, Mr. Davies, the partner in charge, requested my team to carry out a preliminary evaluation of Macro Appliances, Inc. The assessment should be conducted on inherent risks and control design of the company in order to determine its financial health and provide an opinion regarding Macro’s financial statements. In response to the request, my team has carried out assessments on Macro and obtained some of its financial reports that are critical in the preliminary feasibility assessment.Macro Appliances Inc. is a small company that supplies a small line of high-quality household appliances to its customers. With a workforce of 50 total employees including corporate officials, the company provides high-quality household appliances to residential contractors. Prior to the 2008 global financial recession, the wholesale appliance industry experienced gross sales at a rate of 7% annually. However, this industry was significantly affected by the recession, which resulted in decline in sales. During this period, Macro’s sales declined by 15%. However, the wholesale appliance industry experienced a slow economic recovery after the recession as reflected in the annual increase in the real growth rates by approximately 3%.The appliances industry accounted for 27.8% of revenue share in 2016 with an estimated growth rate of approximately 5.4% between 2018 and 2025 (Bhandalkar & Das par, 1). During this period, this industry was valued at $43.34 billion (Grand View Research par, 1). In 2018, the household appliance industry grew by 4.5% (Wolf par, 2). Most of the items in this industry experienced an increase in sales by between 3.5% and 7.8%.As real growth rates for the industry have started to increase by about 3%, Macro has started to recover and capitalize on the market to expands its operations and profitability. Macro’s opportunity for growth is also attributable to the changing lifestyle of consumers and the booming housing market. These trends are expected to enhance the growth of the company, which deals directly with contractors. Therefore, the development of more houses due to the booming housing market implies that the future of Macro Appliances, Inc. looks bright.Conducting this preliminary analysis entailed obtaining and examining the audited financial statements of Macro. My team obtained unaudited financial statements for the year ended December 2018 and 2019. These financial statements were critically studied in order to identify accounts that could have significant impacts on its financial health. The scrutiny of these financial statements revealed the followings:· During the period between 2018 and 2019 financial year, Macro’s sales increased by approximately 20% and accounts receivable increased by 41.11%. Since the financial statements are unaudited, the growth in sales and account receivables could be brought about by some possibilities. It is possible that the firm’s sales and accounts receivables increased because of probable inflation or due to poor strategies in the collection of receivables.· Secondly, Macro reported a dramatic increase in its sales return from 2018 to 2019 i.e. by 52.50%. This dramatic in the firm’s sales return requires additional scrutiny to ensure it accurately reflects Macro’s financial status and health. Additionally, comprehensive scrutiny of this financial measure would help determine whether Macro is using an appropriate framework to estimate allowance for sales return.· Macro Appliances Inc. reported a 20.5% increase in its cost of goods sold during the same period. To account for the cost of goods sold, Macro utilizes FIFO method and the ending inventory. It is necessary to examine whether the company’s increase in cost of goods sold is attributable to decline in the price of materials or another factor in its operations.· The firm’s cash and cash equivalents as well as money market funds declined by 50.71% and 49.22% respectively from 2018 to 2019. This raises significant concerns given that the firm’s account receivables increased by 41.11% during the same period. It could be an indicator that Macro is selling its products to credit unworthy clients. This implies a need to examine Macro’s credit approval policy and whether its collection department is effective in its work or operations.· The other area of concern in the company’s financial operations and statements relates to accounts payable. The firm reported a 167.36% increase in its accounts payable and a 108.33% in current liabilities.The auditing process for Macro Appliances, Inc requires getting in touch with the previous auditor, which will require authorization by the company’s management. This will help obtain additional information about the qualifications, integrity, and ethics of the management. Obtaining such information is essential to understand the current internal control framework and structure of Macro. By obtaining such information, the team will ensure that Macro prepares its financial statements based on the current accounting regulations and principles.Apart from contacting the previous auditor, the team will also need to obtain internal evidence by having full access to relevant financial documents. Some of the relevant internal financial documents include receipts, checkbooks, sales orders, invoices, and purchase orders. External evidence from relevant government agencies, creditors, customers, and vendors will also be obtained and used in the auditing process. This will require management authorization and provision of the contacts of vendors, customers, creditors, investors, and previous auditors.My team will also examine the accuracy of Macro’s current accounting system to ascertain that it’s not the probable cause of inaccurate financial statements.Thank you!Accurate Auditing, Inc.Peter RogersMacro Appliances, Inc.May 3, 2019Dear Mr. Cheney,This letter confirms our understanding and acceptance of the terms and objectives of the engagement.We will review/audit the balance sheet of Macro Appliances Inc. as of December 31, 2019, and the related income statements and cash flow for the year. The main objective of our audit will be to express an opinion regarding Macro’s financial statements for the year ended December 2019. Therefore, we will provide our professional opinion regarding these financial statements based on this audit. We understand that the financial statements are the responsibility of Macro’s management team. To this extent, our responsibility as your auditor is to express a professional opinion regarding them based on our audit.Our audit will be carried out in accordance with the International Standards on Auditing and based on Statements on Standards for Accounting and Review Services stipulated by the American Institute of Certified Public Accountants. Additionally, we will audit the financial statements in accordance with generally accepted auditing standards. These standards require that we prepare and conduct the audit to obtain reasonable assurance that the financial statements are accurate and do not contain any material misstatements.Our audit will basically entail inquiry of the firm’s personnel and analytic procedures, which will require a client representation letter from you. As part of the audit, we will obtain internal and external financial documents. Some of the relevant internal financial documents for the audit include receipts, checkbooks, sales orders, invoices, and purchase orders. On the other hand, external financial documents include evidence from relevant government agencies, creditors, customers, and vendors. To obtain internal and external evidence, we will require management authorization and provision of the contacts of vendors, customers, creditors, investors, and previous auditors.The audit will also seek to examine the current internal control structure at the company. This will help to ascertain that the internal control structure is suitable and does not contribute to any material misstatement in the financial statements.

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We look forward to full cooperation with your staff and trust that they will provide the relevant documentation or information requested for the purpose of the audit. Billing for the audit will be done as the work progresses and depending on the time required by the assigned individuals to carry out their respective tasks.Unless it is amended, superseded, or terminated, this letter will be effective for future years.If this letter accurately expresses your understanding of the engagement, please sign the attached copy and return it to us.We are grateful for the opportunity to serve you and hope that this will be the beginning of a long and meaningful relationship.Sincerely,________________________Executive DirectorAccurate Auditing, Inc.Acknowledged on behalf ofMacro Appliances, Inc. by___________________________ Date: _____________________[Name][Title]Marco Appliances Inc.WP B.2.1Inherent Risk and Materiality MemoInitialsDatePreparedReviewedPreliminary Inherent Risk AssessmentManagement policy of maintaining large inventory to meet customer demand - The auditee maintains large inventories to facilitate sales. However, this increases the risk of obsolete inventory due to slow turnover. Assessing the value of obsolete inventory involves management judgment and increases the risk that inventory valuations will be overstated. Thus, I would recommend careful scrutiny of Southwest's inventory valuation allowance based on the lower of cost or market rule.Management policy that customers pickup all goods from the single warehouse – The requirement that customers pickup all goods from one location increases the risk of theft or fraud because of the potential collusion between the company’s staff and customers. By requiring customers to pick up all goods from the warehouse, this policy provides a loophole Macro’s employees to collude with customers to steal some of the goods. This would in turn create a material misstatement on the financial statements because the stolen goods would not be accurately recorded. Due to the increased risk of misstating inventory, some of the purchases would be damaged because of mishandling. Thus, I would recommend that the management needs to identify and designate a different location for customers to pick up their purchases in order to lessen the inherent risk.Approval of return of goods via a phone call – The current sales returns policy allows customers to return goods via a typical phone call if they receive incorrect or damaged goods. While this enhances convenience for customers, it increases the risk of material misstatement during documentation if the returned items are not scrutinized properly. The inherent risk in the practice is the likelihood of failure to check returned goods properly, which would contribute to material misstatement in the financial records. Therefore, I would recommend that returned items are examined first before being accepted. Moreover, auditors should be allowed to conduct further assessments on the returned goods.Changing authorized selling prices based on competitive evaluation – The authorized selling prices of goods are adjusted based on an assessment of competitors in order to increase Macro’s profitability. The inherent risk in this practice is potential understating or overstating Macro’s sales. Inaccurate recording of sales prices increases the risk of material misstatement of Macro’s balance sheet and income statement. Thus, I would recommend that auditors recommend the limits of price adjustments in order to minimize this inherent risk.Profit-sharing bonus agreement for Macro’s employees – Macro instituted a policy that allows bonus agreement for employees and the top management in order to increase sales and operating efficiency. The inherent risk in this practice is that auditors are unlikely to determine the accurate profits of the firm because profit-sharing bonus agreements are based on unaudited net profits. My recommendation is that the company should utilize audited net profits as the basis for profit-sharing agreement for its employees and the top management.Preliminary Analytical ProceduresDays Inventory Increase - Days inventory increased by 19 days in 2015. This is a fairly large one-year increase and increases the risk of obsolete inventory. We should give some additional attention to valuing the inventory under the lower of cost of market rule.Accounts Receivable Increase – Accounts receivable increased from $301,713 to $425,755 i.e. by 41.11% in 2019. This substantial one-year increase is fairly large and poses a risk to some of the company’s credit sales. In this case, some of Macro’s credit sales could have been turned to doubtful debts that are in turn written off. Additional scrutiny is required to help determine treatment of some of the credit sales.Cash and Cash Equivalents – Despite reporting an increase in financial activity between 2018 and 2019, the firm’s cash and cash equivalents declined by more than 50% i.e. from $20,045 to $10,876. According to Bryant, a business with an increase in cash and cash equivalents has higher liquidity, which implies that it is healthier and poses less risk (par, 1). Macro’s cash and cash equivalents require further audit scrutiny because the substantial decline poses significant liquidity risk and implies that it cannot meet its daily financial obligations.Days Cash in Payables and Accrued Liabilities – Macro posted an increase in days cash in payables and accrued liabilities from 23.0 in 2018 to 50.8 in 2019. This implies that there was an increase in the number of days the company paid its creditors. This financial ratio requires additional audit scrutiny because an increase in days of paying creditors implies that the firm is unable to meet its short-term financial obligations as agreed. This essentially poses a negative image of the company to its creditors.Sales Return Increase - Macro reported a 52.50% increase in sales return from 2018 to 2019. The substantial increase requires additional audit scrutiny to determine whether the firm is using an appropriate framework to estimate allowance for sales return. This would help determine whether the increase accurately reflects Macro’s financial status and health.Preliminary MaterialityBalance Sheet – The materiality amount for the items in the balance sheet was determined using the single rule, which involves applying a fixed percentage rate on a selected concrete financial indicator (Lakis & Masiulevicius, p.120). For Macro, the selected financial indicator is assets and the fixed percentage rate is 2%. This fixed percentage rate is suitable for the company since there are few individuals involved in the business, which enhances the risk of material misstatement of the financial statements. Therefore, 2% of the company’s total assets would be:Materiality = Percentage*Computation base (Vilsanoiu & Buzenche, p.939).=….....

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