Chapter 7: Case 7-25 – New Client Acceptance

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Chapter 7: Case 7-25 – New Client Acceptance,
Comprehensive Case: Mt. Hood Furniture, Inc.
Company Background Information: Your employer, Reddy & Abel, LLP, Certified Public Accountants (who is registered with the PCAOB and audits public companies), has been approached by a prospective client, Mt. Hood Furniture, Inc., about your firm taking on their account. The firm has adopted procedures for the acceptance and retention of clients following the AICPA guidelines for quality control in an accounting practice. The firm requires that a partner interview all prospective clients to determine what services the client needs and the ability of the firm to provide those services. As the prospective senior on the engagement, you accompanied the partner on the interview. The following is a summary of your notes from the interviews with senior management. Notes from Client Interview: Mt. Hood Furniture, Inc. is an Oregon corporation incorporated in 1961. The company is a regional manufacturer of office furniture and cabinetry. The product line includes desks, chairs, filing cabinets, bookcases, credenzas, and European-style cabinets. Approximately 80 percent of fiscal year 20X3 net sales were in office furniture and 20 percent in cabinetry. The cabinetry unit underwent major retooling commencing in 20X2, which approximated 85 percent of the capital expenditures that year. The retooling was financed with significant long-term debt. The improvements enabled the company to manufacture ready-to-assemble furniture products, and develop a modular ready-to-install cabinet line, which has resulted in an increase in sales. The company has developed new, award-winning designs in office furniture, designs that stress the efficient and ergonomic use of technology. Ample opportunity exists to expand sales of the existing product lines. Management estimates that the current physical plant can support up to $50 million in sales without significant additions of manufacturing and distribution capacity. Additional sales up to $50 million are expected to result in additional costs associated with the variable cost of production and variable overheads but should not require increases in fixed costs. Office furniture is a highly competitive, multibillion-dollar annual market. With a strong economy the market has grown about 15 percent per year over the last two years; however, industry experts expect this growth to slow down in the years ahead. Mt. Hood does not have significant market share and competes with a number of nationally recognized companies. Mt. Hood’s primary advantages are competitive pricing and consistently high quality products. Its low-profit margins are part of a pricing strategy to build market share by undercutting the competition. The custom office cabinetry grants the company a wider profit margin and substantial sales growth potential. This is a unique product line; it offers a custom-built look that is not readily available from other manufacturers. Demand is steadily growing. The company plans to expand its marketing in this niche. The company’s manufacturing and executive offices are located in facilities leased from the founder, adjacent to shipping and transportation facilities in the Pacific Northwest. Two adjacent buildings house the corporation, with the offices located above the warehouse. The company purchases raw materials including coil steel, bar stock, hardware, laminated particleboard, casters, fabric, rubber and plastic products, and shipping cartons. Materials are delivered to the dock by common carriers or by suppliers’ trucks. Finished products are shipped FOB from the warehouse or picked up by the customer. Mt. Hood has a delivery truck for smaller, local orders. The company has 180 employees involved in manufacturing operations and 20 in the executive offices. The company’s workforce is stable and highly skilled. Many of the employees have been with the company for more than 15 years. The company’s work...
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