Last year, R&G Furniture reported revenues of $142 million, which made it the third largest manufacturer of office furniture in Canada. Due to a weak economy and innovative and cost-efficient competitors, R&G Furniture's revenues and market share are shrinking year over year. R&G Furniture is known throughout the industry for its high-quality furniture and customized designs; however, its product costs and lead time are much higher than the industry average.

Several months ago, Larry, the CEO and president, met with the vice-president manufacturing, Howard, and the vice-president sales and marketing, Petra, to set a strategic plan to increase company sales by 15% over the next fiscal year. They decided that R&G Furniture should attempt to increase its market share in the low-end office furniture market by offering a separate product line that is less customized and has a lower manufacturing cost. The CEO asked Howard to work on new furniture designs and to supply the estimated manufacturing costs to Petra so that she can establish pricing and prepare the sales team for the launch of the new products.

After the meeting, Petra mentioned to the CEO that the best way to ensure the sales team will focus on selling the lower-end products would be to increase the commissions and bonuses associated with these products. The CEO agreed that the sales team would likely concentrate on selling the higher-end products if the incentive structure remained the same. Therefore, Petra proposed two changes: an increase of 8% for sales commission on the new product line (a portion of which she receives as vice-president) and a restructuring of the sales and marketing department bonuses to include the revenues generated by the new product line.

A couple of weeks later, Petra had not received the cost estimates from Howard. Anxious to start the pricing and advertising process for the new product line, Petra called her friend who works in the manufacturing department. After some persuasive arguments, Petra convinced her friend to give her the preliminary manufacturing costs and sample designs that were circulating in the manufacturing department. Her friend reminded Petra that these costs and designs were not final and that she should get the final costs and designs from Howard. Petra thanked her friend and was content to have everything she needed to get her team started.

Based on the manufacturing costs acquired, Petra set the marketing and sales strategies and R&G Furniture announced its new office furniture product line. When Howard heard this, he was quite alarmed and immediately advised the CEO that he had not provided his final costs for the new line of furniture. He noted that the costs being used were preliminary; however, Larry advised that the company had to proceed as sales orders were already being processed. He also stated that there should not be a huge deviation in the preliminary costs compared to the actual costs. Howard, still unsure as to how the preliminary costs were released, accepted his CEO's final decision.

A few months passed and Larry had heard nothing but great news. He was looking forward to reviewing the quarterly results. At a glance, he noticed that revenues increased by 22% over last year's numbers; however, the smile on his face quickly faded when he saw that the company profits did not increase. As he is questioning these numbers, Larry received a phone call from the customer service vice-president explaining that they have been receiving a large number of complaints from customers concerning late deliveries and a high number of defective products.

Extremely concerned, Larry first called Petra to discuss the situation. Petra quickly pointed out that her employees have done their job as sales have increased substantially. If there is a problem with the profit margins being too low she believes it is due to costs, which are the responsibility of the manufacturing department. She further explained that the pricing was based on costs provided to her by the vice-president manufacturing and that Larry should contact him for further explanation.

Larry then called the vice-president manufacturing to discuss the customer complaints and the increased manufacturing costs. Howard explained that the deviation between the estimated and final costs calculated by manufacturing was only 6% and this would not entirely account for the reduced profit margins. He further outlined problems in producing the new line by explaining that they are using the same equipment to produce both the low-end and high-end product lines. Because there is set-up time required to reconfigure the machines between each production run, the process is time consuming. This constant change could explain the increase in the frequency of machine failures. Howard added that the sales team kept giving rush orders regardless of which product line was currently being produced, resulting in scheduling conflicts and reduced efficiency. Howard added that when he raised the issue about the rush orders being a problem, Petra indicated that it was the CEO who approved them and instructed that they be pushed through as quickly as possible. Furthermore, the sales forecasts are rarely reported to his unit, possibly explaining why they are encountering frequent shortages of raw materials. All these factors have caused much inefficiency.

The CEO, somewhat surprised by the explanations he received, quickly realized there was a conflict between the two vice-presidents and wanted an independent assessment. He asked the internal audit department to review this matter and report on the risks faced by R&G as well as recommendations regarding the new product line.

You, a CPA, are assigned to lead the review and report back to the CEO.

Required

a)Based on the information provided, make a memo to the CEO as requested.