Comprehensive Audit Report: Risk and Controls at Marco Appliances Inc.

This report presents a comprehensive audit of Marco Appliances Inc., encompassing key stages of the audit process. It begins with a client acceptance report, evaluating the company's profile, audit and fraud risks, and ethical considerations. The report then outlines the engagement terms and limitations in an engagement letter, clarifying the responsibilities of management and the auditor. The core of the report involves an assessment of inherent risk and materiality, analyzing potential risks associated with inventory management, sales strategies, and employee practices. This is followed by an evaluation of the control environment, identifying strengths and weaknesses, and recommending improvements. Finally, the report assesses transaction processing control design, highlighting potential weaknesses and suggesting corrective measures. The report utilizes financial data, including balance sheets, to inform its analysis and provides a thorough examination of the company's financial health and control systems.

Running head: RISK AND CONTROLS IN AUDITING
RISK AND CONTROLS IN AUDITING
Name of the Student
Name of the University
Author Note

RISK AND CONTROLS IN AUDITING 1
Table of Contents
Client Acceptance Report ............................................................................................................2
Engagement Letter ......................................................................................................................4
Inherent Risk and Materiality Memo ...........................................................................................7
Evaluation of Control Environment .............................................................................................9
Reference List ........................................................................................................................... 10

RISK AND CONTROLS IN AUDITING 2
Levin, Lombard & Wolod LLC
Accounting firm
District of Columbia
Client Acceptance Report
Marco Appliances, Inc
18 Lane in Annapolis, MD 21401
To,
Supervising Senior Auditor
Introduction
Marco Appliances Inc is a small company that deals in household appliances and is a wholesaler.
The company was being audited for the previous five years by another auditor, and since audit
term with the previous audit firm ended (Kuang et al. 2020). Marco Inc has 50 employees, which
consist of corporate officers who are specialists in supplying superior-quality household appliances
to residential construction contractors. The company is considering IPO in the upcoming year to
expand the business and going on to large-scale operations.
Standards and approaches for Client acceptance
The company prepares its financial statements based on the policies set by the management and as
per the accounting standards set by the Board. The auditing firm must comply with the auditing
standard on client acceptance established by the Auditing Standard Board in the US. (Decker, Ray
& Kizirian, 2016)
Audit and fraud risk
It is a new client, and hence there is an audit risk due to lack of knowledge, and experience with
the company may lead to increased detection risk (Askary, Arnaout & Abughazaleh, 2018). Due
to the global recession in 2008, the US's wholesale appliance industry was affected by it majorly
and showed a prolonged recovery. The recession had affected the appliance industry, which leads
to higher business risk. The gross sales were growing at a rate of 7% p.a. approximately before the
recession, but currently, it is showing a growth of around 3%. This lead to a decline in Marco's
sales by 15%. Since the industry's growth rates are getting better, Marco's management expects
growth in the coming three to five years. It is seen that there are some loopholes in the manager's
marketing strategy that is why the sales dropped by such a huge margin. This indicates that
management might be inefficient, and it becomes mandatory to assess internal control over sales
specifically. When the internal controls are weak, there might be chances of high Control risk.
There is a business risk also since the economy, and particularly this industry was affected
adversely. When the marketing strategy is not efficient and effective, there are chances of fraud
within the organization. (Donelson, Ege & McInnis, 2017)

RISK AND CONTROLS IN AUDITING 3
The items which will reflect the ethical character and qualification for running the
company and how related to audit and fraud risk as stated below –
Employee cost –
The salary expense item is the cost that is being paid to the employees of the company. Marco Inc
interviews their employees on a regular basis, but during hiring, they do not perform a background
check to ensure criminal records. This is a huge risk, and if the employees turn out to be a criminal,
the company will have to suffer huge losses. The person might embezzle funds or cause threat for
assets. The salary expense to a criminal is an additional cost with lot of risks and risks of legal
expenses due to any suit by third party due to such employees.
Revenue –
Sales of the company reflect the income generated by the company to run the operation and
business. When the internal controls are weak over the entire sale procedure, there will be a risk
of fraud, and there are high chances of material misstatement, which will lead t inherent and control
risk (Jones, 2018). It is required to evaluate the procedure of entering into a sale transaction,
whether procurement is done ethically and in a fixed process or not.
Loans –
It is important to evaluate loans of the company, whether there is proper documentation, whether
the loan agreement is adequate, and duly signed. There might be chances that loans are taken for
business but utilized for personal reasons, so it is essential to examine the end-use of loans. The
loan funds can be misused, and it may lead to fraud. When management is also involved, it is
difficult to detect misstatement and fraud. There will be a detection risk if there are no proper input
documents.
The description of items which are relevant to evaluate the relationship with third parties which is
as follows –
Revenue (sales)
For performing audit procedure with respect to revenue, it is important to obtain third party
confirmations, that is from debtors. When assessing the sales procedure, it is essential to obtain
external confirmations from – customers, debtors. Loans –
The audit procedure for evaluating the process of obtaining loans and efficiency of control over
debt activities. For bank loan confirmation from – financial institutions can be obtained, and
account confirmation can be evaluated.
Purchases –
The purchases made by Marco for selling the appliances in the wholesale market are procured
from particular vendors. When performing audit, confirmation can be obtained from such – vendor
to evaluate the correctness of transaction, and entry can be cross-checked with invoice copy of
supplier.
The permissions have been taken from the company's management to ask for external
confirmations.

RISK AND CONTROLS IN AUDITING 4
Levin, Lombard & Wolod LLC
Accounting firm
District of Columbia
Engagement Letter
Date –
To,
Marco Appliances, Inc
18 Lane in Annapolis, MD 21401
The purpose of this letter is to lay down and confirm the audit engagement terms and
limitations which the audit firm has decided to perform for Marco Appliances Inc. for the year
ending 2020.
The audit will be conducted to express an opinion for the "Marco Appliances Inc" on its
Financial Statements, Statement of Income, and Statement of Cash Flow for the year ended.
Responsibility of management
It is the management's responsibility to prepare its Financial Statements as per the
accounting standards and in compliance with all the ethical requirements. Management
responsibilities include the application and maintenance of internal controls for the effective
running of operations, safeguarding the assets, application of accounting policies and principles.
They must make all the financial information and records available for the auditor. The
management of the company and employees must co-ordinate with the auditor and should provide
every information they require to conduct the audit. They must also assist in the preparation of
schedules and analyses for books of accounts separately. If the employees and management
provide this assistance on time, the audit can be conducted effectively and timely.
Responsibility of Auditor
Auditor's responsibility is to express an opinion on the financial statements of the
organization, whether they are showing "true and fair view" or not. The auditor responsibility is to
evaluate whether financial statements are prepared as per the prescribed standards, principles and
framework or not. (Drogalas et al. 2017)
This audit engagement includes reviewing of federal and state income tax returns for Marco
Appliances Inc. The tax effects of any probable transactions will be discussed and identified to
analyze the impact on financial statements and consultation for changes in accounting policies,
principles, procedures, and respective effects. It is not an auditor's responsibility to detect errors
and fraud. Still, while performing audits, if any such transaction or matter comes under
observation, then the auditor will address it and discuss it with the management. However, any
material misstatement is there, or any irregularities or substantial deviation exists, it will be
informed to the company.

RISK AND CONTROLS IN AUDITING 5
All the working papers and information provided by the company will be kept confidential
and will only be used for audit purposes. The fees for audit will be based on the amount discussed
and is fair. If any changes are there in fee structure, the same will be intimated to the management
of Marco inc.
Scope of Audit
The audit procedure's first step will be to gain an understanding of the client's business,
then to understand how internal controls are, and then examining those controls efficiency to the
extent it is relevant and important (SLS, 2017). While conducting the audit, it is essential to
examine that documentary evidence which supports the recorded transactions in the books of
accounts, assessment of inventories, and direct confirmation of trade receivables, and other
particular assets and liabilities with certain creditors, legal counsel, banks and customers. When
the audit process comes to an end, written representations will be asked from the management of
Marco on particular matters of financial statement which require representations by the company.
The audit will be conducted in accordance with approved standards on auditing in the US and
International Standards on Auditing –
(i) Assessing and examining the risk of material misstatement of financial statements of
Marco, whether due to fraud or mistakes.
(ii) The auditor must perform audit procedures and design such procedures that are
responsive to those risks and obtain appropriate and sufficient audit evidence for
providing a basis to express an opinion (Lessambo, 2018).
(iii) The auditor must evaluate the presentation of financial statements as per framework,
including disclosures. To assess whether the financial statements signify the underlying
transactions in a manner that attains fair presentation.
(iv) They must gain an understanding of existing internal control in Marco Inc that are
relevant for designing audit procedures that are appropriate in the situation, and not for
stating an opinion on the usefulness of internal control.
(v) Must identify the appropriateness of going concern assumption used by the company,
whether there are any significant indicators that show going concern assumption is not
proper, and the company might not be able to continue in the long run. There are
chances that such future events or conditions may lead the company to cease to
continue as a going concern.
There will be an inherent limitation of audit, along with internal control's inherent limitation.
(Berglund, & Eshleman, 2019). There will be an unavoidable risk of not detecting the material
misstatements, which will affect the financial statement no matter how adequately the audit is
planned and carried out.
Terms agreement
It is the first audit of Marco Appliances Inc by Levin, Lombard, and Wolod, LLC, once the
audit terms will be agreed by the company, this letter will continue to be effective for any
subsequent reappointment until it is terminated or amended. The audit firm will be obliged if the
company will confirm the agreement by signing it.

RISK AND CONTROLS IN AUDITING 6
Thanking You,
Levin, Lombard, & Wolod LLC
By: _______________________________ Date: ______________
Auditor (Signature)
By: ________________________________ Date: ______________
Marco Appliances, Inc.
By: ________________________________ Date: ______________

RISK AND CONTROLS IN AUDITING 7
Marco Appliances Inc
Inherent Risk and Materiality Memo
WP B.2.1
Initials Date
Prepared
Reviewed
Preliminary Inherent Risk Assessment
 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.
Thus, I would recommend careful scrutiny of Southwest's inventory valuation allowance
based on the lower of cost or market rule.
 Sales marketing strategy is weak – This is the reason sales dropped from a high margin
when compared with the market margin. The internal controls will be weak, and it might
lead to a more inherent risk of internal control.
 The management policy of maintaining large inventory – Marco Inc maintains large
inventories, which is risky, and there are high chances of theft considering the industry
statistics. The stock's account balance and level are high, which can be considered as
inherently risky. The impact of it will be high and it will casue a material impact.
 The company hires employees on a reference basis- without performing a background
check, without examining whether these employees have a criminal record or not. This can
cost the company adversely and hugely. It might result in some legal suits by third parties,
and it will also lead to internal risks, like theft, fraud, leaking out of confidential information
to distort the company’s reputation. It will lead to high inherent risk and have a material
impact.
 Lack of training to employees by management – When the employees are not provided
adequate training, then the chances of material misstatement are high. The employees, if not
provided with sufficient training, will not understand the existing IT process and system of
operations and transactions in the entity; hence will not be able to work efficiently. It will
result in a high risk of material misstatement. (Bhattacharjee, Maletta, & Moreno, 2016)
Preliminary Analytical Procedures
 Days 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 or market rule.

RISK AND CONTROLS IN AUDITING 8
 Current ratio – The current ratio was 3.19 in 2018 and in 2019 it fall to 2.23. This shows
that there is a downfall of .96. The company should pay attention to current asset and must
increase it.
 Quick ratio – There is a decrease in the quick ratio as well. It was 1.79 in 2018, and in
2019 it went down to 1.10. It showed a decline of 39%. The company must focus on
increasing its liquid assets. But it better than the quick ratio of wholesale Heating and AC
industry.
 Gross Margin – The gross profit margin has shown an increase of 16.03% in 2019. This is
due to the increase in sales. It is important to audit the gross profit margin to evaluate the
profitability of company.
 Return on Equity – The return on equity showed an increase in 2019 by 17%. It is a good
thing which investors would like and be ready to invest more in the company.
Preliminary Materiality
 Balance Sheet – The method used to calculate the materiality amount is the Single rule
method (Choudhary, Merkley, & Schipper, 2019). So balance sheet item for which the
materiality amount is identified is total assets.
Calculation of Materiality for 2019
Scale Amount Materiality
Factor
Materiality
Amount
Total assets $ 1,380,934.00 0.50% $ 6,904.67
The materiality amount for total assets is calculated as $6904.67, which indicates that any
misstatement beyond this amount or of this amount will be considered material. The materiality
factor is .50%, as prescribed in the Single rule method. The total asset is a significant item and is
of significant value hence requires a test for materiality.
 Income statement – The income statement item for which materiality is calculated will be
revenue, chances of sales being materially misstated are usually high and is common. And
since it was noticed that there is weak marketing strategy.
Calculation of Materiality for 2019
Scale Amount Materiality
Factor
Materiality
Amount
Total Revenue $ 3,214,029.00 0.50% $ 16,070.15

RISK AND CONTROLS IN AUDITING 9
Marco Appliances Inc
Evaluation of Control Environment
Potential Control Strengths Potential Misstatement Detected or
Corrected
Marco uses a distributed computer system that
gives employees who need access to data the
appropriate access.
This improves the control environment
because all employees are working with one
database, which reduces potential errors from
multiple recording of data.
Passwords are required to have access to
computer systems
It helps in prevention of unauthorized access
and unauthorized modification of data.
the accounting is done by using commercial
accounting software
There will be fewer chances of error, which is
high when the transactions are entered
manually. (Rubino et al. 2017)
They run a backup on a daily basis It will help the organization the most in case of
any interruption, or mishaps.

RISK AND CONTROLS IN AUDITING 10
Reference List
Askary, S., Arnaout, J. P. M., & Abughazaleh, N. M. (2018). Audit evidences and modelling audit
risk using goal programming. International Journal of Applied Decision Sciences, 11(1),
18-35.
Berglund, N. R., & Eshleman, J. D. (2019). Client and audit partner ethnicity and auditor-client
alignment. Managerial Auditing Journal.
Bhattacharjee, S., Maletta, M. J., & Moreno, K. K. (2016). The role of account subjectivity and
risk of material misstatement on auditors' internal audit reliance judgments. Accounting
Horizons, 30(2), 225-238.
Choudhary, P., Merkley, K., & Schipper, K. (2019). Auditors’ quantitative materiality judgments:
Properties and implications for financial reporting reliability. Journal of Accounting
Research, 57(5), 1303-1351.
Decker, J., Ray, R., & Kizirian, T. (2016). The Auditor’s Road Map For Client
Acceptance. Journal of Business Case Studies (JBCS), 12(3), 99-102.
Donelson, D. C., Ege, M. S., & McInnis, J. M. (2017). Internal control weaknesses and financial
reporting fraud. Auditing: A Journal of Practice & Theory, 36(3), 45-69.
Drogalas, G., Pazarskis, M., Anagnostopoulou, E., & Papachristou, A. (2017). The effect of
internal audit effectiveness, auditor responsibility and training in fraud
detection. Accounting and Management Information Systems, 16(4), 434-454.
Jones, M. (2018). Audit Quality: Detection of Material Misstatement.
Kuang, H., Li, H., Sherwood, M. G., & Whited, R. L. (2020). Mandatory Audit Partner Rotations
and Audit Quality in the United States. Auditing: A Journal of Practice and Theory.
Lessambo, F. I. (2018). Audit Evidence and Documentation. In Auditing, Assurance Services, and
Forensics (pp. 155-182). Palgrave Macmillan, Cham.
Rubino, M., Vitolla, F., & Garzoni, A. (2017). The impact of an IT governance framework on the
internal control environment. Records Management Journal.
SLS, L. (2017). audit planning.