Case

It is February 1, 2020, and you are an audit senior at Ben & Jerry LLP (B&J) working on the December 31, 2019, year-end audit for Nice Life Inc. (NLI). This is only B&J's second year as NLI's external auditor. In the prior year, all phases of the audit were performed after the year end.

NLI is a privately owned, lifestyle members-only wellness club situated in Green Valley, Ontario, with resources that include a bar and restaurant, squash and tennis courts, a pool, canoe and kayak rentals, boat docking, and a gym.

Jerry, the partner on the engagement, has asked for a preliminary discussion about the engagement. Jerry begins, "NLI has provided us with the internal financial statements for the December 31, 2019, year-end (Appendix I). Prior to our planning meeting with the client next week, I would like you to determine materiality, including performance materiality. I would also like you to analyze the risk of material misstatement at the financial statement level, including the different components of risk.

"I believe our audit testing can be more efficient. NLI has been working to strengthen internal controls since the previous controller, Khan, was let go in January 2017. While Michael, the new controller, did his best to provide the required details regarding the control environment for last year's audit, details about certain transaction-level controls were lacking. Therefore, our 2018 audit plan was completed with an entirely substantive based approach. Michael is confident that all 2019 transaction-level controls were robust under his leadership. Please review the process notes (Appendix II) and suggest which controls to test this year as part of the audit. Since we will be presenting this to NLI at our planning meeting, ensure you explain the financial statement areas and audit risks that will be addressed so the client understands the purpose behind this testing.

"I met with Michael and Holly, the controller and the general manager of NLI, respectively, last week to discuss audit planning matters. During this meeting, Michael and Holly informed me that on new year's day (January 1, 2020), a teenager fell off the ski lift as a result of a sudden stop halfway up the ski hill, the fall had resulted in a severe head trauma and the family has commenced a lawsuit against NLI. I would like you to include in your memo summarizing the audit implications for the 2019 audit."

Additional Information

During the completion of the 2018 audit, B&J did not identify any errors based on the testing performed. In fact, NLI required minimal journal entries and appeared to have a strong financial reporting staff in place. NLI's management was also open to making any adjustments suggested by B&J. Materiality in 2018 was $40,000.

Required:

EXCLUDE COVID CONSIDERATIONS IN YOUR MEMO

In your memo to Jerry, address the following:

i) A proper audit risk assessment of NLI for the year ended December 31 2019. Assess and analyze the risk of material misstatement at the financial statement level, including the different components of risk. Explain the financial statement areas and audit risks that will be addressed.

ii) Assess materiality for the NLI audit.

iii) Develop appropriate control procedures by transaction cycle based on the identified risk of material misstatement, specifically:

• Revenues/Receivables/Receipts
• Purchases/Payables/Payments

iv) How should the head trauma accident be treated?

appendix 1

Appendix II

Transaction Cycle Description

Revenue

Food and Beverage

• At the bar and the restaurant, members provide their member numbers when they order. Members receive bills from their servers and sign them. Servers collect the signed bills and give them to the food and beverage manager.
• Members may opt for premium food and beverage services, these are recorded as Premium service revenue.
• At the end of each day, the food and beverage manager ensures all sales recorded correspond to signed bills. The manager follows up with the servers if any bills are incomplete.
• The accounts receivable clerk ensures all bills have appropriate sign-offs and posts them to accounts receivable.
• On a monthly basis, the accounts receivable clerk prints members' statements and mails them to members. Michael reviews the accounts receivable list every month and checks aging.

Initiation Fees

• Initiation fees are one-time funds collected when members sign the membership agreement.
• On a monthly basis, Michael prepares the list of all new members and calculates initiation fees.
• Holly reviews the list of new members and ensures each new member has signed an agreement.
• An initiation fee is not recorded until the signed membership agreement is on file.

Cash Receipts

• All payments are received either by cheque, online bank payment, pre-authorized debit or credit card. Pre-authorized debit and credit cards are charged automatically at the end of each month.
• The receptionist opens the mail and prepares a list of all the cheques received using spreadsheet software.
• The accounts receivable clerk receives the cheques and the list prepared by the receptionist and she stamps each cheque to endorse it to NLI's bank account. She credits each member's account with the payment received.
• Deposits of cheques received are dropped off at the bank by various staff members on a rotating basis. A bank receipt is obtained each time and the totals are compared to the spreadsheet. The spreadsheet is initialed by the staff member who dropped off the deposit.
• Michael prepares bank reconciliations on a monthly basis. Holly reviews the bank reconciliation and indicates her review by initialling.

Purchases/Payments

• When an invoice arrives for a purchase made, the department manager responsible for that area (food and beverage, equipment, etc.) reviews the invoice, initials approval, and forwards it to the accounts payable clerk for payment.
• The accounts payable clerk issues a cheque for payment. He ensures the invoice matches payment on the cheque before sending the invoice and cheque to Michael for review.
• Michael ensures the department manager has approved the invoice and verifies that the amount on the invoice agrees to the cheque. Michael stamps each invoice as paid once the cheque is signed.
• Cheques under $1,000 require only Michael's signature. Cheques between $1,000 and $5,000 require both Michael's and Holly's signatures. Cheques greater than $5,000 must be signed by Holly and the chair of the board of directors.
• All capital expenditures are approved by the board of directors at meetings held during the year, and all work orders and purchase agreements are approved and signed by Michael and Holly.

Financial Reporting

• The monthly financial statements are prepared by Michael and reviewed by Holly.
• Michael and Holly present the financial statements and financial summary to the audit committee each month. The following comparisons are included in the financial summary: month-to-date actual versus budget, year-to-date actual versus budget, and year-to-date actual versus prior-year actual. Review and discussion is recorded in the audit committee's minutes. Once satisfied, the audit committee recommends the board of directors to approve the financial statements.
• The board of directors regularly meets the week following the audit committee. Holly and Michael present the financial statements and financial summary to the board for approval. Review, discussion, and approval are recorded in the board of directors' meeting minutes.

APPENDIXI INTERNAL FINANCIAL STATEMENTS Nice Life Inc. Balance Sheet As at December 31 $ Assets Cash Accounts receivable Initiation fees receivable Inventory Prepaid expenses Property, Plant and equipment 2019 (unaudited) $ 37,600 858,600 55,000 51,500 32,700 4,027,300 2018 (audited) 48,600 995,900 45,500 64,500 42,600 3,954,500 $ 5,062,700 $ 5,151,600 $ $ Liabilities Current portion of long-term debt Accounts payable and accrued liabilities Unearned fees Long-term debt 55,000 107,400 1,100,000 384,700 55,000 383,000 935,240 494,500 1,647,100 1,867,740 Equity Share capital Retained Earnings 95,000 3,320,600 3,415,600 95,000 3,188,860 3,283,860 $ 5,062,700 $ 5,151,600 Nice Life Inc. Income Statement and Retained Earnings For the years ended December 31 + $ Revenue Food and beverage Annual fees Premium service revenue Club activities Initiation fees 2019 (unaudited) 1,550,300 1,530,000 435,000 453,600 202,000 4,170,900 2018 (audited) $ 1,600,600 1,400,000 399,500 436,500 218,000 4,054,600 Expenses Food and beverage operations Cost of sales Payroll and benefits Laundry, supplies and other Administration Building and grounds Club activities Amortization Interest on long-term debt 528,200 906,200 124,000 1,558,400 755,200 639,000 595,600 394,900 39,600 3,982,700 516,200 836,600 125,100 1,477,900 730,400 626,000 624,600 384,300 44,000 3,887,200 Income before tax $ 188,200 $ 167,400 Income tax provision 56,460 50,220 Net Income 131,740 117,180 Retained earnings, beginning 3,188,860 3,071,680 Retained earnings, ending $ 3,320,600 $ 3,188,860 APPENDIXI INTERNAL FINANCIAL STATEMENTS Nice Life Inc. Balance Sheet As at December 31 $ Assets Cash Accounts receivable Initiation fees receivable Inventory Prepaid expenses Property, Plant and equipment 2019 (unaudited) $ 37,600 858,600 55,000 51,500 32,700 4,027,300 2018 (audited) 48,600 995,900 45,500 64,500 42,600 3,954,500 $ 5,062,700 $ 5,151,600 $ $ Liabilities Current portion of long-term debt Accounts payable and accrued liabilities Unearned fees Long-term debt 55,000 107,400 1,100,000 384,700 55,000 383,000 935,240 494,500 1,647,100 1,867,740 Equity Share capital Retained Earnings 95,000 3,320,600 3,415,600 95,000 3,188,860 3,283,860 $ 5,062,700 $ 5,151,600 Nice Life Inc. Income Statement and Retained Earnings For the years ended December 31 + $ Revenue Food and beverage Annual fees Premium service revenue Club activities Initiation fees 2019 (unaudited) 1,550,300 1,530,000 435,000 453,600 202,000 4,170,900 2018 (audited) $ 1,600,600 1,400,000 399,500 436,500 218,000 4,054,600 Expenses Food and beverage operations Cost of sales Payroll and benefits Laundry, supplies and other Administration Building and grounds Club activities Amortization Interest on long-term debt 528,200 906,200 124,000 1,558,400 755,200 639,000 595,600 394,900 39,600 3,982,700 516,200 836,600 125,100 1,477,900 730,400 626,000 624,600 384,300 44,000 3,887,200 Income before tax $ 188,200 $ 167,400 Income tax provision 56,460 50,220 Net Income 131,740 117,180 Retained earnings, beginning 3,188,860 3,071,680 Retained earnings, ending $ 3,320,600 $ 3,188,860