Prepared for BUSI 4113 Final Deliverable, Fall 2024

It is December 18, 2024, and you, a team of Senior Accountants at Williams and Yang CPAs, have been called into a meeting with one of the firm’s audit partners, Luke Phelps.

“I’ve recently talked with the Johann Thompson, who is the CEO and a primary shareholder at Mercer Fine Furniture Inc. (MFF). MFF had been serviced by another large regional firm, but they weren’t happy with the service they were receiving, and they decided it was time for a change for the 2024 year-end. I went to school with Johann, he was getting his degree in design and engineering when I was doing my accounting degree, and he later did an MBA. It was great to catch up and talk about old times. I told Johann that we’d be happy to look at taking on MFF as a client. There’s some upfront work we need to do quickly, so I want you all to do what you can with the information you have and note where we need to get more from the company. I think this could be a great addition to the small-medium businesses and charity clients that are this firm’s primary client base.

 “First, I need you to do the up-front know-your-client stuff we have to do when considering acceptance of a new client. The senior partners want these memos to be airtight in case we get reviewed by the provincial review body, so make sure to cite the appropriate CASs when you write that memo. In addition to any issues based on the nature or situation of the client or the industry, make sure to include a discussion of the firm’s capabilities and confirmation that we don’t have any threats to independence. I’m confident that we can do this work effectively, but we need to have a solid understanding when I bring the client to the partnership. Based on your discussion and professional judgement, I want you to give a recommendation on acceptance of MFF as a client.

“Since we need to move fast, I also need a basic preliminary audit planning memo relating to MFF, regardless of your recommendation in the first memo. We need to have a good discussion of the risk of material misstatement, a basic approach, and a calculation of materiality. Based on what you see, I also want you to lay out a few accounts that might be of specific concern, including stating the nature of the concern^[1] and what procedures you’d suggest to give us reasonable assurance of the account being correct. If there’s anything that would need special resources, please discuss that as well.

“I believe that Johann is concerned about some internal control issues at MFF. The company recently hired a new Director of Operations, and its Chief Financial Operator (CFO) has been on medical leave for part of the year, with more junior people trying to fill in the role. Things have gotten very hectic in the warehouse. Johann and the executive team have been very focused on a major contract and issues from a new shareholder buying in. They’d like our help finding out where weaknesses are and giving recommendations. You can prepare that as a Management Letter to the executive team, just remember who the audience is.”

You speak some more and get further information about MFF from talking to Johann (Exhibit I). You also receive early draft financial statements for the year-end with notes (Exhibit II), which you can use for any initial analysis. To help you determine the firm’s capabilities as part of client acceptance, you make some notes about the firm’s capacities and regular clientele (Exhibit III).

Exhibit I: Notes from Meeting with Johann Thomas

Mercer Fine Furniture Inc. (MFF) is a Canadian manufacturer specializing in high-quality wooden furniture. Established in 1985, MFF has grown from a small family-owned business into a mid-sized company with annual revenues of approximately $50 million. The company operates a

manufacturing facility in Ontario and distributes its products across Canada and parts of the United States. Johann Thompson, the grandson of the company’s founder Herold Mercer, is the current CEO and has been in the position for the past seven years.

The company has two main divisions: first, it produces large quantities of furniture that are sold wholesale to distributors at furniture stores (“Retail”). These pieces tend to be established designs with a fully developed production process and can be assembled relatively quickly by lower-skill workers under the supervision of more experienced craftspeople. Second, the company sells highend custom furniture to elite clientele (“Custom”). These projects are more involved, often requiring design work by the company or outside contractors, as well as the labour of the more skilled tradespeople.

Johann described the two lines: “What we sell in retail is great, we stand by our product, and it is still considered high-end. Our assembly employees can make thousands of these with the right supervision. We offer upscale selections for the entire home, including dining, bedroom, living room, home entertainment, and nursery and youth furniture. We also have a line of well-crafted wooden office furniture, including desks and shelves, that tend to be bought by law or accounting firms, and tables bought by companies or restaurants. Custom is where I focus a lot of my effort, since my grandfather originally built this company by making high-end custom furniture based on techniques he brought over from the old country. Although retail pays the bills and brings in the bulk of our revenues, custom is a big part of our brand. It’s lower volume than retail, but a lot higher price. We’ve created furniture like executive desks for major CEOs, as well as beds and bedroom furniture for the Prime Minister and Governor General’s residences.”

The company owns a manufacturing plant and a large warehouse about an hour north of the GTA, where it employs about 80 part-time and full-time workers. Another 40 employees work out of the company’s BC warehouse and workshop, taking advantage of the location’s proximity to Asian shipping lanes. There are about 10 management and executive staff who operate either out of the working locations or out of rented office space in downtown Toronto. The company has a Board of Directors that includes Johann as Chair. Other members of the Mercer family sit on the Board, as does the new shareholder, one representative from the employees, and an independent director. Because many of its competitors are publicly traded, MFF uses IFRS as its basis of accounting.

Although the workers are not formally unionized, they do regularly meet with Johann and the executive team to discuss working conditions and pay. To help them understand the financial realities of the company, this year Johann began showing the workers the financial statements of the company. “Seeing where we are in terms of income and cash helps them understand why it is difficult to give wage increases and other concessions. They can see that we need to do what we can to conserve money.”

Important 2023 Events

• During the year, the company got a big order from Clarke’s, a chain of boutique hotels operating in Ontario, Quebec, and British Columbia. MFF will provide all beds, bedroom furniture, and décor pieces for Clarke’s 450 rooms. “This was a big order, and it needed a lot of work to the deal done. We finalized it in November. The value of the contract is about $2.25 million, including a $250,000 non-refundable deposit that Clarke paid upfront in December. We were able to shift our production lines in December, and the first 20 room sets went out right before the new year.”
• In the middle of the year, MFF was approached by Nelson Vance, a businessman from Halifax who owned a Private Equity (PE) firm, Vance Capital. Nelson liked the company’s products and heard that they were experiencing some liquidity issues. He made an initial offer to purchase 25% of the company. After discussion with the Board and the Executive team, as well as the company’s lawyers and a valuation firm, Vance Capital paid $2.5 million for a 10% stake in the company. Nelson received a seat on the Board of Directors and has regular contact with Johann. It was Nelson who brought in the work from Clarke’s, in whom Vance Capital also holds a significant stake.
• Emily Tilley, the company’s long-time CFO, went off on medical leave in February of 2023. Emily had her accounting degree from a prestigious Canadian university, as well as a CPA designation. Since he had some financial acumen himself and didn’t have time to hire a new person, he took on some of Emily’s duties and gave others to the company’s controller, Sarah Patel. Sarah recently graduated from university in 2021 with a degree in accounting and finance, and a minor in design. She had been planning to begin the CPA program, but her increased duties led her to defer her program start date for a year. Sarah continued to review processes like the bank reconciliation, then reviewing the work she had done for correctness. Johann often signed off on work done by Sarah, although he did not have the time to review it in any level of detail as Emily would have.
• MFF purchases significant amounts of chemicals to aid in the production of furniture, including adhesives, paints, and varnishes. In the process of clearing an area to work on the Clarke’s project, workers found several oil-barrel-sized containers of varnish that showed to be beyond two years old. Two years is considered the maximum time that properly stored varnish can be kept before it is no longer usable in production. Johann was very annoyed by this finding, since the drums cost approximately $10,000 each, and he saw it as wasteful to have to dispose of the varnish rather than using it.
• A new Director of Operations was hired in the current year, as the prior Director retired and moved to Panama. Evan Williams was eager to help at MFF, but recognized some issues. “Although work progresses, there are a lot of unwritten rules or procedures that make it difficult to streamline processes. We have different product lines being created in the same area, while much similar products are widely spread out. I’ve been working to lay things out more logically, with beds created in one area, dressers in another, etc. I’ve also found it difficult to put my finger on inventory when we need it. There is a lot of disorganization in the warehouse, and I still need workers in the warehouse to show me where anything is rather than it being in a logical place. There were also a few times where a piece of inventory wasn’t where they thought it would be, including some where we didn’t find it at all. There is good security in the warehouse, with many more valuable materials in locked rooms. The code to the rooms is ‘1985’, the year that the company was founded.”  
• Evan noted that some processes seemed to be going unfollowed in the production workshop. “There are strict rules in the industry around worker health and safety and remediation of used products. For example, sawdust is meant to be minimized in the workshops through ventilation hoods and removed by certified companies. I found that much of our sawdust was being sold or given to local farmers to absorb moisture on their farms. This is apparently something that’s been done for a long time. I’m not sure if this poses a problem or not.”
• Evam continued: “I went into one of the workshops early in my time here and noticed a strong smell of varnish fumes. Apparently, the ventilator had broken, so fumes hadn’t been removed. We had an engineering firm come in and update the whole system while making this repair, which cost more than $200,000. They say it is now fully compliant with one of the new ISO regulations; Johann is happy to put that in the company’s annual report, though we may need an actual expert to confirm compliance.”
• The retail furniture industry has been experiencing troubles, including a decrease in foot traffic. Some of MFF’s key customers have been slow paying their receivables. Sarah estimates that about $400,000 worth of receivables are more than 90 days past due. Normally she is better at chasing down customer payments, but the additional CFO work has taken up much of her attention.
• An upscale restaurant chain with locations throughout Ontario and Eastern Canada was in the news in early September of 2023 for facing difficult financial conditions in the current economy and being at risk of bankruptcy without government relief. MFF was the supplier for all the chain’s tables and chairs, and they owed MFF approximately $150,000 at yearend, including a recent $30,000 shipment that went out at the end of October. Johann was confident that MFF would be paid.
• MFF took part in a program in 2023 to bring in temporary foreign workers (TFWs) to do some of the labour work in the plant. As the sponsoring organization for these workers, MFF is responsible for making sure that they are adequately screened and that they receive proper training and accommodations while in Canada.
• Workers are supposed to track their time on each piece of furniture, so that the company can track efficiency and cost of production. However, workers were often neglecting to record these times, trying to remember later how long a piece had taken to construct. Many just split their time evenly, though some pieces take much longer than others.
• Ongoing supply chain issues from China and Vietnam have led MFF to reach out to new suppliers for some of their raw materials, especially the specific types of wood that are used in certain lines. Evan has heard that companies sometimes try to pass off one type of wood as another, more expensive wood. He is worried that a shipment of wood received from Brazil may not be the correct (very expensive) wood type, but it is difficult to tell.
• With so many changes, it was sometimes difficult to maintain quality control. Several shipments during the year had seen items returned because of issues with production quality. There had also been an increase in claims under the company’s 20-year manufacturing warranty. Evan and Johann worried that the historical warranty return rate might need to be increased.

Exhibit II: Mercer Fine Furniture Financial Statements with Notes

[1] Accounts Receivable

MFF prepared the following aged accounts receivable statement as at December 31, 2023.

[2] Inventory

Inventory is valued at the lower of cost and net realizable value (LCNRV). MFF inventory includes raw materials (including wood, components, varnish, paints, and trimmings), work in process inventory, and finished goods inventory. These categories are held as follows:

About 60% of raw materials inventory, 40% of work I process inventory, and 25% of finished goods inventory was at the BC location at year-end.

During the year, the company bought an expensive category of wood from a new supplier in Brazil. This specific type of wood is highly valued among purchasers of high-end furniture, and is intended for use in the Clarke’s contract. It is valued at approximately $550,000.

[3] Property, Plant, and Equipment (Net)

PPE includes all land, buildings, equipment, furniture and fixtures, as well as intangible assets owned by the company. The cost of the revamping of the ventilation system was capitalized.

[4] Long-term debt

The company has several debts related to its factories and equipment. The largest bank loan, valued at approximately $4 million, is due in January of 2025. Management remains confident that they will be able to attain a new loan on similar terms. The terms of this loan include maintaining a current ratio greater than 2:1, maintaining a debt to total assets ratio less than 0.5, and approval by the bank of any new debt acquired by the company.

[5] Common Stock

During the year, Vance Capital purchased a 10% stake in MFF for $2,500,000, with an option to purchase another 10% stake at the same valuation in the future if certain conditions are met.

Exhibit III: Williams and Yang CPAs

Williams and Yang (WY) is a large regional firm operating out of the Greater Toronto Area (GTA). WY has 12 partners, seven senior managers, 20 managers and about 100 associates. The firm primarily deals with clients in the GTA and Southwestern Ontario, although they do have clients in Ottawa, Kingston, and North Bay. WY is also part of an association of networked firms that rely on each other for expertise or local work where applicable. The network stretches across Canada and North America.

WY focuses mainly on large owner-run businesses, which tend to use ASPE as their accounting standards. It currently has two clients that use IFRS, both of which have intentions to go public within the next five years. WY has no clients that are publicly traded and will likely discontinue the audit of these clients if they go public. Both of these clients are handled by the same partner and overseen by the same senior manager. Due to the complexities of IFRS, the companies require a lot of work to reduce audit risk and produce an unqualified opinion. The partnership has recently stated an intention to expand its understanding of IFRS to attract more clients who are private but use that standard.

[1] By ‘concern’, Luke means ‘what management assertion is at risk of being violated here’.

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