W&S Partners began the planning phase of the Cloud 9 audit. As part of the risk assessment phase for the new audit, the audit team needs to gain an understanding of Cloud 9's structure and its business environment, determine materiality, and assess inherent risk. This will assist the team in developing an audit strategy and designing the nature, extent, and timing of audit procedures.

Required
Answer the following questions based on the additional information about Cloud 9 presented in the appendix to this text and the current and earlier chapters. You should also consider your answer to the case study questions in earlier chapters where relevant.

Your task is to research the retail and wholesale footwear industries and report back to the audit team. Your report will form part of the overall understanding of Cloud 9's structure and its environment.

You should concentrate your research on providing findings from those areas that have a financial reporting impact and are considered probable given Cloud 9's operations. Use the factors listed in Illustrations 4.2 and 4.3 as a guide for your research.

Part 2: 

Required

Answer the following questions based on the information presented for Cloud 9 in the appendix to this text and the current and earlier chapters. You should also consider your answers to the case study questions in earlier chapters.

a. Using analytical procedures and the information provided in the appendix, perform an analysis of Cloud 9's financial position and its business risks. Discuss the ratios indicating a significant or an unexpected fluctuation.

b. Which specific areas do you believe should receive special emphasis during your audit? Consider your discussion of the analytical procedures results as well as your preliminary estimate of materiality. Prepare a memorandum to Suzie Pickering outlining potential problem areas (that is, where possible material misstatements in the financial statements exist) and any other special concerns.

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Figure 4.2

Lower Inherent Risk Assessments	Factors That Influence Inherent Risk	Higher Inherent Risk Assessments
Satisfied customers who pay on time and are likely to remain a customer in the future Client has many customers	(1) Major customers	Dissatisfied customers who may withhold payment or decide to not purchase from the client in the future Client has only one or very few customers
Reputable suppliers that supply goods on a timely basis Few goods are returned to supplier as faulty Client pays suppliers on a timely basis	(2) Major suppliers	Suppliers may not supply goods on a timely basis Significant amounts of goods are returned to the suppliers because they are faulty Client does not pay suppliers on a timely basis
Trades with countries that are stable Trades in stable foreign currencies Minimal tariffs or barriers to trade Client maintains effective risk management policies regarding foreign trade	(3) Importer or exporter	Trades with countries that are not stable Trades in unstable foreign currencies Complex tariffs and other barriers to trade Client does not maintain effective risk management policies regarding foreign trade
Client well-positioned to adjust to changes in technology	(4) Changes in technology	Client falls behind with changes in technology and has not “kept up with the times”
Client does not offer warranties on its products If client does offer warranties, product quality is high and the likelihood that goods will be returned is low	(5) Warranties	Client offers warranties on its products History of poor product quality and goods being returned for the same problem
Few discounts are given by the client to its customers Client takes advantage of discounts offered by suppliers	(6) Discounts	Client offers discounts to its customers, possibly because it does not have much bargaining power Client misses opportunities to take advantage of supplier discounts
Client has good reputation with customers, suppliers, employees, and the wider community in which it operates	(7) Client reputation	Client does not have a good reputation with customers, employees, and/or the wider community in which it operates
Client has few locations and primary operations are centralized No international operations	(8) Operations	Client has larger number of locations and operations are decentralized Multiple locations operated internationally
No recent implementation of new standards No change in the application of accounting standards Personnel involved in the selection and application of accounting standards are competent and experienced	(9) Selection and application of accounting principles	Recent implementation of new accounting standard Change in the application of an accounting standard Personnel involved in the selection and application of accounting standards lack competence and experience
Determination of account balance is objective and supported by transactions with third parties Transactions are routine and relatively homogeneous Account has low volume of transactions	(10) Significant accounts and classes of transactions	Determination of account balance involves considerable subjectivity Transactions are complex and unique Account has high volume of transactions
Less complex payroll system and benefit structures Defined-contribution pension plans	(11) Relations with employees	More complex payroll system and benefit structures Defined-benefit pension plans
Less reliance on debt for financing Pays interest payments on time Less risk of violating terms of debt covenants	(12) Sources of financing	Heavy reliance on debt as a source of financing Struggles to pay interest payments on time Higher risk for violating terms of debt covenants which could indicate going concern issues
Simple capital structure Pays dividends from operating cash flow	(13) Ownership structure	Complex capital structure Struggles to pay dividends from operating cash flow

Figure 4.3

Lower Inherent Risk Assessments	Industry Factors That Influence	Inherent Risk Higher Inherent Risk Assessments
Less competitive industry, which puts less stress on the client's ability to generate a profit	(1) Level of competition	Very competitive industry, which puts more stress on the client's ability to generate a profit
Good reputation relative to others in the industry Customers and suppliers may be attracted to conduct business with the client versus a competitor	(2) Reputation	Poor reputation relative to others in the industry Customers and suppliers may shift business to a competitor
A new industry with considerable government support and incentives New or established industry with intense international competition with considerable government support and incentives Industry with minimal government regulation and no special taxes or unique financial reporting requirements	(3) Legal, political, and regulatory environment	A new industry with little or no government support New or established industry with intense international competition with little or no government support Heavily regulated industry with special taxes and unique regulations and financial reporting requirements
Demand is not seasonal, which provides steady revenue flow Industry minimally affected by trends/customer preferences Industry has low risk of technological obsolescence	(4) Demand	Seasonal demand for products, which leads to sporadic revenue flow Industry subject to changing trends/customer preferences Industry subject to technological obsolescence
Economy as a whole experiences an upturn, which leads to easily sustainable profit levels	(5) Economy	Economy as a whole experiences a downturn, which leads to pressure to maintain expected profit levels

Cloud 9 Trial Balance October 31, 2022 October 31, 2021 Debit Credit Debit Credit Cash and cash equivalents $ 13,446,154 $ 6,123,884 Accounts receivable 70,485,625 64,867,910 Allowance for doubtful accounts $ 704,856 $ 648,679 Inventory 55,100,000 57,900,000 Investments (derivatives) 13,419,231 13,805,769 Deferred income taxes (current) 2,857,692 3,584,615 Prepaid expenses and other current assets 9,265,385 6,446,154 Property, plant, and equipment Accumulated depreciation 103,803,846 97,576,923 39,761,538 35,207,692 Identifiable intangible assets and goodwill 3,723,007 3,851,923 Accumulated amortization Deferred income taxes and other assets (noncurrent) 9,557,692 8,410,849 Current portion of long-term debt Notes payable Accounts payable 2,115,385 300,125 21,376,923 34,823,077 14,986,457 22,561,538 Accured liabilities 25,803,846 24,150,000 Income taxes payable 2,211,539 3,726,923 Long-term debt Deferred income taxes and other liabilities (noncurrent) Common stock at par value 23,661,538 17,119,106 4,915,384 4,330,769 111,538 107,692 Capital stock in excess of par value 19,415,385 16,484,615 Unearned stock compensation 253,846 480,769 Accumulated other comprehensive income Beginning retained earnings 5,011,538 4,746,154 122,857,692 98,150,473 Dividends 3,866,838 3,299,423 Repurchases of common stock 4,627,381 2,939,393 Revenue 277,338,461 269,442,308 Cost of sales 169,346,154 163,003,846 Selling and administrative 79,092,308 78,246,154 Interest expense 1,438,461 1,773,077 Other expense 453,846 757,692 Income tax expense 9,511,538 $555,260,542 9,238,462 Totals $555,260,542 $527,052,997 $527,052,997