Background

Hardware Depot, Inc. (HD) is a multi-store retailer that sells a variety of home hardware and building supplies used in residential applications. HD has been financially successful and is presently a private company owned exclusively by its founder, Curtis Lowe.Curtis serves as the Company's president andCEO. About 20%of HD's salesare to walk-in customers and the remaining 80% are to construction contractors. HD employees about 100 people-25 are located in the corporate office while the other 75 are spread more or less evenly across the three retail locations.

Curtis Lowe is seriously considering taking the company public as he has not identified any successors to whom he could sensibly transfer ownership of the business. He views going public as the next logicalstep in the Company's progression and intends to use the capital raised to fund the addition ofadditional retail outlets and improvements to its point-of-sale software system. While there has been a recent drop in the leading indicators for the national and local residential real estate market,Curtis'sinvestment bankers and his outside Board of Directors have advised him that the downturn should onlybe temporary and that HD, with its strong local reputation should be able to successfully "sell through"the challenges if they persist.

While remaining quite active in the business, Curtis has implemented a C-Suite of managers to ensurethat the Company's infrastructure will be ready to succeed in a public company environment. Thestructure includes a CFO, a VP of store operations and a VP of human resources.HD's CFO, DonJohnson, is along-time Company employee. Seeing potential in Don right from his early days with HD, Curtis encouraged Don to obtain a four-year accounting degree and an MBA while assisting him infinancing the education and adjusting Don's work schedule to allow him to effectively manage his school workload. HD'sconfidence in Don has paid off with the development of new systems and processes including the implementation of BuilderNet an ERP system specifically built to work with retail hardware companies. Though this system may be a bit more than HD needs at the moment, Curtis agreed that it was a wise investment in the future.

All of HD's management team, including the three store managers are compensated with a market- based package that can be augmented with an incentive program. The incentive program is the same for all participants and awards the team if they can collectively deliver on a balanced scorecard of KPIs that is approved each year by the Board of Directors.

HD's auditor is the Firm of Goldstein & Vogel (GV). Included in the GV audit working paperfiles, is the following memo describing the revenue recognition process for contractor sales at HD.

Revenue Process Narrative:

HD's retail customers pay for merchandise at the store cash registers by using either cash or credit card.Building contractorswill generally purchase product on account where the contractor's main office is

billed monthly for retail purchases made during that month. These customers are generally referred toas "Corporate Bill Accounts" or CBAs. HD maintains a team of three business development employees who are charged with developing new CBAs. Using criteria established by the management team, potential CBAs are targeted and approached by the BD team who discuss the benefits of becoming HD CBAs. CBA criteria include a strong financial track record and good credit standing. Applications to become a CBA are taken by the BD representative and the application is reviewed and approved by the management team, including Curtis. Once accepted as a CBA, the contractor signs the standard CBA agreement, is presented with CBA membership cards and is entered into the BuilderNet system as an approved contractor. BuilderNet maintains a master file of approved CBAs. When purchasing materials at the store locations, theHD cashier will swipe the buyer's CBA membership card to record thetransaction in the BuilderNet system.

Purchased items are scanned directly into the BuilderNet system that will automatically match the item scanned with the corporate price file to calculate the total sales value for the purchase. The central price file is updated automatically based on the purchase price of the related materials from HD vendors and pre-established margin levels approved by Curtis. Weekly, the price file is reviewed by the VP of store operations together with the store managers who will collectively decide if any prices need to be changed in order to meet competition or dispose of slower-moving inventory. Any price reductions proposed that are greater than 2% must be reviewed and approved by Curtis-BuilderNet will actually refuse to process price changes greater than 2% without an online approval by Curtis.

Each in-store CBA sale captured in BuilderNet is copied onto an invoicing file within the system that compilesthe CBA's invoice for the period. Before electronically transmitting the invoices monthly, thebilling clerk will request a report that compares the invoice file with the in-store sales files to ensure that these two sources either agree or can be satisfactorily reconciled. If a reconciliation between these two sources is required, the billing clerk will prepare it manually and submit it to the Controller before the bills are transmitted.

BuilderNet's store management module will capture the sale price and cost of every sales transaction. In accomplishing this, the system refers to the same price file used to extract sales pricing data (remember that this same file was initially triggered by product purchase transactions. In real time the system can deliver on-demand reports of each store's sales margins by store department or SKU. Thesign-on credentials for the BuilderNet system determines which of HD's employees are permitted tohave access to this sensitive margin data.

Contractors will generally pay their invoices by checks written periodically-generally after they have been paid by their customers. Incoming checks are opened by the receptionist in the HD corporate office. Each day the receptionist will make an electronic list of the checks received and make a listing that will identify the payee, the amount and the specific invoice(s) being paid. Once the list is complete the receptionist will immediately email the list to Don Johnson with a copy to the AR clerk. She delivers the hardcopy checks to the Controller. The Controller will deposit the checks in the bank on hislunch break each day returning the validated deposit slip to Don who will compare the receptionist'schecks received listing with the amount of the deposit for the day immediately investigating any discrepancies.

Using the receptionist's checks received listing, the AR clerk will record the individual remittances inBuilderNet which will record the debit to cash and the credit to accounts receivable. Each month-end, the Controller prepares a bank reconciliation that is reviewed and signed off on by Don.

The HD credit manager has on-demand, real time access to the accounts receivable aging at all times. Each week she will make a delinquency report of any CBA with unpaid invoices that have extended beyond the mandatory 30-day term. This delinquency report is shared electronically with the entire executive management team. The credit manager oversees the follow-up process with delinquent customers which typically requires phone contact with follow-up email summarizing the customer'splanned response. The credit manager has the authority to set and change CBA credit limits as needed. The BuilderNet system has been configured to prevent credit sales to any CBA whose account balance has exceeded its pre-established credit limit. When this occurs, the cashier will call the credit manager and ask for instruction as to how they should proceed. The credit manager has been given the discretion to override this preclusion for no more than $1,000.

No outstanding account receivable balance can be written off without the pre-approval of the store operations VP.

At each month-end, the Controller will generate a preliminary trial balance and flash income statement and balance sheet. Using the standard monthly closing checklist the Controller will oversee the process of ensuring that all of the required steps on the checklist have been performed. The checklist includes the steps that each team member must perform in the process including an analysis of each account, reconciliations between preliminary account balances and the underlying supporting detail and, determination of standard monthly journal entries. Any additional entries deemed necessary through these procedures are prepared by the applicable team member and approved by the Controller before they can be entered into the BuilderNet GL. Any non-standard adjusting entries over $10,000 must also be approved by Don. Once this process is complete, the full set of monthly financial statements, including the P&L's of each store and the agreed upon KPIs for the Company. These are reviewed foraccuracy within the accounting department before being transmitted to the leadership team for review and comment. As part of the process, each department head must make a written summary comparing their departmental revenue and cost with the budgeted amounts for that month. Ultimately all of this information is summarized and shared with the HD Board of Directors.

This same closing process is performed each month and also at year-end prior to the G&V audit commencement.

Required:

1. Based on the information provided, briefly describe your overall assessment of HD'sentity-level controls. Explain your answer.
2. What concerns, if any, have you identified regarding the control environment component at HD?