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Uniform Evaluation Report — 2003 155

Paper III- SIMULATION 2 (90 minutes)

You, CA, and your supervising partner met with the new Minister of Economic Development for the
Northwest Territories (NWT) last week. The Minister selected your firm to do the assurance work on an
economic development loans program targeting the tourism industry (the Program) and the meeting was
arranged to discuss the work to be performed. Details of your discussion with the Minister are in Exhibit I
and a description of the Program is in Exhibit II. You and your supervising partner subsequently met with
the Vice-President Special Loans for NWT Credit Union, the administrator of the Program, to discuss the
administration details. During the meeting with the vice-president, you made notes. They are included in
Exhibit III.

On returning to the partner’s office after the second discussion, she tells you that she must leave you on your
own for a short while as she has a conference call scheduled with another client. She asks you to review the
information collected during the meetings and draft a memo to her that deals with the issues raised by the
Minister.
156 Appendix C —Paper III

Paper III- SIMULATION 2 (continued)

EXHIBIT I

EXCERPTS FROM DISCUSSION WITH THE MINISTER OF ECONOMIC DEVELOPMENT

The Minister explained that he is newly appointed to the position and therefore still becoming familiar with
his duties. He explained that, recently, the success of the Program has been challenged by the Opposition in
the Territorial Legislature as a result of an article in one of the national newspapers. The Opposition has
alleged that the Program does not grant loans to as wide a variety of businesses as it should and is
exaggerating the number of jobs it has created. The Minister wanted to satisfy himself as to whether the
comments had any foundation and met with the managers of NWT Credit Union to take a closer look at the
Program.

“Besides the comments made by the Opposition, which I am going to discount on the basis that they are
purely political, I have my own concerns about the Program. The first, concerns the repayment basis
specified in the loan agreement. I’m not so sure that annual net cash flow is the right basis on which to
calculate the repayment owing to the Territorial government. Here we are, over a year into the program, and
the government has yet to receive any interest payments. It’s one thing for the government to support
business through its loan programs but we should expect some sort of return on the loans we advance.

“One of my other concerns is the level of expenses charged to the program by NWT Credit Union. The
expenses seem high. I am also somewhat baffled by the latest unemployment figures for the region
considering all the positive comments I have received from members of the Program’s Board. The Board
members claim the Program has created 2,500 jobs since it began. However, this appears inconsistent with
the latest unemployment figures for the region that show an increase in the unemployment rate. I’ve asked
the Board to look into the matter further since they couldn’t offer me any documentation to support their
figures. Apparently, they are spending all of their time reviewing and approving loan applications.

“Having told you my concerns, I still believe the Program is successful. The economic indicators obtained by
my department show an increase in the number of tourists travelling through the area. That must mean the
Program is working, and that makes me happy. Of course, I will still have to deal with the Opposition’s
comments during the next session.”

After explaining his concerns, the Minister restated his objective of evaluating the success of the Program.
He thinks that an audit of the expenses of the Program is a good starting point and asks for our opinion.
He would like to know what type of assurance reports our firm could provide to help him evaluate the
Program.

Additionally, the Minister noted that, since the program has only been operating for 18 months and in light
of the comments made by the Opposition, he is still looking for any suggestions on how to evaluate the
success of the Program and improve its conditions. On a go-forward basis, he is also interested in
procedures and processes that could be implemented at the Board and Ministry level.
Uniform Evaluation Report — 2003 157

Paper III- SIMULATION 2 (continued)

EXHIBIT II

EXTRACTS FROM A DESCRIPTION OF THE NEW ECONOMIC DEVELOPMENT


LOANS PROGRAM

The Program is a special government-sponsored loans program that started on January 1, 2002, and targets
the tourism industry. The main objectives of the Program are to create jobs and to generate long-term
economic growth through the development of new business in the NWT. Priority is given to companies
operating in the lodging, amusement, retail, restaurant, fishing, or hunting sectors. The Program has been
approved for a five year trial period. It will not be continued beyond five years if it proves to be too
expensive to run. The Program has been operating for 18 months.

The government has contracted NWT Credit Union to administer the Program, rather than establish its own
administration. The basis for the decision was that it would be more cost effective to use an organization
with existing systems and experience, and NWT Credit Union already had a good network of branches in the
Northwest and Yukon Territories.

To monitor the Program and ensure that the Minister’s objectives are met, an eight-member Board of
Directors was appointed by the government. The Board consists of two members of NWT Credit Union‘s
senior management, four government representatives, and two independent businesspersons.

Terms and conditions of granting a loan:

The qualifying client (debtor) is entitled to a maximum loan of $500,000 to assist with the establishment of a
new business or the expansion of an existing business that:

1. Generates investment of two times the loan amount through an existing or new business. The
business must be commercially viable for the region;
2. Creates employment in the region of one job for each $25,000 of government loan principal. The
employment positions must be created within 18 months after receiving the loan;
3. Provides a detailed multi-year business plan that identifies what the funds will be used for and the
anticipated results (i.e., increased employment, revenue, expansion, etc.); and
4. Remains in the region for a minimum period of three years.

The administrator’s traditional lending criteria are applied during the approval process. The Board gives
greater weight to the first two conditions.
158 Appendix C —Paper III

Paper III- SIMULATION 2 (continued)

EXHIBIT II (continued)

EXTRACTS FROM A DESCRIPTION OF THE NEW ECONOMIC DEVELOPMENT


LOANS PROGRAM

Terms of repayment:

Interest will be charged on the outstanding loan balance at 10% per annum.

Principal and interest payments are based on the annual net cash flow of the debtor. If the cash flow is zero
or negative, no payment is required. If a positive cash flow is generated in any one year, the payment will be
50% of the cash flow generated. Payments will be applied to the interest before being applied to the principal
portion of the loan.

After five years, 25% of the loan balance is repayable. The other 75% of the outstanding loan balance, plus
all accumulated unpaid interest, is forgiveable if the conditions of the loan are still met and all the jobs
created are still in place. Otherwise, the outstanding balance must be repaid at that time.

Loan recipients are required to submit annual financial statements to the administrator of the Program.
Uniform Evaluation Report — 2003 159

Paper III- SIMULATION 2 (continued)

EXHIBIT III

NOTES ON ADMINISTRATION OF THE PROGRAM

1. All aspects of the Program are administered by NWT Credit Union. This includes all procedures related
to due diligence, documentation, submissions for approval, tracking of payments due, collections,
registering and release of security, etc. The Program is administered using the existing systems and
procedures of NWT Credit Union, except for the approval process and some other changes described
below.

2. NWT Credit Union is entitled to charge the government, on a monthly basis, all reasonable expenses
associated with administering the Program directly to the Program in accordance with the
Administration Agreement. In addition to being reimbursed for its expenses, NWT Credit Union
receives a fee for service. The fee is calculated based on a percentage of the initial loan amount granted
using a sliding scale that increases with the size of the loan. The fee ranges from 5% to 20%.

3. Recommendations for approval of a development loan are based on the economic development
criteria specified by the Minister‘s office, in addition to the financial analysis and credit checks
normally performed by NWT Credit Union. The recommendations for approval and rejection are
presented to the Board of Directors of the Program. The Vice-President, Special Loans complained
that, in some cases, NWT Credit Union‘s recommendation to reject a loan application was ignored by
the Board. The Board granted such loans because the most essential of the program criteria, creating
jobs, was met, even though the applications did not meet the specified investment generation
requirements of the Program. In other cases, while the financial results were positive and the loan
was recommended by NWT Credit Union, the loan was denied by the Board, apparently on the
grounds that it was not specifically tied to developing the tourism lodges niche. The Vice-President
is wondering why the Minister has bothered to put an administration agreement in place where NWT
Credit Union is responsible for the administration of the loan if the Board can simply overrule the
decisions. He is particularly upset by the cases where the applicants meet all the criteria and are still
turned down.

4. Several restaurant and retail gift shop owners have complained to NWT Credit Union after being
refused a development loan by the Board. They believe they meet the program requirements in the
same way as the tourism lodges, but for some reason they are being prevented from sharing in the
Program. Two restaurant owners have filed formal complaints with the Minister’s office.
160 Appendix C —Paper III

Paper III- SIMULATION 2 (continued)

EXHIBIT III (continued)

NOTES ON ADMINISTRATION OF THE PROGRAM

5. The NWT had been trying to attract new businesses for the past decade with little success. The Program
seems to be helping, especially with the increase in the number of tourism lodges. The area is starting
to gain a reputation for having excellent fishing and hunting packages that are worth the extra travel
time and cost. There is talk of several companies setting up a permanent “eco-village” to draw more
tourists from the United States and Europe. These companies are even talking about setting up
permanent offices to better manage the eco-village joint venture.

6. A separate, self-balancing general ledger and a development loans sub-ledger were established to
account for the Program. Normally, NWT Credit Union‘s computer system automatically accrues
quarterly interest on a loan based on the interest rate in effect for that loan. This accrual feature has
been adjusted for the Program so that the interest calculation is based on a client’s projected cash flows
and the maximum interest payment. Actual client cash-flow results are just starting to become
available. The Vice-President stated that the reported results are, in fact, much lower than the clients
had projected.

7. NWT Credit Union permitted our firm to contact their auditor to obtain their internal control and
systems documentation. The information obtained supports the existence of good segregation of
duties and strong internal controls.