Harrison & Ford, Chartered Accountants

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Commissions

In the Exhibit 4, The recession in the economy leads to the decline of sales in 2010. Mitchejm Lethbridge paid the sales commissions based on projected 2011 sales. The commission expense, $12,000 was recognized at the end of 2010 based on the projected sales of ($150,000) for January, in 2011. This is a managerial decision assists in planning and controlling performance, the company can select any policy for commissions to base off.

However, according to GAAP (2017, IFRS 15, B36), “An entity's fee or commission might be the net amount of consideration that the entity retains after paying the other party the consideration received in exchange for the goods or services to be provided by that party.” Moreover, the matching principle states that all expenses must be matched in the same accounting period as the revenues they helped to earn. For Mitchem Lethbridge, it is possible for the commissions to be realized in 2010, however, the expense should be recorded in 2011 when the sales incurred.

Lease

Mitchem Lethbridge was considering moving offices in 2010. They found a new lease opportunity and according to Jeff the prospective move seemed likely at the end of the 2010 year. Moving to the new building would mean breaking the current leasehold agreement which would result in a penalty to Mitchem in the amount of $18,000. This amount was recorded as a loss even though the payment had not yet been paid. Jeff, in keeping with the principle of faithful representation, may have believed that the probability of this payment being realized was high enough to be recorded on the 2010 statements.

According to ASPE 1510.08 a liability include amount payable as a result of a past event. The $18,000 penalty therefore does not qualify as a liability since the event has not yet occurred. We believe that this should have been considered a contingency and only a note disclosure should have been provided on the 2010 income statement.

In 2011, when it became apparent the company would not be breaking its leasehold agreement, Jeff reversed the accrual in 2011. We believe that since the problem had roots in 2010, and the financial statements were not prepared until February 2011, the 2010 statements should have been adjusted instead.

Amortization

Jeff wrote off the leasehold improvements and charged it to amortization in 2010. The rationale behind this was that they were improvements made to the leased space that they were planning on leaving. This move would make the improvements useless to the company and thus they were added to amortization in 2010. There is no evidence in a reversal of this write off in 2011. These leasehold improvements, according to ASPE (REFERENCE), should have been treated in the same manner as we suggested the leasehold breakage fee should have been treated. In 2011, when it was clear that the company would be staying in the current leased space, the 2010 financial statements should have been adjusted. This includes the depreciation expense from the write off of the leasehold improvements.

Sales Revenue

In 2011, there were many efforts made in order to increase sales for the year. This included the company offering sales discounts in January and December of 2011 for bulk purchases. This is a business decision and is allowed under ASPE; However, in order for the company to be able to recognize the sales from January and December of 2011, the product must have been delivered in that year (ASPE REFERENCE).

It should be noted that encouraging bulk purchases in one year would hinder the company’s ability to project sales, inventory amounts, and cash flows in the future. As a result of customers ordering product for multiple months at a time, the sales in the early months of 2012 would be lower because the customers would not need to reorder during that time. While this is acceptable under ASPE, this might not comply with the spirit of the competition. The competition is intended to reward an improvement in performance, not for one year, but presumably on an ongoing basis. While 2011 sales for the franchise may have been high, 2012 sales dropped (this is shown in exhibit V). This, therefore, is not consistent with an improvement in overall performance of the franchise.

As well, the total monthly sales from 2011 as shown in exhibit V total $1,288,500 and yet revenue for 2011 is recorded on the income statement as $1,306,500. This is a difference of $18,000. We are not given enough information to conclude where this extra $18,000 has come from, but it is possible the leasehold agreement payment reversal from 2010 was included in revenue as the reversal is not shown elsewhere on the statement. We would like to see supporting documents that show the controller’s calculation of sales revenues.

Conclusion & Suggestions

As you requested, we have come to the conclusion that an audit is needed. The treatment of many items, as outlined above, do not comply with ASPE rulings. We have included a quantified table outlining the effect on net income reversing the treatments that do not comply with ASPE regulations. You will notice that according to our findings, Mitchem Lethbridge should not have won the competition. In addition, there were many things, such as a change in manager compensation type and bulk order incentives that appear to have been done to manipulate net income for 2010 and 2011. This is not consistent with the spirit of the competition and we would recommend that new rules are added in the future to prevent these types of manipulation.

We have included a summarized table that few items have effect the income statement that do not comply with the GAAP, tax loss carryforward, Inventory write-off, prepaid commission, etc. In addition, there were other treatments that have manipulate the net income and against the spirit of the contest, such as dividend payment, bulk sales etc. In conclusion, an audit is needed. Mitchem Lethbridge should not have won the competition, According to our calculation in Appendix 1,

And we would recommend to the head office that new guideline and clear rules are needed to prevent these unethical conduct, and

As well, we would like to suggest some more appropriate ways for the company to determine the improved performance of the franchises instead of using solely a percentage increase in net income. Many companies choose to measure performance based on a combination of areas. These could include gross margin, customer service, efficiency, cash flows, and more.