le: Marco Appliances Inherent Risks and Control Design

After working as a financial accountant for several years, you decide to apply for a position you
learned about during a virtual career fair offered by UMGC’s Career Services. The most
prestigious accounting firm in the District of Columbia, Levin, Lombard, & Wolod, LLC, were
looking to hire several accountants and preferred UMGC graduates given the reputation of its
graduate accounting programs. Shortly after the virtual fair, you receive a certified letter in the
mail stating: “The Supervising Senior Auditor approved your application for an auditing position.
Please contact our Human Resources Department at 201-000-0000 to continue in the hiring
process. We look forward to having you on the Levin, Lombard, & Wolod, LLC team.”
Within a few months, the Supervising Senior Auditor (your professor) assigns you to a team
auditing Marco Appliances, Inc. The Supervising Senior Auditor calls to say “I’m assigning you
to this particular audit team because it will provide a good opportunity for you to demonstrate
your knowledge and skills on a portion of the audit process of a valued client, Marco Appliances,
Inc. a small appliance wholesaler.” You are familiar with Marco Appliances (Marco) because
your parents, who owned a retail appliance store decades ago, purchased inventory from
Marco. You recall the store’s address because it is the same as your birthday; 18 January
Lane in Annapolis, MD 21401. The Supervising Senior Auditor leads the audit teams and
makes recommendations, including structuring the parts of the audit and presenting the results
of a preliminary review to the Manager.
During the last five years, a small local CPA firm has been conducting the Marco Appliances
audit. Feeling a need for greater diversity, Marco Appliances selected your firm to conduct its
2015 audit. Marco is a small company with 50 employees including the corporate officers that
specializes in supplying a line of high-quality household appliances to residential construction
contractors in a large and growing metropolitan area. Marco has a list of customers, mostly
custom builders of single-family dwellings and some builders of single and multiple family units.
Marco’s basic marketing strategy is to ensure all inventory items are in stock and offered at
competitive prices. At the end of every quarter, Drew Black, Marco’s President, reviews product
costs and adjusts the authorized selling prices of products, as necessary. He makes the selling
price adjustments based on his assessment of how his competitors may change their pricing in
the coming year. Drew also considers his fiduciary duty to maximize shareholders’ wealth.
The 2008 global recession affected the wholesale appliance industry, which has had a slow
economic recovery but is showing signs of improvement. Before the recession, the industry’s
gross sales were growing at a real rate of approximately 7% per year, with the usual wide
variations from year to year due to fluctuations in the residential housing industry. During the
recession, Marco sales fell 15%. Fortunately, real growth rates for the industry are starting to
increase to around 3% in the current year. Marco management expects future growth in the
industry to be about the same level for the next three to five years. There is some concern that
the Marketing Manager’s marketing strategy is ineffective because Marco sales fell more than
the industry during the recession and have not grown as fast as the industry in recent years.
Marco facilities consist of a single warehouse and office building next to a railroad siding and a
major highway. Warehouse personnel simply unload rail deliveries with the forklifts and flat
trucks used to handle inventory inside the warehouse. Customers pick up all purchases at this
location; thus, the company avoids maintenance expenses on its vehicles, which would be
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incurred if Marco delivered to its customers. To further trim costs, Marco contracts with the
trucking business next door to deliver goods (FOB shipping) to some customers. All sales are
final when appliances leave the Marco loading dock.
Marco is a privately held corporation that was incorporated in the same state in which its home
office is located. It operates in its home state and three surrounding states. Shareholders
include approximately 300 individuals and businesses. Currently, Marco’s top management
owns over 50% of the outstanding stock. The Board of Directors voted to expand operations
and is planning to go public with an initial public offering (IPO) within the next year. Executing an
IPO will require the Board to disclose historical financial information.
Marco currently provides audited financial statements to banks when seeking loans and,
therefore, has incurred audits in each of the last five years by the same accounting firm.
Because Marco is a small company, their local bank insisted on adding restrictive covenants to
the firm’s last loan agreement. These covenants include a provision that allows the bank to call
the loan immediately and in full if Marco’s current and debt to equity ratios fall below specified
levels. The covenants also set limits on the dollar amount of dividends the firm can pay.
To help stimulate sales and operating efficiency, Marco recently instituted a profit-sharing b