Engagement Overview

ACC 411 Cloud9 Case Study

Cloud9 Inc., a listed company (publicly traded) in the United States, is looking to expand. Stotez Shoes was seen as a potential target.

In 1985, Ron Stotez started Stotez Shoes in Seattle, Washington, manufacturing and retailing customized basketball shoes. Ron borrowed from the bank to start a company, using his house as security. Over the years, he worked very hard to establish a profitable niche in the highly competitive sports shoe market. Ron repaid the bank in 1999, and he vows to never borrow again.

In February 2023, Ron received a call from Rhonda Alvarez, the senior vice president of Cloud9. Rhonda expressed an interest in buying Stotez Shoes. Rhonda Alvarez has asked Ron Stotez for audited financial statements of Stotez Shoes. Ron Stotez came to an arrangement with Rhonda Alvarez and sold Stotez Shoes to Cloud9 in 2024.

Your accounting firm Bondi CPA will be conducting the audit of Cloud9. The partner responsible for the audit is Jo Wadley with team members Sharon Gallagher (audit manager) and Ghalen Johnson (audit senior) to assist.

Sharon and Ghalen both discuss their own independence with Jo, to confirm that there are no independence problems associated with either their investments or relationship with Cloud9 or the investments or relationships associated with immediate family members or close relatives.

At the first planning meeting, Sharon and Ghalen focus on the risk assessment phase for the new audit, the audit team needs to gain an understanding of Cloud9s structure and its business environment, determine materiality, and assess the risk of material misstatement.

Once the risk assessment is complete, Bondi CPA must have an audit program they can use for the Cloud9 audit to address how risks are mitigated and to ensure quality evidence is gathered for the accounts that are most at risk of being misstated.

Cloud9 Inc. Company Background

Cloud9 Inc. is a manufacturer and retailer of athletic shoes and apparel, based in Sacramento, California. In 2024, Cloud9 purchased Stotez Shoes from Ron Stotez. As part of the sale agreement, Ron Stotez was appointed to the Cloud9 board of directors.

Cloud9 businesses operate in various international markets. Cloud9 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, its like walking on Cloud9. Currently, Cloud9 is primarily a wholesaler of athletic shoes and apparel to its main customers All Day Sports, Mayer, Bobs, and Varsity Sports.

Cloud9 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 with free on board (FOB) shipping terms, which means Cloud9 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.

Cloud9 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 Cloud9, Heavenly 456 now makes up 50% of total sales.

To further establish the brand, the first Cloud9 retail store was opened in San Francisco, California, on June 1, 2025. 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.

The Cloud9 corporate office has 358 full-time employees but only five in the accounting department. 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 periods.

Some key positions in the accounting and IT area are as follows. CFO: Samantha Young Financial controller: Carla Johnson IT manager: Will Burton

The Company does not have an internal audit department.

Cloud9 set a goal to increase revenue by 3% each year. One of the critical success factors for the company to achieve this 3% increase is to grow its share of the U.S. 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 decline in earnings for the year.

In addition, to build customer loyalty and promote sales in the retail store, Cloud9 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.

The company recently took out an additional loan of $7 million with Windsor 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 more than five years ago from various lending institutions.

All inventory is purchased in U.S. dollars, which the company acquires under forward exchange contracts. The company provides a 12-month warranty on all footwear. Historical claims have been 0.2% of total sales

The most recent financial statements for Cloud9 are provided in separate files.

review the Cloud9 Case Study and use select data provided in the Supporting Materials section to perform an analysis of the company data. Areas covered will include internal controls of the company, IT controls, external and other factors that may impact the company, interview transcripts from company staff and other personnel, as well as Cloud9s financial data. Through your analysis, you will identify a minimum of two internal control deficiencies or anomalies (risks) for each of the following: accounts receivable, accounts payable, inventory, and information technology. Next, you will determine audit tests to be performed and internal control recommendations to remediate any risks. Analyze financial accounting internal controls to identify risk. Include the following:

1. Lines of business Cloud9 deals with
2. Types of Cloud9 customers
3. Types of Cloud9 suppliers
4. Associated general ledger accounts, including materiality
5. Analyze information technology controls to identify risk. Include the following:
   1. IT general controls
   2. Company-level and application controls
   3. Cloud9s ability to adapt to changing technology
6. Analyze external and other factors to identify risk. Include the following:
   1. Laws and regulations that may affect Cloud9
   2. Economy and its impact on Cloud9
   3. Cloud9s industry
7. Analyze financial data gathered through data analytics to identify risk. Include the following:
   1. Validated notes payable balances
   2. Validated inventory balances
   3. Timing of revenues to ensure proper period
   4. Allowance for doubtful accounts
      1. Is it reasonable?
      2. How to confirm?
   5. Liquidity risk based on ratios
   6. Inventory moving based on ratios
   7. Customers paying on time based on ratios
8. Create an audit program to address identified risks. Include the following:
   1. Recommended audit tests for the audit team to perform