Footwear Retailing in Australia - Audit of Cloud 9 Pty Ltd - Case Study Example

Case Study: Cloud 9 Ptl. Ltd. Student’s Name Institutional Affiliation Case Study: Cloud 9 Ptl. Ltd. Chapter 3 General and industry-specific economic trends and conditions The Australian economy has strongly been supported by the mining industry that has ensured its stability. However, the Reserve Bank of Australia has projected a slow growth of the economy due to the economy transitioning from mining investment. Of importance to the audit of Cloud 9 is the projected increase in the consumer products prices by 2.25 percent (Lohan, 2011). This reflects the impact of inflation of the prices of the company’s products explaining the need for emphasis on the pricing policies of the client. The economy is currently recovering from a recession that has hit all the global economies. Therefore, the audit should place emphasis on the profits declared by the client to check for understatement of revenues, as well as expense overstatement. Cloud 9 majorly imports its shoes from China, and thus is involved in foreign exchange market. The Australian dollar has been higher compared to the US dollar, thus meaning that imports would be cheaper at the current exchange rates. Thus, the operations of clients are high affected with foreign currency fluctuations, a factor that would require emphasis during the audit with regards to the exchange rates in the books of account. The footwear industry can be termed labour intensive, since the labour cost is critical with regards to the price of the shoes. However, the labour cost in China is low compared to Australia, thus meaning Cloud 9 benefits from low prices in the imported products. However, the ongoing debate on homeworkers in the industry has been rubbing the retailers negatively, with lobby groups giving the current Fair wear campaign. This may affect the labor relations between the client and its employees in future, since there is likelihood to be strikes taking place in the future. The industry has experienced declining revenues over a five year period, and this has been reflected in the declining margins that Cloud 9 has reported. This has been affected by reduced customer disposable income. Therefore, the trends in the client’s books reflect those impacting the industry, thus reducing the level of risk regarding its going concern. Majority of clients’ transactions are in credit terms. Since it deals with department stores, it is likely that majority of them are debtors and receive discounts for making cash payments. Therefore, it is important for the invoices raised by the client to debtors to be scrutinized, so as to reconcile the goods in the stores and those already sold. The volumes in relation to the transactions are huge, and this may result to errors on the side of the client, resulting in material misstatements. More so, the clients’ operations are decentralized, and as such, their operations in China and U.S where the parent company is situated needs to be included in the reported financial results. It is important that the client discloses other locations where they operate from before the audit commences, since it would allow the audit team to visit them. With regards to the risk of theft, shoes which are the client’s core products can be easily stolen, and also have a ready market as there is no differentiation in the footwear market, thus hard to tell the difference from those of other department stores. However, the client deals in footwear that are customized to consumer requirement, and thus are hard to steal as there lacks a ready market for such shoes. Competitive Environment Cloud 9 specifically deals in footwear and sales the products on the wholesale and retail market. However, the footwear industry has not seen a major change in the brands currently available in terms of new development or additional features, and thus the issue on loss of value is not evident, and thus indicating a stable market. The sales margins in the industry have been on a decline, since the industry data reflect those of the client’s trends, and thus consistency in the information provided. Currently, the major competitors include RCG Corporation, Betts Group Ptl Ltd, Rebel Group and ARH Holdings (Australia) Ptl Ltd, with market shares of 7.5%, 6.2%, 4.5% and 3.3%, respectively (Lohan, 2011). More so, the barriers of entry into the market are low, since the market is characterized with intense competition, an important aspect during the audit with regards to the entity’s going concern. Product Information From analysis of the market, the clients’ products have a specific lifecycle as the products are dependent on styles and trends, thus easy to establish the risk of the client being a going concern (Lohan, 2011). Customer Information With regards to customers, the client relies heavily on the employed population as the more their disposable income, the more they have a higher purchasing power of his products. Also important to the client are women, who form an important segment of his market. Sales revenues will, therefore, be affected by macro-economic forces, such as unemployment exposing the client to the risk of overstatement of revenues due to pressure from shareholders. Supplier information The major suppliers of the client are manufacturing plants in China and U.S, thus explains the need to emphasis on the proper testing of goods in transit account. The exchange rate fluctuation information on the financial statements should also be examined as the client inventories are mostly imported. Technological advances and the effect of the internet The retail and wholesale footwear industry has a generally medium level of technological change. The most commonly used technology in the industry is the computerized point-of-sale that records and controls sales, distribution, and merchandising. Other technologies in use are the barcode scanners, closed circuit TV cameras, Signature capture and Source tagging technologies (Lohan, 2011). With reference to the audit, it is important to test the efficiency of such technology with regard to the risk of errors and provision of audit trail. Internet has impacted the industry in as far as the layers have started online retailing, simultaneous to the conventional retailing. It is important to test whether the online platform can be susceptible to hackers in relation to the risk of fraud. Law and regulatory requirements The industry was previously highly regulated by the Australian government, but has recently been decreasing, and the state of affairs can be said to be light. More recently, the RBA made changes to the Payment System Act through the RBA Interchange Fee Reform, which reduced the merchant costs for all credit transactions, and has resulted in the retailers making major savings (Lohan, 2011). The audit team should consider when the legislation took effect, and when it was implemented in the accounting policies of the client. Chapter 4 Analytical Procedures From the data provided in the trend analysis, there were fluctuations with regards to profit before tax, turnover, gross profit, total assets and equity in comparison to the previous year financial statements. Accounts that show elements of material misstatement include the sales revenue, inventories, suppliers and debtors accounts. The customized shoes may have been rendered obsolete at the time they were being shipped to the client. This would affect the supplier and inventories accounts as they would either be overstated or understated. Therefore, an audit strategy to test the internal control for the client is important. For the analytical analysis to be successful in revealing areas where fluctuations are unexpected to the audit, the profitability ratios, solvency ratios and liquidity ratios, were used to assess the financial position and business risk of the client. The gross profit margin and total asset turnover ratios revealed the fluctuations in the financial statements. Common areas where emphasis should be made in the audit are the inventories, debtors and bank accounts of the client. Also important are the assertions as to these accounts, with regard to measurement, recognition, disclosure and presentation in the financial statement critical to the identification of errors in the account balances. Chapter 5 a. Procedure for engaging component auditors For a client like Cloud 9 who has operations in U.S and China, the auditor with the responsibility of signing the audit report may rely on evidence given by a component auditor in particular components of the report. The group engagement partner would first consider the other auditor’s capacity with regards to the work being undertaken. Also, the engagement partner has to ensure that the auditor has been a member of a reputable professional body. The reputation of the auditor is also a requirement for one to qualify to be a component auditor. The work done by the component auditor must meet the standards and requirements of the group engagement partner with regards to gathering appropriate evidence. b. Engaging an expert An auditor is allowed to seek the services of an expert when members of the audit team do not possess such skills to assess a particular item in the audit. Suzie first would have to make sure that the item under assessment is complex and significant to the audit. Also, there has to be less corroborative evidence so as to necessitate the need for an expert. For the derivative expert, he has to have a good reputation and experience in the field the auditors are seeking their advice. The expert should also bear the necessary qualifications supported by membership with a reputable professional body. Before engaging the expert, Suzie has to assess whether the expert is objective. This means that she has to establish whether the expert has a relationship with the client so as to maintain the fundamental principles of an audit professional. Where there lacks a connection with the client, Suzie may engage the expert. After engagement, she has to discuss with the expert on the scope of his work with regards to timing, extent, and nature of the work. Also, she would give instructions as to the issues the expert has to cover, as well as how it will be used by the auditors. In order for the expert to provide the necessary information to Suzie, the report has to be understandable to the audit team; in that, he would simplify the assessed items. Also, such report has to be supported by data, processes and assumptions that the experts relied on so as to make their conclusions. Finally, so ensure that Suzie has sufficient evidence regarding the derivatives, the report from the expert should be consistent with other information in the audit. The only responsibility Suzie has with regards to the derivatives is assessing the quality of the work submitted by the expert, but would not have to carry out other procedures. c. Working papers Working paper for the Component Auditor Client name: Cloud 9 Ptl. Ltd. Period: Year ended 31 December 2011 Working Paper: Inventory control in China/ U.S testing Purpose of test: The purpose of this audit is to verify whether the control on the value of the goods in transit was implemented in the 12 month period ending 31 December 2011. Work Performed: Considered two balance of inventories shipped from China and examined the dates recorded in the goods in transit account, and compare with the suppliers invoice on the date the inventories where invoiced. Examined the shipping documents from the shipping agent on the date when the shipment was shipped to Australia. Visited the warehouse where goods were stored before shipment to establish its condition. Examined whether the warehouse complies with proper warehousing procedures through its registration documentation. Made reconciliation of the supplier’s invoice and the bill of lading from the shipping company regarding quantity and description of shipment. Results of testing: The inventories shipped in August 24 and November 29 as per the client’s books was recorded in the warehouse records as August 14 and November 15 and on the bill of lading as August 20 and November 20, respectively. The selling price of the goods in transit was same to the previous consignment that was sold in the same accounting period. The quantity and quality of the goods was similar in all the documents tested. Conclusion Based on the tests performed, the goods on transit were properly recorded in the books of account and the policies used to determine the selling prices of the products was consistent with the pricing policy of other consignments. Prepared by: CA Reviewed by: W & S Reference No.000976 Working Paper for the expert Client Name: Cloud 9 Ptl. Ltd. Purpose of the tests: To verify the quality of the stock supplied from China in the 12 month period ending 31 December 2011 Work performed: Examination of the humidity levels at the storage warehouse. Check compliance with storage instructions on shipment. Comparison of samples from warehouse, client and manufacturer in China. Findings: The humidity at the warehouse was conducive for the storage of the shipment, and did not affect the quality of the footwear. Also from the sample, the quality of the three samples was similar, since they had similar quantities, texture and quality. Conclusion: The quality of the shipment was never affected by their storage in the warehouse, but could have suffered a loss in value due to their customized qualities as they experienced delays in delivery to the client. Prepared by: ABC Reviewed by: W & S Reference No.:0000945 References Lohan, R. (2011). Footwear Retailing in Australia. IBISWorld Industry Report G5222. Retrieved from http://www.thebigiron.com.au/documents/doc_1p0goy_110919151656.pdf Read More