Cloud 9 Pty Ltd Company BackgroundIntroduction

McLellan Shoes was originally founded in 1980 by RA McLellan, the Sydney-based company was a manufacturer and retailer of customised basketball shoes.In 1993, Cloud 9 Inc. (a publicly listed United Stated (US) company) purchased the original company from RA McLellan and renamed it Cloud 9 Pty Ltd.As part of the sale agreement, RA McLellan was appointed to the Cloud 9 Pty Ltd board of directors.

The parent company, Cloud 9 Inc., has wholly-owned subsidiaries in the United Kingdom (UK), Germany, Canada, China 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; it's like walking on Cloud 9'.Currently, Cloud 9 Pty Ltd is primarily a wholesaler of athletic shoes to its main customers:David Jones, Myer, Foot Locker and Rebel Sports.

Cloud 9 Pty Ltd receives the majority of its stock from the China production plant, with the remainder coming from the US.All stock is purchased free on board (FOB) shipping terms, which means Cloud 9 Pty Ltd takes ownership of the products once the international courier accepts the goods for delivery.The stock is sent to the main warehouse in Botany, Sydney, which is linked to retailers via an electronic inventory system.When retail stock levels get low, the company ensures deliveries are made using their own transport trucks, thus ensuring control throughout the entire process.

In February 2015, Cloud 9 Inc. 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 she have steadily increased.For cloud 9 Pty Ltd, the 'Heavenly 456' now makes up 20% of total sales.

A specific marketing campaign was initiated in 2017 to promote and build the 'Cloud 9' brand in Australia.The Australian company was granted permission from its parent entity to sponsor a new A-league soccer team, Queensland Thunder, for the 2017 season.Under this sponsorship agreement, Cloud 9 Pty Ltd 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 Pty Ltd has signed Kevin McDonald, the captain of Queensland Thunder, as a spokesman for the brand.This arrangement allows Cloud 9 Pty Ltd to use Kevin's image to promote and build the brand in Australia.

To further establish the brand, the first 'Cloud 9' retail store was opened in the Sydney CBD on 1 June 2017.The store operates on a just-in-time inventory system linked with the main warehouse in Botany.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 stock loss by theft, the company has installed close-circuit television cameras.

Personnel

Cloud 9 Pty Ltd has 52 full-time employees.In the retail store, the company employs part-time staff, with casual employees enhancing staff levels in the busier retail period.

To administer the company's finances Cloud 9 Pty Ltd employs Finance Director, David Collier; Financial Controller, Carla Johnson; and Business Systems Manager, Justin Reeves.These three employees are entitled to participate in the employee share purchase plan and receive share options in Cloud 9 Inc. if revenue targets are met.

Financial Information

Responding to pressure from its parent company, Cloud 9 Pty Ltd set a goal to increase its revenue by 3% for the 2017 fiscal year (note that Cloud 9 Pty Ltd uses a calendar year as its fiscal year).One of the critical success factors for the company to achieve this 3% increase is to grow its share of the Australian 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 loss for the year.

In addition, to build customer loyalty and promote sales in the retail store, Cloud 9 Pty Ltd introduced a loyalty program whereby customers earn one point for every $10 that they spend.Customers can then redeem points online to receive coupons that can be exchanged for merchandise in the store.

On 1 October 2016, the company took out an additional loan of $2 million with Oz Bank to help fund the store costs, and to purchase additional delivery trucks and vans.This loan is repayable over 5 years.The company's other debt relates to loans from one of RA McLellan's other companies, which were issued between 1980 and 1993 when the original company was a sole proprietorship.RA McClellan extended the repayment date as part of the consideration of the sale.

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.

The prior year Statement of Profit and Loss and Other Comprehensive Income and Statement of Financial Positon are provided as additional information in Appendix A of the spreadsheet accompanying this case study.

Other

W&S Partners is an Australian accounting firm with offices located in each of the major cities.W&S Partners has just won the 31 December 2017 audit work for Cloud 9 Pty Ltd.

Prior year audits were conducted by Ellis & Associates.As part of the transfer of records process, the audit partner of W&S Partners met with RJ Ellis (Managing Partner, Ellis & Associates) to discuss acceptance of Cloud 9 Pty Ltd as a client and to inquire about access to Ellis & Associates' work 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 commencing the work.

Task Understanding the Client

You are a graduate working for W&S Partners, an Australian accounting firm with offices located in each of the major cities. W&S Partners has just won the 31 December 2017 statutory audit for Cloud 9 Pty Ltd (Cloud 9). The audit team assigned to this client is:

Partner, Jo Wadley

Audit Manager, Sharon Gallagher

Audit Seniors, Josh Thomas and Suzie Pickering

IT Audit Manager, Mark Batten

Graduates, Ian Harper and you.

As a 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. By understanding the client's business, the audit team can identify potential risks that may have a significant effect on the financial report. This will assist the team complete the audit.

Required

Task 1.1

Your task is to research aspects of 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. In conducting your research, you should consider the following key market forces, as they relate to Cloud 9's operations.

Use the spreadsheet template Task 1-1 provided to answer the questions below.

General and Industry-specific economic trends and conditions

a.What is the current condition of the economy?

b.Is the business affected by developments in other countries, foreign currency fluctuations or other global forces?

c.If the industry is labour intensive, are there unusual or unique labour relations issues?

d.How does the company's growth and overall financial performance compare with the industry, and what are the reasons for any significant differences?

e.What is the volume and type of transactions in the business?

f.Are the client's operations centralised or decentralised?

g.Is the client's business cyclical in nature or influenced by seasonal fluctuations in the market?

h.What is the susceptibility to fraud/theft? (Is the product something that can easily be stolen and has a sale market?)

Competitive environment

a.What products does the client sell, and have there been significant changes with respect to:

-Major products or brands?

-Selling strategies?

-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?

l.What is the effect on the client of potential new entrants into the market? Are there any significant barriers to entering the market?

Product information

m.Is there a specific lifecycle for the product?

n.Is the product dependent on trends or styles?

Customer information

o.Are there specific customers on whom the client is highly dependent?

p.What is the overall profile of the client's customers?Have there been significant fluctuations in the client's customer base?

Supplier information

q.Who are the key suppliers?

r.Are the materials subject to significant price movements or influenced by external market forces?

Technological advances and the effect of the internet

s.How does the industry use technology?

t.What technological trends are impacting the industry?

Laws and regulatory requirements.

u.Are the client's operations affected significantly by local or foreign legislation?

What new laws and regulations recently enacted (or pending) may have significant effects on the company?