EarthWear Hands-on Mini-case
Chapter 6 – Control Environment and Internal Control Documentation
AUDITING & ASSURANCE SERVICES 11e
© The McGraw-Hill Companies, Inc., 2019
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.
Corporate
Governance
Internal Control
Environment
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
Please input your answers into Connect or print a copy of the Print Out to submit unless your
instructor requests an electronic submission. The Print Out is formatted to fit on one page.
CONNECT INPUT
Input your responses from the Print Out into the corresponding questions in Connect.
Control Environment Questionnaire
Client: EarthWear Clothiers
Balance Sheet Date: 12/31/2019
Initial Here Reviewed by: _____ Date: _______
PARTICIPATION OF THE BOARD OF DIRECTORS AND AUDIT COMMITTEE
An entity’s control consciousness is influenced significantly by the entity’s board of directors or audit committee. Attributes include the board or audit committee’s 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.
Yes,
No, N/A
Question
1
2
3
4
5
Are there regular meetings of the board of directors (or comparable bodies) to set
Respond
policies and objectives, review the entity’s performance, and take appropriate action,
Here
and are minutes of such meetings prepared and signed on a timely basis?
Does an audit committee exist?
Yes
Does the audit committee adequately assist the board in maintaining a direct line of
communication with the entity’s external and internal auditors?
Does the audit committee have adequate resources and authority to discharge its
responsibilities?
Yes
Is this evidenced by
Yes
·
The appointment of qualified members?
·
Provide Any Additional Comments Here
The audit committee meets with the external and internal auditors on a
quarterly basis.
Yes
Regular meetings?
·
Comments
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.
Minutes of meetings?
MANAGEMENT’S PHILOSOPHY AND OPERATING STYLE
Management’s philosophy and operating style significantly influence the control environment — particularly when management is dominated by one or a few individuals. Management’s
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,
Question
6
7
8
9
10
Are management and operating decisions dominated by one or a few individuals?
No, N/A
No
Are business risks adequately monitored?
Respond
Here
Is management willing to adjust the financial statements for misstatements that
Yes
approach a material amount?
Does management adequately consult with its auditors on accounting issues?
Yes
Has management been responsive to prior recommendations from its auditors?
Yes
Comments
Provide Any Additional Comments Here
11
Is a high priority given to internal control?
Yes
ORGANIZATIONAL STRUCTURE
An entity’s 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.
Question
12
13
14
15
16
17
Yes,
No, N/A
Is the organization of the entity clearly defined in terms of lines of authority and Respond
responsibility?
Here
Are controls for authorization of transactions established at an adequately high level?
Yes
Are such controls adequately adhered to?
Yes
Is the organizational structure appropriate for the size and complexity of the entity?
Yes
Has management established policies for developing and modifying accounting
Yes
systems and control activities?
Is data processing centralized or decentralized?
Respond
Here
ASSIGNMENT OF AUTHORITY AND RESPONSIBILITY
Comments
Provide Any Additional Comments Here
Provide Any Additional Comments Here
The methods of assigning authority and responsibility should result in clear understanding of reporting relationships and responsibilities established within the entity.
Question
18
19
20
21
22
Yes,
No, N/A
Yes
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?
Are employee job responsibilities, including specific duties, reporting relationships, Respond
and constraints, clearly established and communicated to employees?
Here
Has management clearly communicated the scope of authority and responsibility to
Yes
data processing management?
Does adequate computer systems documentation indicate the controls for authorizing Respond
transactions and approving systems changes?
Here
Is there adequate documentation of data processing controls?
Yes
Comments
Provide Any Additional Comments Here
Provide Any Additional Comments Here
HUMAN RESOURCE POLICIES AND PROCEDURES
Human resource policies and practices relate to hiring, orientation, training, evaluating, counseling, promoting, compensating, and remedial actions. The entity’s human resource
policies and practices should positively influence the entity’s ability to employ sufficiently competent personnel to accomplish its goals and objectives.
Question
23
24
25
26
27
28
Do client accounting personnel appear to have the background and experience for
their duties?
Do client accounting personnel understand the duties and procedures applicable to
their jobs?
Is the turnover of accounting personnel relatively low?
Yes,
No, N/A
Yes
Yes
Yes
Does the entity adequately train new accounting personnel?
Yes
Does the workload of accounting personnel appear to permit them to control the
quality of their work?
Does previous experience with the client indicate sufficient integrity on the part of
personnel?
Yes
© The McGraw-Hill Companies, Inc., 2019
Comments
Yes
There has been no turnover in the last three years.
Risk Assessment Questionnaire
Balance Sheet Date: 12/31/2019
Client: EarthWear Clothiers
Initial Here Reviewed by: _____ Date: _______
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 management’s assertions. Management should initiate plans, programs, or actions to address significant, identified risks or accept the risk because of cost
considerations.
Question
1
2
3
Yes,
No, N/A
Does the entity set entity-wide objectives that state what the entity desires to achieve, Respond
Here
and are they supported by strategic plans?
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
Does the entity have mechanisms to identify and react to changes that may Respond
Here
dramatically and pervasively affect the entity?
Control Procedures Questionnaire
Comments
Provide Any Additional Comments Here
The company’s 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.
Provide Any Additional Comments Here
Balance Sheet Date: 12/31/2019
Client: EarthWear Clothiers
Initial Here Reviewed by: _____ Date: _______
Control procedures include the policies and procedures that ensure that management’s directives are effective in processing and preparing financial statements. Control activities ensure
that the entity’s financial reporting objective is carried out.
Yes,
Question
No, N/A
Comments
4
5
Does management have clear objectives in terms of budget, profit, and other financial
and operating goals?
Yes
Are such objectives:
Yes
· Clearly written?
· Actively communicated throughout the entity?
· Actively monitored?
6
Does the appropriate level of management:
· Adequately investigate variances?
· Take appropriate and timely corrective actions?
7
Yes
EarthWear has a very sophisticated budgeting process that includes
monitoring activities. All significant budget variances are summarized and
explained in a monthly controller’s report. See A20 for extracts of significant
items from the controller’s report.
7
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 Department’s controls over access to (1)
the computer operations area and (2) data programs and files.
Information and Communication Questionnaire
Balance Sheet Date: 12/31/2019
Client: EarthWear Clothiers
Initial Here Reviewed by: _____ Date: _______
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.
Yes,
No, N/A
Question
8
9
10
Yes
Does the information system give management the necessary reports on the entity’s
performance relative to established objectives, including relevant external and internal
information?
Is the information provided to the right people in sufficient detail and in time to enable Respond
Here
them to carry out their responsibilities effectively?
Is the development or revision of information systems over financial reporting based on
a strategic plan?
Yes
Comments
The strategic plan and the budgeting process identify information that is
needed to analyze and monitor the entity’s objectives.
Provide Any Additional Comments Here
There is a strategic plan for updating the information systems over financial
reporting that is revised on an annual basis.
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.
Yes,
Question
No, N/A
Comments
11
Does management communicate employees’ duties and control responsibilities in an
effective manner?
12
Are communication channels established for people to report suspected improprieties?
13
Does communication flow across the organization adequately to enable people to
discharge their responsibilities effectively?
Yes
Respond
Here
Yes
Employees are provided with information regarding their duties during their
initial training.
Provide Any Additional Comments Here
There are good communications channels across departments.
Monitoring Questionnaire
Balance Sheet Date: 12/31/2019
Client: EarthWear Clothiers
Initial Here Reviewed by: _____ Date: _______
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.
Question
14
15
16
Yes,
No, N/A
Respond
How many customer complaints are received about billings?
Here
Are complaints investigated for underlying causes and any internal control deficiencies Respond
Here
corrected?
Comments
Provide Any Additional Comments Here
Provide Any Additional Comments Here
Does the entity have an internal audit function?
Yes
17
Are internal control recommendations made by internal and external auditors
implemented?
Yes
Recommendations that management and the board feel are cost beneficial
are implemented.
18
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., 2019
Name:
Class:
PRINT OUT OF QUESTIONNAIRE RESPONSES
Client: EarthWear Clothiers
Balance Sheet Date: 12/31/2019
Reviewed by: _____ Date: _______
7
Yes,
No, N/A
Comments
CONTROL ENVIRONMENT QUESTIONNAIRE
Are there regular meetings of the board of directors (or comparable bodies) to set
policies and objectives, review the entity’s performance, and take appropriate action, Incomplete Please Complete Control Environment Questionnaire
and are minutes of such meetings prepared and signed on a timely basis?
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
Incomplete Please Complete Control Environment Questionnaire
responsibility?
1
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,
Incomplete Please Complete Control Environment Questionnaire
and constraints, clearly established and communicated to employees?
21
Does adequate computer systems documentation indicate the controls for authorizing
Incomplete Please Complete Control Environment Questionnaire
transactions and approving systems changes?
Name:
Class:
PRINT OUT OF QUESTIONNAIRE RESPONSES
Client: EarthWear Clothiers
Balance Sheet Date: 12/31/2019
Reviewed by: _____ Date: _______
1
Yes,
No, N/A
Comments
CONTROL
ENVIRONMENT
QUESTIONNAIRE
INTERNAL
CONTROL QUESTIONNAIRES
Does the entity set entity-wide objectives that state of what the entity desires to
Incomplete Please Complete Internal Control Questionnaire
achieve, and are they supported by strategic plans?
3
Does the entity have mechanisms to identify and react to changes that may
Incomplete Please Complete Internal Control Questionnaire
dramatically and pervasively affect the entity?
9
Is the information provided to the right people in sufficient detail and in time to enable
Incomplete Please Complete Internal Control Questionnaire
them to carry out their responsibilities effectively?
12
Are communication channels established for people to report suspected
Incomplete Please Complete Internal Control Questionnaire
improprieties?
14
How many customer complaints are received about billings?
15
Are complaints investigated for underlying causes and any internal control
Incomplete Please Complete Internal Control Questionnaire
deficiencies corrected?
© The McGraw-Hill Companies, Inc., 2019
Incomplete Please Complete Internal Control Questionnaire
Name:
Class:
PLEASE ENTER YOUR ANSWERS ON THE
QUESTIONNAIRES.
The fields on the left are filled automatically as you
enter your answers on the Questionnaires.
You may need to RESIZE the rows to display your
answers.
Name:
Class:
Willis & Adams, CPAs
EarthWear Clothiers
Memo on
Internal Control Components
The following information was gathered through inquiry with EarthWear’s Risk Management Officer, Chief
Financial Officer, Chief Information Officer, and Chief Internal Auditor.
THE ENTITY’S RISK ASSESSMENT PROCESS:
EarthWear has established broad objectives. Management has prepared a five-year business plan that
includes goals about the company’s products, responsibilities, and growth plans. The company uses a
business plan and budgeting process to monitor decisions. Monthly meetings are held by senior
management to discuss recent events and how they may affect the company. Management relies heavily on
its Risk Management Department to identify risks that may affect the company, and to recommend
appropriate actions.
CONTROL PROCEDURES:
EarthWear has a very sophisticated budgeting process that includes monitoring activities. All significant
budget variances are summarized and explained in a monthly controller’s report.
INFORMATION SYSTEM AND COMMUNICATION:
The strategic plan and the budgeting process identify information that is needed to analyze and monitor the
entity’s objectives. All department groups within EarthWear are required to provide timely and adequate
financial reporting. Actual performance is reported on a weekly and monthly basis. Performance is monitored
by the controller’s office. There is a strategic plan for updating the information systems over financial reporting
that is revised on an annual basis.
Employees are provided with information regarding their duties during their initial training. EarthWear’s
employee manual states that suspected violations of company policies should be reported to a vice president.
There are procedures that allow such suspected violations to be reported anonymously. There are good
communications channels across departments.
MONITORING:
Customer complaints are generally very low (1 out of every 5,000 invoices). Most complaints relate to delays
in receiving goods that are on order by the company or minor billing discrepancies. All complaints are
investigated for underlying causes and any internal control deficiencies are corrected. Recommendations
made by customers and auditors that management and the board feel are cost beneficial are implemented.
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.
EarthWear Hands-on Mini-cases
©The McGraw-Hill Companies, Inc., 2019
1
Willis & Adams, CPAs
EarthWear Clothiers
Memo on
Corporate Governance and Control Environment Issues
BOARD OF DIRECTORS AND AUDIT COMMITTEE:
The Board of Directors is composed of 5 senior members of management and 4 independent board
members. The Board of Directors meets quarterly to review EarthWear’s performance, or when events occur
or transactions take place that significantly affect the company. The Corporate Secretary prepares minutes
of these meetings within one week and the Secretary signs them after approval of the Board.
The audit committee is composed of two directors of the company who are not members of management.
The audit committee meets quarterly just prior to the board of directors meeting and minutes are maintained
of each meeting. The audit committee also meets with the internal and external auditors each quarter.
MANAGEMENT PHILOSOPHY AND OPERATING STYLE:
EarthWear’s management has created an atmosphere where internal control is taken seriously.
Management is very concerned about misstatements due to error or fraud. The company uses conservative
accounting policies and they are conscientious about developing accounting estimates.
The company manages its business risks through a business plan and a strong budgeting process.
Senior management meet at least monthly to discuss the budget and events that might affect the company.
The company also has a Strategic Risk Management Committee that is responsible for considering how
future events (e.g., Internet sales) may affect the company.
Management issues a Management’s Report on Internal Control over Financial Reporting that includes
a statement about the effectiveness of the company’s internal control over financial reporting. Management
has always been responsive to our recommendations on internal control. Additionally, management consults
with us about new accounting issues and they are usually willing to book misstatements that we identify
during the audit.
ORGANIZATIONAL STRUCTURE:
The company has a well-developed organizational structure with clear lines of authority among the
various operating departments and staff functions. The organizational structure is appropriate for
EarthWear’s activities. All information technology is centralized.
ASSIGNMENT OF AUTHORITY AND RESPONSIBILITY:
The human resources department maintains detailed job descriptions, including specific duties and
reporting responsibilities. Employees are provided this information during their initial training. Management
has reviewed these job descriptions for proper assignment and delegation of authority. The IT department
has strong controls over program changes and it maintains detailed documentation of all information systems.
EarthWear Hands-on Mini-cases
©The McGraw-Hill Companies, Inc., 2019
1
HUMAN RESOURCE POLICIES AND PROCEDURES:
The human resources department maintains sound policies for hiring, training, evaluating, counseling,
promoting, compensating, and taking remedial actions. EarthWear’s accounting personnel are well trained
and have significant experience with their duties. There has been no turnover in the accounting area in over
three years. The accounting department’s workload seems reasonable and the employees have high
integrity.
EarthWear Hands-on Mini-cases
©The McGraw-Hill Companies, Inc., 2019
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