Answer the following questions based on the information for Cloud 9 presented 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.

1. Consider and explain the effects of the opening of Cloud 9s first retail store on its accounts.

2. Describe how this business change would affect the components of audit risk.

3. What changes would you expect to see in inventory transactions and balances as Cloud 9 changes from a wholesale only business to a retail and wholesale business? Be specific in your answer.

4. Which inventory balance and transaction assertions would be most affected? Explain.

5. Describe the population(s) and suggest a sampling approach for substantive testing for inventory.

Cloud 9 Inc. Company Background Cloud 9 Inc. is a manufacturer and retailer of athletic shoes and apparel, based in Sacramento, California. In 2021, Cloud 9 purchased McLellan's Shoes from Ron McLellan. As part of the sale agreement, Ron McLellan was appointed to the Cloud 9 board of directors.

Cloud 9 has wholly owned subsidiaries in Canada and Vietnam, and has built a reputation for its comfortable and durable shoes. The company promotes itself using its now well-known tagline, Our shoes are so comfortable, it's like walking on Cloud 9. Currently, Cloud 9 is primarily a wholesaler of athletic shoes and apparel to its main customers All Day Sports, Mayer, Bob's, and Varsity Sports.

Cloud 9 receives about 25% of its inventory from the Vietnam production plant with the remainder coming from the United States. Also, about 20% of its property, plant, and equipment is located at the Vietnam production plant. All inventory is purchased on free on board (FOB) shipping terms, which means Cloud 9 takes ownership of the products once the international courier accepts the goods for delivery. The inventory is sent to the main warehouse in Sacramento, which is linked to retailers via an electronic inventory system. When retail inventory gets low, the company ensures deliveries are made using its own transport trucks, thus ensuring control throughout the entire process.

In February 2021, Cloud 9 launched its new product line that included the Heavenly 456 walking shoe. Advertising campaigns and media coverage have been very successful, and sales for this style of shoe have steadily increased. For Cloud 9, the Heavenly 456 now makes up 20% of total sales.

A specific marketing campaign was initiated in 2022 to promote and build the Cloud 9 brand in the United States. Cloud 9 decided to sponsor a professional soccer team, Georgia Thunder, for the 2022 season. Under this sponsorship agreement, Cloud 9 is to provide all the athletic footwear and apparel for the team as well as have sole merchandising rights. The agreement also includes general advertising rights at the stadium.

In a separate contractual arrangement, Cloud 9 has signed Miguel Fernandez, the captain of Georgia Thunder, as spokesperson for the brand. This arrangement allows Cloud 9 to use Miguel's image to promote and build the brand.

To further establish the brand, the first Cloud 9 retail store was opened in San Francisco, California, on June 1, 2022. The store operates on a just-in-time inventory system linked with a series of warehouses and distribution centers throughout the United States and Canada. However, the management team reports that there have been a few hiccups in determining ideal stock quantities for the store to allow optimum availability of merchandise to its customers. Because some thefts of merchandise from the store have also occurred, the company has installed closed-circuit television cameras.

Personnel The Cloud 9 corporate office has 358 full-time employees. In the retail store, the company employs two full-time managers and some part-time staff, with seasonal employees enhancing staff levels in the busier retail period.

Some key positions in the accounting and IT area are as follows:

CFO: David Collier Financial controller: Carla Johnson IT manager: Will Burton These three employees are entitled to participate in the employee stock-purchase plan and receive stock options in Cloud 9 if revenue targets are met.

Financial Information Cloud 9 set a goal to increase revenue by 3% for the 2022 fiscal year. One of the critical success factors for the company to achieve this 3% increase is to grow its share of the U.S. footwear market. However, with the new store opening and the subsequent increase in costs, as well as the costs related to the sponsorship deals, the management team is projecting a decline in earnings for the year.

In addition, to build customer loyalty and promote sales in the retail store, Cloud 9 introduced a loyalty program whereby customers earn one point for every $10 that they spend. Customers can then redeem points by going online to receive coupons that can be exchanged for merchandise in the store. On August 1, 2022, the company took out an additional loan of $7 million with Windsor Bank to help fund the store costs and to purchase additional delivery trucks and vans. This loan is repayable over five years. The company's other debt relates to loans issued more than five years ago from various lending institutions.

All inventory is purchased in U.S. dollars, which the company acquires under forward exchange contracts. The company provides a 12-month warranty on all footwear. Historical claims have been 0.2% of total sales.

The most recent financial statements for Cloud 9 are as follows. (Note that these financial statements are also available in Excel format in WileyPLUS.)

Cloud 9 Consolidated Statement of Income For the year ended January 31, 2022 For the year ended January 31, 2021 Revenues $364,953,846 $345,965,385 Costs and expenses: Cost of sales $222,496,154 $207,838,462 Selling and administrative 104,450,000 100,246,154 Interest expense 1,257,692 1,730,769 Other (income)/expense, net 1,311,539 796,154 Total costs and expenses 329,515,385 310,611,539 Income before income taxes 35,438,461 35,353,846 Income taxes 12,757,692 13,080,769 Net income $ 22,680,769 $ 22,273,077