Cloud 9 Inc. is a publicly traded footwear company that is a new audit client of your firm. It operates primarily in North and South America and it is looking to expand into Europe over the next couple of years. It sells comfortable running shoes. The company's year end was February 28, 2021.

During 2020, Cloud 9 was forced to close half of their retail stores, due to a global pandemic that hit the retail industry hard. At the start of 2020, Cloud 9 closed its stores for a period of time. When stores re-opened, sales were slow, not only because older inventory was still on hand, but also because people were slow to go shopping because of an overall economic recession. To ensure social distancing, stores could only accommodate 50% capacity at one time, further impacting sales. Despite implementing new on-line sales to try to improve sales, Cloud 9 realized a significant loss for the year. Part of this loss was offset by government assistance and rent relief they did receive.

Ordering process

Cloud 9 has a central purchasing manager who determines the inventory levels for each store every quarter. When established, the purchasing manager sends an e-mail to the store managers outlining the updated inventory levels required by product. When product levels fall below the required level, store managers complete a purchase requisition to purchase the goods needed. The purchase requisition is e-mailed to the purchasing clerk at head office. The purchasing clerk combines the store requisitions and prepares a preliminary summary order report. When the combined orders for all stores total over $50,000, the preliminary summary order report is sent to the purchasing manager for approval. Once approved, a sequential purchase order is prepared and the order is placed. Due to the lead time for product delivery, stores can run out of product. If a customer wants an item that is not in stock at a particular store, the customer is advised to try the company website.

Goods received and Invoicing

Ordered goods are delivered directly to each store. Store staff receive the goods when they arrive. Staff count the quantity of each item delivered and prepare a handwritten receiving report . Receiving reports are compared to the suppliers shipping document and store staff note any discrepancies. Twice a month, the receiving reports are sent to the accounts payable clerk at head office to be matched with the purchase invoices.

Invoices are sent directly to the accounts payable clerk. Invoice details are matched to the receiving report. If there is a match between the invoice and the receiving report, the invoice details are entered into the accounts payables journal. When entered, the invoice is stamped "entered" by the accounts payable clerk so it is clear the invoice is in process. Invoices are then kept in a temporary file until payment is made. 

Every 30 days, the accounts payables clerk generates a computerized list of payments to be made. This report is sent electronically to the controller. The controller compares the computer generated list to each invoice. He signs the payment listing to indicate approval for payment, and then sends the listing back to the accounts payable clerk to process the payment using online banking. The electronic payments list is filed in order by month.

Inventory

On Feb 28 Cloud 9 closed its stores to conduct an inventory count. The Count Instructions were distributed to all counters in advance and prenumbered count sheets were assigned to the staff conducting the inventory count.

 

Draft Financial statements: 

                                              2020                         2019

Sales                              $37,593,000              $43,987,000

Gross Margin               11,487,000                  15,922,000

Net income before taxes   (1,292,973)         3,453,000

Total assets                     33,286,000            39,036,000

 

 Question 1

(a) What are  6 risk factors and explain how the item impacts the risk of material misstatement.

(b) Find and explains SIX deficiencies in the purchasing system and provide a recommendation to address each deficiency. 

(c ) Given the purchasing process, assume inherent risk and control risk are high What is the resulting detection risk? What type of audit should be performed? 

(d) Determine planning and performance materiality 

(e) List 5 substantive procedures the auditor should perform relating to the client's inventory count.