EarthWear Hands-on Mini-case Chapter 4 - Understanding the Entity and Its Environment © The McGraw-Hill Companies, Inc, !"#!
In this mini-case yo% will complete the &%estionnaire 'or %nderstanding Earth(ear Earth(ear Clothiers, Inc and the environment in which it operates
INSTRUCTIONS:
1
The wor)sheet titled *+%estionnaire* contains a partially completed copy o' the &%estionnaire can thro%gh the &%estions and responses that have already een completed
2
.o% are to complete &%estions #, !, /, 0, 1, #2, #1, #3, and 4" e'er to the in'ormation on the Earth(ear Investor and (illis 5 6dams C76s C76s wesites 8wwwmhhecom9messier:e; 8wwwmhhecom9messier:e; and the ac)gro%nd doc%ment elow to complete the &%estions .o% can also leverage the wor) o' the prior year a%dit team shown in E
$ields yo% are to complete on the &%estionnaire are colored yellow The color will disappear as the 'ield is completed
7rint a copy o' the *7rint =%t* wor)sheet to s%mit in class %nless otherwise indicated y yo%r instr%ctor
A Qestionnaire !or "oc#entin$ the Understandin$ o! EarthWear C%othiers and its En&iron#ent C%ient Na#e: EarthWear C%othiers Entit) and En&iron#ent Cate$or): Natre o! the Entit) +ear ended: "ece#(er 31, 212 Qestion
1
Co#'%eted (): Re&ie*ed (): "ate:
Ris. /actors "escri'tion0Res'onse (hat are the entity>s maBor so%rces o' reven%e, incl%ding the nat%re Hi$h-6a%it) c%othin$ !or otdoor s'orts, sch as hi.in$, s.iin$, !%)o' its prod%cts and9or services? !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 %$$a$e
#"9!19!"#4
An) Re#ainin$ Ris. No
(ho are the entity>s )ey c%stomers?
The co#'an) has a #ai%in$ %ist *hich consists o! a''ro;i#ate%) 211 No 'eo'%e Ho*e&er, a''ro;i#ate%) 7 #i%%ion are &ie*ed as csto#ers (ecase the) #ade at %east one 'rchase !ro# the co#'an) *ithin the %ast 2 #onths Additiona%%), a sr&e) condcted () the Co#'an) in the United States drin$ 21 indicated that a''ro;i#ate%) < o! its csto#ers *ere in the 3- a$e $ro' and had #edian inco#es o! =78,
(ho are the entity>s )ey s%ppliers?
A%% $oods are ' rodced () inde'endent #an!actrers e;ce't !or #ost o! its so!t %$$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$n crrenc) co%d a''reciate re%ati&e to the US "o%%ar, *hich *o%d #a.e s''%ies #ore cost%)
(hat is the entity>s organi@ational str%ct%re?
The company has a well-developed organi@ational str%ct%re with clear lines o' a%thority among the vario%s operating departments and sta'' '%nctions The organi@ational str%ct%re is appropriate 'or Earth(ear>s activities
Ao
(here are its maBor locations?
Doise, Idaho is the main corporate location Earth(ear also has phone and Ao Aone o' these co%ntry locations distri%tion centers in the United ingdom, Germany, and Fapan pose threats to Earth(ear as a res%lt o' e
(hat are the entity>s maBor assets?
In&entor) and 5ro'ert), '%ant, and e6i'#ent
2
3
4
Enter Your Name Here
No
o c%stomer dynamics present any ris)s 'or the entity?
No, the co#'an) has a s!!icient n#(er o! 'eo'%e on their #ai%in$ %ist 211 #i%%ionB and a s!!icient n#(er o! csto#ers *ho h a&e #ade 'rchases in the %ast 2 #onths
No
o social9environmental 'actors present any ris)s 'or the entity?
Ao
Ao
o technological 'actors present any ris)s 'or the entity?
+es Tho$h the co#'an) s*itched to a ne* s)ste#, it !aced si$ni!icant No, 'ro(%e#s *ith the s)ste# *ere 'ro(%e#s in the third and !orth 6arters o! 21 These 'ro(%e#s %ar$er%) reso%&ed !or the #ost 'art co%d contine or arise a$ain 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?
Ao
Ao
6re there any other e
Ao
17 18 19
2 21
Mana$e#ent 'hi%oso'h) and o'eratin$ st)%e: o one or a 'ew individ%als dominate management and operating decisions?
Ao
6re %siness ris)s ade&%ately monitored?
.es The company manages its %siness ris)s thro%gh a %siness plan and a Ao 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
2
Has management adopted so%nd acco%nting principles?
.es
Ao
2
oes management ade&%ately cons%lt with its a%ditor on acco%nting iss%es?
.es Management cons%lts wit h %s ao%t new acco%nting iss%es
Ao
24
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
Ao
oes management give high priority to internal control?
.es Management iss%es a Management>s eport on $inancial tatements that incl%des a statement ao%t the ade&%acy o' the company>s internal control system
Ao
22
23
27
Ao
Ao
28
Has management estalished and maintained internal control that .es will, among other things, initiate, record, process, and report transactions consistent with management assertions in the 'inancial statements?
29
Has management een responsive to prior recommendations 'rom its a%ditors?
Ao
Management has always een responsive to o%r recommendations on internal control
Inte$rit) and ethica% &a%es: Have appropriate entity policies regarding s%ch matters as .es acceptale %siness practices, con'licts o' interest, and codes o' cond%ct een estalished and are they ade&%ately comm%nicated?
Ao
31
oes management demonstrate the appropriate tone at the top, incl%ding e
.es
Ao
32
6re everyday dealings with c%stomers, s%ppliers, employees, and other parties ased on honesty and 'airness?
.es
Ao
33
oes management doc%ment or investigate deviations 'rom estalished controls?
.es
Ao
3
Co##it#ent to co#'etence: see E;hi(it 4-1B
3
oes the company maintain 'ormal or in'ormal Bo descriptions or other means o' de'ining tas)s that comprise partic%lar Bos?
.es
Ao
3
oes management determine to an ade&%ate e
Ao
34
oes evidence e
Ao
.es
Mana$e#ent characteristics: Is there a motivation 'or management to engage in 'ra%d%lent 'inancial reporting? peci'ic indicators might incl%de J 6 signi'icant portion o' management>s compensation represented y on%ses, stoc) options, or other incentives, the val%e o' which is contingent %pon the entity achieving %nd%ly aggressive targets 'or operating res%lts, 'inancial position, or cash 'low
37
Ao (hile management is motivated to ma
Ao
Ao ee comments aove
Ao
o non'inancial management have e
Ao
Ao
Is there high t%rnover o' senior management, co%nsel, or oard memers?
No Unti% /e(rar) 212, *hen EarthWears Chie! Accontin$ 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
J 6n e
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 tas val%es or ethics, or comm%nication o' inappropriate val%es or ethics
38
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
39
?oard o! directors and adit co##ittee:
3
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 .es The Doard o' irectors meet &%arterly to review Earth(ear>s odies; to set policies and oBectives, review the entity>s per'ormance, or when events occ%r or transactions ta)e place that per'ormance, and ta)e appropriate action, and are min%tes o' s%ch signi'icantly a''ects the company meetings prepared and signed on a timely asis?
Ao Ao
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 .es entity ins%re that management>s oBectives are congr%ent with other maBor sta)eholders 8eg, investors and creditors;?
Ao
4
oes an a%dit committee e
.es The a%dit committee is composed o' two directors o' the company who are not memers o' management
Ao
oes the a%dit committee ade&%ately assist the oard in .es The a%dit committee also meets with the internal and es e
Ao
7 8
oes the a%dit committee have ade&%ate reso%rces and a%thority to .es discharge its responsiilities?
Ao
Is this evidenced y
9
J
eg%lar meetings?
J
The appointment o' &%ali'ied memers?
J
Min%tes o' the meetings?
The a%dit committee meets &%arterly B%st prior to the oard o' directors Ao meeting and min%tes are maintained o' each meeting Doth memers o' the a%dit committee have s%stantial 'inancial e
oes the entity set entity wide oBectives that state what the entity desires to achieve, and are they s%pported y strategic plans?
.es
Ao
.es
Ao
1
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?
2
oes the entity have mechanisms to identi'y and react to changes that may dramatically and pervasively a''ect the entity?
.es
Ao
3
oes management have clear oBectives in terms o' %dget, pro'it, and other 'inancial and operating goals?
.es
Ao
6re s%ch oBectives
.es
Ao
.es
Ao
J
Clearly written?
J
6ctively comm%nicated thro%gho%t the entity?
J
6ctively monitored?
oes the appropriate level o' management
J
6de&%ately investigate variances?
Or$aniDationa% strctre:
7
Is the organi@ation o' the entity clearly de'ined in terms o' lines o' a%thority and responsiility?
.es The company has clear lines o' a%thority among the vario%s operating departments and sta'' '%nctions
Ao
8
6re controls 'or a%thori@ation o' transactions estalished at an ade&%ately high level?
.es
Ao
9
6re s%ch controls ade&%ately adhered to?
.es
Ao
4
Is the organi@ational str%ct%re appropriate 'or the si@e and comple
.es
Ao
41
Has management estalished policies 'or developing and modi'ying .es acco%nting systems and control activities?
Ao
42
6re acco%nting and data processing centrali@ed or decentrali@ed?
.es 6 ll in'ormation technology is centrali@ed
Ao
Is there clear assignment o' responsiility and delegation o' a%thority to deal with s%ch matters as organi@ational goals and oBectives, operating '%nctions, and reg%latory re&%irements?
.es The h%man reso%rces department maintains detailed Bo descriptions, incl%ding speci'ic d%ties and reporting responsiilities Management has reviewed these Bo descriptions 'or proper assignment and delegation o' a%thority
Ao
6re employees> Bo responsiilities, incl%ding speci'ic d%ties, reporting relationships, and constraints, clearly estalished and comm%nicated to employees?
.es
Ao
4 4
Has management clearly comm%nicated the scope o' a%thority and .es responsiility to data processing management?
Ao
oes ade&%ate comp%ter systems doc%mentation indicate the controls 'or a%thori@ing transactions and approving systems changes?
.es
Ao
44 47
Is there ade&%ate doc%mentation o' data processing controls?
.es
Ao
Assi$n#ent o! Athorit) and Res'onsi(i%it):
43
Co##nications:
48
oes management comm%nicate employees> d%ties and control responsiilities in an e''ective manner?
.es
Ao
49
oes comm%nication 'low across the organi@ation ade&%ately to enale people to discharge their responsiilities e''ectively?
.es
Ao
oes the entity have a per'ormance meas%rement system?
.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
Ao
71
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
Ao
72
oes the entity enchmar) its per'ormance against its ind%stry and .es maBor competitors?
Ao
oes the entity consider 'inancial analysts> research and earnings
A
7
.
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 Entit) and En&iron#ent Cate$or): Natre o! the Entit) +ear ended: "ece#(er 31, 212 Qestion
1
Co#'%eted (): Re&ie*ed (): "ate:
Ris. /actors "escri'tion0Res'onse (hat are the entity>s maBor so%rces o' reven%e, incl%ding the nat%re Hi$h-6a%it) c%othin$ !or otdoor s'orts, sch as hi.in$, s.iin$, !%)o' its prod%cts and9or services? !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 %$$a$e
Please Complete #"9!19!"#4
An) Re#ainin$ Ris. No
(ho are the entity>s )ey c%stomers?
The co#'an) has a #ai%in$ %ist *hich consists o! a''ro;i#ate%) 211 No 'eo'%e Ho*e&er, a''ro;i#ate%) 7 #i%%ion are &ie*ed as csto#ers (ecase the) #ade at %east one 'rchase !ro# the co#'an) *ithin the %ast 2 #onths Additiona%%), a sr&e) condcted () the Co#'an) in the United States drin$ 21 indicated that a''ro;i#ate%) < o! its csto#ers *ere in the 3- a$e $ro' and had #edian inco#es o! =78,
(ho are the entity>s )ey s%ppliers?
A%% $oods are 'rodced () inde'endent #an!actrers e;ce't !or #ost o! its so!t %$$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$n crrenc) co%d a''reciate re%ati&e to the US "o%%ar, *hich *o%d #a.e s''%ies #ore cost%)
(hat are the entity>s maBor assets?
In&entor) and 5ro'ert), '%ant, and e6i'#ent
No
(hat are the entity>s maBor liailities?
The co#'an) has no %on$ ter# de(t, (t the) do ha&e an nsecred do#estic %ine o! credit sed to !inance 'rchases
No
2
3
4
7
1
oes the competitive ind%stry environment present any ris)s 'or the The Co#'an)s 'rinci'a% co#'etitors are retai% stores, inc%din$ entity? Identi'y any competitors 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 $enera% is intense%) co#'etiti&e o c%stomer dynamics present any ris)s 'or the entity?
No, the co#'an) has a s!!icient n#(er o! 'eo'%e on their #ai%in$ %ist 211 #i%%ionB and a s!!icient n#(er o! csto#ers *ho ha&e #ade 'rchases in the %ast 2 #onths
o technological 'actors present any ris)s 'or the entity?
+es Tho$h the co#'an) s*itched to a ne* s)ste#, it !aced si$ni!icant No, 'ro(%e#s *ith the s)ste# *ere 'ro(%e#s in the third and !orth 6arters o! 21 These 'ro(%e#s %ar$er%) reso%&ed !or the #ost 'art co%d contine or arise a$ain 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
17
19
+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
+es There has (een #ch s'ec%ation o! Caro% Mca)s 6a%i!ications () EarthWear e;ecti&es
