Q1
Cloud 9 Ltd.
December 31, 2020
Setting materiality
Users Users Financial statement area of most concern to the user
Cloud 9 company Concerning of growing marketing and Reflected by revenue
Bank Concerning of the company repay borrow fund
Management Concerning primarily with revenues as this is the basis for their bonuses.
Base selected for planning materiality (PM): Revenue:55633918___________________________________
Justification for selection:
____as normally PBT is used to calculate planning materiality but this year, firm has incurred loss rather than profit due to we did not select PBT. As the company is a service provider so the shareholder are more likely to concerned about revenue . as the revenue is based on njmber of subscription which is less volatile.
______________________________________________________________________
___Base threshold revenue:0.5%
As we are taking the base threshold as a percentage to apply on revenue As we are not making any adjustment in the threshold as there is no such risk which lead to us to modify the threshold there is annualization adjustment as all years of revenue are consistent and there is not any event occurred which lead to us to make annualization adjustment._______________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
Calculation of PM
Current Year Prior Year
20202019
Trial balance amount: ____83,817,576_______76,657,825___________________
Normalizing adjustments
(that is, non-recurring items) _______________________ _______________________
Annualized (if required): _______________________ _______________________
Benchmark applied _______________________ _______________________
Calculated materiality: ___55633918*0.5%=278169.59____________________ _______________________
Conclusion: PM materiality is _____278000_____.
Performance materiality: 70% __278000=194600_______.
Conclusion: Performance materiality is ___194600_______.
Discussion points
Consider how you will use the planning materiality in your audit. What factors might lead you
to increase or decrease the planning materiality amount? Are there qualitative factors that
could impact your materiality decision?
10 Cloud 9 Ltd. - An Audit Case Study
Q2
Assertions
Learning objective
extend your knowledge gained in assignment 1 by taking the
significant risks you have already identified and then conducting further analysis on their
likelihood and materiality.
Risks identified from gaining an understanding of the client's business are referred to as
inherent risks. These risks are considered in the audit-risk formula. The auditor needs to
identify which financial statement assertions may be affected by these inherent risks.
Identifying these risks will help determine the nature of the audit procedures to be performed.
Management implicitly or explicitly makes assertions regarding the recognition,
measurement, and presentation of the various elements of the financial statements and related
disclosures. Auditors use assertions for account balances to form a basis for the assessment of
risks of material misstatement. That is, assertions are used to identify the types of errors that
could occur in transactions that result in the account balances. Consequently, breaking down
the financial statement accounts into these assertions will direct the audit effort to those areas
of higher risk.
Assertions direct the audit, and audit procedures are designed so that they are responsive to
the assessed risks. Broadly, these assertions can be classified in the following categories:
existence or occurrence
completeness
valuation and allocation, or accuracy
rights and obligations
cut-off
classification
presentation, disclosure, and understandability
Required
Using the risks identified in assignment 1 on working paper A1-1, complete the following
information in the relevant columns of the working paper.
Identify the associated financial account (if you haven't done so already) and assertions that
would be affected.
Give an assessment of "high," "medium," or "low" in relation to the likelihood and
materiality of the risk occurring.
A risk should be classified as "high" if it is highly likely to be present and material. A risk
should be classified as "medium" if it may be present and material. Risks should be classified
as "low" if they are unlikely to be present and/or not material.
Discussion points
Did you have any significant risks that could not be linked to an account in the financial
statements and an assertion? Is it still a significant risk?
Given your analysis?for this client?is the overall level of inherent risk "low," "medium,"
or "high"?
Assignment 3 11
Is there significant differentiation between the client's and competitors' merchandise? 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 Is there a specific life cycle for the product? . Is the product dependent on trends or styles? Customer information Are there specific customers on whom the client is highly dependent? What is the overall profile of the client's customers? Have there been significant fluctuations in the client's customer base? Supplier information Who are the key suppliers? Are the materials subject to significant price movements or influenced by external market forces? Technological advances and the effect of the Internet How does the industry use technology? What technological trends are affecting the industry? Laws and regulatory requirements 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? List your potential significant risks in the following table. Also name the account that would potentially be misstated. Leave the "Assertion(s)" and the "Level of inherent risk" columns blank until you complete assignment 3.W/P ref: Prepared by: Date prepared: Cloud 9 Ltd. December 31, 2020 Identification of significant risks Potential risk- Assertion(s) Level of inherent risk description Accountis) (assignment 3) (assignment 3) Discuss your responses with your supervisor (or teacher). Can you clearly distinguish between a risk faced by the business and a significant risk?ASSIGNMENT 1 Understand the business Learning objective As part of the planning process, the audit team needs to gain an understanding of Cloud 9 Lid.'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 statements. This will assist the team in planning and performing the audit, including making inherent risk assessments. assignment will help you learn to identify those potential risks of misstatement and evaluate which of those risks are classified as significant risks (CAS 315.27). Required Josh Thomas, Audit Senior, has asked you to research 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 Lid.'s structure and its environment. You should concentrate your research on providing findings from those areas that have a financial statement impact and are considered probable given Cloud 9 Lid.'s operations. In conducting your research, you should consider the following key market forces, as they relate to Cloud 9 Lid.'s operations. For each area listed below, consider whether that factor could increase the risk of material misstatement in Cloud 9's financial statements. List your potential risks in the table provided. General and industry-specific economic trends and conditions What is the current condition of the economy? Is the business affected by developments in other countries, foreign currency fluctuations, or other global forces? If the industry is labour-intensive, are there unusual or unique labour relations issues? How does the company's growth and overall financial performance compare with the industry, and what are the reasons for any significant differences? What is the volume and type of transactions in the business? Are the client's operations centralized or decentralized? Is the client's business cyclical or influenced by seasonal fluctuations in the market? What is the susceptibility to fraud/theft? (Is the product something that can easily be stolen and has an active market?) Competitive environment 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? Who are the client's major competitors, and what share of the market does each hold? Assignment 1 5DECEMBER 31, 2020 DECEMBER 31, 2019 DR CR DR CR Storage-rent expense, store 191,667 Storage-rent expense, warehouse 3,403,146 3,403, 146 Distribution expenses 2,378,493 2,309,217 Telephone 114,468 Computer and IT costs 290,339 343,370 Advertising and promotion-print 2,398,684 1,203,668 Trade shows 376,840 442,674 Advertising and promotion-TV 2,003, 186 571,545 Advertising and promotion-sponsorships 1,969,959 Rent expense-office 355,546 355,546 Bad debt expense 87,069 138,000 Depreciation-furniture and equipment 806,365 390,830 Depreciation-leasehold improvements 231,505 110,775 Entertainment 253,662 368,808 Professional fees 365,936 527,738 Insurance expense 3,166,480 1,837,082 Recruitment 405,301 341,769 Interest expense-loan from bank 1,170,220 806,812 Income tax expense 567,111 83,817,576 83,817,576 76,657,825 76,657,825 Draft Statement of Income December 31, 2020 Revenue 55,633,918 Cost of goods sold 31,713,252 Gross profit 23,920,666 Other expenses 25,815,995 Loss from operations (1,895,329) Other income 431,182 Loss before taxes (1,464,147) Income tax expense Net loss 1,464,147)TRIAL BALANCE CLOUD 9 LTD. DECEMBER 31, 2020 DECEMBER 31, 2019 DR CR DR CR Cash-operating account 221,615 495,032 Cash-savings account 72,000 1,323,610 Petty cash 500 500 Cash-store locations 1,000 Trade receivables-stores 261,179 Trade receivables-wholesale 12,725,920 13,117,217 Allowance for doubtful accounts 495,723 567,390 Miscellaneous receivables 53,747 62,805 HST receivable 37,748 53,292 Inventory 6,946,706 7,333,555 Goods in transit 543,602 692,159 Allowance for inventory obsolescence 501,346 629,824 Amounts receivable from parent 578,767 578,767 Prepaid rent 345,518 245,039 Prepaid insurance 863,071 510,124 Other prepaid expense 79,053 44,102 Furniture and equipment 2,034,297 1,317,948 Accumulated depreciation-furniture 1,274,980 909,549 and equipment Leasehold improvements 1,523,606 866,762 Accumulated depreciation-leasehold 414,748 251,603 improvements Trade payables 2,506,543 1,458,263 Accrued bonuses 400,000 350,000 Sales commissions payable 487,354 499,487 Other accrued expenses 2,242,356 1,444,164 Inter-company payables 682,476 593,233 Accrued vacation payable 180,030 134,324 Loyalty program provision 71,824 Provision for current tax liabilities 183,846 249,472 Warranty provision 105,174 102,716 Long-term debt 10,203,354 11,472,269 Provision for deferred tax liabilities 228,444 204,340 Share capital 6,265,232 6,265,232 Retained earnings 1,509,046 442,743 Revenue-stores 1,025,251 Revenue-wholesale 54,608,667 51,057,288 Interest from bank 72,691 128,107 Foreign exchange gain/loss 56,747 35,481 Proceeds on disposals 9,256 Other revenue 301,744 295,827 Cost of goods sold-stores 736,898 Cost of goods sold-wholesale 30,976,354 24,590,091 Salaries and employee benefits 5,847,129 11,265,988 Appendix 2 45INTRODUCTION This case study is designed to provide students with the opportunity to work through various audit procedures that are performed during the planning and interim phases of a financial statement audit. Typical client scenarios that are regularly observed in the profession are the basis for this case study, and the aim is to expose students to the tasks they would typically perform in their first year of auditing practice. In this case study, students play the role of a graduate working for W&S Partners, a Canadian accounting firm with offices located in each of the major Canadian cities. W&S Partners has just been awarded the December 31, 2020, statutory audit work for Cloud 9 Lid. The audit team assigned to the client is: Partner, J.M. Wadley; Audit Manager, Sharon Gallagher, Audit Senior, Josh Thomas; and IT Audit Manager, Mark Batten. Prior year audits were conducted by Ellis & Associates. As part of the change of auditors process, J.M. Wadley met with R.J. Ellis (Managing Partner, Ellis & Associates) to discuss the acceptance of Cloud 9 Lid. as a client and to inquire about access to Ellis & Associates' working papers. In the discussion, R.J. Ellis stated that there were no issues that W&S Partners should be aware of before accepting the client or commencing the work. Cloud 9 Lid. company background Founded in 1980 by Ron Mclellan, the Toronto-based company was a manufacturer and retailer of customized basketball shoes. In 1993, Cloud 9 Inc. (a publicly listed Canadian company) purchased the original company from Ron Mclellan and renamed it Cloud 9 Lid. As part of the sale agreement, Ron Mclellan was appointed to the Cloud 9 Lid. board of directors. The parent company, Cloud 9 Inc., has wholly owned subsidiaries in the United States, the United Kingdom (UK), Germany, China, and Brazil, and has built a reputation around the fact that its shoes are comfortable and durable. The company promotes itself using its well-known tagline "Our shoes are so comfortable, it's like walking on Cloud 9." Currently, Cloud 9 Lid. is primarily a wholesaler of athletic shoes to its main customers: David Jones, Myer, Foot Locker, and Rebel Sports. Cloud 9 Lid. receives the majority of its inventory from the production plant in China, with the remainder coming from the United States. All inventory is purchased on free on board (FOB) shipping point, which means Cloud 9 Lid. takes ownership of the products once the international courier accepts the goods for delivery. The inventory is sent to the main warehouse in Richmond, B.C., which is linked to retailers via an electronic inventory system. When retail inventory levels get low, the company ensures deliveries are made using its own transport trucks, thus ensuring control throughout the entire process. A specific marketing campaign was initiated in 2020 to promote and build the Cloud 9 brand in Canada. The Canadian company was granted permission from its parent entity to sponsor a new basketball team, the Thompson Thunders, for the 2020 season. Under this sponsorship agreement, Cloud 9 Lid. 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 Lid. has signed Bodhi Parker, the captain of the Thompson Thunders, as spokesman for the brand. This arrangement allows Cloud 9 Lid. to use Bodhi's image to promote and build the brand in Canada. In February 2020, Cloud 9 Lid. launched its new product line, which included the "Heavenly 456" walking shoe and the "Lightning 7" basketball shoe. Advertising campaigns Introduction 1and media coverage have been very successful and sales of the Heavenly 456 walking shoe have steadily increased. For Cloud 9 Lid., the Heavenly 456 now makes up 25 percent of total sales. The Lightning 7 shoe was marketed in the basketball stadium during Thompson Thunders games as well as heavily advertised using Bodhi Parker's image. Due to a poor first season, sales of the Lightning 7 were unimpressive and, as a result, Cloud 9 still has a large amount of inventory in its warehouse. To further establish the brand, the first Cloud 9 retail store was opened in Toronto, Ontario, on June 1, 2020. The store operates on a just-in-time inventory system linked with the main warehouse in Richmond, B.C. However, the management team reports that there have been a few hiccups in determining ideal inventory 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 Cloud 9 Lid. has 52 full-time employees. In the retail store, the company employs part-time staff, with casual employees enhancing staffing levels in the busier retail period. To administer the company's finances, Cloud 9 Lid. 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 stock option plan and receive stock options in Cloud 9 Inc. if revenue targets are met. Financial information Responding to pressure from its parent company, Cloud 9 Lid. set a goal to increase its revenue by 4 percent for the 2020 fiscal year. One of the critical success factors for the company to achieve this 4-percent increase is to grow its share of the North American 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 Lid. introduced a loyalty program whereby customers earn one point for every $10 that they spend. Customers can then redeem points on-line to receive coupons that can be exchanged for merchandise in the store. On October 1, 2019, the company took out an additional loan of $3 million with Ontario Bank to help fund the store costs, and to purchase additional delivery trucks and vans. This loan is repayable over five years. The company's other debt relates to loans from one of Ron Mclellan's other companies, which were issued between 1980 and 1993 when the original company was a sole proprietorship. R.A. Mclellan extended the repayment date as part of the consideration for the sale. All inventory is purchased in U.S. dollars. The company provides a 12-month warranty on all footwear. Historical claims have been 2 percent of total sales. Refer to Appendix I for the prior year's statement of income and statement of financial position. Required In the following section, there are 12 assignments that are designed to be completed as concepts are introduced throughout the auditing course. 2 Cloud 9 Ltd. - An Audit Case Study
