Appendix
W&S Partners is a U.S.-based accounting firm with offices located in most major cities. W&S Partners will be conducting the January 31, 2023 audit for Cloud 9, Inc., a publicly traded company. The audit team assigned to the client is: Partner, Jo Wadley; Audit Manager, Sharon Gallagher; Audit Senior, Josh Thomas; IT Audit Manager, Mark Batten; Experienced Staff, Suzie Pickering; and First Year Staff, Ian Harper.
Prior-year audits were conducted by Ellis & Associates. As part of the transfer of records process, Jo Wadley met with RJ Ellis (Managing Partner, Ellis & Associates) to discuss acceptance of Cloud 9 as a client and to inquire about access to Ellis & Associates working papers. In the discussion, RJ Ellis stated that there were no issues that W&S Partners should be aware of before accepting the client or beginning the work.
Cloud 9 Inc. Company Background
Cloud 9 is a Sacramento-based manufacturer and retailer of athletic shoes. In 2021, Cloud 9 purchased McLellans Shoes from Ron McLellan. As part of the sale agreement, Ron McLellan was appointed to the Cloud 9 board of directors.
Cloud 9 Inc. has wholly-owned subsidiaries in Canada, Vietnam and Brazil, and has built a reputation around the fact that its shoes have comfort and durability. The company promotes itself using its now well-known tagline, Our shoes are so comfortable, its like walking on Cloud 9. Currently, Cloud 9 is primarily a wholesaler of athletic shoes to its main customers: All Day Sports, Mayer, Bobs, 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 that 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 for the team as well as having 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 spokesman for the brand. This arrangement allows Cloud 9 to use Miguels image to promote and build the brand.
To further establish the brand, the first Cloud 9 retail store was opened in San Francisco on June 1, 2022. The store operates on a just-in-time inventory system linked with the main warehouse in Sacramento. 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 the customers. There have also been some thefts of merchandise from the store and in order to reduce inventory loss by theft, 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 2 full time managers and some part-time staff, with casual employees enhancing staff levels in the busier retail period.
Some key positions in the accounting and IT area are the CFO, David Collier, Financial Controller, Carla Johnson, and 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 companys other debt relates to loans issued more than five years ago from various lending institutions.
All inventory is purchased in US dollars, which the company acquires under forward exchange contracts. The company provides a 12-month warranty on all footwear. Historical claims have been 2% of total sales.
loud 9 - Continuing Case Gain an understanding of the client partners t the planning phase of the Cloud 9 audit. As assessment phase for the new audit, the audit ure and its t, determine materiality, and assess inherent t the team in developing an audit strategy and 1. What is the effect on the client of potential new entrants into the market? Are there any significant barriers to entering the n an understanding of Cloud 9's struct team needs to gain unde husiness environment, risk. This will assist te Product information m. Is th n. Is the product dependent on trends or styles? Customer information ere a specific lifecycle for the product? extent, and timing of audit procedures. equ the following questions based on the additional informa- AnsrCloud 9 presented in the appendix to this book and the ters. You should also consider your an- case study questions in earlier chapters where relevant. to research the retail and wholesale footwear indus t back to the audit team. Your report will form part of understanding of Cloud 9's structure and its environment. ould concentrate your research on providing find ose areas that have a financial reporting impact and re specific customers on whom the client is highly epen nt and earlier You P. What is the overall profile of the client's customers? Have there been significant fluctuations in the client's customer base? Supplier information g. Who are the key suppliers? r. Are the materials subject to significant price movements or from th influenced by external market forces? ing t nsidered probable given Cloud 9's operations. In conduct Technological advances and the effect of the internet h, you should consider the following key market d industry-specific economic trends and conditions business affected by developments in other countries dustry is labor intensive, are there unusual or unique s. How does the industry use technology? forces, as they relate to Cloud 9's operations. General and a. What is the current condition of the economy? b. Is the t. What technological trends are impacting the industry? u. Are the client's operations affected significantly by local o v. What new laws and regulations recently enacted (or pending) Laws and regulatory requirements foreign currency fluctuations, or other global forces? c. If the in may have significant effects on the company? labor relations issues? d. How does the company's growth and overall financial perfor mance compare with the industry, and what are the reasons PART 2 Analytical procedures for any significant differences? e. What are the volume and type of transactions in the business? f. Are the client's operations centralized or decentralized? g. Is the client's business cyclical in nature or influenced by Answer the following questions based on the information pre sented for Cloud 9 in the appendix to this book and the current and earlier chapters. You should also consider your answers to the case study questions in earlier chapters. sonal fluctuations in the market? a. Using analytical procedures and the information provided h. What is the susceptibility to fraud/theft? (Is the product something that can easily be stolen and has a sale market?) 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. Competitive environment What products does the client sell, and have there been signif b. Which specific areas do you believe should receive special icant changes with respect to i. major products or brands? emphasis during your audit? Consider your discussion of the analytical procedures results as well as your prelim- inary 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. Spec ify the accounts and related assertions that would require particular attention se sales/gross margin by product? j. Who are the client's major competitors, and what share of the market does each hold? k. Is there significant differentiation between the client's and competitors' merchandise? loud 9 - Continuing Case Gain an understanding of the client partners t the planning phase of the Cloud 9 audit. As assessment phase for the new audit, the audit ure and its t, determine materiality, and assess inherent t the team in developing an audit strategy and 1. What is the effect on the client of potential new entrants into the market? Are there any significant barriers to entering the n an understanding of Cloud 9's struct team needs to gain unde husiness environment, risk. This will assist te Product information m. Is th n. Is the product dependent on trends or styles? Customer information ere a specific lifecycle for the product? extent, and timing of audit procedures. equ the following questions based on the additional informa- AnsrCloud 9 presented in the appendix to this book and the ters. You should also consider your an- case study questions in earlier chapters where relevant. to research the retail and wholesale footwear indus t back to the audit team. Your report will form part of understanding of Cloud 9's structure and its environment. ould concentrate your research on providing find ose areas that have a financial reporting impact and re specific customers on whom the client is highly epen nt and earlier You P. What is the overall profile of the client's customers? Have there been significant fluctuations in the client's customer base? Supplier information g. Who are the key suppliers? r. Are the materials subject to significant price movements or from th influenced by external market forces? ing t nsidered probable given Cloud 9's operations. In conduct Technological advances and the effect of the internet h, you should consider the following key market d industry-specific economic trends and conditions business affected by developments in other countries dustry is labor intensive, are there unusual or unique s. How does the industry use technology? forces, as they relate to Cloud 9's operations. General and a. What is the current condition of the economy? b. Is the t. What technological trends are impacting the industry? u. Are the client's operations affected significantly by local o v. What new laws and regulations recently enacted (or pending) Laws and regulatory requirements foreign currency fluctuations, or other global forces? c. If the in may have significant effects on the company? labor relations issues? d. How does the company's growth and overall financial perfor mance compare with the industry, and what are the reasons PART 2 Analytical procedures for any significant differences? e. What are the volume and type of transactions in the business? f. Are the client's operations centralized or decentralized? g. Is the client's business cyclical in nature or influenced by Answer the following questions based on the information pre sented for Cloud 9 in the appendix to this book and the current and earlier chapters. You should also consider your answers to the case study questions in earlier chapters. sonal fluctuations in the market? a. Using analytical procedures and the information provided h. What is the susceptibility to fraud/theft? (Is the product something that can easily be stolen and has a sale market?) 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. Competitive environment What products does the client sell, and have there been signif b. Which specific areas do you believe should receive special icant changes with respect to i. major products or brands? emphasis during your audit? Consider your discussion of the analytical procedures results as well as your prelim- inary 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. Spec ify the accounts and related assertions that would require particular attention se sales/gross margin by product? j. Who are the client's major competitors, and what share of the market does each hold? k. Is there significant differentiation between the client's and competitors' merchandise
