MEL'S GROCERY INC.

Mel's Grocery Inc. (MGI) owns and operates a chain of six grocery stores located throughout Nova Scotia. The stores are located in rural communities and MGI's head office is located in Halifax. Due to the fact that MGI stores provide jobs within small, rural communities and MGI's head office has a policy of employing individuals coping with mental and physical disabilities, MGI receives some grant funding from the Nova Scotia Department of Community Services (DCS). DCS requires that MGI's financial statements be audited each year. Details of the grant funding agreement between MGI and DCS are included in Exhibit I.

EXHIBIT I

(excerpts from)

GRANT FUNDING AGREEMENT BETWEEN: MEL'S GROCERY INC (MGI) AND NOVA SCOTIA DEPARTMENT OF COMMUNITY SERVICES (DCS)

Clause 2: On an annual basis, DCS will reimburse MGI for 10% of the total salary and wage expenses incurred by the six grocery stores. The following condition must be met in order to receive the above reimbursement:

At least 30 individuals in total must be employed on a full-time basis by the six MGI grocery stores.

Clause 3: On an annual basis, DCS will reimburse 50% of salary and wage expenses paid to employees who are coping with physical or mental disabilities. Any physical and mental disabilities must be documented by a medical doctor.

Clause 5: Salary and wage expenses per the audited annual financial statements will form the basis for the reimbursement calculations. Detailed records must be kept for salaries and wages such that a DCS auditor can easily track what was reported as salaries and wages for the different categories of employees (i.e., employees with mental or physical disabilities must be tracked separately). MGI is responsible for calculating the reimbursement owing and submitting the claim to DCS within 60 days of each fiscal year-end.

Clause 6: A DCS auditor may be assigned to audit MGI's reported salary and wage expenses without notice. Any abuse discovered in the preparation of a reimbursement claim will result in a cancellation of this agreement.

You have been the auditor of MGI for many years and have a good working relationship with MGI's sole shareholder, Mel Marcus. You admire Mel's integrity and commitment to improving his community and are impressed with how MGI's corporate culture reflects Mel's core values. You recently met with Mel to discuss the upcoming audit for the year ending February 28, 2019. Notes from your meeting, which took place on March 25, are as follows:

• Mel hired a new manager of accounting in November of 2018. Marci Lucas is a professional accountant and is now in charge of accounting and finance for MGI. Marci has already made some year-end adjustments to the financial statements so that everything is in good shape for the visit from the auditors. (These journal entries, which include Marci's supporting notes, are in Exhibit 2.)

EXHIBIT II

MARCI'S ADJUSTING JOURNAL ENTRIES FOR THE YEAR ENDING 28 FEBRUARY 2019

AJE#1:

Estimated loss on purchase commitment	5,000
Estimated liability on purchase commitment		5,000

Supporting notes: MGI grocery stores entered into a purchase contract with a local lobster fisherman in fiscal 2019, when the price of lobster was $4.05 per pound. Per this contract, MGI committed to buying 10,000 pounds of lobster in December of 2019 (fiscal 2020) at a price of $4.05 per pound. Unfortunately, lobster prices have been dropping and are currently at an historical low of only $3.80 per pound. If lobster prices stay low, MGI will be forced to pay more than market price for its lobster. This is likely to happen due to the recession our economy is currently facing. To be conservative, my calculation of the loss we will realize on this contract factored in a price that is 25 cents per pound below the current price of $3.80.

AJE#2:

Salaries and wage expense	14,000
Repairs and maintenance expense	15,000
Building		29,000

Supporting notes: During the year, a lot of work was done to the head office building. This was capitalized in asset accounts by the MGI bookkeeper. However, it is better classified as expense for the period. Details as to the costs incurred are as follows:

The building roof was reshingled at a cost of $12,000. The shingles are made of tin, and cost more than standard shingles but the roofer assured me the extra cost would be worth it as tin shingles do not need to be replaced as often as regular shingles. It was good that we completed this repair as the roof was leaking prior to fixing it. Additional insulation was added to the building at a cost of $7,000. We also had the exterior of the building repainted at a cost of $10,000. Of the total cost incurred of $29,000, I recorded the portion relating to the labour charges as salaries and wage expense and the portion relating to materials used as repairs and maintenance expense. I believe this will better reflect how much we spent on actual materials versus the labour for the trades people hired to perform the work.

AJE#3:

To be determined

Supporting notes: The reimbursement for eligible salary and wages expenses for fiscal 2019 has yet to be prepared. I have been too busy with my other responsibilities to prepare this calculation. I plan to turn my attention to this in late April, in the 2020 fiscal year, after I have the audit behind me and the financial statements are issued.

(Laura Cumming)

• Mel, who knows little about accounting, has recently been taking an on-line accounting class to help him develop a basic understanding of ASPE and financial reporting requirements. He is currently learning about accounting for bad debts and thinks that MGI should switch to the allowance method. He knows that the direct write-off method has been used in the past and is surprised that you (as his auditor) have signed off on it since this method is not recommended per ASPE. He would like you to explain your position on this issue.
• Mel is in the process of designing a bonus plan for MGI employees. The bonuses paid will be based on earnings of MGI. The tentative bonus calculation will call for all earnings before taxes and bonuses in excess of $100,000 to be paid out as bonuses. The first bonus will be based on next year's reported earnings before taxes and bonuses (i.e. earnings for the year ending February 28, 2020.) Mel believes this calculation will result in a generous bonus pool since MGI's earnings before taxes historically averages $200,000$250,000.

Required:

Prepare a memo to your client analyzing any financial reporting and other issues you identify. Identify any additional information you will need from your client to resolve these issues.