CONTENT REQUIREMENTS
Requirement 1
Although this was not an audit engagement for E&Y, some of the allegations against the firm
can be framed in terms of the 10 generally accepted auditing standards. Discuss which of the
ten GAAS was E&Y alleged to have violated and what makes you believe they were violated? (8
points)
Requirement 2
Should there be specific professional standards for CPAs who consult? Given that non-CPAs
who consult do not have formal professional standards, describe the advantages and
disadvantages that result from such standards. (8 points)
Requirement 3
How could the relationships described in 2-28 have affected E&Y’s advice to MGR? Given these
relationships, do you think that E&Y acted unethically? Why or why not? (9 points)
WRITING REQUIREMENTS
Requirement 1
Provide an introduction that draws the reader in and provides the reader a road map to the rest of
your paper. (5 points)
Requirement 2
Provide an introductory sentence for every paragraph that appropriately summarizes the
information in that paragraph. Although this sentence should provide a summary, you
shouldn’t be repeating yourself excessively throughout the paragraph. Underline, bold, or
italicize the introductory sentence. (5 points)
Requirement 3
Provide a conclusion that adequately summarizes the findings of your paper. (5 points)
Writing Restrictions for this assignment:
• Read “On Writing” for the things I will be looking for in your writing
• This paper should read like one comprehensive essay rather than answers to specific
requirements.
• 12-point font
• Double Spaced
• Two page maximum
Part I: Merry-Go-Round (MGR), a clothing retailer located primarily in shopping
10
malls, was founded in 1968.
had expanded to approximately 1,500 stores, 15,000 employees, and $1 billion in annual sales. The
company’s locations in malls targeted the youth and teen market. The company was listed by Forbes
magazine as one of the top 25 companies in the late 1980s. However, in the early 1990s, the company
faced many challenges. One of its cofounders died, and the other left to pursue unrelated business
interests. The company faced stiff competition from other retailers (e.g., The Gap and Banana
Republic), fashion trends changed, and mall traffic declined. Sales fell, and experts speculated that
MGR failed to anticipate key industry trends and lost sight of its cus- tomer market. To try to regain
its strong position, the company acquired Chess King, Inc., a struggling chain of men’s clothing stores
located in malls, in 1993.
By the early 1990s, the company had gone public and
The company’s sales continued to fall, and later in 1993 the company brought back one of its
cofounders to manage the company and wrote down a significant amount of inventory. However, this
inventory write-down caused the company to violate loan covenants. Facing bankruptcy, the
company, based on the advice of its newly hired law firm Swidler and Berlin, hired turnaround
specialists from Ernst and Young (E&Y) to help overcome the financial crisis and develop a longterm business plan. However, the company’s decline continued, and it filed for Chapter 11
reorganization in 1994. In 1996, the remaining assets were sold for pen- nies on the dollar.
Subsequently, a group of 9,000 creditors (including former employees and stock- holders) began
litigation against parties it deemed responsible for their losses. These parties included E&Y, which
the creditors sued for $4 billion in punitive and com- pensatory damages (E&Y’s fees from MGR
totaled $4.5 million).
The lawsuit alleged that E&Y’s incompetence was the main cause of MGR’s decline and demise. The
lawsuit alleged in part that
•
? The turnaround team did not act quickly enough.
•
? The leader of the team took an eight-day vacation at a critical point during the
engagement.
•
? The cost-cutting strategy called for only $11 million in annual savings, despite the
fact that the company was projected to lose up to $200 million in 1994.
•
? While closing unprofitable stores was key to MGR’s survival, by 1995 only 230 of 1,434
stores had been closed and MGR still operated two stores in some malls.
•
? The turnaround team included inexperienced personnel—a retired consultant, a partner
with little experience in the United States or with retail firms in general,
and two recent college graduates.
•

? E&Y charged exorbitant hourly rates and charged unreasonable expenses (e.g.,
charges included reimbursement for a dinner for three of the consultants totaling in excess
of $200).
E&Y denied any wrongdoing but in April 1999 agreed to pay $185 million to settle with the
injured parties.
Required:
a. Although this was not an audit engagement for E&Y, some of the allegations against the
firm can be framed in terms of the 10 generally accepted auditing standards. Which of the 10
GAAS was E&Y alleged to have violated?
10
The following articles were sources for the information in the case: E. MacDonald, “Ernst & Young Will Pay $185
Million to Settle Claims of Merry-Go-Round,” The Wall Street Journal, April 29, 1999, and E. McDonald and S. J.
Paltrow, “Merry-Go-Round: Ernst & Young Advised the Client, but Not about Everything—It Didn’t Reveal Business
Ties Alleged to Pose Conflict with Its Consulting Job—Settlement for $185 Million,” The Wall Street Journal, August
8, 1999, p. A1.
LO 2-12
2-28
2.
Although this was not an audit engagement for E&Y, some of the allegations against the firm
can be framed in terms of the Principles Underlying an Audit Conducted in Accordance with
Generally Accepted Auditing Standards. Which of the Principles was E&Y alleged to have
violated?
3.
Should there be specific professional standards for CPAs who consult? Given that non-CPAs
who consult do not have formal professional standards, describe the advantages and
disadvantages that result from CPAs being subject to such standards.
Part II: Merry-Go-Round. Additional charges made against E&Y included the fol- lowing (recall that
MGR hired E&Y for turnaround consulting services):
•
? E&Y had a close relationship with Rouse Co., one of MGR’s primary landlords
(E&Y was soliciting business from Rouse and provided significant tax services).
•
? Swidler (the law firm that recommended E&Y to MGR) and E&Y had partici- pated in at
least 12 different business arrangements, some of which resulted in
Swidler receiving significant fees from E&Y.
•
? E&Y did not disclose either of these relationships to MGR.
Required:
a. Do you think that E&Y acted unethically, given that it had these relationships?
b. How could these relationships have affected E&Y’s advice to MGR? In other words, refer to the
charges above and speculate as to whether any of the alleged wrong-doings by E&Y may have
stemmed from the relationships described above.
Case 1
E&Y has violated the three general standards and two standard of field work. From
case we know that the E&Y team didn’t act quickly and they took an eight-day vacation at
a critical point during the engagement, it appears to violate the three general standard,
which is required the auditor must have adequate training and proficiency, be independence
with good relationships between E&Y and MGR and professional care. Meanwhile, the
inexperienced team also violated the two standard of field work. In the case mentioned that
the team included inexperienced member-a retired consultant a partner with little
experience and two college students that cause in sufficient understanding MGR’s internal
control and plan not effectively. Therefore, those non-professional auditors didn’t perform
their duties and cause MGR’s demise.
E&Y also has violated the two principles, which is personal responsibilities and
performing principles. By assigning inexperienced staff and the leader who took the
vacation during the engagement, the E&G is against the principle of responsibility and
performance.
We could see from the case that there need to be specific professional standards for
CPAs because the professional CPAs under requirements are more reliable and precision.
the advantage of non-CPAs who don’t have formal professional standards is that their
services will cost less than professional CPAs, however the drawback is less reliable than
professional CPAs.
E&Y acted unethically because they didn’t tell MGR that they had close relationship
with Rouse Co, because the auditors avoid actions or relationships that may appear to effect
independence. If E&Y did have close relationships with Rouse Co, they were lacking the
independence.

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