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Cloud 9 - Continuing Case W&S Partners has just won the January 31, 2023, audit for Cloud 9. The audit team assigned to this client is: Partner, Jo Wadley Audit manager, Sharon Gallagher Audit senior, Josh Thomas IT audit manager, Mark Batten Experienced staff, Suzie Pickering First-year staff, lan Harper 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, determine materiality, and assess the risk of material misstatement. This will assist the team in developing an audit strategy and designing the nature, extent, and timing of audit procedures. One task during the planning phase is to consider the concept of materiality as it applies to the client. Auditors will design procedures to identify and correct errors or irregularities that would have a material effect on the financial statements and affect the decision-making of the users of the financial statements. Materiality is used in determining audit procedures and sample selections, and evaluating differences from client records to audit results. Materiality is the maximum amount of misstatement, individually or in aggregate, that can be accepted in the financial statements. In selecting the benchmark to be used to calculate materiality, the auditors should consider the key drivers of the business. They should ask, "What are the end users (that is, stockholders, banks, etc.) of the accounts going to be looking at?" For example, will stockholders be interested in profit figures that can be used to pay dividends and increase share price? W&S Partners' audit methodology dictates that one planning materiality (PM) amount is to be used for the financial statements as a whole. The benchmark selected for determining materiality is the one determined to be the key driver of the business. W&S Partners' audit methodology dictates that one planning materiality (PM) amount is to be used for the financial statements as a whole. The benchmark selected for determining materiality is the one determined to be the key driver of the business. w&S Partners use the following percentages as starting points for the various benchmarks: Threshold (%) Benchmark Income before tax 5.0 0.5 Total revenue Gross profit 2.0 Total assets 0.5 Equity 1.0 These starting points can be increased or decreased by taking into account qualitative client factors, which could be: The nature of the client's business and industry (for example, rapidly changing, either through growth or downsizing, or an unstable environment). Whether the client is a public company (or subsidiary of) subject to regulations. The knowledge of or high risk of fraud. Typically, income before tax is used; however, it cannot be used if reporting a loss for the year or if profitability is not consistent. When calculating PM based on interim figures, it may be necessary to annualize the results. This allows the auditors to plan the audit properly based on an approximate projected year-end balance. Then, at year-end, the figure is adjusted, if necessary, to reflect the actual results. Required Answer the following questions based on the information presented for Cloud 9 in the appendix to this text and in the current chapter and previous chapters. a Using the October 31 2022 trial balance (in the annendix to this text) calculate planning 1 These starting points can be increased or decreased by taking into account qualitative client factors, which could be: The nature of the client's business and industry (for example, rapidly changing, either through growth or downsizing, or an unstable environment). Whether the client is a public company (or subsidiary of) subject to regulations. The knowledge of or high risk of fraud. Typically, income before tax is used; however, it cannot be used if reporting a loss for the year or if profitability is not consistent. When calculating PM based on interim figures, it may be necessary to annualize the results. This allows the auditors to plan the audit properly based on an approximate projected year-end balance. Then, at year-end, the figure is adjusted, if necessary, to reflect the actual results. Required Answer the following questions based on the information presented for Cloud 9 in the appendix to this text and in the current chapter and previous chapters. 1. a. Using the October 31, 2022, trial balance (in the appendix to this text), calculate planning materiality and include the justification for the benchmark that you have used for your calculation. Use PA 10 workpaper template to complete this problem. D. Cloud 9, Inc. Trial Balance 31-Oct-21 31-Oct-22 Debit Credit Credit Debit 6,123,884 13,446,154 70,485,625 %24 Cash and cash equivalents Accounts recelvable Allowance for doubtful accounts 64,867,910 648,679 704,856 57,900,000 55,100,000 13,419,231 2,857,692 9,265,385 Inventory 13,805,769 3,584,615 Investments (derivatives) Deferred income taxes (current) Prepaid expenses and other current assets Property, plant, and equipment Accumulated depreciation Identifiable intangible assets and goodwill Accumulated amortization Deferred income taxes and other assets (noncurrent) Current portion of long-term debt Notes payable Accounts payable Accrued liabilities Income taxes payable Long-term debt Deferred income taxes and other liabilities (noncurrent) Common stock at par value Capital stock in excess of par value Unearned stock compensation Accumulated other comprehensive,income Beginning retained earnings Dividends 6,446,154 97,576,923 103,803,846 35,207,692 39,761,538 3,851,923 3,723,007 8,410,849 9,557,692 2,115,385 21,376,923 300,125 34,823,077 22,561,538 14,986,457 24,150,000 3,726,923 25,803,846 2,211,539 23,661,538 17,119,106 4,330,769 4,915,384 107,692 111,538 16,484,615 19,415,385 480,769 253,846 4,746,154 5,011,538 98,150,473 122,857,692 3,299,423 2,939,393 3,866,838 Repurchases of common stock 4,627,381 269,442,308 277,338,461 Revenue 163,003,846 169,346,154 79,092,308 1,438,461 Cost of sales 78,246,154 Selling and administrative Interest expense Other expense Income tax expense 1,773,077 757,692 9,238,462 527,052,997 $ 453,846 9,511,538 555,260,542 $ 555,260,542 527,052,997 24 Trial Balance (PBC) Planning Materiality PSSC C4 D. 2 Matelality Base Used: 3 Explanation 4 Percentage Used 5 Explanation of percentage used enter base used, such as income before taxes explain why the base selected is the key driver of the client's business enter the percentage of the materiality base here If you're using the standard percentage per firm policy, enter "standard per policy." If you're using a different percentage (higher or lower), explain why. 6. 7 Calculation of Planning Materiality 8 list the account titles here list amounts here; sum amounts to compute materiality base, then calculate planning materiality using the percentage prescribed in firm policy 9 For example, to calculate based on gross profit, enter the following as of October 31, 2022 10 Annualized at x/(9/12) 277,338,461 $ 208,003,846 11 Revenue 12 less Cost of Sales 13 Gross Profit (127,009,616) (169,346,154) 107,992,307S 80,994,230 14 15 Planning materiality e 2.0% 1,619,885 16 17 delete these instructions once you read and understand them 18 19 20 Client Name: Cloud 9 Inc. Engagement Title: WP Segment and Number: PA-10 Planning and Administration WP Title: Audit of F/S Y/E Ja nu ary 31, 2023 3. 4. Planning Materiality 5. Prepared By: Date: Reviewed By: 6. 7. Date: 8. 9. 10 11 12 13 Purpose 14 15 To determine planning materiality for the audit of Cloud 9, Inc.'s financial statements as 16 of and for the year ended January 31, 2023. 17 18 Link to the Audit Step. 19 20 21 22 Source 23 24 Trial balance as of October 31, 2022 and 2021 (PBC), at w/p PA-10a 25 W&S Partners Policy for Establishing Planning Materiality 26 27 28 Scope/Methodology 29 30 Using the trial balance as of October 31, 2022 and 2021, I computed planning materiality 31 in accordance with W&S Partners policy. 32 33 34 Conclusion 35 36 37 38 39 Results 40 41 42 See planning materiality worksheet. 43 44