CLOUD 9 CASE STUDY
Aims of this assignment:
This assignment is designed to facilitate your learning of the key skills and knowledge needed when facing a financial report audit of a company, and how to analyse, research and pinpoint facets of the company that require auditing attention.
Case Background
This case analysis relates to the continuous case study, titled Cloud 9, which is featured in Moroney, Campbell & Hamilton (2017), Auditing: a practical approach, 3e, John Wiley & Sons, Australia (textbook). The details of the case study covers key aspects of a financial report audit.
Ron McLellan established his business, McLellan’s Shoes, in 1980. Since then he has run his business as a sole trader. Ron keeps records and his wife helps him prepare basic accounting records. As McLellan’s Shoes has no outside owners, Ron has never seen the need to have his accounts audited. When Chip Masters from Cloud 9 Inc. expressed an interest in buying McLellan’s Shoes in 1995, Ron was asked to provide audited financial reports.
INSTRUCTIONS:
A. Read the Cloud 9 case study background information in the Appendix of the textbook (Moroney 3e, pp XXXXXXXXXX), and
B. Answer the following THREE questions – as enumerated below. In doing so, cite relevant sections of the Auditing standards and/or related regulations where appropriate.
· Your answer should be approximately 2,500 words.
· Late submission will be deducted 10% of the awarded marks per calendar day. Submission is not accepted after being late 10 days.
Questions:
Please answer ALL Questions after fully reading the Cloud 9 case study.
1. Cloud 9 is a new client to your firm. Discuss factors that will influence your:
· Client acceptance decision (2 points)
· Audit planning (2 points)
· Preliminary risk assessment (2 points)
· Preliminary materiality calculation (2 points)
(2 x 4 = 8 points)
2. Identify FOUR inherent risks that are involved in Cloud 9 and its industry, name the account and audit assertions that would potentially be misstated and give an assessment of “high”, “medium” or low in relation to the likelihood and materiality of the risk occu
ing and justify your assessment. Answer in the following tabular format:
Inherent risk description
Accounts affected
Assertions affected
Risk assessment (likelihood and materiality)
1
2
3
4
(2 x 4 = 8 points)
3. Review the transcript of meeting with Carla Johnson, the Financial Controller of Cloud 9 (Appendix, Moroney 3e, pp XXXXXXXXXX), identify THREE internal controls that Cloud 9 has in place to stop e
ors occu
ing as well as the accounts and assertions covered by those controls and explain how you (as auditors of Cloud 9) will test these controls. Answer in the following tabular format:
Internal control description
Accounts affected
Assertions affected
Proposed tests of controls
1
2
3
(3 x 3 = 9 points)
Total Content – 25 points
someTitle
APPENDIX 439
APPENDIX
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 2016 statutory audit work for Cloud 9 Pty Ltd. The audit team
assigned to the client is: Partner, Jo Wadley; Audit Manager, Sharon Gallagher; Audit Senior, Josh
Thomas; IT Audit Manager, Mark Batten and you.
Prior-year audits were conducted by Ellis & Associates. As part of the transfer of records process, Jo
Wadley 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’ workpapers. 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.
Cloud 9 Pty Ltd company background
Originally founded in 1980 by R.A. McLellan, the Sydney-based company was a manufacturer
and retailer of customised basketball shoes. In 1996, Cloud 9, Inc. (a publicly listed United States
[US] company) purchased the original company from R.A. (Ron) McLellan and renamed it Cloud 9
Pty Ltd. As part of the sale agreement, R.A. 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), Ger-
many, 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 com-
fortable; it’s like walking on Cloud 9’. Cu
ently, Cloud 9 Pty Ltd is primarily a wholesaler of athletic
shoes to its main customers: David Jones, Myer, Foot Locker and Rebel Sports. In 2013, it also started a
small on-line channel to supply direct to customers.
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 on 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, that 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 Fe
uary 2008, Cloud 9, Inc. launched a 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 shoe have steadily increased. For Cloud 9 Pty Ltd, the ‘Heavenly 456’ now makes up 20 per cent of
total sales.
In July 2014, Cloud 9, Inc. launched its new product line called ‘Work on Clouds’, a safety boot with
steel capped toes, primarily targeted for fly-in fly-out workers in the mining industry. Cloud 9, Inc. has
een successful in launching this product with two key customers being Rin Tin Limited and Peacock
Prospecting Limited making up 75 per cent of all sales of this product. They are also in final negotiations
with Newnotold Mining Limited to supply their workers in their Indonesian gold mine as a 1-year trial.
A new and creative marketing campaign was initiated in 2010 to promote and build the ‘Cloud 9’
and in Australia and New Zealand. The Australian company was granted permission from its parent
entity to sponsor the A-league soccer team, Queensland Thunder, for the 2010 season. Given the suc-
cess of this sponsorship agreement, they also now sponsor the Melbourne Rugby Union team as well
as the New Zealand Rugby League team. Under these sponsorship agreements, Cloud 9 Pty Ltd pro-
vides all the athletic footwear for the team as well as having sole merchandising rights. The agreement
also includes general advertising rights at the stadiums where each team play and naming rights for the
player uniforms.
Moroney, Robyn. AUDITING: A PRACTICAL APPROACH 3E, Wiley, 2014. ProQuest Ebook Central, http:
ebookcentral.proquest.com/li
mit/detail.action?docID=4748092.
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440 APPENDIX
The first ‘Cloud 9’ retail store was opened in the Sydney CBD on 1 June 2010. The store operates on
a just-in-time inventory system linked with the main warehouse in Botany. In the first 12 months, the
management team reported a few hiccups in determining ideal stock quantities for the store to allow
optimum availability of merchandise to the customers. There were also some thefts of merchandise from
the store and, in order to reduce stock loss by theft, the company installed closed-circuit television cam-
eras. These initial teething problems were resolved quickly, and Cloud 9, Inc. has expanded its retail net-
work to include a store in Chadstone Shopping Centre, Melbourne, Westfield Carousel Shopping Centre
in Perth and Sylvia Park in central Auckland.
Personnel
Cloud 9 Pty Ltd has 82 full-time employees. In the retail stores, the company employs part-time staff,
with casual employees enhancing staff levels in the busier retail periods.
To administer the company’s finances Cloud 9 Pty Ltd employs Finance Director, David Collier; Finan-
cial Controller, Carla Johnson; and Business Systems Manager, Justin Reeves. These three employees
are entitled to participate in the employee share-purchase plan and receive stock options in Cloud 9, Inc.
if a number of key performance targets are met. These include revenue and profit before tax targets.
Financial information
Cloud 9 Pty Ltd has set a goal to increase its revenue by 3 per cent (compound) for the 5 years beginning
1 July 2014. One of the critical success factors for the company to achieve this 3 per cent increase is to
grow its share of the Australian footwear market, including in particular the safety boot market.
In addition, to build customer loyalty and promote sales online and in the retail stores, Cloud 9 Pty
Ltd has 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 2014, the company took out a new loan of $2 million with the ANZ Bank to help fund
the expansion of the online supply chain (a larger warehouse and higher inventory on hand given the
new safety boot line). This loan is repayable over 5 years. The company’s other debt relates to loans
from one of R.A. 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 stock is purchased in US dollars, which the company acquires under forward exchange contracts.
The company provides a 12-month wa
anty on all footwear. The wa
anty covers any manufacturing
faults but excludes normal wear and tear. Historical claims have been 2 per cent of total sales.
Refer below and on the next page for the prior-year statement of comprehensive income and statement
of financial position.
CLOUD 9 PTY LTD
Statement of comprehensive income
31 December 2015
Notes
31 December
2015
$
31 December
2014
$
Revenue XXXXXXXXXX XXXXXXXXXX
Bo
owing costs XXXXXXXXXX145)
Other expenses from ordinary activities XXXXXXXXXX XXXXXXXXXX)
Profit before income tax XXXXXXXXXX 974
Income tax expense XXXXXXXXXX)