Audit Procedure

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I. Title: Audit Procedures

II. Introduction

The AICPA Pre-certification Core Competency Framework provides detailed information

of the following project competencies:

Risk assessment, analysis and management: o Assess, analyze and manage risk using appropriate frameworks,

professional judgment and skepticism for effective business management. Measurement analysis and interpretation:

o Identify and apply appropriate, reliable and verifiable measurements to analyze data for a given purpose and intended use.

Reporting: o Identify the appropriate content and communicate clearly and objectively

to the intended audience the work performed and the results as governed by professional standards, required by law or dictated by the business environment.

Research: o Identify, access and apply relevant professional frameworks, standards

and guidance, as well as other information for analysis and to make informed decisions.

Process and research management: o Identify concepts and techniques for business planning, operations and

evaluation processes, as well as resource management, and consider how they are used in an organization.

Governance perspective: o Understand the legal and regulatory environments affecting an

organization and their effects on an organization’s operations, internal controls and enterprise risk management. Recognize an organization’s social and environmental responsibilities.

Professional behavior: o Practice in a manner that is consistent with the character and high

standards set by the AICPA and the accounting profession. Demonstrate a work ethic and respect for diversity, as well as a commitment to continuously acquire new personal and professional skills and knowledge.

Decision-making: o Objectively identify and critically assess issues and use professional

judgment to develop appropriate decision models, identify and analyze the costs and benefits of alternative courses of action and recommend optimal solutions.

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Communication: o Actively listen and effectively deliver information in multiple formats

tailored to the intended audience.

Scenario:

After working as a financial accountant for a number of years, you decide to apply for a

position you learned about from a virtual career fair offered by UMGC’s Career

Services. The most prestigious accounting firm in the District of Columbia, Gilbert,

Lombard, & Wolod 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: Your application for an

auditing position been approved by the Supervising Senor Auditor. Please contact our

Human Resources Department at 201-000-0000 to continue in the hiring process. We

look forward to having you on the Gilbert, Lombard, & Wolod 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 you with a good

opportunity 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’re very

familiar with Marco Appliances because your parents, who owned a retail appliance

store decades ago, purchased inventory from Marco Appliances.

The auditing team is led by the Supervising Senior Auditor who will be making

recommendations to the Manager of the engagement, structuring the parts of audit, and

presenting the results of a preliminary review to the Manager.

Marco has been audited in each of the last five years by a small, local CPA firm.

However, your firm has been engaged to do an audit for 2015.

Marco Appliances, Inc. (Marco) is a small firm with about 50 total employees including

corporate officers. It specializes in supplying a relatively small line of high-quality

household appliances to residential construction contractors in a large and growing

metropolitan area. Marco has a large list of customers, mostly custom builders of

single-family dwellings and some large builders of single and multiple family units.

Marco’s basic marketing strategy is to have inventory available at all times and to sell

this inventory at competitive prices. At the end of every quarter, the President, Drew

Black, reviews product costs and adjusts the authorized selling prices of products, as

necessary. He makes the selling price adjustments based on his assessment of what

his competitors will do with pricing and what is required to provide competitive profits to

the owners of Marco.

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Table 1: A summary of major personnel and their position in the company

Personnel Position

Harper Kim Secretary / Treasurer

Cooper Teal Bookkeeper

Dakota Amalia Controller

Drew Black President

Harley Magenta Major shareholder, Chairman of the Board

Stephen Violet Accountant

Montana Green Retired CPA and Board Member

Mr. Zen Marketing Manager

The global recession in 2008 affected the wholesale appliance industry, which has had

a slow economic recovery since, but is showing signs of recovery. Before the

recession, the industry's gross sales were growing at a real rate of about 7% per year,

with the usual wide variations from year to year due to fluctuations in the residential

housing starts. During the recession, Marco sales fell 15%. However, real growth rates

for the industry are starting to increase to about 3% in the current year. Marco

management expects future growth in the industry to be around the same level for the

next three to five years. Mr. Zen's market strategy does not seem to be very effective

because Marco sales have not grown as fast as the industry in recent years and fell

more than the industry during the recession.

Marco facilities are located in a single warehouse and office building adjacent 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 pickup all purchases in this location: thus, the company avoids maintenance

expenses on its own vehicles, which would be incurred if Marco delivered to its

customers. However, Marco has an arrangement with a trucking business next door to

deliver goods to some customers on FOB shipping point basis. Sales are final when

appliances leave the Marco loading dock for customer pickup orders and deliveries.

Marco is a privately held corporation incorporated in the same state in which its home

office is located. It operates in its home state and three surrounding states.

Stockholders include approximately 300 individuals and businesses. Currently, Marco

top management holds over 50% of the stock. The Board of Directors wants to expand

operations and is anticipating going 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 requesting loans

and, therefore, has had audits for each of the last five years from the same accounting

firm. Because Marco is small, their local bank insisted on adding restrictive covenants

to the firm's last loan agreement. These covenants include a provision that calls the

loan immediately and in full if Marco’s current and debt to equity ratios fall below

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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 bonus agreement for its employees, including top management. Management

negotiated the plan because employees have gone without raises for several years.

The agreement bases employee bonuses on unaudited net income for the past year

because of the need to adjust employees' salaries at the beginning of each year.

However, management will adjust future bonuses for any audit adjustments made after

the bonuses are set based on unaudited data. The firm sets a bonus pool based on five

percent of operating income, which limits the total available to pay bonuses.

Management bases individual bonuses on an employee's position, length of service,

and certain specific negotiated terms with individual officers.

Marco’s Board of Directors includes its current president, secretary/treasurer, and

controller. It also includes two shareholders, who each hold about a 5% interest in the

firm, and one retired CPA, Montana Green. While there is no audit committee, the

board as a whole takes an active role in hiring and monitoring the firm's outside auditor.

It also relies on the leadership of Mr. Washington to determine the scope of the audit

engagement. Mr. Washington was recruited to the Board last year because the prior

president and controller retired during the year and, therefore, the current president and

controller have been in their positions for less than one year. Management promoted

the new controller from within, but they recruited the new president from outside the

firm.

Marco selected a new auditor for this year's audit engagement because their previous

auditor had been with the company for five years. The Board felt it was time to get new

insights into their operations. In addition, they wanted to hire a larger auditing firm with

a more established reputation to support their anticipated IPO.

The Control Environment

Marco’s accountant, Stephen Violet, prepares financial statements and various financial

statistics for the officers to review monthly. The Board reviews similar statistics on a

quarterly basis at the regular Board meetings and questions the officers closely about

what is going on in the business. In addition, Mr. Zen personally follows sales figures

and gross profit margins.

Supervisors interview all perspective employees for positions they supervise. In

addition, at least one of the corporate officers also interviews each perspective

employee. Most of the key employees, including the officers, have been with Marco for

more than ten years. However, due to the high demand for accountants, Stephen Violet

and most of the accounting staff have been employed at Marco for less than 3 years.

While Marco checks references for any prospective employee, they do not check

criminal records or perform other forms of background checks.

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A computer network and personal computers support Marco accounting and inventory

management systems. Personal computers are located in the offices and warehouse

and a central server handles all accounting and inventory files. Printers are located in

areas where employees need printed documents and other records routinely. The

computer is used to control and process most transactions, to print documents, prepare

accounting records, and prepare periodic financial statements. Marco uses commercial

software recommended by their auditor. To date, they have had only the usual startup

problems. They have used it for two years and have upgraded it once.

Marco only issues accounts and passwords to employees with jobs requiring computer

data entry or access to file information and reports. Passwords are required to enter the

system. Access is limited such that employees only have access to the information they

need to perform their duties. Access is also limited in nature such that some employees

who do not have the authority to enter data have read-only access while those whose

jobs require data entry have both read and write access. Normal access to the files

takes place via the software, which subjects any input to various logical and numerical

tests. Most input is backed up by paper trails of source documents and other business

papers. In addition, the firm uses an Internet service to back up all files on the Internet.

Marco manually runs a backup at the end of each day. They have no other Internet

presence other than an informational Website that does not allow potential customers to

order merchandise.

Marco has a complete set of policies, procedures, and manuals that management

requires employees to use. Management is aggressive about updating the manuals

and training new employees to ensure they understand the policies and procedures that

affect their duties. Management also requires employees to attend brief review

seminars on the policies and procedures that affect their positions once a year. These

policies include a code of conduct and employees are required to sign a statement

agreeing to it when they are hired.

Sales and Collection Processing

Sales Requisitions

Marco uses the PC network to manage inventory, sales requisitions, and sales orders.

Salesclerks who can read the perpetual inventory records via their PCs take customer

orders. Most orders originate from phone requests, but a few arrive on a walk-in basis

and some occasionally come in the mail. Usually, building contractors or their

representatives call to get current price quotes and find out if specific appliances are in

stock. When goods are available and the price is satisfactory, a salesclerk originates a

sales requisition and the process of approving and filling it begins if customers plan to

pick up their order the same day. Orders received after 4:00 PM cannot be delivered

the same day; buyers are so informed. In addition, salesclerks can immediately inform

a caller about out-of-stock items and establish a back order for the customer. Back

orders are processed early each day, but before they are filled, the buyers are called

back to confirm that the orders are still valid.

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To originate a sales requisition, the sales clerk inputs the appropriate information into

his or her PC: customer number, the product(s) identification, and order quantity. The

computer system enters the customer's name and address, and the date of the

requisition automatically on all requisitions as originated. The computer keeps track of

all customer requisition and order information and prints a requisition form with today's

date on it for transmittal to the controller, Dakota Amalia.

Sales clerks cannot set up new customers in Marco’s computer system. If a new

customer calls to place an order, they are referred to Ms. Amalia, the controller, who is

the only person authorized to set up new customers in the system.

The computer updates the perpetual inventory records by flagging the items as on order

as soon as the sales clerk enters the requisition into the system to avoid over-

commitment of goods not available due to existing orders that are pending credit

approval. However, this is the only way that a sales clerk can alter the perpetual

inventory records (i.e., by initiating a sales requisition).

Order Approval

Every few minutes (immediately if things are slow), one of the salesclerks hand-carries

the pending requisitions to Dakota Amalia, the controller. The secretary presents them

to Ms. Amalia who approves them either immediately, based on first-hand knowledge of

the customer's credit record, or after reviewing the customer's account record on her

PC. Ms. Amalia initials the requisition to indicate approval of the sale and enters an

approval for the requisition in the accounting system.

When Ms. Amalia enters her approval code, the system creates and prints three copies

of a sales order form; assigns a sequential number to it; and moves the sales order

record in the computer to the open sales order file. Copies one and two of the sales

order are sent to the warehouse where they are held until they can be filled. The

approval copy of the requisition form is attached to copy three of the sales order and

forwarded to the bookkeeper, Cooper Teal. These forms are filed in the open sales

order (physical) file for later matching with each delivery advice.

The computer system notifies the sales clerk who originated the requisition when Ms.

Amalia approves or disapproves the requisition. If the customer has requested an

update on the order, the sales clerks call back the customer to let them know their

orders have been approved and that delivery to their driver has been authorized.

If Ms. Amalia disapproves the requisition, the computer system reverses the perpetual

inventory entry for the pending sale and removes the record from the temporary

customer order file. Sales clerks then call customers Ms. Amalia did not approve to

inform them of the situation. If they dispute the denial of credit, they are transferred to

Ms. Amalia’ telephone extension.

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Delivery

The sales order forms sent to the warehouse represent authorizations to deliver to the

contractors or their representatives. The warehouse supervisor assigns one warehouse

clerk to fill each order. This clerk typically retrieves each item with a forklift and brings it

to the loading dock area of the warehouse. If the receiving driver is already there, the

items are loaded directly, one at a time, until the order is complete. Otherwise, the

warehouse clerk gathers all of the items and wraps a length of plastic ribbon around the

ordered items to keep them separate from other orders. If the loading area becomes

congested, the clerk fills the orders only after drivers have arrived.

After the warehouse clerk fills an order, he enters the product quantities, product

number, date, and customer number into a warehouse PC. This triggers the printing of

a computer dated sequentially numbered four-copy delivery advice. The customer's

driver signs the delivery advice (all copies) to indicate receipt of the complete order and

receives the first two copies. Copy three goes into a warehouse file in numerical order.

Copy four, along with one copy of the sales order, is delivered to Mr. Cooper Teal. The

warehouse clerk's working copy of the sales order is usually discarded.

Billing

When Mr. Cooper Teal receives a delivery advice, he matches them with the open sales

orders and reviews them for agreement in products and quantities ordered and

delivered. If they match, Mr. Cooper Teal initials the delivery advice and enters the date

of delivery into the open sales order file on the PC. The computer automatically prices

the products, calculates product amounts, totals the invoice, and calculates the cash

discount, which is 2/10 net 30. The computer then prints a sequentially numbered, four-

part sales invoice and writes the specifics of the sale to a daily-computerized sales file.

The bookkeeper records the gross sales, not net. Copies one and two of the invoice

are mailed to the customer. Copy three is filed by the customer and copy four, along

with the delivery advice, sales order, and approved sales requisition, are filed by invoice

number.

In the afternoon, Mr. Cooper Teal uses the sales recording software to access the daily

sales record, the accounts receivable subsidiary ledger file, and the sales journal file.

Sales for the day are posted at their gross amounts to the individual customer's

subsidiary accounts receivable and to the sales journal file. The latter file is accessed

monthly by the software to summarize sales by product and to make monthly postings

to the general ledger. The subsidiary ledger is used to review customer credit

worthiness, to manage collections, and to determine write-offs.

Collections Management and Write-offs

The controller, Ms. Amalia, whose secretary runs the software to produce an aged

account receivable trial balance by customer, manages collections. A working trial

balance is generated at least once a week and more frequently if collections lag. Ms.

Amalia decides what to do about specific accounts. Menu-driven software permits the

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Secretary to look up individual customer accounts, to write off invoices or whole

accounts, and to generate customer statements for invoices past due by any specified

number of days. The software also permits the printing of pre-drafted letters to the

customers to accompany any of these actions. It is normal practice for Ms. Amalia to

consider write-offs only once at the end of the month. Marco’s general policy is to write

off any invoice exceeding six months from the time of sale. However, Ms. Amalia is

authorized to make all final write-off decisions. The bookkeeper credits the allowance

account if write-offs are subsequently collected. The accounts receivable subsidiary

ledger is reconciled to the general ledger monthly.

Once each month, another software routine is used to add interest to customers'

accounts equal to 1% of all invoices past due by 30 or more days. This routine also lists

the interest charges by invoice by account in an interest journal, summarizes

transactions for the month, and posts the total to the interest revenue and accounts

receivable accounts in the general ledger.

Sales Returns

If customers receive incorrect or damaged items, they typically call and indicate they

want to return the goods. One of the officers approves the return and notifies the

warehouse to accept the returned goods. When the customer returns the goods, a

warehouse clerk completes a receiving report. The warehouse retains one copy, the

customer's representative receives a copy, and the bookkeeper receives a copy. Mr.

Cooper Teal enters the data for the return and the original sale into his PC. The

computer records the return in an open credit memorandum file and prints a two-copy

credit memorandum. Mr. Cooper Teal sends the credit memorandum to the controller,

Ms. Amalia for approval; she then returns it to Mr. Cooper Teal. Upon receipt of the

signed credit memorandum, Mr. Cooper Teal enters Ms. Amalia initials into the credit

memorandum record on his PC. The computer then posts the credit to the customers'

accounts receivable and transfers the credit memorandum information to the sales

return file, from which the entries in the Sales Returns Journal are made by the

computer system monthly. Marco exchanges defective goods with the good's supplier

for undamaged goods or, if the supplier prefers, the damaged units are disposed of and

an allowance is received on the next purchase.

Cash Receipts

The receptionist opens the mail daily, restrictively endorses all checks received, and

routes the other mail to appropriate personnel. She separates the checks from the

remittance advice (copy two of Marco’s sales invoice) and sends the checks to the

Secretary-treasurer, Harper Kim, who prepares the bank deposit slip and takes the

deposit to the bank. The bank deposit form is a three-copy form. The first and second

copies go to the bank with the checks and Mr. Violet, the accountant, receives the third

copy.

The receptionist forwards the remittance advices to Mr. Violet, who first reviews them

for appropriateness of any discounts taken and enters them into a daily cash receipts

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file on his PC. After printing a listing of the remittance file and reconciling it to the

deposit slip copy provided by Ms. Kim, Mr. Violet runs software that posts the individual

receipts, to include the amount of any cash discounts, to the customers' accounts

receivable and the total to the cash receipts journal file. The day's remittance advices

are filed by customer number and the copy of the deposit slip is filed by date.

Purchases and Payments Processing

Merchandise Purchases

Each morning before the first sales orders are processed, the bookkeeper, Mr. Cooper

Teal, runs the software routine that combines (1) the current perpetual inventory

quantity, less items flagged as on order by customers, plus any inventory orders in

transit for each inventory item with (2) the reorder stock quantities for each item set by

Mr. Zen and the warehouse supervisor. When the current quantity of an item is below

the reorder level, telephone price quotes for the standard order quantity are sought from

various distributors. The computer prints a sequentially numbered, five-copy purchase

order form addressed to the supplier who quoted the lowest price.

The computer automatically adds the quantity ordered to the inventory-in-transit files.

The inventory-in-transit will be counted in the daily reorder calculation, until the goods

arrive and are included in inventory. Mr. Cooper Teal calls the supplier to place a

purchase order. Subsequently, he mails purchase order copies one and two to the

supplier. Copy three of the purchase order is filed in numerical order; copy four goes to

the warehouse, with quantities omitted, as authorization to receive goods; and copy five

goes to Mr. Violet who places it in an unmatched purchase order file. The following

table summarizes the distribution of purchase order copies:

PO Copy # Status

1 & 2 Mailed to the supplier

3 Filed in numerical order

4 Sent to the warehouse as authorization to receive goods

5 Sent to Mr. Violet who places it in an unmatched purchase order file

Receipt of Goods

All merchandise is purchased Free on Board (FOB) Marco’s railroad siding so MARCO

does not pay the incoming freight costs nor take title to the inventory until it arrives at

their railroad siding. When merchandise arrives, the appropriate purchase order is

identified by reference to the accompanying shipping documents. Warehouse

personnel count the shipment and inspect it for exterior evidence of damage (e.g.,

punctures in the cartons or crates). The warehouse only accepts clearly undamaged

goods. The warehouse clerk enters quantities received on copy four of the purchase

order and signs that copy to acknowledge receipt of the goods. Signed copies of

purchase orders are then forwarded to Mr. Violet as receiving advices.

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Vouching and Recording Payables for Merchandise

On receipt of signed receiving advice from the warehouse, Mr. Violet enters the

quantities received into the perpetual inventory file via a PC. As a byproduct, the

computer purges the purchase order from the inventory-in-transit file and produces a

message indicating any difference between the quantity ordered and the quantity

received. A copy of the purchase order is then attached to copy five in the numerical

unmatched purchase order file. It is matched with the vendor’s invoice when the latter

arrives.

When the receptionist opens the mail, she forwards any vendor invoices to Mr. Violet

who matches them with the unmatched purchase orders and receiving advices. If a

receiving advice is not on file for the invoice, he places it in an unmatched invoice file

pending receipt of goods. Mr. Violet attempts to match the open purchase orders and

unmatched invoices on a daily basis.

When Mr. Violet matches an invoice with the corresponding receiving advice, he

compares quantities and prices on the purchase order and receiving advice to the

vendor’s invoice and tests the arithmetic accuracy of the invoice. Mr. Violet initials the

invoice to indicate that this has been done and then keys the vendor, product quantity,

price, date of receipt of goods, and discount information into an open voucher file on the

computer. The terms are customarily 2/10 net 30. The information is automatically

added to the voucher register file and a sequentially numbered voucher is printed to

control subsequent disbursement and to serve as the control document for recording

the liability and purchase.

The computer software summarizes the voucher register file monthly and posts the

summary figures to the general ledger accounts. Other software produces a trial

balance of the open voucher file any time, either by date due or by vendor. The

vouchers (now with the vendor's invoice, receiving advices, and copy five of the

purchase orders attached) are held in a physical open voucher file in due-date order.

The discount date is used unless otherwise ordered by Ms. Kim.

Non-merchandise Purchases and Services Received

The purchases of supplies and other goods are handled in exactly the same way as

purchases of merchandise with two exceptions. First, Mr. Violet, using software that

prints the purchase order and adds the information to the open purchase order file,

originates purchase orders for such items as a new PC. Second, all such purchases

not involving capital assets are posted to expense accounts directly. No inventory

accounts are maintained for these items.

When the receptionist opens the mail, invoices for services, such as utilities, are sent to

Ms. Kim for approval. If she approves them, they become the equivalent of a purchase

order and receiving advice. Ms. Kim stamps her approval, signs, and forwards them to

Mr. Violet. Mr. Violet periodically (usually once a month) enters the data from such

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items, including appropriate payment date and terms, into the open voucher file. The

invoices and/or statements are attached to the vouchers that are printed by the software

program. These voucher packages are placed in the physical open voucher file and are

treated the same as the vouchers for purchases of merchandise.

Cash Disbursements

Each morning, Ms. Kim, the Secretary-treasurer, reviews Marco’s short-term cash

situation. This process is aided by software that summarizes the vouchers due on that

day. Ms. Kim compares the summarized amount due on that day to the available ready

cash and a float factor based on the average daily disbursements and the average

number of days it takes for checks to clear the bank. If the cash less float exceeds the

amount of vouchers due by at least the minimum cash balance set by Ms. Kim, she

authorizes the payment of all vouchers due on that day. Ms. Kim then transfers the

excess cash from Marco’s demand account to a money market account that earns

interest. If the difference is less than the minimum cash balance set by Ms. Kim and

there is cash available above the minimum balance required in the money market

account, Ms. Kim authorizes payment of the vouchers due that day and transfers funds

from the money market account to Marco’s demand account.

If sufficient funds are not available in the combined demand and money market

accounts, Ms. Kim considers borrowing from the bank on the prearranged line of credit.

If the line of credit is also inadequate, which is rare, Ms. Kim confers with Mr. Zen. Ms.

Kim and Mr. Zen generally meet at least once a month to plan for intermediate and

long-term financing needs.

After Ms. Kim authorizes the day's payments, the approved voucher packages are

forwarded to Ms. Amalia who compares the information to the supporting documents. If

the voucher data are accurate, Ms. Amalia initials the face of the voucher and enters an

authorization code via PC into the open voucher file. This triggers the printing of a pre-

numbered check and detachable remittance advice based on the data in the open

voucher file. The disbursement data are automatically transferred to the cash

disbursements journal file and purged from the open voucher file. Ms. Amalia signs the

checks and forwards them to Mr. Zen's Secretary.

Mr. Zen’s secretary cancels the voucher document packages, presents the checks to

Mr. Zen for counter signature, mails the checks to the vendors, and returns the

documents to Mr. Violet for filing in voucher number order.

Bank Reconciliations

Upon receipt of the bank statements each month, Ms. Kim reconciles the beginning and

ending balances and the receipts and disbursements to the book amounts. She

forwards the reconciliations to Mr. Zen for review. He then returns them to Ms. Kim for

filing.

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Inventory and Cost of Goods Sold

Marco maintains perpetual inventory records on each appliance. Each sale and

purchase transaction is entered in the subsidiary ledgers for the particular item sold or

purchased as described above. At the end of the month, a worksheet is prepared to

cost the ending inventory on a FIFO. Mr. Violet uses a software package to accomplish

the costing of ending inventory. The software is able to access both the perpetual

inventory ledger and the voucher register file. At the end of the costing routine, the

software produces the journal entry to recognize ending inventory and cost of goods

sold for the month and enters the latter in the appropriate general ledger accounts.

III. Steps to Completion

Step 1: Conduct Internet and library research.

Do an Internet and/or library search to determine the current state of the U.S.

economy and the household appliance industry. This will be the basis of your

summary of possible client audit and fraud risks that will be included in your

report below. You need at least three sources of information for the U.S.

economy and industry analysis; be sure to cite your sources in your report. You

can use the most recent two years for your internet search of the U.S. economy

and industry. The Marco financial statements are dated 20X1 and 20X2.

Complete your internet research using the end of last year and the end of the

previous year. For example, if this year is 2025, use 2024 and 2023 data.

Step 2: Create a client acceptance report.

Prepare a client acceptance report to the partner in charge of your engagement.

Use your own words to prepare a report to the partner. There is no standard way

to write a report and there is no template for a client acceptance report. Internal

reports such as a client acceptance report are proprietary and confidential –

information and data that would be included in a client acceptance report will vary

depending on the audit firm and the client involved. Your report will need to

contain lists of additional information the audit firm would need to gather before

the client acceptance decision is finalized.

The new firm name, which includes your last name, should be in a letterhead at

the top of your client acceptance report. Address the report to the partner in

For all deliverables, you must change the firm

name from Gilbert, Lombard, & Wolod to YOUR

LAST NAME, Gilbert, Lombard, & Wolod. For

example: Levin, Gilbert, Lombard, & Wolod.

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charge of the audit, which you can assume is your instructor. This isn't a

standard audit report, and you can format it as a memo to your supervisor that

contains the required information and sections discussed below.

Page 97 starts of your Auditing textbook material discusses the client acceptance

process. The client acceptance report is important because it aids in the process

of evaluating whether or not to accept a client. The report would probably be

written by an audit manager that will possibly be in charge of the potential audit

to the partner in charge of the potential audit. There are a number of points that

are on pages 97 through 100 that you should consider in your client acceptance

report.

Your client acceptance report should contain the following sections:

A summary of possible client audit and fraud risks that you develop from your

review of the publicly available information on the U.S. economy and the firm's

unaudited 20X1 (as stated, you can use the most recent years such as 20X1 and

20X2) financial statements as well as the limited industrial data provided in the

project. Use at least three sources of information; state your sources for the

economy and industry analysis. Cite your sources in your client acceptance

report.

A description of items you recommend the audit firm research concerning

Marco’s managers that would address their ethical character and qualifications to

run a firm like Marco along with a list of possible information sources. Include a

brief discussion of why you included each item by discussing how it would affect

audit and fraud risk. Include three sources of information where you would

expect to find this information. A source of information is somewhere you would

look to develop this information and can be internal information within the firm,

public source, or discussions with parties that might be familiar with Marco’s

management. Cite your sources.

A description of items you recommend the audit firm research concerning

Marco’s relationships with third parties to include customers, vendors, financial

institutions the work with, and legal counsel that would be relevant to assess

audit risk. Include possible sources of information for each – where you would

expect to find the information. Include a brief discussion why you included each

item by discussing how it would affect audit and fraud risk. Include three sources

of information (cite your sources).

A description of items you recommend the audit firm review internally to

determine the need for outside experts on the audit and whether the audit firm is

sufficiently independent of Marco. Just provide a general discussion of the

sources you would use here.

The grading for the report has a style component.

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Hints: The text provides limited information on where to look for client

acceptance information in its discussion of the process. However, the sources

are similar to the ones it discusses in covering inherent risk assessment. The

main difference between the two uses of the information is client confidentiality.

Once you have accepted the client, you have much greater access to

information. Before you have accepted the client, you will need the client's

permission to contact third parties or the third parties will risk legal liability for

violating Marco’s confidentiality. Thus, your report should consider getting the

client's permission where necessary. In addition, client acceptance decisions

involve different components of the risk model. When the risk of accepting this

client, you need to be clear on which component is at risk. For example, audit

risk issues involve risk to the auditor from such things as the risks of future

litigation that don't directly affect the risk of material misstatement. Inherent risks

involve features of the firm and its environment that will increase the risk of

material misstatement. You probably will not be able to find sources detailing a

client acceptance report; however, there are many sources of information about a

client engagement letter – you can search the internet for the information and

include the same type of information that you find for a client engagement letter

in your client acceptance report.

3. Draft engagement letter

Prepare a draft engagement letter for Marco.

The new firm name (that includes your last name) needs to be at the top of the

engagement letter as a letterhead. Fill in as much of the normal sections of the

letter as possible given the information you have gathered. The engagement will

only cover the financial statements and not any additional services. You can

search the internet for sources of information that would be included in a client

engagement letter. Include some of the information that you have included in

your client acceptance report.

Page 100 of your Auditing textbook material discusses the engagement letter.

The auditors prepare the engagement letter and sign it. They then present the

engagement letter to the auditee for the auditee's signature. Once signed, the

engagement letter represents a contract between the two parties.

The engagement letter is important because it is the contract between the auditor

and the auditee. You need to create a letterhead for the new firm name and

address your engagement letter to your potential client. You need lines at the

bottom of the engagement letter for partner signatures and client signatures.

You need dates for the signatures.

You can indicate the signatures and dates in a manner similar to the following:

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__________________________________

(Your law firm name)

By: _______________________________

(Your name)

__________________________________

(Client name) Date

__________________________________

(Client name) Date

Note: there are a number of points that are on pages 97 through 100 that you should

consider in your engagement letter.

Acceptance and Engagement Letters

(2 above) Your Client Acceptance Report - You report should be between two and three

single-spaced pages using 1" margins and 12-point font. You also don't need to include

more than three suggested sources for each section of the report. Name you file with

your name and " Marco Client," and then attach it to the Marco 1 Assignment in LEO

under Deliverable 1. The client acceptance report is a report written by an audit

manager to an audit manager – these people would work for the same firm.

(3 above) Your Draft Engagement Letter - Your engagement letter should be between

one and two single-spaced pages using 1" margins and 12-point font. Name your file

with your name and " Marco Engagement," and attach it to the Marco 1 Assignment in

LEO under Deliverable 1. An engagement letter is written by the partner of the audit

firm to the potential audit client – these people work for two separate firms.

Step 4. Inherent Risk and Materiality Reports

Part a - Perform the following deliverables and document them in the Marco Risk and

Materiality Memo Template Word document. You probably need to review the material

in your text and online sources to understand internal controls and how they relate to

inherent risk.

Preliminary Inherent Risk Assessment - Review the description of Marco Appliances,

Inc. and identify four entity-level inherent risks based on the information provided. I

have listed one potential inherent risk area as an example, and you need to add four

more to the list. Inherent risks can flow from client's business risks, the nature of its

governance structure, and its strategic plans. However, you need to be clear about how

your risks create an increased risk of material misstatement in the financial statements

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and not just how they might create risks of lower operating or business performance for

the firm.

Thus, for each inherent risk, describe the feature of the firm you believe affects inherent

risk and explain how and why. By "how," I mean whether it increases or decreases

inherent risk. Make sure your "how" addresses a specific risk to the accuracy of the

financial statements and whether audit effort should be increased or decreased for

specific accounts or related groups of accounts if possible.

Limit your inherent risk analysis to the following sections of the project:

Description of Firm and Market Conditions

The Control Environment (only identify issues related to inherent risk)

Part b. covers risks identified using analytical procedures based on the financial data.

You will be asked to identify transaction process risks associated with sales and

purchases in another Deliverable.

1. Preliminary Analytical Procedures - Review Marco Appliance's financial

statements, ratios, and industrial data presented at the end of this document.

Identify four accounts that you believe need additional audit scrutiny and explain

why. I have included one example - and you will need to add four more to the

list. Copies of Marco’s audited 20X1 and unaudited 20X2 financial statements

are included after these requirements. Some common ratios for Marco and their

industry are also included. You can search through your accounting material and

online sources for ratios that would be used in analytical procedures.

2. Preliminary Materiality Judgments- Set two preliminary materiality dollar

amounts for the Marco audit - one for the balance sheet and one for the income

statement. Document how you calculated your materiality amounts and explain

why you chose the approach you did. There are many sources of materiality level

judgments for audits in websites on the internet. You can select the approach

that you like – remember that you need to explain the approach that would be

best for Marco. Remember that the materiality level sets the level for

transactions that an auditor will look at; below that level the auditor may not look

at the transaction unless there is a high risk for that particular type of transaction.

Completed Marco Inherent Risk and Materiality Memo Template file containing

the results of your inherent risk assessments, preliminary analytical review, and

materiality level determination. The Marco Inherent Risk and Materiality Memo

Template is in Course Resources. Rename you file with your name and " Marco

2”, and then attach it to the Marco 2 Assignment in LEO under Deliverable 2.

(Continued on the next page)

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Marco Appliances, Inc.

Financial Ratios

(Amounts in U.S. Dollars)

20X2

Operating Performance

Overall Performance

Return on Assets 7.3% 7.5%

Return on Equity 11.4% 13.3%

Asset Turnover 2.4 2.4

Cash Conversion Cycle

Days cash in receivables 40.0 47.0

Days cash in inventories 52.0 70.6

Days needs 92.0 117.6

Days cash in payables and accrued liabilities 23.0 50.8

Net conversion cycle 69.0 66.8

Financial Position

Short-term

Current Ratio 3.19 2.23

Quick Ratio 1.79 1.10

Dividend payout 92.6%

Long-term

Total debt to equity 0.57 0.76

Long-term debt to equity 0.30 0.24

Effective Tax Rate 23.4% 26.5%

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Wholesale Heating and AC Industry

Comparative Balance Sheet Percentages

12/31/20X1 12/31/20X2

% of Assets % of Assets

Cash and Equivalents 5.00 4.50

Accounts Receivable (net) 35.00 37.00

Inventory 40.00 39.00

Other Current Assets 1.50 1.40

Total Current Assets 81.50 81.90

Fixed Assets (net) 17.50 17.00

Intangible Assets (net) 1.00 1.10

Other Non-Current Assets 18.50 18.10

Total Assets 100.00 100.00

Liabilities

Accounts Payable 28.50 30.50

Short-term Loan Payables 13.50 14.00

Income Taxes Payable 2.00 2.20

Other Current Liabilities 1.40 1.30

Total Current Liabilities 45.40 48.00

Long-term Debt 8.90 8.50

Net Worth 45.70 43.50

Total Liabilities and Net Worth 100.00 100.00

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Comparative Income Statement Percentages

Net Sales 100.00% 100.00%

Cost of Goods Sold 79.00% 79.50%

Gross Margin 21.00% 20.50%

Total Expenses 16.50% 17.00%

Income before Taxes 4.50% 3.50%

Asset Turnover 2.60 times 2.55 times

Return on Assets 6.20% 5.90%

Current Ratio 1.80 1.71

Quick Ratio 0.88 0.86

Total Debt to Equity 1.19 1.30

Long-term Debt to Equity 0.19 0.20

Final Submission:

Review the Marco project to evaluate their control environment strengths and

weaknesses. For each strength, provide a short description of the activity or feature

you believe is a strength and then explain how it strengthens their control environment.

For each weakness, provide a description of the activity or feature that you believe is a

control environment weakness, an explanation of how it weakens the control

environment, and a recommended improvement. Limit your answer to three major

strengths and three major weaknesses. I have provided one example of each in the

template file, and you need to add three more strengths and three more weaknesses to

the table in the template file.

Review their specific controls over sales and collections (i.e., based on the Sales and

Collection Processing section of the project) and purchases and payments (i.e., based

on the Purchasing and Payments Processing section of the project) to evaluate

transaction control weakness.

Describe the control weakness (a short statement of weakness):

Describe how the weakness could create a material error in the financial statements

including which general ledger accounts and audit objective might be affected (be clear

on which category is involved, balance, transaction, or presentation and disclosure) and

provide an explanation of how the weakness might lead to a violation of the audit

objective.

Make a recommendation on how their controls could be improved to mitigate this

weakness; and

Discuss some potential weaknesses in the control you suggest (e.g., how it might

be overridden).

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Limit your answers to the four most serious weaknesses you find in the sales and

collection processes and the four most serious weaknesses you find in the purchases

and payments processes. The template file has separate sections for each step in

these processes to help you structure your answer. The four weaknesses in each of the

processes can be spread in any way across the steps and you are not required to have

any minimum number in any step.

Your control weaknesses and recommendations need to be specific to the project and

sensitive to the size of the organization. The following are some examples of

recommendations that would not be appropriate for Marco:

They are too small and cannot afford to establish and internal audit department nor

contract out those services to an outside auditor.

They cannot afford to make significant changes to their current computer systems and

so recommendations to computerize their current manual operations are not practical.

However, all their information is currently stored electronically and so you may suggest

simple ways they could more effectively share or control that data.

The operations of their EDP environment are not completely described in the project.

Thus, your critique of their controls should be limited to those portions of their EDP

environment that are included in the project description.

Document your findings in the Marco Controls Template file. The Marco Controls

Template is in Course Resources. Rename your file with your name and " Marco Final

Submission," before attaching it to the Project 2 Assignment folder in LEO.

IV. Deliverables

The Final version of your project. Include all files used throughout the project.

V. Rubric:

You will find the rubric in LEO under Contents>Learning Resources>Projects &

Rubrics>Project 2 Rubric.

VI. Helpful hints:

Guidance to enhance your final deliverables:

As your professor, I eagerly look forward to reading your deliverables. It is

fine to quote sources to illustrate or support your own thoughts, however,

every graded assessment in graduate accounting courses will be based on

the content you have thought about and you have written in your own words.

To properly guide you, I need to read your thoughts and interpretations, which

demonstrate your comprehension of the learning goals and ability to perform

the competencies.

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You may submit draft versions in your Assignment folder to have Turnitin

generate a Similarity Score, which will help you determine if additional content

may need a citation.

Read the grading rubric before submitting your final version to ensure you

have met all of the requirements of this project.

Consider incorporating feedback you received from family and friends you

asked to read your deliverables and/or watch your presentation.

You may submit your draft documents to the writing tutors for helpful hints to

improve your final deliverable. You may access tutoring under Resources in

the top menu and then selecting Access Tutoring.

Review the Late Policy located in Learning Resources under Content.

Note: no assignments are accepted after the last day of class.

Submit all required files on or before the due date.