7e Ch6 Mini Case Controls_solutions

EarthWear Hands-on Mini-caseChapter 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 entity’s 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 entity’s 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 MANAGEMENT’S 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 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. 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, 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 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. 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 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. 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 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. 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 controller’s report. See A20 for extracts of significant items from the controller’s 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 Department’s 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 management’s directives are effective in processing and preparing financial statements. Control activities ensure that the entity’s 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 management’s 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 entity’s 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 entity’s 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 entity’s 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