P1 Course Notes PDF
P1 Course Notes PDF
Paper P1
Course Notes
For exams from 1 September 2015 to
31 August 2016
ISBN: 9781472797568
37
55
81
103
115
143
INTRODUCTION
Knowledge the course notes will help you to learn and understand the key knowledge
topics to allow you to progress up the Achievement Ladder
2.
Support you can revisit specific elements in your course notes in the light of feedback you
receive as you attempt each step on the Achievement Ladder.
Remember, the Achievement Ladder is the unique tool to allow you to see your own progression
towards being fully prepared for the real exam.
INTRODUCTION
The syllabus
The broad syllabus headings are:
A
B
C
D
E
Main capabilities
On successful completion of this paper, candidates should be able to:
Define governance and explain its function in the effective management and control of
organisations and of the resources for which they are accountable;
Evaluate the professional accountants role in internal control, review and compliance;
Explain and evaluate the role of the accountant in controlling and mitigating risk;
Online ethics
module
Professional
Papers
Governance, Risk
and Ethics (P1)
Audit &
Assurance (F8)
Accountant in
Business (F1)
This diagram shows where direct (solid line arrows) and indirect (dashed line arrows) links exist
between this paper and other papers that may precede or follow it.
The Governance, Risk and Ethics syllabus assumes some of the knowledge acquired in papers F1
Accountant in Business but develops and applies this further and in greater depth. There is also
the presumption that students will have completed the online ethics module. The ACCA consider
Paper P1 Governance, Risk and Ethics to be the gateway paper to Professional level studies, as it
provides valuable information for all other papers.
5
INTRODUCTION
Chapter 1
Chapter 1
Chapters 2 & 3
A4 Board committees
Chapter 3
A5 Directors remuneration
Chapter 3
Chapter 2
Chapters 2 & 11
Chapters 2 & 3
Chapter 2
Chapter 8
Chapters 4, 5, 7 & 8
C2 Categories of risk
Chapter 6
Chapters 7, 8 & 10
Chapters 4 & 8
Chapter 4
Chapters 4, 5, 6, 7 & 8
Chapter 8
Chapters 5 & 7
Chapters 5 & 7
INTRODUCTION
E1 Ethical theories
Chapter 9
Chapter 11
Chapter 10
Chapter 10
Chapter 10
Chapters 9 & 10
Chapter 11
INTRODUCTION
Marks
50
2 25
Each question will have its own small scenario; therefore all answers
must apply knowledge in context. Each question will be sub-divided
into several requirements; there are usually at least three
requirements in each question.
Questions will be drawn from any part of the syllabus, but each one
is likely to focus on one or two specific areas in detail.
100
INTRODUCTION
Key to icons
The following icons appear in this set of study notes
Real-life examples
For further details see your Checkpoint Guidance
INTRODUCTION
10
SKILLS BANK
1 Effective use of
reading time
5 Time management
4 Communication and
2 Accurate analysis of
presentation skills
a questions
requirements
3 Planning a
well structured
answer
A
B
11
SKILLS BANK
A
B
Your answer needs to be carefully balanced, so that you go into more detail for higher level verbs. You
need to make sure that you use your technical knowledge selectively and structure your answer
appropriately in response to the requirements.
12
Scope of corporate
governance
Analyse the purposes and objectives of June 2013 Q4a (7 marks) discussing the general
corporate governance
purposes of governance codes for listed companies
Explain, and apply in the context of
corporate governance, the key
underpinning concepts.
13
Overview
Definition of corporate
governance
Principles
Theories
Stakeholder Models
14
1.1
1.2
Corporate governance is a fundamental internal control system ensuring the best interests
of the company are serviced in the most efficient and effective manner.
Lecture example 1
Exam skills
Required
Identify the benefits to any business of applying a corporate governance framework.
Solution
15
1.4
In the exam you may also need to ascertain whether or not the governance procedures in
use in a particular company are in line with best practice (covered later).
1.5
The following diagram illustrates the 11 core principles that underlie good corporate
governance.
Integrity
Fairness
Judgement
Independence
Scepticism
Reputation
16
Transparency
Probity
Responsibility
Accountability
Innovation
2.1
Agency theory is used to study the problems of motivation and control when a principal
needs the help of an agent to carry out activities.
2.2
Agency theory would describe the shareholders in a company as the principals, with the
board their agents who are empowered to act in their interests.
2.3
In practice the powers of shareholders tend to be very restricted. They normally have no
right to inspect the books of account, and forecasts of future prospects are gleaned from the
annual report and accounts, stockbrokers reports and media sources. There is an
information asymmetry; the agent has more information than the principal.
The diagram below illustrates how agency works in practice:
Self-interest
Self-interest
appoints
PRINCIPAL
AGENT
(directors/ managers/
employees)
(shareholder)
Detailed information
17
Agency theory assumes that agent and principal act in their own self-interest. These
interests may conflict. The agency problem in joint stock companies derives from the
principals (shareholders) not being able to run the business themselves and therefore
having to rely on agents (directors) to do so for them.
2.5
The separation of ownership from management can cause issues if there is a breach of trust
by directors either by intentional action, omission, neglect, or incompetence.
Lecture example 2
Required
Identify some reasons why shareholders might become concerned about the management of an
organisation in which they hold an investment.
Solution
One power that shareholders possess is the right to remove the directors from office. But
shareholders have to take the initiative to do this, and in many companies, the shareholders
lack the energy and organisation to take such a step. Ultimately they can vote in favour of a
takeover or removal of individual directors or entire boards, but this may be undesirable.
2.7
Shareholders can take steps to exercise control, but such action will be expensive, time
consuming and difficult to manage because it is difficult to:
2.8
(a)
Verify what the board is doing, partly because the board has access to more
information about its activities than the principal does; and
(b)
Introduce mechanisms to control the activities of the board, without preventing it from
functioning effectively.
Lecture example 3
Required
Suggest some ways in which shareholders can monitor and control a board of directors.
Solution
3.1
Transaction cost theory provides an explanation of why organisations like companies exist,
rather than all transactions being carried out between individual entrepreneurs.
3.2
Companies will try to keep as many transactions as possible in-house in order to:
(a)
(b)
(c)
To achieve this, companies will seek vertical integration (ie they will purchase suppliers or
producers later in the production process).
3.3
Transaction cost theory also states that managers organise their transactions to pursue their
own objectives. They are influenced by
(a)
(b)
(c)
19
The implications of transaction cost theory are that management tend to play safe, and
concentrate on easily understood markets and individual transactions they can easily
control. The focus on low-risk activities may discourage potential investors who are looking
for a large return. Alternatively shareholders dissatisfied with low profits may seek greater
involvement in governance.
3.5
This extends the idea of the agency problem. It explains why the agency problem is more
severe the larger an organisation becomes.
4.1
Stakeholders are people, groups or organisations that can affect or be affected by the
actions or policies of an organisation. Each stakeholder group has different expectations
about what it wants, and therefore different claims upon the organisation.
4.2
Internal
Connected
External
Mendelow classifies stakeholders on a matrix [below] whose axes are power held and
likelihood of showing an interest in the organisations activities. These factors will help
define the type of relationship the organisation should seek with its stakeholders, and how it
should view their concerns.
Level of interest
Low
High
Low
Minimal Effort
Keep Informed
Keep Satisfied
Key Players
Power
4.3
Stakeholder group
High
20
Members
Active
Passive
4.5
Lecture example 4
Classroom discussion
Required
Discuss the importance to an organisation of recognising its stakeholders when making significant
strategic decisions. (Q4b Dec 2012)
(8 marks)
Solution
21
A principle of company law in most jurisdictions remains the fiduciary and legal obligations
that managers have to maximise shareholder wealth. Therefore, if managers are to fulfil
responsibilities to a wider stakeholder base, it must not jeopardise long term profitability.
4.7
Some commentators have tried to reconcile stakeholder and agency theory by arguing that
managers are stakeholders, responsible as agents to all other stakeholders. However
stakeholders have divergent interests that may be difficult to reconcile, this does not absolve
management from at least trying to reconcile their interests.
4.8
5.1
The scope of corporate governance is vast and we shall expand on the following key issues
during this course of study.
5.2
Major issues pertaining to corporate governance that could arise in any exam question are
illustrated below.
Fiduciary
duties of
directors
Compulsory
voluntary
best practice
Directors
remuneration
and reward
Corporate social
responsibility
MAJOR
ISSUES
Board
composition
and balance
Business
ethics
Rights and
responsibilities
of shareholders
Risk management
and internal
control
22
Reliability
of financial
reporting
Chapter summary
Section Topic
Summary
Definitions and
fundamental
principles
Agency theory
Transaction cost
theory
Stakeholders
Issues in
corporate
governance
23
END OF CHAPTER
24
Approaches to corporate
governance
How have the syllabus learning outcomes been examined?
Syllabus learning outcomes
Describe, compare and contrast various December 2014 Q2 (10+9+6 marks) considering public
public, private, charity and NGOs
sector governance in a failing school
Evaluate governance and the role of
politics in public sector organisations
vs private companies
Overview
Approaches to corporate
governance
Corporate ownership
Principles or Rules?
National and global
influences
Principles-based approach
Rules-based approaches
UK Corporate Governance
Code
US Sarbanes-Oxley Act
26
Principles or rules?
1.1
The big debate about corporate governance globally is whether the guidance should in the
form of principles or detailed rules and regulations.
Features
Benefits
Principles-based approach
Rules-based approach
Non-compliance cannot be
justified. A company has either
succeeded or failed in complying.
Examples
27
2.1
A key distinction that has been drawn between the corporate governance systems
worldwide in different regimes has been between the insider and outsider models of
ownership described below. In practice most regimes fall somewhere between the two.
Insider systems
2.2
Insider (or relationship-based) systems are where most companies listed on the local stock
exchange are owned and controlled by a small number of major shareholders. The
shareholders may be members of the companys founding families, banks, other companies
or the government.
2.3
The reason for the concentration of share ownership is the legal system.
Advantages
Disadvantages
Outsider systems
2.4
Outsider systems are ones where shareholding is more widely dispersed, and there is the
manager-ownership separation. Such shareholders can be drawn from varied and
disparate sources and can have both small and large holdings.
2.5
There tends to be more diverse shareholder ownership in jurisdictions such as the UK that
have strong protection for non-controlling (minority) interests.
28
Disadvantages
Lecture example 1
Classro om discussion
Required
Discuss the impact of the following factors on the development of corporate governance codes,
rules and laws in recent years.
Solution
Globalisation
Foreign investment
Financial reporting
Local culture
Corporate scandals
29
Cadbury
Greenbury
Hampel
30
OECD
Interest in governance arises from global
investment issues
Wide consultation with members
Published principles of corporate governance
Rights of shareholders
Role of stakeholders
Board responsibilities
31
Lecture example 2
Classroom discussion
Required
'The goal of international codes of corporate governance should be the development of a universal
set of rules.' Evaluate this attitude towards corporate governance.
Solution
Evaluate
For 'international codes should be developing universal rules'
32
5.1
5.2
5.3
5.4
International impact
It is not strong enough on some issues, and at the same time over-rigid on others.
(b)
Directors may avoid consulting lawyers if they believe that SOx could override lawyerclient privilege.
(c)
(d)
Companies are turning away from the US stock markets and towards other markets.
33
6.1
Purposes and
objectives
Private sector
Public sector
Charitable
Profit
Public goods or
services not
delivered by the
private sector
Market
Performance
(how is success
measured?)
Ownership
(who owns them?)
Stakeholders
(including lobby
groups)
(who also holds an
interest in them?)
NGO/QuANGO*
Partners,
shareholders and
lenders
Taxpayer
Independent
(with some
philanthropic
influence)
Lobby groups
may influence
government
policy to support
their own aims
(both for and
against)
Population (local
and national)
Trustees
Taxpayers may
lobby for better
use of their taxes
Meeting own
needs
More tailored
results than
charities or the
public sector
could deliver
Can be state or
government
owned
The term public sector can be used to describe entities at a variety of levels:
Sub-national
National
Based upon the four organs of state: executive (responsible for running
the state); legislature (responsible for the legal framework); judiciary
(responsible for enforcing that legal framework) and secretariat (the
administration function charged with delivering executive policy).
The executive (or government) is made up of many departments and
setting strategy based on policy. In the case of a democracy, the
governing party (or a coalition if no one party has overall control) sets this
strategy in line with its elected mandate from the population.
Supra-national
34
When contrasted with private sector organisations, governance in the public sector can
vary quite significantly, although it ultimately depends on objectives and leadership:
Strategic
objectives
Private sector
Public sector
Achievement of State-defined
service delivery to meet social need
Leadership
Governance
Lecture example 3
Classro om discussion
Required
Discuss the following questions when considering factors that could influence public sector policy.
Solution
Should there be a public sector?
What are the priorities? Health, education and welfare ('from the cradle to the grave')
Influence of taxpayers who do not use services they still have to pay for?
Does privatisation play a positive role in helping economies to deliver public sector provision?
35
Chapter summary
Section Topic
Summary
Principles or
rules
Ownership
Corporate
governance in
the UK
Corporate
governance in
other
jurisdictions
The South African King Report was published after the collapse
of apartheid. It emphasises fairness to all groups in society and
economic wellbeing.
The Sarbanes
Oxley Act
Public sector
governance
Public and private sector entities, plus charities and NGOs, all
have different goals so their governance must reflect that.
END OF CHAPTER
36
You have now covered the Topic that will be assessed in Step 1 of your Achievement Ladder.
It is vital in terms of your progress towards exam readiness that you attempt this Step in the near future.
You will receive feedback on your performance, and you can use the wide range of online resources and
ongoing BPP support to help address any improvement areas. This will help you to tailor your learning
exactly to your own individual requirements.
Course notes
chapter
Topic name
Subtopic/Chapter name
Scope of corporate
governance
Approaches to corporate
governance
37
Achievement Ladder
38
Corporate governance
practice and reporting
How have the syllabus learning outcomes been examined?
Syllabus learning outcomes
December 2014 Q3a (10 marks) suitability for taking CEO role
December 2014 Q4c (6 marks) and June 2012 Q4b (8 marks)
on the advantages of CPD and induction for directors
December 2011 Q2b (8 marks) separate Chair/CEO
June 2011 Q1di (8 marks) CEO role managing risks
June 2009 Q1e (10 marks) criticism of CEO on I/Cs
December 2013 Q4a (3+5 marks) how directors can leave the
service of a board (theory and practice)
Overview
Corporate governance
practice and reporting
Boards of directors
Board effectiveness
Non-executive directors
Unitary vs Multi-tier
boards
Remuneration
Governance
disclosures
40
1.1
The board
(a)
Is collectively responsible for promoting the success of the company by directing and
supervising the companys affairs.
(b)
(c)
Should set the companys strategic aims, ensure that the necessary financial and
human resources are in place for the company to meet its objectives and review
management performance.
Effectiveness of boards
2.1
To remain effective, directors should extend their knowledge and skills continuously.
2.2
Significant issues that professional development should cover on a regular basis include:
Strategic
planning
Audit
practice and
procedures
Legal and
regulatory
issues
Financial
management
TRAINING AND
DEVELOPMENT
Human
resource
issues
Risk
management
2.3
Corporate
governance
An appraisal of the board's performance is an important control over it, aimed at improving
board effectiveness, maximising strengths and tackling weaknesses. It should be seen as
an essential part of the feedback process within the company and may prompt the board to
change its methods and/or objectives.
41
2.4
All directors should be individually appraised; criteria that could be applied include:
Continuous
professional
development
Independent
and
innovative
thinking
Familiarity
with business
and industry
information
APPRAISAL
CRITERIA
Active
participation
in all
business
Contribution
towards
business
development
Positive and
enthusiastic
committee
work
Lecture example 1
Classroom discussion
Solution
42
43
3.1
3.2
(a)
Size the balance needs to be struck between the benefits of having varied views
and opinions, alongside the need for coherence of decision-making.
(b)
Inside/outside mix the split between executive decision-making directors and nonexecutive directors. Independent non-executive directors have a key role in
governance. Their number and status should mean that their views carry significant
weight.
(c)
44
Lecture example 2
Required
Assess the benefits of the separation of the roles of chief executive and chairman and explain how
accountability to shareholders is increased by the separation of these roles.
(12 marks)
(Q3b Dec 2007 exam)
Solution
Assessment of benefits. The examiners mark scheme allowed a maximum of 10 marks for the
first part of the requirement.
1
Accountability to shareholders
45
Remuneration Committee is
responsible for advising on
executive director remuneration
policy and the specific package
for each director.
Nominations Committee is
responsible for recommending the
appointments of new directors to
the board.
Non-executive directors
4.1
4.2
NEDs have a key role in reducing conflicts of interest between management (including
executive directors) and shareholders by providing balance to the board. They bring an
independent viewpoint as they are not full time employees.
4.3
4.4
(a)
(b)
(c)
Risk. NEDs should satisfy themselves that financial information is accurate and that
financial controls and systems of risk management are robust.
(d)
People. NEDs are responsible for determining appropriate levels of remuneration for
executives, and are key figures in the appointment and removal of senior managers
and in succession planning.
The key problems with NED's tend to centre around two issues:
Lecture example 3
Classroom discussion
Required
Explain reasons why NEDs may not be sufficiently independent or effective.
Recommend ways in which organisations can attempt to overcome both these problems.
Solution
47
5.1
5.2
In some countries (eg Germany) the board is split into multi-tiers, separating the executive
from other directors (and senior management). This structure is also common in not-forprofit organisations.
5.3
(b)
Lecture example 4
Required
Evaluate the case for and against operating a two-tier board structure.
Solution
For
48
(8 marks)
Against
Directors' remuneration
6.1
6.2
(a)
(b)
Motivate them to achieve performance levels that are in the shareholders best
interests as well as their own personal interests.
(b)
(c)
Taking account of the position of the company relative to other similar companies.
However the UK Code also notes 'the risk of an upward ratchet of remuneration levels
with no corresponding improvement in performance' and the need to be sensitive to
pay conditions within the company.
49
Lecture example 5
Classroom discussion
Required
Explain and assess the effect of various components of remuneration packages on directors
behaviour.
Solution
Basic Salary
Benefits
Pensions
Shares
Share Options
50
Remuneration policy
(b)
(c)
(d)
The duration of contracts with directors, and notice periods and termination payments
under such contracts.
Governance disclosures
7.1
Annual reports should disclose whether the organisation has complied with governance
regulations and codes.
7.2
Environmental
reporting
A statement that
the company is a
going concern
GOVERNANCE
DISCLOSURES
A statement on
relations and
dialogue with
shareholders
An operating
and financial
review (OFR)
Details of relations
with auditors
including reasons
for change
A statement that the
directors have
reviewed the
effectiveness of
internal controls
51
Lecture example 6
Suggest some key elements to be included in:
'Information about the board of directors.'
'A statement on relations and dialogue with shareholders.'
Solution
'Information about the board of directors.'
52
Chapter summary
Section Topic
Summary
Effectiveness of boards
Non-executive directors
Directors remuneration
Governance disclosures
53
END OF CHAPTER
54
You have now covered the Topics that will be assessed in Step 2 of your Achievement Ladder. This
mainly focuses on the shaded topics below but will also include some recap questions on earlier
topics.
It is vital in terms of your progress towards exam readiness that you attempt this Step in the near future.
You will receive feedback on your performance, and you can use the wide range of online resources and
ongoing BPP support to help address any improvement areas. This will help you to tailor your learning
exactly to your own individual requirements.
Course notes
chapter
Topic name
Subtopic/Chapter name
Scope of corporate
governance
Approaches to corporate
governance
Corporate governance
practice and reporting
55
Achievement Ladder
56
Define and explain internal management control December 2007 Q1d (16 marks) why internal
controls are important and how to improve them
Explain and explore the importance and
objectives of internal control and risk
management in corporate governance
57
Overview
Frameworks
Objectives
Elements
58
1.1
1.2
The two main sources of guidance on internal controls are contained in COSO (The
Committee of Sponsoring Organisations of the Treadway Commission) and Turnbull (The
Turnbull Report).
1.3
COSO has the support of the Securities and Exchange Commission (SEC) which is the
body in charge of implementing and enforcing the Sarbanes Oxley (SOx) legislation in the
USA. It is therefore most relevant to those companies following the SOx rules on internal
controls.
1.4
2.1
COSO and Turnbull give broadly similar objectives for internal control systems. The Turnbull
objectives are listed below.
Turnbull
A companys system of internal control has a key role in the management of risks that
are significant to the fulfilment of its business objectives.
Since profits are in part the reward for successful risk taking, the purpose of internal
controls is to manage and control risk appropriately rather than to eliminate it.
Effectiveness and efficiency of operations.
Ensure the reliability of internal and external reporting.
Assist compliance with laws and regulations.
Safeguard the shareholders investment and the companys assets.
2.2
More practically, internal controls should help organisations to counter risk, maintain the
quality of financial reporting and ensure compliance.
2.3
They provide reasonable assurance that organisations will achieve their objectives.
59
Lecture example 1
Class discussion
Appendix B gives some background information about the UK high street retailer Marks and
Spencer (M&S).
Required
Evaluate the importance of effective internal controls to different stakeholder groups for a large
retail organisation such as M&S.
Solution
60
3.1
COSO and Turnbull share many elements of internal control / enterprise risk management
as the table below illustrates:
COSO
Turnbull
Control Environment
Control Environment
Risk Assessment
Control Activities
Control Activities
Monitoring activities
3.2
COSO uses a diagram called the COSO Enterprise Risk Management (ERM) cube to
describe how the elements of the framework, the objectives of the framework and the levels
of an organisation fit together.
nc
Control Environment
Risk Assessment
Control Activities
Entity Level
Division
Operation Unit
Function
Co
pl
ia
tin
or
er
Op
Re
p
ns
io
at
While the COSO cube is unlikely to be examined in detail, it does provide a framework for
identifying and managing risk.
3.3
Chapter summary
Section Topic
Summary
Internal control
frameworks
nc
e
ia
m
pl
Op
Control Environment
Risk Assessment
Control Activities
Entity Level
Division
Operation Unit
Function
ns
tio
a
er
Elements of internal
control / enterprise risk
management
Co
Objectives of internal
controls
or
Re
p
END OF CHAPTER
62
63
Overview
Risk Attitudes and internal
environment
Control environment
Risk Appetite
Sound System
Stakeholder Attitude
64
pl
ia
nc
e
Control Environment
Risk Assessment
Control Activities
Entity Level
Division
Operation Unit
Function
Co
m
er
Op
Re
po
r
ns
io
at
tin
g
1.1
The first element of the COSO cube relates to the strategic management of an organisation.
1.2
1.3
COSO identifies the following factors which constitute the control environment:
(a)
(b)
(c)
(d)
(e)
1.4
1.5
Control procedures, which comprise the detailed controls at lower levels are covered in
Chapter 7.
1.6
When assessing an effective internal control system, an organisation should consider both
the control environment and the control procedures.
Objective setting
2.1
Objectives for an organisation should help deliver an organisation's strategy, and they
should be consistent with its risk appetite.
65
3.1
Risk is a condition in which there exists a quantifiable dispersion in the possible results of an
activity.
3.2
Risk appetite is a measure of a company's capacity and willingness to accept different risks.
Lecture example 1
Class discussion
Required
Suggest some reasons why organisations face risks on a daily basis.
Consider why organisations might seek to increase the risk they face.
Solution
4.1
4.2
They are likely to react adversely if a company does not conform to their expectations.
4.3
The attitude of some stakeholder groups to risk could have an influence on the companys
strategy. These groups are:
(a)
(b)
(c)
(d)
(e)
Shareholders
Debt providers
Employees
Customers
Government, regulatory and other bodies.
66
Lecture example 2
Class discussion
Appendix B gives some background information about M&S. Different stakeholder groups can
affect or be affected by the risk management strategy at M&S.
Required
For each stakeholder group evaluate their attitude towards risk-taking by the company.
Solution
Shareholders
Debt providers
Employees
Customers
67
5.1
The Turnbull Report discusses a sound system of internal control which would have the
following characteristics:
(a)
(b)
(c)
(d)
5.2
The Turnbull guidance is 'based on the adoption by a companys board of a risk based
approach to establishing a sound system of internal control'.
Embedding risk
6.1
Lecture example 3
Required
Recommend practical ways in which risk awareness can be embedded in an organisation at
different levels.
Solution
68
7.1
The board has overall accountability for risk management as part of its corporate
governance responsibilities.
7.2
The board may choose to delegate responsibility to line management or a separate risk
management function.
7.3
A risk committee could also be set up, and can include both executive and non-executive
directors.
7.4
If there is no risk committee, the audit committee will take responsibility for risk
management.
Lecture example 4
Required
Construct an argument for setting up a risk committee that:
Solution
(a)
(b)
Is staffed by NEDs.
69
Lecture example 5
Required
Identify some tasks which a risk committee should fulfil.
Solution
70
Chapter summary
Section Topic
Summary
Control environment
Objective setting
Risk appetite
Stakeholder
Responses to risk
Sound systems of
internal control
Embedding risk
Risk management
responsibilities
71
END OF CHAPTER
72
Risks
6: RISKS
Overview
Risks
Part of COSO
Categorising Risk
Events
Scope
74
Function
pl
ia
nc
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Risk Assessment
Control Activities
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6: RISKS
Event identification
1.1
The diagram above illustrates how risk identification fits into the COSO ERM framework.
1.2
1.3
Risks once identified can be included within the firms risk register and kept under review.
Risk events
2.1
A key aspect of risk identification emphasised in the COSO ERM Framework is the
identification of events that could impact upon implementation of strategy or achievement of
a firms objectives.
2.2
(b)
(c)
(d)
Escalation triggers, certain events happening or levels being reached that require
immediate action
(e)
Event interdependencies. Identifying how one event can trigger another and how
events can occur concurrently.
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6: RISKS
Categorising risk
3.1
3.2
An advantage of analysing risks by scope, separating them into strategic and operational
risks is to ensure they are considered by the most appropriate level of management. Some
organisations choose to maintain separate risk registers for strategic and operational risks.
3.3
An advantage of categorising risk by function is that they can be analysed and managed by
managers with appropriate technical expertise. For example legal risks will be managed by
a legal department.
4.1
Strategic risks are those risks that relate to the fundamental long term decisions that
directors take about the future of an organisation.
4.2
The most significant risks are focused on the impact they would have on the company's
ability to survive in the long term.
Lecture example 1
Class discussion
Required
Give an example of each of the following 'strategic' risk categories:
Solution
Technology
Product
Resources
Competition
Investment
Reputation
4.3
The main differences between strategic and operational risks relate to:
(a)
(b)
(c)
(d)
Scope of impact
Source of risk
Duration of impact
Scale of financial and resource consequences
76
6: RISKS
4.4
Operational risk is the risk of loss from a failure of internal business and control processes
and will affect day to day operations.
4.5
Internal control
Audit inadequacies
Human errors
Fraud
Business interruption
Loss of key personnel
Classification of risk
5.1
There are many different types of risks faced by organisations, particularly those with
commercial or international activities.
Lecture example 2
Required
Explain the following types of risk using an example if appropriate.
Solution
Market risk
Credit risk
Liquidity risk
Legal risk
Health, safety and environmental risk
Reputation risk
Business probity risk
Derivatives risk
77
6: RISKS
Physical
Financial
Product
Legal
Political
Property (inc
intellectual)
RISK
CLASSIFICATION
Economic
Environmental
Fraud
Technological
Organisational
Knowledge
management
Reputation
Trade (inc
FOREX)
78
6: RISKS
Chapter summary
Section Topic
Summary
Event identification
Risk events
Categorising risk
Strategic and
operational risks
Classification of risk
79
Market
Credit
Liquidity
Technological
Legal
Health, safety and environmental
Reputation
Business probity
Derivatives
6: RISKS
END OF CHAPTER
80
You have now covered the Topics that will be assessed in Step 3 of your Achievement Ladder. This
mainly focuses on the shaded topics below but will also include some recap questions on earlier
topics.
It is vital in terms of your progress towards exam readiness that you attempt this Step in the near future.
You will receive feedback on your performance, and you can use the wide range of online resources and
ongoing BPP support to help address any improvement areas. This will help you to tailor your learning
exactly to your own individual requirements.
Course notes
chapter
Topic name
Subtopic/Chapter name
Scope of corporate
governance
Approaches to corporate
governance
Corporate governance
practice and reporting
Risks
Risks
81
Achievement Ladder
82
Explain and assess the ALARP principle in December 2011 Q1civ explaining why ALARP means
risk assessment and how this relates to
further health and safety failures cannot be prevented
severity and probability
December 2007 Q2c (12 marks) on CEO rewards
Explain the sources, and assess the
importance of, accurate information for
risk management
83
Overview
Risk assessment
Risk profiling
Risk quantification
Risk consolidation
Risk response
Control procedures
84
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Risk Assessment
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Risk assessment
1.1
1.2
Identification
Analysis
Profiling
Quantification
Consolidation
1.3
Types and categories of risks that an organisation might face were identified in Chapter 6.
1.4
85
Lecture example 1
Class discussion
Required
Identify some ideas to answer the questions identified above.
Solution
(a)
Who?
(b)
How?
(c)
How often?
Risk profiling
2.1
Having assessed the risk it can be mapped onto a grid of impact and likelihood
Likelihood
High
Low
Low
High
Impact
2.2
The risk profile allows the company to prioritise its treatment of different risks. It may choose
to spend less on managing one risk in order to release funds to manage another more
effectively.
Risk quantification
3.1
Risks that require more analysis will be quantified, where possible results and losses are
considered.
3.2
Techniques for carrying out risk quantification include sensitivity analysis and accounting
ratios. Although unlikely to be directly tested in the exam understanding the quantifiable
effect on business is key to scoring good marks.
Lecture example 2
Class discussion
Calcit is a company hoping to launch a new product. The initial investment of $6m will generate
revenues of $5m in each of the next two years. The variable costs are expected to be $1.5m per
annum in the next two years. Calcits cost of capital is 8%.
Required
Assess whether the project is more sensitive to the risks associated with variable costs or price.
Solution
87
Risk consolidation
4.1
4.2
Risk consolidation will also incorporate portfolio management. Consolidating risks together
may reduce overall risk because of diversification.
4.3
Risks will need to be considered in conjunction with other risks which may provide a hedge
against them.
4.4
Senior managers will need to judge the priority of different risks, ensure that risk
management is aligned with the companys objectives and with its risk appetite.
Risk response
5.1
Risk Transfer
Risk Avoidance
Risk Reduction
Risk Acceptance
5.2
5.3
High
ACCEPT
TRANSFER
REDUCE
AVOID
Low
Likelihood
(frequency)
High
5.4
Some businesses face risks which are high likelihood and high consequence. If this arises
out of their core business they are unlikely to avoid it. The concept of ALARP (as low as
reasonably possible) is a way of considering the trade off between the costs of mitigating
the risk and the assessment of the risk.
5.5
The level of risk considered as low as reasonably practicable may be a good compromise.
88
Lecture example 3
Class discussion
Among the risks that M&S faces you may have identified the following:
(a)
Theft of inventory
(b)
(c)
Failure of the EFTPOS system (the technology to record credit and debit card transactions
electronically and to maintain the computerised inventory records)
(d)
(e)
Required
Assess each risk and discuss an appropriate strategy for responding to the risk.
Solution
5.6
The risk management process helps organisations to prioritise their risks but cannot
eliminate them altogether: usually gross risks (risks without any mitigation) and residual
risks (risks that remain once management action has been taken to address them) are
compared to assess how effective such risk response action has been.
89
6.1
6.2
(a)
Corporate controls (eg general policy statements, the established core culture and
overall monitoring procedures, corporate governance?)
(b)
(c)
(d)
You could use the mnemonic SPAMSOAP to help generate ideas for specific controls.
Segregation of duties, with no one person having total control of an area eg the
chairman/CEO roles should be split (Cadbury)
Physical measures to secure the custody of assets eg access control to buildings
Authorisation and approval of all business activities by appropriate persons
eg non-executive directors to decide directors pay and sit on a remuneration committee
Management should provide control through analysis and review of accounts eg tasking
internal audit
Supervision of the recording and operations of day-to-day transactions eg budget
monitoring through exception or variance reports
Organisation identifies reporting lines, levels of authority and responsibility. This ensures
everyone is aware of their control (and other) responsibilities, especially in ensuring
adherence to management policies eg enabling named staff to act independently within
areas of delegated power
Arithmetical and accounting to check the correct and accurate recording and processing of
transactions eg bank account reconciliation
Personnel Attention should be given to selection, training and qualifications of personnel,
as well as personal qualities eg checking reference during a recruitment process.
90
Chapter summary
Section Topic
Summary
Risk assessment
Risk profiling
Risk quantification
Risk consolidation
Risk response
91
END OF CHAPTER
92
Information,
communication and
monitoring
June 2012 Q2b & c (17 marks) role of the risk committee
and how they differ in different sized companies
93
Overview
Information, communication and
monitoring
Information
Communication
Monitoring
Committees
Internal audit
Risk manager
94
External reporting
Control Environment
Risk Assessment
Control Activities
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Information
1.1
In order to fulfil their duties effectively the board of directors (and sub committees) need a
wide range of information.
1.2
1.3
In the exam you may be asked to examine the information in a scenario in terms of its
ACCURATE characteristics.
95
Lecture example 1
Discussion
Required
Suggest some sources of information directors could use under the following headings.
Internal
External
Formal
Informal
Communication
2.1
The board must make sure that staff abilities and attitudes are suitable, and that everyone
has access to appropriate organisational information.
Lecture example 2
Required
Suggest ways in which directors can both inform and influence staff.
Solution
96
Monitoring
3.1
The board of directors is responsible for the companys system of internal control. This
includes doing the following:
(a)
(b)
(c)
3.2
3.3
3.4
All employees have responsibility for internal controls as part of their accountability for
achieving objectives.
Audit committee
3.5
The board should establish an audit committee of at least three (two in the case of smaller
companies) members, who should all be independent non-executive directors. The board
may delegate some of its duties to the Audit Committee (and the Risk Committee).
3.6
The board should satisfy itself that at least one member of the audit committee has recent
and relevant financial experience. (Under SOX having fulfilled the role of CEO is not
sufficient experience to qualify as the financial expert on the audit committee.)
3.7
The audit committee should have written terms of reference. Under SOX this is referred to
as the Audit Committee Charter.
97
Monitoring &
Reviewing
3.9
Financial
statements
Price sensitive
information
Internal financial
controls
Independence of
external auditors
Policy setting
Overseeing
Effective internal
audit
Appointment of
external auditors
Remuneration of
external auditors
The audit committee is the body responsible for whistleblower procedures within the
company. They have to ensure that any problems will be brought to their attention.
3.10 As part of their role of monitoring internal audit, the audit committee should carry out a
formal annual review of internal audit. If there is no internal audit function present, the audit
committee should consider annually whether there is still no need for internal audit or if one
might now be required.
3.11 According to Turnbull the factors that will influence this decision are:
Company Size
Company
Complexity
Unexpected risk
events
Cost v benefit
analysis
Problems in the
internal control
3.12 The Turnbull Report states that listed companies without an internal audit function should
annually review the need to have one.
98
Internal audit
3.13 Internal audit is a form of control put in place by the board in order to help achieve the
companys objectives.
3.14 Internal audit is an important part of the internal control system and it can therefore be
regarded as having the same objectives as the rest of the internal control system: ie
safeguarding assets; economy, efficiency & effectiveness of operations; reporting; and
compliance.
3.15 The internal audit department reports to the audit committee who will carry out an annual
review of the internal audit function covering:
(a)
(b)
(c)
(d)
Scope of work
Authority
Independence
Resources
3.16 As well as the objectives listed at 3.14 above the scope of the work performed by internal
audit can include:
(a)
(b)
(c)
3.17 To ensure the internal audit department has sufficient authority, the audit committee will
consider whether the terms of reference of the internal audit department are sufficiently
broad and whether the reports produced by the internal audit department have been
reviewed and action taken.
3.18 The audit committee will need to ensure that the internal audit department is adequately
resourced in terms of hours, physical resources and appropriate knowledge, skills and
experience.
Risk committee
4.1
The risk committee may include executive and non-executive directors. It is often chaired by
the companys CEO. The risk committee was covered in detail in Chapter 5.
99
Risk manager
5.1
A risk manager needs to combine technical skills in credit, market and operational risk with
leadership and persuasive skills.
5.2
External reporting
6.1
The board is responsible for reporting on risk and internal control to shareholders. It does
this annually in the Annual Report and at the AGM.
6.2
6.3
To fulfil their obligations directors should regularly review the adequacy of internal controls
considering:
(a)
(b)
(c)
(d)
(e)
100
Lecture example 3
Class discussion
Solution
(The following checklist contains all the elements required by Turnbull and the UK Corporate
Governance Code.)
Report Contents
101
Chapter summary
Section Topic
Summary
Information
requirements of the
board
Communication
Risk committee
Risk manager
External reporting
END OF CHAPTER
102
You have now covered the Topics that will be assessed in Step 4 of your Achievement Ladder. This
mainly focuses on the shaded topics below but will also include some recap questions on earlier
topics. As a reminder, Step 4 must be completed and submitted in order to be able to qualify for Pass
Assurance. It is Written Assessment 1 and can also be found at the back of these course notes.
It is vital in terms of your progress towards exam readiness that you attempt this Step in the near future.
You will receive feedback on your performance, and you can use the wide range of online resources and
ongoing BPP support to help address any improvement areas. This will help you to tailor your learning
exactly to your own individual requirements.
Course notes
chapter
Topic name
Subtopic/Chapter name
Scope of corporate
governance
Approaches to corporate
governance
Corporate governance
practice and reporting
Risks
Risks
Information, communication
and monitoring
103
Achievement Ladder
104
Personal ethics
105
9: PERSONAL ETHICS
Overview
Personal ethics
Ethics
Ethical theories
106
9: PERSONAL ETHICS
Ethical theories
1.1
Ethics is:
(a)
(b)
(c)
(d)
Concerned with right and wrong, and how conduct is judged to be good or bad.
About how we should live our lives and, how we should behave towards other people.
Relevant to all forms of human activity, including the business world.
Problematic in business where the primary purpose is material gain.
Ethical absolutism
1.2
Absolutism is the view that there is an unchanging set of ethical principles that will apply in
all situations, at all times and in all societies.
1.3
(b)
(c)
Natural law approaches to ethics, based on the idea that a set of natural moral rules
exists and we can come to know what they are.
(d)
Criticisms of absolutism
Relativism is the view that a wide variety of acceptable ethical beliefs and practices exist.
1.5
Relativism recognises the differences that exist between the rules of behaviour prevailing in
different cultures. This is clearly a matter of significance in the context of international
business and recognises that ethical opinions may change over time.
107
9: PERSONAL ETHICS
Lecture example 1
Required
Examine the relative merits and demerits of adopting an ethically relativist approach in business?
[8 marks]
Solution
An ethical decision will lead to an action which will have consequences. A deontological
approach judges the action, while a teleological approach judges the outcomes.
Decision
Action
Outcome
Duty
Benefit / Harm
Deontological ethics
1.7
Deontology is concerned with the application of universal ethical principles in order to arrive
at rules of conduct. Deontology lays down criteria by which actions may be judged in
advance [Emmanuel Kant].
1.8
Deontology tests actions and establishes where your duty lies based on:
(a)
(b)
1.9
A criticism of deontological ethics is that you cannot take actions in a vacuum and must
have regard for their consequences. However, we cannot always know what the
consequences of our actions would be.
108
9: PERSONAL ETHICS
Utilitarianism can be summed up in the 'greatest good' principle. This says that when
deciding on a course of action we should choose the one that is likely to result in the
greatest good for the greatest number of people. The problem is how do we define
what is good for people.
(b)
Lecture example 2
Class discussion
Required
Identify some factors that will influence both an organisation's and an individual's ethical
perspective.
Solution
109
9: PERSONAL ETHICS
2.1
2.2
They show the reasoning process of individuals; it is possible that individuals at different
levels will make the same moral decisions, but they will do so as a result of different
reasoning processes.
2.3
Level 1 Pre-conventional
Level 2 Conventional
Law and Order means abiding by the law and responding to the
obligations of duty
Level 3 Post-conventional
110
9: PERSONAL ETHICS
Lecture example 3
Class discussio n
GSA is a listed pharmaceutical company that operates across different countries but has its
headquarters in a European country. The company is considering the extension of one of its
production facilities but this will require the compulsory purchase of local houses for demolition in
order to accommodate the necessary building work. The new facility will be working on creating a
new chemical that is expected to significantly improve water purification in under-developed
countries. Home-owners have been approached for their initial responses about this proposal
before it is debated by the GSA board.
Required
(a)
Recommend how home-owners would respond using Deontological and both forms of
Teleological ethical principles.
Following some consultation, the decision to obtain a compulsory purchase order for land and
homes is adopted by the board despite mixed reactions from those affected. At a meeting of local
residents, three home-owners presented their views:
Bal pointed out that regardless of what the residents may want, they have an obligation to
under-developed countries to support this initiative and relocate.
Uwe said that it is 'just capitalism at work here' and people should accept it. He will be
pushing for the company to pay him as much money as possible for his house, which he
knows is in a poor state of repair but which he hopes will be overlooked.
Ming is a corporate lawyer who has obtained details of case law that sets a precedent about
how such compulsory purchase orders should be approached by both companies and
residents she suggest that this approach is followed regardless of what home-owners
want.
Required
(b)
Using the Kohlberg model, explain which level each of the three residents is operating at.
Solution
(a)
Deontological
Teleological
(b)
Bal
Uwe
Ming
111
9: PERSONAL ETHICS
IFAC Code
3.1
The IFAC Code states that firms should have established policies to resolve conflict and
should consider:
1.
2.
3.
4.
5.
The facts
The ethical issues involved
Related fundamental principles
Established internal procedures
Alternative courses of action, considering the consequences of each
The American Accounting Association (AAA) Model frames the ethical decision as a series
of answers to questions.
(a)
(b)
(c)
(d)
(e)
(f)
(g)
Tuckers 5 question model is a benchmark against which to test the ethicality of a decision.
Ask yourself, is the decision:
(a)
(b)
(c)
(d)
(e)
Profitable?
Legal?
Fair and equitable?
Right, which is prone to subjective judgement?
Sustainable or environmentally sound?
Lecture example 4
GSA is a listed pharmaceutical company that operates across different countries but has its
headquarters in a European country. In general terms it always complies with the law financial
statements are filed on time, employee and sales taxes are paid over to the local tax authority
but despite the parent company recording high operating profits, it recently paid a very low level of
corporate tax due to apparent loopholes in the legislation (sometimes referred to as 'legal tax
avoidance'). This became a controversial news story and led to calls for a boycott of the companys
products unless they voluntarily paid more corporate tax. GSAs Chief Executive Martyn Rice
agreed to respond to the media on behalf of the board.
112
9: PERSONAL ETHICS
Required
(a)
Recommend a response for the Chief Executive to make from the perspective of Absolutist
and Relativist ethical principles.
(b)
Assess the proposal to make no voluntary payment of corporate tax by the company using:
(i)
(ii)
Tuckers 5 questions
Solution
(a)
Absolutist
Relativist
(b)
(i)
(ii)
AAA
(a)
(b)
(c)
What are the norms, principles and values related to the case?
(d)
(e)
What is the best course of action that is consistent with the norms, principles
and values identified?
(f)
(g)
Tucker
(a)
Profitable?
(b)
Legal?
(c)
(d)
(e)
113
9: PERSONAL ETHICS
Chapter summary
Section Topic
Summary
Ethical theories
Kohlbergs
stages of human
moral
development
Frameworks for
ethical conflict
resolution
END OF CHAPTER
114
You have now covered the Topics that will be assessed in Step 5 in your Achievement Ladder. This
mainly focuses on the shaded topics below but will also include some recap questions on earlier
topics.
It is vital in terms of your progress towards exam readiness that you attempt this Step in the near future.
You will receive feedback on your performance, and you can use the wide range of online resources and
ongoing BPP support to help address any improvement areas. This will help you to tailor your learning
exactly to your own individual requirements.
Course notes
chapter
Topic name
Subtopic/Chapter name
Scope of corporate
governance
Approaches to corporate
governance
Corporate governance
practice and reporting
Risks
Risks
Information, communication
and monitoring
Personal ethics
Personal ethics
115
Achievement Ladder
116
Professional ethics
117
Overview
Professional ethics
Threats of professional
independence
118
1.1
1.2
1.3
Among the most important obligations for modern professionals is maintaining confidentiality
and upholding ethical standards.
1.4
The public interest is considered to be the collective well-being of the community of people
and institutions the professional accountant serves, including clients, lenders, governments,
employers, employees, investors, the business and financial community and others who rely
on the work of professional accountants (IFAC).
The influence of the accountancy profession on business and society is potentially huge. It
can be established simply by considering all the different involvements that accountants
have:
(a)
(b)
(c)
(d)
(e)
1.6
Financial accounting
Audit
Management accounting
Consulting
Taxation
The financial information included within accounts can have a number of impacts:
Mechanistic issues, where
the accounts are used to judge
the performance of a company
or its directors in line with a
regulation or contract.
1.7
Critics of the accountancy profession emphasise that accountants prime role is that of
resource allocation, and thereby they act as agents of capitalism.
1.8
Are too passive, allowing too great a variety of accounting treatments, and failing to
impose meaningful responsibilities on auditors such as an explicit responsibility to
detect and report fraud
(b)
Emphasise the wrong principles, giving priority to client confidentiality over disclosure
in the wider public interest
119
2.1
Organisations have responded to wide and varied pressures from external stakeholders to
be seen to act ethically by publishing ethical codes.
2.2
Ethical codes contain a series of statements setting out the organisation's core values and
explaining how it sees its responsibilities towards its stakeholders. They cover specific areas
such as gifts, anti-competitive behaviour and so on. However, often they do little more than
describe current acceptable practices.
Lecture example 1
Classroom discussion
Required
Apart from the use of ethical codes, how else can an organisation aim to control and influence the
ethical behaviour of staff?
Solution
2.3
120
3.1
(b)
(c)
Disadvantages of a principles-based
framework
The ACCA has published its own Code of Ethics and Conduct for its members, which is
broadly based on the same principles as the IFAC Code.
121
The table below details fundamental principles upon which the code is based. These can be
easily remembered using the PIPCO mnemonic:
Fundamental principles
3.4
3.5
Professional
competence and
due care
Integrity
Professional
behaviour
Confidentiality
Objectivity
Safeguards against breach of compliance with the IFAC and ACCA guidance include:
(a)
(b)
Safeguards within the client/ the accountancy firm's own systems and procedures
(c)
Educational training and experience requirements for entry into the profession,
together with continuing professional development.
In the exam you may be required to evaluate the ethical behaviour of a professional
accountant using the fundamental principles (Q1c December 2012)
122
Lecture example 2
Classroom discussion
Required
Identify some benefits of adopting an ethical code, and recommend how an organisation might go
about developing one.
Solution
4.1
Self-interest
Self-review
Advocacy
Familiarity
Intimidation
123
Self-interest threat
4.2
The ACCA Code of Ethics and Conduct highlights a great number of areas in which a selfinterest threat to independence might arise.
A partner or
employee on
the board of an
audit client
Family or close
personal relationships
Contingent fees
based on the
outcome of a
transaction
SELF INTEREST
THREAT
Client lends a material
sum of money to an
audit firm or member
of audit team
4.3
Valuable gift
and/or hospitality
(b)
(c)
(d)
Maintaining records such that the firm is able to demonstrate that appropriate staff
and time are spent on the engagement
(e)
Compliance with all applicable audit standards, guidelines and quality control
procedures
Self-review threat
4.4
Self-review threat is where an audit firm provides services other than audit services to an
audit client (ie providing multiple services). There is a great deal of guidance in the ACCA
and IFAC rules about threats arising from services accountancy firms might provide to their
audit clients.
124
Safeguards
Providing valuation services where Using separate personnel for the valuation and
audited financial statements
the audit
comprise figures generated
Second partner review
Advocacy threat
4.5
An advocacy threat arises in certain situations where the audit firm assume the clients part
in a dispute or somehow acting as their advocate. The most obvious instances of this would
be when a firm acts as an expert witness in a court case.
4.6
(b)
(c)
Familiarity threat
4.7
Familiarity threat is where independence is jeopardised by the audit firm and its staff
becoming over familiar with the client and its staff. As a result they may become too
sympathetic to their views and interests.
Intimidation threat
4.8
Lecture example 3
Exam-stan dard
GSA is a listed pharmaceutical company that operates across different countries but has its
headquarters in a European country. You work as a trainee for a small professional firm which has
been asked to act as advisers to GSA. The Finance Director of GSA studied with the engagement
partner so is happy to give him the work, especially as he believes that the firms experience in tax
advice can help identify any future tax loopholes. The engagement is very high-profile for your firm,
so it has been offered at a discount to the firms normal fees, although you understand that the
GSA board has indicated that it expects fees to stay low as it wants you to act as both internal and
external auditors in order to improve efficiencies.
You are in the corridor about to deliver coffee for a planning meeting between your firm and GSA
when you overhear the end of a conversation between the engagement partner and the Finance
Director in the meeting room: ...obviously, if the tax savings identified are sufficiently imaginative
and creative, there will be a special bonus for you, although this will need to be hushed up to
satisfy those who feel we should all now be acting in the public interest...
Required
(a)
(b)
(c)
Describe the nature of the conversation that you have overheard, including any possible
actions that you feel you may need to take.
Solution
126
127
Chapter summary
Section Topic
Summary
Corporate codes of
ethics
IFAC professional code The IFAC code is a principles based code. The
of ethics
ACCAs code is broadly based on the IFAC code.
The fundamental principals are:
Integrity
Professional Behaviour
Confidentiality
Objectivity
Threats to compliance
with the fundamental
principles for
accountants in practice
END OF CHAPTER
128
Corporate social
responsibility
129
130
Overview
Corporate Social
Responsibility
CSR
Corporate
Citizenship
CSR Stances
CSR
Viewpoints
Environmental
management systems
Sustainability and
environmental
footprint
Social footprint
Social and
environmental audits
Integrated reporting
131
Environmental
reporting & GRI
1.1
1.2
This obligation can be seen to extend beyond statutory obligations to comply with
legislation.
CSR
(Carroll)
Corporate
citizenship
(Matten et al)
Ethical Stances
(Johnson &
Scholes)
7 Social
Responsibility
Viewpoints
(Gray Owen &
Adams)
Economic
To shareholders
wanting
dividends/capital
gains, to employees
wanting fair
employment, to
customers wanting
good quality products
Legal
Obeying the law is a
requirement in all
societies, though legal
compliance imposes
greater burdens in
some societies rather
than others
Limited view
consists of limited
projects undertaken
in the businesss selfinterest.
The main
stakeholder groups
that the corporation
engages with are
local communities
and employees.
Equivalent view is
based on a wider
general definition of
corporate social
responsibility that is
partly voluntary and
partly imposed
132
Short-term
shareholder interest
Pristine capitalists:
Business has no
moral responsibilities
It is for government
alone to impose wider beyond their
obligations to
constraints on
shareholders and
corporate
creditors.
governance.
This minimalist
approach would
accept a duty of
obedience to the
demands of the law,
but would not
undertake to comply
with any less
substantial rules of
conduct.
Expedients:
Social responsibility
may be appropriate if
it is in the business
economic interests.
Long-term
shareholder interest
Proponents of the
social contract:
There is effectively a
contract or agreement
between the
organisations and
those who are
affected by their
decisions.
Philanthropic
Multiple
shareholder
obligations
Accepting the
legitimacy of the
expectations and/or
claims of
stakeholders other
than shareholders
and build those
expectations into its
stated purposes.
This would be
because without
appropriate
relationships with
groups such as
suppliers, employers
and customers, the
organisation would
not be able to
function.
Shaper of society,
although it is
accepted that this
role is largely the
preserve of public
sector organisations.
Charitable donations,
contributions to local
communities, and
providing employees
with the chances to
improve their own
lives
133
Social ecologists
believe that business
activities result in
resource exhaustion;
waste and pollution
must therefore be
modified.
Organisations must
also be socially
responsible.
Socialists seek to
promote egalitarian
equality. Business
decision-making
should no longer be
determined by the
requirements of
capitalism and
materialism but
should promote
equality.
Radical feminists
aim to promote
feminine values such
as co-operation and
empathy
Deep ecologists
(greens) suggest that
man has no greater
rights to resources or
life than other species.
Lecture example 1
Classroom discussio n
Proponents of CSR argue that there is a strong business case for considering stakeholders,
whereas critics argue that CSR distracts from the fundamental economic role of businesses.
Required
Identify some arguments supporting the case both for and against CSR. (You may want to
consider what might motivate an interest in CSR.)
Solution
Lecture example 2
GSA is a listed pharmaceutical company that operates across different countries but has its
headquarters in a European country. In general terms it always complies with the law financial
statements are filed on time, employee and sales taxes are paid over to the local tax authority
but despite the parent company recording high operating profits, it recently paid a very low level of
corporate tax due to apparent loopholes in the legislation (sometimes referred to as 'legal tax
avoidance'). This became a controversial news story and led to calls for a boycott of the companys
products unless they voluntarily paid more corporate tax. GSAs Chief Executive Martyn Rice
agreed to respond to the media on behalf of the board.
Required
Recommend a response for the Chief Executive to make from each of the seven positions on CSR
suggested by Gray, Owen and Adams.
Solution
Pristine capitalist
Expedient
Social contract
Social ecologists
Socialist
Radical feminist
Deep ecologist
134
Sustainability
2.1
Sustainability means limiting the use of depleting resources to a level that can be
replenished.
2.2
Sustainable development is development that meets the needs of the present without
compromising the ability of future generations to meet their own needs.
2.3
Sustainable
by whom?
Sustainable at
what cost?
Sustainable
for whom?
SUSTAINABILITY
ISSUES
Sustainable for
how long?
Sustainable
in what way?
2.4
A key issue is generational equity, ensuring that future generations are able to enjoy the
same environmental conditions, and in social terms per capita welfare is maintained or
increased.
2.5
2.6
(a)
Weak sustainability believes that the focus should be on sustaining the human
species and the natural environment can be regarded as a resource. The weak
sustainability viewpoint tends to dominate discussion within the Western economic
viewpoint.
(b)
Strong sustainability stresses the need for harmony with the natural world; it is
important to sustain all species, not just the human race. They see a requirement for
fundamental change, including a change in how man perceives economic growth (and
whether it is pursued at all).
135
Social Footprint
3.1
Social footprint is a measure of the impact or effect that an entity can have on a given set
of concerns or stakeholder interests.
3.2
It is the impact on people, society and the wellbeing of communities. Impacts can be
positive such as job creation and community benefits) or negative, such as when a plant
closure increases unemployment and the local community suffers.
Social Accounting
3.3
3.4
Lecture example 3
Classroom discussio n
Solution
People (social)
Planet (environment)
Profit (business)
136
4.1
The Global Reporting Initiative is a reporting framework and arose from the need to address
the failure of the current governance structures to respond to changes in the global
economy. The GRI aims to develop transparency, accountability, reporting and sustainable
development. Its vision is that reporting on economic, environmental and social importance
should become as routine and comparable as financial reporting.
4.2
The main section of the Guidelines sets out the framework of a sustainability report. It
consists of five sections.
1.
Vision and strategy. Description of the reporting organisation's strategy with regard
to sustainability, including a statement from the CEO.
2.
Profile. Overview of the reporting organisation's structure and operations and of the
scope of the report.
3.
4.
GRI content index. A table supplied by the reporting organisation identifying where
the information listed in the Guidelines is located within the organisation's annual
report.
5.
4.4
The company is less able to conceal important information and this helps to reduce the
agency gap between a companys directors and its shareholders (covered in Chapter 1).
Demonstrates the firms responsiveness to issues that threaten the perception of their
ethics and competence.
137
5.2
(b)
(c)
(d)
(e)
Audit results to form the basis of setting environmental objectives and the revision of
the environmental policy to achieve those objectives
(f)
ISO 14000
5.3
ISO 14000 provides a general framework on which a number of specific standards have
been based (the ISO family of standards).
5.4
An environmental policy statement, which should be the basis for future action. It
needs therefore to be based on reliable data, and allow for the development of
specific targets.
(b)
(c)
(d)
(e)
138
Lecture example 4
Classroom discussio n
Required
Identify the benefits of an organisation achieving external accreditation for its CSR activities.
Solution
6.1
Social audit is the process of checking whether an organisation has achieved set targets.
6.2
(b)
Identifying that all current environment programmes are congruent with the mission
of the company.
(c)
(d)
6.3
6.4
Environmental audits help organisations to identify possible liabilities from their ongoing
activities, assess the threat of unethical behaviour and even act as a form of marketing for
investors especially sensitive to having environmentally and socially questionable
representation in their portfolios.
6.5
7.1
7.2
Where <IR> differs from other forms of reporting is that it focuses on the process not the
product, using a series of capitals to illustrate how an organisation creates value for all
stakeholders, not just shareholders:
Category of capital
Financial
Manufactured
Human
Intellectual
Natural
Social
7.3
There are a series of seven guiding principles that <IR> requires to be seen as meaningful:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
Lecture example 5
Classroom discussion
Required
For each of the following aspects of a companys operations, suggest the most appropriate form of
<IR> capital that could be used to monitor it.
Solution
Company operations
141
Chapter summary
Section Topic
Summary
Organisations ethical
and social
responsibility stances
Sustainability
3
4
Social accounting,
auditing and reporting
Environmental
reporting
Environmental
management systems
Social and
environmental audits
Integrated reporting
END OF CHAPTER
142
In the final run up to your exam, you should attempt Step 6 as the final check that you are fully prepared
to move onto the revision phase of your studies. As a reminder, Step 6 must be completed and submitted
in order to be able to qualify for Pass Assurance. It is Written Assessment 2 and can also be found at the
back of these course notes.
It covers all the Topics in your course. As ever, you will receive feedback on your performance, and you
can use the wide range of online resources to help address any final areas where you need to fine tune
your knowledge or technique.
Course notes
chapter
Topic name
Subtopic/Chapter name
Scope of corporate
governance
Approaches to corporate
governance
Corporate governance
practice and reporting
Risks
Risks
Information, communication
and monitoring
Personal ethics
Personal ethics
Professional ethics
Professional ethics
10
143
11
Achievement Ladder
144
Answers to
Lecture Examples
145
Chapter 1
Answer to Lecture Example 1
Improved risk management. The reduction of downside risk will reduce business losses.
Overall business performance is enhanced by focusing attention on areas of critical importance.
Defines clear accountability for executive decision making.
It provides both an appropriate and adequate system of internal control, which permeates the organisation
from top to bottom.
Best practice guidelines are applied by management, who therefore strive to improve their performance.
Encourages ethical behaviour and corporate social responsibility.
Safeguards the firm from misuse of business assets, both tangible and intangible.
Can attract new investment, particularly in developing countries.
Decline in profitability
Lack of disclosures in annual accounts
Fall in share price
Adverse commentary by analysts
Change in business environment
Change in key personnel
146
Chapter 2
Answer to Lecture Example 1
(a)
(b)
The differential treatment of domestic and foreign investors, both in terms of reporting and
associated rights/dividends, also the excessive influence of majority shareholders in insider
jurisdictions, caused many investors to call for parity of treatment.
(c)
Issues concerning financial reporting were raised by many investors and were the focus of
much debate and litigation. Shareholder confidence in what was being reported in many
instances was eroded.
(d)
The characteristics of individual countries may have a significant influence in the way corporate
governance has developed. The King report emphasises the importance of qualities that are
fundamental to the South African culture such as collectiveness, consensus, helpfulness, fairness,
consultation and religious faith in the development of best practice.
(e)
An increasing number of high profile corporate scandals and collapses including Polly Peck
International, BCCI, and Maxwell Communications Corporation prompted the development of
governance codes in the early 1990s. However, the scandals since then have raised questions
about further measures that may be necessary.
(b)
It gives investors the understanding and therefore confidence to invest in global capital markets.
(c)
It makes it easier for countries to implement corporate governance codes since they are not
having to produce their own codes from scratch.
(d)
A number of problems have been identified with international codes of corporate governance.
(a)
International principles represent a lowest common denominator of general, fairly banal and
meaningless principles.
(b)
Any attempt to strengthen the principles will be extremely difficult because of global differences
in legal structures, financial systems and structures of corporate ownership, culture and economic
factors.
(c)
(d)
147
Here are some points that could be considered for each question:
Should there be a public sector?
Health, education and welfare (from the cradle to the grave) are these key?
What about defence, business, foreign policy (including overseas aid), the environment,
agriculture, the arts, energy, transport etc, etc?
Influence of taxpayers who do not use services they still have to pay for?
Receiving free healthcare, education and social care at point of service happens in many states
(eg the UK) but in others (eg the USA) such services are paid for to some extent by those that use
them
If you pay your taxes and they go towards funding services that you prefer to pay for yourself (eg
private education or private medical care via health insurance) should you be able to opt out of
paying taxes?
Should people pay more or less tax in this way? Should people pay taxes at all?
Does privatisation play a positive role in helping economies to deliver public sector provision?
Should public utilities such as water, gas, electricity and railways ever be privatised? Can markets
ever deliver the efficiencies required to benefit consumers if profit gets in the way? Are regulators
strong enough to make such markets fair to consumers and companies alike?
Short term cash boost, reckless sale of family silver or wise decision to limit future liabilities (eg
in the UK in 2013, the Royal Mail was floated via IPO but six months later allegations were made
by politicians that it had been undervalued by 1bn in the UK Governments haste to make the
sale a success. While the Royal Mail presented a potentially significant liability on public sector
finances due to pension and operating deficits, it had started to show signs of recovery, prompting
calls that it was only sold to benefit investors and not the UK in general. Time will tell on this,
although in an industry where physical deliveries are being phased out in favour of digital products
books, music and other entertainments maybe this was a good deal after all. Source:
http://www.bbc.co.uk/news/28263467)
Outside the UK, privatisation remains a divisive issue from proposals to privatise six major
airports in India (http://timesofindia.indiatimes.com/business/india-business/Bidding-forprivatisation-of-6-airports-deferred-again/articleshow/30469979.cms) to the sale of state assets in
Brazil to support their economy (http://www.forbes.com/sites/kenrapoza/2012/08/10/brazil-opensroads-to-privatization/) and even massive investment by China in African infrastructure
(http://www.scmp.com/business/economy/article/1301343/natural-resources-oil-underwritechinese-investment-africa) the tension between public and private sector remains.
148
Chapter 3
Answer to Lecture Example 1
Leadership
Separating the roles ensure that there is not a single individual with unfettered power. The
principle that the roles should be separated was established following the frauds carried out by
Robert Maxwell at Mirror Group Newspapers in the early 1990s.
(b)
The CEO can then run the company; the chairman can run the board. Separation of the roles
allows them both to be given suitable focus. The chairman should be looking to the interests of the
shareholders; the CEO is concerned implementing the boards strategy.
(c)
It reflects the reality that both jobs are demanding roles. In particular in large companies (eg
FTSE100 companies) it would be too demanding for one person to carry out both functions.
(d)
Having two different people in the role brings two different perspectives, two sets of experience
and skills and therefore improves decision making.
(e)
The separation of roles avoids the risk of conflicts of interest. The CEOs remuneration will contain
performance related bonuses. He may be inclined to take unacceptable risks to make sure that he
earns his bonus.
Accountability to shareholders
(a)
The board cannot make the CEO truly accountable for management if it is led by the CEO.
(b)
Separation of the roles means that the board is more able to express its concerns effectively by
providing a joint channel of reporting (the chairman) for the non-executive directors.
[Note: The UK Cadbury report recommends that if the posts were held by the same individual, there
should be a strong independent element on the board with a recognised senior member. The UK Higgs
report suggests that a senior independent non-executive director should be appointed who would be
available to shareholders who have concerns that were not resolved through the normal channels. The
UK Corporate Governance Code also suggests that the CEO should not go on to become chairman of the
same company. If a CEO did become chairman, the main risk is that he or she will interfere in matters
that are the responsibility of the new CEO and thus exercise undue influence over him or her.]
149
Effectiveness
Quality
Experience
Number
Availability
Ways of overcoming problems
Service contracts
Disclosure
Training
Market rates of pay
Induction to organisation
The clear and formal separation between the monitors and those being monitored.
(b)
The supervisory/policy board has the capacity to be an effective guard against management
inefficiency or worse. Its existence may act as a deterrent to fraud or irregularity in a similar way to
the independent audit.
(c)
The supervisory board system should take account of the needs of stakeholders other than
shareholders, specifically employees, who are clearly important stakeholders in practice.
(d)
The system actively encourages transparency within the company, between the boards and,
through the supervisory board, to the employees and the shareholders. It also involves the
shareholders and employees in the supervision and appointment of directors.
Confusion over authority and therefore a lack of accountability can arise with multi-tier boards.
This criticism has been particularly levelled at Japanese companies where the consequence is
allegedly often over-secretive procedures.
(b)
The management board may restrict the information passed on to the supervisory board and the
boards may only liaise infrequently.
(c)
The supervisory board may not be as independent as would be wished, depending on how
rigorous the appointment procedures are. In addition, members of the supervisory board can be,
indeed are likely to be, shareholder representatives; this could detract from legal requirements
that shareholders don't instruct directors how to manage if the supervisory board was particularly
strong.
Basic salary will be in accordance with the terms of the directors contract of employment, and is
not related to the performance of the company or the director. Instead it is determined by the
experience of the director and what other companies might be prepared to pay (the market rate).
(b)
Performance related bonuses Directors may be paid a cash bonus for good (generally
accounting) performance. To guard against excessive payouts, some companies impose limits on
bonus plans as a fixed percentage of salary or pay.
(c)
Transaction bonuses tend to be much more controversial. Some chief executives get bonuses
for acquisitions, regardless of subsequent performance, possibly indeed further bonuses for
spinning off acquisitions that have not worked out.
(d)
Directors may be awarded shares in the company with limits (a few years) on when they can be
sold in return for good performance.
150
(e)
Share options give directors the right to purchase shares at a specified exercise price over a
specified time period in the future. If the price of the shares rises so that it exceeds the exercise
price by the time the options can be exercised, the directors will be able to purchase shares at
lower than their market value. [The UK Corporate Governance Code states that non-executive
directors should not normally be offered share options, as options may impact upon their
independence.]
(f)
Benefits in kind could include transport (eg a car), health provisions, life assurance, holidays,
expenses and loans. The remuneration committees should consider the benefit to the director and
the cost to the company of the complete package. Also the committee should consider how the
directors package relates to the package for employees; ideally perhaps the package offered to
the directors should be an extension of the package applied to the employees.
(g)
Pensions Many companies may pay pension contributions for directors and staff. In some cases
however, there may be separate schemes available for directors at higher rates than for
employees. The UK Corporate Governance Code states that as a general rule only basic salary
should be pensionable. The Code emphasises that the remuneration committee should consider
the pension consequences and associated costs to the company of basic salary increases and
any other changes in pensionable remuneration, especially for directors close to retirement.
Chapter 4
Answer to Lecture Example 1
(a)
Shareholders want to ensure that their investment is protected. The benefit of internal controls for
them is that they will reduce the incidence of fraud and error. Controls will also manage risks
faced by the company thus reducing the overall risk faced by investors. However controls cost
money to design, implement and monitor and this will reduce the value of the shareholders
investment. They therefore want an appropriate balance of controls, so more controls over high
risk areas and fewer over areas where they are less exposed.
(b)
Debt providers want to protect the capital they have put into the company and to receive interest.
They will want to make sure that controls are adequate to protect their investment. They will be
less concerned with controls being costly unless the cost is so great as to put the whole company
at risk and thereby expose any creditors to risk.
(c)
Employees are concerned about job security so will want to see controls that are adequate to
protect the future of the company. Employees were particularly badly affected by the Mirror Group
corporate failure where Robert Maxwell misappropriated pension funds. Employees are therefore
concerned to see adequate controls over their pension funds. They also have a stake in the
reputation of the company and therefore in how reputation risk is managed. Employees have to
151
operate controls and will therefore not want them to add an unnecessary burden to their work.
They will want controls that protect them against any perceived threats.
(d)
Customers will want to their dealings with the company to be pleasant and hassle free. They will
be unhappy about controls that are overly intrusive (M&S traditionally had a reputation for no
quibbling over returns and gained Christmas sales from people buying presents that could be
returned). On the other hand customers will want to be assured of the safety (and recently the
ethical provenance) of the products they are buying and will expect adequate controls in this area.
(e)
Government, regulatory and other bodies will want to assure that adequate controls exist to
cover statutory compliance. They may audit this themselves (VAT and PAYE compliance) or
respond when there is a breach (health and safety).
Chapter 5
Answer to Lecture Example 1
Shareholders are not necessarily risk averse, but they will expect higher returns from high risk
companies. They may well have acquired their shares to fit into a balanced portfolio. They will be
concerned if there is an unexpected change in the companys risk appetite and may choose to
invest elsewhere. Many of M&Ss small private investors do so out of loyalty and might be
expected to prefer a low risk investment. The second biggest investor is Legal & General who will
hold M&S shares as part of a balanced portfolio.
(b)
Debt providers are most concerned about the risk of non-payment and they can take various
actions with potentially serious consequences such as:
(c)
Employees will be concerned about threats to their job prospects (money, promotion, benefits
and satisfaction) and ultimately threats to the jobs themselves. The variety of actions employees
can take include:
(d)
Denial of credit
Higher interest charges,
Applying restrictive covenants
Requiring security (eg mortgage)
Putting the company into liquidation.
Customers will be concerned with threats to their getting the goods or services that they have
been promised, or not getting the value from the goods or services that they expect. The risk to
the firm is that they could take their business elsewhere. M&S built its reputation as a good value
brand and suffered in the 1990s when there was a perceived fall in quality.
152
(e)
Governments, regulatory and other bodies will be particularly concerned with risks that the
organisation does not act as a good corporate citizen, implementing for example, poor
employment or environmental policies. A number of the variety of actions that can be taken could
have serious consequences.
(f)
Government can impose tax increases or regulation or take legal action. Pressure groups tactics
can include publicity, direct action, sabotage or pressure on government or other stakeholders.
Training
Workshops
Monitoring
Shadowing
Ethical codes
Good leadership
Set up compliance/risk management department
Build risk identification into job descriptions
Create risk register
Executive directors
(b)
Knowledge of company
Risk key concern
Remuneration can be linked to risk management
Supports strategic planning
Non-executive directors
Independence/objectivity
External experience
No financial gains linked to decision
Assess risks
Review risk register
Advise board
Review findings of internal audit
Set risk policy
Ensure risk management system exists
Chapter 6
Answer to Lecture Example 1
153
Chapter 7
Answer to Lecture Example 1
Who
How
Board
NED's
Risk committee
Audit committee
Audit dept
Managers and employees
Consultants
How often
Forecasting
Scenario building
Variance analysis
Competitor analysis
Observation
Meetings/discussions
Interviews/questionnaires
Monthly?
Quarterly?
Annually?
154
High
Low
ACCEPT
(b) Under/overstocking
Not very likely but could
erode profits
borderline ACCEPT or
REDUCE
Likelihood
(frequency)
REDUCE
High
TRANSFER
AVOID
Note: there are many potential answers here, as the assessment of a particular risk does not mean the
response selected will automatically follow (economic downturn and competition are both high impact
high likelihood, but that does not mean that a company faced with such risks can avoid them and may
choose to reduce them somehow). Sensible responses to assessed risks will usually be rewarded.
Chapter 8
Answer to Lecture Example 1
Internal (formal)
Management accounts
HR reports
Variances
Exception reports
External (formal)
Market research
Company accounts
Benchmarking
Analysis reports
Internal (informal)
Complaints
Feedback
Employee opinion
External (informal)
Press/PR
Internet/competitors websites
155
Report Contents
The existence of a process for managing
risk
Chapter 9
Answer to Lecture Example 1
Merits
(a)
Relativism highlights differences in cultural beliefs; for example all cultures may say that it is
wrong to kill innocents, but different cultures may have different beliefs about who innocents
actually are.
(b)
Whereas differing absolutist beliefs tend to result in moral conflict between people; relativist ethics
should act to resolve such conflicts.
(c)
In the modern business environment where the global economy prevails business is conducted in
many different countries (and cultures), adopting a relativist approach presumes more flexibility
and thereby greater success.
(d)
Relativism highlights our cognitive bias in observing with our senses (we see only what we know
and understand) and our notational bias (what we measure without using our senses is subject to
the bias of the measurement methods used).
Demerits
(a)
Strong relativism is a based on a fundamental contradiction; the statement that All statements are
relative is itself an absolute, non-relative statement. However, it is possible to argue that some
universal truths exist, but deny other supposedly objective truths.
(b)
A common criticism of relativism is that it leads to a philosophy of anything goes, denying the
existence of morality and permitting activities that are harmful to others.
(c)
Some critics have argued for the existence of natural absolute moral laws.
(d)
(e)
If its valid to say that everyones differing opinions are right, then its equally valid to say that
everyones differing opinions are wrong. This can lead to immense confusion and disagreement,
and breakdown in communication and trust.
156
Age
Experience
Size of organisation
Backgrounds
Education
Nationalities
Religions
Market stakeholders
Bal is operating at the post-conventional level, specifically the 'principled conscience' plane as
she feels compelled to act regardless of personal opinion.
Ming is following the conventional level and adopting behaviour at the 'law and order' plane as
she is focusing on the obligation to follow the law and what it tells her about how she should
behave.
157
Part (b)
AAA
Tucker
Chapter 10
Answer to Lecture Example 1
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
158
Development
Consultation
Base on existing codes (eg ACCA)
Provide examples
Test on employees
(b)
(c)
Describe the nature of the conversation that you have overheard, including any possible actions
that you feel you may need to take:
The conversation appears to have been discussing further tax avoidance and possibly even illegal tax
evasion and the payment of a bonus to the firm for securing such savings on behalf of the company. This
sounds like a situation where bribery and corruption are being discussed you are now placed in a
difficult position as you need to consider your responsibilities as an employee but also your
responsibilities as a professional to act in the public interest, which should be above those owed to
your employer if illegal or unethical activity is being considered.
To address this conflict of interests, you may wish to consult an independent partner (such as an ethics
partner) within your firm however, given the size of the firm here, this may not be practical and no
such role may exist. It may be illegal if you are aware of possible criminal activity but do not disclose
it, so in the absence of any formal mechanism within your firm you may wish to present your concerns
to a third party this process is known as 'whistle-blowing' which satisfies your duty to act in the public
interest but would probably lead to your departure from the firm.
The threat of such retaliation from an employer (such as legal action, disciplinary procedures,
redundancy and poor employment references) can be significant, especially so early in your career, and
so presents a difficult choice for any whistle-blower.
159
Chapter 11
Answer to Lecture Example 1
Business case for CSR
Builds reputation
Attracts investors/employees/customers
Can be a source of competitive advantage
Can tie into branding
Pre-empts legislation
Unregulated therefore easy to incorporate
Good PR
Credibility
Receive advice and support.
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Question and
Answer bank
161
Answers
162
Questions
1
Core principles
The core principles of corporate governance are: integrity, fairness, judgement, independence,
openness, probity, responsibility, accountability, innovation, scepticism and reputation.
Required
(a)
Define each of the core principles of corporate governance in your own words.
(9 marks)
(b)
Explain the importance of each of the principles in the context of corporate governance.(16 marks)
(Total = 25 marks)
Describe, with brief comments, the factors, which influenced the introduction of the various
frameworks, codes and systems of corporate governance.
(10 marks)
(b)
Describe how the introduction of each of the successive frameworks, codes and systems of
corporate governance has contributed to better corporate governance.
(15 marks)
(Total = 25 marks)
Non-executive directors
It is a principle of corporate governance that the board of directors should be able to exercise an objective
judgement on the company's affairs. However, it is recognised that potential conflicts of interest can arise
between the owners of a company and its management. As a means of dealing with the potential conflicts
of interest, it was recommended by the Cadbury Committee in the UK that the boards of companies with
a London Stock Exchange listing should appoint a minimum number of non-executive directors (NEDs). A
distinction was also made between independent and non-independent non-executive directors.
A variety of criticisms have been made of the system of NEDs. These include the argument that many
non-executives are executive directors of other major companies, which restricts their willingness to
speak out on the company's affairs. NEDs have also been criticised for holding a non-executive post with
too many companies, sometimes five or even more.
In the UK, some criticism has also been voiced against the growing practice of paying NEDs partly in
shares or share options of the company.
Required
(a)
(7 marks)
(b)
What are the main areas for a potential conflict of interest between the shareholders of a company
and the executive directors? Explain how the use of non-executive directors should help to deal
with this problem.
(11 marks)
(c)
In your view, what might be the objections to paying NEDs in shares or share options of the
company, and do you agree with those objections?
(7 marks)
(Total = 25 marks)
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Board of directors
Required
You are required to write a report to the board of directors of a new company, which outlines the following
areas.
(a)
(b)
(c)
(d)
(25 marks)
Caius plc
Caius plc is seeking a listing on the London Stock Exchange. The directors of the company are aware
that certain listed companies have attracted considerable criticism in recent years over directors pay and
conditions. There have been claims in the media that the pay and conditions of some directors have been
far too generous and that the remuneration policies adopted by some companies have been far from
transparent. The directors of Caius plc are keen to ensure that, if the bid for a listing is successful, all
aspects relating to their pay and conditions must be in line with best practice.
Required
Write a report to the directors of Caius plc set out the policies and frameworks that should be adopted by
the company to ensure that directors pay and conditions are fair and transparent.
(25 marks)
Types of risk
Required
Define the main types of risks that a company faces, and explain how codes of corporate governance can
assist in managing these on a day-to-day basis.
(25 marks)
COSO Framework
Required
(a)
The COSO Enterprise Risk Management Framework says that, having assessed relevant risks;
management should determine how it would respond. Responses include risk avoidance,
reduction, sharing, and acceptance. Give brief examples of each of these responses.
(10 marks)
(b)
Management should identify control activities needed to help ensure that risk responses are
carried out properly and in a timely manner. Describe some examples of possible control
activities.
(15 marks)
(Total = 25 marks)
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Audit process
The audit process is an important element of corporate governance.
Required
(a)
Describe the external audit process and internal audit process and discuss the role of each type of
audit in contributing towards an effective system of corporate governance.
(10 marks)
(b)
(3 marks)
(Total = 13 marks)
Ethical considerations
You were appointed financial controller of a firm of builders' merchants almost a year ago, with the
prospect of becoming finance director if you performed well.
The problem customer
An old-established customer, a contractor, X Ltd, which has expanded to take on a very large contract, is
causing problems with delayed payments. X Ltd is a family firm, largely owned by its Managing
Director, Y.
Following a discussion at a management meeting, the sales director and a member of your staff visited
the customer with instructions to 'try and resolve the matter of delayed payments'.
The meeting
At the meeting, the sales director took the lead, having known Y for many years. Y provided the last
annual accounts and the latest management accounts and contract accounts. This one large contract that
X Ltd had undertaken represents some 70% of its current activity.
If all, or almost all, suppliers allow additional credit for material, and X Ltd uses its very limited remaining
bank facilities to pay the workforce, Y thinks the company should be able to complete the next stage of
the contract, get the architect to certify the work has been completed, and obtain a progress payment.
This would enable X Ltd to pay suppliers, get more materials, and finish the contract. However, Y
considers the company will make a significant loss on the contract and will only be able to trade on a
much-reduced scale thereafter.
The sales director suggested, and Y agreed, an arrangement by which Y would make a payment from
personal funds, against which your company would release materials to X Ltd. When it receives the
progress payment X Ltd will pay your company from its company's funds and reduce the amount owing to
well within normal terms. Your company will then repay Y the personal funds he has paid.
It was agreed that this arrangement should be discussed and agreed with your managing director in the
morning.
After the meeting
On his return, the sales director commented that this sort of arrangement was probably the only way of
getting any money back if X Ltd went into liquidation nothing would be recovered.
Later you received a telephone message that Z, the finance director of another firm of builders' merchants
and whom you know through ACCA branch meetings, has asked you to telephone urgently regarding the
credit status of X Ltd.
Required
Write a report to your managing director explaining the issues involved and recommending the action to
be taken on the account and on the telephone message.
(25 marks)
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10 Corporate citizenship
Required
Write a report to the directors of a UK public limited company explaining the following aspects of
corporate citizenship.
(a)
(b)
(c)
(25 marks)
Explain, with reference to the case, the factors that are typically considered when deciding to
establish internal audit in an organisation.
(10 marks)
(b)
Construct the argument in favour of appointing the new internal auditor from outside the company
rather than promoting internally.
(6 marks)
(c)
Critically evaluate Mr Kumas's belief that the internal auditor should report to him as finance
director.
(4 marks)
(d)
Define 'objectivity' and describe characteristics that might demonstrate an internal auditor's
professional objectivity.
(5 marks)
(Total = 25 marks)
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12 Southern Construction
Southern Construction, started as a small family-run business in the 1980s. John Falshaw, the founder
and self-appointed chairman of the board, foresaw rapid expansion and so decided that the firm should
go public. The timing of this decision was unfortunate as it coincided with an economic recession, which
hit the building trade very hard. The strain was too much and Falshaw suffered a massive heart attack,
and was forced to retire.
In the past Falshaw had run things with a heavy hand and things were done his way or not at all! The
board served as a rubber stamp for his decisions, and as a result, financial and operational controls
were weak or non-existent.
The new chairman was trying desperately to maintain existing levels of financing. However, the firms
bank was very unsettled by recent events, and insisted that Southern Construction plc recruit some nonexecutive directors to strengthen the effectiveness of the board.
Thomas Edwards FCCA had recently retired as financial controller of a large engineering company. He
was delighted when he was approached by the chairman of Southern Construction plc with the offer of
becoming a non-executive director and chair of the yet to be established audit committee. On accepting
the position, the head of internal audit, Mary Flanagan, was instructed to report directly to Edwards. New
internal controls were instituted and additional internal audit staff were recruited.
One day Mary Flanagan reported that her team had found that a salesman had been submitting false
expenses vouchers running into thousands of pounds. Mary, who had a reputation for integrity and
thoroughness, was particularly upset because the actions were a clear violation of the Southern
Construction Code of Ethics and Conduct. The salesman in question was Elmer Pearson. When asked
what should be done with Pearson, she responded, 'The penalty called for submitting false expense
claims is summary dismissal no exceptions'.
It transpired that Pearson would go out with another sales rep, and then both would submit an expenses
claim for the same trip. Internal audit had unearthed dozens of vouchers like this, some even claiming for
imaginary trips.
Edwards was concerned about the reaction of the bank if they learned about the fraudulent activity.
Later that day, Flanagan phoned Edwards at home. She sounded upset, but wanted to talk. Im
confused she said, my loyalties are being pulled in so many directions, I dont know what to think. She
went on to point out that she had known Pearson for over ten years, and he had always been friendly and
helpful to her. She wondered if long service and loyalty to the firm deserved special consideration.
The following day Edwards confronted Pearson. Pearson admitted to the double billing and imaginary
trips. When he was accused of clearly violating the Code, he said 'you dictate my resignation, Ill sign it
and be out of here tonight'. Edwards responded to this by advising Pearson that if any criminal activity
were involved, it wouldnt stop there.
To this, Pearson looked incredulous and began to argue his case strongly. He was currently working on a
big deal with a Japanese businessman a market Southern Construction had been trying to crack for
some time. His budget has been cut to the bone, so he used the money from the expenses subterfuge to
finance the sales pitch. All that is left on a $10 million deal is for the papers to be signed and Pearson was
the only man who had developed the personal relationship with the Japanese businessman to secure
this.
Edwards sat in his office pondering about what to. The bank has just been on the phone requesting a
meeting next week to discuss progress in strengthening the controls within the business.
Required
(a)
(14 marks)
(b)
Evaluate your final recommendation using Tucker's 5 questions, reaching a conclusion. (6 marks)
(Total = 20 marks)
ENDOF
OFQUESTION
ANSWER BANK
END
BANK
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Answers
1
Core principles
Integrity means being honest and straightforward. It suggests a wholeness which could imply a
characteristic that is as important to maintain in ones personal life as in ones professional or business
dealings.
In the context of corporate governance, corporations and directors are expected to act with integrity
towards shareholders and other stakeholders. Directors sometimes seek to defend their actions by
claiming that they acted with integrity. This can be taken to mean that they are acting in the best interests
of others rather than from personal self interest.
Fairness means considering the views and claims of all those with a reasonable claim against the
company.
Fairness is important in corporate governance because directors have to balance the competing claims of
different stakeholder groups. While directors have a legal fiduciary duty towards the shareholders of the
company they have a moral and social obligation to other groups.
Judgement means demonstrating effective decision making.
Directors are expected to do their best to protect their shareholders investment and indeed to generate a
return on that investment. They do so by making sound strategic decisions that will be profitable for the
company in the long term.
Independence in the context of both directors and auditors means having minimal links to the company.
It is important to have independent directors represented on the board in order to maintain objectivity in
strategic decision making and in scrutinising the performance of the company and their fellow directors.
This means that investors can be confident that the decision making process is not unduly influenced by
self interest.
Openness or transparency means disclosing information that people outside the organisation can rely on.
Openness is important in terms of reporting performance (financial and non-financial) so that investors
and other interested parties can make informed decisions. It is also important in terms of the procedures
that a company adopts so for example it is more transparent and consequently fairer to ask independent
directors to nominate new board members through an agreed robust process than to ask shareholders
with a significant holding to nominate their own candidate.
Probity means honesty (from the latin word for honest, probus) but it also signifies virtue and integrity. In
particular it is mentioned as a characteristic important for those business dealings which are not covered
by legal obligations.
In the context of corporate governance it is establishing the need to go beyond contractual and legal
obligations to deal fairly and honestly and establishing wider moral obligations. In the context of risk
management probity risk is defined as the risk that the company wont 'do the right thing'.
Responsibility means acknowledging and seeking to remedy problems. There is a suggestion that it is the
imposition of a wider obligation than that imposed by law.
In the context of corporate governance one might take on wider responsibility through acknowledging
ones obligations to stakeholders other than just the shareholders or alternatively by increasing ones
obligations towards shareholders.
Accountability means an obligation to explain the outcome of ones actions.
In the context of corporate governance directors have to make account to the shareholders to explain
what they have done with their investment. They have to declare whether they have made profits or
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losses. Accountability could be considered in terms of the mandatory disclosures that are required from
companies and their directors.
Innovation means governance systems evolving over time to meet the changing needs of society.
Scepticism is the state of mid where you do not necessarily believe everything put before you but neither
do you disbelieve everything either it is the ability to retain an open mind whatever the situation.
Reputation means the perception that others have about you.
Investors price the shares of a company based on their perceptions of its future profitability, their
perceptions of its risk and their perceptions about the capabilities and characteristics of the directors. SO
the share price is entirely founded on perceptions. Events which damage the reputation of the company
will inevitably have an effect on share price.
Tutorial Note: In the real exam you should expect to have to define and explain the importance of one or
two of these principles. It is likely that there will be two marks available for a well explained definition of a
core principle. There could then be anything from 2 to 10 marks for an explanation of its importance.
Often there are clues in the scenario as to the importance of a core principle and often there are marks
available for applying the principle to the facts of the scenario.
In recent years a number of factors have influenced the introduction of a variety of frameworks,
codes and systems of corporate governance throughout the world. The factors are discussed
below:
(i)
One of the factors giving rise to the pressure for better corporate governance was concern
that some large companies were not providing fair accounts, with profits and asset values
being, in some cases, artificially inflated. In the late 1980s there were a number of wellpublicised corporate failures, which were unexpected, as the audited financial statements
had given no indication of such problems. There was a view that the external auditors
were unable to perform their function properly perhaps because a powerful or
unscrupulous chief executive could keep information away from them.
(ii)
There have also been criticisms that the external auditors of a company are not always as
independent as they should be or as the shareholders believe them to be. This was often
the case due to the fact that the auditors relied on the company not just for the audit fee
but also for substantial fees for other consultancy work throughout the year.
(iii)
Allied to these concerns were concerns that some large companies were being run for the
benefit of the directors of the companies rather than for the shareholders. These concerns
raised questions about the conflict of interest between the board of directors and the
shareholders and there was particular concern about too much power being in the hands
of one individual or a small number of individuals. This was particularly the case where
one powerful individual held the posts of both chairman and chief executive and where
boards of directors lacked balance.
(iv)
There was also an issue with directors' remuneration, which was often viewed, as
excessive whether the company was only performing no differently from an average
company or indeed was performing badly.
(v)
In the light of many corporate failures, concern was also expressed about the board's
knowledge and handling of the risks that faced the business and of the adequacy of
internal control systems within companies.
(vi)
As there was a trend towards global investment many large institutions, particularly in the
US and also in the UK, were seeking to invest substantial funds in companies in other
countries. In many instances there were concerns about the lack of shareholder rights and
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of disregard for minority shareholders rights shown by major shareholders or the boards of
these companies.
(b)
In the UK the Principles of Good Governance have now been brought together in the voluntary UK
Code.
This Code has stemmed from a number of other codes, reports and frameworks:
The Higgs review of the role and effectiveness of non-executive directors, followed by the
Tyson report on the recruitment and development of non-executive directors
The Financial Reporting Council published the latest version of the Code in 2012. The main
requirements of the Code have attempted to address many of the concerns, which led to these
successive frameworks, codes and systems of corporate governance.
Here are some examples.
(i)
The concerns regarding the board of directors and directors' powers are central to the
Code. Every listed company should be headed by an effective board, which should lead
and control the company. The two key tasks at the top of every listed company are the
running of the board, and the executive responsibility of the running of the company.
(ii)
The board should include a balance of executive and non-executive directors (including
independent non-executives) such that no individual or small group of individuals can
dominate the board's decision making. It is recommended that non-executive directors
should comprise at least half the board.
(iii)
There should be formal and transparent procedures for the appointment of new directors
to the board and all directors should be required to submit themselves for re-election at
regular intervals and at least every three years (some more frequently depending on the
type of entity).
(iv)
The level of remuneration paid to directors should be sufficient to attract and retain the
directors needed to run the company successfully but companies should avoid paying
more than is necessary for this purpose. A proportion of executive directors' remuneration
should be structured so as to link rewards to corporate and individual performance. The
board should set up a remuneration committee of independent non-executive directors
who will devise schemes of remuneration, which will be recommended to the board.
(v)
The board should present balanced and understandable assessment of the company's
position and prospects. The directors should explain their responsibility for preparing the
accounts and there should be a statement from the auditors about their reporting
responsibilities.
(vi)
The board should maintain a sound system of internal control to safeguard the
shareholders' investment and the company's assets. The directors should, at least
annually, conduct a review of the effectiveness of the systems of internal controls and
should report to the shareholders that they have done this. The review should cover all
controls including financial, operational and compliance controls and risk management.
Companies who do not have an internal audit function should from time to time review the
need for one.
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(vii)
The board should establish formal and transparent arrangements for considering how they
should apply the financial reporting and internal control principles and for maintaining an
appropriate relationship with the company's auditors. The audit committee should be made
up of at least three non-executive directors and this committee's duties include keeping
under review the scope and results of the audit and its cost effectiveness and the
independence and objectivity of the auditors. Where the auditors also supply a substantial
volume of non-audit services to the company the committee should keep the nature and
extent of such services under review.
(viii)
Companies should be ready to enter into a dialogue with institutional shareholders based
on the mutual understanding of objectives. Boards should use the AGM to communicate
with private investors and to encourage their participation.
Non-executive directors
(a)
Non-independent NEDs
A NED is not independent if he or she is on the board representing the interests of a major
shareholder, because the views given by the director will be made in the best interests of that
shareholder. Similarly it is debateable whether a director is independent when he or she has a
close relationship with the company or any other executive director. For example a former chief
executive of the company might be given a non-executive role after retirement. He would not be
independent.
Independent NEDs
In contrast an independent NED is a person who has no connection with the company other than
as a non-executive director, and who should be able to give an independent opinion on the affairs
of the company, without influence form any other director or shareholder.
(b)
Conflicts of interest
A potential conflict of interest occurs when the executive director or senior management of a
company might be inclined to take decisions that would not be in the interests of the companys
shareholders. Although there are several areas where a conflict of interest could arise, the major
problem areas are those of remuneration of the directors and senior managers, financial reporting
and nominations of new board members.
Remuneration
If executive directors are allowed to decide their own remuneration, they could be inclined to pay
themselves as much as possible, without having to hold themselves to account or justify their high
pay. Where incentive schemes are in place, there is a risk that incentive schemes devised by the
executive directors for themselves will be linked to achieving performance targets that are not
necessarily in the shareholders interests. For example rewarding directors with a bonus for
achieving profit growth is of no value to shareholders if the result is higher business risk and a
lower share price.
Remuneration Committee
Corporate governance in may countries, such as the UKs Corporate Governance Code, calls for
a remuneration committee of the board to be established to decide on directors pay, including
incentive schemes, and for this committee to comprise at least three, or in the case of smaller
companies two, members, who should all be independent non-executive directors.
The remuneration committee should have delegated responsibility for setting remuneration for all
executive directors and the chairman, including pension rights and any compensation payments.
The committee should also recommend and monitor the level and structure of remuneration for
senior management. The NEDs should in principle, be able to devise fair remuneration packages
that include an incentive element, in which the performance targets bring the objectives of the
executive directors more into line with those of he shareholders.
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Financial Reporting
A second potential area for conflict of interest is financial reporting. The executive directors might
be tempted to window dress the results if the company, in order to present the financial results in
a way that reflects better on themselves and their achievements.
Audit Committee
There should be an audit committee of the board, consisting of non-executive directors, whose
task should be to consider issues relating to financial reporting and financial control systems. This
committee should be responsible for maintaining regular liaison with the external auditors. The UK
Code says that the audit committee should comprise at least three or in the case of small
companies, two members, who should all be independent NEDs. The board should satisfy itself
that at least one member of the audit committee has recent and relevant financial experience.
Nominations to the board
A third potential area for conflict is nominations of new board members. A powerful chairman or
chief executive could be tempted to appoint their supporters or yes men to the board, and so
strengthen their position on the board. The UK code recommends that there should be a
nominations committee of the board manned by NEDs.
Other areas
Other areas of potential conflict of interest can be identified, such as succession planning, and the
boards decisions on making acquisitions or in preparing defences against a takeover bid. In each
of these areas NEDs should be able to provide a counter balance to the self interested views of
executive directors.
(c)
Share Payments
In many companies, NEDs receive a fixed cash payment for their services, without any incentives.
However some companies pay their NEDs in shares.
They would argue that the more equity the NEDs hold, the more likely they will be to look at
issues from the point of view of the shareholders. There is a risk that a NED holding shares could
be more concerned with short-term movements in the share price and the opportunity of making a
short term profit from selling their shares. However, a suitable precaution against this could be to
obtain the agreement of a NED not to sell his or her shares until after leaving the board.
Share Options
The argument that NEDs should be rewarded with share options is more contentious, but it has
been widely practised in the UK and is even more common in the US. The argument against
rewarding NEDs with share options is that this form of remuneration could align the interests of
the NEDs more closely with the executive directors, who also hold share options. NEDs should
give independent advice, and it can be argued that it is therefore not appropriate to incentivise
them in the same way as the executives.
The UK Code points out that holding of share options could be relevant to the determination of a
non-executive directors independence. It states that remuneration for non-executive directors
should not include share options. If, exceptionally, options are granted, shareholder approval
should be sought in advance and any share acquired by exercise of the options should be held
until at least one year after the non-executive director leaves the board.
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Board of directors
REPORT
To:
From:
Date:
Subject:
Board of directors
Consultant
December X4
Board of directors and committees
Chairman
The UK Corporate Governance Code states that there should be a clear division between the chief
executive of the company, who has executive responsibility for running the company's business, and the
chairman of the board of directors who is responsible for running the board.
The main roles of the chairman should be to:
Ensure that all members of the board receive accurate, timely and relevant information
Ensure that adequate time is allowed for the discussion of complex or contentious issues
Ensure that the performance of individual directors and the board as a whole, together with its
committees, are evaluated at least once a year
Non-executive directors
The board should include a balance of executive and non-executive directors and the role of the nonexecutive directors should include the following elements.
Being well informed about the company and the environment within which it operates
Ensuring that sufficient, accurate, clear and timely information is provided to the board in advance
of meetings
Satisfying themselves that the risk management systems are robust and defensible
Playing an important role in the appointment and removal of directors and in succession planning
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Remuneration committee
The remuneration committee should be made up of non-executive directors as it is responsible for setting
the remuneration for all executive directors, the chairman and the company secretary.
As well as this basic responsibility the remuneration committee has other duties.
To ensure that any contractual terms on termination and payments made are fair both to the
company and the individual
To determine the total individual remuneration package for each executive director including
bonuses, incentive payments and share options
To agree the policy for authorising expense claims from the chief executive and chairman
To ensure that all required disclosures for remuneration matters are fulfilled
Nomination committee
The UK Code requires that there should be formal, rigorous and transparent procedures for the
appointment of new directors to the board. The nomination committee, made up of a majority of
independent non-executive directors, can carry out this role. The main duties of this committee are to:
Evaluate the current balance of skills, knowledge and experience on the board and with this in
mind to prepare a description of the role and capabilities required for a particular appointment
Assess whether the non-executive directors are spending enough time to fulfil their duties
Consider succession planning and in particular what skills and expertise are needed, given the
challenges and opportunities facing the company
Prepare a statement for the annual report including the process used for appointments and
explains if external advice or advertising has been used. The statement should also state the
membership of the committee, and the number of committee meetings attended over the year.
Caius plc
Tutor's note. A good guideline for this type of question would be the key points relating to directors
remuneration from the UK Code. This will give you most of the key areas that require to be discussed.
To:
From:
Date:
Subject:
In order to ensure that directors pay and conditions are fair and transparent the company should adopt
the following policies and frameworks.
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Types of risk
There are many different types of risk faced by commercial organisations, particularly those with
international activities. They may be categorised under the following headings:
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The type of industries/markets within which the business operates the extent to which sales are
vulnerable to changes in fashion, technology etc
The stage in a product's life cycle, with high risks in the introductory and declining stages
The dependence upon inputs with fluctuating prices, eg wheat, oil etc
The level of operating gearing the proportion of fixed costs in total costs the higher the level,
the greater sales need to be made to break even
Trading risks
Both domestic and international traders will face trading risks, although those faced by the latter will
generally be greater due to the increased distances and times involved. The types of trading risk include:
Physical risk the risk of goods being lost or stolen in transit, or the documents accompanying the
goods going astray
Credit risk the possibility of payment default by the customer. This is discussed further below.
Trade risk the risk of the customer refusing to accept the goods on delivery (due to substandard/ inappropriate goods or other reasons), or the cancellation of the order in transit
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Technological risk
All businesses depend to some extent on technology, either in the support of its business activities (eg
the computers used by the accounts, stores and treasury departments), or more directly in its production
or marketing activities.
As technology evolves and develops, firms can find themselves using out of date equipment and
marketing methods, which may leave them at a competitive disadvantage. Products in a high-tech
industry have very short life cycles, and a firm must recognise and plan for continual replacement and
upgrading of products if it is not to lose market share.
Fraud risk
All businesses run the risk of loss through the fraudulent activities of its employees, including
management.
How the codes of corporate governance can assist in managing the risks
Corporate governance is concerned with the control and influence exerted over a company's operations
and its employees by the decisions of top management, usually the board of directors.
The codes of corporate governance are guidelines and recommendations developed over a number of
years by various committees and researchers (Cadbury, Greenbury, Hampel, Higgs, and Smith) and now
incorporated in the UK into the Corporate Governance Code published in July 2012 by the Financial
Reporting Council.
A significant element of the Code is concerned with the way internal controls are implemented and
reviewed in order that such risks as those outlined above would be managed. The code includes the
Turnbull report.
The Turnbull report included recommendations that:
Management should identify and evaluate the risks to which they will be exposed in the
achievement of their corporate objectives. These will include both the traditional areas of risk
discussed above, but also those increasingly arising from intangible assets, such as reputation
and branding.
Risk control should be embedded in the culture and processes of the business, rather than
being the subject of a completely separate management system. Each person in the organisation
should be aware of, and manage, the significant risks related to the tasks they perform.
Directors should continually review and monitor risk control issues. It should regularly review
reports on internal control from line managers and, where appropriate, from internal auditors
and other specialists.
Regular discussion of risk and control issues at board meetings should be encouraged.
Risk analysis and assessment should form part of the evaluation of every major capital
investment or proposed acquisition.
Financial risk analysis will very much depend upon commercial judgement, but the following
questions may be used as a framework for the assessment of their impact on company value:
What is the effect on the underlying present and future profitability of the business?
What is the effect on the underlying present and future liquidity and value of assets
employed in the business?
What is the effect on the present and future debt structure of the business?
The relative likelihood of the events giving rise to the risks also needs to be assessed.
177
This can then be combined with the level of impact to prioritise the risks.
Once risks have been prioritised, management needs to decide what to do about them, and how they can
be managed and monitored in the future.
Strategies for management of a given risk include:
Acceptance
Transfer eg by insurance or joint venture
Elimination by hedging, or ceasing the activity/operation
Control by building in operational controls
COSO Framework
(a)
Avoidance means exiting the activities that give rise to risk. Risk avoidance may involve
disposing of a business unit, product line, or geographical segment, or simply deciding not to
engage in new initiatives/activities that would give rise to the risks.
If reduction is the chosen response then action is taken to reduce risk likelihood or impact, or
both. This typically involves any of a large number of everyday business decisions, including
diversifying product offerings, establishing operational limits for activities, establishing more
effective business processes, enhancing management involvement in decision making and
monitoring, rebalancing the entitys portfolio of assets to reduce exposure to certain types of
losses, or reallocating capital among operating units.
Sharing entails reducing risk likelihood or impact by transferring or otherwise sharing a portion
of the risk. Common techniques include purchasing insurance products, engaging in hedging
transactions, entering into joint ventures or partnerships, sharing risk through contractual
agreements with customers, vendors, or other business partners, or outsourcing an activity.
If acceptance is the chosen response no action is taken to affect risk likelihood or impact: the risk
is accepted because it already conforms to the entitys risk tolerances. The entity may have selfinsured against loss, or it may rely upon natural offsets within a portfolio.
(b)
Control activities are the actions of people to implement policies, directly or through application of
technology, in such a way as to help ensure that managements risk responses are carried out.
Many procedures are commonly performed by personnel at various organisational levels that
serve to enforce adherence to established action plans and to keep entities on track toward
achieving their objectives.
Here are some examples.
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Physical controls Equipment, inventories, securities, cash, and other assets are
physically secured and periodically counted and compared with amounts shown on control
records.
Audit process
(a)
The external audit process must demonstrate whether the financial statements show a true and
fair view of the financial position and performance of the company. The external auditors must
also report as to whether the financial statements have been prepared in accordance with relevant
statute and whether certain specifics have been complied with:
The auditors have received all of the information and explanations required to carry out
their audit
The report to the shareholders by the external auditor is in the form of an opinion as to whether
the accounts show a true and fair view in the audit report. An unqualified opinion should give
shareholders and other users of the financial statements confidence in those financial statements
but it is not a guarantee from the auditors that the financial statements are totally correct.
During the course of the external audit the auditors will consider and test the internal accounting
systems of the company and make recommendations for improvements. However there is little
else that directly contributes towards the effective system of corporate governance as the auditor
is not required to consider whether the statements of the directors regarding internal controls are
comprehensive or comment on the effectiveness of the company's corporate governance
procedures or risk procedures.
179
The internal audit function is not a legal requirement, but the board of directors may set up an
internal audit department after considering the costs and benefits. The work of internal auditors is
not set out in law but is decided upon by the board of directors or senior management. The work
of the internal audit function will therefore vary from company to company, but the following are
typical areas that the internal audit function may be required to consider.
As the remit of the internal audit function is as wide as is necessary then this can be a valuable
resource to management, contributing towards an effective system of corporate governance.
(b)
When the external auditors are carrying out their audit they will expect full co-operation from the
internal auditors. The internal auditors should ensure that the accounting and internal control
systems are operating satisfactorily but the external auditor will test those systems independently.
The external auditors will not tend to rely on the work of the internal auditors in general terms but
the work on systems, controls and procedures that have been carried out by the internal audit
function will be of some assistance to the external auditors in their role.
Ethical considerations
To:
From:
Date:
Subject:
This report assumes that you have read the enclosed documents prepared by the Sales Director
concerning her recent meeting with Y, the Managing Director of X Ltd. In brief, we are being asked to
supply further materials on credit to X Ltd on the understanding that this offers our best chance of being
paid both for long-outstanding existing debts and the further debts that will arise.
Firstly I need to point out that our Sales Director feels that we should accept what has been informally
agreed but she has openly admitted that she has difficulty in taking an objective view of the situation,
having done business with Y for many years.
However, the agreement that is being proposed leaves me with grave doubts, both on ethical grounds
and from the point of view of the business.
Our options are:
180
Why can X Ltd not obtain an advance from their bank against the promise of the next progress
payment? Has this option been attempted? If not, is the bank fully aware of the difficulties of X
Ltd?
Are X Ltd already 'trading wrongfully', which is illegal? To knowingly enter into an agreement that
allows this to continue calls our own integrity into question.
If we are satisfied on point (a), we could encourage X Ltd to enter into negotiations with all of its suppliers.
We can let it be known that we will be willing to help if others are: this will put X Ltd in a stronger position.
If X Ltd is able to get the level of support needed, this option is the one that I recommend.
If both you and Y agree to this I may have an immediate opportunity to help out, since (as I mentioned) I
have already had an enquiry from an acquaintance working for another supplier who will also, I think, be
keen to salvage something from the situation if at all possible.
Confidentiality is an issue at present, so for the time being I have sent a fax explaining that we are
currently negotiating with X Ltd and that I will be in touch once I know the outcome of our talks. (You will
realise that my own professional integrity could be compromised if I supply information that could be
considered misleading. I cannot simply ignore the enquiry or be cagey about it since this could itself be
construed as a 'bad' reference.)
Suing for payment or writing off the debt
Since we are unlikely to recover our debt this option will simply increase our loss because we will have to
pay legal costs. X Ltd may be counting on the fact that we know this.
One possible virtue of this option is that the threat of liquidation, or liquidation itself, may force Y to come
to an arrangement with all creditors if we are unable to persuade him to try this by other means.
Writing off the debt now has the virtue that we do not risk losing a further amount by supplying more
materials. On the down side, it could make us look 'soft' to other customers, and it is possibly unduly
181
harsh not to give X Ltd a chance to recover the situation. It is not in our long-term interests for our
customers to go out of business.
I cannot recommend either of these options except in the very last resort.
Wider issues
We need to consider whether this situation has arisen due to problems with credit control on our part. It
could perhaps be argued that we should have worked more closely with X Ltd to prevent the problem
arising in the first place. We should have been aware that X Ltd was taking on a much larger contract
than it has previously been used to dealing with and we should have anticipated problems.
Over the next few days I shall be looking into ways in which our credit control systems can be adapted to
ensure that external matters such as this are taken into account.
10 Corporate citizenship
REPORT
To:
From:
Date:
Subject:
Directors
Consultant
Dec X4
Corporate citizenship
Introduction
Companies have choices as to how they manage their businesses. These choices can be many and
varied but the choices that are made can determine whether or not the company is seen as a good
citizen. Many of the world's companies are setting high standards of behaviour in many aspects of
business and in a wider social context.
Corporate citizenship
The concept of corporate citizenship recognises that there is a connection between the everyday
activities of companies and the well being of society as a whole. In recent years companies have adopted
a more comprehensive approach to corporate citizenship in general, and this includes social and
environmental responsibility.
Directors now accept that they are not only responsible to the shareholders the owners of the company
but also to a wider selection of other stakeholders which will include employees, customers, investors,
business partners, suppliers, the community and the government.
It can be argued that corporate citizenship is made up of three key components:
(1)
(2)
(3)
The basic values, policies and practices of a company and its business at home and abroad
The management of environmental and social issues within the value chain of business partners
The voluntary contributions made by a company to community development around the world
Employees. Issues that may affect employees and the company's treatment of those employees
include wage rates, health and safety provisions, accident rates, training opportunities and how
changes such as downsizing and redundancies are handled.
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Customers. Customers in global, competitive markets are increasingly concerned not only with
price but also value of goods and services. Quality issues are paramount to most companies
including how complaints are handled. Increasingly customers are also concerned with the
background to the goods they have purchased and the conditions under which they were
manufactured. In an age of environmental concerns customers are also concerned with factors
such as the safe disposal or recycling of products once used.
Suppliers. The activities of one company will necessarily have a knock-on effect on other
companies with which it deals, in particular suppliers. Companies will be concerned about the
long-term stability of their suppliers, the sustainability of jobs at their suppliers and timely payment
of their suppliers.
The community. Concerns here for a company will centre on charitable gifts and donations, the
support of employees providing charitable gifts or services, investment within the community and
the willingness to listen to community concerns and to enter into meaningful dialogue.
Government. Many companies pay huge amounts of taxes, which are vital for the sustainability,
and growth of many countries and economies. Companies should be concerned with issues such
as fair transfer pricing policies and compliance with the laws and regulations of all the countries
within which they operate.
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(a)
7
3
(b)
(c)
(d)
2
3
10
6
4
5
25
(a)
Turnbull report
The UK Turnbull report lists a number of considerations which will be taken into account when
deciding whether to establish an internal audit department; most are relevant here.
Scale and complexity of operations
This has clearly increased recently with rapid growth meaning more products and activities being
taken on, and possibly more that can go wrong. Internal audit review can act as a check on the
decision-making processes, that all the implications of the change in business have been fully
considered.
Number of employees
Increases in employee numbers are an indication of changes in size and the need for
development of human resource systems, which internal audit would wish to evaluate.
Changes in organisational systems
Overall control systems will have to develop, and internal audit will be an important part of this
change. Internal audit may be particularly needed as a check on the development of other parts of
the system; with rapid growth, there is a danger that information systems for example may not
develop in a way that is best for the company.
Changes in key risks
Changes in products and activities will bring changes in risks. There will be risks associated with
the production and sales of the new products, such as production stoppages, health and
safety considerations and distribution difficulties. There may also be changes in the general
risks that Franks and Fisher faces, with possibly the increased risk of inefficiencies and
diseconomies of scale. Internal audit can review the adequacy of the overall risk
management systems for coping with these changes and carry out work on specific areas of
high areas.
Problems with internal systems
The breakdown has highlighted possible problems with quality standards. The recent changes
may mean that they would be inadequate anyway even if rigorously enforced. However they
have not been employed conscientiously, and this calls into question whether other parts of the
control systems are working as effectively as they should be. Internal audit should definitely
investigate this.
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Unacceptable events
Clearly the production breakdown was an unacceptable event because of its consequences and
its avoidability. Franks and Fisher is trying to establish itself in various product markets and
therefore disruption in supply could have particularly serious consequences. If internal audit
recommendations can reduce the chances of this happening in future, clearly this will be a major
benefit.
Cost-benefit considerations
The fact that the board are talking about limiting internal audit's work may indicate that costbenefit considerations are significant. Fears that internal audit will interfere with operational
departments may well be exaggerated, and well-directed internal audit work should bring
benefits. However if internal audit's work is going to be seriously limited, it may not be worthwhile
employing an internal auditor.
(b)
(c)
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Definition of objectivity
Objectivity means not letting bias, conflict or undue influence of others to override
professional or business judgements. It implies detachment and not letting personal feelings
intrude into professional judgements.
Demonstrating objectivity
Lack of favouritism
Internal auditors should not accept gifts nor undue favours from the departments that they are
auditing.
Fairness
Internal auditors should avoid the perception that they are out to 'hit' certain individuals or
departments. They should not take sides, not being influenced by office politics in determining
the work carried out and the reports given.
Not responding to intimidation
Internal auditors should choose which areas to audit based on their objectives and risk analysis,
and not be kept away from certain areas by aggressive managers. Internal audit should also
cover the whole management process and not just audit the operational areas.
Valid opinion
Internal auditors should aim to deliver a report that satisfies the needs of their principal (the audit
committee).This means producing a report based on all relevant factors rather than one
designed to please operational departments.
12 Southern Construction
(a)
Should Pearson be punished even if he has acted for the greater good of the
organisation? (utilitarianism)
186
Should Edwards conceal the issue from key stakeholders regardless of how he
chooses to act? (Transparency issues)
Deal with any tricky situation in house if there is no legal reason to disclose
Consider the wider impact of a rash decision ie he is a key member of the team
and so sacking him could make the situation worse
Sack Edwards
Suspend pending further investigation
Interview him and accept his version
Investigate the extent of the losses before deciding what to do
Verbal warning but ask him to continue to work with client
Demote/remove authority
Keep in position but reduce authorisation limits
Do nothing
187
188
Appendix A:
Pilot paper questions
and answers
189
Pilot paper
Paper P1
Governance, Risk and Ethics
Time allowed
Reading and planning:
Writing:
15 minutes
3 hours
Note: some questions from the original pilot paper have been removed from these notes to be used
elsewhere in your BPP materials. Those that remain are to be used on the taught phase of your studies.
Question 1
Chemco is a well-established listed European chemical company involved in research into, and the production of,
a range of chemicals used in industries such as agrochemicals, oil and gas, paint, plastics and building materials.
A strategic priority recognised by the Chemco board some time ago was to increase its international presence as
a means of gaining international market share and servicing its increasingly geographically dispersed customer
base. The Chemco board, which operated as a unitary structure, identified JPX as a possible acquisition target
because of its good product fit with Chemco and the fact that its geographical coverage would significantly
strengthen Chemcos internationalisation strategy. Based outside Europe in a region of growth in the chemical
industry, JPX was seen by analysts as a good opportunity for Chemco, especially as JPXs recent flotation had
provided potential access to a controlling shareholding through the regional stock market where JPX operated.
When the board of Chemco met to discuss the proposed acquisition of JPX, a number of issues were tabled for
discussion. Bill White, Chemcos chief executive, had overseen the research process that had identified JPX as a
potential acquisition target. He was driving the process and wanted the Chemco board of directors to approve the
next move, which was to begin the valuation process with a view to making an offer to JPXs shareholders. Bill
said that the strategic benefits of this acquisition was in increasing overseas market share and gaining
economies of scale.
While Chemco was a public company, JPX had been family owned and operated for most of its thirty-five year
history. Seventy-five percent of the share capital was floated on its own countrys stock exchange two years ago,
but Leena Sharif, Chemcos company secretary, suggested that the corporate governance requirements in JPXs
country were not as rigorous as in many parts of the world. She also suggested that the family business culture
was still present in JPX and pointed out that it operated a two-tier board with members of the family on the upper
tier. At the last annual general meeting, observers noticed that the JPX board, mainly consisting of family
members, had dominated discussions and had discouraged the expression of views from the companys
external shareholders. JPX had no non-executive directors and none of the board committee structure that many
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listed companies like Chemco had in place. Bill reported that although JPXs department heads were all
directors, they were not invited to attend board meetings when strategy and management monitoring issues were
being discussed. They were, he said, treated more like middle management by the upper tier of the JPX board
and that important views may not be being heard when devising strategy. Leena suggested that these features
made the JPX boards upper tier less externally accountable and less likely to take advice when making
decisions. She said that board accountability was fundamental to public trust and that JPXs board might do well
to recognise this, especially if the acquisition were to go ahead.
Chemcos finance director, Susan Brown advised caution over the whole acquisition proposal. She saw the
proposal as being very risky. In addition to the uncertainties over exposure to foreign markets, she believed that
Chemco would also have difficulties with integrating JPX into the Chemco culture and structure. While Chemco
was fully compliant with corporate governance best practice, the country in which JPX was based had few
corporate governance requirements. Manprit Randhawa, Chemcos operations director, asked Bill if he knew
anything about JPXs risk exposure. Manprit suggested that the acquisition of JPX might expose Chemco to a
number of risks that could not only affect the success of the proposed acquisition but also, potentially, Chemco
itself. Bill replied that he would look at the risks in more detail if the Chemco board agreed to take the proposal
forward to its next stage.
Finance director Susan Brown, had obtained the most recent annual report for JPX and highlighted what she
considered to be an interesting, but unexplained, comment about negative local environmental impact in its
accounts. She asked chief executive Bill White if he could find out what the comment meant and whether JPX
had any plans to make provision for any environmental impact. Bill White was able to report, based on his
previous dealings with JPX, that it did not produce any voluntary environmental reporting. The Chemco board
broadly supported the idea of environmental reporting although company secretary Leena Sharif recently told Bill
White that she was unaware of the meaning of the terms environmental footprint and environmental reporting
and so couldnt say whether she was supportive or not. It was agreed, however, that relevant information on
JPXs environmental performance and risk would be necessary if the acquisition went ahead.
Required
(a)
Evaluate JPXs current corporate governance arrangements and explain why they are likely to be
considered inadequate by the Chemco board.
(10 marks)
(b)
Manprit suggested that the acquisition of JPX might expose Chemco to a number of risks. Illustrating from
the case as required, identify the risks that Chemco might incur in acquiring JPX and explain how risk can
be assessed.
(15 marks)
(c)
Construct the case for JPX adopting a unitary board structure after the proposed acquisition. Your answer
should include an explanation of the advantages of unitary boards and a convincing case FOR the JPX
board changing to a unitary structure.
(10 marks)
(d)
Explain FOUR roles of non-executive directors (NEDs) and assess the specific contributions that NEDs
could make to improve the governance of the JPX board.
(7 marks)
(e)
Write a memo to Leena Sharif defining environmental footprint and briefly explaining the importance of
environmental reporting for JPX.
(8 marks)
(Total = 50 marks)
Question 1
This question is an example of whats likely to be a common type of question on this paper, evaluate the
inadequacies and suggest improvements. However parts (c) and (d) are quite specific about which areas you
have to discuss, indicating you need a detailed knowledge of corporate governance issues to underpin your
discussions. The question part on risk is mixed in with this discussion on corporate governance, indicating how
different parts of the syllabus will be combined in the case study question.
This question covers material from a number of chapters, and you can expect Question 1 to be drawn from areas
covered across the whole of your Study Text.
191
Question 2
In a recent case, it emerged that Frank Finn, a sales director at ABC Co, had been awarded a substantial overinflation annual basic pay award with no apparent link to performance. When a major institutional shareholder,
Swanland Investments, looked into the issue, it emerged that Mr Finn had a cross directorship with Joe Ng, an
executive director of DEF Co. Mr Ng was a non-executive director of ABC and chairman of its remunerations
committee. Swanland Investments argued at the annual general meeting that there was 'a problem with the
independence' of Mr Ng and further, that Mr Finns remuneration package as a sales director was considered to
be poorly aligned to Swanlands interests because it was too much weighted by basic pay and contained
inadequate levels of incentive.
Swanland Investments proposed that the composition of Mr Finns remuneration package be reconsidered by the
remunerations committee and that Mr Ng should not be present during the discussion. Another of the larger
institutional shareholders, Hanoi House, objected to this, proposing instead that Mr Ng and Mr Finn both resign
from their respective non-executive directorships as there was 'clear evidence of malpractice'. Swanland
considered this too radical a step, as Mr Ngs input was, in its opinion, valuable on ABCs board.
Required
(a)
Explain FOUR roles of a remuneration committee and how the cross directorship undermines these roles
at ABC Co.
(12 marks)
(b)
Swanland Investments believed Mr Finns remuneration package to be poorly aligned to its interests.
With reference to the different components of a directors remuneration package, explain how Mr Finns
remuneration might be more aligned to shareholders interests at ABC Co.
(8 marks)
(c)
Evaluate the proposal from Hanoi House that both Mr Ng and Mr Finn be required to resign from their
respective non-executive positions.
(5 marks)
(Total = 25 marks)
Question 2
This question has some similarities to Question 1, requiring knowledge of specific areas of good corporate
governance practice and application of that knowledge to identify weaknesses and recommend improvements.
Ethics part (c) is only worth 5 marks; you may well encounter more complex ethical situations requiring
discussion worth more marks.
Chapter 3 of your Study Text thoroughly covers the issues involved in this question.
192
193
194
195
196
197
END OF APPENDIX A
198
Appendix B:
Information
about M&S
199
Brief History
1880s and 1890s: Having started trading from a market stall in Leeds the founder Michael Marks moved to
Manchester and in 1894 went into partnership with Tom Spencer.
1900s: Tom Spencer died in 1905 (although he had not been an active partner in the business for a while) and
Michael Marks in 1907. Michael was succeeded in the business by his son Simon, still only in his late teens.
1920s to 1950s: The business bought direct from manufacturers with whom it established good, if slightly
paternalistic relationships. There was a similar tone in the staff welfare introduced in the 1930s. In 1926 the
company went public although the family retained a high level of power.
1960s and 1970s: The charismatic Chairman Simon Marks died in 1964, succeeded by family member Israel
Seiff.
1980s and 1990s: Derek Rayner became the first Chairman from outside the founding families. He was
Chairman from 1984 to 1991 and oversaw the acquisition of the American company Brooks Brothers in 1988
(subsequently sold in 2001). He took steps to secure his successor Richard Greenbury by appointing him CEO in
1988. Richard Greenbury was Chairman (and CEO) until 1999. In 1998 M&S was the first British retailer to make
pre-tax profits of more than 1billion.
2000s: Following Richard Greenburys departure the company suffered a slump in its fortunes. There were
problems in the board room and shareholders were keen to know who to blame for the companys problems.
Some believed the problems stemmed from decisions made by Richard Greenbury. The company finally started
accepting credit cards (other than its own store card) in early 2000. Stuart Rose the current CEO is credited with
turning the business around following his appointment in 2004.
2008: In early 2008 the business was criticised when it was announced that Stuart Rose was to be elevated to
the position of Executive Chairman (ie joint CEO/Chairman). There was also criticism after it emerged that he
had invested money in a business belonging to one of the non-executive directors. The company announced
disappointing trading results on 1 July 2008 and saw the value of its shares fall by nearly a quarter in one day (to
2.40 having reached a peak of 7.66 in May 2007) although its profits after tax were an impressive 821 million
for the year to 29/3/08 (660 million in the previous year).
2010: In May 2010 Marc Bolland replaced Stuart Rose as CEO. Stuart Rose remained as Chairman until a
successor, Robert Swanwell was appointed in January 2011. Marc Bolland is a NED at Manpower Inc and
Robert Swanwell serves as a NED at HMV Group plc.
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DETACH THIS SHEET AND STAPLE IT TO YOUR SCRIPT. YOU ARE ADVISED TO PHOTOCOPY YOUR SCRIPT BEFORE SENDING THE ORIGINAL IN FOR MARKING.
Return address:
Company: .........................................................................
Date of birth: ........................................ 19......................
.................................................................................................................
Postcode: ................................................................................................
ACCA PAPER P1
Governance, Risk and Ethics
Written Assessment 1
RESULTS
Question
Q1
Q2
Maximum
25
25
Total
% Mark
50
100%
Score
Marked by:
Marker's assessment
Ticks in the left-hand boxes indicate a good aspect of your performance.
Tick in the right-hand boxes highlight areas you need to work on.
(Note: Boxes may be left empty if the comments are not applicable to your script)
Approach
Questions correctly interpreted
Good
performance
Relevant to
question
How to
improve
Improvement
needed
Careful reading
Review the definitions of
question words
Technical content
Understanding of principles
Computation
High standard of accuracy
Appearance/Layout
Neat handwriting
Use plenty of space
Use headings and
subheadings
Use short paragraphs
Written style
Concise business style
217
218
Question 1
Question text
Sixstreams Water provides tap water and sewage services for about 10% of the population of the
European country in which it is based. Internationally it provides consultancy services to water
suppliers in developing countries. It is the monopoly supplier in the region in which it operates and
consequently is heavily regulated by the national government. It has been listed on a European stock
exchange for about 20 years. Perceived by investors as a low risk, low return investment its share
price and the volume of trading in its shares increased significantly following news that a water
supplier, TAP Water, based in East Asia was considering making a takeover offer for Sixstreams
Water.
On news of the takeover regional politicians voiced concerns about a business that was of such
importance to the region being controlled by a foreign company. However these concerns did not
prevent the takeover of Sixstreams by TAP Water going ahead some weeks later.
On acquiring Sixstreams Water, TAP Water have retained all the executive director s but have
replaced the non-executive directors with three new non-executives (NEDs) who are all executive
directors of the holding company TAP Water.
Required
(a) Explain the competing stakeholder claims of short-term shareholders, long-term investors and
customers of Sixstreams Water and recommend how conflicts between these claims should be
resolved.
(12 marks)
(b) Briefly describe the role of non-executive directors and assess the decision to replace the NEDs
at Sixstreams.
(5 marks)
(c) Compare and contrast the rules-based approach used to regulate Sixstreams Waters operational
activities with the principles-based approach used for corporate governance of the company.
(8 marks)
(Total = 25 marks)
219
Question 2
Question text
Felicia Galka works as the risk manager for a large European listed company which operates public
transport (rail, bus and ferries) in and between several European countries. She recently attended an
international conference on risk management. Most of the conference delegates were risk managers
but found that they came from a wide range of backgrounds and that their roles differed widely from
one organisation to another.
Practically all the delegates attended the opening session on reputation risk, which was described as
the risk of risks.
Felecia also attended a session on probity risk and another on derivative risk. These had both been
recent issues for her employer as it had tendered bids to various governments awarding operating
licences for train and ferry routes and had been considering forward contracts to manage the risks of
fuel price increases.
While networking with other conference delegates the main focus of discussion was on the difficulty of
getting anybody else in their organisations to take risk seriously. A common them e was that the risk
managers were perceived as Health and Safety Police.
Required
(a) Define and explain the sources and impacts of the three common business risks discussed at the
conference seminars: reputation risk, probity risk and derivatives risk.
(12 marks)
(b) Explain and assess the role of the risk manager in identifying and monitoring risk.
(8 marks)
(5 marks)
(Total = 25 marks)
220
DETACH THIS SHEET AND STAPLE IT TO YOUR SCRIPT. YOU ARE ADVISED TO PHOTOCOPY YOUR SCRIPT BEFORE SENDING THE ORIGINAL IN FOR MARKING.
Return address:
Company: .........................................................................
Date of birth: ........................................ 19......................
.................................................................................................................
Postcode: ................................................................................................
RESULTS
Question
Q1
Q2
Q3
Q4
Maximum
40
20
20
20
Total
% Mark
80
100%
Score
Marked by:
AC13 P1(2)
ACP1CEQ(2A)13
Marker's assessment
Ticks in the left-hand boxes indicate a good aspect of your performance.
Tick in the right-hand boxes highlight areas you need to work on.
(Note: Boxes may be left empty if the comments are not applicable to your script)
Approach
Questions correctly interpreted
Good
performance
Relevant to
question
How to
improve
Improvement
needed
Careful reading
Review the definitions of
question words
Technical content
Understanding of principles
Computation
High standard of accuracy
Appearance/Layout
Neat handwriting
Use plenty of space
Use headings and
subheadings
Use short paragraphs
Written style
Concise business style
223
224
Section A
Question 1 this question is compulsory
Question text
Company details
Friar Holdings plc is a company based on the south coast of England specialising mainly in property
management, but with a large subsidiary, Renton Marine, specialising in boatbuilding. Friar Holdings
was floated on the Stock Exchange last year, and as a result its shareholding pattern changed,
although Chris Friar, its Chief Executive for the last ten years, still owns 22% of the issued share
capital. The Allied and Temple Merchant Bank owns 16% of the issued share capital and no other
shareholder owns more than 5%.
Board details
The board members of Friar Holdings are as follows:
Tim Heward and Jane Heward are married, and April Ralph is engaged to be married to Chris
Friar.
April Ralph was previously Managing Director of Renton Marine until her resignation two years ago
when Renton Marine was acquired by Friar Holdings. Lorna Wade is Managing Director of Wade
Boats, a company that sells top-of-the range yachts and has been supplied by Renton Marine for a
number of years. Gordon Underwood is the only board member with significant financial experience
and a professional qualification.
Up until 18 months ago Gordon Underwood was the partner in charge of the audit of Friar Holdings
until he left the auditors and joined the board of Friar Holdings.
April Ralph and Lorna Wilde were appointed as non-executive directors when Friar Holdings obtained
a listing; the other directors have been directors for a number of years.
The only board committee is the audit committee chaired by Gordon Underwood, which also includes
April Ralph and Lorna Wilde. Friar Holdings small internal audit department reports to the audit
committee.
Friar Holdings is about to prepare its first accounts after having been floated.
The following issues were discussed at a recent board meeting.
Corporate governance disclosures
Gordon Underwood indicated that as a listed company, Friar Holdings would have to fulfil enhanced
legal and stock exchange disclosure requirements, including disclosing failures to fulfil corporate
governance disclosure requirements. Chris Friar commented that clearly the codes gave companies a
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choice. Friar Holdings only needed to comply with the governance requirements that the board
thought were appropriate, and could list the disclosure requirements with which it had not complied.
Directors remuneration
Chris Friar said that his own salary would increase by 10%, and that he would speak separately with
each director, telling them what their salary would be for the following year. As well as basic salary
and bonuses (determined by Chris Friar on the basis of what he believes appropriate for each
director) directors also have pension contributions paid into a directors pension scheme. There is no
staff pension scheme in Friar Holdings. Chris Friar appraises all other directors using his own criteria
and his decisions on salary and bonuses are made on the basis of those appraisals.
Redevelopment of boat yard
Chris Friar proposed closing the Merman boatyard that was run by Renton Marine on the grounds that
it was earning insufficient return. As the boatyard was located on the banks of the River Humble,
Chris Friar proposed turning the site into luxury flats and a leisure complex. He commented that this
represented a major strategic opportunity for Friar Holdings. The shareholders would be happy with
the high expected return on investment and that many people would wish to buy luxury apartments
and use the leisure complex. Chris Friar commented that the development would also benefit the local
economy, providing jobs in the leisure complex and bringing more people into the area.
Shareholder concerns
At a recent board meeting of the Allied and Temple bank, concern was expressed about the attitudes
to corporate governance of the board of Friar Holdings, and the lack of communication that between
the board of Friar Holdings and the bank since the bank acquired its shareholding when Friar
Holdings was listed. The chairman of the bank also raised concerns about the proposed development,
since a leak to the local press had led to unfavourable publicity about the plan. The Allied and Temple
bank has marketed itself as the ethical bank and thus is very wary of maintaining investments that
may be connected with unethical behaviour.
The banks board is also aware of criticisms made by other institutional shareholders about the level
of remuneration paid to the directors of Friar Holdings.
As a result of its discussions, the banks board gave Sir James Soames, a member of the board,
responsibility for liasing with the board of Friar Holdings and communicating the banks concerns.
Required
(a) Evaluate Friar Holdings current corporate governance arrangements and explain why they are
likely to be considered inadequate by the Allied and Temple bank and other major shareholders.
Your answer should not include discussion of remuneration issues or communication with
shareholders.
(12 marks)
(b) Write a memo to Sir James Soames recommending improvements in Friar Holdings
arrangements for determining remuneration and remuneration policies.
(10 marks) (Including 2 professional marks)
(c) Discuss how the Allied and Temple bank and other institutional shareholders can increase their
influence over Friar Holdings.
(8 marks)
(d) Construct a case for the board of Friar Holdings taking into account additional stakeholder
interests to those currently being considered, when deciding whether and how to pursue the
proposed new development.
(10 marks) (Including 2 professional marks)
(Total = 40 marks)
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Required
As a consultant, prepare a report on this proposal for the Board. In your report:
(a) Explain, using examples of the statements found in ethical codes, the ways in which a code of
conduct can help to change organisational culture and encourage ethical behaviour. (7 marks)
(b) Advise the board on the steps that should be taken to enforce the code.
(6 marks)
(c) Recommend any other changes, including possible control systems, that may be needed to
achieve the Chairman's aims.
(7 marks)
(Total = 20 marks)
Question 4
Question text
'The Enron debacle is the latest reminder of the perniciousness of a business elite. Directors of Enron
made a huge amount of money from cooking the books and roasting the accounts. Non-executive
directors were the pals of directors, hired to put up the appearance of corporate accountability to
stakeholders, and collecting hefty fees for an odd day's work'. (Austin Mitchell MP, May 2002)
Required
(a) Explain the role of non-executive directors in the corporate governance of a listed company.
(7 marks)
(b) Discuss the potential problems associated with this role and suggest ways in which these may be
avoided.
(8 marks)
Hammond Transport plc is shortly to seek a stock exchange listing and as a consequence is
improving its corporate governance. One step it is taking is setting up an audit committee. The
directors are currently interviewing potential non-executive directors and has been asking them their
views of what the responsibilities of non-executive directors and the audit committee should be.
Applicant 1 stated that she had read Austin Mitchell's views and fully agreed with them. In her opinion
non-executive directors were 'guardian angels' and as a result they should adopt an
uncompromisingly ethical approach to all their duties, particularly their work on the audit committee.
Applicant 2 stated that Austin Mitchell's views were good for quick quotes in the press. However 'in
the real world' away from politics, non-executive directors had to be primarily responsible for
promoting the company's interests the job of directors was to direct the company towards
maximising its profits. The bigger the profits, the greater the benefits to more people. The financial
and opportunity costs of setting up the audit committee were only worthwhile if it could demonstrate its
recommendations had produced clear benefits.
Required
(c) Analyse the applicants' views on the responsibilities of the audit committee using the
deontological and utilitarian views of ethics.
(5 marks)
(Total = 20 marks)
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