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, respectively.

Industry Outlook

• The Fed has been raising interest rates and it might be difficult to raise additional funds at a low interest rate if funding is needed in the future.
• The economy in Dubai has been declining in the last 12 months based on a drop in tourism.
• Prices of oil have made it more expensive for tourists to take a flight around the world.
• Tourism around the world is dropping based on the China-US trade war, a popping of the real estate bubble that almost doubled prices around the world in the last 15 years.
• The President of the US has recently threatened Dubai with sanctions if they do not approve his new hotel there.

Financial Statements (Excerpt)

Account

July 1, 2019***

June 30, 2019

June 30, 2018

June 30, 2017

Assets*

$25m***

$48.5m

$50m

$50.9m

Liabilities**

$18.7m

$43.9m

$43.7m

$43.8m

Equity

$6.3m

$3.6m

$6.3m

$7.1m

Revenue

TBD

$2.95m^

$3.0m

$3.1m

Expenses

TBD

$2.80m

$2.7m

$2.6m

Net Income/ (Loss)

TBD

$150K

$300K

$500K

*Assets consist primarily of cash, land/buildings, other assets.

** Liabilities consist primarily of the Long Term Debt discussed above and accounts payable.

***Projected 12 month figures based on the partial Sale of the Miami property to pay down the loan.

^Error of $810K from cash flow projection still not corrected in this number.

REQUIRED

1. Were the financial statements materially misstated because of the control deficiency? ((a)Yes or (b)No) Briefly explain why.
2. What is the auditor's responsibility with respect to the error discussed above (Incorrect cash flow projection and the control C05 not working)?
3. Would you report this to the (a) board of directors/Management? (b)The SEC? (c)The PCAOB? (d)The police? Explain why briefly.
4. Should the CFO be fired? Why or why not?