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Cloud 9 - Continuing Case Part 1: Gain an Understanding of the Client W&S Partners began the planning phase of the Cloud 9 audit. As 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 inherent risk. This will assist the team in developing an audit strategy and designing the nature, extent, and timing of audit procedures.

Required Answer the following questions based on the additional information about Cloud 9 presented in the appendix to this text and the current and earlier chapters. You should also consider your answer to the case study questions in earlier chapters where relevant.

Your task is 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'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. Use the factors listed in Illustrations 4.2 and 4.3 as a guide for your research.

Part 2: Analytical Procedures

Required Answer the following questions based on the information presented for Cloud 9 in the appendix to this text and the current and earlier chapters. You should also consider your answers to the case study questions in earlier chapters.

a. Using analytical procedures and the information provided in the appendix, perform an analysis of Cloud 9's financial position and its business risks. Discuss the ratios indicating a significant or an unexpected fluctuation. b. Which specific areas do you believe should receive special emphasis during your audit? Consider your discussion of the analytical procedures results as well as your preliminary estimate of materiality. Prepare a memorandum to Suzie Pickering outlining potential problem areas (that is, where possible material misstatements in the financial statements exist) and any other special concerns.

Figure 4.2

Lower Inherent Risk Assessments	Factors That Influence Inherent Risk	Higher Inherent Risk Assessments
Satisfied customers who pay on time and are likely to remain a customer in the future Client has many customers	(1) Major customers	Dissatisfied customers who may withhold payment or decide to not purchase from the client in the future Client has only one or very few customers
Reputable suppliers that supply goods on a timely basis Few goods are returned to supplier as faulty Client pays suppliers on a timely basis	(2) Major suppliers	Suppliers may not supply goods on a timely basis Significant amounts of goods are returned to the suppliers because they are faulty Client does not pay suppliers on a timely basis
Trades with countries that are stable Trades in stable foreign currencies Minimal tariffs or barriers to trade Client maintains effective risk management policies regarding foreign trade	(3) Importer or exporter	Trades with countries that are not stable Trades in unstable foreign currencies Complex tariffs and other barriers to trade Client does not maintain effective risk management policies regarding foreign trade
Client well-positioned to adjust to changes in technology	(4) Changes in technology	Client falls behind with changes in technology and has not kept up with the times
Client does not offer warranties on its products If client does offer warranties, product quality is high and the likelihood that goods will be returned is low	(5) Warranties	Client offers warranties on its products History of poor product quality and goods being returned for the same problem
Few discounts are given by the client to its customers Client takes advantage of discounts offered by suppliers	(6) Discounts	Client offers discounts to its customers, possibly because it does not have much bargaining power Client misses opportunities to take advantage of supplier discounts
Client has good reputation with customers, suppliers, employees, and the wider community in which it operates	(7) Client reputation	Client does not have a good reputation with customers, employees, and/or the wider community in which it operates
Client has few locations and primary operations are centralized No international operations	(8) Operations	Client has larger number of locations and operations are decentralized Multiple locations operated internationally
No recent implementation of new standards No change in the application of accounting standards Personnel involved in the selection and application of accounting standards are competent and experienced	(9) Selection and application of accounting principles	Recent implementation of new accounting standard Change in the application of an accounting standard Personnel involved in the selection and application of accounting standards lack competence and experience
Determination of account balance is objective and supported by transactions with third parties Transactions are routine and relatively homogeneous Account has low volume of transactions	(10) Significant accounts and classes of transactions	Determination of account balance involves considerable subjectivity Transactions are complex and unique Account has high volume of transactions
Less complex payroll system and benefit structures Defined-contribution pension plans	(11) Relations with employees	More complex payroll system and benefit structures Defined-benefit pension plans
Less reliance on debt for financing Pays interest payments on time Less risk of violating terms of debt covenants	(12) Sources of financing	Heavy reliance on debt as a source of financing Struggles to pay interest payments on time Higher risk for violating terms of debt covenants which could indicate going concern issues
Simple capital structure Pays dividends from operating cash flow	(13) Ownership structure	Complex capital structure Struggles to pay dividends from operating cash flow

Figure 4.3

Lower Inherent Risk Assessments	Industry Factors That Influence	Inherent Risk Higher Inherent Risk Assessments
Less competitive industry, which puts less stress on the client's ability to generate a profit	(1) Level of competition	Very competitive industry, which puts more stress on the client's ability to generate a profit
Good reputation relative to others in the industry Customers and suppliers may be attracted to conduct business with the client versus a competitor	(2) Reputation	Poor reputation relative to others in the industry Customers and suppliers may shift business to a competitor
A new industry with considerable government support and incentives New or established industry with intense international competition with considerable government support and incentives Industry with minimal government regulation and no special taxes or unique financial reporting requirements	(3) Legal, political, and regulatory environment	A new industry with little or no government support New or established industry with intense international competition with little or no government support Heavily regulated industry with special taxes and unique regulations and financial reporting requirements
Demand is not seasonal, which provides steady revenue flow Industry minimally affected by trends/customer preferences Industry has low risk of technological obsolescence	(4) Demand	Seasonal demand for products, which leads to sporadic revenue flow Industry subject to changing trends/customer preferences Industry subject to technological obsolescence
Economy as a whole experiences an upturn, which leads to easily sustainable profit levels	(5) Economy	Economy as a whole experiences a downturn, which leads to pressure to maintain expected profit levels

Cloud 9 Condensed Cash Flow Statement For the year ended January 31, 2022 January 31, 2021 Cash provided by operations $ 25,250,000 $ 26,907,692 Cash used by investing activities (13,165,385) (16,923,077) Cash used by financing activities * (13,457,692) (9,696,154) Effect of exchange rate changes on cash 3,284,616 1,873,077 Net increase in cash and cash equivalents 1,911,539 2,161,538 Cash and cash equivalents, beginning of year 9,780,769 7,619,231 Cash and cash equivalents, end of year $ 11,692,308 $ 9,780,769 Cloud 9 Consolidated Balance Sheet January 31, 2022 January 31, 2021 $11,692,308 62,361,538 54,773,077 14,460.577 3:357,692 5.250,000 $ 9.780,769 60,361,539 55,615,385 14,852,885 3,288,461 7,276,923 $151,895,192 62,261,539 3,820,192 5,853,846 $223,830,769 $151,175,962 60,900,000 3,950,961 9,238,462 $225,265,385 Assets Current assets: Cash and cash equivalents Accounts receivable, less allowance for doubtful accounts of $2,773,077 and $2,515,385 Inventory Investments (derivatives) Deferred income taxes Prepaid expenses and other current assets Total current assets Property, plant, and equipment, net Identifiable intangible assets and goodwill, net Deferred income taxes and other assets Total assets Liabilities and Stockholders' Equity Current liabilties: Current portion of long-term debt Notes payable Accounts payable Accrued liabilities Income taxes payable Total current liabilities Long-term debt Deferred income taxes and other liabilities Stockholders' equity: Common stock at par value Capital in excess of par value Unearned stock compensation Accumulated other comprehensive income Retaining earnings Total stockholders' equity Total liabilties and stockholders' equity $ 207,692 28,896,154 20,615,385 18,157,692 842,308 $ 1,926,923 35.546,154 20,915,385 23,336,581 582,650 $ 68,719,231 16,765,384 3,942,308 $ 82,307,693 18,088,462 4,253,846 107,692 17,669,231 (380,769) (5,850,000) 122,857,692 107,692 14,192,308 (450,000) (4,273,077) 111,038,461 134.403,846 $223,830,769 120,615,384 $225,265,385 Cloud 9 Consolidated Statement of Income For the year ended January 31, 2022 $364,953,846 For the year ended January 31, 2021 $345,965,385 Revenues Costs and expenses: Cost of sales Selling and administrative Interest expense Other (income)/expense, net Total costs and expenses Income before income taxes Income taxes Net income $222,496,154 104,450,000 1,257,692 1,311,539 $207,838,462 100,246,154 1,730,769 796,154 329,515,385 35,438,461 12,757,692 $ 22,680,769 310,611,539 35,353,846 13,080,769 $ 22,273,077 Cloud 9 Condensed Cash Flow Statement For the year ended January 31, 2022 January 31, 2021 Cash provided by operations $ 25,250,000 $ 26,907,692 Cash used by investing activities (13,165,385) (16,923,077) Cash used by financing activities * (13,457,692) (9,696,154) Effect of exchange rate changes on cash 3,284,616 1,873,077 Net increase in cash and cash equivalents 1,911,539 2,161,538 Cash and cash equivalents, beginning of year 9,780,769 7,619,231 Cash and cash equivalents, end of year $ 11,692,308 $ 9,780,769 Cloud 9 Consolidated Balance Sheet January 31, 2022 January 31, 2021 $11,692,308 62,361,538 54,773,077 14,460.577 3:357,692 5.250,000 $ 9.780,769 60,361,539 55,615,385 14,852,885 3,288,461 7,276,923 $151,895,192 62,261,539 3,820,192 5,853,846 $223,830,769 $151,175,962 60,900,000 3,950,961 9,238,462 $225,265,385 Assets Current assets: Cash and cash equivalents Accounts receivable, less allowance for doubtful accounts of $2,773,077 and $2,515,385 Inventory Investments (derivatives) Deferred income taxes Prepaid expenses and other current assets Total current assets Property, plant, and equipment, net Identifiable intangible assets and goodwill, net Deferred income taxes and other assets Total assets Liabilities and Stockholders' Equity Current liabilties: Current portion of long-term debt Notes payable Accounts payable Accrued liabilities Income taxes payable Total current liabilities Long-term debt Deferred income taxes and other liabilities Stockholders' equity: Common stock at par value Capital in excess of par value Unearned stock compensation Accumulated other comprehensive income Retaining earnings Total stockholders' equity Total liabilties and stockholders' equity $ 207,692 28,896,154 20,615,385 18,157,692 842,308 $ 1,926,923 35.546,154 20,915,385 23,336,581 582,650 $ 68,719,231 16,765,384 3,942,308 $ 82,307,693 18,088,462 4,253,846 107,692 17,669,231 (380,769) (5,850,000) 122,857,692 107,692 14,192,308 (450,000) (4,273,077) 111,038,461 134.403,846 $223,830,769 120,615,384 $225,265,385 Cloud 9 Consolidated Statement of Income For the year ended January 31, 2022 $364,953,846 For the year ended January 31, 2021 $345,965,385 Revenues Costs and expenses: Cost of sales Selling and administrative Interest expense Other (income)/expense, net Total costs and expenses Income before income taxes Income taxes Net income $222,496,154 104,450,000 1,257,692 1,311,539 $207,838,462 100,246,154 1,730,769 796,154 329,515,385 35,438,461 12,757,692 $ 22,680,769 310,611,539 35,353,846 13,080,769 $ 22,273,077