1 SHR CASE STUDY The following case study has 2 parts (Part A & B). Complete all requires of these 2 parts typed/double-spaced/12-font in 5 pages or less Background Information SHR Corporation (SHR) is a midsize, publicly traded direct marketer and retailer of outdoor sporting goods based in the United States. Its common stock is listed on the New York Stock Exchange under the symbol SHR. The company prides itself on selling high-quality outdoor sporting goods at competitive prices and providing outstanding customer service. SHR directly markets its merchandise through two major channelsits catalogs and its websiteto customers in the United States and nearly 100 other countries. It currently has retail stores and distribution centers in the United States, Canada, and Europe. SHR Corporation recently purchased MVF Company, a manufacturer of high-quality outdoor sportswear. SHR also purchases merchandise from highly reputable vendors in the United States and several other countries. SHR Corporation has enjoyed several consecutive years of sustained growth as reflected in the selected financial information, expressed in millions of dollars (US), presented below: CASE STUDIES Case Study 1: Auditing Entity-Level Controls 2017 2016 2015 Total Assets $700.5 $546.5 $491.3 Sales Revenue 763.5 665.7 589.8 Operating Income 57.5 45.0 38.9 Net Income 34.3 29.0 26.0 Senior management is continuing its efforts to grow the company, increase its market share, and enhance shareholder value by: Further expanding its direct sales globally. Systematically increasing the number of retail stores. Selectively acquiring other businesses that are aligned with its core competencies. Increasing competition over the past several years has motivated management to continuously pursue new and innovative ways to differentiate SHRs products, streamline the companys business processes, and take full advantage of advances in IT. Operating efficiency is a critical component of SHRs competitive pricing strategy. The risks that concern senior management the most heading into fiscal 2018 include: The continuing economic uncertainty further decreases discretionary consumer spending, which in turn will adversely affect the companys sales and profitability. Mounting competition in the industry may make it increasingly difficult to differentiate the companys high-quality merchandise at prices consumers are willing to pay. 2 Deterioration of the companys brand or its positive image in the marketplace may adversely affect sales and profitability. Failure to successfully integrate newly acquired businesses may adversely affect the companys performance. The inability to generate operating efficiencies and leverage IT may adversely affect the companys profits. Placing too much emphasis on operating efficiencies may adversely affect product quality and customer service. During the first six months of 2018, SHR has experienced slower sales growth and higher operating expenses than anticipated. There is growing concern that forecasted performance targets for the year will not be achieved. Scenario 1: Ethical Behavior is Good Business The concept that ethical behavior is good business is integral to SHRs strategy. For example, the companys 2017 annual report includes this statement: Sound ethical conduct is a key component of how we do business and continues to contribute significantly to the companys success. Requirements of CASE STUDIES Case Study 1: Part A - Auditing Entity-Level Controls Remember the following definitions as you complete the requirements under Scenario 1 Activities 1 below: Business Objective: To demonstrate sound ethical conduct in everything we do. Business Risk: Disregard for sound ethical principles, either intentional or unintentional, may cause managers and employees to cut corners, embellish performance results, misuse company resources, or otherwise act in a manner that harms the company and its stakeholders. Use the business objective and business risk stated above as the basis for answering the following questions. As he or she deems necessary Scenario 1 Activities 1. Management asserts that entity-level controls are designed adequately and operating effectively to reduce the above stated risk to an acceptably low level. Identify the key entity-level controls you expect to find in place if managements assertion is true. Keep in mind that entity-level controls may exist in any of the five COSO components of internal control (control environment, risk assessment, controls, information and communication, and monitoring). Many elements of the control environment are soft in nature. They may, for example, involve senior management behavior that intrinsically leaves little, if any, audit trail. An example of a soft control that you may have included in your answer to question 1 above is expressed as follows: Senior management fosters a strong corporate ethical climate by what they say and what they do. They lead by example when faced with tough business decisions involving ethical ramifications. Requirements of Part A: 1. Identify the audit procedures you would use to determine whether this control exists and are operating effectively within SHR Corporation. Describe the evidence you might find that would indicate operating effectively (be specific). Keep in mind that you need to build a sufficient body of appropriate evidence to support a valid conclusion. 3 Part B - entity-level controls over the companys ethics program Study the scenario presented below about SHR Corporations. SHR Corporation has a reputation of sound ethical conduct. In recent years, however, the company has not had to deal with an economic downturn, the level of new competition it is now facing, or the decreasing profitability it has experienced during the first two quarters of 2018. Three years ago, the company put in place a comprehensive, written code of conduct (the Code) that is applicable to directors, management, and employees. The Code is posted on the organizations website and intranet. All new employees receive a copy of the Code when they are hired and participate in orientation training that includes coverage of the Code. Some minor revisions were made to the Code during the first few months after its introduction, but no changes have been made since then. A whistleblower program that includes an anonymous hotline was put in place last year for employees and third parties to report suspected violations of the Code. The vice president of internal audit and her direct reports monitor the whistleblower hotline and report suspected violations of the Code to appropriate levels of management and/or the audit committee. Calls on the anonymous hotline have been infrequent, with very few suspected Code violations of a significant nature being reported to senior management or the audit committee. The internal audit function (internal auditing) recently surveyed senior management and the audit committee regarding the companys ethics program and conducted follow-up interviews with the audit committee chair and selected members of the senior management team. These procedures produced the following information: The audit committees charter does not include an explicit provision for overseeing senior managements ethical conduct or monitoring its adherence to prescribed internal control policies and procedures. The audit committee chair is confident, however, that any misconduct on the part of senior management would come to light via the companys whistleblower program and the committees quarterly meetings with the vice president of internal audit. The senior management team informally holds each other accountable for complying with the Code. Senior management believes that it clearly conveys the importance of ethical conduct and compliance with the Code via emails, webcasts, and town hall meetings. Senior managements assessed level of inherent ethical misconduct risk has remained consistently low over the past three years. Internal audit separately surveyed a sample of managers and employees regarding the companys ethics programs and received responses from 75 percent of the survey recipients. This survey produced the following information: All company personnel are required to certify in writing on an annual basis that they understand and are in compliance with the Code. Follow-up procedures performed by internal audit indicated that 80 percent of managers and 90 percent of employees submitted the fiscal 2017 certification. 50 percent of the respondents said that they referred to the Code one or more times during 2017. 4 Managers commonly discuss business ethics during employee performance evaluations, but written performance evaluation standards do not include ethical conduct criteria. No formal provisions exist for rewarding personnel who demonstrate sound ethical behavior or for disciplining those who demonstrate unethical behavior. Managers and employees are unenthusiastic about using the anonymous whistleblower hotline, largely because they see no evidence that appropriate actions will be taken to address unethical conduct. Periodic ethics training is encouraged but not required. The company offers no ethics training in-house, other than that provided to new employees. Managers and employees in general believe that senior management is ethical. They also believe, however, that senior management does very little to inform them about the companys ethical policies. Less than 50 percent of the respondents could recall hearing or reading anything about business ethics from senior management during the first six months of 2018. A smaller percentage was aware of senior managements ethics is good business statement in the 2017 annual report. One manager included a written comment in his survey response indicating a perception that senior management appears to be preoccupied with the lackluster performance results the company is achieving. Required of Part B: a. Identify the strengths and weaknesses in SHR Corporations entity-level controls over the companys ethics program. Be sure to consider both governance and management-oversight controls. Propose specific recommendations to rectify the weaknesses noted. Based on the information provided, formulate an overall conclusion about the effectiveness of SHRs entity-level controls over its ethics program. b. Discuss how the entity-level controls relating to the companys ethics program might affect senior managements decisions given the nature of the risks the company now faces. Provide some examples. c. Discuss how the entity-level controls relating to the companys ethics program might affect managers and employees behavior at the business process level. Provide some examples. d. Discuss how SHRs entity-level controls over the companys ethics program may impact your subsequent audit of controls over the companys purchases and accounts payable process. More specifically, discuss how your conclusion would affect your: 1. Professional skepticism. 2. Assessment of process-level inherent risks. 3. Approach to evaluating the design adequacy of process-level controls. 4. Inclination to perform direct tests of transactions in search of indirect evidence to support your conclusion about the design adequacy and operating effectiveness of process-level controls.