Audit Planning Report: Macro Appliances Inc. Risk Assessment

Accurate Auditing, Inc.
Date: May 2, 2019
To: Partner in Charge
From: Senior Staff Auditor
Subject: Client Acceptance Report

On May 4, 2019, 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 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 growth at a rate of 7% annually. However, this industry was significantly affected by the recession, which resulted in a decline in sales. During this period, Macro's sales declined by 15%. The wholesale appliance industry subsequently experienced a slow economic recovery after the recession, as reflected in the annual increase in real growth rates of 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, the 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 items in this industry experienced an increase in sales of between 3.5% and 7.8%.

As real growth rates for the industry have started to increase by about 3%, Macro has begun to recover and capitalize on the market to expand 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. The development of more houses due to the booming housing market implies that the future of Macro Appliances, Inc. looks promising.

Conducting this preliminary analysis entailed obtaining and examining the audited financial statements of Macro. My team obtained unaudited financial statements for the years ended December 2018 and 2019. These financial statements were critically studied in order to identify accounts that could have significant impacts on the company's financial health. The scrutiny of these financial statements revealed the following:

During the period between the 2018 and 2019 financial years, 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 accounts receivable could be attributable to several possibilities. It is possible that the firm's sales and accounts receivable increased because of probable inflation or because of poor strategies in the collection of receivables.

Macro also reported a dramatic increase in its sales returns from 2018 to 2019 — specifically, a 52.50% increase. This dramatic rise in the firm's sales returns 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 returns.

Macro Appliances, Inc. reported a 20.5% increase in its cost of goods sold during the same period. To account for cost of goods sold, Macro utilizes the FIFO method and ending inventory. It is necessary to examine whether the company's increase in cost of goods sold is attributable to a decline in the price of materials or to 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 accounts receivable 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 operating effectively.

The other area of concern relates to accounts payable. The firm reported a 167.36% increase in its accounts payable and a 108.33% increase in current liabilities.

The auditing process for Macro Appliances, Inc. requires getting in touch with the previous auditor, which will require authorization from the company's management. This will help obtain additional information about the qualifications, integrity, and ethics of management. Obtaining such information is essential to understanding the current internal control framework and structure of Macro. It will also ensure that Macro prepares its financial statements in accordance with 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. 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 contact information for vendors, customers, creditors, investors, and previous auditors.

My team will also examine the accuracy of Macro's current accounting system to ascertain that it is not a probable cause of inaccurate financial statements.

Accurate Auditing, Inc.
Macro Appliances, Inc.
May 3, 2019

Dear Mr. Partner in Charge,

This letter confirms our understanding and acceptance of the terms and objectives of the engagement.

We will 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. We understand that the financial statements are the responsibility of Macro's management team. 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 plan and conduct the audit to obtain reasonable assurance that the financial statements are accurate and do not contain any material misstatements.

Our audit will essentially 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. Relevant internal financial documents include receipts, checkbooks, sales orders, invoices, and purchase orders. External financial documents include evidence from relevant government agencies, creditors, customers, and vendors. To obtain this evidence, we will require management authorization and provision of contacts for 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 ascertain that the internal control structure is suitable and does not contribute to any material misstatement in the financial statements.

We look forward to full cooperation with your staff and trust that they will provide the relevant documentation and 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 assigned individuals to carry out their respective tasks.

Unless amended, superseded, or terminated, this letter will remain 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 Director
Accurate Auditing, Inc.

Acknowledged on behalf of Macro Appliances, Inc. by:
___________________________ Date: _____________________

Marco Appliances, Inc. — WP B.2.1: Inherent Risk and Materiality Memo

Management 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. Careful scrutiny of Macro's inventory valuation allowance based on the lower-of-cost-or-market rule is recommended.

Management policy requiring customers to pick up all goods from the single warehouse. The requirement that customers pick up all goods from one location increases the risk of theft or fraud because of the potential for collusion between company staff and customers. This policy provides a loophole through which Macro's employees could collude with customers to steal goods, which would in turn create a material misstatement on the financial statements because the stolen goods would not be accurately recorded. Additionally, some purchases could be damaged because of mishandling. It is recommended that management identify and designate a different location for customers to pick up their purchases in order to lessen this inherent risk.

Approval of returns via a phone call. The current sales returns policy allows customers to return goods by 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 returned items are not properly scrutinized. The inherent risk is the likelihood of failure to check returned goods properly, which would contribute to material misstatement in the financial records. It is recommended that returned items be examined before acceptance and that auditors be permitted to conduct further assessments on returned goods.

Changing authorized selling prices based on competitive evaluation. Authorized selling prices are adjusted based on an assessment of competitors in order to increase Macro's profitability. The inherent risk in this practice is the potential for 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. It is recommended that auditors define the limits of price adjustments in order to minimize this inherent risk.

Profit-sharing bonus agreement for Macro's employees. Macro has instituted a policy allowing bonus agreements for employees and top management in order to increase sales and operating efficiency. The inherent risk is that auditors are unlikely to determine the firm's accurate profits because profit-sharing bonus agreements are based on unaudited net profits. The recommendation is that the company utilize audited net profits as the basis for its profit-sharing agreement.

Days Inventory Increase. Days inventory increased by 19 days. This is a fairly large one-year increase and raises the risk of obsolete inventory. Additional attention should be given to valuing inventory under the lower-of-cost-or-market rule.

Accounts Receivable Increase. Accounts receivable increased from $301,713 to $425,755 — a 41.11% increase in 2019. This substantial one-year increase poses a risk to some of the company's credit sales. Some of Macro's credit sales could have become doubtful debts and been written off. Additional scrutiny is required to help determine the treatment of some of these 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%, from $20,045 to $10,876. According to Bryant, a business with increasing cash and cash equivalents has higher liquidity, implying 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 suggests the company may be unable to 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 the number of days the company took to pay its creditors increased substantially. This financial ratio requires additional audit scrutiny because an increase in creditor payment days suggests the firm is unable to meet its short-term financial obligations as agreed, projecting a negative image to creditors.

Sales Return Increase. Macro reported a 52.50% increase in sales returns 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 returns and whether the increase accurately reflects Macro's financial status and health.

Balance Sheet. The materiality amount for items in the balance sheet was determined using the single rule, which involves applying a fixed percentage rate to a selected financial indicator (Lakis & Masiulevicius, p. 120). For Macro, the selected financial indicator is total assets and the fixed percentage rate is 2%. This rate is appropriate given the small number of individuals involved in the business, which heightens the risk of material misstatement.

Materiality = Percentage × Computation base (Vilsanoiu & Buzenche, p. 939).
= 2% × $1,380,934
= $27,619

Income Statement. The single rule is also used to determine materiality for the income statement. A 1% fixed percentage rate is applied to sales revenue, which is an important financial indicator in the income statement.

Materiality = Percentage × Computation base (Vilsanoiu & Buzenche, p. 939).
= 1% × $3,307,873
= $33,079

Marco Appliances, Inc. — WP C.1.: Evaluation of Control Environment

Distributed computer system with role-based access. Macro uses a distributed computer system that gives employees who need access to data the appropriate access. This improves the control environment because all employees work with one database, which reduces potential errors from multiple recording of data.

Password-protected computer system applications. Macro uses passwords to limit access to computer system applications. This ensures that only authorized personnel have access to the computer system, which in turn safeguards financial records and prevents unauthorized access.

Regular employee training. Macro's management carries out regular employee training to enhance standards of operations. This ensures that the firm's employees are competent and possess the necessary skills to perform their respective duties. Employee training also helps lessen the chances of unethical and fraudulent activities by enhancing compliance with established procedures and operational standards.

Back-up input of computer transactions using source documents and paper trails. This ensures that a redundant system exists and can be utilized in case of computer system failure. It also helps to minimize errors or manipulation and safeguards against misstatement.

Lack of ongoing monitoring of employee compliance. The company describes extensive use of policies and procedures and yearly retraining sessions, but does not mention any ongoing monitoring of employee behavior or use of compliance records in annual performance reviews. Having clear policies with excellent training is good, but a monitoring system is needed to ensure the emphasis and training are working. It is recommended that Macro implement annual reviews that include evaluation of how effectively employees are implementing firm policies and procedures.

No criminal or background checks in hiring. Macro's hiring process involves evaluating references but does not include criminal or background checks on potential employees. While references help provide information regarding a candidate, background checks are necessary to verify that information and to help the management avoid theft, fraud, or mismanagement by new hires. Macro should conduct extensive background and criminal checks when hiring.

Limited accounting staff experience. Macro's accounting staff have limited experience, which raises concerns regarding the accuracy and reliability of its financial statements. The lack of in-depth accounting knowledge increases the risk of misstatement of financial records. Macro should incorporate training on accounting processes and practices as part of its regular employee training program.

No documented computer system maintenance procedures. The company uses a computer system for its everyday operations but does not describe how this system is maintained or how system problems are resolved. Computer startup issues and other system problems remain a major challenge for Macro and increase the likelihood of loss of financial records. Regular system upgrades should be carried out to safeguard financial records.

Marco Appliances, Inc. — WP C.2.: Evaluation of Transaction Processing Control Design

Insufficient credit checks for new clients. The failure to conduct sufficient credit checks increases the likelihood of bad debts and loss of revenue. A senior manager should be designated to examine the creditworthiness of new clients before any transactions are made.

Lack of proper monitoring of inventory levels. Without adequate inventory monitoring, there is a probability of overstating revenue because of back-ordering transactions — sales could be recorded without actual delivery of orders. Bouncing checks due to insufficient funds may also result. An inventory monitoring system should be established.

Lack of separation of duties in order processing. The sales clerk both records orders and generates sales requisitions, which increases the likelihood of inaccurate records due to errors. A different employee should be designated to generate sales requisitions after orders are recorded.

Failure to deliver orders within the required time due to early cut-off. This creates a misleading inventory balance and the possibility of selling undelivered orders to another customer. Orders should be delivered on the same day they are accepted.

Collection of goods at the firm's warehouse. This creates the possibility of collusion between customers and employees to steal goods or overstate the cost of goods, resulting in revenue loss. A different pickup location should be designated for items and a sales clerk should be assigned to check orders.

Deleting copies of sales orders. Deleting sales order copies creates the likelihood of over- or understating sales revenues. A system to preserve documents and maintain backup copies should be established.