EarthWear Hands-on Mini-case
Understanding the Entity and Its Environment
In this mini-case you will complete the questionnaire for understanding EarthWear Clothiers, Inc. and the
environment in which it operates.
INSTRUCTIONS:
The worksheet titled "Questionnaire" contains a partially completed copy of the questionnaire. Scan
1 through the questions and responses that have already been completed.
You are to complete questions 1, 2, 3, 6, 7, 15, 17, 19, and 40. Refer to the information on the EarthWear
2 annual report and the background document to complete the questions. You can also leverage the work
of the prior year audit team shown in Exhibit 4-3 of your text.
Hint: Refer to the Company History/Background page and Consolidated Financial Statements in the annual report
Fields you are to complete on the questionnaire are colored yellow. The color will disappear as the field is completed.
Please print a copy of the Print Out to submit . The Print Out is formatted to fit on one page.
3
A Questionnaire for Documenting the Understanding of
EarthWear Clothiers and its Environment
Client Name: EarthWear Clothiers Completed by: Wong Ching Long
Entity and Environment Category: Nature of the Entity Reviewed by:
Year ended: December 31, 2019 Date: 3/25/2021
Question Risk Factors Description/Response Any Remaining Risk
What are the entity’s major sources of revenue, including the nature Selling outdoor cloths NO
of its products and/or services?
1
Who are the entity’s key customers? affluent, college-educated, professional and style-conscious individuals NO
2
Who are the entity’s key suppliers? independent supplies from all over the world, mainlt includes Asia, Central NO
America and Mexico
What is the entity’s organizational structure? The company has a well-developed organizational structure with clear lines of No.
authority among the various operating departments and staff functions. The
4 organizational structure is appropriate for EarthWear’s activities.
Where are its major locations? Boise, Idaho is the main corporate location. EarthWear also has phone and No. None of these country locations
distribution centers in the United Kingdom, Germany, and Japan. pose threats to EarthWear as a result
5 of expropriation or limits on repatriation
of earnings.
What are the entity’s major assets? Inventory Yes, as in some cases company might
over state inventory to aid a better
6 finacial statement.
What are the entity’s major liabilities? Accounts payable No.
7
What are the entity’s financial characteristics including financing The company uses its line of credit to meet its normal financing activities. No.
8 sources and current and prospective financial condition? Overall the company’s financial condition is good.
9 Are there any potential related parties? No. No.
Are there any individually significant events and transactions such No. No.
10 as acquisitions or disposals of subsidiaries, businesses, or product
lines during the year?
11 Does the entity have any major uncertainties or contingencies? No. No.
Do general economic conditions present any risks for the entity? The company’s business is highly seasonal. Most of the company’s sales No. The company is aware of the
and profit are realized during the fourth quarter. importance of fourth quarter sales.
12 The company continues to refine its
catalog mailings, so quarterly results
may fluctuate.
13 Does the regulatory environment present any risks for the entity? No. No.
Does the legal/political environment present any risks for the entity? No. No.
14
Does the competitive industry environment present any risks for the The competeive market does increase the risk of a frud for the company as it NO
entity? Identify any competitors. is facing more and more serious compete in the market. Competeitors
15 includes brand like timerland.
Do supplier dynamics present any risks for the entity? No. The company has an adequate number of suppliers. No one supply can No.
16 significantly affect the company’s operations.
Do customer dynamics present any risks for the entity? No. The company has a list of frequent customer and the type of customer No.
are very stable. Also customer are mostly indivuals so they will not have the
17 avility to significantly affect the company's operation
18 Do social/environmental factors present any risks for the entity? No. No.
Do technological factors present any risks for the entity? No NO.
19
Do accounting principles, including those that are industry-specific No. No.
20 and determined by regulatory authority present any risks for the
entity?
Are there any other external factors that present a risk for the entity? No. No.
21
Management philosophy and operating style:
Do one or a few individuals dominate management and operating No. No.
22 decisions?
Are business risks adequately monitored? Yes. The company manages its business risks through a business plan and a No.
strong budgeting process. Senior management meet at least monthly to
23 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.
24 Has management adopted sound accounting principles? Yes. No.
Does management adequately consult with its auditor on accounting Yes. Management consults with us about new accounting issues. No.
25 issues?
Is management willing to adjust the financial statements for Yes. Management are willing to book misstatements that we identify during No.
26 misstatements that approach a material amount? the audit.
Does management give high priority to internal control? Yes. Management issues a Management’s Report on Financial Statements No.
27 that includes a statement about the adequacy of the company’s internal
control system.
Has management established and maintained internal control that Yes. No.
will, among other things, initiate, record, process, and report
28 transactions consistent with management assertions in the financial
statements?
Has management been responsive to prior recommendations from Management has always been responsive to our recommendations on No.
29 its auditors? internal control.
Integrity and ethical values:
Have appropriate entity policies regarding such matters as Yes. No.
acceptable business practices, conflicts of interest, and codes of
30 conduct been established and are they adequately communicated?
Does management demonstrate the appropriate “tone at the top,” Yes. No.
31 including explicit moral guidance about what is right or wrong?
Are everyday dealings with customers, suppliers, employees, and Yes. No.
32 other parties based on honesty and fairness?
Does management document or investigate deviations from Yes. No.
33 established controls?
Commitment to competence: (see Exhibit 6-1)
Does the company maintain formal or informal job descriptions or Yes. No.
34 other means of defining tasks that comprise particular jobs?
Does management determine to an adequate extent the knowledge Yes. No.
35 and skills needed to perform particular jobs?
Does evidence exist that employees have the requisite knowledge Yes. No.
36 and skills to perform their job?
Management characteristics:
Is there a motivation for management to engage in fraudulent No. While management is motivated to maximize shareholder wealth, they No.
financial reporting? Specific indicators might include: are not motivated to engage in fraudulent financial reporting.
· A significant portion of management’s compensation
represented by bonuses, stock options, or other incentives,
the value of which is contingent upon the entity achieving
unduly aggressive targets for operating results, financial
position, or cash flow.
· An excessive interest by management in maintaining
37 or increasing the entity’s stock price or earnings trend
through the use of unusually aggressive accounting
practices.
· A practice by management of committing to analysts,
creditors, and other third parties to achieve what appear to
be unduly aggressive or clearly unrealistic forecasts.
· An interest by management in pursuing inappropriate
means to minimize reported earnings for tax‑motivated
reasons.
Is there a failure by management to display and communicate an No. See comments above. No.
appropriate attitude regarding internal control and the financial
reporting process? Specific indicators might include:
· An ineffective means of communicating and
supporting the entity’s values or ethics, or communication of
inappropriate values or ethics.
· Domination of management by a single person or
small group without compensating controls such as effective
oversight by the board of directors or audit committee.
38 · Inadequate monitoring of significant controls.
· Management failing to correct known reportable
conditions on a timely basis.
· Management setting unduly aggressive financial
targets and expectations for operating personnel.
· Management displaying a significant disregard for
regulatory authorities.
· Management continuing to employ an ineffective
accounting, information technology, or internal auditing staff.
Do nonfinancial management have excessive participation in, or No. No.
39 preoccupation with, the selection of accounting principles or the
determination of significant estimates?
Is there high turnover of senior management, counsel, or board NO. NO.
members?
40
Are there strained relationship between management and the No. No.
current or predecessor auditor? Specific indicators might include:
· Frequent disputes with the current or predecessor
auditor on accounting, auditing, or reporting matters.
· Unreasonable demands on the auditor including
unreasonable time constraints regarding the completion of
the audit or the issuance of the auditor s reports.
41 · Formal or informal restrictions on the auditor that
inappropriately limit his or her access to people or
information or his or her ability to communicate effectively
with the board of directors or the audit committee.
· Domineering management behavior in dealing with
the auditor, especially involving attempts to influence the
scope of the auditor s work.
Is there a known history of securities law violations or claims against No. No.
42 the entity or its senior management alleging fraud or violations of
securities laws?
Board of directors and audit committee:
Does the board of directors and its major committees contain an Yes. The Board of Directors is composed of 5 senior members of No.
43 appropriate number of “independent” directors? management and 4 independent board members.
Are there regular meetings of the board of directors (or comparable Yes. The Board of Directors meet quarterly to review EarthWear’s No.
bodies) to set policies and objectives, review the entity’s performance, or when events occur or transactions take place that
performance, and take appropriate action, and are minutes of such significantly affects the company.
44 meetings prepared and signed on a timely basis?
The Corporate Secretary prepares minutes of these meetings within one
week and the Secretary signs them after approval of the Board.
Does the board of directors insure that the overall operations of the Yes. No.
45 entity insure that management’s objectives are congruent with other
major stakeholders (e.g., investors and creditors)?
Does an audit committee exist? If so, is the audit committee Yes. The audit committee is composed of two directors of the company who No.
46 composed of “independent” directors? are not members of management.
Does the audit committee adequately assist the board in maintaining Yes. The audit committee also meets with the internal and external auditors No.
47 a direct line of communication with the entity’s external and internal each quarter.
auditors?
Does the audit committee have adequate resources and authority to Yes. No.
48 discharge its responsibilities?
Is this evidenced by The audit committee meets quarterly just prior to the board of directors No.
meeting and minutes are maintained of each meeting. Both members of the
· Regular meetings?
49 audit committee have substantial financial experience.
· The appointment of qualified members?
· Minutes of the meetings?
Does the entity set entity wide objectives that state what the entity Yes. No.
50 desires to achieve, and are they supported by strategic plans?
Does the entity have a risk analysis process that includes estimating Yes. No.
the significance of the risks, assessing the likelihood of their
51 occurring, and determining the actions needed to respond to the
risks?
Does the entity have mechanisms to identify and react to changes Yes. No.
52 that may dramatically and pervasively affect the entity?
Does management have clear objectives in terms of budget, profit, Yes. No.
53 and other financial and operating goals?
Are such objectives Yes. No.
· Clearly written?
54
· Actively communicated throughout the entity?
· Actively monitored?
Does the appropriate level of management Yes. No.
55 · Adequately investigate variances?
· Take appropriate and timely corrective
actions?
Has management established procedures to prevent unauthorized Yes. No.
56 access to, or destruction of, documents, records, assets, programs,
and data files?
Organizational structure:
Is the organization of the entity clearly defined in terms of lines of Yes. The company has clear lines of authority among the various operating No.
57 authority and responsibility? departments and staff functions.
Are controls for authorization of transactions established at an Yes. No.
58 adequately high level?
59 Are such controls adequately adhered to? Yes. No.
Is the organizational structure appropriate for the size and Yes. No.
60 complexity of the entity?
Has management established policies for developing and modifying Yes. No.
61 accounting systems and control activities?
Are accounting and data processing centralized or decentralized? Yes. All information technology is centralized. No.
62
Assignment of Authority and Responsibility:
Is there clear assignment of responsibility and delegation of Yes. The human resources department maintains detailed job descriptions, No.
authority to deal with such matters as organizational goals and including specific duties and reporting responsibilities. Management has
63 objectives, operating functions, and regulatory requirements? reviewed these job descriptions for proper assignment and delegation of
authority.
Are employees’ job responsibilities, including specific duties, Yes. No.
64 reporting relationships, and constraints, clearly established and
communicated to employees?
Has management clearly communicated the scope of authority and Yes. No.
65 responsibility to data processing management?
Does adequate computer systems documentation indicate the Yes. No.
66 controls for authorizing transactions and approving systems
changes?
67 Is there adequate documentation of data processing controls? Yes. No.
Communications:
Does management communicate employees’ duties and control Yes. No.
68 responsibilities in an effective manner?
Does communication flow across the organization adequately to Yes. No.
69 enable people to discharge their responsibilities effectively?
Does the entity have a performance measurement system? Yes. The company manages performance through a business plan and a No.
70 strong budgeting process. Senior management meet at least monthly to
discuss the budget and corporate performance.
If so, what key performance indicators (KPIs) are used by Inventory Turnover, Gross Profit Percentage, Days of Inventory on hand, No.
71 management to measure performance? Return on Assets, Return on Equity
Does the entity benchmark its performance against its industry and Yes. No.
72 major competitors?
Does the entity consider financial analysts’ research and earnings Yes. No.
73 reports?
Does the information system give management the necessary Yes. No.
74 reports on the entity’s performance relative to established
objectives, including internal and external information?
75 How often are performance reports prepared? Yes. No.
Is the information provided to the right people in sufficient detail and Yes. No.
76 in time to enable them to carry out their responsibilities?
Are communication channels established for people to report Yes. No.
77 suspected improprieties?
78 Does the entity have an internal audit function? Yes. No.
Are recommendations made by the internal and external auditors Yes. No.
79 implemented?
Name:
Class:
A Questionnaire for Documenting the Understanding of
EarthWear Clothiers and its Environment
Client Name: EarthWear Clothiers Completed by: Wong Ching Long
Entity and Environment Category: Nature of the Entity Reviewed by:
Year ended: December 31, 2019 Date: 3/25/2021
Question Risk Factors Description/Response Any Remaining Risk
What are the entity’s major sources of revenue, including the nature Selling outdoor cloths NO
of its products and/or services?
1
Who are the entity’s key customers? affluent, college-educated, professional and style-conscious individuals NO
2
Who are the entity’s key suppliers? independent supplies from all over the world, mainlt includes Asia, Central NO
America and Mexico
What are the entity’s major assets? Inventory Yes, as in some cases company might
over state inventory to aid a better
6 finacial statement.
What are the entity’s major liabilities? Accounts payable No.
7
Does the competitive industry environment present any risks for the The competeive market does increase the risk of a frud for the company as it NO
entity? Identify any competitors. is facing more and more serious compete in the market. Competeitors
15 includes brand like timerland.
Do customer dynamics present any risks for the entity? No. The company has a list of frequent customer and the type of customer No.
are very stable. Also customer are mostly indivuals so they will not have the
17 avility to significantly affect the company's operation
Do technological factors present any risks for the entity? No NO.
19
Is there high turnover of senior management, counsel, or board NO. NO.
members?
40
