CONTEMPORARY CLOTHING CO. (Suggested time: 120 minutes) Contemporary Clothing Co. (CCC) was established in 1998 by two good friends, Aaliyah Morgan and Melissa McIntyre. At that time, Aaliyah and Melissa had just graduated from one of the Ontario fashion design schools and decided to apply their passion for fashion to an entrepreneurial setting. They created their own garment patterns and sewed them at home. Since they had no funds to open any stores, Aaliyah and Melissa distributed the garments between friends, family and members of their local community. CCC quickly became well-known for its unique fashionable wear. CCC remains a direct selling company. All of the garments are distributed by the company's sales coordinators and are not available in stores. Typically, sales coordinators hold presentations at their friends' homes and show the guests how to put an entire wardrobe together with just a few CCC items from the most current collection. Melissa and Aaliyah are still both actively involved in managing the business. However, they are now considering retiring from the fashion industry as the intense competition has made it too stressful. The founders have already contacted an American private investor who is well known for buying Canadian companies and merging them with their American counterparts in his portfolio. He indicated that he may be interested in purchasing CCC but would need to examine the audited financial statements before he pursues it any further. Green, Gibbons & Gaston LLP (GGG) were recently appointed auditors for the December 31, 2020 year-end. You, CPA, have been assigned as the audit senior for the engagement. It is now February 25, 2021 and Allie Green, the engagement partner, calls you into her office and says, "I need you to prepare an audit engagement planning memo for the CCC audit. This will be the first time that CCC has been audited or reviewed. Please address any accounting issues that we need to discuss with the client. Provide your recommendations on the appropriate accounting treatments to be used and suggest appropriate audit procedures to be performed pertaining to these issues. CCC uses International Financial Reporting Standards. "You need to prepare a separate draft report to Melissa and Aaliyah for my review that identifies any internal control weaknesses and how to fix them io order to help maximize the value of CCC. The founders mentioned that they were concerned about the number of sales coordinators leaving and how the sales coordinators are supervised. They want your advice on how to deal with those concerns." The engagement partner provided you with some background information on CCC's operations (Appendix 1), notes from her meeting with CCC's Director of Sales (Appendix II), information about the company's on-line ordering system (Appendix III) and additional information she obtained from the company's bookkeeper (Appendix IV). APPENDIXI BACKGROUND INFORMATION ON CONTEMPORARY CLOTHING CO. OPERATIONS Fashion Shows CCC has two seasons: spring/summer and fall/winter. The spring/summer season commences on March 1 and the fall/winter season commences on September 18 A new collection is previewed by the sales coordinators several months before the start of the season. The CCC fashion show for the spring/Summer 2021 collection was held in October 2020. At the fashion shows, all sales coordinators are invited to attend workshops on entrepreneurship, selling strategies and business development ideas. However, these workshops are not mandatory. Revenue The company's sales coordinators purchase garments at a discount and then resell them to customers at full price, which is set by CCC. The sales coordinators' discounts vary from 15% to 45%. All discounts are approved by CCC's Director of Sales on an annual basis based on pre- defined criteria. Revenue is recognized upon order by the sales coordinator. All sales are final as sales coordinators cannot return any of the goods shipped. CCC has responsibility for ensuring shipments are received by the sales coordinators. Inventory All inventory items are held in stock at original cost for a period of 24 months. At the end of that period, any unsold inventory is written off and donated to local charities. Total sales for 2020 were $12,706,700 and the year-end inventory balance was $1,500,000. A total of 90 percent of sales in 2020 related to the 2020 fall/winter and the 2021 spring/summer collections. Inventory is accounted for on a first-in, first-out basis. High Health Limited (HHL) In 2018, CCC partnered with HHL, a popular retail chain that specializes in natural health food and diet supplements. With a purchase of over $200 of CCC merchandise, customers were eligible for a discount on the HHL products sold through the CCC's website. CCC purchased the products from HHL at warehouse prices, stored them on its premises and sent the products to the customer upon receiving the order. This venture became a significant portion of CCC's business. Despite actively promoting HHL products, CCC had to write off a major portion of its HHL inventory in the current year as all the products are made from natural ingredients and are highly perishable CCC decided to discontinue all operations related to HHL products as of November 1, 2020 and reported related expenses, net of revenues, as discontinued operations in the income statement. HHL convinced Melissa and Aaliyah to keep the promotion on their website with a link to the HHL website. HHL processes the orders once received through the website and ships them directly to the customer. CCC estimates the commission fees received from HHL will comprise 2% of total CCC's revenue in 2021. APPENDIX II NOTES FROM MEETING WITH SUZANNE HIL SDEN, DIRECTOR OF SALES CCC places a great emphasis on its sales force, as the sales coordinators are the core of the company's business model. Suzanne explained that there are many benefits to joining the CCC sales force, especially for 'stay-at-home' mothers: a flexible schedule, no start-up fixed costs, no requirement for sales or fashion experience, and no pre-defined quotas. Sales force members are responsible for providing and covering the costs of their own automobiles, laptop, and cell phone. Once recruited, each new sales coordinator is awarded a contract to provide sales services for CCC for an indefinite period of time. They are expected to begin holding presentations at their friends' homes as quickly as possible. There is frequent travel required and sales coordinators need to be able to transport numerous sample items. As such, access to an automobile is mandatory. Furthermore, they are not provided with CCC business cards, email addresses, nor use of CCC's office facilities. Suzanne circulates a survey to all sales coordinators annually that includes quantitative and qualitative information, such as feedback from end-users and best practices for selling. Her assistant summarizes the results of the survey but Suzanne has not had any time to review the information for 2020. Some of the quantitative information gathered from the survey is presented below: 2020 2019 Number of coordinators 898 943 1,205 Average number of years of service 3.6 7 7.3 On January 1, 2020, Suzanne implemented an incentive program for news coordinators. They are now allocated $20,000 when they join to be used for any business development expenses related to establishing their own clientele, excluding the purchase garments from CCC for resale and the costs related to automobiles and communication devices. The sales coordinator is required to summarize her business development expenses and present all supporting receipts for reimbursement of the $20,000. The company's bookkeeper, Samantha Allen, issues a cheque for $20,000 to the sales coordinator upon receipt of the summary. When she has time, reviews the summary and matches all the expenses to the accompanying receipts. Since the start of the incentive program, Samantha has received 252 packages and has only had time to review 167 of them. 2018 APPENDIX II (continued) NOTES FROM MEETING WITH SUZANNE HIL SDEN, DIRECTOR OF SALES As part of the flexibility offered by CCC, all sales coordinators set their own goals in the beginning of the fiscal year and need to report those to the Director of Sales. They include total sales volume, number of home presentations to be held, and number of new sales coordinators brought into the business. Suzanne's responsibility is to approve the goals and notify the sales coordinator if any of them are deemed to be inappropriate. She received the 2021 goals from all the sales coordinators by January 1, 2021 but still has not had the time to review and approve some of them. Suzanne explained that CCC recently moved towards greater efficiency and effectiveness of operations, as recommended by an external consultant, and eliminated 25% of its management staff which put an additional pressure on Suzanne's workload. Suzanne could not remember any instances where she would not approve coordinators' goals and objectives as it is really up to the sales coordinators to set their own pace. APPENDIX III ON-LINE ORDERING SYSTEM Sales coordinators make all their orders on-line by filling out an order form. The order form allows sales coordinators to input their information into preset fields (e.g., first name, last name, shipping address, phone number, discount percentage, number of garments of each style). All the sales prices are populated automatically by the website. Purchases can be paid for by credit card. The sales coordinator enters her credit card information using pre-defined pull-down menus (e.g., credit card type, credit card expiry date). CCC uses Payment Link to process credit card payments. If the credit card number corresponds to the personal information provided, the transaction is accepted. CCC receives a weekly report from Payment Link that lists all of the transactions processed. The website is automatically linked to CCC's accounting application. All communications between the CCC website and Payment Link are encrypted. A weekly deposit is made of all credit card payments processed by Payment Link. . APPENDIX IV INFORMATION OBTAINED FROM SAMANTHA ALLEN, BOOKKEEPER Suzanne's assistant prints out the orders from the website every morning and passes one copy to the bookkeeper and another copy to the warehouse shipping coordinator. Once the order is assembled, which usually happens on the same day, goods are shipped to the sales coordinators and revenue is recognized in the system. Samantha processes all orders immediately after she receives them from Suzanne's assistant Sales coordinators can choose to pay with a debit card. They select this option on the on-line order form. In ordec to pay with a debit card, the sales coordinator would need to have a pre- authorized withdrawal approval on file. Samantha processes the sales coordinator's debit card information and receives a notification in cases where there were insufficient funds on the next business day. If a debitor credit card payment was not processed successfully, the purchase order is passed to the customer service representative for further follow-up. Once new credit card or debit card information is obtained from the sales coordinator, the paperwork is passed back to Samantha for completion of payment Sometimes, sales coordinators refuse to provide a valid credit card number until they receive the goods. Samantha has still not been able to collect some of the sales coordinators' outstanding balances. It is estimated that 3% of the sales will not be paid for by the sales coordinators. For 2020, CCC earned a gross profit of $8.8 million and a net loss of $997,000 after recording a net loss from discontinued operations of $2.1 million. The Controller, who does not have an accounting designation, has always prepared CCC's accounting records. CCC has a purchase contract with Big-Time Fabrics (BTF). The purchase contract requires CCC to purchase 5,000 yards of fabric from BTF monthly at a rate of $8 per yard. The contract began on January 1, 2020 and expires on December 31, 2022. Prices for fabric have declined since year-end and the same fabric could now be purchased at a market price of $6.50 per yard. However, CCC plans to discontinue the product that uses this fabric effective February 28, 2021 and has no other use for the fabric. CCC will have used all fabric on hand as of February 28. The contract contains a termination penalty of $200,000. Even though this will not impact the current year-end, CCC has asked us to explain the accounting for the contract after the discontinuation date and the audit partner would like you to provide procedures for next year's audit . CONTEMPORARY CLOTHING CO. (Suggested time: 120 minutes) Contemporary Clothing Co. (CCC) was established in 1998 by two good friends, Aaliyah Morgan and Melissa McIntyre. At that time, Aaliyah and Melissa had just graduated from one of the Ontario fashion design schools and decided to apply their passion for fashion to an entrepreneurial setting. They created their own garment patterns and sewed them at home. Since they had no funds to open any stores, Aaliyah and Melissa distributed the garments between friends, family and members of their local community. CCC quickly became well-known for its unique fashionable wear. CCC remains a direct selling company. All of the garments are distributed by the company's sales coordinators and are not available in stores. Typically, sales coordinators hold presentations at their friends' homes and show the guests how to put an entire wardrobe together with just a few CCC items from the most current collection. Melissa and Aaliyah are still both actively involved in managing the business. However, they are now considering retiring from the fashion industry as the intense competition has made it too stressful. The founders have already contacted an American private investor who is well known for buying Canadian companies and merging them with their American counterparts in his portfolio. He indicated that he may be interested in purchasing CCC but would need to examine the audited financial statements before he pursues it any further. Green, Gibbons & Gaston LLP (GGG) were recently appointed auditors for the December 31, 2020 year-end. You, CPA, have been assigned as the audit senior for the engagement. It is now February 25, 2021 and Allie Green, the engagement partner, calls you into her office and says, "I need you to prepare an audit engagement planning memo for the CCC audit. This will be the first time that CCC has been audited or reviewed. Please address any accounting issues that we need to discuss with the client. Provide your recommendations on the appropriate accounting treatments to be used and suggest appropriate audit procedures to be performed pertaining to these issues. CCC uses International Financial Reporting Standards. "You need to prepare a separate draft report to Melissa and Aaliyah for my review that identifies any internal control weaknesses and how to fix them io order to help maximize the value of CCC. The founders mentioned that they were concerned about the number of sales coordinators leaving and how the sales coordinators are supervised. They want your advice on how to deal with those concerns." The engagement partner provided you with some background information on CCC's operations (Appendix 1), notes from her meeting with CCC's Director of Sales (Appendix II), information about the company's on-line ordering system (Appendix III) and additional information she obtained from the company's bookkeeper (Appendix IV). APPENDIXI BACKGROUND INFORMATION ON CONTEMPORARY CLOTHING CO. OPERATIONS Fashion Shows CCC has two seasons: spring/summer and fall/winter. The spring/summer season commences on March 1 and the fall/winter season commences on September 18 A new collection is previewed by the sales coordinators several months before the start of the season. The CCC fashion show for the spring/Summer 2021 collection was held in October 2020. At the fashion shows, all sales coordinators are invited to attend workshops on entrepreneurship, selling strategies and business development ideas. However, these workshops are not mandatory. Revenue The company's sales coordinators purchase garments at a discount and then resell them to customers at full price, which is set by CCC. The sales coordinators' discounts vary from 15% to 45%. All discounts are approved by CCC's Director of Sales on an annual basis based on pre- defined criteria. Revenue is recognized upon order by the sales coordinator. All sales are final as sales coordinators cannot return any of the goods shipped. CCC has responsibility for ensuring shipments are received by the sales coordinators. Inventory All inventory items are held in stock at original cost for a period of 24 months. At the end of that period, any unsold inventory is written off and donated to local charities. Total sales for 2020 were $12,706,700 and the year-end inventory balance was $1,500,000. A total of 90 percent of sales in 2020 related to the 2020 fall/winter and the 2021 spring/summer collections. Inventory is accounted for on a first-in, first-out basis. High Health Limited (HHL) In 2018, CCC partnered with HHL, a popular retail chain that specializes in natural health food and diet supplements. With a purchase of over $200 of CCC merchandise, customers were eligible for a discount on the HHL products sold through the CCC's website. CCC purchased the products from HHL at warehouse prices, stored them on its premises and sent the products to the customer upon receiving the order. This venture became a significant portion of CCC's business. Despite actively promoting HHL products, CCC had to write off a major portion of its HHL inventory in the current year as all the products are made from natural ingredients and are highly perishable CCC decided to discontinue all operations related to HHL products as of November 1, 2020 and reported related expenses, net of revenues, as discontinued operations in the income statement. HHL convinced Melissa and Aaliyah to keep the promotion on their website with a link to the HHL website. HHL processes the orders once received through the website and ships them directly to the customer. CCC estimates the commission fees received from HHL will comprise 2% of total CCC's revenue in 2021. APPENDIX II NOTES FROM MEETING WITH SUZANNE HIL SDEN, DIRECTOR OF SALES CCC places a great emphasis on its sales force, as the sales coordinators are the core of the company's business model. Suzanne explained that there are many benefits to joining the CCC sales force, especially for 'stay-at-home' mothers: a flexible schedule, no start-up fixed costs, no requirement for sales or fashion experience, and no pre-defined quotas. Sales force members are responsible for providing and covering the costs of their own automobiles, laptop, and cell phone. Once recruited, each new sales coordinator is awarded a contract to provide sales services for CCC for an indefinite period of time. They are expected to begin holding presentations at their friends' homes as quickly as possible. There is frequent travel required and sales coordinators need to be able to transport numerous sample items. As such, access to an automobile is mandatory. Furthermore, they are not provided with CCC business cards, email addresses, nor use of CCC's office facilities. Suzanne circulates a survey to all sales coordinators annually that includes quantitative and qualitative information, such as feedback from end-users and best practices for selling. Her assistant summarizes the results of the survey but Suzanne has not had any time to review the information for 2020. Some of the quantitative information gathered from the survey is presented below: 2020 2019 Number of coordinators 898 943 1,205 Average number of years of service 3.6 7 7.3 On January 1, 2020, Suzanne implemented an incentive program for news coordinators. They are now allocated $20,000 when they join to be used for any business development expenses related to establishing their own clientele, excluding the purchase garments from CCC for resale and the costs related to automobiles and communication devices. The sales coordinator is required to summarize her business development expenses and present all supporting receipts for reimbursement of the $20,000. The company's bookkeeper, Samantha Allen, issues a cheque for $20,000 to the sales coordinator upon receipt of the summary. When she has time, reviews the summary and matches all the expenses to the accompanying receipts. Since the start of the incentive program, Samantha has received 252 packages and has only had time to review 167 of them. 2018 APPENDIX II (continued) NOTES FROM MEETING WITH SUZANNE HIL SDEN, DIRECTOR OF SALES As part of the flexibility offered by CCC, all sales coordinators set their own goals in the beginning of the fiscal year and need to report those to the Director of Sales. They include total sales volume, number of home presentations to be held, and number of new sales coordinators brought into the business. Suzanne's responsibility is to approve the goals and notify the sales coordinator if any of them are deemed to be inappropriate. She received the 2021 goals from all the sales coordinators by January 1, 2021 but still has not had the time to review and approve some of them. Suzanne explained that CCC recently moved towards greater efficiency and effectiveness of operations, as recommended by an external consultant, and eliminated 25% of its management staff which put an additional pressure on Suzanne's workload. Suzanne could not remember any instances where she would not approve coordinators' goals and objectives as it is really up to the sales coordinators to set their own pace. APPENDIX III ON-LINE ORDERING SYSTEM Sales coordinators make all their orders on-line by filling out an order form. The order form allows sales coordinators to input their information into preset fields (e.g., first name, last name, shipping address, phone number, discount percentage, number of garments of each style). All the sales prices are populated automatically by the website. Purchases can be paid for by credit card. The sales coordinator enters her credit card information using pre-defined pull-down menus (e.g., credit card type, credit card expiry date). CCC uses Payment Link to process credit card payments. If the credit card number corresponds to the personal information provided, the transaction is accepted. CCC receives a weekly report from Payment Link that lists all of the transactions processed. The website is automatically linked to CCC's accounting application. All communications between the CCC website and Payment Link are encrypted. A weekly deposit is made of all credit card payments processed by Payment Link. . APPENDIX IV INFORMATION OBTAINED FROM SAMANTHA ALLEN, BOOKKEEPER Suzanne's assistant prints out the orders from the website every morning and passes one copy to the bookkeeper and another copy to the warehouse shipping coordinator. Once the order is assembled, which usually happens on the same day, goods are shipped to the sales coordinators and revenue is recognized in the system. Samantha processes all orders immediately after she receives them from Suzanne's assistant Sales coordinators can choose to pay with a debit card. They select this option on the on-line order form. In ordec to pay with a debit card, the sales coordinator would need to have a pre- authorized withdrawal approval on file. Samantha processes the sales coordinator's debit card information and receives a notification in cases where there were insufficient funds on the next business day. If a debitor credit card payment was not processed successfully, the purchase order is passed to the customer service representative for further follow-up. Once new credit card or debit card information is obtained from the sales coordinator, the paperwork is passed back to Samantha for completion of payment Sometimes, sales coordinators refuse to provide a valid credit card number until they receive the goods. Samantha has still not been able to collect some of the sales coordinators' outstanding balances. It is estimated that 3% of the sales will not be paid for by the sales coordinators. For 2020, CCC earned a gross profit of $8.8 million and a net loss of $997,000 after recording a net loss from discontinued operations of $2.1 million. The Controller, who does not have an accounting designation, has always prepared CCC's accounting records. CCC has a purchase contract with Big-Time Fabrics (BTF). The purchase contract requires CCC to purchase 5,000 yards of fabric from BTF monthly at a rate of $8 per yard. The contract began on January 1, 2020 and expires on December 31, 2022. Prices for fabric have declined since year-end and the same fabric could now be purchased at a market price of $6.50 per yard. However, CCC plans to discontinue the product that uses this fabric effective February 28, 2021 and has no other use for the fabric. CCC will have used all fabric on hand as of February 28. The contract contains a termination penalty of $200,000. Even though this will not impact the current year-end, CCC has asked us to explain the accounting for the contract after the discontinuation date and the audit partner would like you to provide procedures for next year's audit