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Cacique Inc P1 Professional Accountant Revison Pack 2008 Section One- Revision Notes Active – seek to participate in organisation’s activities (mangers, shareholders, regulators, pressure group) Passive – don’t’ seek to participate in policy-making (shareholders, local communities, government Duties of Directors Corporate governance guidelines reinforce legal judiciary duties to act in company’s best interest use powers for proper purpose, avoid conflicts interest and exercise duty of care. Board of Composition To avoid domination by single/small group of executive directors. Accounting and Auditing Foster transparency and reliability of account increasing investor risks. Tougher auditing standards and requirements for auditors to avoid contact of interest. Directors being paid undeserved and excessive remuneration and bonuses. Allegations that directors have been rewarded for making losses. Board Supervision Need for board to meet regularly to consider effectively organisation’s activities, risks and control systems. Corporate Social Responsibility Builds on stakeholders’ debate what responsibilities should organization and board fulfil. APPROACHES TO CORPORATE GOVERNACE Principles-Based Approach Most corporate governance codes have been drawn up on the basis of a principles-based approach with broad guidance supplemented by limited specific requirements. Dander may be that over- broad principles are not strong enough. Insider Systems 1

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Page 1: REvision Pack 08-Questions and Answers

Cacique IncP1 Professional Accountant

Revison Pack 2008 Section One- Revision NotesActive – seek to participate in organisation’s activities (mangers, shareholders, regulators, pressure group)

Passive – don’t’ seek to participate in policy-making (shareholders, local communities, government

Duties of Directors

Corporate governance guidelines reinforce legal judiciary duties to act in company’s best interest use powers for proper purpose, avoid conflicts interest and exercise duty of care.

Board of Composition

To avoid domination by single/small group of executive directors.

Accounting and Auditing

Foster transparency and reliability of account increasing investor risks. Tougher auditing standards and requirements for auditors to avoid contact of interest.

Directors being paid undeserved and excessive remuneration and bonuses.  Allegations that directors have been rewarded for making losses.

Board Supervision

Need for board to meet regularly to consider effectively organisation’s activities, risks and control systems.

Corporate Social Responsibility

Builds on stakeholders’ debate what responsibilities should organization and board fulfil.

APPROACHES TO CORPORATE GOVERNACE

Principles-Based Approach

Most corporate governance codes have been drawn up on the basis of a principles-based approach with broad guidance supplemented by limited specific requirements. Dander may be that over-broad principles are not strong enough.

Insider Systems

Most companies listed on stock exchange are controlled by a few individuals.

Advantages/Disadvantages

Strong owner-manager links Longer-term view Discrimination v minority Lack of monitoring/governance

Robust governance regime Hostile takeover threat constrains management Agency problems Short-term priorities

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Revison Pack 2008

Advantages of Principles

Avoids inflexible rulesLess burdensomeAllows scope for developmentComply or explainEmphasis on investor judgement

Outsider Systems

Shareholdings are widely dispersed, manager/owner separation

Governance Development

Internationalisation Investor Treatment Openness Integrity Accountability Financial Reporting Weakness Corporate scandals Individual Country Charteristics

Cadbury Report

Aims to address weakness in director-auditor arrangements particularly perception that auditors often capitulate to director. Code of best practice covers role of the board, audit financial reporting and shareholder relations.

Greenbury Report

Executive determine executive directors’ remuneration and service contracts limited to one year

Hampel Report

Principles-based approach requiring companies to comply with or explain department from best practice.

Combined Code

Code derives from Cadbury, Greenbury and Hampel reports, supplemented by:

Turnbull report – risk and internal control Smith report – audit committees Higgs report – non-executive directors

King ReportSouth African report advocating integrated approach to variety of stakeholders and importance of social and environmental as well as economic activities. Report emphasizes need for shareholder activism and disclosure ad regulatory measure.

OCED Principles

Organisation for Economic Co-operation and Development produced non-building principles to address the interests of global investors. Companies should work towards achieving principles, and principles are guidelines for individuals countries to develop own codes.

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Revison Pack 2008Principles

Shareholders participation and voting on directors Shareholders/stakeholder rights Equitable treatment of all shareholders Stakeholders treatment of all shareholders Stakeholders rights protected Timely/accurate disclosure of material matters Board responsible for strategy and monitoring Board should act with due diligence and in company’s best interests

International Corporate Governance network has provided practical guidance for boards to operate efficiently and complete for scare capital.

ICGN Guidance Board’s role in strategy/monitoring emphasized Directors need appropriate shills/experience Directors show independence judgement Directors fulfil fiduciary duties Formal process of director evaluation Shareholders’ voting rights protected Major changes require shareholder approval Returns benchmarked v similar equity coast Full disclosure of voting rights Code of ethics Need to manage stakeholder relationships productively

Sarbanes-Oxley

The Sarbanes-oxley act was response to the collapse od enron, on of America’s biggest companies. The act is more prescriptive than codes in other jurisdictions, impacting on disclosures, audits, ethics and directors’ share trading.

Auditing

The non-audit services auditors can provide are significantly restricted and auditots are subject to various other rules.

Compulsory partner rotation Retention of audit papers Quality control standard Review internal control systems

Weaknesses at Enron

Lack of transparency in accounts Non-executive directors weak Lack of external audit scrutiny Directors’ use of inside information Dishonesty and law-breaking

Corporate Responsibility

Chief executive/chief finance officer certify

Appropriateness of accounts

Accounts fairly reflect operations and financial condition

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Revison Pack 2008If account have to restated the forfeit their bonuses.

Audit Committees

Every listed company should have an audit committee consisting of independent directors, with member(s) with that financial expertise. Audit committee should be responsible for:

Appointment compensation and oversight of auditors Discussing key accounting policies with auditors Setting up complaints mechanisms

Employee/auditors will be grated whistle-blowing protection if they disclose private employer information to parties involved in a fraud claim

Internal Control Report

Annual accounts must contain internal control reports:

State management responsibility for control structure/financial reporting procedures Assess effectiveness of control structure/financial reporting procedures (with audit report) State whether code of conduct for senior financial officers has been adopted

There should be appropriate disclosure of material off-balance sheet transactions.

Contribution of Codes Hightlighted advantages of good corporate governance Emphasised key dangers Provided benchmarks Promoted good Practice Emphasised accountability Stresses transparency

Carroll’s Model

Four levels of responsibility

Economic – shareholders/employees/customers Legal – comply with laws Ethical – act in fair and just way Philanthropic – generosity to employees/community

Corporate Citizenship

CSR debate often framed in terms of what constitutes good citizenship Limited – voluntary philanthrophy Equivalent – focus on broad stakeholder base Extended – organizations respect and promote social civil political rights

Impact of CSR

Objectives Mission statements Ethical codes Governance codes Stakeholder board representation Corporate social reporting

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Revison Pack 2008

Ownership Responsibilities

By buying shares, shareholders buy a responsibility to ensure that company is managed in ways consistent with public welfare. Ownership responsibilities of institutional shareholders have been stressed institutional shareholders’ large % shareholdings meaning they should be actively involved and pressure managers.

Ownership View Problems

Shareholders with small % holdings aren’t influential Shareholders can easily dispose of shares and this loosens feelings of obligation

Economic self-interest and allocative efficiency ensure maximum economic growth and hence maximum social welfare. CSR concepts diminish growth and hence welfare.

CSR is too focused on what organizations wish to disclose in accounts and emphasizes too narrow a range of stakeholders. CSR operates within existing framework; fundamental structural changes is needed.

CORPORATE GOVERNANCE PRACTICE AND REPORTING

Corporate governance practice is a key are in this syllabus, and you can expect many questions on whether an organization is following good practice.

Scope of Board’s Role

The board should have a formal schedule of matters reserved to it for decisions. Board is also responsible for overseeing strategy, monitoring risk control systems and management, and ensuring effective communication.

Nomination of Directors

Nomination committee should oversee appointments and make recommendation to the board. Needs to consider: Executives/non-executives Gaps in current board’s skills Expanding board diversity Continuity and succession planning

Matters for Board Decision

Mergers and takeovers Acquisitions/disposals of major assets Investments Capital projects Loans/borrowing facilities Major foreign currency transactions

Legal and Regulatory Frameworks

Legal responsibilities Avoidance of conflict of interest Time limits on appointments Limits on service contracts Departures from office Insider dealing

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Revison Pack 2008CPD and Appraisals

All board members should have training covering strategy, management, legal responsibilities and company related issues.There should be annual appraisals of performance of the whole board and of individual directors.

Multi-tier Boards

Companies in some countries are run by two or more boards often with supervisory/management role split.

Board Appraisal

Performance against objectives Contribution to strategy/environment Response to problems Considering right matters Communications Effectiveness of board committees Quality of feedback Adequacy of decision-making

Advantages Multi-tier Boards

Supervisors/supervised separation Deters management fraud Better links with stakeholders Better use of non-executive time

Disadvantages Multi-tier Boards

Lack of accountability Don’t receive information from managers Supervisory board decision-making restricted Less effective at questioning managers

Board Membership

Companies need to consider optimum size balance executive and non-executive directors and diversity of membership.

Board committee supervise specific areas doesn’t absolve main board from overall responsibilities. Key committees

o Nomination o Internal audit o Remuneration o Risk management

Division of Responsibilities

No-one individual should have unfettered control. Ideally chairman and chief executive should be different people; if not there should be a strong independent element on the board with a recognized senior member.

Responsibilities of Chairman

Running board Accurate board information Effective shareholder communication New director induction Board appraisal

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Revison Pack 2008 Board development

Responsibilities of CEO

Strategic development Investment analysis Risk management Recommendations to board committee

Non-Executives (NEDs)

NEDs have no executive (managerial) responsibilities. They should provide balance and help to reduce conflict between executive directors and shareholders. The majority of non-executive directors should be independent.

Number of NRDs

USA-NEDs majority on board, others – sufficient NEDs for views to carry significant weight.

Independence of NEDs

No business/financial/other connection No share options/pensions Appointment for specific term Ability to take independence advice

Advantages of NEDs

External experience and knowledge Wider perspective Comfort for investors Confidant/enabler Board members but objectives

Disadvantages of NEDs

Independence Restricted recruitment Difficult to impose views Can’s prevent problems Limited time

Principles

UK’s Greenbury committee suggests:-

Directors remuneration set by independent board members Bonuses related to measurable performance/enhanced shareholder value Full transparency in annual accounts

Remuneration Committee

Committee of independent NEDs determing. Remuneration policy Specific remuneration packages

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Revison Pack 2008Remuneration Statement

Consider and disclose:-

Remuneration policy Arrangements for individual directors Consider allowing members to vote on remuneration statement in account.

Service Contracts

It serve contracts are too long premature termination may mean significant payments. Serve contracts should be 12 months normally.

Elements of Remuneration Package

Basic salary – in contract of employmentPerformance-related bonuses – limited possibly to maximum % of pay, shouldn’t be given for transactions?Shares – granted on condition can’t be soldShare options – purchased at specific exercise price, encouragement to improve company’s performance and hence share prices options (and shares) to be held for certain length of timeBenefits-in-kind – is cost excessive and how comparable are they with what employees are givenPensions – best practice to make only basic salary pensionable

Facts Affecting Remuneration Levels

Need to attract directors Interest of shareholders Weighting and phasing of different parts of package Director/manager differentials Impact of director/manager resigning Performance measures

Performance measures

Variety of financial/non-financial measures Focus on current performance Avoid short-termism Reward individual effort

Relationship With Shareholder

Directors should be held accountable by requiring them to submit to regular re-election (every three years). Boards should consider relationships with all shareholders, particular institutional shareholders.

Myners report addresses problems with administering proxy votes and misuse of proxy votes. Recommends

Clear agreements between beneficial owners and investments managers Stock lending shouldn’t happen Electronic voting Poll (including proxies) for all general meeting resolutions.

Relationship With Stakeholders

OECD stresses role of:-

Employees Creditors

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Revison Pack 2008 Suppliers Investors Government

Position of Stakeholders should be:-

Protected by law Enhanced by participation (eg employees share ownership, profit sharing arrangements seat on board)

Notice 20 days Business Question andBefore presentation answer sessions

General Meetings

Shareholders vote on Shareholders vote onSubstantially separate report and accounts

Reporting

London Stock Exchange requires:-

Narrative statement of how principles in combined Code have been applies Statement of compliance/details of reasons for non compliance

Voluntary Disclosure

Disclosures above statutory/best practice minimum disclosures should follow certain principles

Planned process Transparency in disclosures made Consultation with users All relevant information considered Disclosure subject to review

Major Disclosures

Board composition, directors, NEDs evaluation of board performance Committee reports Relations with auditors and shareholders Review of internal controls Going concern Sustainability reporting OFR

INTERNAL CONTROL SYSTEMS

Elements of Control Systems

Plan/Target/Objective – what system designed to achieve Sensor – detects control system behaviour Inputs/Processes/Outputs – main stages of operations Comparator – compares actual behaviour with plan Effector – enacts control action to change system behaviour

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Revison Pack 2008Cyberntic Control System

Process of control within system

Identification of system objectives Setting targets for systems objectives Measuring system achievements/outputs Comparing achievements with targets Identify corrective action Implementing corrective action

Control Systems and Risks

Objectives                                          Ability to reduce risks Nature/extent of risks                        Costs/benefits of controls Acceptable risks                                 Changes in risk conditions Likelihood risks materialize

Characteristics of Control Systems

Ease of target achievement                  Consistency of measures Qualitative quantitative measures      Management intervention Short/long-term measures                  Automatic control mechanisms Reliance on social relationship

Control Framework

              Control Environment                        Control Procedures

Features of Controls Facilitate effective and efficient operation Appropriate response to risks (safeguarding of assets, liability management) Ensure quality of reporting (maintenance of records, generation of relevant information) Ensure compliance with laws and regulations Embedded in operations Form part of culture Capable of quick response

Assurance From Internal Controls

Internal controls can only provide reasonable assurance that management objectives will be achieved, because of their limitation.

Limitation of Controls

Costs can’t outweigh benefits Human error Employee collusion Fraud Management bypass/over-ride Only cope with routine transaction Dependent on data processing

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Revison Pack 2008 Can’t deal with external environmental factors

Benefits of Controls

Benefits may be financial (less costs)Benefits may be non-financial (efficiency and effectiveness improvements, less internal audit resources required)

Costs of Controls

Costs include direct costs (salary) opportunity costs (time) and perhaps reduced flexibility, responsiveness and creativity.

Benefits V Costs

Difficult to estimate risk exposure Difficult to estimate impact of controls Comparison of financial costs v non-financial benefits

Control Environment

The control environment is the attitude, awareness and actions of management in relation to internal controls.

Signature of Control Environment

The control environment provides the background for the operation of other controls. It is significant element in control system effectiveness.

Elements of Control Environment

Management’s philosophy and operating style Organizational structure Methods of imposing control Integrity, ethical values and competence

Strong Control Environment

Clear risk management strategies Culture/code of conduct/HRM/reward systems support objectives and risk limitation Senior management commitment to competence, integrity and trust Clear authority and responsibility Communication procedures Staff have knowledge, skills and tools

Classification of Control

Corporate are general policy, culture, values overall monitoring Management include planning, performance monitoring, risk evaluation Administrative include organization structure, authority and reporting lines communication channels Accounting are recording of transactions and safeguarding records, transactions and assets Prevent stop errors, happening including checks of documentation before payment/deliveries made Detect pick up errors Correct minimize or negate errors eg back-up Non-discretionary can’t be bypassed General relate to environment

Types of Control Procedure

Approval and control of documents Controls over computerized applications and IT environment

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Revison Pack 2008 Checking arithmetical accuracy Control accounts Trial balances Reconciliations Physical counts Comparing internal and external data Limiting direct physical access

INTERNAL AUDIT

Internal audit is an independent appraisal activity established within an organization which examines and evaluate the adequacy and effectiveness of other controls.

Need For Internal Audit

Need will depend on complexity of activities, number of employees, also cost-benefits considerations. Necessary when:

Changes in organization structure Changes in key risks Problems with internal control systems Increased number of unexplained or unacceptable events

Objectives depends on information and recommendation required by organization.

Internal Audit Areas

Accounting and internal control systems Financial and opening information Economy, efficiency and effectiveness Compliance with laws and regulations Safeguarding of assets Implementation of organization’s objectives Risk identification and management Special investigations

Business Risks Risk Risk appetiteObjectives crystallisation

Internal Audit Assessment

Adequate risk Risk Internal Risk managementManagement/ management/ controls processesResponse control culture

INDEPENDENCE

IA should be independent of activities and management being audited

Threats To Independence

Threats include involvement in systems design and consultancy, familiarity with other staff and reporting to finance director whose activities are being audited.

Dealing With Threats

IA staff don’t audit their previous departments

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Revison Pack 2008 IA staff don’t audit systems they designed Unrestricted access to records, staff personnel Rotation of IA staff

Appraisal of Internal Audit Objectivity

Impartiality

Unbiased views

Valid opinion

Access to all areas

Relevant skills

Audit senior managers

External Audit

External audit is a periodic examination of the books of account and records of an entity carried out by an independent third party to ensure they have been properly maintained, are accurate and comply with established concepts, principle, accounting standard, legal requirements and give a true and fair view.

Distinction Between Internal And External Audit

Reason Relating To Reason

Internal An activity designed to add value and improve an organisation’s operations. Reposts to management.

Internal audit’s work relates to the operations of the organization.

Internal auditors are very often employees of the organization, although sometimes the internal audit function is outsourced.

External An exercise to enable auditors to express an opinion in the financial statements. Reports to shareholders.

External audit’s work relates to the financial statements. They are concerned with the financial records that underline these

External auditors are independent of the company and its management. They are appointed by the shareholders.

STANDARDS AND REVIEWProfessional ProficiencyThis includes using staff with sufficient knowledge and experience, compliance with professional standards, proper supervision and due care.

Scope of WorkAuditors should assess adequacy of controls, quality of performance, compliance of regulations and standards, asset safeguarding, VFM.

Audit performanceProper structuring of audit work including planning, examination, reporting and follow-up.

ManagementIA should have mission statement, written policies, personnel development, co-ordination with external audit and quality assurance system.

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Revison Pack 2008IA should report to audit committee not finance director and be independent of line management. Auditors should not work their own work.

AuthorityIA should have unrestricted assess to documents and personnel, be capable of handling sensitive issues and communication well.

Quality ControlQuality control procedure should ensure work conducted in accordance with internal standards; formal quality assurance system should be in place.Scope

Organisation’s aims Flexibility Key areas covered

Independence Adequate safeguards Reporting to audit committee No operational/consultancy responsibilities?

Annual ReviewsBoard/IA committee should conduct an annual review covering scope, authority and independence and resources.Authority

Terms of reference Senior staff support Findings actioned

Resources Time Computers Knowledge, skills and experience

INTERNAL AUDIT COMMITTEERole of internal audit committee

Improve quality of financial reporting Create climate of control Enable NEDs to pay positive role Help finance director Strengthen position and independence of external auditors Increase public confidence

Audit committee should consist of independent non-executive directors and should include member(s) with significant and recent financial experience.

Duties of internal audit committee Review of financial statements including changes in policies, judgement areas, compliance. Relationship with external auditors including appointment/removal, independence, scope, liaison. Review of internal audit including standards, scope, resources, reporting, work plans, liaison with external auditors, results. Review of internal control including systems adequacy, legal compliance, fraud risk, auditors reports, disclosures Review of risk management Investigations

NATURE OF RISKSClassificationFundamental – affects society in generalParticular – individual in controlSpeculative – good or bad consequencesPure – only outcomes harmful

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Revison Pack 2008Certainty means possible outcomes and/or chances of each occurring are unknown.

Risk and returnBusinesses may tolerate higher risk levels provided they can receive a higher return. Value driver analysis identifies risk-return links.Benefits of risk management

Predictability of Cash flows Limitation of effects of bad events Increased shareholder confidence Weigh costs

Corporate governance reports aims to address shareholder concerns that directors are not achieving adequate returns for risks incurred and provide mechanisms for controlling directors who are taking excessive risks. Directors’ responsibility for monitoring and disclosing risk management is stressed.

STRATEGIC RISKSFundamental risks to organisation’s profits/existence arising from the sector its in and the nature of what it does. Strategic risks arises out of decisions about resources, products, acquisitions and investments.Factors affecting strategic risks

Stakeholders State of economy Nature of industry/market Level of competition Availability/Price of resources Flexibility of production Ability to innovate/R&D Stage of product life cycle.

OPERATIONAL RISKS

Risks of loss from failures in internal business and control processes.Examples :- IT Failure Human error

Loss of key staffFraudBusiness interruptionInternal audit weaknesses

FINANCIAL RISKSThreats to organisation’s continued existence through lack of available funds.Examples: Inappropriate gearing structure

Lack of long-term capitalFraud and misuse of fundsCurrency, interest and market riskCredit and liquidity risk.

Legal and Political risksLegal risk includes fines or threats of closedown, or incurring cost to fight legal actions. Political risk is the risk that political action will affect position and value of the organization. Examples include quotas, tariffs, exchange controls and nationalization.Environmental Risks Risk of loss to business arising out of environmental effects of operations. Organistaions could suffer fines, bad publicity, non-co-operation. Risks include pollution and disruption to local community through traffic organization generates.Technological RisksRisks of loss to the organisation through inadequacy of, or disruption to, its IT systems and resources.

Examples of Technological risks Physical damages through fire/flood/adverse weather Human sabotage Accidental disruption

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Revison Pack 2008 Human error Malfunctioning hardware/software Dishonest use of system Viruses and hacking .

Health and Safety risksRisks include loss of employees’ time because of injury and having to pay compensation or legal costs due to breaches. Risks arises because of lack of policy, poor culture, lack of emergency procedures, failure to deal with hazards.

TYPES OF RISKSFraud risksRisk of loss through fraudulent activities of employees or managers. Fraud risks are often increased by poor corporate governance procedure, allowing senior staff to commit fraud because mechanisms to challenge their behaviour are ineffective.Signs of fraud risks

Questionable management integrity/competence Excessive financial reporting pressure Poorly designed systems Unusual transactions or trends Problems in obtaining sufficient appropriate audit evidence Problems with IT systems

Property risks Rsik from damage, distruction or theft of property. Dangers include fire, wind, water leakage and vandalism.Disruption RisksRisk of disruption to operations caused by IT failures, employee problems, supplier loss, legal action.Resource Wastage risksRisks include incurring excessive costs (poor procurement) or waste of employees’ time and resources.Trading risksRisks of disruption in the course of trade.Types of trading risks

- Physical – risk of goods being lost or stolen in transit, or documentation going astray.- Trade – risk of customer refusing to accept goods or cancellation of order in transit- Liquidity – risk of being unable to finance the organization’s activities.

Product risksRisk to financial loss due to producing a poor quality product. These include

Need to compensate dissatisfied customers Possible loss of sale Need for expenditure on quality control procedures

Organisational RisksRisks that members/employees of an organization will behave in ways detrimental to the organization, e.g. Failure to adapt to change.

Reputation riskReputation risk is a loss of reputation resulting from adverse consequences of another risk.

RISK ANALYSIS

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Crystallization of risks

Poor customer service

Poor ethicsFailure to innovate

POOR REPUTATION

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Revison Pack 2008

Risk identificationNeed to know whether likely perils are present and be aware of possibility of unlikely risks.Risk condition identification

Physical inspection Enquires Brainstorming Checklists Benchmarking

Risks AssessmentDifficult to forecast financial effects of disaster, particularly to include all likely costs arising.Event identification

External events of economic conditions Internal events e.g. human error Conditions resulting in risks Trends and root causes Event interdependencies

Risk ProfilingUse likelihood/consequences matrix as basis for setting priorities for risk management.

Consequences

L Low HighIK LowEL Loss of Suppliers Loss of key customersI Failure of computer systemsH

Loss of lower-level staff Loss of senior or specialist staffO Loss of sales to competitorO Loss of sales due to macroeconomic D factors

High

Risk quantification

Needs an idea of possible result of losses, together with distributions and confidence limits.

Key calculations Average or expected result or loss Frequency of losses Chances of losses Largest predictable loss

Risk ConsolidationNeed to aggregate at organization level risks identified and quantified at corporate level.

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SHAREHOLDERS AND RISKS

Shareholders R - Dividend impact

I - Capital gain impact

Debt Providers S - Dependent on their risk appetite

K - Threat to repayment- Security imposed

- Job threatsEmployees C - Health and Safety

O - Ability to take action

N - Losses on Slaes

Suplliers C - Unwiling credit suppliers

E - Disruption of relationships

Customers R - Delivery failures

N - Lack of Value

S - Poor qualityWider Community - Poor employment policies

- Adverse impact on the environment

Risk AttributesPersonal Views –emotional SatisfactionNational Influences- Govt ProtectionRisk Attitudes-Shareholder RequirementsOrganizational Influences – Size Structure, Development and Past ExperienceCultural Influences - Fatalists (No Control)

- Hierarchist (formal procedures)- Individualist (wish to control) - Egalitarian( Sharing /Transfer)

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Revison Pack 2008Risk Thermostat

Perceptual filters-  

Egalitarians “If you can’t prove it is safe assume it is dangerous”

Individualists “If you can’t prove it is dangerous assume it is safe”

Fatalist …buys a lottery ticket yet ducks if something is going to hit him, feels little control and low expectations

Hierarchists …view risk as a scientifically manageable problem

Enterprise Risk ManagementA framework suggested by COSO for dealing with risk – a process operated at organization level that helps staff understand risks, responsibilities and authority levels. ERM should

- Apply in strategy- Apply ion all areas - Identify events affecting entity- Manage risk according to the risk appetite- Provide reasonable assurance- Support organizational objectives

Elements of ERM Control activates/environment Objective setting Event information Risk assessment /response Information and communication Monitoring

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Revison Pack 2008Benefits of ERM

Align risks appetite with strategy Link growth , risk and return Chose best risk response Minimize surprises and losses Manage risk over whole origination Allow organization to seize opportunities

CIMA’s Risk Management cycleRisk AwarenessEmbedding Risk AwarenessRisk Assessment should evolve into a consistent activity embedded across all processes rather than being separate and stand alone. Focus needs to be on:

- Threats to shareholders/ stakeholders- Consistent action –oriented risk assessment

Risk Register - ?Risk control environment

o Risk Management philosophyo Risk appetiteo Integrityo Ethicso Organizational environment

Risk Policy Statemento Definitions and Objectiveso Regulatory Requirementso Links to strategic decision making’o Key areaso Risk classificationo Risk Responsibilitieso Important Controlso Assurance Reportingo Training

Risks CultureMiles and SnowStrategic cultures:

o Defenders- Low risks, secure marketso Prospectors- Results, therefore riskso Analyzers-Balance Risks and profitso Reactors-Muddle along

Deal and KennedyLevels of risk and feedback

o Process- Low risk and no feedback( bureaucracies)o Work Hard, Play Hard- Low risk, rapid feedback( customer service)o Bet Your company- high risk, long-term decisions (R&D)o Tough guy, macho culture-High risk, rapid feedback(financial services, team sports)

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Revison Pack 2008HandyRoles and authorityPower- power in a few handsRole-delegated authorities within defined structureTask-power from expertise and problem solvingPerson- focus on individual talentChanging a culture

Internal communications programme Training Involvement in risk identification Incentives Key personnel persuasion Infrastructure

Risk Management and ResponsibilitiesBoard- determines risk management strategy and monitors overall risks, sets and reviews internal controlSenior Mangers- Build on board’s overall framework, specifying risk management methods and coordinate responsesInternal Audit- Audit risk management/key risk area controls.External audit- Audit risk areas that impact materially on financial statementsLine Managers- Indentify and evaluate risks in their areas, use performance indicators for monitoring, implement responsesStaff- Follow risk management procedures have good understaffing, report dangersRisk Management Committee-responsible for monitoring and supervising risk identification and management- can be staffed by EDs- allows audit committee to concentrate on financial risksRole of RM Committee

Approve RM Strategy Review reports of risks Monitor overall exposure Monitor changes in circumstances Access effectiveness of RM systems Review statement on internal control

Role of RM function Helping to determine RM strategies Champions of RM Building a risk awareness culture Establishing risk policies and structures Developing and reviewing RM processes Coordinating functional responses Preparing report for BOD/shareholders

Response to Risks Likelihood/consequences Matrix

Information Requirements and Reporting

Directors’ Information requirements

Directors need information about risks linked to achievement of organization’s objective andControl mechanisms that should respond to changes in business environment.

Directors should:

Compare different sources of data21

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Revison Pack 2008 Consider adequacy of communication channels Provide feedback Review management/information systems

Communication of policies

Trunbull report recommends policies are communicated in following areas:

Customer relations Service levels Health, safety and environment Asset security and business continuity Expenditure Accounting, financial and other reporting

Communication methods

Guidance from chief executive Circulation of risk policies Staff involvement in policy development Workshops and training Wistleblowing procedures

Review of Internal controls

Risks

Strategic Consequences

Risk Assessmento Clear objectiveso Assessment of o Significant riskso Acceptable riskso understood

Identifying, Evaluating and managing risksControl Environment/activities

o Risk management policyo Effective cultureo Senior managemento Commitmento Clear authority lineso Communication

Control system effectivenessInformation and Communication

o Quality of reportso Changing information needso Balanced reporting?o Whistle blowing channels

Actions to reduce risk

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Revison Pack 2008Need for more monitoringMonitoring

o Effective processeso Flexibilityo Follow-upo Significant event

Annual review of controlsReview should be wider-ranging than normal review covering:

Changes in risks faced Changes in organization’s ability to respond to risks Scope and quality of management’s monitoring of risk and internal control Work of/need for internal audit Extent and frequency of reports to board Significant controls, failings and weaknesses

Reporting on risk managementBoard should disclose existence of process for managing risks; ho the board reviewed the effectiveness of the process and whether the process accords with the Turnbull guidance

Contents of report Responsibility for internal control Responsibility for review of effectiveness System provides reasonable assurance v loss Summary of review Process for dealing with problems Weaknesses resulting in material losses

Ethics and the public interest

Lack of objective standardsNon-cognitivism – no possibility of acquiring objective knowledge of moral principlesMoral relativism – right and wrong are culturally determined

Teleological ethicsMoral judgments based on outcomes or consequences. Utilitarianism means acting for the greatest good to the greatest number.Objective standardsCognitivism - objective, universal principles exist and can be known, ethics can be regarded as absolute

Kant stated that acts can be judged in advance by moral criteria Do as you would be done by Treat people as autonomous beings and not as means to an end. Act as if acting in accordance with universal laws

Egoism

Act is ethically justified if decision-makers pursue short-term desires or long-term interests (justification for free market)Pluralism

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Revison Pack 2008Different views may exist but it should be possible to reach a consensus; morality is a social phenomenon/.

National and cultural beliefso Differences lie in four main areaso Role of individual v collective goodo Acceptance of power distributiono Desire to avoid uncertaintyoo Masculinity v femininity (money/possessions v people/relationships

Psychological factorsFocus is on how people think and how they decide what is morally right and wrong.

Focus on controlo How much influence individuals believe they have over their own liveso Internal individuals have significance influenceo External individual live lives shaped/circumstances

MoralityActions are influenced not only by people’s own integrity but also how much awareness they have of their actions’ moral consequences

Moral DevelopmentKohlberg’s three levels

1. Ethics determined by rewards/punishments2. Ethics determined by others’ expectations3. Individual makes own ethical decisions

Moral IntensityCan be used to decide how ethically significant an issue is.

Criteria Magnitude of consequences Society’s view of problem Probability of effect Speed consequences will occur Nearness of those affected Level of suffering of those affected

Moral Framing

How issues are perceived in organizations. Use of language can be important (fairness/honesty) but also significant is the degree to which managers are willing to frame issues in moral terms

Organizational culture Basic assumptions that define organization’s view of itself and It’s environment Components of organizational culture

Values

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Revison Pack 2008 Beliefs Behaviors Taken for granted assumptions

Systems of rewardEthical positions can be affected for better or worse by remuneration.

o Basics of reward may encourage undesirable practices.o Failing to reward/punishing ethical behavior may deter it.

AuthorityManager’s can encourage good or bad behavior by the example they set whether they set targets that encourage poor behavior or fail to stop unethical behavior.Work RolesThe work role individuals have will determine what they believe to be ethical

BureaucracyA system including detailed rules and procedures that underpins reward and authority systems.Bureaucracy characteristics

Rules override individual beliefs Morality in terms of following procedures Distancing individuals from consequences Denial if individual moral status

Organizational field

Organizations share a common business environment and hence common norms and values.

Ethical Stance

Short Term Shareholder InterestMinimum complianceGov’t imposes wider constraints

Long Term Shareholder Interest Wider view of ethical responses Better for reputation Prevents more legal regulation

Multiple Stakeholder Building relationships Which stakeholders? Which obligations?

Shaper of Society Constitution requirements Accountability Financial Viability

Social Responsibility

Prime Capitalist- Private Property rights paramount ,companies exist to ,make profits and achieve economic efficiency

Expedients- Acknowledgment of business excesses, acceptance of limited social and moral responsibilities25

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Social contract problems- Survival depends on delivery of benefits to society/groups that determine its power, behavior .adheres to society norms

Social ecologists- modification needed of economic processes , resulting in resource exhaustion, waste, pollution

Socialists-Society’s framework should promote equality , not requirements of capitalism

Radical feminists-Need for emphasis on feminine vales such as cooperation, reflection, fundamental readjustment of society required.

Deep ecologists -Human rights to existence don’t exceed other species rights. Economic systems should not trade species for economic survival

Public interestThe collective well-being of the community of people and institutions the accountant serves. But lack of statutory definition can make it difficult to enforce.Critics have claimed profession acts against public interest in a number of ways.

Against public interest Accounting standards allow excessive leeway Ineffective auditing standards Emphasize confidentiality over public interest

ProfessionalismCompliance with relevant laws and regulations, and avoidance of actions that may bring discredit on society.

Influence of professionCritics have accused the profession of Getting the numbers wrong Failing to realize the assumptions used in preparing accounts support a capitalist authoritarian view of society.

Ethics and professional practiceCode of conduct

Code sets out expectations of ways employees will behave.However, issuing a code isn’t enough; the code needs to be backed by:

Commitment of senior management Staff understanding of importance of ethics Staff commitment to ethics

Contents of codes Ethical principles Commitment required from employees Compliance with law Treatment of customers Treatment of suppliers Commitment to fair competition Commitment to environment Commitment to community Corporate citizenship

Other measures

Detailed guidance

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Revison Pack 2008 Recruitment /Selection/Induction Training Reward schemes Whistle-blowing procedures Ethical departments/audits

Problems with codesCodes may be seen as inflexible and under sets of rules that are not relevant to the ethical situations employees encounter

Professional CodesProfessional codes stress the importance of the public interest. Most then set out:

Fundamental principles Conceptual framework Threats to compliance Safeguards

Fundamental principlesIntegrity – straightforwardness/honesty

Objectivity – avoid influence by bias/conflicts of interest/ Undue influence

Professional competence/due care – maintain knowledge/ Comply with standards

Confidentiality – don’t disclose to third parties unless legal/ Professional duly.

Professional behavior – avoid actions discrediting profession

Principles – based codes Onus on active thought Cannot include all dilemmas Avoids over-narrow legalism Good understanding Flexibility for different situations International codes v regional expectations Responsive to change Difficult to enforce legally Can include prohibitions/minimum standards If voluntary, cannot insist on compliance

Threats and Safeguards Self Interest

Self-review Advocacy Familiarity Intimidation Intimidation

Professional safeguards Entry requirements Training requirements CPD requirements Professional standards Professional monitoring Disciplinary procedures External review

Workplace safeguards Peer review Independent consultation Partner/staff rotation Discussion/disclosure to audit committee Reperformance by another firm

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Resolution of ethical problemsFirms should have established policies accountants, should consider:

The facts The ethical issues Related fundamental principles Established internal procedures Alternative public interest

Responsibilities to employer/as professionalsBoth require acting with probity, integrity and due Diligence. May be conflict over confidentiality in Public interest situations and responsibilities to wider Stakeholder base.

Tucker’s model of decision-making

Profitable Right Legal Sustainable Fair

American Accounting Association Facts Best course of action Ethical issues Consequences Norms/principles/ values Decision Alternative courses of action

Independence

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Advocacy threatWhere accountants take client’s part, act as their advocate or will earn fees from client if successful outcome is achieved (contingent fees) Examples include provision of legal service and corporate finance advice.Family threat

Family relationships between client and firm Personal relationships between client and firm Long association with client Recent service with client Future employment with client

Conflicts of interestThese can arise from accountants acting for Clients with whom they are in dispute, e.g. over Quality of work. It can also arise through between two clients for whom accountants are acting

Intimidation threat Close business relationships Family relationships Personal relationships Staff employed by client Litigation

Social and environmental issuesSocial and Environmental ImpactDepletion of natural resources Adverse visual and aural impacts Air and water emissions

Creating conditions leading to acid rain How organizations affect Contribution to climate change

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Revison Pack 2008The environment

Waste DisposalNegative health impacts

Lowering local quality of life

Environmental costsWaste Management, Remediation, Compliance activities, Permit fees, Environmental training, R&D, Maintenance, Legal Costs, Environmental assurance bonds, Environmental certification, Natural resource inputs, Record keeping and reporting

Contingencies Remediation/compensation Future regulatory impacts Essential product improvements Employee health and safety Environmental knowledge acquisition Non-sustainable inputs Impaired assets

Stakeholders and reputation riskIncreasingly stakeholders are aware of environmental impacts and require businesses to do more to deal with them. Being known as a poor corporate citizen can pose a serious reputation risk.SustainabilitySustainability is ensuring that economic Development meets the needs of the Present without compromising the future.

Sustainability for organizations means developing strategies by which an organization only uses resources at rate that can be replenished, and emissions of waste don’t exceed environments ability to absorb themFor whom?

Other species % of current population

In what way Natural/social/economic

How long Availability of raw materials Dependent on climate change

At what cost Presentation Substitution/compensation possible

Strong sustainability Fundamental change in perceptions required Harmony with natural world Sustain all species Continue to pursue economic growth

Weak sustainability Catastrophe prevention Sustaining humanity

Regulate resource usage Maintenance of existing system

Reporting

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Revison Pack 2008The Global Reporting Initiative aims to develop Sustainability Reporting Guidelines for organizations to use when reporting on economic, environmental and social dimensions of their activities, products and services.

Sustainability report Vision and strategy Profile Governance structure and management systems GRI content index Performance indicators

GRI Indicators Direct economic impact – on key stake holders

Environmental – use of natural resources, emissions, transport usage, compliance with standards

Labor practices – employment practices, health and safety, training, diversity Human rights – strategy, non-discrimination, Workers’ rights, low paid labor Society – community contribution, political activities, competitive attitudes

Full cost accountingFull cost accounting ultimately allows the incorporation Of all costs/benefits into accounting equation, including Environmental and social externalities

Environmental ManagementEMASEmphasis on verified improvement and disclosure requirements include

Environmental policy statement On-site environmental review Environmental management system Environmental audits and actions Public environmental statement

ISO ENVIRONMENTAL MANAGEMENT SYSTEMISO standards state that an environmental management should comprise.

Environmental policy statement Assessment of environmental impacts and obligations Management system Internal audits/reports to senior management Compliance declaration

Environmental policy statement A basis for future action based on reliable data and setting specific targets

Internal statement tailored to organizations requirements and mission External charter adoption compliance with objective standards, allows international comparisons

Environmental control systemsControl systems should cover relevant functions and activities

Policy development and objectives Life cycle assessment Compliance Waste and pollution minimization

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Revison Pack 2008 R&D Performance reporting

Social and Environmental Audits

Rationale Consistency with mission of organization

SOCIAL AUDITS

Objectives and priorities

Degree of company action

Social audits can concentrate on a specific decision (disinvestment) or aspects of an organization’s activities (direct impacts upon the local community).

Environmental auditAssesses how organization is safeguarding the environment. It should enhance management control of environmental practice and compliance with internal policies and external reputation.

Types of Audit Environmental impact assessment of major Projects Surveys of organization’s impact SWOT analysis Quality management programme Eco-audit BS7750 compliance Supplier audits

Audit ReviewAuditors will concentrate on a number of aspects of the control environment which impacts upon an organization’s environmental impact.Audit ReviewAuditors will concentrate on a number of aspects of the control environment which impacts upon an organization’s environmental impact.

road knowledge Compliance procedures Environmental information systems Performance targets and review Implementation of previous recommendations True and fair reporting

Audit Work Review of evidence of environmental impact Assessment of environmental policy Detailed testing of adherence to policy

Section Two- Revision Questions

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Revison Pack 2008Q1The board of Worldwide Minerals (WM) was meeting for the last monthly meeting before the publication of the yearendresults. There were two points of discussion on the agenda. First was the discussion of the year-end results;second was the crucial latest minerals reserves report.

WM is a large listed multinational company that deals with natural minerals that are extracted from the ground,processed and sold to a wide range of industrial and construction companies. In order to maintain a consistent supplyof minerals into its principal markets, an essential part of WM’s business strategy is the seeking out of new sourcesand the measurement of known reserves. Investment analysts have often pointed out that WM’s value rests principallyupon the accuracy of its reserve reports as these are the best indicators of future cash flows and earnings. In order tosupport this key part of its strategy, WM has a large and well-funded geological survey department which, accordingto the company website, contains ‘some of the world’s best geologists and minerals scientists’. In its investor relationsliterature, the company claims that:

‘our experts search the earth for mineral reserves and once located, they are carefully measured so that the companycan always report on known reserves. This knowledge underpins market confidence and keeps our customerssupplied with the inventory they need. You can trust our reserve reports – our reputation depends on it!’

At the board meeting, the head of the geological survey department, Ranjana Tyler, reported that there was a problemwith the latest report because one of the major reserve figures had recently been found to be wrong. The mineral inquestion, mallerite, was WM’s largest mineral in volume terms and Ranjana explained that the mallerite reserves ina deep mine in a certain part of the world had been significantly overestimated. She explained that, based on theinterim minerals report, the stock market analysts were expecting WM to announce known mallerite reserves of4·8 billion tonnes. The actual figure was closer to 2·4 billion tonnes. It was agreed that this difference was sufficientto affect WM’s market value, despite the otherwise good results for the past year. Vanda Monroe, the finance director,said that the share price reflects market confidence in future earnings. She said that an announcement of an incorrectestimation like that for mallerite would cause a reduction in share value. More importantly for WM itself, however, itcould undermine confidence in the geological survey department. All agreed that as this was strategically importantfor the company, it was a top priority to deal with this problem.

Ranjana explained how the situation had arisen. The major mallerite mine was in a country new to WM’s operations.The WM engineer at the mine said it was difficult to deal with some local people because, according to the engineer,‘they didn’t like to give us bad news’. The engineer explained that when the mine was found to be smaller thanoriginally thought, he was not told until it was too late to reduce the price paid for the mine. This was embarrassingand it was agreed that it would affect market confidence in WM if it was made public.The board discussed the options open to it. The chairman, who was also a qualified accountant, was Tim Blake. Hebegan by expressing serious concern about the overestimation and then invited the board to express views freely. Gary

Howells, the operations director, said that because disclosing the error to the market would be so damaging, it mightbe best to keep it a secret and hope that new reserves can be found in the near future that will make up for theshortfall. He said that it was unlikely that this concealment would be found out as shareholders trusted WM and theyhad many years of good investor relations to draw on. Vanda Monroe, the finance director, reminded the board thatthe company was bound to certain standards of truthfulness and transparency by its stock market listing. She pointedout that they were constrained by codes of governance and ethics by the stock market and that colleagues should beaware that WM would be in technical breach of these if the incorrect estimation was concealed from investors. Finally,

Martin Chan, the human resources director, said that the error should be disclosed to the investors because he wouldnot want to be deceived if he were an outside investor in the company. He argued that whatever the governance codessaid and whatever the cost in terms of reputation and market value, WM should admit its error and cope withwhatever consequences arose. The WM board contains three non-executive directors and their views were alsoinvited.

At the preliminary results presentation some time later, one analyst, Christina Gonzales, who had become aware ofthe mallerite problem, asked about internal audit and control systems, and whether they were adequate in such areserve-sensitive industry. WM’s chairman, Tim Blake, said that he intended to write a letter to all investors andanalysts in the light of the mallerite problem which he hoped would address some of the issues that Miss Gonzales

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Revison Pack 2008had raised.

Required:(a) Define ‘transparency’ and evaluate its importance as an underlying principle in corporate governance and inrelevant and reliable financial reporting. Your answer should refer to the case as appropriate. (10 marks)

(b) Explain Kohlberg’s three levels of moral development and identify the levels of moral developmentdemonstrated by the contributions of Gary Howells, Vanda Monroe and Martin Chan. (12 marks)

(c) Critically discuss FOUR principal roles of non-executive directors and explain the potential tensions betweenthese roles that WM’s non-executive directors may experience in advising on the disclosure of theoverestimation of the mallerite reserve. (12 marks)

(d) Draft a letter for Tim Blake to send to WM’s investors to include the following:(i) why you believe robust internal controls to be important; and(ii) proposals on how internal systems might be improved in the light of the overestimation of mallerite at WM.Note: four professional marks are available within the marks allocated to requirement (d) for the structure,content, style and layout of the letter.(16 marks)(50 marks)

Q2

SeaShells is a small company operating from an island nearcontinental Europe. SeaShells is a private company with 25 shareholders; its shares are not traded on any stock exchange. However, the board is constituted in accordance with good corporate governance practice with an appropriate balance of executive and non-executive directors. There are also remuneration and audit committees.The main business of SeaShells is packaging of fresh seafood (fish, oysters, crab etc.) and selling these to supermarkets and other retailers. The company employs 150 people, mainly in the packing departments. Packing is labour intensive due to the need to clear and prepare fish etc. by hand prior to packing. Supplies of seafood are obtained from the island's fishing fleet, whose only significant customer is SeaShells. Given that there are only 9,000 living on the island, this makes SeaShells one of the island's major employers. There is some concern that SeaShells' increased demand for seafood is causing over-exploitation of some fish species, and that the population of these fish may "crash" or decrease dramatically in the near future.

In the last few weeks, the directors of SeaShells have decided to transfer almost all of the packaging of seafood to another country. The seafood will be moved by refrigerated ships to this other country, packaged by workers there and then moved back by ship to SeaShells for resale as before. The rationale behind this move is that labour costs are only 1/10`h of the costs on the island. Even taking into account transportation costs, this move will halve the packaging costs of SeaShells. As a result of the move, the workforce will decrease to 35 people. The decision has resulted in significant adverse publicity for SeaShells on the island, although the reaction from customers has been positive as the company can offer reduced prices on many products.

The directors of SeaShells believe that the decision to transfer the packaging of seafood is correct because, as the CEO explained, the decision is "best for the company, best for the shareholders and best for the directors". The comment concerning directors can be justified in terms of directors' remuneration - 75% of the total remuneration package of the directors is based on performance related pay, the main element of this being the net profit of SeaShells. The remaining 25% of remuneration relates to salary and is based on a 3 year contract with SeaShells. Other (non-salary) remuneration includes company contributions to a pension scheme and a share option scheme, with options being exercisable in 5 years based on the share price 1 year ago.

Required

(a) Explain Mendelow's theory of stakeholder power. Identify the stakeholders involved in the decision totransfer packaging

of seafood to another country, and discuss the response of each group to this decision. (14 marks)

(b) Using Gray, Owens and Adams' viewpoints on social responsibility as a framework for your answer, evaluate the decision to transfer packaging seafood to another country. (14 marks)

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Revison Pack 2008(c) Prepare a memo for the board that explains the concept of 'sustainability'', and evaluates the extent to which SeaShells' activities can be considered sustainable and discusses methods of reporting that can be used by SeaShells to explain the environmental impact of its activities.

(d) Discuss corporate governance best practice in terms of directors' remuneration and assess the extent to which remuneration in SeaShells meets these requirements, making any recommendations you consider appropriate. (8 marks)

Q3Pacific Goods is a large retail company, selling a wide range of goods from small household items such as cleaning materials to garden tools and a limited range of gifts and chocolates. The company was founded in the 1800's and now trades in 23 countries with more than 250 stores. The company's image is one of being 'cheap and cheerful' that is staff are always happy to assist customers, although the goods themselves are moderately priced.

Over the past three years, Mr Carson (the CEO) has attempted to take Pacific Goods more 'up-market'. Ranges of cheap goods were discontinued and more expensive items placed on sale. A new company logo and corporate slogan were implemented in an attempt to re-brand the company. The board of Pacific Goods provided Mr Carson with unanimous support, effectively ignoring warnings from some store managers concerning the demographic profile of their customers and how the move would adversely affect that profile.

The risk committee was also concerned that this decision was not fully evaluated. However, the committee was not provided with. the time or information to make an effective evaluation. The committee comprises one non-executive director and three store managers. In terms of corporate governance, Pacific Goods also maintains an appointment committee and an audit committee. Each committee comprises two executive directors and one non-executive director. Mr Beckett, the Chairman of Pacific Goods and a major shareholder, has always maintained that it is important to follow the principles of corporate governance rather than follow rigorous regulations. The fact that Pacific Goods is not a quoted company confirms his belief that it is the 'spirit' of corporate governance only that needs to be followed.

To compliment the new image, Mr Carson required store managers to provide detailed reports on achievement of profit and insisted on downsizing the number of shop staff to achieve an enhanced level of profit. Remaining staff were also required to work longer hours with only minimal pay increases on an annual basis. Store managers were also to refer a range of decisions (although the exact list was never published) to the newly appointed human resources director, the son of Mr Carson. Mr Carson jnr has just graduated from business school and was seen by the board as having all the necessary skills to assist store managers in their difficult task of managing budgets and people. The appointment of Mr Carson jnr was made without the involvement of the appointments committee. Unfortunately, the store managers (rather than the board's optimism) were proved correct and the move upmarket was disastrous. Sales at Pacific Goods have fallen by around 25% in the last two years. Mr Carson (snr and jnr) resigned their positions and the remaining board members are attempting to 'rescue' the company. Mr Beckett collapsed from a heart attack at about the same time and is now convalescing; he does not expect to work for at least six months.

In response to the problems facing the company, the appointment committee has taken the unusual step of appointing Mr Staite to be the company's chairman and CEO. Mr Staite has had significant previous experience in re-focusing corporate strategy; it is the appointment committee's belief that this is the most effective way of ensuring Pacific Goods survives as a going concern over the next few years.

Required (a) Prepare a memorandum for the board explaining what is meant by the term 'control environment' and evaluating the

control environment within Pacific Goods. (14 marks) (including 2 professional marks)

(b) Explain the principles-based approach to corporate governance, describing the advantages of this approach. Discuss

whether the approach is appropriate for Pacific Goods. (14 marks)

c) Define strategic and operational risk. Identify and describe the strategic and operational risks facing Pacific Goods. (14 marks)(d) Discuss the ethical and corporate governance issues resulting from Mr. Staite's position on the board of Pacific Goods plc, recommending how the issues can be resolved. (8 marks) (including 3 professional

Q4Chemco 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

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Revison Pack 2008geographically 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 Chemco's 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 JPX's 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, Chemco's 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 JPX's 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 country's stock exchange two years ago, but Leena Sharif, Chemco's company secretary, suggested that the corporate governance requirements in JPX's 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 company's external shareholders. JPX had no non-executive directors and none of the board committee structure that many listed companies like Chemco had in place. Bill reported that although JPX's 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 board's 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 JPX's board might do well to recognise this, especially if the acquisition were to go ahead.

Chemco's 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, Chemco's operations director, asked Bill if he knew anything about JPX's 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 couldn't say whether she was supportive or not. It was agreed, however, that

relevant information on JPX's environmental performance and risk would be necessary if the acquisition went ahead.

Required

(a) Evaluate JPX's 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)

(including 2 professional 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)

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Revison Pack 2008(e) Write a memo to Leena Sharif defining 'environmental footprint' and briefly explaining the importance of environmental

reporting for JPX. (8 marks) (including 2 professional marks)

Section Four

Q1The board of JH Graphics, a design and artwork company, was debating an agenda item on the possible adoption ofa corporate code of ethics. Jenny Harris, the chief executive and majority shareholder, was a leading supporter of theidea. She said that many of the large companies in the industry had adopted codes of ethics and that she thoughtit would signal the importance that JH Graphics placed on ethics. She also said that she was personally driven byhigh ethical values and that she wanted to express these through her work and through the company’s activities andpolicies.

Alan Leroy, the creative director, explained that he would support the adoption of the code of ethics as long as it helpedto support the company’s long-term strategic objectives. He said that he could see no other reason as the companywas ‘not a charity’ and had to maximise shareholder value above all other objectives. In particular, he was keen, as ashareholder himself, to know what the code would cost to draw up and how much it would cost to comply with it overand above existing costs.

Jenny argued that having a code would help to resolve some ethical issues, one of which, she suggested, was aproblem the company was having over a particular image it had recently produced for a newspaper advertisement. Theimage was produced for an advertising client and although the client was pleased, it had offended a particular religiousgroup because of its content and design.

When it was discovered who had produced the ‘offending’ image, some religious leaders criticised JH Graphics forbeing insensitive and offensive to their religion. For a brief time, the events were a major news story. As politicians,journalists and others debated the issues in the media, the board of JH Graphics was involved in intense discussionsand faced with a dilemma as to whether or not to issue a public apology for the offence caused by the image and toask the client to withdraw it.

Alan argued that having a code of ethics would not have helped in that situation, as the issue was so complicated.His view was that the company should not apologise for the image and that he didn’t care very much that the imageoffended people. He said it was bringing the company free publicity and that was good for the business. Jenny said thatshe had sympathy for the viewpoint of the offended religious leaders. Although she disagreed with them, she understoodthe importance to some people of firmly-held beliefs. The board agreed that as there seemed to be arguments bothways, the decision on how the company should deal with the image should be Jenny’s as chief executive.

Required:

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Revison Pack 2008(a) Analyse Jenny’s and Alan’s motivations for adopting the code of ethics using the normative-instrumental formsof stakeholder theory. (8 marks)(b) Assess Jenny’s decision on the possible apology for the ‘offending’ image from conventional and preconventionalmoral development perspectives. (4 marks)(c) Explain and assess the factors that the board of JH Graphics might consider in deciding how to respond to thecontroversy over the offending image. (10 marks)(d) Comment on the legitimacy of the religious group’s claims on JH Graphics’s activities. (3 marks)(25 marks)

Q2The board of Franks & Fisher, a large manufacturing company, decided to set up an internal control and audit function.The proposal was to appoint an internal auditor at mid-management level and also to establish a board level internalaudit committee made up mainly of non-executive directors.The initiative to do so was driven by a recent period of rapid growth. The company had taken on many more activitiesas a result of growth in its product range. The board decided that the increased size and complexity of its operationscreated the need for greater control over internal activities and that an internal audit function was a good way forward.The need was highlighted by a recent event where internal quality standards were not enforced, resulting in thestoppage of a production line for several hours. The production director angrily described the stoppage as ‘entirelyavoidable’ and the finance director, Jason Kumas, said that the stoppage had been very costly.

Mr Kumas said that there were problems with internal control in a number of areas of the company’s operations andthat there was a great need for internal audit. He said that as the head of the company’s accounting and financefunction, the new internal auditor should report to him. The reasons for this, he said, were because as an accountant,he was already familiar with auditing procedure and the fact that he already had information on budgets and other‘control’ information that the internal auditor would need.

It was decided that the new internal auditor needed to be a person of some experience and with enough personalitynot to be intimidated nor diverted by other department heads who might find the internal audits an inconvenience. Onedebate the board had was whether it would be better to recruit to the position from inside or outside the company. Asecond argument was over the limits of authority that the internal auditor might be given. It was pointed out that whilethe board considered the role of internal audit to be very important, it didn’t want it to interfere with the activities ofother departments to the point where their operational effectiveness was reduced.

Required:(a) Explain, with reference to the case, the factors that are typically considered when deciding to establishinternal audit in an organisation. (10 marks)(b) Construct the argument in favour of appointing the new internal auditor from outside the company rather than

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Revison Pack 2008promoting 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 professionalobjectivity. (5 marks)(25 marks)

Q3

Sonia Tan, a fund manager at institutional investor Sentosa House, was reviewing the annual report of one of the majorcompanies in her portfolio. The company, Eastern Products, had recently undergone a number of board changes as aresult of a lack of confidence in its management from its major institutional investors of which Sentosa House was one.The problems started two years ago when a new chairman at Eastern Products (Thomas Hoo) started to pursue whatthe institutional investors regarded as very risky strategies whilst at the same time failing to comply with a stock marketrequirement on the number of non-executive directors on the board.

Sonia rang Eastern’s investor relations department to ask why it still was not in compliance with the requirementsrelating to non-executive directors. She was told that because Eastern was listed in a principles-based jurisdiction, therequirement was not compulsory. It was simply that Eastern chose not to comply with that particular requirement.When Sonia asked how its board committees could be made up with an insufficient number of non-executive directors,the investor relations manager said he didn’t know and that Sonia should contact the chairman directly. She was alsotold that there was no longer a risk committee because the chairman saw no need for one.

Sonia telephoned Thomas Hoo, the chairman of Eastern Products. She began by reminding him that Sentosa Housewas one of Eastern’s main shareholders and currently owned 13% of the company. She went on to explain that shehad concerns over the governance of Eastern Products and that she would like Thomas to explain his non-compliancewith some of the stock market’s requirements and also why he was pursuing strategies viewed by many investors asvery risky. Thomas reminded Sonia that Eastern had outperformed its sector in terms of earnings per share in bothyears since he had become chairman and that rather than question him, she should trust him to run the company ashe saw fit. He thanked Sentosa House for its support and hung up the phone.

Required:(a) Explain what an ‘agency cost’ is and discuss the problems that might increase agency costs for Sentosa Housein the case of Eastern Products. (7 marks)(b) Describe, with reference to the case, the conditions under which it might be appropriate for an institutionalinvestor to intervene in a company whose shares it holds. (10 marks)(c) Evaluate the contribution that a risk committee made up of non-executive directors could make to Sonia’sconfidence in the management of Eastern Products. (4 marks)

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Revison Pack 2008(d) Assess the opinion given to Sonia that because Eastern Products was listed in a principles-based jurisdiction,compliance with the stock market’s rules was ‘not compulsory’. (4 marks)(25 marks)

Q4

MegaMart MegaMart plc is a medium sized retailer of fashion goods with some 200 outlets spread throughout the UK. A publicly quoted company on the London Stock Market, it has pursued a growth strategy based on the aggressive acquisition of a number of smaller retail groups. This growth has gone down well with shareholders, but a significant slowdown in retail sales has resulted in falling profits, dividends and, as a consequence, its share price. MegaMart had been the creation of one man, Rex Lord, a high profile entrepreneur, convinced that his unique experience of the retail business gained through a lifetime working in the sector was sufficient to guide the company through its current misfortunes. His dominance of the company was secured through his role as both Chairman and Chief Executive of the company. His control of his board of directors was almost total and his style of management such that his decisions were rarely challenged at board level. He felt no need for any non-executive directors drawn from outside the company to be on the board. Shareholders were already asking questions on his exuberant lifestyle and lavish entertainment, at company expense, which regularly made the headlines in the popular press. Rex's high profile personal life also was regularly exposed to public scrutiny and media attention.

As a result of the downturn in the company's fortunes some of his acquisitions have been looked at more closely and there are, as yet, unsubstantiated claims that MegaMart's share price had been maintained through premature disclosure of proposed acquisitions and evidence of insider trading. Rex had amassed a personal fortune through the acquisitions, share options and above average performance related bonuses, which had on occasion been questioned at the Shareholders' Annual General Meeting. His idiosyncratic and arrogant style of management had been associated with a reluctance to accept criticism from any quarter and to pay little attention to communicating with shareholders.

Recently, there has been concern expressed in the financial press that the auditors appointed by MegaMart, some twenty years ago, were also providing consultancy services on his acquisition strategy and on methods used to finance the deals.

Required

(a) Analyse the corporate governance issues raised by the management style of Rex Lord. (15 marks)

(b) Rex Lord has consistently resisted the appointment of independent, non-executive directors to the board of MegaMart plc. Assess the

advantages that the company might gain through the appointment of such directors. (10 marks) (Total = 25 marks)

Q5

VSYS Inc manufactures a range of computer products including silicon chips, hard drives and advanced graphic cards from its single factory located in a medium-sized town in central USA. About 20% of the working population are employed at VSYS, and the company has a reputation for being a good employer with specific focus on maintaining and enhancing benefits for its employees. A local university runs courses specifically for potential employees of VSYS.

Although the company is profitable, the recent management accounts show falling margins with the possibility of a loss being made next year; the first in the 25 year history of the company. The main reasons for the falling profits have been identified as increasing competition from manufacturers in the Far East, and ongoing quality control issues with several key manufacturers. A recent feasibility study shows that moving production to a Far Eastern country would enable VSYS to take advantage of lower labour costs and proximity to suppliers of high quality components. The administration and marketing functions would remain at their current location. While a final decision has yet to be made, the Board is aware of the negative impact this could have on the image of the company and are therefore reluctant to make a firm commitment.

Movement of production systems to the Far East is seen as a particular problem for VSYS. Specific areas of concern include:(i) Obtaining and maintaining supplies from new suppliers(ii) Setting up production lines with new workforce and new machinery(iii) Maintaining sufficient inventory of materials to meet demand when the delivery times are uncertain (iv) Implementing any necessary revisions to the management accounting systems

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Revison Pack 2008

Required (a) (i) Explain the main principles of corporate governance for listed companies, with specific reference toestablishing and maintaining an internal control system and the role of internal audit.(ii) Identify and assess any risks or potential problems with the internal control system in VSYS arising from the decision to outsource operations to the Far East, briefly describing methods of minimising those risks or problems. (16 marks)

(b) Analyse the extent to which VSYS's plans to outsource to the Far East represent a change in its social responsibility stance and evaluate the consequences of a change in stance. (9 marks)

Q6 Independence

As the newly-appointed finance director of a quoted company, you have just been asked by the chairman to advise him on the effectiveness of the existing internal audit department.

The chairman explained that internal audit has been established in the company for many years. The chief internal auditor, who has held this post for many years, has reported direct to the chairman. He has always had a right of access to the Board, and, since the establishment of an Audit Committee, has worked closely with that committee. However, there had been increasing friction in recent years between the chief internal auditor and your predecessor as finance director. Internal audit was regarded by your predecessor as expensive, slow, cumbersome, and ineffective.Required

Write a report to the chairman recommending how the effectiveness of the internal audit department should be assessed.

Your report should deal specifically with the following issues.

(a) Recommendations of whether you should carry out the assessment yourself, or, if not, who should do so(8 marks)

(b) Recommendations of specific objectives for the internal audit department related to the aims of the department. You should explain how performance of the internal audit department against each of its objectives could be evaluated, and provide for each objective an example of a performance measure that could assist in this. (17 marks)

Q7

A large doctor's practice, with six partners and two practice nurses, has decided to increase its income by providing day surgery facilities. The existing building would be extended to provide room for the surgical unit and storage facilities for equipment and drugs. The aim is to offer patients the opportunity to have minor surgical procedures conducted by a doctor at their local practice, thus avoiding any unfamiliarity and possible delays to treatment that might result from referral to a hospital. Blood and samples taken during the surgery will be sent away to the local hospital for testing but the patient will get the results from their doctor at the practice. It is anticipated that the introduction of the day surgery facility will increase practice income by approximately 20 per cent.Required

(a) Evaluate the additional risks that the doctors' practice may expect to face as a consequence of the introduction of the new facility

and explain how a risk management model might be used to understand and control such risks. (14 marks)(b) Explain the meaning of the term 'risk appetite' and discuss who should take responsibility for defining that appetite in the context of the

scenario outlined above. (5 marks)(c) Analyse how an internal audit of the practice may contribute to an assessment of its risk management procedures. (6 marks)

Q8The LinesRUs Company is responsible for maintaining the railway infrastructure for the rail network in a large European country. Main areas of responsibility for the company include:

• Ensuring that the railway tracks are safe• Signalling equipment is installed correctly and works properly • Maintenance of overhead power lines for electric trains

Income is fixed each year dependent on the number of train services being operated and is paid via a central rail authority. The company is granted a sole franchise each year to provide services on the rail network.

Work is scheduled in accordance with the amount of income, and to provide LinesRUs with an acceptable operating profit. Any additional work over and above standard maintenance (e.g. due to foreseen factors such as bridges being damaged by road vehicles and unforeseen

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Revison Pack 2008factors such as car drivers falling asleep and driving their cars onto railway tracks) is negotiated separately and additional income obtained to repair the infrastructure in these situations.A lot of maintenance work is relatively simple (e.g. tightening nuts and bolts holding railway tracks together) but is extremely important as an error may result in a train leaving the rails and crashing. The board of LinesRUs is aware of many of these risks and attempts to include them in a risk management policy.

However, recently a train was derailed causing the death of 27 passengers. Initial investigations show that faulty maintenance was the cause of the derailment. One of the unforeseen consequences of the crash has been a fall in the numbers of people using trains with a subsequent fall in income for train operators. LinesRUs are being sued by the train operators for loss of income, and the national press are suggesting LinesRUs must be incompetent and are calling for a re-evaluation of the method of providing maintenance on the rail network.

Required

(a) Discuss the stages of an appropriate risk analysis policy for LinesRUs. (16 marks)

(b) Discuss the options available to LinesRUs to deal with the risks arising from the rail crash mentioned above.(9 marks) (Total = 25 marks)

Q9You 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 local business group meetings, has asked you to telephone urgently regarding the credit status of X Ltd.

Required

Write a report to your Managing Director, evaluating the options available and recommending the action to be taken on the account and on the

telephone message.

Q10

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Revison Pack 2008Z plc is a publicly quoted company. Its products are based on raw materials grown in tropical countries and processed either in these countries

or in the eventual sales markets. Processing is undertaken partly by Z plc and partly by sub-contractors. The products are branded and sold

worldwide, but mainly in the United Kingdom and North America. They are sold to consumers through a very large number of outlets.

The non-executive directors have for some time expressed concern that the company has not developed any systems of environmental or social

reporting to shareholders, although many comparable companies already publish such information as part of their Annual Report. A government

minister has now stated that legislation will be considered if all companies do not make progress on reporting on social and environmental

policies.

The chief executive has always regarded reporting as ideally never exceeding legal requirements.

As management accountant, you have been asked by the finance director to draft a report to the Board on the potential environmental and

social issues on which reporting may be required.

Required

Discuss the reasons for, and the problems involved in, preparing this report, and explain how the following issues will impact upon this report:

(a) The range of environmental and social issues to cover

(b) The range of business activity to cover(c) The information requirements at board level as well as the information to be published

Q11

The Managing Director of a company which makes and sells defence equipment worldwide has had a most unhappy meeting with his Chairman.

They have both just read a newspaper report of a statement made by a disgruntled ex-employee, after a court case for compensation for his dismissal.

In the statement, the ex-employee stated that the company had been selling equipment in breach of a United Nations embargo, and that such sales have been made on a number of occasions.The Chairman is concerned because:

(i) He did not anticipate such unfortunate public criticism of the company

(ii) (ii) He was not aware of such irregular sales

(iii) He thought all possible had been done, by establishing an audit committee in line with the Combined Code recommendations, to ensure that such problems would never arise

(iv) He thought the internal audit department should have detected all actions contrary to the Company code of conduct and reported them to him immediately.

Required

(a) Discuss the case for establishing an audit committee and demonstrate how it may contribute to the solution of problems such as those

outlined above. (13 marks)

(b) Discuss the extent to which the internal audit department may be involved in ensuring compliance with the Company code of conduct, and recommend the steps that may be required to ensure that decisions taken within a company are ethical. (12 marks)

Q12

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Revison Pack 2008(a) Explain how a control system can help to minimise the risk of fraud in purchasing. (11 marks) Some codes of conduct appear

to have a double standard. One such is quoted below.

Customer and supplier relations

The company does not seek to gain any advantage through the improper use of business courtesies or other inducements. Good judgement and moderation must be exercised to avoid misinterpretation and adverse effect on the reputation of the company and its employees. Offering, giving, soliciting or receiving any form of bribe is prohibited.

Business courtesiesGifts, favours and entertainment may be given in the following circumstances.

(i) If they are consistent with customary business practices.

(ii) If they are not excessive in value and cannot be construed as a bribe or payoff. (iii) If they are not in contravention of applicable law or ethical standards.(iv) If they will not embarrass the company or the employee if publicly disclosed.

Gifts, favours, entertainment or other inducements may not be accepted by employees from any person or organisation that does or seeks business with, or is a competitor of, the company, except as common courtesies usually associated with customary business practices. An especially strict standard applies when suppliers are involved. Favours or entertainment, appropriate in our sales programmes may not be appropriate or acceptable from suppliers. It is never acceptable to accept a gift in cash or cash equivalent.

Required

(b) Discuss the acceptability of the above code of conduct. If you consider it appropriate, recommend any amendments you would

wish to see in the code of conduct. (14 marks)

Q13Drofdarb plc is a British publicly owned company, which competes mainly on the UK market for sporting goods: replica kits, training equipment, leisurewear and sporting accessories such as balls and pads. It has a Board of Directors that comprises the following:

Chairman Mr S McNamara

Chief Executive Mr I Harris

Finance Director Mr C McKenna

Executive Director (Clothing) Mr D Solomona

Executive Director (Equipment) Mr J Langley

Non-Executive Director Mr S Hape

Non-Executive Director Mr A Lynch

The Chairman, Mr McNamara, is concerned that Drofdarb's previously good reputation as a good "corporate citizen" may have become tarnished after

the following:

The introduction of a new computer system combining manufacturing, ordering and accounting procedures in the last 12 months

• Press reports suggesting widespread non-compliance with the corporate governance regulations among FTSE 350 companies, especially

in relation to non-executive directors

Rumours of poor controls within the finance function at Drofdarb leading to allegations of financial irregularities.

The finance function is staffed mostly by ACCA members and students - any claims regarding the quality and integrity of his staff are hotly

refuted by the FD Mr McKenna, who feels that the company already does enough to meet the requirements for good internal controls.

Mr McNamara has been assessed as independent in his role as Chairman, leaving a need for a third non-executive director (NED) to make the balance of independent to non-independent board members 50 50. A vacancy is to be advertised in the next month.

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Revison Pack 2008Mr McKenna has suggested that instead of repeating the lengthy and expensive recruitment process that preceded the appointment of both Mr Hape and Mr Lynch, the company should consider the appointment of Mr B McDermott. His credentials are as follows:• Current executive director of Sdeel plc - a competitor of Drofdarb's

• Previously the external auditor of Drofdarb - he resigned his position as senior partner two years ago in favour of a more commercial role• Mr McDermott was appointed by Sdeel because of his knowledge of the industry and his family's connections with Sdeel's historical owners,

who had sold up and bought into Drofdarb some 20 years before - he currently owns a 2% shareholding in Drofdarb as well as "a few shares to balance his portfolio" in Sdeel plc.

Mr McNamara is keen for the board to be seen to be following good corporate governance practices. He is also mindful of the requirements of the Turnbull Committee in ensuring internal controls are sufficient and that no problems exist with trusting staff. Consequently he has contacted the current auditors to advise him on what he should do.

Required

You are the senior partner of the current auditors and have agreed to respond to Mr. McNamara. Draft notes for your discussions with him

that aim to:

(a) Describe the fundamental ethical principles that should be present in all finance staff, and what needs to be done in the business to encourage staff to act ethically (9 marks)

(b) Explain the main elements of a risk-based approach by the board to internal controls, and discuss the limitations of a risk-based approach (6 marks)

(c) Describe the role of a non-executive director and discuss whether Mr B McDermott would be a suitable independent non-executive director of Drofdarb (10 marks)

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