Appendix A Appendix A: Cloud 9 Ltd. W&S Partners is a Canadian accounting firm with offices located in each of the major cities. W&S Partners has just won the December 31, 2023, statutory audit work for Cloud 9 Ltd. The audit team assigned to the client is Partner, Jo Wadley; Audit Manager, Sharon Gallagher; Audit Seniors, Josh Thomas and Suzie Pickering; IT Audit Manager, Mark Batten; and Audit Juniors, including Ian Harper, Weijing Fei, and you. Prior-year audits were conducted by Ellis & Associates. As part of the change of auditors process, Jo Wadley met with R. J. Ellis (Managing Partner, Ellis & Associates) to discuss acceptance of Cloud 9 Ltd. as a client and to inquire about access to Ellis & Associates work 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 Ltd. Company Background Originally founded in 2000 by Ron McLellan, the Toronto-based company was a manufacturer and retailer of customized basketball shoes. In 2013, Cloud 9 Inc. (a publicly listed Canadian company) purchased the original company from Ron McLellan and renamed it Cloud 9 Ltd. As part of the sale agreement, Ron McLellan was appointed to the Cloud 9 Ltd. board of directors. The parent company, Cloud 9 Inc., has wholly owned subsidiaries in the United Kingdom, Germany, United States, China, and Brazil, and has built a reputation around the fact that its shoes are comfortable and durable. The company promotes itself using its now well-known tagline, Our shoes are so comfortable, its like walking on Cloud 9. Currently, Cloud 9 Ltd. is primarily a wholesaler of athletic shoes to its main customers: David Jones, Meyer Sports, Foot Locker, and Rebel Sports. Cloud 9 Ltd. receives the majority of its inventory from the production plant in China, with the remainder coming from the United States. All inventory is purchased free on board (FOB) shipping point, which means Cloud 9 Ltd. 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 through an electronic inventory system. When retail inventory levels get low, the company ensures that deliveries are made using its own transport trucks, thus ensuring control throughout the entire process. In February 2021, Cloud 9 Ltd. launched its new product line, which 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 Ltd., the Heavenly 456 now makes up 20 percent of total sales. A specific marketing campaign was initiated in 2023 to promote and build the Cloud 9 brand in Canada. The Canadian company was granted permission from its parent entity to sponsor a new soccer team, the Thompson Thunders, for the 2023 season. Under this sponsorship agreement, Cloud 9 Ltd. is to provide all the athletic footwear for the team, and have sole merchandising rights. The agreement also includes general advertising rights at the stadium. In a separate contractual arrangement, Cloud 9 Ltd. has signed Kevin McDonald, the captain of the Thompson Thunders, as spokesperson for the brand. This arrangement allows Cloud 9 Ltd. to use Kevins image to promote and build the brand in Canada. To further establish the brand, the first Cloud 9 retail store was opened in Toronto on June 1, 2023. The store operates on a just-in-time inventory system linked with the main warehouse in Richmond. 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 Ltd. has 52 full-time employees. In the retail store, the company employs part-time staff, with casual employees enhancing staff levels in the busier retail period. To administer the companys finances, Cloud 9 Ltd. 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 share purchase 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 Ltd. set a goal of increasing its revenue by 3 percent for the 2023 fiscal year. One of the critical success factors for the company achieving this 3-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 Ltd. introduced a loyalty program whereby customers earn one point for every $10 that they spend. Customers can then redeem points by going online to receive coupons that can be exchanged for merchandise in the store. On October 1, 2022, the company took out an additional loan of $2 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 companys other debt relates to loans issued five years ago from a company that is majority-owned by one of the directors. All inventory is purchased in U.S. dollars, which the company translates into Canadian dollars. The company provides a 12-month warranty on all footwear. Historical claims have been 2 percent of total sales.

TRANSCRIPT OF MEETING WITH CARLA JOHNSON Present: Carla Johnson, Financial Controller, Cloud 9 Ltd. Josh Thomas, Audit Senior, W&S Partners

JT: Thanks for seeing me, Carla. CJ: Youre welcome, Josh. What can I do for you? JT: I need to ask you some questions about Cloud 9s process for recording wholesale revenue transactions, including the trade receivables and cash receipts aspects. After I understand the process, Ill need to select a sample transaction to confirm my understanding of the process as you have explained. CJ: Well, I can tell you what should be happening, but you may want to go and speak to the sales manager or warehouse managers to confirm that they do what the company policy and procedures say. JT: Good point, Ill make appointments to see them. Thanks. So lets start at the beginninghow does a sales transaction get initiated? CJ: Weve got a pretty complex inventory management software system called Swift. It was designed by some of our tech guys in the United States. It tracks and does everything! JT: Sounds impressive! CJ: Anyway, the customerslets say the Sport Mart store in Torontocomplete a purchase order online through a site that is linked to Swift. JT: How do the customers decide the quantity and know the price? CJ: Swift is linked (dont ask me how) and sends an alert when the inventory balance of our products gets below the predetermined limit they set with us. They can select the quantity based on their needs, but the prices are set in the system. They get sent price lists from the sales manager so they know the current prices. JT: How often are prices changed? CJ: Depends on the market, really. They dont change too frequently. JT: What if you dont have the products? CJ: The system doesnt allow them to place an order greater than our current inventory levels. If they need more, they need to fill out a separate request form that gets emailed to our warehouse manager so she can place the order with China. JT: OK, so they complete a purchase order. Then what? CJ: The submitted purchase order goes through a credit check and then becomes a sales order. Thats all done behind the scenes in the system. We really dont see anything on our side until the sales order stage. JT: Guess that saves a lot of time and trees! CJ: Yeah, theres so much that we rely on the system to do for us, its scary. If we were hit by an electrical storm, wed be in trouble. JT: What happens to the sales ordershow do they get filled? CJ: Every day, the warehouse manager downloads the outstanding sales orders to these little hand-held computer/scanner thingies. Its very Star Trek. Warehouse personnel use these to select the items off the shelves onto pallets. The pallets are taken to a staging area where each product is then scanned. This establishes the shipping document in Swift, which then gets printed for the delivery. JT: Are the shipping documents approved before the goods go out the door? How do you know that what got sent is what was ordered? CJ: Swift matches the quantities and products on the shipping document to the sales order. Once they match, the approval box is activated and the shipping supervisor can enter his pass code. This officially approves the shipping document and it gets printed. JT: How many orders do you fill in a day? It sounds like a lot for one person to do. CJ: We probably complete about 50 orders a day. Shoes arent perishable items, you know, so its not like we are sending products to every store, every day. Were trying out the pit crew concept, where theres two shipping supervisors with about four to five warehouse employees in their crew team. So they are in the staging area with them and do it right there with the hand-held devices. They like to have little contests to see who can do it the fastest. You should go down there; its quite a lively group. David encourages it and its been great for productivity and morale. JT: Sounds like a great working environment. Better than being stuck in a broom closet sifting through invoices! CJ: Ah, the life of an auditor. I remember the good old days JT: And the goods are sent out on your own trucks? CJ: Thats right. Weve bought our own trucks and vans rather than relying on couriers. The drivers pick up their loads in the morning and bring back anything undelivered. Because shoes are an easy product to off-load, we have to be careful about theft. So nothing can be left in the back of a truck at the end of the day. It comes back here and gets locked up in the shipping cage until it can be delivered again. JT: Why would goods be undelivered? CJ: Sometimes the drivers get behind or the store is closed unexpectedly. So there are occasions when all the goods wont get delivered in the day. JT: OK, so once the goods are delivered to the customer, how do you bill them? CJ: The drivers have the customers sign for the goods and then give us the signed copy. We go into the billing system and pull up the draft invoice that was generated when the shipping document was approved. We match the quantities in the invoice against the shipping document and confirm customer sign-off. This way, we only bill for those goods that were actually received by the customer. At 4 p.m., we do a batch run for the day. The copy is stapled to the signed shipping document and put on file. The running of the batch run posts the invoices to the sales journal and accounts receivable subledger. JT: Does finance ever go back to the sales order? CJ: No. Since a shipping document cant get generated unless it agrees to the sales order, we dont go back that far into the process. Why, do you think we have to? JT: I wouldnt say so at this stage. But youd have to be sure to have some tight controls around Swift, given that it seems to do everything. CJ: Like I said, it does everything. JT: What is the cash receipts process? CJ: We get most payments via EFT, so my AR clerk downloads the previous days receipts from online banking. She then goes into the subledger to post the receipts against the customer accounts. When shes finished posting each entry, she runs a batch report of all postings and reconciles it back to the bank statement. I review that reconciliation and sign off. JT: Are bank reconciliations done in a timely manner? CJ: I do bank recs each month for the operating and savings accounts. David reviews and approves them. Keep in mind what I just explained is for the wholesale transactions. We have separate procedures for the store regarding daily cash balance reconciliations to the deposits in the operating bank account. JT: Yes, our graduate will be handling the store side of the sales to cash receipts process. They will probably come and talk to you in a day or two. Well, I think that should do it for now. I may have some follow-up questions for you as I start getting my head around all of this. CJ: Doors always open. JT: Thanks for your time.

You are a graduate working for W&S Partners, a Canadian accounting firm with offices located in each of Canadas major cities. W&S Partners has just been awarded the December 31, 2023, audit for Cloud 9 Ltd. (Cloud 9). The audit team assigned to this client is: Jo Wadley, partner Sharon Gallagher, audit manager Josh Thomas and Suzie Pickering, audit seniors Mark Batten, IT audit manager Ian Harper and you, graduates As a part of the planning process for the new audit, the audit team needs to gain an understanding of Cloud 9s structure and its business environment. By understanding the clients 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. Required Answer the following questions based on the additional information about Cloud 9 presented in Appendix A and in this 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 9s 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 9s operations. In conducting your research, you should consider the following key market forces as they relate to Cloud 9s operations.

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 companys 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 clients operations centralized or decentralized?

Is the clients business cyclical in nature or influenced by seasonal fluctuations in the market? What is the susceptibility to fraud and theft? (Is the product something that can easily be stolen and has a ready market?)