Audit Case Study: Assessing Materiality and Business Risks at Cloud 9

This case study provides a comprehensive analysis of the auditing and assurance processes for Cloud 9 Pty Ltd, a company engaged in the wholesale of athletic shoes. The study begins by determining the appropriate planning materiality (PM) base, suggesting total assets due to the significant impact of disposal proceeds on profitability. It then delves into analytical procedures, including ratio analysis to assess business risks, focusing on profitability, liquidity, efficiency, and solvency ratios. Special emphasis is placed on cash and trade receivables due to their susceptibility to fraud. Furthermore, the report examines executive compensation disclosures in three ASX-listed mining companies (Altura Mining, BHP Billiton, and Rio Tinto Plc), comparing remuneration structures and their links to company performance. The analysis reveals that while some companies have direct links between executive pay and profitability/share price, others rely on long-term incentive plans. Desklib offers a platform for students to access similar solved assignments and past papers.

Running head: AUDITING AND ASSURANCE
Auditing and assurance
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Table of Contents
Case study – Cloud 9..................................................................................................................2
Part 1 – Materiality.................................................................................................................2
Part 2 – Analytical procedure.................................................................................................3
Research question.......................................................................................................................6
Introduction............................................................................................................................6
Discussion..............................................................................................................................6
Conclusion..............................................................................................................................9
Reference..................................................................................................................................10

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Case study – Cloud 9
Part 1 – Materiality
Planning materiality (PM)
Planning materiality is considered as the amount of misstatement that is set by the
auditors at the stage of planning of the audit on the basis of materiality with regard to the
financial statements. PM is used by the auditor for assessing whether individually or in
aggregate with any other item the misstatement misstated the financial report materially.
Misstatements may mislead the users who make their decisions based on the misstated
financial statements. Once the materiality involved in financial report recognised by the
auditor, based on that the auditor set the tolerable misstatement or performance materiality
for the financial statements. However, the PM shall be higher as compared to the
performance materiality (Lakis and Masiulevičius 2017).
In the given scenario, Cloud 9 Pty Ltd is mainly engaged in whole selling of the
athletic shoes to the main customers Myer, David Jones, rebel Sports and Foot Locker. In the
year 2013 the company also started the online small supply channel for direct supplying to
the customers. W&S Partners, the Australian accounting firm that offers accounting and audit
related services has recently been appointed as the auditor of Cloud 9 Pty Ltd. The auditors
started planning for the audit of the company for considering materiality concept through
gaining an understanding of client’s business structure and environment (Swart 2018).
Various bases are used while establishing the materiality like 5% of profit, 0.5% of turnover,
2% of gross profit, 0.5% of total asset and 1% of equity. Generally, profit before tax is
considered while establishing the materiality base. However, if the company reported loss for
the year or if the profitability is significantly affected by any particular transaction or

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adjustment, profit before tax cannot be used as the base for establishing materiality level. In
the given case of Cloud 9 Pty Ltd it is recognised that company’s profitability significantly
increased from the proceeds received from disposals amounting to 15,76,859 (Barndt, Fuller
and Flynn 2016). Hence, profit before tax cannot be considered for establishing materiality
base. Considering total asset for establishing the materiality base will be appropriate for
Cloud 9 Pty Ltd as the company is engaged in the business for athletic shoe and it is assumed
that significant amount of the company is involved in inventories, cash, trade receivables and
plant – equipment. As per the given information amount if total asset for the company for the
year 2016 was 328,64,958. Hence, the materiality based on total asset will be 0.5% on total
asset that is 164,324.79 (Audsabumrungrat, Pornupatham and Tan 2015).
Part 2 – Analytical procedure
(a) Analysis of business risks for Cloud 9 Pty Ltd
It is compulsory for the auditor to perform the risk assessment for identification and
assessment of the risks of the risk involved with material misstatement related to the financial
report at the level of assertion and procedure for risk assessment through analytical
procedure. Analytical procedure for Cloud 9 Pty Ltd will be carried out through ratio analysis
(Amiram et al. 2017)

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Ratio analysis
Profitability ratio – this ratio is analysed for analysing the ability of the company to
generate profit from the revenue of the entity. Stakeholders of the company will be interested
in knowing the profitability as they are interested in getting return on their investment and
receiving their dues on time. Looking into gross profit that focuses on the revenue left with
the entity after paying COGS it can be identified that gross profit is reduced from 56.58% to
55.54%. Further, the net profit margin that focuses on the revenue left with the entity after
paying expenses, it can be identified that net profit is increased from 3.70% to 5.06% (Greco,
Figueira and Ehrgott 2016).
Liquidity ratio – it is analysed for analysing the ability of the entity to meet its short term
liabilities with the available current assets. Current ratio of the company that compares the
current assets against the current liabilities is reduced from 1.69 to 2.62. Further, quick ratio

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that compares the current assets excluding the assets those take some times to be converted
into cash against the current liabilities has been increased from 1.26 to 1.98.
Efficiency ratio – both the efficiency ratios of of the company indicating that the
efficiency of the company has been reduced as inventories turnover ratio reduced from 4.35
to 3.82 and receivable turnover ratio reduced from 3.83 to 3.04 (Greco, Figueira and Ehrgott
2016).
Solvency ratio – both the solvency ratio of the company are indicating that the the solvency
position of the company has been improved as both the solvency ratios are reduced.
(b) Specific areas that shall receive special emphasis
Based on the above analytical procedure and materiality estimate the auditor shall pay
special emphasis on cash and trade receivables. Both these items are always susceptible to
fraud risk as these are most liquid assets. Further, the reduction of current ratio is indicating
that the company is not giving required attention to these items (Greco, Figueira and Ehrgott
2016).

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Research question
Introduction
The main purpose of the report is to focus on the disclosures regarding compensation
paid to to executives for assessing their performance. 3 ASX listed companies those will be
considered for this report is Altura Mining, BHP Billiton and Rio Tinto Plc. All these
companies are from the Australian mining industry.
Discussion
Executive’s payment
Looking into the annual report of the Altura Mining it can be identified that the
remuneration package of the entity includes –
 Key benefits including fees, salaries, non-monetary benefits and bonuses including
provision for motor vehicle
 Post employment benefits that includes superannuation and the prescribed retirement
benefits Equity performance right and the share option that is granted as per long-term
incentive plan (Alturamining.com 2019).
Looking into the annual report of BHP Billiton it can be identified that the
remuneration component of the company includes base salary, pension contributions, benefits
including the personal insurance, tax assistance and relocation benefits, STI for encouraging

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and focussing on CEO’s efforts for delivering entity’s strategic priorities and LTI for
focussing on CEO’s efforts regarding achievement of sustainable value creation for long term
(BHP 2019).
Looking into Rio Tinto Plc it can be identified that the company’s remuneration
payment to the executives include base salary, STIP payment in cash, STIP payment in
deferred shares, LTIP, superannuation or pension and other benefits (Riotinto.com 2019).

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Most payment –
Looking into all three company’s remuneration structure it can be identified that total
remuneration payment made by Altura Mining amounted to $ 19,48,603, total remuneration
payment made by Rio Tinto Plc amounted to $ 36,86,000 and total remuneration payment
made by BHP Billiton amounted to $ 36,83,000. Hence, Rio Tinto Plc is paying the highest
amount of remuneration to its executives.
Profit linked remuneration
None of the personal remuneration package of Altura Mining’s is directly linked to
profitability of the company or any other performance measure. It maintains long-term
incentive plan under which the employees are granted share options and performance rights
(Alturamining.com 2019).
BHP Billiton’s performance measure is used for determining STI outcomes for CEO
as well as other employees are linked to delivery of behaviours and strategy aligned to calues
of charter (BHP 2019).

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Remuneration policy of Rio Tinto Plc is linked with the performance targets over
short as well as long term for assuring that the executive’s rewards are aligned to delivery of
short as well as long term priorities and the long-term sustainable growth in the shareholders
value (Riotinto.com 2019).
Hence, Rio Tinto’s executive’s payment are most linked with profit and share price
performance of the entity.
Conclusion
From the above discussion it can be concluded that the executives from Australian
companies are basically paid fixed salaries, short term benefits, long term benefits and some
of the company’s payments are linked with profit and share price performance of the entity.
Other payments include in the remuneration structure are Salaries include cash and fees both
or any one, post employment benefits that includes superannuation and the prescribed
retirement benefits.

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Reference
Alturamining.com., 2019. Altura Mining | Charging Forward with Lithium. [online]
Available at: https://alturamining.com/ [Accessed 30 Jan. 2019].
Amiram, D., Chircop, J., Landsman, W.R. and Peasnell, K.V., 2017. Mandatorily disclosed
materiality thresholds, their determinants, and their association with earnings multiples.
Audsabumrungrat, J., Pornupatham, S. and Tan, H.T., 2015. Joint Impact of Materiality
Guidance and Justification Requirement on Auditors' Planning Materiality. Behavioral
Research in Accounting, 28(2), pp.17-27.
Barndt, R.J., Fuller, L.R. and Flynn, K.E., 2016. Teaching Inherent Risk and Tolerable
Misstatement in Auditing: A Modified Delphi Method as a Teaching Tool. In Advances in
Accounting Education: Teaching and Curriculum Innovations(pp. 125-140). Emerald Group
Publishing Limited.
BHP. 2019. BHP | A leading global resources company. [online] Available at:
https://www.bhp.com/ [Accessed 30 Jan. 2019].
Greco, S., Figueira, J. and Ehrgott, M., 2016. Multiple criteria decision analysis. New York:
Springer.
Lakis, V. and Masiulevičius, A., 2017. Acceptable Audit Materiality For Users Of Financial
Statements. Journal of Management, 2(31).
Riotinto.com., 2019. Global home. [online] Available at: https://www.riotinto.com/
[Accessed 30 Jan. 2019].

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Swart, J.J., 2018. Audit methodologies: developing an integrated planning model
incorporating audit materiality, risk and sampling (Doctoral dissertation, North-West
University).