Cloud 9 Background Summary (see detailed background near the end of case file)

Cloud 9 Inc., a listed company (publicly traded) in the United States (U.S.), is looking to expand. McLellan's Shoes was seen as a potential target. In 1985, Ron McLellan started McLellan's Shoes in Seattle, Washington, manufacturing and retailing customized basketball shoes. Ron borrowed from the bank to start the company, using his house as security, and over the years he worked very hard to establish a profitable niche in the highly competitive sport shoe market. Ron repaid the bank in 1999, and he vows to never borrow again. As the business grew, Ron's wife and three adult children started to work with him, with responsibility for administration, marketing and sales, production, and distribution. By the early 2000s, Ron's business employed 20 people full-time, most of whom work in production. There are also several casual employees and part-time staff in the retail outlet in Seattle, particularly during busy periods.

Chapter 5 | Cloud 9 Current Environment

At the next planning meeting for the Cloud 9 audit, Suzie Pickering presents the results of the analytical procedures performed so far and a working draft of the audit program. The audit manager, Sharon Gallagher, and the audit senior, Josh Thomas, are also involved in the planning, with special responsibility for the internal control assessment.

The meetings agenda is to discuss the available sources of evidence at Cloud 9 and specify these in the detailed audit program. The team members also must ensure they have enough evidence to conduct the audit. Two specific issues worry members of the team. First, there are three very large asset balances on Cloud 9s trial balance that have particular valuation issues. Josh suggests that a specialist will be required for the derivatives, but they can handle the accounts receivable and inventory themselves. Second, Sharon is worried about how they will gather evidence regarding a subsidiary located in Vietnam. W&S Partners does not have an office in Vietnam, so they must determine the most effective and efficient way to gather evidence regarding the subsidiary. In the planning meeting, the team considers the following:

• What evidence is available?
• What criteria will the team use to choose among alternative sources of evidence?
• What are the implications of using the work of specialists and other auditors?

--

--

Cloud 9s permanent file contains the basic information about the company (that is, its headquarters address, key senior staff and their employment contracts) plus a copy of the engagement letter appointing W&S Partners and stating the scope of the audit. Sharon and Suzie have gathered copies of some of the relevant agreements and will add these and more to the permanent file. Joshs documentation of Cloud 9s system of internal control will be added to the permanent file once it is completed.

--

The first major item in the current file for Cloud 9 is the audit plan with the detailed audit program. The current file also contains documentation for every test performed during the audit. Ian is still struggling with how to correctly complete the papers. He often forgets to complete all the relevant fields and Sharon and Josh are continually sending papers back to him with requests to clarify some of his comments. However, embedding the working papers in Excel has made life easier, because an error message will be generated if certain key fields are not completed.

Chapter 5 Analysis | Engaging other Auditors and Specialists

W&S Partners will need the assistance of auditors in Vietnam and a derivatives specialist to complete the Cloud 9 audit.

The other auditors will be asked to provide evidence about the inventory shipped to the United States from the production plant in Vietnam and about the property, plant, and equipment at the Vietnam plant. Although the inventory is sent FOB shipping point, there have been several occasions when the shipping agent was unable to place the inventory on a ship. In these cases, the inventory was stored in the shipping agents warehouse until a vessel became available. Suzie has some concerns about the quality of the warehouses because if the goods are damaged they could become worthless, and the value of goods in transit will be overstated.

In addition, Josh has asked Jo Wadley (the partner) for help in choosing a specialist to help with valuation aspects of the audit of derivatives. Jo has provided him with three names of specialists in the field, but she has had no personal experience with any of them. Josh must make a choice and engage the specialist soon to be sure the specialists opinion will be received in time to complete the audit.

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

Required

1. Access AS 1210 Using the Work of a Specialist at www.pcaobus.org. Advise Josh on engaging the derivatives specialist. Discuss the qualities the specialist must possess. What must the specialist provide to Josh so that he can be sure he has sufficient appropriate evidence about the derivatives? What steps must Josh perform? Cite the audit standard in your response