EarthWear Hands-on Mini-case
EarthWear Hands-on Mini-case
Chapter 4 - Understanding the Entity and Its Environment
Chapter 4 - Understanding the Entity and Its Environment
© The McGraw-Hill Companies, Inc, !"#!
© The McGraw-Hill Companies, Inc, !"#!
INSTRUCTIONS:
INSTRUCTIONS:
11
22
Hint: Refer to the Company H
Hint: Refer to the Company History/Background page and Consolidated Financial Statements on the EarthW
istory/Background page and Consolidated Financial Statements on the EarthWear Website
ear Website
$ields yo% are to complete on the &%estionnaire are colored yellow The color will disappear as the 'ield is completed
$ields yo% are to complete on the &%estionnaire are colored yellow The color will disappear as the 'ield is completed
In this mini-case
In this mini-case yo% will complete the
yo% will complete the &%estionnaire 'or %nderstanding Earth(ea
&%estionnaire 'or %nderstanding Earth(ear Clothiers, Inc
r Clothiers, Inc and the
and the
environment in which it
environment in which it operates
operates
The wor)sheet titled *+%estionnaire* contains a partially
The wor)sheet titled *+%estionnaire* contains a partially completed copy o' the &%estionnaire can
completed copy o' the &%estionnaire can
thro%gh the &%estions and responses that have
thro%gh the &%estions and responses that have already een completed
already een completed
.
.o% are to complete &%estions #, !, /, 0,
o% are to complete &%estions #, !, /, 0, 1, #2, #1, #3, and 4" e'er to the
1, #2, #1, #3, and 4" e'er to the in'ormation on the Earth(ear
in'ormation on the Earth(ear
Investor and (illis
Investor and (illis 5 6dams C7
5 6dams C76s wesites 8wwwmhhecom9me
6s wesites 8wwwmhhecom9messier:e; and the
ssier:e; and the ac)gro%nd doc%ment
ac)gro%nd doc%ment
elow to complete the &%estions .o% can also leverage the wor) o'
elow to complete the &%estions .o% can also leverage the wor) o' the prior year
the prior year a%dit team shown in
a%dit team shown in
E<hiit 4-/ o' yo%r te<t
E<hiit 4-/ o' yo%r te<t
7rint a copy o' the *7rint
A Qestionnaire !or "oc#entin$ the Understandin$ o! EarthWear C%othiers and its En&iron#ent
C%ient Na#e: EarthWear C%othiers Co#'%eted (): Enter Your Name Here Entit) and En&iron#ent Cate$or): Natre o! the Entit) Re&ie*ed ():
+earended: "ece#(er31,212 "ate: #"9!19!"#4 Qestion Ris. /actors "escri'tion0Res'onse An) Re#ainin$ Ris.
1
No
2
(ho are the entity>s )ey c%stomers? No
3
(ho are the entity>s )ey s%ppliers?
(hat is the entity>s organi@ational str%ct%re? Ao
(here are its maBor locations?
4
(hat are the entity>s maBor assets? In&entor) and 5ro'ert), '%ant, and e6i'#ent No (hat are the entity>s maBor so%rces o' reven%e, incl%ding the nat%re
o' its prod%cts and9or services?
Hi$h-6a%it) c%othin$ !or otdoor s'orts, sch as hi.in$, s.iin$, !%)-!ishin$, and *hite-*ater .a)a.in$ O&er the )ears, the Co#'an)s 'rodct %ines ha&e $ro*n to inc%de casa% c%othin$, accessories, shoes and so!t %$$a$e
The co#'an) has a #ai%in$ %ist *hich consists o! a''ro;i#ate%) 211 'eo'%e Ho*e&er, a''ro;i#ate%) 7 #i%%ion are &ie*ed as csto#ers (ecase the) #ade at %east one 'rchase !ro# the co#'an) *ithin the %ast 2 #onths Additiona%%), a sr&e) condcted () the Co#'an) in the United States drin$ 21 indicated that a''ro;i#ate%) < o! its csto#ers *ere in the 3- a$e $ro' and had #edian inco#es o! =78,
A%% $oods are ' rodced () inde'endent #an!actrers e;ce't !or #ost o! its so!t %$$a$e, *hich is asse#(%ed at the Co#'an)s !aci%ities "rin$ 211, the Co#'an) 'rchased #erchandise !ro# a''ro;i#ate%) 3 do#estic and !orei$n #an!actrers One #an!actrer and one inter#ediar) acconted !or a(ot 1-29< o! the Co#'an)s recei&ed #erchandise, res'ecti&e%), in 211 In 211 a(ot 8< o ! the Co#'an)s #erchandise *as i#'orted, #ain%) !ro# Asia, Centra% A#erica, and Me;ico
+es, the co#'an) *o%d (e s(>ect to a n#(er o! ris.s /or e;a#'%e, i! these !orei$n contries nder$o econo#ic hardshi's or sto' s''%)in$ to the Co#'an), the Co#'an) *o%d need to !ind a%ternati&e s''%iers Additiona%%), *or.ers (oth do#estica%%) and
internationa%%) co%d nder$o a stri.e, ths sto''in$ shi'#ent o! s''%ies /rther#ore, the &a%e o! !orei$n crrenc) co%d a''reciate re%ati&e to the US "o%%ar, *hich *o%d #a.e s''%ies #ore cost%) The company has a well-developed organi@ational str%ct%re with clear lines
o' a%thority among the vario%s operating departments and sta'' '%nctions The organi@ational str%ct%re is appropriate 'or Earth(ear>s activities Doise, Idaho is the main corporate location Earth(ear also has phone and distri%tion centers in the United ingdom, Germany, and Fapan
Ao Aone o' these co%ntry locations pose threats to Earth(ear as a res%lt o' e<propriation or limits on repatriation o' earnings
17
o c%stomer dynamics present any ris)s 'or the entity? No
18
o social9environmental 'actors present any ris)s 'or the entity? Ao Ao19
o technological 'actors present any ris)s 'or the entity?
2
Ao Ao
21
6re there any other e<ternal 'actors that present a ris) 'or the entity? Ao AoNo, the co#'an) has a s!!icient n#(er o! 'eo'%e on their #ai%in$ %ist 211 #i%%ionB and a s!!icient n#(er o! csto#ers *ho h a&e #ade 'rchases in the %ast 2 #onths
+es Tho$h the co#'an) s*itched to a ne* s)ste#, it !aced si$ni!icant 'ro(%e#s in the third and !orth 6arters o! 21 These 'ro(%e#s co%d contine or arise a$ain
No, 'ro(%e#s *ith the s)ste# *ere %ar$er%) reso%&ed !or the #ost 'art a!ter 21
o acco%nting principles, incl%ding those that are ind%stry-speci'ic and determined y reg%latory a%thority present any ris)s 'or the entity?
22
Ao Ao23
6re%sinessris)sade&%atelymonitored? Ao
2
Has management adopted so%nd acco%nting principles? .es Ao2
.es Management cons%lts with %s ao%t new acco%nting iss%es Ao24
Ao27
oes management give high priority to internal control? Ao
28
.es Ao29
Ao3
.es Ao31
.es Ao32
.es Ao33
.es Ao3
.es Ao3
.es Ao34
.es AoMana$e#ent 'hi%oso'h) and o'eratin$ st)%e:
o one or a 'ew individ%als dominate management and operating decisions?
.es The company manages its %siness ris)s thro%gh a %siness plan and a strong %dgeting process enior management meet at least monthly to disc%ss the %dget and events that might a''ect the company The company also has a trategic is) Management Committee that is responsile 'or considering how '%t%re events 8eg, Internet sales; may a''ect the company oes management ade&%ately cons%lt with its a%ditor on
acco%nting iss%es?
Is management willing to adB%st the 'inancial statements 'or misstatements that approach a material amo%nt?
.es Management are willing to oo) misstatements that we identi'y d%ring the a%dit
.es Management iss%es a Management>s eport on $inancial tatements that incl%des a statement ao%t the ade&%acy o' the company>s internal control system
Has management estalished and maintained internal control that will, among other things, initiate, record, process, and report
transactions consistent with management assertions in the 'inancial statements?
Has management een responsive to prior recommendations 'rom its a%ditors?
Management has always een responsive to o%r recommendations on internal control
Inte$rit) and ethica% &a%es:
Have appropriate entity policies regarding s%ch matters as acceptale %siness practices, con'licts o' interest, and codes o' cond%ct een estalished and are they ade&%ately comm%nicated? oes management demonstrate the appropriate tone at the top, incl%ding e<plicit moral g%idance ao%t what is right or wrong? 6re everyday dealings with c%stomers, s%ppliers, employees, and other parties ased on honesty and 'airness?
oes management doc%ment or investigate deviations 'rom estalished controls?
Co##it#ent to co#'etence: see E;hi(it 4-1B
oes the company maintain 'ormal or in'ormal Bo descriptions or other means o' de'ining tas)s that comprise partic%lar Bos? oes management determine to an ade&%ate e<tent the )nowledge and s)ills needed to per'orm partic%lar Bos?
37
Ao
38
Ao ee comments aove Ao
39
Ao Ao
Mana$e#ent characteristics:
Is there a motivation 'or management to engage in 'ra%d%lent 'inancial reporting? peci'ic indicators might incl%de
Ao (hile management is motivated to ma<imi@e shareholder wealth, they are not motivated to engage in 'ra%d%lent 'inancial reporting
J 6 signi'icant portion o' management>s compensation represented y on%ses, stoc) options, or other incentives, the val%e o' which is contingent %pon the entity achieving %nd%ly aggressive targets 'or operating res%lts, 'inancial position, or cash 'low
J 6n e<cessive interest y management in maintaining or increasing the entity>s stoc) price or earnings trend thro%gh the %se o' %n%s%ally aggressive acco%nting practices J 6 practice y management o' committing to analysts, creditors, and other third parties to achieve what appear to e %nd%ly aggressive or clearly %nrealistic 'orecasts
J 6n interest y management in p%rs%ing inappropriate means to minimi@e reported earnings 'or ta<Kmotivated reasons
Is there a 'ail%re y management to display and comm%nicate an appropriate attit%de regarding internal control and the 'inancial reporting process? peci'ic indicators might incl%de
J 6n ine''ective means o' comm%nicating and s%pporting the entity>s val%es or ethics, or comm%nication o' inappropriate val%es or ethics
J omination o' management y a single person or small gro%p witho%t compensating controls s%ch as e''ective oversight y the oard o' directors or a%dit committee J Inade&%ate monitoring o' signi'icant controls J Management 'ailing to correct )nown reportale conditions on a timely asis
J Management setting %nd%ly aggressive 'inancial targets and e<pectations 'or operating personnel
J Management displaying a signi'icant disregard 'or reg%latory a%thorities
J Management contin%ing to employ an ine''ective acco%nting, in'ormation technology, or internal a%diting sta'' o non'inancial management have e<cessive participation in, or preocc%pation with, the selection o' acco%nting principles or the determination o' signi'icant estimates?
Is there high t%rnover o' senior management, co%nsel, or oard memers?
No Unti% /e(rar) 212, *hen EarthWears Chie! Accontin$ O!!icer, ?rad Norton ne;'ected%) %e!t the co#'an) to ta.e another >o( Ho*e&er, 'rior to that, the co#'an)s e;ecti&e tea# had (een the sa#e !or )ears
+es There has (een #ch s'ec%ation o! Caro% Mca)s 6a%i!ications () EarthWear e;ecti&es
3
Ao
Ao
.es Ao4
Ao7
Ao8
.es Ao9
Isthisevidencedy Ao
.es Ao1
.es Ao2
.es Ao3
.es Ao
6res%choBectives .es Ao
oes the appropriate level o' management .es Ao ?oard o! directors and adit co##ittee:
oes the oard o' directors and its maBor committees contain an appropriate n%mer o' independent directors?
.es The Doard o' irectors is composed o' 2 senior memers o' management and 4 independent oard memers
6re there reg%lar meetings o' the oard o' directors 8or comparale odies; to set policies and oBectives, review the entity>s
per'ormance, and ta)e appropriate action, and are min%tes o' s%ch meetings prepared and signed on a timely asis?
.es The Doard o' irectors meet &%arterly to review Earth(ear>s per'ormance, or when events occ%r or transactions ta)e place that signi'icantly a''ects the company
The Corporate ecretary prepares min%tes o' these meetings within one wee) and the ecretary signs them a'ter approval o' the Doard oes the oard o' directors ins%re that the overall operations o' the
entity ins%re that management>s oBectives are congr%ent with other maBor sta)eholders 8eg, investors and creditors;?
oes an a%dit committee e<ist? I' so, is the a%dit committee composed o' independent directors?
.es The a%dit committee is composed o' two directors o' the company who are not memers o' management
oes the a%dit committee ade&%ately assist the oard in
maintaining a direct line o' comm%nication with the entity>s e<ternal and internal a%ditors?
.es The a%dit committee also meets with the internal and e<ternal a%ditors each &%arter
oes the a%dit committee have ade&%ate reso%rces and a%thority to discharge its responsiilities?
The a%dit committee meets &%arterly B%st prior to the oard o' directors meeting and min%tes are maintained o' each meeting Doth memers o' the a%dit committee have s%stantial 'inancial e<perience
J eg%lar meetings?
J The appointment o' &%ali'ied memers? J Min%tes o' the meetings?
oes the entity set entity wide oBectives that state what the entity desires to achieve, and are they s%pported y strategic plans? oes the entity have a ris) analysis process that incl%des estimating the signi'icance o' the ris)s, assessing the li)elihood o' their occ%rring, and determining the actions needed to respond to the ris)s?
oes the entity have mechanisms to identi'y and react to changes that may dramatically and pervasively a''ect the entity?
oes management have clear oBectives in terms o' %dget, pro'it, and other 'inancial and operating goals?
J Clearly written?
J 6ctively comm%nicated thro%gho%t the entity? J 6ctively monitored?
7
Ao8
.es Ao9
6re s%ch controls ade&%ately adhered to? .es Ao4
.es Ao41
.es Ao42
6re acco%nting and data processing centrali@ed or decentrali@ed? .es 6 ll in'ormation technology is centrali@ed AoAssi$n#ent o! Athorit) and Res'onsi(i%it):
43
Ao4
.es Ao4
.es Ao44
.es Ao47
Is there ade&%ate doc%mentation o' data processing controls? .es AoCo##nications:
48
.es Ao49
.es Ao7
oes the entity have a per'ormance meas%rement system? Ao
71
Ao72
.es Ao. A
Or$aniDationa% strctre:
Is the organi@ation o' the entity clearly de'ined in terms o' lines o' a%thority and responsiility?
.es The company has clear lines o' a%thority among the vario%s operating departments and sta'' '%nctions
6re controls 'or a%thori@ation o' transactions estalished at an ade&%ately high level?
Is the organi@ational str%ct%re appropriate 'or the si@e and comple<ity o' the entity?
Has management estalished policies 'or developing and modi'ying acco%nting systems and control activities?
Is there clear assignment o' responsiility and delegation o' a%thority to deal with s%ch matters as organi@ational goals and oBectives, operating '%nctions, and reg%latory re&%irements?
.es The h%man reso%rces department maintains detailed Bo descriptions, incl%ding speci'ic d%ties and reporting responsiilities Management has reviewed these Bo descriptions 'or proper assignment and delegation o' a%thority
6re employees> Bo responsiilities, incl%ding speci'ic d%ties, reporting relationships, and constraints, clearly estalished and comm%nicated to employees?
Has management clearly comm%nicated the scope o' a%thority and responsiility to data processing management?
oes ade&%ate comp%ter systems doc%mentation indicate the controls 'or a%thori@ing transactions and approving systems changes?
oes management comm%nicate employees> d%ties and control responsiilities in an e''ective manner?
oes comm%nication 'low across the organi@ation ade&%ately to enale people to discharge their responsiilities e''ectively?
.es The company manages per'ormance thro%gh a %siness plan and a strong %dgeting process enior management meet at least monthly to disc%ss the %dget and corporate per'ormance
I' so, what )ey per'ormance indicators 87Is; are %sed y management to meas%re per'ormance?
Inventory T%rnover, Gross 7ro'it 7ercentage, ays o' Inventory on hand, et%rn on 6ssets, et%rn on E&%ity
oes the entity enchmar) its per'ormance against its ind%stry and maBor competitors?
Na#e: C%ass:
A Qestionnaire !or "oc#entin$ the Understandin$ o! EarthWear C%othiers and its En&iron#ent
C%ient Na#e: EarthWear C%othiers Co#'%eted (): Entit) and En&iron#ent Cate$or): Natre o! the Entit) Re&ie*ed ():
+earended:"ece#(er31,212 "ate: #"9!19!"#4 Qestion Ris. /actors "escri'tion0Res'onse An) Re#ainin$ Ris.
1
No
2
(ho are the entity>s )ey c%stomers? No
3
(ho are the entity>s )ey s%ppliers?
4
(hat are the entity>s maBor assets? In&entor) and 5ro'ert), '%ant, and e6i'#ent No
7
(hat are the entity>s maBor liailities? No
1
17
o c%stomer dynamics present any ris)s 'or the entity? No
19
o technological 'actors present any ris)s 'or the entity?
Please Complete
(hat are the entity>s maBor so%rces o' reven%e, incl%ding the nat%re o' its prod%cts and9or services?
Hi$h-6a%it) c%othin$ !or otdoor s'orts, sch as hi.in$, s.iin$, !%)-!ishin$, and *hite-*ater .a)a.in$ O&er the )ears, the Co#'an)s 'rodct %ines ha&e $ro*n to inc%de casa% c%othin$, accessories, shoes and so!t %$$a$e
The co#'an) has a #ai%in$ %ist *hich consists o! a''ro;i#ate%) 211 'eo'%e Ho*e&er, a''ro;i#ate%) 7 #i%%ion are &ie*ed as csto#ers (ecase the) #ade at %east one 'rchase !ro# the co#'an) *ithin the %ast 2 #onths Additiona%%), a sr&e) condcted () the Co#'an) in the United States drin$ 21 indicated that a''ro;i#ate%) < o! its csto#ers *ere in the 3- a$e $ro' and had #edian inco#es o! =78,
A%% $oods are 'rodced () inde'endent #an!actrers e;ce't !or #ost o! its so!t %$$a$e, *hich is asse#(%ed at the Co#'an)s !aci%ities "rin$ 211, the Co#'an) 'rchased #erchandise !ro# a''ro;i#ate%) 3 do#estic and !orei$n #an!actrers One #an!actrer and one inter#ediar) acconted !or a(ot 1-29< o! the Co#'an)s recei&ed #erchandise, res'ecti&e%), in 211 In 211 a(ot 8< o! the Co#'an)s #erchandise *as i#'orted, #ain%) !ro# Asia, Centra% A#erica, and Me;ico
+es, the co#'an) *o%d (e s(>ect to a n#(er o! ris.s /or e;a#'%e, i! these !orei$n contries nder$o econo#ic hardshi's or sto' s''%)in$ to the Co#'an), the Co#'an) *o%d need to !ind a%ternati&e s''%iers Additiona%%), *or.ers (oth do#estica%%) and
internationa%%) co%d nder$o a stri.e, ths sto''in$ shi'#ent o! s''%ies /rther#ore, the &a%e o! !orei$n crrenc) co%d a''reciate re%ati&e to the US "o%%ar, *hich *o%d #a.e s''%ies #ore cost%)
The co#'an) has no %on$ ter# de(t, (t the) do ha&e an nsecred do#estic %ine o! credit sed to !inance 'rchases
oes the competitive ind%stry environment present any ris)s 'or the entity? Identi'y any competitors
The Co#'an)s 'rinci'a% co#'etitors are retai% stores, inc%din$ s'ecia%t) sho's, de'art#ent stores, and other cata%o$ co#'anies "irect co#'etitors inc%de Eddie ?aer, @ands End, @@ ?ean, 5ata$onia, and Ti#(er%and The a''are% retai% (siness in $enera% is intense%) co#'etiti&e
+es, the co#'an) #a) a%so !ace increased co#'etition !ro# other retai%ers as the n#(er o! te%e&ision sho''in$ channe%s and the &ariet) o! #erchandise o!!ered o&er the internet increase No, the co#'an) has a s!!icient n#(er o! 'eo'%e on their #ai%in$ %ist
211 #i%%ionB and a s!!icient n#(er o! csto#ers *ho ha&e #ade 'rchases in the %ast 2 #onths
+es Tho$h the co#'an) s*itched to a ne* s)ste#, it !aced si$ni!icant 'ro(%e#s in the third and !orth 6arters o! 21 These 'ro(%e#s co%d contine or arise a$ain
No, 'ro(%e#s *ith the s)ste# *ere %ar$er%) reso%&ed !or the #ost 'art a!ter 21
Is there high t%rnover o' senior management, co%nsel, or oard memers?
No Unti% /e(rar) 212, *hen EarthWears Chie! Accontin$ O!!icer, ?rad Norton ne;'ected%) %e!t the co#'an) to ta.e another >o( Ho*e&er, 'rior to that, the co#'an)s e;ecti&e tea# had (een the sa#e !or )ears
+es There has (een #ch s'ec%ation o! Caro% Mca)s 6a%i!ications () EarthWear e;ecti&es
