Cloud 9 - Continuing Case

Effective internal controls at the transaction level are designed to prevent or detect and correct material misstatements that could occur within the flow of transactions. In the case study assignment in Chapter 6, you were required to identify potential misstatements and affected assertions within the wholesale credit sales.

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

Required

1. a.For each assertion related to wholesale credit sales, identify a key control in Cloud 9's system of internal control.
2. b.For each key control identified in (a), explain how you would test the control.
3. c.For each control identified in (a), explain the evidence that would lead the auditor to believe that the there was a deviation from the prescribed control.

CASE BELOW:

Appendix A

Cloud 9 Inc. Audit

W&S Partners is a U.S.-based accounting firm with offices located in most major cities. W&S Partners will be conducting the January 31, 2023, audit for Cloud 9 Inc., a publicly traded company. The audit team assigned to the client is:

• Partner: Jo Wadley
• Audit manager: Sharon Gallagher
• Audit senior: Josh Thomas
• IT audit manager: Mark Batten
• Experienced staff: Suzie Pickering
• First-year staff: Ian Harper

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 as a client and to inquire about access to Ellis & Associates' working papers. In the discussion, RJ Ellis stated that there were no issues that W&S Partners should be aware of before accepting the client or beginning the work.

Cloud 9 Inc. Company Background

Cloud 9 Inc. is a manufacturer and retailer of athletic shoes and apparel, based in Sacramento, California. In 2021, Cloud 9 purchased McLellan's Shoes from Ron McLellan. As part of the sale agreement, Ron McLellan was appointed to the Cloud 9 board of directors.

Cloud 9 has wholly owned subsidiaries in Canada and Vietnam, and has built a reputation for its comfortable and durable shoes. The company promotes itself using its now well-known tagline, "Our shoes are so comfortable, it's like walking on Cloud 9." Currently, Cloud 9 is primarily a wholesaler of athletic shoes and apparel to its main customers All Day Sports, Mayer, Bob's, and Varsity Sports.

Cloud 9 receives about 25% of its inventory from the Vietnam production plant with the remainder coming from the United States. Also, about 20% of its property, plant, and equipment is located at the Vietnam production plant. All inventory is purchased on free on board (FOB) shipping terms, which means Cloud 9 takes ownership of the products once the international courier accepts the goods for delivery. The inventory is sent to the main warehouse in Sacramento, which is linked to retailers via an electronic inventory system. When retail inventory gets low, the company ensures deliveries are made using its own transport trucks, thus ensuring control throughout the entire process.

In February 2021, Cloud 9 launched its 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, the Heavenly 456 now makes up 20% of total sales.

A specific marketing campaign was initiated in 2022 to promote and build the Cloud 9 brand in the United States. Cloud 9 decided to sponsor a professional soccer team, Georgia Thunder, for the 2022 season. Under this sponsorship agreement, Cloud 9 is to provide all the athletic footwear and apparel for the team as well as have sole merchandising rights. The agreement also includes general advertising rights at the stadium.

In a separate contractual arrangement, Cloud 9 has signed Miguel Fernandez, the captain of Georgia Thunder, as spokesperson for the brand. This arrangement allows Cloud 9 to use Miguel's image to promote and build the brand.

To further establish the brand, the first Cloud 9 retail store was opened in San Francisco, California, on June 1, 2022. The store operates on a just-in-time inventory system linked with a series of warehouses and distribution centers throughout the United States and Canada. However, the management team reports that there have been a few hiccups in determining ideal stock quantities for the store to allow optimum availability of merchandise to its customers. Because some thefts of merchandise from the store have also occurred, the company has installed closed-circuit television cameras.

Personnel

The Cloud 9 corporate office has 358 full-time employees. In the retail store, the company employs two full-time managers and some part-time staff, with seasonal employees enhancing staff levels in the busier retail period.

Some key positions in the accounting and IT area are as follows:

• CFO: David Collier
• Financial controller: Carla Johnson
• IT manager: Will Burton

These three employees are entitled to participate in the employee stock-purchase plan and receive stock options in Cloud 9 if revenue targets are met.