The partner on the Cloud 9 audit, Jo Wadley, has called a meeting with the audit team (Sharon Gallagher, Josh Thomas, and Mark Batten) to discuss the completion of the audit. Jo wants to be sure that she is briefed on all contentious matters so that she can resolve them at the scheduled meetings with Cloud 9’s audit committee and management. Sharon, Josh, and Mark hold a preliminary meeting to prepare for the meeting with the partner. On the agenda are final evidence and misstatements evaluation, search for loss contingencies, subsequent events procedures and evidence, going concern procedures and assessment, and communication with Cloud 9’s audit committee. What issues have arisen with Cloud 9’s audit? How can they make sure the partner is fully prepared for the meeting with the client’s management? Josh (senior) mailed out the legal letters two weeks prior to the expected completion of the fieldwork date. He sent letters to all attorneys that Cloud 9 paid for legal services during the year. All responses have been received from the attorneys. Based on the responses, there do not seem to be any pending legal issues that would have a material effect on Cloud 9’s financial statements. Procedures to search for subsequent events at Cloud 9 are documented in the audit program. These include a review of minutes of board meetings in January, February, and March, and an analysis of the interim results for these months (including analytical procedures). The partner, Jo Wadley, will also formally ask management about any subsequent events that have come to management’s attention in the meetings held between year-end and the audit report date. For example, does Cloud 9 have any plans to issue additional stock? Have there been any significant tax assessments or fines? Has Cloud 9 entered into any additional borrowings or contracts? The CFO tells Jo that Cloud 9 is in the process of signing a five-year purchase commitment with a new supplier located in Colombia, South America. The paperwork should be complete by the next day. The purchase commitment locks in a good price for some of Cloud 9’s raw materials. Cloud 9 is predicting that prices of some of its raw materials will be rising over the next few years, so locking in a commitment now can help save costs in the future. Jo relays information about this subsequent event back to the team. They will need to confirm the details of the contract and review Cloud 9’s disclosure of this Type II subsequent event. Sharon suggests that each member of the team ask themselves whether they believe that sufficient appropriate evidence has been gathered on which to base an audit opinion, given their knowledge and involvement in the audit. Are assessments of control risk and materiality still valid given evidence obtained from substantive procedures? No material misstatements were found during substantive testing, and there is no evidence to suggest that materiality should be adjusted. All confirmations sent to customers, financial institutions, and the stock registrar and transfer agent have been returned and any differences resolved. It appears that the only other major outstanding items are the engagement quality control review and the going concern assessment. Sharon and the team discuss the existence of any issues throwing doubt on the appropriateness of the going concern assumption at Cloud 9. The financial ratios indicate no problems with solvency, and the major borrowings are not due to be repaid or refinanced for another four years. However, Cloud 9’s management is anticipating a decline in earnings this year because of the costs associated with the new store opening and the sponsorship deal. Cloud 9 does have a sizeable line of credit at its bank that is currently not being utilized. If Cloud 9 has an unexpected need for additional cash, Cloud 9 management could draw on the line of credit. The team makes a note that these issues have been formally reviewed and they conclude that there are no significant issues casting substantial doubt on the going concern assumption. Sharon prepares a draft management representation letter for Jo, the partner, to review before presenting it to Cloud 9’s CEO and CFO to sign. The letter includes a statement about management’s responsibility for critical accounting policies and critical accounting estimates. Sharon also drafts a report to be used for communication with Cloud 9’s audit committee. The report includes critical items for Cloud 9. Revenue recognition is a critical accounting policy to discuss with the audit committee. Key items that impact revenue recognition include the opening of a new company-owned store and sales and sales returns to retailers such as department stores. Some of the critical accounting estimates to discuss with the audit committee include estimating the allowance for doubtful accounts, inventory valuation in light of a fickle fashion market, and valuation of derivatives. 

Based on your findings from the Cloud 9 problems, evaluate whether Cloud 9 has any significant deficiencies or material weaknesses in internal control.