Founded in 1980 by Ron McLellan, the Toronto-based company was a manufacturer and retailer of customized basketball
Question:
Founded in 1980 by Ron McLellan, the Toronto-based company was a manufacturer and retailer of customized basketball shoes. In 1993, 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 States, the United Kingdom (UK), Germany, China, and Brazil, and has built a reputation around the fact that its shoes are comfortable and durable. The company promotes itself using its well-known tagline “Our shoes are so comfortable, it’s like walking on Cloud 9.” Currently, Cloud 9 Ltd. is primarily a wholesaler of athletic shoes to its main customers: David Jones, Myer, 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 on 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 via an electronic inventory system. When retail inventory levels get low, the company ensures deliveries are made using its own transport trucks, thus ensuring control throughout the entire process.
A specific marketing campaign was initiated in 2020 to promote and build the Cloud 9 brandin Canada. The Canadian company was granted permission from its parent entity to sponsor a new basketball team, the Thompson Thunders, for the 2020 season. Under this sponsorshipagreement, Cloud 9 Ltd. is to provide all the athletic footwear for the team as well as having sole merchandising rights. The agreement also includes general advertising rights at the stadium.
In a separate contractual arrangement, Cloud 9 Ltd. has signed Bodhi Parker, the captain of the Thompson Thunders, as spokesman for the brand. This arrangement allows Cloud 9 Ltd. to use Bodhi’s image to promote and build the brand in Canada.
In February 2020, Cloud 9 Ltd. launched its new product line, which included the“Heavenly 456” walking shoe and the “Lightning 7” basketball shoe. Advertising campaigns
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and media coverage have been very successful and sales of the Heavenly 456 walking shoe have steadily increased. For Cloud 9 Ltd., the Heavenly 456 now makes up 25 percent of total sales. The Lightning 7 shoe was marketed in the basketball stadium during Thompson Thunders
games as well as heavily advertised using Bodhi Parker’s image. Due to a poor first season, sales of the Lightning 7 were unimpressive and, as a result, Cloud 9 still has a large amount of
inventory in its warehouse.
To further establish the brand, the first Cloud 9 retail store was opened in Toronto, Ontario, on June 1, 2020. The store operates on a just-in-time inventory system linked with the main
warehouse in Richmond, B.C. 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 staffing levels in the busier retail period.
To administer the company’s 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 stock option 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 to increase its revenue by 4 percent for the 2020 fiscal year. One of the critical success factors for the company to achieve this 4-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 on-line to receive coupons that can be exchanged for merchandise in the store.
On October 1, 2019, the company took out an additional loan of $3 million with OntarioBank to help fund the store costs, and to purchase additional delivery trucks and vans. This loan
is repayable over five years. The company’s other debt relates to loans from one of Ron 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 inventory is purchased in U.S. dollars. The company provides a 12-month warranty on all footwear. Historical claims have been 2 percent of total sales.
a) List your potential significant risks with your examples in the working paper provided.
b) For each significant risk, identify the account(s) that would potentially be misstated.
Intermediate Accounting
ISBN: 978-0077400163
6th edition
Authors: J. David Spiceland, James Sepe, Mark Nelson