7.9 Explain what is meant by objective setting and describe the four types of objectives
used in ERM.
Objective setting, the second ERM component, is determining what the company hopes to
achieve. It is often referred to as the corporate vision or mission. The four types of
objectives used in ERM are:
1. Strategic objectives are high-level goals that align with the company’s mission,
support it, and create shareholder value. Management should identify alternative
7.10 Discuss several ways that ERM processes can be continuously monitored and
modified so that deficiencies are reported to management.
1. Have a special team or internal auditing perform a formal or a self-assessment ERM
evaluation.
7. Have a chief security officer (CSO), who is independent of the information system
function, be in charge of system security and report to the chief operating officer
(COO) or the CEO. Have a chief compliance officer (CCO), who reports to the same
people, be responsible for all compliance issues
SUGGESTED SOLUTIONS TO THE PROBLEMS
7.1 You are an audit supervisor assigned to a new client, Go-Go Corporation, which is
listed on the New York Stock Exchange. You visited Go-Go’s corporate headquarters
to become acquainted with key personnel and to conduct a preliminary review of the
company’s accounting policies, controls, and systems. During this visit, the following
events occurred:
a. You met with Go-Go’s audit committee, which consists of the corporate controller,
treasurer, financial vice president, and budget director.
b. You recognized the treasurer as a former aide to Ernie Eggers, who was convicted
of fraud several years ago.
c. Management explained its plans to change accounting methods for depreciation
from the accelerated to the straight-line method. Management implied that if your
firm does not concur with this change, Go-Go will employ other auditors.
d. You learned that the financial vice president manages a staff of five internal
auditors.
e. You noted that all management authority seems to reside with three brothers, who
serve as chief executive officer, president, and financial vice president.
f. You were told that the performance of division and department managers is
evaluated on a subjective basis, because Go-Go’s management believes that formal
performance evaluation procedures are counterproductive.
g. You learned that the company has reported increases in earnings per share for
each of the past 25 quarters; however, earnings during the current quarter have
leveled off and may decline.
h. You reviewed the company’s policy and procedures manual, which listed policies
for dealing with customers, vendors, and employees.
i. Your preliminary assessment is that the accounting systems are well designed and
that they employ effective internal control procedures.
j. Some employees complained that some managers occasionally contradict the
instructions of other managers regarding proper data security procedures.
k. After a careful review of the budget for data security enhancement projects, you
feel the budget appears to be adequate.
l. The enhanced network firewall project appeared to be on a very aggressive
implementation schedule. The IT manager mentioned that even if he put all of his
personnel on the project for the next five weeks, he still would not complete the
project in time. The manager has mentioned this to company management, which
seems unwilling to modify the schedule.
m. Several new employees have had trouble completing some of their duties, and they
do not appear to know who to ask for help.
n. Go–Go’s strategy is to achieve consistent growth for its shareholders. However, its
policy is not to invest in any project unless its payback period is no more than 48
months and yields an internal rate of return that exceeds its cost of capital by 3%.
o. You observe that company purchasing agents wear clothing and exhibit other
paraphernalia from major vendors. The purchasing department manager proudly
displays a picture of himself holding a big fish on the deck of a luxury fishing boat
that has the logo of a major Go-Go vendor painted on its wheelhouse.
The information you have obtained suggests potential problems relating to Go-Go’s
internal environment. Identify the problems, and explain them in relation to the
internal environment concepts discussed in this chapter
The underlined items correspond to one of the 7 elements of the internal environment
covered in the text.
a. You met with Go-Go’s audit committee, which consists of the corporate
controller, treasurer, financial vice president, and budget director.
PROBLEM: Section 301 of the Sarbanes-Oxley Act of 2002 (SOX) applies to
publicly held companies and their auditors. It requires audit committee members to
be on the company’s board of directors and to be independent of the company. That
is not the case at Go-Go Corporation.
b. You recognized the treasurer as a former aide to Ernie Eggers, who was
convicted of fraud several years ago.
PROBLEM: Because the position of corporate treasurer involves managing cash and
other financial assets, it is critical that the position be filled with someone of
unquestioned commitment to integrity and ethical values. This question presents
somewhat of a dilemma. Here are the two sides of that dilemma.
On the one hand, just because the treasurer worked for someone that turned out to be
dishonest does NOT mean the treasurer is dishonest as well. Everyone should be
judged on his or her own merits, not those of someone else. Therefore, you need to
be careful not to assume automatically that the treasurer is dishonest.
On the other hand, the fact that the treasurer has been an aide to someone convicted
of fraud should raise questions in your mind. You should approach all audits with the
requisite skeptical attitude. That skeptical attitude should be heightened due to his
past associations.
c. Management explained its plans to change accounting methods for depreciation
from the accelerated to the straight-line method. Management implied that if
your firm does not concur with this change, Go-Go will employ other auditors.
PROBLEM: Why would a company want to move from an accelerated depreciation
method to one with a lower depreciation write-off? One reason is that it reduces
depreciation expense, thereby increasing net income and, potentially, the company’s
stock price. Alternatively, they may be looking for a way to mask, or hide, other
company problems that will affect net income.
d. You learned that the financial vice president manages a staff of five internal
auditors.
PROBLEM: The internal audit function is not organizationally independent of the
accounting and finance functions.
e. You noted that all management authority seems to reside with three brothers,
who serve as chief executive officer, president, and financial vice president.
PROBLEM: The dominance of an organization’s management by one or a few
individuals is an aspect of management’s philosophy and operating style that might
indicate a problem with the internal environment, in that there may be a potential for
this small group to override the internal control system. Just because a family is run
by family members does not indicate there is a problem such as fraud – but it does
make it easier to commit and that should be take into consideration.
f. You were told that the performance of division and department managers is
evaluated on a subjective basis, because Go-Go’s management believes that
formal performance evaluation procedures are counterproductive.
PROBLEM: This indicates a possible problem with management’s human resource
standards and their methods of monitoring performance. Subjective evaluation
methods are often not be as effective in detecting problems or in identifying good
performance as objective measures, such as formal performance evaluation
procedures, that have been communicated to employees.
g. You learned that the company has reported increases in earnings per share for
each of the past 25 quarters; however, earnings during the current quarter have
leveled off and may decline.
PROBLEM: Management’s philosophy and operating style, as well as their
commitment to integrity and ethical values, can be tested when a company faces
declining earnings. When earnings per share decrease or when they do not meet
expectations, company stock can take a dive, sometimes a significant one. As a
result, a company may try and avoid earnings decreases when possible. The problem
comes when management uses questionable or even illegal means to prop up their
earnings.
h. You reviewed the company’s policy and procedures manual, which listed policies
for dealing with customers, vendors, and employees.
PROBLEM: One of the methods of assigning authority and responsibility is a
written and comprehensive policies and procedures manual. Go-Go has a written
policy and procedures manual, but it is incomplete. It is limited to only three areas:
policies for dealing with customers, vendors, and employees.
i. Your preliminary assessment is that the accounting systems are well designed
and that they employ effective internal control procedures.
PROBLEM: Even though you believe that the accounting systems are well designed,
and that they employ effective internal control procedures, you cannot rely on that
belief. The most effective internal control systems and procedures can be negated by
a weak internal control environment, such as top management overriding the internal
controls. In other words, there is no evidence that the controls are effective or that
employees use and follow them.
j. Some employees complained that some managers occasionally contradict the
instructions of other managers regarding proper data security procedures.
PROBLEM: It does not appear that there is a clear line of authority and
responsibility for data security policies and procedures.
k. After a careful review of the budget for data security enhancement projects, you
feel the budget appears to be adequate.
PROBLEM: This item does not appear to be a problem. Your careful review
indicates that the company appears to be allocating sufficient budget dollars to fund
the data security enhancement projects.
l. The enhanced network firewall project appeared to be on a very aggressive
implementation schedule. The IT manager mentioned that even if he put all of
his personnel on the project for the next five weeks, he still would not complete
the project in time. The manager has mentioned this to company management,
which seems unwilling to modify the schedule.
PROBLEM: The firewall implementation schedule is not feasible.
m. Several new employees have had trouble completing some of their duties, and
they do not appear to know who to ask for help.
PROBLEM: Employee training and support appear to be rather weak. Companies
that shortchange training are more likely to have more fraud and more security
breaches.
If the employees do not know who to turn to for help, the company’s organizational
structure and methods of assigning authority and responsibility appear to be lacking
or unexplained.
n. Go–Go’s strategy is to achieve consistent growth for its shareholders. It also has
a policy not to invest in any project unless its payback period is no more than 48
months and yields an internal rate of return that exceeds its cost of capital by
3%.
PROBLEM: Go-Go’s risk appetite, although aggressive, appears to be grounded in
solid capital budgeting principles. This item, therefore, does not appear to be a
problem
o. You observe that company purchasing agents wear clothing and exhibit other
paraphernalia from major vendors. The purchasing department manager
proudly displays a picture of himself holding a big fish on the deck of a luxury
fishing boat that has the logo of a major Go-Go vendor painted on its
wheelhouse.
PROBLEM: Gifts from vendors can unduly influence purchasing agents to buy more
goods from the gifting vendors. Purchasing decision should be free of this sort of
bias.