Lux Hotel Co. (the “Company”) is a private company that operates luxury hotel properties. It was noted that the company is head quartered in Dubai, and its main hotel is operated on the Palm Island in Dubai. The company seeks tourists from around the world to visit but primarily relies upon tourism from Western Europe (UK, France, Germany), and USA/ Canada. The company has only been around for three years and was launched by Abdullah Mohammad, a former graduate of Queens College. Abdullah worked at PwC after he graduated and eventually became partner at the big 4. He used to audit clients in the hotel and entertainment industry. After 20 years with the firm including eight years as partner he was able to use his own savings for a down payment of his lifelong dream to run a resort hotel. Lux Hotel Co. was founded in 2015 by Abdullah and a few friends. They obtained a $43.5 million dollar loan and had just enough for the down payment and collateral. Since 2015 in addition to the main resort property in Dubai the Company also purchased a smaller resort in Miami, Florida in 2017. In December 2018 the company started trading on the NASDAQ stock exchange under a special provision that allowed small companies to list without having to have an audit over internal controls performed (ICFR), and without all the compliance and expense of a large corporation. Operations of the Business The Company is still run like a start up with a small team of employees. Abdullah serves as the CEO. The CFO as Mikael Yahyah who graduated from Baruch with an MBA and had 1 year of work experience at Deloitte & Touche as an associate before starting with the Company. Mikael is Abdullah’s cousin. The Company does not have a formal Board of Directors or Audit Committee, but plans to have one in the future. The rest of the management team consists of five-ten employees from various backgrounds and countries. Many have some experience at other Hotel chains like Marriott or Hilton. The firm has 10 bullet points written by Abdullah on a single piece of paper that is posted in the breakroom that serves as the Code of Ethics. The employee turnover rate has historically been low but has recently reached 25%. A small Management team is in Miami (2 people, but the rest of the team is based in Dubai). The Manager of the Miami property quit three months ago and a replacement has not been found yet. Note the company outsources hiring of maids/janitors/front desk staff to an outsourcing company from the Phillipines. Those workers are considered freelancers and are paid an hourly wage. These employees focus on their respective tasks but do not participate in the management team. The outsourcing handles payroll to workers and receives a pro-rated fixed monthly payment for providing staff. The Company partners with various travel websites like AirBnB, Hotels.com, Travelocity.com, and various travel agencies to attract customers. The company uses a Salesforce cloud based accounting & operating system to record all journal entries, and operations such as booking hotel reservations, cancelling reservations, sending reminder e-mails to guests, generating invoices for guests, etc. The system was launched in January of 2019 and the employees are still getting used to it. The system before this was QuickBooks and excel spreadsheets and required a much more manual process. Key Controls Some of the key controls the company has are: C01- The Management team CEO/CFO- meet with the managers of both properties on a weekly basis using Skype and discuss both operations (vacancy rates, customer satisfaction, staff hiring/firing). C02- The Outsourcing Company sends supervisors to check on the performance of the staff monthly. Any performance issues are resolved and updates provided to the Company monthly. C03- The CFO- performs a Bank Reconciliation on a weekly basis. (WEEKLY CONTROL) C04- The CFO prepares financial records on a monthly basis to share with the CEO/ Investors and the management team. (MONTHLY CONTROL) C05- A staff accountant prepares cash flow projections that The CFO monitors/reviews, and makes sure there is sufficient cash to pay the loan and staff salaries, etc. (MONTHLY CONTROL) C06- A staff accountant and the CFO prepare the Financial Statements which are reviewed by the CEO, and shared with the banks, Investors, and the management team. (ANNUAL CONTROL) C07- A Staff Accountant handles all vendor invoice payments, writing checks, depositing cash, recording journal entries in the Sales Force software. (DAILY CONTROL) C08: The Company receives a SOC 1 report from Sales force that shows testing of the IT system by a third party auditor. This helps the company get comfortable that the Salesforce IT system is operating as expected. (ANNUAL CONTROL) Recent Default on Loan As of June 30, 2019, Lux Hotel Co. had $43.2 million in uncollateralized term loans outstanding with two lenders, Bank A ($12.96 million) and Bank B ($30.24 million). As a result of lower than expected travel during the holiday season, the company was not be able to meet the short-term requirements of the Debt and ended up in default. However upon futher investigation it was noted the shortfall was primarily caused by the Company projected a short-term cash flow shortage for Q2 but because the staff person entered a typo into the cash flow spreadsheet ($900,000 instead of $90K of revenue from the Miami Resort) and the CFO did not review the cash projections on a timely basis (within 5 business days) because he was on vacation, for three weeks, (he also missed the error when he reviewed it upon his return). It was determined that Control C05 was not executed correctly. After the fiscal year end on June 20, 2019 the Lux Hotel Co. restructured and amended the Original Debt (the “Restructuring”) with Bank A. As part of the terms of amending the Original Debt: The Company sold its 50 percent investment in the Miami Resort in exchange for $25.0 million, which was used to pay down the loan balance. This reduced the Original Debt balance from $43.2 million to $18.2 million. The Company agreed to new interest terms, which included raising the interest rate from 5 percent to 6 percent. The Original Debt required annual payments consisting of principal and interest of $1.68 million and $3.92 million to Bank A and Bank B, respectively. The Company performed a quantitative analysis of the Modified Debt and determined that the effective interest rate was approximately 6.45 percent and 8.78 percent for the Modified Debt held by Bank A and Bank B, respectivelyUsing Illustration 8.8: “Example of an Extent of testing table,” Calculate how many instances of the control would normally have been tested for control C05? Use your answer to Q1 above to determine if you will seek:

(a) Reasonable Assurance from tests of controls;

(b) More than limited Assurance from Tests of Controls; or

(c) Limited Assurance from Tests of Controls. Look at the facts above to determine the frequency of control C05.

More Assurance Less Assurance Reasonable Assurance from Tests of Controls More Than Limited Limited Assurance Assurance from

1. 1. What is the auditor’s responsibility with respect to the error discussed above (Incorrect cash flow projection and the control C05 not working)?

The company follows with manual testing. As an audit,

2. 2. Would you report this to the (a) Those Charged with Governance of the Entity/Management? (b) Management? (c)The SEC? (d)The PCAOB? (e)The police? Explain why briefly.

3. 3. Should the CFO be fired? Why or why not?