Merry-Go-Round
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
ON WRITING
Here are my expectations for all writing assignments:
• Typed in 12-point Times New Roman font
• Double spaced
• Reasonable margins (no smaller than 1 inch)
• In essay format with a proper introduction, body, and conclusion
Since I expect your writing to improve over the semester, I will be more lenient in my
grading of your writing skills at the beginning of the semester. However, these are the
types of grammar issues I expect not to see in any of your writing – penalties will
become harsher as the semester continues (examples are included on page two):
• There should be no run-on or incomplete sentences.
• The paper should be free of misspellings.
• More than one typographical error. Significant typographical errors may result in
a zero for the assignment.
• Inappropriate language and continued misuse of punctuation.
As the semester progresses, you may find that the penalties/comments are harsh.
However, my goal is to train you for the business world, and poor writing, poor spelling,
and typographical errors are not tolerated in business. I would rather you learn how to
address these problems in a classroom setting rather than on your first job with millions
of dollars at risk.
I believe the main reason for poor writing with college students is a lack of attention
rather than a lack of understanding. I believe many of you think you can complete a
written assignment in one sitting, with no editing. THIS IS NOT TRUE! Many of you
will need to write at least two drafts of EVERY assignment in order to make it clear and
concise, using proper grammar with no errors. Some of you will need more than two
drafts. Recognize this and work with it, allowing yourself enough lead time to complete
an assignment and revise it as necessary. Not only do I want you to learn concepts, but I
want you to learn your own writing needs to better prepare you for your future.
EXAMPLES OF POOR WRITING
Run On Sentences
The auditor should have given more consideration to the accounting issues not all
intangible assets should be amortized.
The manager gave the auditor an explanation that was reasonable and the auditor wrote
down the explanation in her workpapers without asking for any additional proof and it
was found later that this explanation could not completely explain the fluctuation in
salaries expense which resulted in the auditors stating there were no material errors when
in fact there were.
Incomplete Sentences/Sentence Fragments
Because the company bought more fixed assets.
While the senior reviewed the new evidence.
Other (poor punctuation, poor language, typographical/spelling errors)
The auditor should asses all material changes.
The auditor’s estimation of the account balance was right on.
The companies financial statements were incorrect.
We reviewed the inventory listing; and determined that it was complete.
We reviewed the inventory listing, it was complete.
There were many things that we could learn form this client.
More examples will be provided as the semester progresses – taken from your papers.
Don’t be an example!
DISCUSSION CASES
LO 2-2, 2-10, 2-12
2-27 Part I: Merry-Go-Round (MGR), a clothing retailer located primarily in shopping
malls, was founded in 1968.10 By the early 1990s, the company had gone public and
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.
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 long-
term 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.,
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loan covenants. Facing bankruptcy, the company, based on
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 long-
term 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?
10The 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. Al.
Chapter 2 The Financial Statement Auditing Environment
65
b. 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?
c. 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.
.
2-28 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.
NINANITO

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