EarthWear Hands-on Mini-case

Chapter 6 - Control Environment and Internal Control Documentation

The McGraw-Hill Companies, Inc., 2010
In this mini-case you will complete questionnaires for evaluating the corporate governance and
internal control environment of EarthWear Clothiers, Inc.
INSTRUCTIONS:
1
Double-click on the following icons (documents will open in Microsoft Word) and read the memos on
Corporate Governance and Control Environment Issues and Internal Control Components. Refer back
to these memos as you answer the questionnaires.
2
The worksheets titled "Control Environ. Questionnaire" and "Internal Control Questionnaires" contain
partially completed copies of the questionnaires you are to finish. Scan through the questions that
have already been completed.
3
Using the information outlined in the memos above and answers to other questions in the
questionnaires, complete questions 1, 7, 12, 17, 19, and 21 of the Control Environment Questionnaire
and questions 1, 3, 9, 12, 14, and 15 of the Internal Control Questionnaire.
Fields you are to complete on the questionnaire are colored yellow. The color will disappear when the field is completed.
4
When the questionnaires are completed, enter your initials in the yellow boxes with title "Initial Here" .
5
Print the "Print Out" worksheet unless your instructor indicates to submit the completed file
electronically. The "Print Out" worksheet contains only those questions you have completed and is
formatted to print on two pages.
Internal Control
Environment
Corporate
Governance
Client: EarthWear Clothiers Balance Sheet Date: 12/31/2010
Initial Here Reviewed by: _____ Date: _______
Yes,
No, N/A Comments
1
Are there regular meetings of the board of directors (or comparable bodies) to set
policies and objectives, review the entitys performance, and take appropriate action,
and are minutes of such meetings prepared and signed on a timely basis?
Respond
Here
Provide Any Additional Comments Here
2
Does an audit committee exist? Yes
3
Does the audit committee adequately assist the board in maintaining a direct line of
communication with the entitys external and internal auditors?
Yes The audit committee meets with the external and internal auditors on a
quarterly basis.
Is this evidenced by
Regular meetings?
The appointment of qualified members?
Minutes of meetings?
Yes,
No, N/A Comments
6
Are management and operating decisions dominated by one or a few individuals? No
7
Are business risks adequately monitored? Respond
Here
Provide Any Additional Comments Here
8
Is management willing to adjust the financial statements for misstatements that
approach a material amount?
Yes
9
Does management adequately consult with its auditors on accounting issues? Yes
10
Has management been responsive to prior recommendations from its auditors? Yes
11
Is a high priority given to internal control? Yes
4
5
Question
Question
Does the audit committee have adequate resources and authority to discharge its
responsibilities?
Yes
MANAGEMENTS PHILOSOPHY AND OPERATING STYLE
Yes The audit committee also meets quarterly, just prior to the quarterly board of
directors meeting. Minutes are maintained of each meeting. The audit
committee consists only of individuals who are not part of management.
Control Environment Questionnaire
PARTICIPATION OF THE BOARD OF DIRECTORS AND AUDIT COMMITTEE
An entitys control consciousness is influenced significantly by the entitys board of directors or audit committee. Attributes include the board or audit committees independence from
management, the experience and stature of its members, the extent of its involvement and scrutiny of activities, the appropriateness of its actions, the degree to which difficult questions
are raised and pursued with management, and its interaction with internal and external auditors.
Managements philosophy and operating style significantly influence the control environment particularly when management is dominated by one or a few individuals. Managements
philosophy and operating style should create a positive atmosphere that reduces the risk of misstatement and that is conducive to the effective operation of internal control.
Yes,
No, N/A Comments
12
Is the organization of the entity clearly defined in terms of lines of authority and
responsibility?
Respond
Here
Provide Any Additional Comments Here
13
Are controls for authorization of transactions established at an adequately high level? Yes
14
Are such controls adequately adhered to? Yes
15
Is the organizational structure appropriate for the size and complexity of the entity? Yes
16
Has management established policies for developing and modifying accounting
systems and control activities?
Yes
17
Is data processing centralized or decentralized? Respond
Here
Provide Any Additional Comments Here
Yes,
No, N/A Comments
18
Is there a clear assignment of responsibility and delegation of authority to deal with
such matters as organizational goals and objectives, operating functions, and
regulatory requirements?
Yes
19
Are employee job responsibilities, including specific duties, reporting relationships,
and constraints, clearly established and communicated to employees?
Respond
Here
Provide Any Additional Comments Here
20
Has management clearly communicated the scope of authority and responsibility to
data processing management?
Yes
21
Does adequate computer systems documentation indicate the controls for authorizing
transactions and approving systems changes?
Respond
Here
Provide Any Additional Comments Here
22
Is there adequate documentation of data processing controls? Yes
Question
Question
ASSIGNMENT OF AUTHORITY AND RESPONSIBILITY
ORGANIZATIONAL STRUCTURE
The methods of assigning authority and responsibility should result in clear understanding of reporting relationships and responsibilities established within the entity.
An entitys organizational structure provides the framework within which its activities for achieving entity-wide objectives are planned, executed, controlled, and monitored. Establishing
a relevant organizational structure includes considering key areas of authority and responsibility and appropriate lines of reporting.
Yes,
No, N/A Comments
23
Do client accounting personnel appear to have the background and experience for
their duties?
Yes
24
Do client accounting personnel understand the duties and procedures applicable to
their jobs?
Yes
25
Is the turnover of accounting personnel relatively low? Yes There has been no turnover in the last three years.
26
Does the entity adequately train new accounting personnel? Yes
27
Does the workload of accounting personnel appear to permit them to control the
quality of their work?
Yes
28
Does previous experience with the client indicate sufficient integrity on the part of
personnel?
Yes
The McGraw-Hill Companies, Inc., 2010
Question
Human resource policies and practices relate to hiring, orientation, training, evaluating, counseling, promoting, compensating, and remedial actions. The entitys human resource
policies and practices should positively influence the entitys ability to employ sufficiently competent personnel to accomplish its goals and objectives.
HUMAN RESOURCE POLICIES AND PROCEDURES
Client: EarthWear Clothiers Balance Sheet Date: 12/31/2010
Initial Here Reviewed by: _____ Date: _______
Yes,
No, N/A Comments
1
Does the entity set entity-wide objectives that state what the entity desires to achieve,
and are they supported by strategic plans?
Respond
Here
Provide Any Additional Comments Here
Does the entity have a risk analysis process that includes estimating the significance of
the risks, assessing the likelihood of their occurring, and determining the actions
needed to respond to the risks?
Yes The companys business plan and budgeting process includes analyzing
risks that might affect the company. Monthly meetings are held by senior
management to discuss recent events and how they may affect the company.
3
Does the entity have mechanisms to identify and react to changes that may
dramatically and pervasively affect the entity?
Respond
Here
Provide Any Additional Comments Here
Client: EarthWear Clothiers Balance Sheet Date: 12/31/2010
Initial Here Reviewed by: _____ Date: _______
Yes,
No, N/A Comments
Does management have clear objectives in terms of budget, profit, and other financial
and operating goals?
Yes EarthWear has a very sophisticated budgeting process that includes
monitoring activities. All significant budget variances are summarized and
explained in a monthly controllers report. See A20 for extracts of significant
items from the controllers report.
Are such objectives: Yes
Clearly written?
Actively communicated throughout the entity?
Actively monitored?
Does the appropriate level of management: Yes
Adequately investigate variances?
Take appropriate and timely corrective actions?
Has management established procedures to prevent unauthorized access to, or
destruction of, documents, records, assets, programs and data files?
Yes See B10 for a description of the IT Departments controls over access to (1)
the computer operations area and (2) data programs and files.
Control procedures include the policies and procedures that ensure that managements directives are effective in processing and preparing financial statements. Control activities ensure
that the entitys financial reporting objective is carried out.
Question
4
Question
2
Control Procedures Questionnaire
5
6
7
Risk Assessment Questionnaire
A risk assessment process should consider external and internal events and circumstances that may occur and adversely affect its ability to initiate, record, process, and report financial
data consistent with managements assertions. Management should initiate plans, programs, or actions to address significant, identified risks or accept the risk because of cost
considerations.
Client: EarthWear Clothiers Balance Sheet Date: 12/31/2010
Initial Here Reviewed by: _____ Date: _______
Yes,
No, N/A Comments
Does the information system give management the necessary reports on the entitys
performance relative to established objectives, including relevant external and internal
information?
Yes The strategic plan and the budgeting process identify information that is
needed to analyze and monitor the entitys objectives.
9
Is the information provided to the right people in sufficient detail and in time to enable
them to carry out their responsibilities effectively?
Respond
Here
Provide Any Additional Comments Here
Is the development or revision of information systems over financial reporting based on
a strategic plan?
Yes There is a strategic plan for updating the information systems over financial
reporting that is revised on an annual basis.
Yes,
No, N/A Comments
Does management communicate employees duties and control responsibilities in an
effective manner?
Yes Employees are provided with information regarding their duties during their
initial training.
12 Are communication channels established for people to report suspected improprieties?
Respond
Here
Provide Any Additional Comments Here
Does communication flow across the organization adequately to enable people to
discharge their responsibilities effectively?
Yes There are good communications channels across departments.
11
13
Question
8
10
Question
Information and Communication Questionnaire
INFORMATION SYSTEMS
Information systems initiate, record, process, and report information. Relevant information includes industry, economic, and regulatory information obtained from external sources, as well
as internally generated information.
COMMUNICATION
Communication includes the extent to which personnel understand how their activities in the financial reporting information system relate to the work of others and the means of reporting
exceptions to an appropriate level within the entity.
Client: EarthWear Clothiers Balance Sheet Date: 12/31/2010
Initial Here Reviewed by: _____ Date: _______
Yes,
No, N/A Comments
14 How many customer complaints are received about billings?
Respond
Here
Provide Any Additional Comments Here
15
Are complaints investigated for underlying causes and any internal control deficiencies
corrected?
Respond
Here
Provide Any Additional Comments Here
Does the entity have an internal audit function? Yes
Are internal control recommendations made by internal and external auditors
implemented?
Yes Recommendations that management and the board feel are cost beneficial
are implemented.
Does the entity conduct separate evaluations of internal control? Yes The board of directors focuses on the control environment and monitoring
activities. The audit committee meets regularly with the internal and external
auditors about control related activities.
The McGraw-Hill Companies, Inc., 2010
16
17
18
Question
Management should monitor internal control in the ordinary course of operations. This monitoring includes regular management and supervisory activities and other actions personnel
take in performing their duties that assess the quality of internal control.
Monitoring Questionnaire
Name:
Class:
Client: EarthWear Clothiers Balance Sheet Date: 12/31/2010
Reviewed by: _____ Date: _______
Yes,
No, N/A Comments
1
Are there regular meetings of the board of directors (or comparable bodies) to set
policies and objectives, review the entitys performance, and take appropriate action,
and are minutes of such meetings prepared and signed on a timely basis?
Incomplete Please Complete Control Environment Questionnaire
7
Are business risks adequately monitored?
Incomplete Please Complete Control Environment Questionnaire
12
Is the organization of the entity clearly defined in terms of lines of authority and
responsibility?
Incomplete Please Complete Control Environment Questionnaire
17
Are accounting and data processing centralized or decentralized?
Incomplete Please Complete Control Environment Questionnaire
19
Are employee job responsibilities, including specific duties, reporting relationships,
and constraints, clearly established and communicated to employees?
Incomplete Please Complete Control Environment Questionnaire
21
Does adequate computer systems documentation indicate the controls for authorizing
transactions and approving systems changes?
Incomplete Please Complete Control Environment Questionnaire
PRINT OUT OF QUESTIONNAIRE RESPONSES
CONTROL ENVIRONMENT QUESTIONNAIRE
Name:
Class:
Client: EarthWear Clothiers Balance Sheet Date: 12/31/2010
Reviewed by: _____ Date: _______
Yes,
No, N/A Comments
PRINT OUT OF QUESTIONNAIRE RESPONSES
CONTROL ENVIRONMENT QUESTIONNAIRE
1
Does the entity set entity-wide objectives that state of what the entity desires to
achieve, and are they supported by strategic plans?
Incomplete Please Complete Internal Control Questionnaire
3
Does the entity have mechanisms to identify and react to changes that may
dramatically and pervasively affect the entity?
Incomplete Please Complete Internal Control Questionnaire
9
Is the information provided to the right people in sufficient detail and in time to enable
them to carry out their responsibilities effectively?
Incomplete Please Complete Internal Control Questionnaire
12
Are communication channels established for people to report suspected
improprieties?
Incomplete Please Complete Internal Control Questionnaire
14 How many customer complaints are received about billings? Incomplete Please Complete Internal Control Questionnaire
15
Are complaints investigated for underlying causes and any internal control
deficiencies corrected?
Incomplete Please Complete Internal Control Questionnaire
INTERNAL CONTROL QUESTIONNAIRES