Cash Flow Statement
accounting fi rm with offi ces 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 pro- cess, 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 is a Sacramento-based manufacturer and retailer of athletic shoes. 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 Inc. has wholly owned subsidiaries in Canada, Vietnam, and Brazil, and has built a reputation around the fact that its shoes have comfort and durability. The company pro- motes 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 to its main custom- ers 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 equip- ment 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 inter- national 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 specifi c 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 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.
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A-2 APPENDIX A Cloud 9 Inc. Audit
To further establish the brand, the fi rst Cloud 9 retail store was opened in San Francisco on June 1, 2022. The store operates on a just-in-time inventory system linked with the main warehouse in Sacramento. 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 offi ce has 358 full-time employees. In the retail store, the company em- ploys 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.
Financial Information Cloud 9 set a goal to increase revenue by 3% for the 2022 fi scal 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, Cloud 9 in- troduced 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 August 1, 2022, the company 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 fi ve years. The company’s other debt relates to loans issued more than fi ve 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 2% of total sales.
Cloud 9 Consolidated Statement of Income For the year ended
January 31, 2022 For the year ended
January 31, 2021 Revenues $364,953,846 $345,965,385 Costs and expenses: Cost of sales 222,496,154 207,838,462 Selling and administrative 103,450,000 100,246,154 Interest expense 2,257,692 1,730,769 Other (income)/expense, net 1,311,539 796,154 Total costs and expenses 329,515,385 310,611,539 Income before income taxes 35,438,461 35,353,846 Income taxes 12,757,692 13,080,769 Net income $ 22,680,769 $ 22,273,077
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Cloud 9 Inc. Company Background A-3
Cloud 9 Consolidated Balance Sheet January 31, 2022 January 31, 2021
ASSETS Current Assets: Cash and cash equivalents 11,692,308 9,780,769 Accounts receivable, less allowance for doubtful accounts of $2,773,077 and $2,515,385
Inventory 54,773,077 55,615,385 Investments (Derivatives) 14,460,577 14,852,885 Deferred income taxes 3,357,692 3,288,461 Prepaid expenses and other current assets 5,250,000 7,276,923 Total current assets 151,895,192 151,175,962 Property, plant and equipment, net 62,261,539 60,900,000 Identifi able intangible assets and goodwill, net 3,820,192 3,950,961 Deferred income taxes and other assets 5,853,846 9,238,462 Total assets $223,830,769 $225,265,385
LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilties: Current protion of long-term debt 207,692 1,926,923 Notes payable 32,896,154 35,546,154 Accounts payable 16,615,385 20,915,385 Accrued liabilities 18,157,692 23,336,581 Income taxes payable 842,308 582,650 Total current liabilities 68,719,231 82,307,693 Long-term debt 16,765,384 18,088,462 Deferred income taxes and other liabilities 3,942,308 4,253,846 Shareholders’ equity Common stock at par value 107,692 107,692 Capital in excess of par value 17,669,231 14,192,308 Unearned stock compensation (380,769) (450,000) Accumulated other comprehensive income (5,850,000) (4,273,077) Retaining earnings 122,857,692 111,038,461 Total shareholders’ equity 134,403,846 120,615,384 Total liabilties and shareholders’ equity $223,830,769 $225,265,385
Cloud 9 Condensed Cash Flow Statement For the year ended
January 31, 2022 January 31, 2021 Cash provided by operations 25,250,000 26,907,692 Cash used by investing activities (13,165,385) (16,923,077) Cash used by fi nancing activities* (13,457,692) (9,696,154) Eff ect of exchange rate changes on cash 3,284,616 1,873,077 Net increase in cash and cash equivalents $ 1,911,539 $ 2,161,538 Cash and cash equivalents, beginning of year 9,780,769 7,619,231 Cash and cash equivalents, end of year $ 11,692,308 $ 9,780,769
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