Week 3 Case Study - year 2020 PDF

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CHAPTER 3: RISK ASSESSMENT I WEEK 3: CASE STUDY CLOUD 9

You are a graduate working for W&S Partners, 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 for Cloud 9 Pty Ltd (Cloud 9). The audit team assigned to this client is: 

Partner, Jo Wadley

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Audit Manager, Sharon Gallagher

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Audit Senior, Josh Thomas and Suzie Pickering

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IT Audit Manager, Mark Batten

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Graduates, Ian Harper and you

As a part of the risk assessment phase for the new audit, the audit team needs to gain an understanding of Cloud 9’s structure and its business environment. By understanding the client’s business, the audit team can identify potential risks that may have a significant effect on the financial report. This will assist the team complete the audit. Required Answer the following questions based on the additional information about Cloud 9 presented in the appendix to this text and the current 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 9’s 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 9’s operations. In conducting your research, you should consider the following key market forces, as they relate to Cloud 9’s operations. Note 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 9’s 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 9’s

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operations. In conducting your research, you should consider the following key market forces, as they related to Cloud 9’s operations. 

General and industry-specific economic trends and conditions

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Competitive environment

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Product information

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Customer information

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Supplier information

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Technological advances and the effect of the internet

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Laws and regulatory requirements

Economic Characteristics/ Supplier Information/ Regulatory The Australian footwear market is expected to contract over the next few years (IBIS world): 

Household consumption expenditure has decreased over the last few years with petrol and housing prices increasing. Expenditure is mostly going towards travel and leisure rather than closing or footwear

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Tariff reductions have led to a decrease in prices for consumers

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Lower pricing levels and improved quality of Chinese imports have resulted in large volume increases. Cloud 9 Pty has responded well to this shift by obtaining the majority of its good from their China distribution plant

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The strength of the Australian dollar against the US dollar during the early part of 2010s has improved the foreign currency exchange issues, but currency market is unstable (e.g. falling A$ vs US$ in 2015)

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Having a retail outlet/ store increases the risk of theft (and has been proven) and need for skilled or at least consistent labour

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Consider effect of recent events e.g. share market instability, online retail footwear, contraction in mining industry in Australia (affecting work boot sales)

Competitive Environment/ Product Information/ Customer Information Competition is high and increasing, with price and quality the deciding factors: 

The ability to supply footwear retailers with products in a timely manner is an important success factor against competitors. Footwear is subject to fashion trends, and vulnerable to online competition

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Image and functionality are two of the most important characteristics consumers use to differentiate footwear. An aggressive marketing campaign, often using sports and fitness preferences are key to establishing brand recognition. Different factors impact sale of work boots (less fashion dependent)

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The industry is relatively capital intensive – need for warehousing, transportation, stock – is high and may create barriers to entry

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While entry from new wholesalers can be difficult based on agreements between existing wholesalers and retailers, the trend in the industry is for the customer to buy directly from the manufacturer. Cloud 9 has responded well to this trend by opening its own store, thereby taking out the wholesaler

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Discount stores are surpassing department stores – this may impact Cloud 9’s current customer base and sales opportunities

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To boost repeat customer visits, retailers are developing loyalty programs. While Cloud 9 started a program this year, it remains to be seen if the benefits will be achieved given the low regularity of consumers purchasing athletic footwear

Technology and Systems Technological advances in this industry have mainly been in the areas of replacing the need for skilled labour with computerized automation of inventory control: 

Computers allow inventory to be stored on an international basis; allowing for more efficiency transportation and distribution

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Distribution management software allows advanced order management, inventory management, and delivery systems to be combined in one seamless supply chain

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An online presence will provide a competitive advantage through increased marketing power and the ability to provide product information

By considering these factors, the auditor would identify key business risks that would have a material effect on the financial statements. These risks are inherent to the business operations. Based on the research above, the Cloud 9 audit team have identified the following audit risks areas: Growth of revenues given industry outlook and management incentive Consumer discretionary spend is low and expected to grow slightly or decline for the year. Management receive bonuses based on revenue targets, which was set at 3%. General economic conditions will also impact retail businesses with their recoverability of debt and valuation of assets.

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Use of IT for inventory management system Retail businesses are reliant on a smooth supply chain process. Where a business uses products with a long lead time, there is significant pressure to ensure that the correct type and quantity of stock is ordered to meet the requirements of customers. Level of competition Most sectors of retailing are relatively mature and continue to compete on the traditional basis of price, brand strength and level of market power. Price remains important in most mass market areas of retailing. Merchandise cycle and fashion trends Rapidly changing fashion trends and slow sales outlooks can result in obsolete stock. Health of mining sector will impact on sales of work boots.

Misappropriation of stock and cash Retail business selling highly desirable and moveable products (e.g. PC games, CDs, designer sunglasses) will be exposed to an increased risk of theft. In addition, employees handling cash at store locations increase the risk of fraud through theft also. Rebates/ discount to retailers For the wholesale business, there is a significant pressure from retailers to receive generous rebates or volume discounts. Retailers are heavily influenced by landlords and consumers; therefore, they control their profits through the supply chain, thus impacting the wholesaler. Note to The Lecturer From a big picture perspective, you may want to highlight the key risks in respect of understanding the wholesale/retail industry. This does not directly affect the outcome of the case study for Cloud 9 given the limited company background provided. 

How does the company control the suppliers/manufacturers? Are they onshore or offshore?

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How do they determine the quantity/style for their purchases from the manufacturer? Ultimately, the wholesaler inherits some of the risk when determining stock balances to effectively service the retailers

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What are the terms and conditions within the retailers? What rebates or discounts are provided? As price is the key driver in retail, this will be the area of concern when dealing with retailers

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