ACCA p1 Notes PDF

Governance, Risk and Ethics
Paper P1
Course Notes
For exams from 1 September 2015 to
31 August 2016
ISBN: 9781472797568
Improving study material and removing errors
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2
P1 Governance, Risk and Ethics
Study Programme
Taught Phase Study Programme
Page
Introduction to the paper and the course .......................................................................................... 4
1 Scope of corporate governance .............................................................................................. 13
2 Approaches to corporate governance ..................................................................................... 25
Achievement Ladder Step 1 37
3 Corporate governance practice and reporting......................................................................... 39
4 Internal control systems........................................................................................................... 57

5 Risk attitudes and internal environment .................................................................................. 63
6 Risks........................................................................................................................................ 73
7 Risk assessment and response............................................................................................... 83

8 Information, communication and monitoring ........................................................................... 93
9 Personal ethics ...................................................................................................................... 105
10 Professional ethics ................................................................................................................ 117

11 Corporate social responsibility............................................................................................... 129
12 Answers to Lecture Examples............................................................................................... 145

13 Question and Answer bank ................................................................................................... 161
14 Appendix A: Pilot paper questions and answers ................................................................... 189
15 Appendix B: Information about M&S (Day 2 lecture examples) ............................................ 199
16 Written Assessment Questions ............................................................................................. 215
3
INTRODUCTION
Welcome to P1 Governance, Risk and Ethics

Our aim is to help you confidently prepare for success in your exam in an effective and efficient
way; allowing you to personalise your learning experience, step by step, whilst being supported by
BPP’s team of experts.
These course notes are one of the components of your P1 programme, and are one of the tools
you have at your disposal as a student of BPP. They focus primarily on ensuring you acquire the
technical knowledge and understanding required to pass your exam. They have been written by
our subject matter experts and tutors, are will be delivered to you by our expert tutor team, be it in
centre or online.
These course notes play two important roles in your programme:
1. Knowledge – the course notes will help you to learn and understand the key knowledge
topics to allow you to progress up the Achievement Ladder
2. Support – you can revisit specific elements in your course notes in the light of feedback you
receive as you attempt each step on the Achievement Ladder.
Remember, the Achievement Ladder is the unique tool to allow you to see your own progression
towards being fully prepared for the real exam.
4
INTRODUCTION
Introduction to Paper P1 Governance, Risk and Ethics
Overall aim of the syllabus

To apply relevant knowledge, skills and exercise professional judgement in carrying out the role of
the accountant relating to governance, internal control, compliance and the management of risk
within an organisation, in the context of an overall ethical framework.
The syllabus
The broad syllabus headings are:
A Governance and responsibility

B Internal control and review
C Identifying and assessing risk
D Controlling risk
E Professional values, ethics and social responsibility
Main capabilities
On successful completion of this paper, candidates should be able to:
 Define governance and explain its function in the effective management and control of
organisations and of the resources for which they are accountable;
 Evaluate the professional accountant’s role in internal control, review and compliance;
 Explain the role of the accountant in identifying and assessing risk
 Explain and evaluate the role of the accountant in controlling and mitigating risk;
 Demonstrate the application of professional values and judgement through an ethical
framework that is in the best interests of society and the profession, in compliance with
relevant professional codes, laws and regulations.
Links with other papers Professional
Papers
Online ethics Governance, Risk Audit &

module and Ethics (P1) Assurance (F8)
Accountant in
Business (F1)
This diagram shows where direct (solid line arrows) and indirect (dashed line arrows) links exist
between this paper and other papers that may precede or follow it.
The Governance, Risk and Ethics syllabus assumes some of the knowledge acquired in papers F1
Accountant in Business but develops and applies this further and in greater depth. There is also
the presumption that students will have completed the online ethics module. The ACCA consider
Paper P1 Governance, Risk and Ethics to be the gateway paper to Professional level studies, as it
provides valuable information for all other papers.
5
INTRODUCTION
Taught Phase Aims
Achieving ACCA's Study Guide Outcomes
A Governance and responsibility
A1 The scope of governance Chapter 1

A2 Agency relationships and theories Chapter 1
A3 The board of directors Chapters 2 & 3
A4 Board committees Chapter 3
A5 Directors’ remuneration Chapter 3
A6 Different approaches to corporate governance Chapter 2
A7 Corporate governance and corporate social responsibility Chapters 2 & 11
A8 Governance: reporting and disclosure Chapters 2 & 3
A9 Public sector governance Chapter 2
B Internal control and review
B1 Management control systems in corporate governance Chapter 4

B2 Internal control, audit and compliance in corporate governance Chapters 7, 8 & 10
B3 Internal control and reporting Chapters 4 & 8
B4 Management information in audit and internal control Chapter 8
C Identifying and assessing risk
C1 Risk and the risk management process Chapters 4, 5, 7 & 8

C2 Categories of risk Chapter 6
C3 Identification, assessment and measurement of risk Chapters 4, 5, 6, 7 & 8
D Controlling and managing risk
D1 Targeting and monitoring risk Chapter 8

D2 Methods of controlling and reducing risk Chapters 5 & 7
D3 Risk avoidance, retention and modelling Chapters 5 & 7
6
INTRODUCTION
E Professional values, ethics and social responsibility
E1 Ethical theories Chapter 9

E2 Different approaches to ethics and social responsibility Chapter 11
E3 Professions and the public interest Chapter 10
E4 Professional practice and codes of ethics Chapter 10
E5 Conflicts of interest and the consequences of unethical behaviour Chapter 10
E6 Ethical characteristics of professionalism Chapters 9 & 10
E7 Integrated reporting and sustainability issues in the conduct of Chapter 11
business
7
INTRODUCTION
Assessment methods and format of the exam

The examination is a three-hour paper, with 15 additional minutes allowed at the start of the exam
for reading and planning. It will be entirely discursive and most questions will adopt a
scenario/case study approach.
Format of the Exam Marks

The paper is divided into two sections
Section A This ONE question is compulsory and MUST be attempted 50
This question is based on a detailed scenario, which provides a
context for the answer to be applied to. The question will be sub-
divided into several requirements, which could cover any number of
parts of the syllabus in an integrative approach.
Section B TWO optional questions from a choice of THREE are to be 2 × 25
attempted
Each question will have its own small scenario; therefore all answers
must apply knowledge in context. Each question will be sub-divided
into several requirements; there are usually at least three
requirements in each question.
Questions will be drawn from any part of the syllabus, but each one
is likely to focus on one or two specific areas in detail.
100
8
INTRODUCTION
Key to icons
The following icons appear in this set of study notes
Real-life examples
For further details see your Checkpoint Guidance
Section reference in the Study Text

You could further consolidate your knowledge in this area with additional
reading from the Study Text.
9
INTRODUCTION
10
SKILLS BANK
Key skills required to pass

Our analysis of the examiner’s comments on past exams, together with our experience of preparing
students for this type of exam, suggests that to pass Paper P1 you will need to develop a number of key
skills.
1 Effective use of
reading time
5 Time management
4 Communication and
presentation skills 2 Accurate analysis of
a question’s
requirements
3 Planning a
well structured
answer
B C
11
SKILLS BANK
Skill 1 – Effective use of reading time
Effective use of your reading and planning time means using it to go through the optional questions,
quickly transfer knowledge onto the exam paper and then decide on which question from section B you
are not going to do.
Skill 2 – Accurate analysis of a question's requirements
You need to become skilful at working out exactly what is being asked of you. This means understanding
the requirement verbs and breaking down each question requirement into all its constituent parts.
B C Skill 3 – Planning a well structured answer
Your answer needs to be carefully balanced, so that you go into more detail for higher level verbs. You
need to make sure that you use your technical knowledge selectively and structure your answer
appropriately in response to the requirements.
Skill 4 – Communication and presentation skills
This exam contains professional marks and the key is to take care in the style of your writing. Think
carefully about any formats that are requested, use straightforward language and think about the
audience you are being asked to write for. The examiner expects all answers to be presented with great
clarity, as it is less about great volume and more about high quality that generates high marks
Skill 5 – Time management
One key decision you can make before you get into the exam is the order in which you tackle the
questions. You need to be aware of the time for each question and become skilled at apportioning your
time between the sub-requirements.
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Scope of corporate
governance
How have the syllabus learning outcomes been examined?

Syllabus learning outcomes Example past paper questions
Define and explain the meaning of December 2012 Q2a (10 marks) explaining the meaning
corporate governance of governance and how it helps avoid corporate failure
Analyse the purposes and objectives of June 2013 Q4a (7 marks) discussing the general
corporate governance purposes of governance codes for listed companies
Explain, and apply in the context of Accountability – December 2014 part of Q1dii (6 marks)
corporate governance, the key Judgement and reputation – June 2014, explanations as
underpinning concepts. part of Q1a (6 marks)
Transparency – June 2013 Q1di (6 marks)
Independence – June 2012 Q2a (8 marks)
Integrity – part of June 2013 Q1di (6 marks)
Explain, and analyse the issues raised June 2012 Q1d (18 marks) applying Mendelow to
by, the development of the joint stock consider how owners are influenced by a key
company as the dominant form of stakeholders
business organisation and the December 2007 Q1a (10 marks) on how transparency
separation of ownership and control affects reporting within governance
over business activity
Define and explore agency theory December 2013 definition, part of Q2b (10 marks)
June 2010 Q1c (10 marks) required a detailed
examination of agency theory in a public company and
how it differs in private companies
Analyse and discuss the role and December 2014 Q3c (6 marks) explaining conflict of
influence of institutional investors in interest when a potential director owns shares in a
governance (pension funds, insurance supplier
companies and mutual funds) June 2014 Q1c (10 marks) and December 2010 Q1a (12
marks) – why institutional investors might intervene in
the governance of a company
13
1: SCOPE OF CORPORATE GOVERNANCE
Overview
Scope of corporate governance
Definition of corporate
governance
Principles
Theories Stakeholder Models
14
1 Definition of corporate governance

1.1 Corporate governance can be defined as: a set of relationships between a company’s
directors, its shareholders and other stakeholders. It also provides structure through
which the objectives of the company are set, and the means of obtaining these
objectives and monitoring performance are determined (OECD).
Corporate governance is the system by which organisations are directed and
controlled. (Cadbury report)
1.2 Corporate governance is a fundamental internal control system ensuring the best interests
of the company are serviced in the most efficient and effective manner.
Lecture example 1 Exam skills
Required
Identify the benefits to any business of applying a corporate governance framework.
Solution
15
1.3 For corporate governance to be effective it must be embedded as a feature of the inherent
business culture, ie the way business is conducted.
1.4 In the exam you may also need to ascertain whether or not the governance procedures in
use in a particular company are in line with best practice (covered later).
1.5 The following diagram illustrates the 11 core principles that underlie good corporate
governance.
Qualities that ensure the Qualities that ensure honest

best decisions are made. and transparent disclosures
 Integrity  Transparency
 Fairness  Probity
 Judgement  Responsibility
 Independence  Accountability
 Scepticism  Innovation
 Reputation
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1.6 Definitions of each of these:
Integrity: Straightforward dealing and completeness; high moral character; honesty

Fairness: Balance; respecting the rights and views of any group with a legitimate interest
Judgement: Making complex decisions that enhance the organisation’s prosperity
Independence: Free from bias or undue influence; independence of mind and in appearance
Scepticism: Considering all parts of a business with an open mind; no preconceptions
Transparency: Open and clear disclosure, including voluntary disclosure of reliable information
Probity: Truthful and not misleading; avoiding disingenuous behaviour
Responsibility: Acknowledgement of praise or blame; open management of errors and failures
Accountability: having to answer for the consequences of actions and knowing who that relates to
Innovation: Change happens and governance must stay fit for purpose regardless
Reputation: Other people’s perceptions or expectations: a valuable asset of any organisation.
2 Corporate governance and agency theory

2.1 Agency theory is used to study the problems of motivation and control when a principal
needs the help of an agent to carry out activities.
2.2 Agency theory would describe the shareholders in a company as the principals, with the
board their agents who are empowered to act in their interests.
2.3 In practice the powers of shareholders tend to be very restricted. They normally have no
right to inspect the books of account, and forecasts of future prospects are gleaned from the
annual report and accounts, stockbrokers’ reports and media sources. There is an
information asymmetry; the agent has more information than the principal.
The diagram below illustrates how agency works in practice:
Self-interest Self-interest
PRINCIPAL appoints AGENT

(shareholder) (directors/ managers/
employees)
Detailed information
17
The agency problem

2.4 Agency theory assumes that agent and principal act in their own self-interest. These
interests may conflict. The agency problem in joint stock companies derives from the
principals (shareholders) not being able to run the business themselves and therefore
having to rely on agents (directors) to do so for them.
2.5 The separation of ownership from management can cause issues if there is a breach of trust
by directors either by intentional action, omission, neglect, or incompetence.
Lecture example 2 Exam standard question
Required
Identify some reasons why shareholders might become concerned about the management of an
organisation in which they hold an investment.
Solution
The agency solution

2.6 One power that shareholders possess is the right to remove the directors from office. But
shareholders have to take the initiative to do this, and in many companies, the shareholders
lack the energy and organisation to take such a step. Ultimately they can vote in favour of a
takeover or removal of individual directors or entire boards, but this may be undesirable.
2.7 Shareholders can take steps to exercise control, but such action will be expensive, time
consuming and difficult to manage because it is difficult to:
(a) Verify what the board is doing, partly because the board has access to more
information about its activities than the principal does; and
(b) Introduce mechanisms to control the activities of the board, without preventing it from
functioning effectively.
2.8 Any steps taken by shareholders are likely to incur agency costs.
18
Required
Suggest some ways in which shareholders can monitor and control a board of directors.
Solution
3 Transaction cost theory

3.1 Transaction cost theory provides an explanation of why organisations like companies exist,
rather than all transactions being carried out between individual entrepreneurs.
3.2 Companies will try to keep as many transactions as possible in-house in order to:
(a) Reduce uncertainties about dealing with suppliers,
(b) Avoid high purchase prices, and
(c) Manage quality.
To achieve this, companies will seek vertical integration (ie they will purchase suppliers or
producers later in the production process).
3.3 Transaction cost theory also states that managers organise their transactions to pursue their
own objectives. They are influenced by
(a) The amounts that they personally will gain,
(b) The probability of bad behaviour being discovered, and
(c) The extent to which their actions are tolerated or encouraged in corporate culture.
19
3.4 The implications of transaction cost theory are that management tend to play safe, and
concentrate on easily understood markets and individual transactions they can easily
control. The focus on low-risk activities may discourage potential investors who are looking
for a large return. Alternatively shareholders dissatisfied with low profits may seek greater
involvement in governance.
3.5 This extends the idea of the agency problem. It explains why the agency problem is more
severe the larger an organisation becomes.
4 Stakeholders in corporate governance

4.1 Stakeholders are people, groups or organisations that can affect or be affected by the
actions or policies of an organisation. Each stakeholder group has different expectations
about what it wants, and therefore different claims upon the organisation.
4.2 Stakeholders can be classified by their proximity to the organisation.
Stakeholder group Members

Internal Employees, management, the board
Connected Shareholders, customers, suppliers, lenders
External The government, local government, the public,
pressure groups, the media, competition, trade unions
4.3 Mendelow classifies stakeholders on a matrix [below] whose axes are power held and
likelihood of showing an interest in the organisation’s activities. These factors will help
define the type of relationship the organisation should seek with its stakeholders, and how it
should view their concerns.
Level of interest
Low High
Low
Minimal Effort Keep Informed

Power
Keep Satisfied Key Players
High
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4.4 Another way of viewing stakeholders is as follows:
Stakeholder group Members

Active Those who seek to participate in the organisation’s activities.
This includes managers and some shareholders, but may
also include other groups such as regulators and pressure
groups.
Passive Those who do not seek to participate in policy-making, such
as most shareholders, local communities and government.
4.5 Passive stakeholders may still be interested and powerful. If corporate governance
arrangements are to develop still further, there may be a need for powerful, passive
stakeholders (eg institutional investors) to take a more active role.
Lecture example 4 Classroom discussion
Required
Discuss the importance to an organisation of recognising its stakeholders when making significant
strategic decisions. (Q4b Dec 2012) (8 marks)
Solution
21
Problems with stakeholder theory

4.6 A principle of company law in most jurisdictions remains the fiduciary and legal obligations
that managers have to maximise shareholder wealth. Therefore, if managers are to fulfil
responsibilities to a wider stakeholder base, it must not jeopardise long term profitability.
4.7 Some commentators have tried to reconcile stakeholder and agency theory by arguing that
managers are stakeholders, responsible as agents to all other stakeholders. However
stakeholders have divergent interests that may be difficult to reconcile, this does not absolve
management from at least trying to reconcile their interests.
4.8 There are two fundamentally different motivations for considering stakeholders.
(a) The instrumental view justifies considering stakeholders because of the economic
benefits to the company [Milton Friedman].
(b) The normative view is based on the idea that the company has moral obligations
towards stakeholders.
5 Major issues in corporate governance

5.1 The scope of corporate governance is vast and we shall expand on the following key issues
during this course of study.
5.2 Major issues pertaining to corporate governance that could arise in any exam question are
illustrated below.
Fiduciary
Compulsory
duties of
voluntary
directors
best practice Directors
remuneration
and reward
Corporate social
responsibility
Board
MAJOR composition
ISSUES and balance
Business
ethics
Reliability
Rights and of financial
responsibilities reporting
Risk management
of shareholders
and internal
control
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6 Chapter summary
Section Topic Summary
1 Definitions and Corporate Governance is concerned with the structures,

fundamental processes and relationships that are fundamental to the
principles company's objectives.
Corporate Governance is built on the foundation of
fundamental principles that seek to ensure good decision
making, honest disclosure and reputation.
2 Agency theory Principals (shareholders) appoint agents (directors) to act on
their behalf.
The agency problem arises because of the agents’ self-
interest and information asymmetry, with the agent having
more information than the principal.
Agency costs are incurred in trying to align the interests of the
agent with those of the principal. These are the costs of
monitoring, controlling and incentivising the agents.
3 Transaction cost Transaction Cost Theory extends agency theory to managers
theory and employees.
4 Stakeholders Stakeholders are any group that affects or is affected by the
company.
Stakeholder claims are what the stakeholder wants.
Mendelow’s grid is used to assess suitable responses:
ignore, inform, satisfy or key player.
Attitudes to stakeholders can be described as normative or
instrumental.
5 Issues in Major issues have arisen out of corporate scandals. Try and
corporate keep an eye on emerging issues by reviewing quality
governance newspapers or news websites.
23
END OF CHAPTER
24
Approaches to corporate
governance

Describe and compare the essentials December 2013 Q2a (7 marks) and December 2011
of rules and principles-based Q2a (12 marks) distinguish between rules and principles
approaches to corporate governance based approaches, then apply to a scenario
December 2012 Q2b (8 marks) explain the differences
then consider “comply or explain”
Describe and critically evaluate the June 2013 Q4a (7 marks) definition and purposes of a
reasons behind the development and code of corporate governance
use of codes of practice in corporate December 2007 Q3c (8 marks) national variation of
governance (acknowledging national codes
differences and convergence)
Discuss and critically assess the December 2014 Q1a (7 marks) conflicting stakeholder
concept of stakeholders and claims
stakeholding in organisations and how December 2012 Q4b (8 marks) importance of identifying
this can affect strategy and corporate stakeholders when making strategic decisions
governance
December 2012 Q4c (12 marks) consider stakeholder
claims and how they differ
June 2010 Q1a (12 marks) differentiating voluntary and
involuntary stakeholders at a nuclear power station
Explain and explore the Sarbanes- June 2014 Q4c (9 marks) compulsory reporting of
Oxley Act (2002) as an example of a internal controls like s.404 to prevent failure
rules-based approach to corporate December 2013 Q2c (8 marks) exempting small
governance companies from full s.404 reporting
Define and distinguish between June 2014 Q2c (9 marks) usefulness of voluntary and
mandatory and voluntary disclosure mandatory reporting disclosures to a personal investor
Distinguish between unitary and two- June 2012 Q4c (7 marks) distinguishing between both
tier boards structures and discussing difficulties of implementing
Describe, compare and contrast various December 2014 Q2 (10+9+6 marks) considering public
public, private, charity and NGOs sector governance in a failing school
Evaluate governance and the role of June 2011 Q3a (9 marks) differences between charities
politics in public sector organisations and listed companies, including governance
vs private companies
25
2: APPROACHES TO CORPORATE GOVERNANCE
Overview
governance
Corporate ownership Principles or Rules?
National and global

influences
Principles-based approach Rules-based approaches
Major corporate scandals Major corporate scandals
UK Corporate Governance US Sarbanes-Oxley Act

Code
Public sector governance
26
1 Principles or rules?
1.1 The big debate about corporate governance globally is whether the guidance should in the
form of principles or detailed rules and regulations.
Principles-based approach Rules-based approach
Features Sets out broad principles (eg 'The Organisations are required to
Board should be effective') comply with a detailed and rigid
supported by guidance. code.
Works on a comply or explain Non-compliance cannot be
basis, with any departure from the justified. A company has either
specific provisions of codes succeeded or failed in complying.
requiring an explanation
Allows investors to decide if they Investors tend to rely on a third
agree that departure from the code party (eg SEC) to penalise the
is appropriate company for non-compliance.
Benefits Allows for greater flexibility and Easier compliance with the rules,
potential cost savings as they are unambiguous, and can
Applies across different legal be evidenced
jurisdictions, which makes the Provides a consistent minimum
governance of a multi-national standard of governance for
business more effective investors confidence
Forces both boards and
shareholders to think about the
consequence of governance
arrangements
Disadvantages The principles are so broad that Allows no leeway or deviation,
they are of very little use as a irrespective of how illogical the
guide to best corporate situation is.
governance practice. Enforcement can be difficult for
Investors cannot be confident of situations that are not covered
consistency in approach explicitly in the rules.
Incorrectly viewed as voluntary
Where you find Favoured in legal jurisdictions Favoured in legal jurisdictions (and
them where the governing bodies of cultures) that lay great emphasis
stock markets have had the prime on obeying the letter of the law
role in setting standards for rather than the spirit of it.
companies to follow.
Examples UK Corporate Governance Code USA Sarbanes-Oxley Act 2002
2010 (SOx)
27
2 Influence of ownership on corporate governance

2.1 A key distinction that has been drawn between the corporate governance systems
worldwide in different regimes has been between the insider and outsider models of
ownership described below. In practice most regimes fall somewhere between the two.
Insider systems
2.2 Insider (or relationship-based) systems are where most companies listed on the local stock
exchange are owned and controlled by a small number of major shareholders. The
shareholders may be members of the company’s founding families, banks, other companies
or the government.
2.3 The reason for the concentration of share ownership is the legal system.
Advantages Disadvantages
It is easier to establish ties between owners There may be discrimination against
and managers; therefore the agency minority shareholders.
problem is reduced.
It is easier to influence management, policy Insider systems tend not to develop more
and strategy through dialogue. formal governance structures until they are
forced to.
A smaller base of shareholders may be May be reluctant to employ outsiders in
more willing to take a long-term strategic influential positions and recruit independent
view of their investment. non-executive directors.
More prone to opaque financial
transactions and misuse of funds.
Many large shareholders (particularly
financial institutions) tend to avoid shares
that are seen as speculative and invest only
in 'blue chip' shares.
Outsider systems
2.4 Outsider systems are ones where shareholding is more widely dispersed, and there is the
manager-ownership separation. Such shareholders can be drawn from varied and
disparate sources and can have both small and large holdings.
2.5 There tends to be more diverse shareholder ownership in jurisdictions such as the UK that
have strong protection for non-controlling (minority) interests.
28
Advantages Disadvantages
The separation of ownership and Companies are more likely to have an
management has provided an impetus for agency problem and significant agency
the development of more robust legal and costs.
governance regimes to protect
shareholders.
Shareholders have voting rights that they The larger shareholders in these regimes
can use to exercise control. tend to have short-term priorities and prefer
to sell their shares.
Hostile takeovers are far more frequent,
and the threat of these acts as a
disciplining mechanism on company
management.
2.6 British and American systems can both be classified as outsider systems.
Lecture example 1 Classro om discussion
Required
Discuss the impact of the following factors on the development of corporate governance codes,
rules and laws in recent years.
Solution
Globalisation
Foreign investment
Financial reporting
Local culture
Corporate scandals
29
3 Corporate governance development in the UK

Cadbury Report 1992
 Voluntary code of best practice
 Defined roles for all involved with financial
statements
 Clear division of responsibilities
 Non-executive directors
 Audit committee
Greenbury Report 1995

 Determination of directors' pay
 Disclosure of directors' pay
 Remuneration committee
Hampel Report 1998

 Reduce regulatory burden
 Principles-based approach
Combined Code 1998

 Code of best practice derived from
– Cadbury
– Greenbury
– Hampel
Turnbull Report 1998

 Risk management
 Internal control
Smith Report 2003

 Role of audit committees
Higgs Report 2003

 Role of non-executive directors
Combined Code 2006 and 2008

 2006 updated for Turnbull, Smith & Higgs
 2008 revision 2 minor restrictions removed
 2010 UK Corporate Governance Code
30
4 Corporate governance covering other jurisdictions
King Report – South Africa

 Integrated approach to corporate governance
 Stakeholder interests and involvement central
 Social, environmental and economic aspects
 Regulatory disclosure
Singapore Code – 2001 and 2005

 Similar to UK Corporate Governance Code
 Describe governance practice
 Explain deviations
OECD
 Interest in governance arises from global
investment issues
 Wide consultation with members
 Published principles of corporate governance
– Rights of shareholders
– Equitable treatment of shareholders
– Role of stakeholders
– Disclosure and transparency
– Board responsibilities
International Corporate Governance Network

(ICGN)
 Report published in 2005
 Practical guidance to companies
– Board structure, membership and operation
– Shareholders' rights and equitable
treatment
– Audit and accounts
– Ethics and stakeholders, including
corporate social responsibility
 Promotes communication between investors and
companies to stimulate economic growth and
success
31
Required
'The goal of international codes of corporate governance should be the development of a universal
set of rules.' Evaluate this attitude towards corporate governance.
Solution
Evaluate
For 'international codes should be developing universal rules'
Against 'international codes should be developing universal rules'
32
5 The Sarbanes-Oxley Act 2002

5.1 Sarbanes-Oxley (SOx) arose from the inadequacies in US corporate governance
arrangements, shown by the Enron scandal.
5.2 SOx adopts a rules-based approach to governance.
5.3 Specific provisions of SOx legislation include:

The establishment of the Public Company Accounting Oversight Board.
Auditors should review internal control systems.
There should be rotation of lead or reviewing audit partners every five years.
Auditors are expressly prohibited from carrying out most non-audit services.
Audit committees should be responsible for the appointment, compensation and
oversight of auditors.
All members of audit committees should be independent, and at least one member
should be a financial expert.
Annual reports should contain internal control reports that state the responsibility of
management for establishing and maintaining an adequate internal control structure
and procedures for financial reporting and assess their effectiveness.
The chief executive officer and chief finance officer should certify the appropriateness
of the financial statements.
5.4 The impact of SOx is widespread, illustrated in the table below:

US Domestic impact International impact
For listed companies, fulfilling the Around 1,500 non-US companies list their
requirement to ensure their internal controls shares in the US. They are covered by the
are properly documented and tested provisions of SOx
For accountancy firms, SOx has formally The US being such a significant influence
stripped them of almost all non-audit worldwide, SOx is likely to persuade other
revenue streams that they used to derive countries to adopt a rules-based approach
from their audit clients to corporate governance
For lawyers, SOx requires them to whistle
blow on any wrong doing they uncover at
client companies, right up to board level
5.5 There are a number of criticisms of SOx, including:

(a) It is not strong enough on some issues, and at the same time over-rigid on others.
(b) Directors may avoid consulting lawyers if they believe that SOx could override lawyer-
client privilege.
(c) A SOx compliance industry has sprung up.
(d) Companies are turning away from the US stock markets and towards other markets.
33
6 Public sector governance

6.1 In addition to the governance of private companies, you need to be able to describe,
compare and contrast the following types of organisation in the following ways:
Private sector Public sector Charitable NGO/QuANGO*

Purposes and Profit Public goods or Meeting a need not provided by either
objectives Market services not public or private sectors (the so-called
(what are they for?) delivered by the 'third sector') such as health, relief,
private sector education and support
Performance Agency-driven, Value for money Value for money More tailored
(how is success but usually profit (3 Es) (3 Es) results than
measured?) and market share Meeting social Meeting own charities or the
needs needs public sector
could deliver
Ownership Partners, Taxpayer Independent Can be state or
(who owns them?) shareholders and (with some government
lenders philanthropic owned
influence)
Stakeholders Lobby groups Population (local Trustees
(including lobby may influence and national) Population (local and national)
groups) government Taxpayers may Pressure groups to stop action that
(who also holds an policy to support lobby for better may have initially led to the creation
interest in them?) their own aims use of their taxes of the charity/NGO
(both for and
against)
* NGO = non-government organisation; QuANGO = Quasi-autonomous non-government organisation
Levels of public sector organisations

6.2 The term “public sector” can be used to describe entities at a variety of levels:
Sub-national Regional assemblies, local authorities, states or cantons with a
variety of responsibilities and devolved political powers.
National Based upon the four organs of state: executive (responsible for running
the state); legislature (responsible for the legal framework); judiciary
(responsible for enforcing that legal framework) and secretariat (the
administration function charged with delivering executive policy).
The executive (or government) is made up of many departments and
setting strategy based on policy. In the case of a democracy, the
governing party (or a coalition if no one party has overall control) sets this
strategy in line with its elected mandate from the population.
Supra-national Governments form bodies for shared purposes – examples are the
European Union, United Nations and the World Trade Organisation.
34
Strategic objectives, leadership and governance arrangements

6.3 When contrasted with private sector organisations, governance in the public sector can
vary quite significantly, although it ultimately depends on objectives and leadership:
Private sector Public sector

Strategic Profit and/or market share Achievement of State-defined
objectives Anything else in their incorporation service delivery to meet social need
documents Securing value for money with
taxpayers’ funds
Leadership Board of directors (influenced by Delegated authority from State
shareholders) (based on principles of public life)
Governance Principles or rules-based in order to Reporting to an oversight body
satisfy shareholders (such as a board of governors)
External audit (for entities above External audit and political (as well
certain thresholds) as media) scrutiny
Demonstration of good use of public
funds in meeting social need
(controlled by budgets and KPIs)
Democratic control, political influence and public sector policy

implementation
6.4 Democratically elected executives (governments) are voted in after an election with a
mandate to set public sector policy. What factors will influence that policy?
Lecture example 3 Classro om discussion
Required
Discuss the following questions when considering factors that could influence public sector policy.
Solution
Should there be a public sector?
What are the priorities? Health, education and welfare ('from the cradle to the grave')
Influence of taxpayers who do not use services they still have to pay for?
Does privatisation play a positive role in helping economies to deliver public sector provision?
35
7 Chapter summary
1 Principles or Principles based practice outlines core principles to ensure

rules good corporate guidance. Departures from best practice have
to be disclosed (‘comply or explain’) and investors then take
appropriate action. The advantages of principles are flexibility,
adaptability and avoiding ‘loopholes’.
Rules based practice requires compliance with a detailed code.
Compliance in full is mandatory. Non-compliance is penalised
often by a regulator. The advantages of rules are that they are
unambiguous and easier to monitor.
2 Ownership Insider organisations (eg family firms) have reduced agency
costs and often arise in jurisdictions with weak minority interest
protection.
Outsider organisations dominate in the US and UK and are
characterised by many small investors and institutional
investors.
3 Corporate The UK Corporate Governance Code covers directors,
governance in remuneration, accounting and controls, auditors and
the UK institutional investors. It is supported by guidance (such as the
Turnbull Report).
Corporate Governance emerged as an issue in the early
1990’s following corporate failures such as Polly Peck and
Mirror Group (unfettered power of dominant directors) and later
Barings Bank (poor internal controls).
4 Corporate The South African King Report was published after the collapse
governance in of apartheid. It emphasises fairness to all groups in society and
other economic wellbeing.
jurisdictions The OECD (governments) and ICGN (investors) both issue
guidance which is useful where no local code is available.
5 The Sarbanes The Sarbanes Oxley Act (SOx) is the US rules based code
Oxley Act enacted after the collapse of Enron and WorldCom which
affects all companies listed on US stock exchanges and their
subsidiaries.
Its main provisions cover the audit profession, audit
committees, internal controls, CEO and CFO responsibility for
financial statements, plus many detailed provisions such as full
disclosure of off-balance sheet finance.
6 Public sector Public and private sector entities, plus charities and NGOs, all
governance have different goals so their governance must reflect that.
END OF CHAPTER
36
Achievement Ladder Step 1
You have now covered the Topic that will be assessed in Step 1 of your Achievement Ladder.
It is vital in terms of your progress towards ‘exam readiness’ that you attempt this Step in the near future.
You will receive feedback on your performance, and you can use the wide range of online resources and
ongoing BPP support to help address any improvement areas. This will help you to tailor your learning
exactly to your own individual requirements.
Course notes
Topic name Subtopic/Chapter name
chapter
Scope of corporate
Scope of corporate governance 1
governance
Approaches to corporate governance 2
governance
37
Achievement Ladder
38
Corporate governance
practice and reporting

Explain and evaluate the roles December 2014 Q3a (10 marks) suitability for taking CEO role
and responsibilities of boards of December 2014 Q4c (6 marks) and June 2012 Q4b (8 marks)
directors, including differences on the advantages of CPD and induction for directors
between CEO and chairman and December 2011 Q2b (8 marks) separate Chair/CEO
training and appraisal of all June 2011 Q1di (8 marks) CEO role managing risks
directors (including NEDs) June 2009 Q1e (10 marks) criticism of CEO on I/Cs
Describe and analyse the December 2013 Q4a (3+5 marks) how directors can leave the
general principles of the legal service of a board (theory and practice)
frameworks within which June 2008 Q3c (5 marks) on “retirement by rotation”
directors operate on boards
Explain and evaluate the role December 2013 Q3a (8 marks) and June 2008 Q3b (8 marks)
and purpose of the main board on nomination committees
committees in effective June 2010 Q2a (10 marks) criticising a remuneration
corporate governance committee
Explain and assess the effect of June 2013 Q4b (8 marks) constructing a package that retains
various components of directors but encourages growth
remuneration packages on December 2011 Q3a (10 marks) purpose and factors
directors’ behaviour influencing the reward package of a CEO
Explain and assess the general June 2011 Q1d (8+6 marks) CEO defending position
principles of disclosure and June 2008 Q3a&B (4+5 marks) on Chairman’s lack of action
communication with and communication with shareholders
shareholders
Describe and assess the December 2014 Q3b (9 marks) benefits of suitable NEDs and
purposes, roles and difficulties encountered during recruitment
responsibilities of Non-Exec June 2013 Q4c (10 marks) on roles of NEDs plus discussion of
Directors elements of their remuneration
December 2010 Q3a&b (8+7 marks) NED issues
Explain legal, ethical, December 2013 Q1c (10 marks) on labour market conditions
competitive and regulatory relative to high rewards for a new CEO
issues of directors’ remuneration
Explain diversity and evaluate December 2013 Q3b (8 marks) explaining the advantages of
issues relating to diversity on diversity (in line with article content)
boards of directors
39
3: CORPORATE GOVERNANCE PRACTICE AND REPORTING
Overview
Corporate governance
practice and reporting
Boards of directors Board effectiveness
Non-executive directors Unitary vs Multi-tier

boards
Remuneration Governance
disclosures
UK Corporate Governance Code

 Section A – Leadership
 Section B – Effectiveness
 Section C – Accountability
 Section D – Remuneration
 Section E – Relations with Shareholders
40
1 The role of the board

1.1 The board
(a) Is collectively responsible for promoting the success of the company by directing and
supervising the company’s affairs.
(b) Provides entrepreneurial leadership of the company, within a framework of prudent
and effective controls, which enable risk to be assessed and managed.
(c) Should set the company’s strategic aims, ensure that the necessary financial and
human resources are in place for the company to meet its objectives and review
management performance.
2 Effectiveness of boards
2.1 To remain effective, directors should extend their knowledge and skills continuously.
2.2 Significant issues that professional development should cover on a regular basis include:
Strategic
planning
Audit
practice and Financial
procedures management
TRAINING AND
Legal and DEVELOPMENT
regulatory
issues Human
resource
issues
Risk
management Corporate
governance
2.3 An appraisal of the board's performance is an important control over it, aimed at improving
board effectiveness, maximising strengths and tackling weaknesses. It should be seen as
an essential part of the feedback process within the company and may prompt the board to
change its methods and/or objectives.
41
2.4 All directors should be individually appraised; criteria that could be applied include:
Independent
and
innovative
thinking
Continuous Familiarity
professional with business
development and industry
information
APPRAISAL
CRITERIA
Contribution Active
towards participation
business in all
development business
Positive and
enthusiastic
committee
work
(Extract from UK Corporate Governance Code)

A1 The Role of the Board
Every company should be headed by an effective board, which is collectively responsible
for the success of the company.
Required
Discuss the characteristics that might be demonstrated by an effective board of directors.
Solution
42
43
3 Board membership and roles

3.1 Key issues for consideration for board membership are:
(a) Size – the balance needs to be struck between the benefits of having varied views
and opinions, alongside the need for coherence of decision-making.
(b) Inside/outside mix – the split between executive decision-making directors and non-
executive directors. Independent non-executive directors have a key role in
governance. Their number and status should mean that their views carry significant
weight.
(c) Diversity mix in terms of gender, ethnicity, backgrounds, experience, etc.
3.2 Division of responsibilities at the head of an organisation is most simply achieved by

separating the roles of chairman and chief executive
Responsibilities of the chairman of Responsibilities of the chief executive

the board officer
Provide leadership to the board, ensuring Provide leadership to the business,
its effectiveness and setting its agenda ensuring the effectiveness of business
operations and setting strategy
Ensuring the board receives accurate and Providing accurate and timely information
timely information
Ensuring effective communication with Communicating effectively with significant
shareholders and that their views are stakeholders
communicated to the board as a whole.
Facilitate effective contribution from NEDS, Facilitate the effective implementation of
ensure constructive relations between board decisions.
execs and NEDs
Take the lead in providing an induction Cooperate in induction and development.
programme for new directors and in board
development
Meet with the NEDs without the executives Cooperate by providing any necessary
present resources.
Facilitating board appraisal Cooperate in board appraisal.
Encouraging active engagement by all the Cooperate with all the members of the
members of the board board.
44
Lecture example 2 Skills: Appropriate level of detail
Required
Assess the benefits of the separation of the roles of chief executive and chairman and explain how
‘accountability to shareholders’ is increased by the separation of these roles. (12 marks)
(Q3b Dec 2007 exam)
Solution
Assessment of benefits. The examiner’s mark scheme allowed a maximum of 10 marks for the
first part of the requirement.
1
Accountability to shareholders
45
3.3 Many companies operate a series of board sub-committees responsible for supervising
specific aspects of governance. The main board committees are:
Audit Committee is responsible Remuneration Committee is

for liaising with external audit, responsible for advising on
supervising internal audit and executive director remuneration
reviewing the annual accounts and policy and the specific package
internal controls. (See Chapter 8) for each director.
Nominations Committee is Risk Committee is responsible

responsible for recommending the for overseeing risk
appointments of new directors to management. (See chapter 5)
the board.
4 Non-executive directors
4.1 Non-executive directors (NEDs) have no executive (managerial) responsibilities or power.
Their primary function is to consider and safeguard the interests of shareholders.
4.2 NEDs have a key role in reducing conflicts of interest between management (including
executive directors) and shareholders by providing balance to the board. They bring an
independent viewpoint as they are not full time employees.
4.3 The role of non-executive directors includes:

(a) Strategy. contributing to, and challenging the direction of, strategy.
(b) Scrutiny. NEDs should scrutinise the performance of management in meeting goals
and objectives, monitor the reporting of performance. They should represent the
shareholders' interests to ensure agency issues don't arise to reduce shareholder
value. (See Chapter 1)
(c) Risk. NEDs should satisfy themselves that financial information is accurate and that
financial controls and systems of risk management are robust.
(d) People. NEDs are responsible for determining appropriate levels of remuneration for
executives, and are key figures in the appointment and removal of senior managers
and in succession planning.
4.4 The main advantages of bringing NED's onto a board are as follows:
 External expertise and experience
 Wider perspective
 Independent and objective view
 Compliance with corporate governance codes
 Assurance to, and confidence for, 3rd parties.
46
4.5 The key problems with NED's tend to centre around two issues:
 Lack of true independence
 Lack of effectiveness.
Required
Explain reasons why NEDs may not be sufficiently independent or effective.
Recommend ways in which organisations can attempt to overcome both these problems.
Solution
47
5 Unitary and multi-tier boards

5.1 The single board structure with sub-committees is known as a unitary structure
Advantages of unitary structure Disadvantages of a unitary structure

All participants have equal legal A NED or independent director cannot be
responsibility for management of the expected to both manage and monitor
company and strategic performance
A single board promotes easier co- The time requirements on non-executive
operation and co-ordination directors may be onerous
The presence of NEDs should lead to There is no specific provision for
better decisions being made employees to be represented on the
management board
Independent NEDs are less likely to be Emphasises the divide between the
excluded from decision-making and given shareholders and the directors
restricted access to information
5.2 In some countries (eg Germany) the board is split into multi-tiers, separating the executive
from other directors (and senior management). This structure is also common in not-for-
profit organisations.
5.3 This multi tier approach can take the form of a:

(a) Supervisory board with no executive function. It reviews the company's direction
and strategy, and is responsible for safeguarding stakeholders' interests.
(b) Management or executive board composed entirely of executive
directors/managers. It is responsible for the running of the business. The supervisory
board appoints the management board.
Required
Evaluate the case for and against operating a two-tier board structure. (8 marks)
Solution
For
48
Against
6 Directors' remuneration
6.1 The purpose of directors’ remuneration is to be sufficient to:
(a) Attract and retain individuals of sufficient calibre, and
(b) Motivate them to achieve performance levels that are in the shareholders’ best
interests as well as their own personal interests.
6.2 The Remuneration Committee determines the organisation's general policy on the
remuneration of executive directors, which according to the UK Code should involve:
(a) A significant proportion of rewards being related to measurable business
performance or enhanced shareholder value.
(b) Full transparency of directors' remuneration in the annual accounts.
(c) Taking account of the position of the company relative to other similar companies.
However the UK Code also notes 'the risk of an upward ratchet of remuneration levels
with no corresponding improvement in performance' and the need to be sensitive to
pay conditions within the company.
49
Required
Explain and assess the effect of various components of remuneration packages on directors’
behaviour.
Solution
Basic Salary
Performance Related Pay
Benefits
Pensions
Shares
Share Options
50
6.3 In order for the financial statements to present an accurate picture of remuneration
arrangements, the annual report would need to disclose:
(a) Remuneration policy
(b) Detailed arrangements for individual directors
(c) Performance conditions attached to remuneration packages
(d) The duration of contracts with directors, and notice periods and termination payments
under such contracts.
7 Governance disclosures
7.1 Annual reports should disclose whether the organisation has complied with governance
regulations and codes.
7.2 Governance disclosures should include:
An operating
Information and financial
Environmental about the review (OFR)
reporting board of
directors
Reports from the

A statement that Remuneration,
the company is a Audit & Nomination
going concern committees
GOVERNANCE
DISCLOSURES
Details of relations
A statement on with auditors
relations and including reasons
dialogue with for change
shareholders
A statement that the
directors have
reviewed the
effectiveness of
internal controls
51
Lecture example 6
Suggest some key elements to be included in:
'Information about the board of directors.'
'A statement on relations and dialogue with shareholders.'
Solution
'Information about the board of directors.'
'A statement on relations and dialogue with shareholders.'
52
8 Chapter summary
1 The role of the board The board act as agents for the shareholders. They
provide leadership and establish strategies to ensure
that the company achieves its objectives.
2 Effectiveness of boards The first principle in the UK Code is that the board
should be effective. This requires training and
development of board members and appraisal of the
performance of the whole board and of individual
members.
3 Board membership and The board should be balanced. The Chairman of the
roles board runs the board and the CEO who should be a
different person runs the company.
4 Non-executive directors NEDs are not involved in the day to day running of
the company. Ideally they should be independent.
They have four main roles; scrutinising the decisions
and disclosures of the board; advising objectively on
strategy, risk and people (remuneration and
nominations).
5 Unitary and multi-tier A single board can speed up decision making and
boards ensure uniformity of authority and responsibility.
Multi-tier boards are common in continental Europe
and are a good way of widening participation in
strategic decisions. The supervisory board often
includes employee or union representatives.
6 Directors’ remuneration Basic salary, benefits and pensions are not related to
performance and should be sufficient to recruit and
retain the right people.
Performance Related Remuneration should be
designed to align the director’s interests to the
objectives of the company. They can relate to KPIs.
7 Governance disclosures The disclosure required will depend on the corporate

governance regime. In a principles-based regime the
disclosure should be adequate to allow the investors
to make informed decisions about corporate
governance (comply or explain).
53
END OF CHAPTER
54
You have now covered the Topics that will be assessed in Step 2 of your Achievement Ladder. This
mainly focuses on the shaded topics below but will also include some recap questions on earlier
topics.
Course notes
chapter
Scope of corporate
governance
governance
Corporate governance Corporate governance practice and
3
practice and reporting reporting
55
Achievement Ladder
56
Internal control systems

Define and explain internal management control December 2007 Q1d (16 marks) why internal
controls are important and how to improve them
Explain and explore the importance and June 2012 Q1c (12 marks) purposes and
objectives of internal control and risk challenges of internal control.
management in corporate governance December 2008 Q3a&b (5+5+10 marks) define
control objectives and then consider broader
organisational factors and control arrangements
Identify and assess the importance of elements December 2014 Q4b (9 marks) on why internal
or components of internal control systems controls can never be guaranteed to be
effective despite their cost
December 2013 Q1di (8 marks) explaining the
difficulties of implementing internal controls
December 2012 Q3b (10 marks) identifying
specific deficiencies in an internal control
system
Define and explain risk in the context of December 2012 Q1d i) (8 marks) part of an
corporate governance article distinguishing between types of risk and
how a situation is strategic [ie board level]
Describe and evaluate a framework for board December 2012 Q1d ii) (9 marks) part of an
level consideration of risk article covering board responsibilities for
internal control
Explain and assess how internal controls June 2013 Q2c (6 marks) how effective internal
underpin and provide information for accurate controls can provide assurance on the integrity
financial reporting of financial reporting
57
4: INTERNAL CONTROL SYSTEMS
Overview
Internal control systems
Frameworks
Objectives
Elements
58
1 Internal control frameworks

1.1 Definition: Internal control is a process affected by an entity’s board of directors,
management and other personnel, designed to provide reasonable assurance regarding the
achievement of objectives. (COSO)
1.2 The two main sources of guidance on internal controls are contained in COSO (The
Committee of Sponsoring Organisations of the Treadway Commission) and Turnbull (The
Turnbull Report).
1.3 COSO has the support of the Securities and Exchange Commission (SEC) which is the
body in charge of implementing and enforcing the Sarbanes Oxley (SOx) legislation in the
USA. It is therefore most relevant to those companies following the SOx rules on internal
controls.
1.4 The UK Turnbull Report was commissioned in order to give guidance to companies
following the principles of the UK’s 2010 Corporate Governance Code. Principle C2 of the
Code is that 'The Board should maintain sound risk management and internal control
systems'.
2 Objectives of internal control

2.1 COSO and Turnbull give broadly similar objectives for internal control systems. The Turnbull
objectives are listed below.
Turnbull
A company’s system of internal control has a key role in the management of risks that
are significant to the fulfilment of its business objectives.
Since profits are in part the reward for successful risk taking, the purpose of internal
controls is to manage and control risk appropriately rather than to eliminate it.
Effectiveness and efficiency of operations.
Ensure the reliability of internal and external reporting.
Assist compliance with laws and regulations.
Safeguard the shareholders’ investment and the company’s assets.
2.2 More practically, internal controls should help organisations to counter risk, maintain the
quality of financial reporting and ensure compliance.
2.3 They provide reasonable assurance that organisations will achieve their objectives.
59
Lecture example 1 Class discussion
Appendix B gives some background information about the UK high street retailer Marks and
Spencer (M&S).
Required
Evaluate the importance of effective internal controls to different stakeholder groups for a large
retail organisation such as M&S.
Solution
60
3 Elements of internal control/enterprise risk

management
3.1 COSO and Turnbull share many elements of internal control / enterprise risk management
as the table below illustrates:
COSO Turnbull
Control Environment Control Environment

Risk Assessment
Control Activities Control Activities
Information and Communication Information and communication processes
Monitoring activities Processes for monitoring continuing effectiveness of
the Internal Control System
Policies, processes, tasks, behaviours and other
aspects
3.2 COSO uses a diagram called the COSO Enterprise Risk Management (ERM) cube to
describe how the elements of the framework, the objectives of the framework and the levels
of an organisation fit together.
While the COSO cube is unlikely to be examined in detail, it does provide a framework for
identifying and managing risk.
ns
e
g
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nc
tin
at
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er
or
pl
Op
p
m
Re
Co
Operation Unit
Function
Control Environment
Division
Risk Assessment
Entity Level
Control Activities
Information & Communication
Monitoring Activities
3.3 ERM should help organisations in the following way:

1. Alignment of risk appetite and strategy
2. Enhance risk response decisions
3. Reduce operational surprises and losses
4. Identify and manage multiple and cross-enterprise risks
5. Seize business opportunities
6. Improve the deployment of capital
61
4 Chapter summary
1 Internal control Internal control frameworks cover the control

frameworks environment and control procedures.
Two key frameworks are COSO a US framework
and the Turnbull Guidance which supports the UK’s
Corporate Governance Code.
2 Objectives of internal The five main purposes of internal control systems
controls are to help a company: achieve objectives efficiently
and effectively; respond to risk; ensure the quality of
reporting; ensure compliance; and safeguard
assets.
3 Elements of internal ns
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tio
nc
tin
control / enterprise risk
ia
a
er
or
pl
Op
m
Re
Co
management
Operation Unit
Function
Control Environment
Division
Risk Assessment
Entity Level
Control Activities
The COSO cube contains all the elements

The control environment is dependent on corporate
culture, management styles, organisational
structures, and ethical values.
Control activities can be classified according to level
from corporate controls (eg policies), management
controls (eg budgets, business process controls (eg
authorisation limits) down to transaction controls (eg
arithmetic checks).
END OF CHAPTER
62
Risk attitudes and
internal environment

Identify, and assess the impact upon, the December 2012 Q4b (8 marks) on the
stakeholders involved in business risk importance of recognising all stakeholders as
part of decisions
Explain the importance of risk awareness at all June 2011 Q2d (6 marks) “there should be a
levels in an organisation culture of risks awareness at all levels”
Describe and analyse the concept of June 2013 Q3c (6 marks) on how risk
embedding risk in an organisation’s systems management can be embedded in a bank
and procedures December 2010 (15 marks) importance and
methods of embedding risk awareness,
together with obstacles to embedding risk
awareness
Describe and evaluate the concept of December 2009 Q4a&b (6+8 marks) describe
embedding risk in an organisation’s culture and and assess ability to implement December 2007
values Q2b (5 marks) “getting risk awareness
embedded in company culture”
Explain and evaluate the different attitudes June 2012 Q1a (6 marks) explanation and
towards risk and how these can affect strategy demonstration of risk appetite
Explain and assess the necessity of incurring December 2007 Q2c (12 marks) on why some
risk as part of competitively managing a risks cannot be avoided, they will just need to
business organisation be managed
Explain risk appetite and how this affects risk June 2014 Q2a (part of 8 marks) explaining
policy impact on a personal investor
Evaluate the difficulties of risk perception December 2011 Q1c (8 marks) including
including the concepts of objective and differences as part of a broader statement on
subjective risk perception internal control failures from the CEO
Explain the dynamic nature of risk assessment June 2011 Q2a (part of 8 marks) on why risks
are dynamic and need to be assessed regularly
63
5: RISK ATTITUDES AND INTERNAL ENVIRONMENT
Overview
Risk Attitudes and internal

environment
Control environment
Risk Appetite Sound System
Stakeholder Attitude Embedding risk awareness
64
ns
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tin
at
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pl
po
Op
m
Re
Co
Operation Unit
Function
Control Environment
Division
Risk Assessment
Entity Level
Control Activities
1 Control (or internal) environment

1.1 The first element of the COSO cube relates to the strategic management of an organisation.
1.2 The control environment relates to 'the Tone at the Top'.
1.3 COSO identifies the following factors which constitute the control environment:
(a) Corporate culture or tone of the organisation
(b) Management style including risk management philosophy
(c) Organisational structure
(d) Risk appetite
(e) Integrity and ethical values
1.4 Turnbull considers the following when reviewing the control environment:
(a) Senior management commitment
(b) Clear strategy
(c) Strong business culture
(d) Clear definition of authority, responsibility and accountability
(e) Effective internal communication, adequate knowledge, skills and resources
1.5 Control procedures, which comprise the detailed controls at lower levels are covered in
Chapter 7.
1.6 When assessing an effective internal control system, an organisation should consider both
the control environment and the control procedures.
2 Objective setting
2.1 Objectives for an organisation should help deliver an organisation's strategy, and they
should be consistent with its risk appetite.
65
3 Risk and risk appetite

3.1 Risk is a condition in which there exists a quantifiable dispersion in the possible results of an
activity.
3.2 Risk appetite is a measure of a company's capacity and willingness to accept different risks.
Required
Suggest some reasons why organisations face risks on a daily basis.
Consider why organisations might seek to increase the risk they face.
Solution
4 Stakeholder responses to risk

4.1 Stakeholder groups are not necessarily risk averse.
4.2 They are likely to react adversely if a company does not conform to their expectations.
4.3 The attitude of some stakeholder groups to risk could have an influence on the company’s
strategy. These groups are:
(a) Shareholders
(b) Debt providers
(c) Employees
(d) Customers
(e) Government, regulatory and other bodies.
66
Appendix B gives some background information about M&S. Different stakeholder groups can
affect or be affected by the risk management strategy at M&S.
Required
For each stakeholder group evaluate their attitude towards risk-taking by the company.
Solution
Shareholders
Debt providers
Employees
Customers
Government, regulatory and other bodies
67
5 'Sound' systems of internal control

5.1 The Turnbull Report discusses a sound’ system of internal control which would have the
following characteristics:
(a) Be embedded in the operations of the organisation
(b) Form part of the culture
(c) Be capable of responding quickly to evolving risks within the business
(d) Include procedures for reporting immediately to management any significant control
weaknesses, together with control action taken to remedy the situation (whistle blower
provisions).
5.2 The Turnbull guidance is 'based on the adoption by a company’s board of a risk based
approach to establishing a sound system of internal control'.
6 Embedding risk
6.1 Risk should be embedded in the company’s:
(a) Systems and procedures;
(b) Culture and values.
Required
Recommend practical ways in which risk awareness can be embedded in an organisation at
different levels.
Solution
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7 Risk management responsibilities

7.1 The board has overall accountability for risk management as part of its corporate
governance responsibilities.
7.2 The board may choose to delegate responsibility to line management or a separate risk
management function.
7.3 A risk committee could also be set up, and can include both executive and non-executive
directors.
7.4 If there is no risk committee, the audit committee will take responsibility for risk
management.
Lecture example 4 Exam style question
Required
Construct an argument for setting up a risk committee that:
Solution
(a) Is staffed by executive directors
(b) Is staffed by NEDs.
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Required
Identify some tasks which a risk committee should fulfil.
Solution
70
8 Chapter summary
1 Control environment COSO and Turnbull both identify culture and

management as contributing to the control environment.
2 Objective setting Objectives for an organisation should support an
organisation's mission and should be consistent with its
risk appetite.
3 Risk appetite Risk appetite is a measure of the company’s capacity to
accept risk and depends on attitudes to risk and the risks
already accepted by the company.
4 Stakeholder The stakeholder groups who might affect corporate
Responses to risk strategy because of their attitude or response to risk are
the shareholders, customers and suppliers, debt
providers and government. They are usually seeking to
protect their stakeholder claims.
5 ‘Sound’ systems of Per Turnbull ‘sound’ controls are embedded, cultural,
internal control and responsive to risks and weaknesses.
6 Embedding risk Risks should be embedded in systems and in culture.
Risk awareness is aided by communication and risk
registers. COSO has suggestions for encouraging risk
ownership.
7 Risk management Risk management must be 'owned' for it to be effective.
responsibilities
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END OF CHAPTER
72
Risks

Define and compare (distinguish between) June 2013 Q1c (part of 10 marks) on how
strategic and operational risks internal controls can be strategic in nature
December 2012 Q1d (part of 8 marks) and
December 2008 Q1b (part of 10 marks), each
one directly testing the syllabus learning
outcome
Define and explain the sources and impacts of Exchange rate risk, supply risk and international
common business risks, including industry or political risk – December 2014 Q1c (9 marks)
sector specific risks Business vs financial risk – June 2014 Q2b (8
marks)
Technological risk – December 2013 Q4b (2
marks)
Financial risk – June 2013 Q3c (4 marks)
Entrepreneurial risk – June 2009 Q4c (4 marks)
Market risk – December 2011 Q2b (2 marks)
and December 2008 Q3c (5 marks)
Environmental risk – December 2010 Q2c (part
of 10 marks) on why environmental risks are
strategic
Pilot Paper Q1b (6 marks) on risk identification
Describe and evaluate the nature and December 2011 Q3 (10 marks) understanding
importance of business and financial risks the nature of market risk and how it can best be
managed
Explain and evaluate the concepts of related June 2013 Q1a (part of 10 marks) requiring a
and correlated risk factors brief explanation of correlation between legal
and reputation risk
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6: RISKS
Overview
Risks
Part of COSO
Events Categorising Risk
Scope Function
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1 Event identification
1.1 The diagram above illustrates how risk identification fits into the COSO ERM framework.
1.2 Risk identification is a continuous (iterative) process.
1.3 Risks once identified can be included within the firm’s risk register and kept under review.
2 Risk events
2.1 A key aspect of risk identification emphasised in the COSO ERM Framework is the
identification of events that could impact upon implementation of strategy or achievement of
a firm’s objectives.
2.2 Such events could include:

(a) External events such as economic changes, political developments or technological
advances
(b) Internal events such as equipment problems, human error or difficulties with
products
(c) Trends and root causes
(d) Escalation triggers, certain events happening or levels being reached that require
immediate action
(e) Event interdependencies. Identifying how one event can trigger another and how
events can occur concurrently.
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6: RISKS
3 Categorising risk
3.1 Risks can be categorised by scope or function.
3.2 An advantage of analysing risks by scope, separating them into strategic and operational
risks is to ensure they are considered by the most appropriate level of management. Some
organisations choose to maintain separate risk registers for strategic and operational risks.
3.3 An advantage of categorising risk by function is that they can be analysed and managed by
managers with appropriate technical expertise. For example legal risks will be managed by
a legal department.
4 Strategic and operational risks

4.1 Strategic risks are those risks that relate to the fundamental long term decisions that
directors take about the future of an organisation.
4.2 The most significant risks are focused on the impact they would have on the company's
ability to survive in the long term.
Required
Give an example of each of the following 'strategic' risk categories:
Solution
Technology
Product
Resources
Competition
Investment
Reputation
4.3 The main differences between strategic and operational risks relate to:
(a) Scope of impact
(b) Source of risk
(c) Duration of impact
(d) Scale of financial and resource consequences
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6: RISKS
4.4 Operational risk is the risk of loss from a failure of internal business and control processes
and will affect day to day operations.
4.5 Operational risk includes losses arising from:
(a) Internal control
(b) Audit inadequacies
(c) Human errors
(d) Fraud
(e) Business interruption
(f) Loss of key personnel
5 Classification of risk
5.1 There are many different types of risks faced by organisations, particularly those with
commercial or international activities.
Required
Explain the following types of risk using an example if appropriate.
Solution
Market risk
Credit risk
Liquidity risk
Legal risk
Health, safety and environmental risk
Reputation risk
Business probity risk
Derivatives risk
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6: RISKS
Financial Legal
Physical
Product Political
Economic
Property (inc RISK
intellectual) CLASSIFICATION
Environmental
Fraud
Technological
Organisational
Knowledge
Reputation management
Trade (inc
FOREX)
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6: RISKS
6 Chapter summary
1 Event identification Risk identification is an element of the COSO Enterprise

Risk Management (ERM) cube and is a continuous
process.
2 Risk events Risk can arise from internal or external events. Trends,
interdependencies and escalation triggers can give insight
into potential risks.
3 Categorising risk Risks are categorised in order to manage them more
effectively. They should be dealt with at an appropriate
level within the organisation and by people with
appropriate technical expertise.
4 Strategic and Strategic risks arise from fundamental long term
operational risks decisions. Operational risks are what can go wrong on a
day-to-day basis.
5 Classification of risk Common risks faced by businesses include:
– Market
– Credit
– Liquidity
– Technological
– Legal
– Health, safety and environmental
– Reputation
– Business probity
– Derivatives
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6: RISKS
END OF CHAPTER
80
topics.
Course notes
chapter
Scope of corporate
governance
governance
3
Internal control and risk Internal control systems 4
attitudes Risk attitudes and internal environment 5
Risks Risks 6
81
Achievement Ladder
82
Risk assessment and
response

Explore and evaluate the effectiveness of December 2009 Q1b (12 marks) and June 2009 Q1b
internal control systems (10 marks) on internal control failures
December 2007 Q1d (6 marks) why robust internal
controls are important
Explain and analyse the concepts of June 2011 Q2 (25 marks) both risks and controls
assessing the severity and probability of December 2008 Q2b (10 marks) and June 2008
risk events Q1b&c (6+9 marks) on risk assessment using TARA
Explain and analyse the concepts of December 2012 Q1b (10 marks) explaining the term
spreading and diversifying risk and when 'risk diversification' and why it would be very difficult
this would be appropriate to attempt in practice
Explain and assess the importance of risk December 2007 Q2a (12 marks) on using the TARA
transference, avoidance, reduction and model
acceptance
Explain and assess the ALARP principle in December 2011 Q1civ explaining why ALARP means
risk assessment and how this relates to further health and safety failures cannot be prevented
severity and probability December 2007 Q2c (12 marks) on CEO rewards
Explain the sources, and assess the December 2013 Q1b (10 marks) assessing four risks
importance of, accurate information for and explaining why subjective judgement may limit
risk management the accuracy of risk assessment
Explain the importance and nature of June 2013 Q3a (8 marks) explain risk assessment
management responses to changing risk and discuss its need to be continuous and ongoing
assessments
Identify and assess how business June 2013 Q3c (part of 10 marks) on how financial
organisations use policies and techniques risks can be managed by a bank
to mitigate various types of business and
financial risks
83
7: RISK ASSESSMENT AND RESPONSE
Overview
Risk assessment and response
Risk assessment
Risk profiling
Risk quantification
Risk consolidation
Risk response
Control procedures
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1 Risk assessment
1.1 The COSO cube broadly identifies key steps of assessing risks.
1.2 Those steps are:

 Identification
 Analysis
 Profiling
 Quantification
 Consolidation
1.3 Types and categories of risks that an organisation might face were identified in Chapter 6.
1.4 When deciding on a process for assessing risk an organisation needs to consider:
(a) Who should do it?
(b) How it should be done?
(c) How often it should be done?
85
Required
Identify some ideas to answer the questions identified above.
Solution
(a) Who?
(b) How?
(c) How often?
2 Risk profiling
2.1 Having assessed the risk it can be mapped onto a grid of impact and likelihood
High
Likelihood
Low
Low High
Impact
2.2 The risk tolerance boundary reflects the company’s risk appetite.
86
2.3 The risk profile allows the company to prioritise its treatment of different risks. It may choose
to spend less on managing one risk in order to release funds to manage another more
effectively.
3 Risk quantification
3.1 Risks that require more analysis will be quantified, where possible results and losses are
considered.
3.2 Techniques for carrying out risk quantification include sensitivity analysis and accounting
ratios. Although unlikely to be directly tested in the exam understanding the quantifiable
effect on business is key to scoring good marks.
Calcit is a company hoping to launch a new product. The initial investment of $6m will generate
revenues of $5m in each of the next two years. The variable costs are expected to be $1.5m per
annum in the next two years. Calcit’s cost of capital is 8%.
Required
Assess whether the project is more sensitive to the risks associated with variable costs or price.
Solution
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4 Risk consolidation
4.1 Risks are summarised in order to report them to senior management.
4.2 Risk consolidation will also incorporate portfolio management. Consolidating risks together
may reduce overall risk because of diversification.
4.3 Risks will need to be considered in conjunction with other risks which may provide a hedge
against them.
4.4 Senior managers will need to judge the priority of different risks, ensure that risk
management is aligned with the company’s objectives and with its risk appetite.
5 Risk response
5.1 In order to deal with risk, organisations will consider:
 Risk Transfer
 Risk Avoidance
 Risk Reduction
 Risk Acceptance
5.2 You should remember this as the TARA model.
5.3 The likelihood/consequences matrix is a means of matching a suitable strategy to a given

risk.
Consequences
(impact)
Low High
Low
ACCEPT TRANSFER
Likelihood
(frequency)
High REDUCE AVOID
5.4 Some businesses face risks which are high likelihood and high consequence. If this arises
out of their core business they are unlikely to avoid it. The concept of ALARP (as low as
reasonably possible) is a way of considering the trade off between the costs of mitigating
the risk and the assessment of the risk.
5.5 The level of risk considered ‘as low as reasonably practicable’ may be a good compromise.
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Among the risks that M&S faces you may have identified the following:
(a) Theft of inventory
(b) Under/overstocking specific lines from the women’s fashion ranges
(c) Failure of the EFTPOS system (the technology to record credit and debit card transactions
electronically and to maintain the computerised inventory records)
(d) An economic downturn resulting in lower rates of sales growth.
(e) New competitor undercutting on price
Required
Assess each risk and discuss an appropriate strategy for responding to the risk.
Solution
5.6 The risk management process helps organisations to prioritise their risks but cannot
eliminate them altogether: usually gross risks (risks without any mitigation) and residual
risks (risks that remain once management action has been taken to address them) are
compared to assess how effective such risk response action has been.
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6 Controls (methods of risk reduction)

6.1 Controls can be operated at different levels of the business:
(a) Corporate controls (eg general policy statements, the established core culture and
overall monitoring procedures, corporate governance?)
(b) Management controls (eg planning and performance monitoring)
(c) Business process controls (eg authorisation limits and reconciliation)
(d) Transaction controls include (eg accuracy and completeness checks)
6.2 You could use the mnemonic SPAMSOAP to help generate ideas for specific controls.
Segregation of duties, with no one person having total control of an area eg the
chairman/CEO roles should be split (Cadbury)
Physical measures to secure the custody of assets eg access control to buildings
Authorisation and approval of all business activities by appropriate persons
eg non-executive directors to decide directors’ pay and sit on a remuneration committee
Management should provide control through analysis and review of accounts eg tasking
internal audit
Supervision of the recording and operations of day-to-day transactions eg budget
monitoring through exception or variance reports
Organisation identifies reporting lines, levels of authority and responsibility. This ensures
everyone is aware of their control (and other) responsibilities, especially in ensuring
adherence to management policies eg enabling named staff to act independently within
areas of delegated power
Arithmetical and accounting to check the correct and accurate recording and processing of
transactions eg bank account reconciliation
Personnel Attention should be given to selection, training and qualifications of personnel,
as well as personal qualities eg checking reference during a recruitment process.
90
7 Chapter summary
1 Risk assessment Organisations may have a formal process/department

2 Risk profiling Risk will be considered and analysed so that the directors
can decide how to respond.
3 Risk quantification Management accounting techniques will be used to try to
put a value on a risk.
4 Risk consolidation The final process of risk consolidation takes a step back to
look at the overall picture. Risks can be summarised for
reporting or identified as hedges for one another.
5 Risk response The 'TARA' model highlights 4 potential responses to a risk.
6 Controls (methods Suitable controls should be chosen which best mitigate or
of risk reduction) reduce a known risk.
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END OF CHAPTER
92
Information,
communication and
monitoring

Describe the function and importance of December 2014 Q4a (10 marks) the case for establishing
internal audit internal audit
December 2013 Q1dii (6 marks) & June 2013 Q2a
(7 marks) on the importance of the role of internal audit
December 2008 Q3b (5 marks) explaining organisational
factors determining the need for internal audit
Explain and evaluate the importance of June 2013 Q2b (12 marks) on audit committees
compliance and the role of the internal audit December 2008 Q3b (10 marks) criticising internal audit
committee in internal control and internal control arrangements in a company
Define and describe management June 2012 Q2b & c (17 marks) role of the risk committee
responsibilities in risk management and how they differ in different sized companies
June 2009 Q1e (10 marks) on the role of the CEO in
internal control
Explain and evaluate the role of the risk June 2009 Q4a&c (4+7 marks) describing the risk
committee and risk manager in identifying and manager’s role and evaluating the commercial director’s
monitoring risk view of risk management
Describe and assess the need to report on December 2013 Q1d (8+8 marks) on risk audits
internal controls to shareholders and the December 2012 Q3b (10 marks) as part of a broader
content of a report on internal control and question on internal control failure
audit, including internal and external risk
auditing in monitoring risk June 2008 Q4b&c (8+4 marks) on external reporting of
internal controls and their suitability for SMEs
Explain and assess the need for adequate December 2009 Q1d (6 marks) on the importance of
information flows to management for the possessing all relevant risk and control information
purposes of the management of internal December 2007 Q4a (10 marks) on the importance of
control and risk identifying all stakeholders before proceeding with projects
Evaluate the qualities and characteristics of December 2012 Q3c (10 marks) discuss general qualities
information required in internal control and risk of good information and ways of improving information
management and monitoring flow
Describe the process and importance of December 2010 Q1cii (8 marks) on mandatory external
externally reporting on internal control and risk reporting of internal financial controls and risks
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8: INFORMATION, COMMUNICATION AND MONITORING
Overview
Information, communication and

monitoring
Information
Communication Monitoring External reporting
Committees Internal audit
Risk manager
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1 Information
1.1 In order to fulfil their duties effectively the board of directors (and sub committees) need a
wide range of information.
1.2 Information should be characterised as:

Accurate
Complete
Cost-beneficial
User targeted
Relevant to task
Authoritative
Timely
Easy to use
1.3 In the exam you may be asked to examine the information in a scenario in terms of its
ACCURATE characteristics.
95
Lecture example 1 Discussion
Required
Suggest some sources of information directors could use under the following headings.
Internal External
Formal
Informal
2 Communication
2.1 The board must make sure that staff abilities and attitudes are suitable, and that everyone
has access to appropriate organisational information.
Lecture example 2
Required
Suggest ways in which directors can both inform and influence staff.
Solution
96
3 Monitoring
3.1 The board of directors is responsible for the company’s system of internal control. This
includes doing the following:
(a) Setting appropriate policies
(b) Seeking regular assurance
(c) Ensuring effective risk management.
3.2 In determining policies for internal control the board should consider:
(a) The nature and extent of risks
(b) The extent of acceptable risks
(c) The categories of acceptable risk
(d) The likelihood of the risk materialising
(e) The company’s ability to reduce the incidence and impact of risks
(f) The cost of operating particular control relative to the benefits.
3.3 It is the role of management to implement board policies on risk and control:
(a) Identify and evaluate risks;
(b) Operate the system of internal control;
(c) Monitor the effectiveness of the system of internal control.
3.4 All employees have responsibility for internal controls as part of their accountability for
achieving objectives.
Audit committee
3.5 The board should establish an audit committee of at least three (two in the case of smaller
companies) members, who should all be independent non-executive directors. The board
may delegate some of its duties to the Audit Committee (and the Risk Committee).
3.6 The board should satisfy itself that at least one member of the audit committee has recent
and relevant financial experience. (Under SOX having fulfilled the role of CEO is not
sufficient experience to qualify as the financial expert on the audit committee.)
3.7 The audit committee should have written terms of reference. Under SOX this is referred to
as the Audit Committee Charter.
97
3.8 The role of the audit committee encompasses:
Monitoring & Overseeing Policy setting

Reviewing  Effective internal  Non audit service
 Financial audit provided by
statements external auditors
 Appointment of
(NB most are
 Price sensitive external auditors
barred under
information  Remuneration of SOx)
 Internal financial external auditors
controls
 Independence of
external auditors
3.9 The audit committee is the body responsible for whistleblower procedures within the
company. They have to ensure that any problems will be brought to their attention.
3.10 As part of their role of monitoring internal audit, the audit committee should carry out a
formal annual review of internal audit. If there is no internal audit function present, the audit
committee should consider annually whether there is still no need for internal audit or if one
might now be required.
3.11 According to Turnbull the factors that will influence this decision are:
£$¥€
Company Size Unexpected risk Cost v benefit

events analysis
Company
Complexity Problems in the
internal control
3.12 The Turnbull Report states that listed companies without an internal audit function should
annually review the need to have one.
98
Internal audit
3.13 Internal audit is a form of control put in place by the board in order to help achieve the
company’s objectives.
3.14 Internal audit is an important part of the internal control system and it can therefore be
regarded as having the same objectives as the rest of the internal control system: ie
safeguarding assets; economy, efficiency & effectiveness of operations; reporting; and
compliance.
3.15 The internal audit department reports to the audit committee who will carry out an annual
review of the internal audit function covering:
(a) Scope of work
(b) Authority
(c) Independence
(d) Resources
3.16 As well as the objectives listed at 3.14 above the scope of the work performed by internal
audit can include:
(a) Risk management processes
(b) Value for money audits
(c) Attainment of company goals and objectives
3.17 To ensure the internal audit department has sufficient authority, the audit committee will
consider whether the terms of reference of the internal audit department are sufficiently
broad and whether the reports produced by the internal audit department have been
reviewed and action taken.
3.18 The audit committee will need to ensure that the internal audit department is adequately
resourced in terms of hours, physical resources and appropriate knowledge, skills and
experience.
4 Risk committee
4.1 The risk committee may include executive and non-executive directors. It is often chaired by
the company’s CEO. The risk committee was covered in detail in Chapter 5.
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5 Risk manager
5.1 A risk manager needs to combine technical skills in credit, market and operational risk with
leadership and persuasive skills.
5.2 COSO lists their responsibilities as:

(a) Leadership of enterprise risk management
(b) Establishing and promoting enterprise risk management
(c) Developing polices
(d) Common risk management policies
(e) Establishing a common risk language
(f) Dealing with insurance companies
(g) Implementing risk indicators, (ie designing early warning systems)
(h) Allocation of resources based on risk
(i) Reporting to the CEO
6 External reporting
6.1 The board is responsible for reporting on risk and internal control to shareholders. It does
this annually in the Annual Report and at the AGM.
6.2 Directors are required to report annually on risk and internal controls.
6.3 To fulfil their obligations directors should regularly review the adequacy of internal controls
considering:
(a) Changes since the last formal review
(b) The company’s ability to respond to changes in the business environment
(c) The scope and quality of management monitoring (including internal audit)
(d) The extent and frequency of reports to the board
(e) Significant controls failing or weaknesses
100
Appendix B contains extracts from M&S’s annual report for 2011.

Required
Highlight the parts of the report that are fulfilling the directors’ obligations to report on risk and
internal control.
Solution
(The following checklist contains all the elements required by Turnbull and the UK Corporate
Governance Code.)
Report Contents 
The existence of a process for managing risk
How the board has reviewed the effectiveness of the process
That the process accords with the guidance
Formally acknowledge the boards responsibility for internal control and review
An explanation that the system manages but does not eliminate risk
A summary of the process for reviewing internal controls
Information about material weaknesses
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7 Chapter summary
1 Information The board are ultimately responsible for the internal

requirements of the control system. They are responsible for reporting to the
board shareholders on the risks and controls and so require
information to do so.
2 Communication Internal communication is vital for ensuring staff are
informed.
3 Internal control and Three independent NEDs (one with financial expertise)
monitoring form the audit committee. They review financial
statements, oversee internal audit and deal with the
appointment and remuneration of external auditors.
They have to check the independence of external audit
and determine the company’s policy for non-audit work.
(Under SOx most non-audit work is not permitted.)
The audit committee decide if an internal audit function
is required. They monitor the work of internal audit. The
objectives of internal audit are the same as all other
controls (safeguard assets etc).
Internal audit should report to the audit committee (or the
main board) in order to ensure their independence.
4 Risk committee The risk committee sets policies on the extent and
categories of acceptable risk. The risk committee can
include executive directors.
5 Risk manager A risk manager is usually a technical expert. There role
can extend from developing risk policies to dealing with
insurance companies.
6 External reporting Directors report annually to shareholders on risk and
controls. The contents of the report will cover their
responsibilities for managing risk and for the internal
control system, include a review of effectiveness and
report on any major changes and material weaknesses.
END OF CHAPTER
102
topics. As a reminder, Step 4 must be completed and submitted in order to be able to qualify for Pass
Assurance. It is Written Assessment 1 and can also be found at the back of these course notes.
Course notes
chapter
Scope of corporate
governance
governance
3
Risks Risks 6
Risk assessment and
Risk assessment and response 7
response
Information, communication Information, communication and
8
and monitoring monitoring
103
Achievement Ladder
104
Personal ethics

Explain and distinguish between the ethical December 2010 Q1b (10 marks) and June 2008
theories of relativism and absolutism Q2c (6 marks) on how each would affect the
outcome of an ethical dilemma
Describe and distinguish between June 2013 Q1dii (10 marks) arguing against the
deontological and payment of a bribe to secure a business contract
teleological/consequentialist approaches to December 2008 Q4c (9 marks) using both to
ethics evaluate the belief that child labour is wrong
Pilot Paper Q3c (6 marks) explain and contrast
Explain, in an accounting and governance June 2009 Q1a (6+4+2 marks) theory and
context, Kohlberg’s stages of human moral application in a ”rogue trader” scenario
development June 2011 Q1b (12 marks) explanation and
application of theory in a motor manufacturer
December 2007 Q1b (12 marks) theory and
application in a manipulated F/S scenario
Apply commonly used ethical decision- Tucker: December 2012 Q4a (10 marks) and
making models in accounting and December 2008 Q1a (10 marks)
professional contexts: American Accounting AAA: June 2012 Q1b (14 marks) and December
Association model, Tucker’s 5-question 2009 Q1a (14 marks)
model
Explain and analyse the content and nature of June 2014 Q4a (8 marks) explaining how to act
ethical decision making using content from adopting both conventional and post-conventional
Kohlberg’s framework as appropriate ethical assumptions
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9: PERSONAL ETHICS
Overview
Personal ethics
Ethics
Ethical theories Kohlberg's stages of human

moral development
Models of ethical conflict

resolution
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9: PERSONAL ETHICS
1 Ethical theories
1.1 Ethics is:
(a) Concerned with right and wrong, and how conduct is judged to be good or bad.
(b) About how we should live our lives and, how we should behave towards other people.
(c) Relevant to all forms of human activity, including the business world.
(d) Problematic in business where the primary purpose is material gain.
Ethical absolutism
1.2 Absolutism is the view that there is an unchanging set of ethical principles that will apply in
all situations, at all times and in all societies.
1.3 The methods of establishing ethical absolutism include:

(a) Religion, based on the concept of universally applicable principles.
(b) Law, a source of reference for establishing principles.
(c) Natural law approaches to ethics, based on the idea that a set of ‘natural’ moral rules
exists and we can come to know what they are.
(d) Deontological approaches (see below).
Strengths of absolutism Criticisms of absolutism

Absolutism lays down that there are certain Absolutist ethics takes no account of
unambiguous rules that people are able to evolving norms within society and the
follow, knowing that their actions are right. development of ‘advances’ in morality.
The existence of absolute rules makes the Irrespective of the source of absolute
application of corporate governance and ethical principles, they are then subject to
comparing the performance of business human interpretation with the result that
units more achievable. different views may exist on the same
issue.
There will never be universal agreement.
Two absolutist positions may be
incompatible and therefore irreconcilable,
eg is it permissible to tell a lie in order to
save an innocent life?
Absolutism versus relativism

1.4 Relativism is the view that a wide variety of acceptable ethical beliefs and practices exist.
1.5 Relativism recognises the differences that exist between the rules of behaviour prevailing in
different cultures. This is clearly a matter of significance in the context of international
business and recognises that ethical opinions may change over time.
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9: PERSONAL ETHICS
Required
Examine the relative merits and demerits of adopting an ethically relativist approach in business?
[8 marks]
Solution
Deontological v Teleological ethics

1.6 An ethical decision will lead to an action which will have consequences. A deontological
approach judges the action, while a teleological approach judges the outcomes.
Decision Action Outcome
Duty Benefit / Harm
Deontological ethics
1.7 Deontology is concerned with the application of universal ethical principles in order to arrive
at rules of conduct. Deontology lays down criteria by which actions may be judged in
advance [Emmanuel Kant].
1.8 Deontology tests actions and establishes where your duty lies based on:
(a) Applying the rule universally and consistently.
(b) Rules should respect human dignity.
1.9 A criticism of deontological ethics is that you cannot take actions in a vacuum and must
have regard for their consequences. However, we cannot always know what the
consequences of our actions would be.
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9: PERSONAL ETHICS
Teleological (or consequentialist) ethics

1.10 The teleological approach to ethics is to make moral judgements about courses of action by
reference to their outcomes or consequences. Right or wrong becomes a question of benefit
or harm.
1.11 There are two versions of consequentialist ethics:

(a) Utilitarianism can be summed up in the 'greatest good' principle. This says that when
deciding on a course of action we should choose the one that is likely to result in the
greatest good for the greatest number of people. The problem is how do we define
what is good for people.
(b) Egoism states that an act is ethically justified if decision-makers freely decide to
pursue their own short-term desires or their long-term interests. The subject of all
ethical decisions is the self.
Application in the real world

1.12 Absolutism and relativism are the ends of a spectrum, and deontology & teleological
reasoning could also be regarded this way. Most people acknowledge that other views
exists (relativism) while maintaining that there are some are shared values (absolutism).
1.13 This viewpoint is helpful in business situations where a range of perspectives have to be
understood in order to establish a course of action. It emphasises the importance of morality
as a social phenomenon; that some rules and arrangements need to be established for us to
live together and we therefore need a good understanding of the different moralities that we
will encounter.
Required
Identify some factors that will influence both an organisation's and an individual's ethical
perspective.
Solution
109
9: PERSONAL ETHICS
2 Kohlberg’s stages of human moral development

2.1 Kohlberg describes the development of individuals’ ethical reasoning in terms of
progression through three levels with two planes within each level. These levels can be
related to ethical behaviour.
2.2 They show the reasoning process of individuals; it is possible that individuals at different
levels will make the same moral decisions, but they will do so as a result of different
reasoning processes.
2.3 Kohlberg emphasises how the decision is reached, not what is decided.
Level 1 Pre-conventional
 Obedience and Punishment: suggests that obedience is
compelled by the threat or application of punishment
 Individualism, Instrumentalism, and Exchange considers that
right behaviour means acting in one's own best interests
Level 2 Conventional
 Peer pressure view; is an attitude that seeks to do what will gain
the approval of others
 Law and Order means abiding by the law and responding to the
obligations of duty
Level 3 Post-conventional
 Social Contract is an understanding of social mutuality and a
genuine interest in the welfare of others
 Principled conscience is based on respect for universal
principles and the demands of individual conscience
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9: PERSONAL ETHICS
Lecture example 3 Class discussio n
GSA is a listed pharmaceutical company that operates across different countries but has its
headquarters in a European country. The company is considering the extension of one of its
production facilities but this will require the compulsory purchase of local houses for demolition in
order to accommodate the necessary building work. The new facility will be working on creating a
new chemical that is expected to significantly improve water purification in under-developed
countries. Home-owners have been approached for their initial responses about this proposal
before it is debated by the GSA board.
Required
(a) Recommend how home-owners would respond using Deontological and both forms of
Teleological ethical principles.
Following some consultation, the decision to obtain a compulsory purchase order for land and
homes is adopted by the board despite mixed reactions from those affected. At a meeting of local
residents, three home-owners presented their views:
 Bal pointed out that regardless of what the residents may want, they have an obligation to
under-developed countries to support this initiative and relocate.
 Uwe said that it is 'just capitalism at work here' and people should accept it. He will be
pushing for the company to pay him as much money as possible for his house, which he
knows is in a poor state of repair but which he hopes will be overlooked.
 Ming is a corporate lawyer who has obtained details of case law that sets a precedent about
how such compulsory purchase orders should be approached by both companies and
residents – she suggest that this approach is followed regardless of what home-owners
want.
Required
(b) Using the Kohlberg model, explain which level each of the three residents is operating at.
Solution
(a) Deontological
Teleological
(b) Bal
Uwe
Ming
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9: PERSONAL ETHICS
3 Frameworks for ethical conflict resolution

IFAC Code
3.1 The IFAC Code states that firms should have established policies to resolve conflict and
should consider:
1. The facts
2. The ethical issues involved
3. Related fundamental principles
4. Established internal procedures
5. Alternative courses of action, considering the consequences of each
American Accounting Association model

3.2 The American Accounting Association (AAA) Model frames the ethical decision as a series
of answers to questions.
(a) What are the facts of the case?
(b) What are the ethical issues in the case?
(c) What are the norms, principles and values related to the case?
(d) What are the alternative courses of action?
(e) What is the best course of action that is consistent with the norms, principles
and values identified?
(f) What are the consequences of each course of action?
(g) What is the decision?
Tucker’s 5-question model

3.3 Tucker’s 5 question model is a benchmark against which to test the ethicality of a decision.
Ask yourself, is the decision:
(a) Profitable?
(b) Legal?
(c) Fair and equitable?
(d) Right, which is prone to subjective judgement?
(e) Sustainable or environmentally sound?
Lecture example 4 Group discu ssion
headquarters in a European country. In general terms it always complies with the law – financial
statements are filed on time, employee and sales taxes are paid over to the local tax authority –
but despite the parent company recording high operating profits, it recently paid a very low level of
corporate tax due to apparent loopholes in the legislation (sometimes referred to as 'legal tax
avoidance'). This became a controversial news story and led to calls for a boycott of the company’s
products unless they voluntarily paid more corporate tax. GSA’s Chief Executive Martyn Rice
agreed to respond to the media on behalf of the board.
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9: PERSONAL ETHICS
Required
(a) Recommend a response for the Chief Executive to make from the perspective of Absolutist
and Relativist ethical principles.
(b) Assess the proposal to make no voluntary payment of corporate tax by the company using:
(i) The AAA model
(ii) Tucker’s 5 questions
Solution
(a) Absolutist
Relativist
(b) (i) AAA

(a) What are the facts of the case?
(b) What are the ethical issues in the case?
(c) What are the norms, principles and values related to the case?
(d) What are the alternative courses of action?
(e) What is the best course of action that is consistent with the norms, principles
and values identified?
(f) What are the consequences of each course of action?
(g) What is the decision?
(ii) Tucker
(a) Profitable?
(b) Legal?
(c) Fair and equitable?
(d) Right, which is prone to subjective judgement?
(e) Sustainable or environmentally sound?
113
9: PERSONAL ETHICS
4 Chapter summary
1 Ethical theories Ethics is concerned with issues of right and wrong.

Relativism is the belief that ideas of right and wrong are
subjective. Relativism contrasts with absolutism, the belief
that there are universal, objective moral truths.
Deontological ethics establishes rules for how you should or
should not act depending on the rightness of the action.
Teleological or consequentialist ethics looks beyond the
action to the outcome. This approach can be split into two,
utilitarianism which makes judgements based on the
greatest good and egoism which makes judgements based
on the consequences for the individual (the thief’s rule).
2 Kohlberg’s Kohlberg describes the development of individuals’ ethical
stages of human reasoning through three stages or levels.
moral Pre-conventional: reward/punishment and self-interest
development
Conventional: 'good boy/girl' and legal or social conventions
Post-conventional: concern for others and principled
conscience
3 Frameworks for The IFAC and American Accounting Association Models
ethical conflict cover broadly the same issues. Consideration should be
resolution given to: the facts, the ethical issues, fundamental
principles, internal procedures, alternatives.
Tucker’s 5 questions are, is the decision: Profitable? Legal?
Fair? Right? Sustainable?
END OF CHAPTER
114
You have now covered the Topics that will be assessed in Step 5 in your Achievement Ladder. This
topics.
Course notes
chapter
Scope of corporate
governance
governance
3
Risks Risks 6
Risk assessment and
response
8
Personal ethics Personal ethics 9
115
Achievement Ladder
116
Professional ethics

Explain and explore the nature of a profession June 2014 Q3c (9 marks) explain the public interest
and professionalism including the public December 2013 Q4c (9 marks) on how awareness of a
interest professional duty to public interest could prevent errors
December 2012 Q1c (9 marks) examines the professional
and ethical behaviour of the FD
June 2009 Q2a (5 marks) 'what is the public interest?'
Analyse the role of accounting as a profession June 2010 Q4b (7 marks) and June 2009 Q2c (7 marks)
in society on the role society expects accountants to play
Describe and explore and areas covered by June 2014 Q1b (11 marks), June 2008 Q4a (9 marks) and
corporate codes of ethics December 2011 Q1a (10 marks) codes and behaviour
Describe, assess the content of, and Integrity: June 2013 Q1di (6 marks) and December 2009
principles behind, professional codes of ethics Q3a (5 marks)
Describe and assess the codes of ethics Pilot Paper Q3a (11 marks) Professor Cheung
relevant to accounting professionals such as Pilot Paper Q4c (4 marks) FF Co
IESBA (IFAC) or professional body codes
Explain and evaluate the nature of impacts of June 2014 Q3a (8 marks) explanation and benefits
ethical threats and safeguards, plus risks to June 2012 Q3b application of ethical safeguards
auditor independence June 2009 Q2b (5+8 marks) describe and assess threats
Describe and discuss rules-based and June 2014 Q4b (8 marks) construct an ethical case for
principles-based approaches to resolving whistle-blowing the use of inferior meat in food products
ethical dilemmas encountered in professional June 2010 Q2c (5 marks) construct an ethical case for the
accounting voluntary reduction of CEO’s pension after failure
Describe and evaluate issues associated with June 2012 Q3a (10 marks) and December 2010 Q3a (8
conflicts of interest and ethical conflict marks) explaining conflicts of interest
resolution
Explain and explore bribery and corruption, December 2014 Q1b (10 marks) explaining the impact of
how they can be reduced and any barriers to corruption
implementing such measures June 2013 Q1dii (10 marks) assessing the payment of a
bribe to secure a business contract
117
10: PROFESSIONAL ETHICS
Overview
Professional ethics
Accountants and the public

interest (IFAC)
Professional codes of ethics Corporate codes of ethics
IFAC ethical code ACCA 'The Rule Book'
Threats of professional
independence
118
1 Professions and the public interest

1.1 IFAC's code of ethics defines professionalism in terms of professional behaviour.
1.2 Professional behaviour imposes an obligation on professional accountants to comply with

relevant laws and regulations and avoid any action that may bring discredit to the
profession.
1.3 Among the most important obligations for modern professionals is maintaining confidentiality
and upholding ethical standards.
1.4 The public interest is considered to be the collective well-being of the community of people
and institutions the professional accountant serves, including clients, lenders, governments,
employers, employees, investors, the business and financial community and others who rely
on the work of professional accountants (IFAC).
Influence of the accountancy profession on organisations

1.5 The influence of the accountancy profession on business and society is potentially huge. It
can be established simply by considering all the different involvements that accountants
have:
(a) Financial accounting
(b) Audit
(c) Management accounting
(d) Consulting
(e) Taxation
1.6 The financial information included within accounts can have a number of impacts:
Mechanistic issues, where Judgemental issues are

the accounts are used to judge where the figures in the
the performance of a company accounts influence the
or its directors in line with a judgement of their users.
regulation or contract.
1.7 Critics of the accountancy profession emphasise that accountants’ prime role is that of
resource allocation, and thereby they act as agents of capitalism.
1.8 They argue that accountancy regulations:

(a) Are too passive, allowing too great a variety of accounting treatments, and failing to
impose meaningful responsibilities on auditors such as an explicit responsibility to
detect and report fraud
(b) Emphasise the wrong principles, giving priority to client confidentiality over disclosure
in the wider public interest
119
2 Corporate codes of ethics (practice)

2.1 Organisations have responded to wide and varied pressures from external stakeholders to
be seen to act ethically by publishing ethical codes.
2.2 Ethical codes contain a series of statements setting out the organisation's core values and
explaining how it sees its responsibilities towards its stakeholders. They cover specific areas
such as gifts, anti-competitive behaviour and so on. However, often they do little more than
describe current acceptable practices.
Required
Apart from the use of ethical codes, how else can an organisation aim to control and influence the
ethical behaviour of staff?
Solution
2.3 The typical features of an ethical code could be as follows:

 Guidance on acceptable and unacceptable behaviour
 Specific examples of company expectations
 Links to the organisation's mission and objectives
 Clear guidance on consequences and sanctions
 Standards for the ethical treatment of suppliers, customers, employees
120
3 IFAC professional code of ethics

3.1 The IFAC Code of Ethics provides a good illustration of a principle-based approach:
(a) The code clarifies up-front acceptance by the accountancy profession of their
responsibility to act in the public interest.
(b) The detailed guidance is preceded by the underlying fundamental principles of ethics.
(c) The guide supplies a conceptual framework that requires accountants to identify,
evaluate and address threats to compliance, and applying safeguards to eliminate the
threats to reduce them to an acceptable level.
Advantages of a principles-based Disadvantages of a principles-based

framework framework
The onus is on the professional accountant Ethical codes cannot include all
to think about relevant issues in a given circumstances and dilemmas, so
situation, rather than simply avoiding a accountants need a very good
checklist of unacceptable actions. understanding of the underlying principles.
A framework prevents professionals International codes cannot fully capture
interpreting legalistic requirements narrowly regional cultural variations in beliefs and
to get around the ethical requirements. practice.
It allows for variations, which is important Principles-based codes can be difficult to
as situations differ. enforce legally, unless the breach of the
code is blatant. Most are therefore
voluntary and perhaps therefore, less
effective.
It can accommodate a rapidly changing
environment, such as the one in which
accountants operate.
3.2 The ACCA has published its own Code of Ethics and Conduct for its members, which is
broadly based on the same principles as the IFAC Code.
121
3.3 The table below details fundamental principles upon which the code is based. These can be
easily remembered using the PIPCO mnemonic:
Fundamental principles
Professional Members have a continuing duty to maintain professional knowledge
competence and and skill at a level required to ensure that a client or employer
due care receives competent professional service based on current
developments in practice, legislation and techniques. Members
should act diligently and in accordance with applicable technical and
professional standards when providing professional services.
Integrity Members should be straightforward and honest in all business and

professional relationships.
Professional Members should comply with relevant laws and regulations and
behaviour should avoid any action that discredits the profession.
Confidentiality Members should respect the confidentiality of information acquired

as a result of their professional and business relationships and
should not disclose any such information to third parties without
proper or specific authority or unless there is a legal or professional
right or duty to disclose. Confidential information acquired as a result
of professional and business relationships should not be used for the
personal advantage of members or third parties.
Objectivity Members should not allow bias, conflicts of interest or undue

influence of others to override professional or business judgements.
3.4 Safeguards against breach of compliance with the IFAC and ACCA guidance include:
(a) Safeguards created by the profession, legislation or regulation (eg corporate
governance)
(b) Safeguards within the client/ the accountancy firm's own systems and procedures
(c) Educational training and experience requirements for entry into the profession,
together with continuing professional development.
3.5 In the exam you may be required to evaluate the ethical behaviour of a professional
accountant using the fundamental principles (Q1c December 2012)
122
Required
Identify some benefits of adopting an ethical code, and recommend how an organisation might go
about developing one.
Solution
4 Threats to compliance with the fundamental

principles for accountants in practice
(Revision from F8)
4.1 Threats to independence of action and conflicts of interest include:
 Self-interest
 Self-review
 Advocacy
 Familiarity
 Intimidation
123
Self-interest threat
4.2 The ACCA Code of Ethics and Conduct highlights a great number of areas in which a self-
interest threat to independence might arise.
Family or close
personal relationships
Lowballing, when a firm
quotes a significantly Contingent fees
lower fee level for an based on the
audit service outcome of a
transaction
SELF INTEREST
THREAT
A partner or
employee on Client lends a material
the board of an sum of money to an
audit client audit firm or member
of audit team
Client represents a large

proportion of a Valuable gift
firm’s/partner’s total fees and/or hospitality
4.3 Safeguards in these situations might include:

(a) Discussing the issues with the audit committee of the client
(b) Taking steps to reduce the dependency on the client
(c) Consulting an independent third party such as ACCA
(d) Maintaining records such that the firm is able to demonstrate that appropriate staff
and time are spent on the engagement
(e) Compliance with all applicable audit standards, guidelines and quality control
procedures
Self-review threat
4.4 Self-review threat is where an audit firm provides services other than audit services to an
audit client (ie providing multiple services). There is a great deal of guidance in the ACCA
and IFAC rules about threats arising from services accountancy firms might provide to their
audit clients.
124
Threat Safeguards
If an individual on the audit team  Obtaining a quality control review of the
had been recently employed by, or individual’s work on the assignment
otherwise involved with the client,
 Discussing the issue with the audit committee
the audit firm should consider the
threat to independence arising  Removing the individual from the team
Having custody of an audit client’s  Ensuring non-audit team staff are used for these
assets, supervising client roles
employees in the performance of
their normal duties, and preparing  Involving an independent professional
source documents on behalf of the accountant to advise
client also pose significant self-  Quality control policies on what staff are and are
review threats not allowed to do for clients
 Making appropriate disclosures to those charged
with governance
 Resigning from the audit engagement
Preparing accounting records and  Using staff members other than audit team
financial statements, and then members to carry out work
auditing them
 Obtaining client approval for work undertaken
Providing valuation services where  Using separate personnel for the valuation and
audited financial statements the audit
comprise figures generated
 Second partner review
 Confirming that the client understands the

valuation and the assumptions used
 Ensuring the client acknowledges responsibility
for the valuation
Provision of internal audit services  The firm should ensure that the client
to an external audit client is acknowledges its responsibility for establishing,
permitted in most jurisdictions, but maintaining and monitoring the system of
not in the US under Sarbanes- internal controls
Oxley
Advocacy threat
4.5 An advocacy threat arises in certain situations where the audit firm assume the client’s part
in a dispute or somehow acting as their advocate. The most obvious instances of this would
be when a firm acts as an expert witness in a court case.
4.6 Relevant safeguards might be:

(a) Using different departments in the firm to carry out the work
(b) Making full disclosure to the client’s audit committee
(c) Withdrawal from an engagement if the risk to independence is considered too great
125
Familiarity threat
4.7 Familiarity threat is where independence is jeopardised by the audit firm and its staff
becoming over familiar with the client and its staff. As a result they may become too
sympathetic to their views and interests.
Intimidation threat
4.8 An intimidation threat arises when a professional accountant is deterred from acting
objectively by threats, actual or perceived. Situations which might create intimidation threats
include:
(a) Threats of dismissal
(b) Threats of litigation
(c) Pressure to reduce fees or the extent of work performed
Lecture example 3 Exam-stan dard
headquarters in a European country. You work as a trainee for a small professional firm which has
been asked to act as advisers to GSA. The Finance Director of GSA studied with the engagement
partner so is happy to give him the work, especially as he believes that the firm’s experience in tax
advice can help identify any future tax loopholes. The engagement is very high-profile for your firm,
so it has been offered at a discount to the firm’s normal fees, although you understand that the
GSA board has indicated that it expects fees to stay low as it wants you to act as both internal and
external auditors in order to improve efficiencies.
You are in the corridor about to deliver coffee for a planning meeting between your firm and GSA
when you overhear the end of a conversation between the engagement partner and the Finance
Director in the meeting room: “...obviously, if the tax savings identified are sufficiently imaginative
and creative, there will be a special bonus for you, although this will need to be hushed up to
satisfy those who feel we should all now be acting in the public interest...”
Required
(a) Identify the ethical threats presented in the scenario.
(b) Explain what is meant by the public interest in this case.
(c) Describe the nature of the conversation that you have overheard, including any possible
actions that you feel you may need to take.
Solution
126
127
5 Chapter summary
1 Professions and the Professions and professional bodies have a dual role,
public interest protecting the interests of their members and
protecting the public interest. Professionalism means
avoiding actions which would discredit the
accountancy profession. Acting in the public interest
means acting for the welfare of society as a whole.
This may conflict with detailed professional ethical
duties such as the duty of confidentiality.
2 Corporate codes of Ethical codes set out the company’s core values and
ethics usually contain detailed guidance about issues like
anti-competitive practices and bribes/gifts. To be
effective they need board level commitment,
communicating, monitoring and sanctions.
Failures of codes are that they can contradict actual
practice.
3 IFAC professional code The IFAC code is a principles based code. The
of ethics ACCA’s code is broadly based on the IFAC code.
The fundamental principals are:
– Professional competence and due care
– Integrity
– Professional Behaviour
– Confidentiality
– Objectivity
4 Threats to compliance The threats to independence are: self-interest, self
with the fundamental review, advocacy, association/familiarity and
principles for intimidation. Safeguards are put in place to counter
accountants in practice these threats.
END OF CHAPTER
128
Corporate social
responsibility

Describe and evaluate Gray, Owen and Adams’ December 2013 Q3c (9 marks) explaining how
seven positions on social responsibility and corporate social responsibility and ethical
other constructions of the corporate and stance differ between a charity and a company
personal ethical stance Pristine capitalist: December 2011 Q4a&b
(10+6 marks), June 2011 Q1dii (6 marks),
December 2007 Q4b (8 marks) and December
2008 Q1ci (8 marks)
Social contract: December 2007 Q4b (8 marks)
Expedient: December 2011 Q4a&b (10+6
marks)
Deep ecologist: June 2009 Q2c (7 marks)
Explain and explore social responsibility in the December 2014 Q1di (6 marks) on being a
context of corporate governance and the corporate citizen
concept of the organisation as a corporate December 2014 Q2dii (part of 6 marks) and
citizen of society with rights and responsibilities June 2013 Q3b (7 marks) on fiduciary duty
December 2007 Q4c (7 marks) on fiduciary
responsibility
Explain and assess the concept of integrated December 2013 Q1ai (4 marks) contrasting
reporting and evaluate the issues concerning sustainability with economic sustainability
accounting for sustainability (including June 2008 Q1d&e (3+8 marks) on sustainability
alternative definitions of capital)
Pilot Paper Q1e (4 marks) defining
environmental footprint
Describe and assess the social and June 2013 Q1b (10 marks) and Pilot Paper Q1e
environmental effects that economic activity can (4 marks) on the use and importance of
have (in terms of social and environmental environmental reporting
footprints and environmental reporting) December 2012 Q1a (10 marks) on social
footprint
June 2010 Q1dii (6 marks) on environmental
footprint
129
11: CORPORATE SOCIAL RESPONSIBILITY

Describe the main features of internal
management systems for underpinning
environmental and sustainability accounting
Explain and assess the typical content elements December 2014 Q1diii (8 marks) on basic
and guiding principles of an integrated report framework and potential benefits to
and discuss the usefulness of this information to stakeholders of reporting on different capital
stakeholders types
Explain the nature of social and environmental June 2014 Q3b (8 marks) on environmental
audit and evaluate the contribution it can make auditing and reporting as a way of
to the assurance of integrated reports demonstrating environmental sustainability
December 2011 Q1b (10 marks) on voluntary
disclosure of environmental risk management
December 2010 Q2b (9 marks) explaining the
stages of an environmental audit and any
issues in developing these
130
Overview
Corporate Social
Responsibility
CSR Corporate CSR Stances CSR

Citizenship Viewpoints
Social and Environmental

issues
Sustainability and
Environmental Environmental
environmental
management systems reporting & GRI
footprint
Social footprint
Social and
environmental audits
Integrated reporting
131
1 Organisations' ethical & social responsibility stances

1.1 Corporate social responsibility is a concept whereby organisations consider the interests of
society by taking responsibility for the impact of their activities on wider stakeholders.
1.2 This obligation can be seen to extend beyond statutory obligations to comply with
legislation.
CSR Corporate Ethical Stances 7 Social
(Carroll) citizenship (Johnson & Responsibility
(Matten et al) Scholes) Viewpoints
(Gray Owen &
Adams)
Economic Limited view Short-term Pristine capitalists:
To shareholders consists of limited shareholder interest Business has no
wanting projects undertaken It is for government moral responsibilities
dividends/capital in the business’s self- alone to impose wider beyond their
gains, to employees interest. constraints on obligations to
wanting fair The main corporate shareholders and
employment, to stakeholder groups governance. creditors.
customers wanting that the corporation This minimalist
good quality products engages with are approach would Expedients:
local communities accept a duty of Social responsibility
and employees. obedience to the may be appropriate if
demands of the law, it is in the business’
but would not economic interests.
undertake to comply
with any less
substantial rules of
conduct.
Legal Equivalent view is Long-term Proponents of the

Obeying the law is a based on a wider shareholder interest social contract:
requirement in all general definition of (a) Corporate image There is effectively a
societies, though legal corporate social may be enhanced by contract or agreement
compliance imposes responsibility that is an assumption of between the
greater burdens in partly voluntary and wider responsibilities. organisations and
some societies rather partly imposed those who are
(b) The responsible
than others exercise of corporate affected by their
power may prevent a decisions.
build-up of social and
political pressure for
legal regulation.
132
Ethical Extended view will Multiple Social ecologists

Companies are promote: shareholder believe that business
required to act in a fair • Social rights of obligations activities result in
and just way even if citizens by provision Accepting the resource exhaustion;
the law does not of, for example, legitimacy of the waste and pollution
compel them to do so decent working expectations and/or must therefore be
conditions claims of modified.
stakeholders other Organisations must
• Civil rights, by
than shareholders also be socially
intervening to
and build those responsible.
promote citizens'
individual rights expectations into its
themselves or to stated purposes. Socialists seek to
pressurise This would be promote egalitarian
governments to because without equality. Business
promote citizens' appropriate decision-making
rights relationships with should no longer be
• Political rights by groups such as determined by the
allowing individuals suppliers, employers requirements of
to promote their and customers, the capitalism and
causes by using organisation would materialism but
corporate power. not be able to should promote
function. equality.
Philanthropic Shaper of society, Radical feminists

Charitable donations, although it is aim to promote
contributions to local accepted that this feminine values such
communities, and role is largely the as co-operation and
providing employees preserve of public empathy
with the chances to sector organisations. Deep ecologists
improve their own (greens) suggest that
lives man has no greater
rights to resources or
life than other species.
133
Lecture example 1 Classroom discussio n
Proponents of CSR argue that there is a strong business case for considering stakeholders,
whereas critics argue that CSR distracts from the fundamental economic role of businesses.
Required
Identify some arguments supporting the case both for and against CSR. (You may want to
consider what might motivate an interest in CSR.)
Solution
Lecture example 2 Exam stan dard
headquarters in a European country. In general terms it always complies with the law – financial
statements are filed on time, employee and sales taxes are paid over to the local tax authority –
but despite the parent company recording high operating profits, it recently paid a very low level of
corporate tax due to apparent loopholes in the legislation (sometimes referred to as 'legal tax
avoidance'). This became a controversial news story and led to calls for a boycott of the company’s
products unless they voluntarily paid more corporate tax. GSA’s Chief Executive Martyn Rice
agreed to respond to the media on behalf of the board.
Required
Recommend a response for the Chief Executive to make from each of the seven positions on CSR
suggested by Gray, Owen and Adams.
Solution
Pristine capitalist
Expedient
Social contract
Social ecologists
Socialist
Radical feminist
Deep ecologist
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2 Sustainability
2.1 Sustainability means limiting the use of depleting resources to a level that can be
replenished.
2.2 Sustainable development is development that meets the needs of the present without
compromising the ability of future generations to meet their own needs.
2.3 When considering sustainability a number of questions need to be considered:
Sustainable
by whom?
Sustainable at Sustainable
what cost? for whom?
SUSTAINABILITY
ISSUES
Sustainable for Sustainable

how long? in what way?
2.4 A key issue is generational equity, ensuring that future generations are able to enjoy the
same environmental conditions, and in social terms per capita welfare is maintained or
increased.
2.5 The two approaches to sustainability are:

(a) Weak sustainability believes that the focus should be on sustaining the human
species and the natural environment can be regarded as a resource. The weak
sustainability viewpoint tends to dominate discussion within the Western economic
viewpoint.
(b) Strong sustainability stresses the need for harmony with the natural world; it is
important to sustain all species, not just the human race. They see a requirement for
fundamental change, including a change in how man perceives economic growth (and
whether it is pursued at all).
2.6 Environmental footprint is a measure of the impact that a particular business’s activities
have upon the environment including its resource environment and pollution emissions.
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2.7 Examples of factors used to determine a firm’s environmental footprint include:

(a) Depletion of natural resources
(b) Noise and aesthetic impacts
(c) Residual air and water emissions
(d) Long-term waste disposal (exacerbated by excessive product packaging)
(e) Uncompensated health effects
(f) Change in the local quality of life (through for example, the impact of tourism)
3 Social footprint and accounting

Social Footprint
3.1 Social footprint is a measure of the impact or effect that an entity can have on a given set
of concerns or stakeholder interests.
3.2 It is the impact on people, society and the wellbeing of communities. Impacts can be
positive such as job creation and community benefits) or negative, such as when a plant
closure increases unemployment and the local community suffers.
Social Accounting
3.3 Social accounting is a concept describing the communication of social and environmental
effects of a company's economic actions to stakeholders.
3.4 A number of reporting guidelines have been developed to serve as frameworks eg

 ISO 14000 Environmental Management Standard
 Global Report Initiative (GRI) sustainability reporting guidelines.
 AA1000 Standard – based on triple bottom line (3BL) reporting
 FTSE4 Good index
Triple bottom line accounting clearly describes the goal of CSR.

Required
Suggest some areas that a company might report on under the headings below.
Solution
People (social)
Planet (environment)
Profit (business)
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4 Environmental reporting & Global Reporting Initiative

4.1 The Global Reporting Initiative is a reporting framework and arose from the need to address
the failure of the current governance structures to respond to changes in the global
economy. The GRI aims to develop transparency, accountability, reporting and sustainable
development. Its vision is that reporting on economic, environmental and social importance
should become as routine and comparable as financial reporting.
4.2 The main section of the Guidelines sets out the framework of a sustainability report. It
consists of five sections.
1. Vision and strategy. Description of the reporting organisation's strategy with regard
to sustainability, including a statement from the CEO.
2. Profile. Overview of the reporting organisation's structure and operations and of the
scope of the report.
3. Governance structure and management systems. Description of organisational
structure, policies and management systems, including stakeholder engagement
efforts.
4. GRI content index. A table supplied by the reporting organisation identifying where
the information listed in the Guidelines is located within the organisation's annual
report.
5. Performance indicators. Measures of the impact or effect of the reporting
organisation divided into integrated, economic, environmental, and social
performance indicators.
Purposes of environmental reporting

4.3 A company’s environmental reporting is capable of serving the information needs of a range
of both internal and external stakeholders, and discharge their accountabilities to
shareholders, society and to future generations.
4.4 The company is less able to conceal important information and this helps to reduce the
agency gap between a company’s directors and its shareholders (covered in Chapter 1).
Advantages of environmental reporting:

4.5 Environmental reporting has environmental, social and business benefits
 Demonstrates the firm’s responsiveness to issues that threaten the perception of their
ethics and competence.
 Covers a range of environmental risks. Concerned shareholders will use environmental
reports to assess the ways that environmental risks are being effectively managed.
 Encourages operational efficiency because the systems necessary to collect and
process the data that comprises the environmental report would produce management
information that could save costs and increase operational efficiency.
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5 Environmental management systems

Eco-Management and Audit Scheme (EMAS)
5.1 EMAS is a voluntary scheme that emphasises targets and improvements, on-site
inspections and requirements for disclosure and verification.
5.2 Requirements for EMAS registration

(a) An environmental policy containing commitments to comply with legislation and
achieve continuous environmental performance improvement
(b) An on-site environmental review
(c) An environmental management system that is based on the review and the
company’s environmental policy
(d) Environmental audits at sites at least every three years
(e) Audit results to form the basis of setting environmental objectives and the revision of
the environmental policy to achieve those objectives
(f) A public environmental statement validated by accredited environmental verifiers
containing detailed disclosures about policy, management systems and performance
in areas such as pollution, waste, raw material usage, energy, water and noise.
ISO 14000
5.3 ISO 14000 provides a general framework on which a number of specific standards have
been based (the ISO family of standards).
5.4 ISO 14001 prescribes that an environmental management system must comprise:
(a) An environmental policy statement, which should be the basis for future action. It
needs therefore to be based on reliable data, and allow for the development of
specific targets.
(b) Assessment of environmental aspects and legal and voluntary obligations.
(c) A management system ensuring effective monitoring and reporting on environmental
compliance.
(d) Internal audits and reports to senior management.
(e) A public declaration that ISO 14001 is being complied with.
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Required
Identify the benefits of an organisation achieving external accreditation for its CSR activities.
Solution
6 Social and environmental audits

6.1 Social audit is the process of checking whether an organisation has achieved set targets.
6.2 Generally, social audits will involve:

(a) Establishing whether the organisation has a rationale for engaging in socially
responsible activity.
(b) Identifying that all current environment programmes are congruent with the mission
of the company.
(c) Assessing objectives and priorities related to these programmes
(d) Evaluating company involvement in such programmes past, present and future.
6.3 An environmental audit is a systematic, documented, periodic and objective evaluation of

how well an entity, its management and equipment are performing, with the aim of helping to
safeguard the environment by facilitating management control of environmental practices
and assessing compliance with entity policies and external regulations.
6.4 Environmental audits help organisations to identify possible liabilities from their ongoing
activities, assess the threat of unethical behaviour and even act as a form of marketing for
investors especially sensitive to having environmentally and socially questionable
representation in their portfolios.
6.5 The process of completing environmental audits requires three stages:

a) Agreement on suitable metrics to assess environmental performance (this will include
what should be measured and how, and fits in with the idea of footprint)
b) The measurement of actual performance and comparison with targets
c) A report from the auditor stating levels of compliance or variance.
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7 Integrated Reporting <IR>

7.1 “<IR> is a process founded on integrated thinking that results in a periodic integrated
report by an organization about value creation over time and related communications
regarding aspects of value creation. An integrated report is a concise communication
about how an organization’s strategy, governance, performance and prospects, in the
context of its external environment, lead to the creation of value in the short, medium and
long term.” (http://www.theiirc.org/)
7.2 Where <IR> differs from other forms of reporting is that it focuses on the process not the
product, using a series of capitals to illustrate how an organisation creates value for all
stakeholders, not just shareholders:
Category of capital Characteristic elements of the category of capital
Financial Funds available for use in production or service provision, obtained
through financing or generated through operations
Manufactured Manufactured physical objects used in production or service
provision; including buildings, equipment, and infrastructure
Human Skills, experience and motivation to innovate:
Alignment and support for an organisation’s governance framework
and ethical values
Ability to understand and implement organisation’s strategies
Loyalties and motivations for improvements
Intellectual Intangible assets, providing competitive advantage:
Patents, copyrights, software and organisation systems
Brand and reputation
Natural Inputs to goods and services, and natural environment on which an
organisation’s activities have an impact:
Water, land, minerals and forests
Biodiversity and health of eco-systems
Social The institutions and relationships established within and between
each community, stakeholder group, and network to enhance
individual and collective well-being.
Includes an organisation’s social licence to operate.
7.3 There are a series of seven guiding principles that <IR> requires to be seen as meaningful:
(i) Strategic and forward-looking
(ii) Connectivity across all relationships that create value
(iii) Stakeholder relationships and how they work to create value
(iv) Materiality, disclosing those matters that substantially affect value creation
(v) Reliability and completeness, avoiding any bias
(vi) Conciseness (to encourage people to read about <IR>)
(vii) Consistent and comparable presentation with other organisations and over time.
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Required
For each of the following aspects of a company’s operations, suggest the most appropriate form of
<IR> capital that could be used to monitor it.
Solution
Company operations Suggested <IR> capital?
A new computer game to be sold for use across different
platforms – apps, PC and gaming consoles
A term loan for expansion of manufacturing facilities
A publishing company’s printed products
A scheme that allows employees to study for a qualification
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8 Chapter summary
1 Organisations’ ethical There are four different models which identify different
and social positions that can be taken. They broadly cover
responsibility stances stances of narrow economic self interest, wider social
obligations, and a more principled ethical stance
through to a philanthropic position. (Carroll’s CSR)
The other models are: Corporate Citizenship (limited,
equivalent and extended views); Ethical Stances
(Shot-term shareholder, long-term shareholder,
stakeholder and shaper of society); and Gray, Owen
& Adams 7 positions (Pristine Capitalist, Expedient,
Social Contract, Social Ecologist, Socialist, Radical
Feminist and Deep Ecologist)
2 Sustainability Businesses are concerned with their social and
environmental impact on current and future
generations because of the potential effect on their
reputation, potential costs and because of the
likelihood of increased legal controls.
Impact is measured in terms of footprints.
3 Social accounting, Organisations can opt to follow different guidelines.
auditing and reporting
4 Environmental The growing impact of the GRI on business
reporting organisations and how this can prove advantageous
in many ways, including governance.
5 Environmental EMAS is a voluntary scheme based on improving
management systems targets, inspection and verification of performance.
ISO 14000 provides a prescription for an
environmental management system.
6 Social and Social audits usually focus on checks as to whether a
environmental audits company has met previously stated social policies.
Environmental audits can range in scope from
mandatory Environmental Impact Assessments
required for many large scale projects to
environmental SWOT analysis as part of wider
strategic planning.
7 Integrated reporting The most recent reporting addition to assist educated
corporate investors and amateurs alike in identifying
how value is created from a variety of capitals for all
organisations.
END OF CHAPTER
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In the final run up to your exam, you should attempt Step 6 as the final check that you are fully prepared
to move onto the revision phase of your studies. As a reminder, Step 6 must be completed and submitted
in order to be able to qualify for Pass Assurance. It is Written Assessment 2 and can also be found at the
back of these course notes.
It covers all the Topics in your course. As ever, you will receive feedback on your performance, and you
can use the wide range of online resources to help address any final areas where you need to fine tune
your knowledge or technique.
Course notes
chapter
Scope of corporate
governance
governance
3
Risks Risks 6
Risk assessment and
response
8
Personal ethics Personal ethics 9
Professional ethics Professional ethics 10
Corporate social responsibility Corporate social responsibility 11
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Achievement Ladder
144
Answers to
Lecture Examples
145
12: ANSWERS TO LECTURE EXAMPLES
Chapter 1
Answer to Lecture Example 1
Improved risk management. The reduction of downside risk will reduce business losses.
Overall business performance is enhanced by focusing attention on areas of critical importance.
Defines clear accountability for executive decision making.
It provides both an appropriate and adequate system of internal control, which permeates the organisation
from top to bottom.
Best practice guidelines are applied by management, who therefore strive to improve their performance.
Encourages ethical behaviour and corporate social responsibility.
Safeguards the firm from misuse of business assets, both tangible and intangible.
Can attract new investment, particularly in developing countries.

 Decline in profitability
 Lack of disclosures in annual accounts
 Fall in share price
 Adverse commentary by analysts
 Change in business environment
 Change in key personnel

Monitoring systems
Increase numbers of Non-Executive Directors (NEDs)
Request formation of committees
Employ consultants
Attend AGM and question board
Controls
Performance related pay
Bonuses
Share options

 To establish support for strategic goals
 To pre-empt negative reactions
 To assess level of interest and power
 To identify ways of communicating with and managing shareholders
146
Chapter 2
(a) Increasing internationalisation and globalisation meant that investors and institutional
investors in particular, began to invest outside their home countries. The King report in South
Africa highlights the role of the free movement of capital, commenting that investors are
promoting governance in their own self-interest.
(b) The differential treatment of domestic and foreign investors, both in terms of reporting and
associated rights/dividends, also the excessive influence of majority shareholders in insider
jurisdictions, caused many investors to call for parity of treatment.
(c) Issues concerning financial reporting were raised by many investors and were the focus of
much debate and litigation. Shareholder confidence in what was being reported in many
instances was eroded.
(d) The characteristics of individual countries may have a significant influence in the way corporate
governance has developed. The King report emphasises the importance of qualities that are
fundamental to the South African culture such as collectiveness, consensus, helpfulness, fairness,
consultation and religious faith in the development of best practice.
(e) An increasing number of high profile corporate scandals and collapses including Polly Peck
International, BCCI, and Maxwell Communications Corporation prompted the development of
governance codes in the early 1990s. However, the scandals since then have raised questions
about further measures that may be necessary.

The benefits of international codes of corporate governance include
(a) It provides a standardised approach which helps multi-national companies to enforce consistent
codes across their operations.
(b) It gives investors the understanding and therefore confidence to invest in global capital markets.
(c) It makes it easier for countries to implement corporate governance codes since they are not
having to produce their own codes from scratch.
(d) It ensures a minimum level of corporate governance.
A number of problems have been identified with international codes of corporate governance.
(a) International principles represent a lowest common denominator of general, fairly banal and
meaningless principles.
(b) Any attempt to strengthen the principles will be extremely difficult because of global differences
in legal structures, financial systems and structures of corporate ownership, culture and economic
factors.
(c) As international guidance has to be based on best practice in a number of regimes, development
will always lag behind changes in the most advanced regimes.
(d) The codes have no legislative power.

When considering public sector policy provision, there are no right and wrong answers (unless based on
factual inaccuracies) so the debate should attempt to consider all possible viewpoints and attempt to find
a way to accommodate as many of them as possible (in keeping with the process of democracy).
147
Here are some points that could be considered for each question:
Should there be a public sector?
 Do companies provide society with everything they need?
 What if people face hardship – should they get any help?
 Can we afford a public sector? Can we afford not to have one?
What are the priorities?
 Health, education and welfare (“from the cradle to the grave”) – are these key?
 What about defence, business, foreign policy (including overseas aid), the environment,
agriculture, the arts, energy, transport etc, etc?
Influence of taxpayers who do not use services they still have to pay for?
 Receiving free healthcare, education and social care at point of service happens in many states
(eg the UK) but in others (eg the USA) such services are paid for to some extent by those that use
them
 If you pay your taxes and they go towards funding services that you prefer to pay for yourself (eg
private education or private medical care via health insurance) should you be able to opt out of
paying taxes?
 Should people pay more or less tax in this way? Should people pay taxes at all?
Does privatisation play a positive role in helping economies to deliver public sector provision?
 Should public utilities such as water, gas, electricity and railways ever be privatised? Can markets
ever deliver the efficiencies required to benefit consumers if profit gets in the way? Are regulators
strong enough to make such markets fair to consumers and companies alike?
 Short term cash boost, reckless sale of “family silver” or wise decision to limit future liabilities (eg
in the UK in 2013, the Royal Mail was floated via IPO but six months later allegations were made
by politicians that it had been undervalued by £1bn in the UK Government’s haste to make the
sale a success. While the Royal Mail presented a potentially significant liability on public sector
finances due to pension and operating deficits, it had started to show signs of recovery, prompting
calls that it was only sold to benefit investors and not the UK in general. Time will tell on this,
although in an industry where physical deliveries are being phased out in favour of digital products
– books, music and other entertainments – maybe this was a good deal after all. Source:
http://www.bbc.co.uk/news/28263467)
 Outside the UK, privatisation remains a divisive issue – from proposals to privatise six major
airports in India (http://timesofindia.indiatimes.com/business/india-business/Bidding-for-
privatisation-of-6-airports-deferred-again/articleshow/30469979.cms) to the sale of state assets in
Brazil to support their economy (http://www.forbes.com/sites/kenrapoza/2012/08/10/brazil-opens-
roads-to-privatization/) and even massive investment by China in African infrastructure
(http://www.scmp.com/business/economy/article/1301343/natural-resources-oil-underwrite-
chinese-investment-africa) the tension between public and private sector remains.
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Chapter 3
 Leadership
 Independence (an appropriate balance of executive and non-executive directors)
 A suitable balance of skills and experience
 Diverse backgrounds in order to represent different stakeholder groups.
 Integrity, probity and fairness in order to manage any conflicts of interest.
 Good communications between members and to stakeholders
 Equal participation in robust discussions

(a) Separating the roles ensure that there is not a single individual with unfettered power. The
principle that the roles should be separated was established following the frauds carried out by
Robert Maxwell at Mirror Group Newspapers in the early 1990s.
(b) The CEO can then run the company; the chairman can run the board. Separation of the roles
allows them both to be given suitable focus. The chairman should be looking to the interests of the
shareholders; the CEO is concerned implementing the board’s strategy.
(c) It reflects the reality that both jobs are demanding roles. In particular in large companies (eg
FTSE100 companies) it would be too demanding for one person to carry out both functions.
(d) Having two different people in the role brings two different perspectives, two sets of experience
and skills and therefore improves decision making.
(e) The separation of roles avoids the risk of conflicts of interest. The CEO’s remuneration will contain
performance related bonuses. He may be inclined to take unacceptable risks to make sure that he
earns his bonus.
Accountability to shareholders
(a) The board cannot make the CEO truly accountable for management if it is led by the CEO.
(b) Separation of the roles means that the board is more able to express its concerns effectively by
providing a joint channel of reporting (the chairman) for the non-executive directors.
[Note: The UK Cadbury report recommends that if the posts were held by the same individual, there
should be a strong independent element on the board with a recognised senior member. The UK Higgs
report suggests that a senior independent non-executive director should be appointed who would be
available to shareholders who have concerns that were not resolved through the normal channels. The
UK Corporate Governance Code also suggests that the CEO should not go on to become chairman of the
same company. If a CEO did become chairman, the main risk is that he or she will interfere in matters
that are the responsibility of the new CEO and thus exercise undue influence over him or her.]

Independence
Length of service
Cross-directorships
Inflated pay
Share options
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Effectiveness
Quality
Experience
Number
Availability
Ways of overcoming problems
Service contracts
Disclosure
Training
Market rates of pay
Induction to organisation

Advantages of multi-tier boards
(a) The clear and formal separation between the monitors and those being monitored.
(b) The supervisory/policy board has the capacity to be an effective guard against management
inefficiency or worse. Its existence may act as a deterrent to fraud or irregularity in a similar way to
the independent audit.
(c) The supervisory board system should take account of the needs of stakeholders other than
shareholders, specifically employees, who are clearly important stakeholders in practice.
(d) The system actively encourages transparency within the company, between the boards and,
through the supervisory board, to the employees and the shareholders. It also involves the
shareholders and employees in the supervision and appointment of directors.
Disadvantages of multi-tier boards
(a) Confusion over authority and therefore a lack of accountability can arise with multi-tier boards.
This criticism has been particularly levelled at Japanese companies where the consequence is
allegedly often over-secretive procedures.
(b) The management board may restrict the information passed on to the supervisory board and the
boards may only liaise infrequently.
(c) The supervisory board may not be as independent as would be wished, depending on how
rigorous the appointment procedures are. In addition, members of the supervisory board can be,
indeed are likely to be, shareholder representatives; this could detract from legal requirements
that shareholders don't instruct directors how to manage if the supervisory board was particularly
strong.

(a) Basic salary will be in accordance with the terms of the directors’ contract of employment, and is
not related to the performance of the company or the director. Instead it is determined by the
experience of the director and what other companies might be prepared to pay (the market rate).
(b) Performance related bonuses Directors may be paid a cash bonus for good (generally
accounting) performance. To guard against excessive payouts, some companies impose limits on
bonus plans as a fixed percentage of salary or pay.
(c) Transaction bonuses tend to be much more controversial. Some chief executives get bonuses
for acquisitions, regardless of subsequent performance, possibly indeed further bonuses for
spinning off acquisitions that have not worked out.
(d) Directors may be awarded shares in the company with limits (a few years) on when they can be
sold in return for good performance.
150
(e) Share options give directors the right to purchase shares at a specified exercise price over a
specified time period in the future. If the price of the shares rises so that it exceeds the exercise
price by the time the options can be exercised, the directors will be able to purchase shares at
lower than their market value. [The UK Corporate Governance Code states that non-executive
directors should not normally be offered share options, as options may impact upon their
independence.]
(f) Benefits in kind could include transport (eg a car), health provisions, life assurance, holidays,
expenses and loans. The remuneration committees should consider the benefit to the director and
the cost to the company of the complete package. Also the committee should consider how the
directors’ package relates to the package for employees; ideally perhaps the package offered to
the directors should be an extension of the package applied to the employees.
(g) Pensions Many companies may pay pension contributions for directors and staff. In some cases
however, there may be separate schemes available for directors at higher rates than for
employees. The UK Corporate Governance Code states that as a general rule only basic salary
should be pensionable. The Code emphasises that the remuneration committee should consider
the pension consequences and associated costs to the company of basic salary increases and
any other changes in pensionable remuneration, especially for directors close to retirement.

Information about the board
Names
Length of service
Remuneration
Attendance at meetings
Background
Statement on relations and dialogue with shareholders
Nature of communication
AGM information
Chapter 4
(a) Shareholders want to ensure that their investment is protected. The benefit of internal controls for
them is that they will reduce the incidence of fraud and error. Controls will also manage risks
faced by the company thus reducing the overall risk faced by investors. However controls cost
money to design, implement and monitor and this will reduce the value of the shareholders
investment. They therefore want an appropriate balance of controls, so more controls over high
risk areas and fewer over areas where they are less exposed.
(b) Debt providers want to protect the capital they have put into the company and to receive interest.
They will want to make sure that controls are adequate to protect their investment. They will be
less concerned with controls being costly unless the cost is so great as to put the whole company
at risk and thereby expose any creditors to risk.
(c) Employees are concerned about job security so will want to see controls that are adequate to
protect the future of the company. Employees were particularly badly affected by the Mirror Group
corporate failure where Robert Maxwell misappropriated pension funds. Employees are therefore
concerned to see adequate controls over their pension funds. They also have a stake in the
reputation of the company and therefore in how reputation risk is managed. Employees have to
151
operate controls and will therefore not want them to add an unnecessary burden to their work.
They will want controls that protect them against any perceived threats.
(d) Customers will want to their dealings with the company to be pleasant and hassle free. They will
be unhappy about controls that are overly intrusive (M&S traditionally had a reputation for no
quibbling over returns and gained Christmas sales from people buying presents that could be
returned). On the other hand customers will want to be assured of the safety (and recently the
ethical provenance) of the products they are buying and will expect adequate controls in this area.
(e) Government, regulatory and other bodies will want to assure that adequate controls exist to
cover statutory compliance. They may audit this themselves (VAT and PAYE compliance) or
respond when there is a breach (health and safety).
Chapter 5
 Changing business environment eg PEST factors/5 forces
 Individual employees at all levels making decisions
 Control failures/bypassed
 Unexpected hazards
Reasons to embrace more risk?
 Greater demands from stakeholders (customers, suppliers and shareholders)
 Market environment becoming more competitive

(a) Shareholders are not necessarily risk averse, but they will expect higher returns from high risk
companies. They may well have acquired their shares to fit into a balanced portfolio. They will be
concerned if there is an unexpected change in the company’s risk appetite and may choose to
invest elsewhere. Many of M&S’s small private investors do so out of loyalty and might be
expected to prefer a low risk investment. The second biggest investor is Legal & General who will
hold M&S shares as part of a balanced portfolio.
(b) Debt providers are most concerned about the risk of non-payment and they can take various
actions with potentially serious consequences such as:
 Denial of credit
 Higher interest charges,
 Applying restrictive covenants
 Requiring security (eg mortgage)
 Putting the company into liquidation.
(c) Employees will be concerned about threats to their job prospects (money, promotion, benefits
and satisfaction) and ultimately threats to the jobs themselves. The variety of actions employees
can take include:
 Pursuing of their own goals rather than shareholder interests
 Industrial action,
 Refusal to co-operate
 Resignation
(d) Customers will be concerned with threats to their getting the goods or services that they have
been promised, or not getting the value from the goods or services that they expect. The risk to
the firm is that they could take their business elsewhere. M&S built its reputation as a good value
brand and suffered in the 1990s when there was a perceived fall in quality.
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(e) Governments, regulatory and other bodies will be particularly concerned with risks that the
organisation does not act as a good corporate citizen, implementing for example, poor
employment or environmental policies. A number of the variety of actions that can be taken could
have serious consequences.
(f) Government can impose tax increases or regulation or take legal action. Pressure groups tactics
can include publicity, direct action, sabotage or pressure on government or other stakeholders.

 Training
 Workshops
 Monitoring
 Shadowing
 Ethical codes
 Good leadership
 Set up compliance/risk management department
 Build risk identification into job descriptions
 Create risk register

Risk committee
(a) Executive directors
 Knowledge of company
 Risk – key concern
 Remuneration can be linked to risk management
 Supports strategic planning
(b) Non-executive directors
 Independence/objectivity
 External experience
 No financial gains linked to decision

 Assess risks
 Review risk register
 Advise board
 Review findings of internal audit
 Set risk policy
 Ensure risk management system exists
Chapter 6
 Lack of investment in IT (Technology)
 Product failure/recall (Product)
 Lack of availability of staff (Resources)
 Fall in share price (Investment)
 Adverse PR/press (Reputation)
 New entrant (Competition)
 Failed project (Product/Competition/Reputation/Investment/Technology/Product)
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Market risk: A risk or loss due to an adverse move in the market value of an asset – a stock, resource,
commodity or underlying derivative. This could also include risks within markets where a company trades.
Credit risk: The risk of not receiving payment for goods or services received (both domestically and for
exporters)
Liquidity risk: The risk of having insufficient funds to meet debts and other obligations as they fall due
(eg bank overdrafts, term loans etc). Insolvency occurs for businesses with inadequate liquid assets to be
able to continue trading.
Legal risk: Failure to meet certain standards (such as trading or licensing) plus the threat of fines or
penalties for any non-compliance
Health, safety and environmental risk: Risk of damage to or from the environment, plus damage to
individuals (whether employees or not) through business activities, plus any associated fines or penalties
Reputation risk: Loss of reputation caused by adverse consequences arising from any other risks (such
as product failure, association with unethical behaviour or illegal activity)
Business probity risk: Risk of dishonest or unethical behaviour in an organisation (such as theft or
fraud)
Derivatives risk: Sustaining financial losses due to changes in the value of financial instruments (and not
hedging them!)
Chapter 7
Who How How often
Board  Forecasting Monthly?
NED's  Scenario building Quarterly?
Risk committee  Variance analysis Annually?
Audit committee  Competitor analysis
Audit dept  Observation
Managers and employees  Meetings/discussions
Consultants  Interviews/questionnaires

The net present value of the project requires of both year’s net cashflows to be discounted at 8%:
($5m – $1.5m) × 1.783 = $6.241m less initial outlay of $6.000m = $241,000 +ve NPV (accept)
Revenues net present value = ($5m × 1.783) = $8.915m
Price sensitivity = 241 / 8,915 = 3%
Variable costs net present value = ($1.5m × 1.783) = $2.675m
Variable cost sensitivity = 241 / 2,675 = 9%
Changes in the selling price of this product are a higher risk than changes in the variable costs, as
revenues only need to fall by 3% (the equivalent of $241,000) to make the project only break-even.
Variable costs would need to rise by nearly 10% for the project to only break-even.
154

Consequences
(impact)
Low High
Low
ACCEPT (a) Theft of inventory TRANSFER
Quite likely and could
(b) Under/overstocking erode profits – ACCEPT,
Likelihood Not very likely but could REDUCE or TRANSFER?
(frequency) erode profits –
borderline ACCEPT or (c) Failure of EFTPOS
REDUCE Unlikely but high impact –
REDUCE REDUCE or TRANSFER? AVOID
High
(d) Economic downturn and (e) Competition
Both very likely and high impact – AVOID or REDUCE?
Note: there are many potential answers here, as the assessment of a particular risk does not mean the
response selected will automatically follow (economic downturn and competition are both high impact
high likelihood, but that does not mean that a company faced with such risks can avoid them and may
choose to reduce them somehow). Sensible responses to assessed risks will usually be rewarded.
Chapter 8
Internal (formal) External (formal)
Management accounts Market research
HR reports Company accounts
Variances Benchmarking
Exception reports Analysis reports
Internal (informal) External (informal)

Complaints Press/PR
Feedback Internet/competitors websites
Employee opinion

Ethical code
Clear communication
Tone at the top, leading by example
Consultation
Incentives
155

Report Contents 
The existence of a process for managing Page 45, within the section on Accountability
risk (paragraph 2)
How the board has reviewed the Page 45, within the section on Accountability
effectiveness of the process (paragraph 3)
That the process accords with the Page 41, as part of the section illustrating the M&S
guidance governance 'map'
Formally acknowledge the boards Page 43, within the paragraph headed 'Monitoring
responsibility for internal control and risk'
review
An explanation that the system manages Not explicitly stated, but at the bottom of page 47,
but does not eliminate risk there is an explanation that others may be present
A summary of the process for reviewing Mitigating activities on pages 46 and 47
internal controls
Information about material weaknesses There is no information about material weaknesses,
but perhaps other 'unknowns' may be relevant
here.
Chapter 9
Merits
(a) Relativism highlights differences in cultural beliefs; for example all cultures may say that it is
wrong to kill innocents, but different cultures may have different beliefs about who innocents
actually are.
(b) Whereas differing absolutist beliefs tend to result in moral conflict between people; relativist ethics
should act to resolve such conflicts.
(c) In the modern business environment where the global economy prevails business is conducted in
many different countries (and cultures), adopting a relativist approach presumes more flexibility
and thereby greater success.
(d) Relativism highlights our cognitive bias in observing with our senses (we see only what we know
and understand) and our notational bias (what we measure without using our senses is subject to
the bias of the measurement methods used).
Demerits
(a) Strong relativism is a based on a fundamental contradiction; the statement that ‘All statements are
relative’ is itself an absolute, non-relative statement. However, it is possible to argue that some
universal truths exist, but deny other supposedly objective truths.
(b) A common criticism of relativism is that it leads to a philosophy of ‘anything goes’, denying the
existence of morality and permitting activities that are harmful to others.
(c) Some critics have argued for the existence of natural absolute moral laws.
(d) Ideas such as objectivity and final truth do have value.
(e) If it’s valid to say that everyone’s differing opinions are right, then it’s equally valid to say that
everyone’s differing opinions are wrong. This can lead to immense confusion and disagreement,
and breakdown in communication and trust.
156

 Age
 Experience
 Size of organisation
 Backgrounds
 Education
 Nationalities
 Religions
 Market stakeholders

Part (a)
Deontological – There would be no interest in the reasons behind the compulsory purchase order
(anything related to the new chemical would therefore be irrelevant) so in this case, it would solely be a
decision on whether or not GSA is wrong to force them to relocate.
Teleological – utilitarianism – The new chemical becomes relevant now, so the 'greater good' wins and
home-owners would acknowledge that moving a few people’s homes could save millions of lives in under-
developed countries.
Teleological – egoism – While the new chemical is still relevant, the effect on themselves is what home-
owners would ultimately consider here (there is currently no way of knowing whether they would accept or
reject the offer as it would depend on the financial settlement offered by GSA).
Part (b)
 Bal is operating at the post-conventional level, specifically the 'principled conscience' plane as
she feels compelled to act regardless of personal opinion.
 Uwe is acting in a pre-conventional way, best displaying characteristics of the 'individualism,
instrumentalism and exchange' plane by acting in his own best interests.
 Ming is following the conventional level and adopting behaviour at the 'law and order' plane as
she is focusing on the obligation to follow the law and what it tells her about how she should
behave.

Part (a)
Absolutist – The board would defend itself and maintain it has done nothing wrong as the tax laws were
not broken, just interrogated to find a legitimate way to avoid paying more tax than necessary. Employee-
related taxes and sales taxes are paid over so GSA is contributing to the public purse. Beyond the law,
there is no other obligation to pay tax voluntarily.
Relativist – Although there is no obligation to pay tax, the company may decide to pay some tax
voluntarily as a gesture of goodwill to society (whether there is some self-interest to avoid losing sales is
a debateable point here, but the key message is that taking a relativist approach means considering each
case individually without precedent).
157
Part (b)
AAA Tucker
Facts – GSA has legally paid low rates of Profitable? – Initially yes, as shareholders’ funds
corporate tax. have not been diverted to pay a voluntary sum
Ethics – The low rate of corporate tax paid is (however, paying tax voluntarily would reduce the
unpopular among customers and critics, so paying threat of a sales boycott which may offset any
more may help the company’s reputation in the payment made) so there may be a trade-off here.
long term.
Norms – What is GSA’s past behaviour regarding Legal? – Yes – in either case (paying or not
corporate tax? Has there been a precedent set by paying tax) GSA is operating within the law.
either tax laws or case law? Has GSA signed up to
any corporate code of ethics (either internally or
Fair? – GSA may establish how widespread the
within the industry) to set any expectation?
use of such tax avoidance really is – if others in the
Alternatives – GSA can either do nothing and be same industry have also adopted this policy, it will
unpopular or pay a voluntary amount of tax as an probably continue to feel there is 'safety in
apparent 'donation' and attempt to diffuse the numbers' (however, this will inevitably attract
situation. criticism that as GSA can afford the best tax
Advice consistent with norms – Whatever past experts to interpret the law, such advice is too
behaviour GSA has adopted might inform future expensive for others, leading to inequity in tax
actions, unless it can argue the circumstances are advice).
different now. If there is a code that GSA has
signed up to, it should adopt what the spirit or letter
Right? – Very difficult to call – as there is such
of the code demands.
resistance from the public, the continuing defence
Consequences – Non-payment would lead to of these actions as legal tax avoidance appears
further deterioration of GSA’s reputation and unsustainable (see below).
possible adverse sales impacts.
Payment would be a voluntary reduction of
Sustainable? – There are no environmental
shareholders’ funds, but would reduce the adverse
issues but this may affect profits in the longer term,
reputation and sales impact.
leading to questions over how economically
Decision – It depends on the company’s ethical sustainable such a policy really is.
stance, but the global mood currently appears to
support voluntary payment of tax in such cases.
Chapter 10
(a) Clear commitment from management
(b) Recruitment and selection policies and procedures
(c) Careful induction
(d) Staff training and workshops
(e) Terms contained with contracts of employment
(f) Objectives setting (Management by Objectives)
(g) Staff appraisal and reporting systems
(h) Remuneration and reward schemes
(i) Sanctions for clear breach of ethical rules
(j) Ethical (internal) audit
158

Benefits Development
Guidance Consultation
Clarity Base on existing codes (eg ACCA)
Replace/reduce rules Provide examples
Communication to stakeholders Test on employees

(a) Identify the ethical threats presented in the scenario:
Self-interest – low fees; compromised ethics in order to retain the engagement
Self-review – internal audit services will need to be relied upon for external audit opinion
Intimidation – pressure to reduce fees; could a small firm stand up to a large multinational if they
disagreed on a proposed accounting treatment or modification to the auditor’s opinion?
Advocacy – acting as tax advisers at the same time as being independent external auditors (there is
some self-review threat here too)
Familiarity – the partner is friends with the FD which could lead to a lack of objectivity and independence
in certain judgements during the audit
(b) Explain what is meant by the public interest in this case:
The public interest relates to public confidence in professions, who act for the collective well-being of the
community of people that they serve (including clients, lenders, governments, employers, employees,
investors, the business and financial community and others who rely on the work of those professions).
In this case, the public interest is those who feel the company should be paying its fair share of taxes
to support the national economy, and those who feel that the accountancy firm should not assist the
company to this aim, as it owes a duty to society as well as to its clients. Any conflicts of interest
should be identified as such by awareness of the various threats mentioned above and may lead the firm
to either adopt certain safeguards before they can act or decline to act in certain cases.
(c) Describe the nature of the conversation that you have overheard, including any possible actions
that you feel you may need to take:
The conversation appears to have been discussing further tax avoidance and possibly even illegal tax
evasion and the payment of a bonus to the firm for securing such savings on behalf of the company. This
sounds like a situation where bribery and corruption are being discussed – you are now placed in a
difficult position as you need to consider your responsibilities as an employee but also your
responsibilities as a professional to act in the public interest, which should be above those owed to
your employer if illegal or unethical activity is being considered.
To address this conflict of interests, you may wish to consult an independent partner (such as an ethics
partner) within your firm – however, given the size of the firm here, this may not be practical and no
such role may exist. It may be illegal if you are aware of possible criminal activity but do not disclose
it, so in the absence of any formal mechanism within your firm you may wish to present your concerns
to a third party – this process is known as 'whistle-blowing' which satisfies your duty to act in the public
interest but would probably lead to your departure from the firm.
The threat of such retaliation from an employer (such as legal action, disciplinary procedures,
redundancy and poor employment references) can be significant, especially so early in your career, and
so presents a difficult choice for any whistle-blower.
159
Chapter 11
Business case for CSR Business case against CSR
– Builds reputation – Organisations are responsible to shareholders
– Attracts investors/employees/customers  CSR is 'stealing' their funds
– Can be a source of competitive advantage – Benefits do not outweigh costs
– Can tie into branding – Time consuming
– Pre-empts legislation – Seen as PR only (most stakeholders will be
– Unregulated therefore easy to incorporate cynical)

Pristine capitalist – The company should not pay any more tax than is legally due as that would erode
shareholder wealth
Expedient – The company could pay tax to present the impression that it wishes to empathise with its
customers, thus reducing the threat of further adverse reputational damage and sales boycotts (it may
even attempt to calculate the point at which marginal extra tax paid equals marginal sales restored)
Social contract – The company should pay a fair amount of tax as society expects it to play its part
Social ecologists – All companies should pay as much tax as possible in order to support society and
those who need assistance
Socialist – The company should definitely pay more tax just like the workforce has to (employing
expensive tax advisors that employees cannot afford is unfair)
Radical feminist – The company should pay tax to in order to empathise with society and the pain it feels
from punitive taxation
Deep ecologist – The company should donate money to an environmental pressure group (eg
Greenpeace) and consider whether it is operating with enough of a social and environmental mandate to
continue trading (as a pharmaceutical company, this is debateable)

People – Employee benefits; Charitable donations
Planet – Waste management
Profit – Benefits brought to local community for example via education schemes, community projects.

– Good PR
– Credibility
– Receive advice and support.

Company operations Suggested <IR> capital?
A new computer game to be sold for use across Intellectual (software is specifically mentioned)
different platforms – apps, PC and gaming consoles
A term loan for expansion of manufacturing facilities Financial (funds for use in production)
A publishing company’s printed products Natural (inputs to goods, plus printing leaves a
footprint from cartridges)
A scheme that allows employees to study for a Human (either skills or motivation for staff)
qualification
END OF ANSWERS TO LECTURE EXAMPLES
160
Question and
Answer bank
161
Index to Question and
Answer bank
Page
Questions Answers
1 Core principles....................................................................................................163......................... 168
2 Frameworks, codes and systems .......................................................................163......................... 169
3 Non-executive directors......................................................................................163......................... 171
4 Board of directors ...............................................................................................164......................... 173
5 Caius plc.............................................................................................................164......................... 174
6 Types of risk .......................................................................................................164......................... 175
7 COSO Framework..............................................................................................164......................... 178
8 Audit process......................................................................................................165......................... 179
9 Ethical considerations.........................................................................................165......................... 180
10 Corporate citizenship..........................................................................................166......................... 182
11 Franks & Fisher .................................................................................................166......................... 184
12 Southern Construction .......................................................................................167......................... 186
162
13: QUESTION AND ANSWER BANK
Questions
1 Core principles
The core principles of corporate governance are: integrity, fairness, judgement, independence,
openness, probity, responsibility, accountability, innovation, scepticism and reputation.
Required
(a) Define each of the core principles of corporate governance in your own words. (9 marks)
(b) Explain the importance of each of the principles in the context of corporate governance.(16 marks)
(Total = 25 marks)
2 Frameworks, codes and systems

Required
(a) Describe, with brief comments, the factors, which influenced the introduction of the various
frameworks, codes and systems of corporate governance. (10 marks)
(b) Describe how the introduction of each of the successive frameworks, codes and systems of
corporate governance has contributed to better corporate governance. (15 marks)
(Total = 25 marks)
It is a principle of corporate governance that the board of directors should be able to exercise an objective
judgement on the company's affairs. However, it is recognised that potential conflicts of interest can arise
between the owners of a company and its management. As a means of dealing with the potential conflicts
of interest, it was recommended by the Cadbury Committee in the UK that the boards of companies with
a London Stock Exchange listing should appoint a minimum number of non-executive directors (NEDs). A
distinction was also made between independent and non-independent non-executive directors.
A variety of criticisms have been made of the system of NEDs. These include the argument that many
non-executives are executive directors of other major companies, which restricts their willingness to
speak out on the company's affairs. NEDs have also been criticised for holding a non-executive post with
too many companies, sometimes five or even more.
In the UK, some criticism has also been voiced against the growing practice of paying NEDs partly in
shares or share options of the company.
Required
(a) Explain the distinction between independent and non-independent NEDs. (7 marks)
(b) What are the main areas for a potential conflict of interest between the shareholders of a company
and the executive directors? Explain how the use of non-executive directors should help to deal
with this problem. (11 marks)
(c) In your view, what might be the objections to paying NEDs in shares or share options of the
company, and do you agree with those objections? (7 marks)
(Total = 25 marks)
163
4 Board of directors
Required
You are required to write a report to the board of directors of a new company, which outlines the following
areas.
(a) The responsibilities of the chairman of the board
(b) The role of the non-executive directors
(c) The role of the remuneration committee
(d) The role of the nomination committee (25 marks)
5 Caius plc
Caius plc is seeking a listing on the London Stock Exchange. The directors of the company are aware
that certain listed companies have attracted considerable criticism in recent years over directors’ pay and
conditions. There have been claims in the media that the pay and conditions of some directors have been
far too generous and that the remuneration policies adopted by some companies have been far from
transparent. The directors of Caius plc are keen to ensure that, if the bid for a listing is successful, all
aspects relating to their pay and conditions must be in line with best practice.
Required
Write a report to the directors of Caius plc set out the policies and frameworks that should be adopted by
the company to ensure that directors’ pay and conditions are fair and transparent. (25 marks)
6 Types of risk
Required
Define the main types of risks that a company faces, and explain how codes of corporate governance can
assist in managing these on a day-to-day basis. (25 marks)
7 COSO Framework
Required
(a) The COSO Enterprise Risk Management Framework says that, having assessed relevant risks;
management should determine how it would respond. Responses include risk avoidance,
reduction, sharing, and acceptance. Give brief examples of each of these responses.
(10 marks)
(b) Management should identify control activities needed to help ensure that risk responses are
carried out properly and in a timely manner. Describe some examples of possible control
activities. (15 marks)
(Total = 25 marks)
164
8 Audit process
The audit process is an important element of corporate governance.
Required
(a) Describe the external audit process and internal audit process and discuss the role of each type of
audit in contributing towards an effective system of corporate governance. (10 marks)
(b) Briefly discuss the relationship between the two types of audit. (3 marks)
(Total = 13 marks)
9 Ethical considerations
You were appointed financial controller of a firm of builders' merchants almost a year ago, with the
prospect of becoming finance director if you performed well.
The problem customer
An old-established customer, a contractor, X Ltd, which has expanded to take on a very large contract, is
causing problems with delayed payments. X Ltd is a family firm, largely owned by its Managing
Director, Y.
Following a discussion at a management meeting, the sales director and a member of your staff visited
the customer with instructions to 'try and resolve the matter of delayed payments'.
The meeting
At the meeting, the sales director took the lead, having known Y for many years. Y provided the last
annual accounts and the latest management accounts and contract accounts. This one large contract that
X Ltd had undertaken represents some 70% of its current activity.
If all, or almost all, suppliers allow additional credit for material, and X Ltd uses its very limited remaining
bank facilities to pay the workforce, Y thinks the company should be able to complete the next stage of
the contract, get the architect to certify the work has been completed, and obtain a progress payment.
This would enable X Ltd to pay suppliers, get more materials, and finish the contract. However, Y
considers the company will make a significant loss on the contract and will only be able to trade on a
much-reduced scale thereafter.
The sales director suggested, and Y agreed, an arrangement by which Y would make a payment from
personal funds, against which your company would release materials to X Ltd. When it receives the
progress payment X Ltd will pay your company from its company's funds and reduce the amount owing to
well within normal terms. Your company will then repay Y the personal funds he has paid.
It was agreed that this arrangement should be discussed and agreed with your managing director in the
morning.
After the meeting
On his return, the sales director commented that this sort of arrangement was probably the only way of
getting any money back – if X Ltd went into liquidation nothing would be recovered.
Later you received a telephone message that Z, the finance director of another firm of builders' merchants
and whom you know through ACCA branch meetings, has asked you to telephone urgently regarding the
credit status of X Ltd.
Required
Write a report to your managing director explaining the issues involved and recommending the action to
be taken on the account and on the telephone message. (25 marks)
165
10 Corporate citizenship
Required
Write a report to the directors of a UK public limited company explaining the following aspects of
corporate citizenship.
(a) The concept of corporate citizenship
(b) Ways in which social and environmental issues may affect companies
(c) Ethical issues that a board of directors might face (25 marks)
11 Franks & Fisher (Examiner question)

The 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 internal audit 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 activities as a result of growth in its product range. The board decided that the increased size and
complexity of its operations created 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 the stoppage of a production line for several hours. The
production director angrily described the stoppage as 'entirely avoidable' 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 and that there was a great need for internal audit. He said that as the head of the company's
accounting and finance function, 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
personality not to be intimidated nor diverted by other department heads who might find the internal
audits an inconvenience. One debate the board had was whether it would be better to recruit to the
position from inside or outside the company. A second argument was over the limits of authority that the
internal auditor might be given. It was pointed out that while the board considered the role of internal audit
to be very important, it didn't want it to interfere with the activities of other 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
establish internal audit in an organisation. (10 marks)
(b) Construct the argument in favour of appointing the new internal auditor from outside the company
rather than promoting internally. (6 marks)
(c) Critically evaluate Mr Kumas's belief that the internal auditor should report to him as finance
director. (4 marks)
(d) Define 'objectivity' and describe characteristics that might demonstrate an internal auditor's
professional objectivity. (5 marks)
(Total = 25 marks)
166
12 Southern Construction
Southern Construction, started as a small family-run business in the 1980s. John Falshaw, the founder
and self-appointed chairman of the board, foresaw rapid expansion and so decided that the firm should
go public. The timing of this decision was unfortunate as it coincided with an economic recession, which
hit the building trade very hard. The strain was too much and Falshaw suffered a massive heart attack,
and was forced to retire.
In the past Falshaw had run things with a heavy hand and things were done his way or not at all! The
board served as a ‘rubber stamp’ for his decisions, and as a result, financial and operational controls
were weak or non-existent.
The new chairman was trying desperately to maintain existing levels of financing. However, the firm’s
bank was very unsettled by recent events, and insisted that Southern Construction plc recruit some non-
executive directors to strengthen the effectiveness of the board.
Thomas Edwards FCCA had recently retired as financial controller of a large engineering company. He
was delighted when he was approached by the chairman of Southern Construction plc with the offer of
becoming a non-executive director and chair of the yet to be established audit committee. On accepting
the position, the head of internal audit, Mary Flanagan, was instructed to report directly to Edwards. New
internal controls were instituted and additional internal audit staff were recruited.
One day Mary Flanagan reported that her team had found that a salesman had been submitting false
expenses vouchers running into thousands of pounds. Mary, who had a reputation for integrity and
thoroughness, was particularly upset because the actions were a clear violation of the Southern
Construction Code of Ethics and Conduct. The salesman in question was Elmer Pearson. When asked
what should be done with Pearson, she responded, 'The penalty called for submitting false expense
claims is summary dismissal – no exceptions'.
It transpired that Pearson would go out with another sales rep, and then both would submit an expenses
claim for the same trip. Internal audit had unearthed dozens of vouchers like this, some even claiming for
imaginary trips.
Edwards was concerned about the reaction of the bank if they learned about the fraudulent activity.
Later that day, Flanagan phoned Edwards at home. She sounded upset, but wanted to talk. “I’m
confused” she said, “my loyalties are being pulled in so many directions, I don’t know what to think”. She
went on to point out that she had known Pearson for over ten years, and he had always been friendly and
helpful to her. She wondered if long service and loyalty to the firm deserved special consideration.
The following day Edwards confronted Pearson. Pearson admitted to the double billing and imaginary
trips. When he was accused of clearly violating the Code, he said 'you dictate my resignation, I’ll sign it
and be out of here tonight'. Edwards responded to this by advising Pearson that if any criminal activity
were involved, it wouldn’t stop there.
To this, Pearson looked incredulous and began to argue his case strongly. He was currently working on a
big deal with a Japanese businessman – a market Southern Construction had been trying to crack for
some time. His budget has been cut to the bone, so he used the money from the expenses subterfuge to
finance the sales pitch. All that is left on a $10 million deal is for the papers to be signed and Pearson was
the only man who had developed the personal relationship with the Japanese businessman to secure
this.
Edwards sat in his office pondering about what to. The bank has just been on the phone requesting a
meeting next week to discuss progress in strengthening the controls within the business.
Required
(a) Using the AAA model, advise Edwards on what to do. (14 marks)
(b) Evaluate your final recommendation using Tucker's 5 questions, reaching a conclusion. (6 marks)
(Total = 20 marks)
ENDOF
END OFQUESTION
ANSWER BANK
BANK
167
Answers
1 Core principles
Integrity means being honest and straightforward. It suggests a wholeness which could imply a
characteristic that is as important to maintain in ones personal life as in ones professional or business
dealings.
In the context of corporate governance, corporations and directors are expected to act with integrity
towards shareholders and other stakeholders. Directors sometimes seek to defend their actions by
claiming that they acted with integrity. This can be taken to mean that they are acting in the best interests
of others rather than from personal self interest.
Fairness means considering the views and claims of all those with a reasonable claim against the
company.
Fairness is important in corporate governance because directors have to balance the competing claims of
different stakeholder groups. While directors have a legal fiduciary duty towards the shareholders of the
company they have a moral and social obligation to other groups.
Judgement means demonstrating effective decision making.
Directors are expected to do their best to protect their shareholders investment and indeed to generate a
return on that investment. They do so by making sound strategic decisions that will be profitable for the
company in the long term.
Independence in the context of both directors and auditors means having minimal links to the company.
It is important to have independent directors represented on the board in order to maintain objectivity in
strategic decision making and in scrutinising the performance of the company and their fellow directors.
This means that investors can be confident that the decision making process is not unduly influenced by
self interest.
Openness or transparency means disclosing information that people outside the organisation can rely on.
Openness is important in terms of reporting performance (financial and non-financial) so that investors
and other interested parties can make informed decisions. It is also important in terms of the procedures
that a company adopts so for example it is more transparent and consequently fairer to ask independent
directors to nominate new board members through an agreed robust process than to ask shareholders
with a significant holding to nominate their own candidate.
Probity means honesty (from the latin word for honest, probus) but it also signifies virtue and integrity. In
particular it is mentioned as a characteristic important for those business dealings which are not covered
by legal obligations.
In the context of corporate governance it is establishing the need to go beyond contractual and legal
obligations to deal fairly and honestly and establishing wider moral obligations. In the context of risk
management probity risk is defined as the risk that the company won’t 'do the right thing'.
Responsibility means acknowledging and seeking to remedy problems. There is a suggestion that it is the
imposition of a wider obligation than that imposed by law.
In the context of corporate governance one might take on wider responsibility through acknowledging
ones obligations to stakeholders other than just the shareholders or alternatively by increasing ones
obligations towards shareholders.
Accountability means an obligation to explain the outcome of ones actions.
In the context of corporate governance directors have to make account to the shareholders to explain
what they have done with their investment. They have to declare whether they have made profits or
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losses. Accountability could be considered in terms of the mandatory disclosures that are required from
companies and their directors.
Innovation means governance systems evolving over time to meet the changing needs of society.
Scepticism is the state of mid where you do not necessarily believe everything put before you but neither
do you disbelieve everything either – it is the ability to retain an open mind whatever the situation.
Reputation means the perception that others have about you.
Investors price the shares of a company based on their perceptions of its future profitability, their
perceptions of its risk and their perceptions about the capabilities and characteristics of the directors. SO
the share price is entirely founded on perceptions. Events which damage the reputation of the company
will inevitably have an effect on share price.
Tutorial Note: In the real exam you should expect to have to define and explain the importance of one or
two of these principles. It is likely that there will be two marks available for a well explained definition of a
core principle. There could then be anything from 2 to 10 marks for an explanation of its importance.
Often there are clues in the scenario as to the importance of a core principle and often there are marks
available for applying the principle to the facts of the scenario.
2 Frameworks, codes and systems

(a) In recent years a number of factors have influenced the introduction of a variety of frameworks,
codes and systems of corporate governance throughout the world. The factors are discussed
below:
(i) One of the factors giving rise to the pressure for better corporate governance was concern
that some large companies were not providing fair accounts, with profits and asset values
being, in some cases, artificially inflated. In the late 1980s there were a number of well-
publicised corporate failures, which were unexpected, as the audited financial statements
had given no indication of such problems. There was a view that the external auditors
were unable to perform their function properly perhaps because a powerful or
unscrupulous chief executive could keep information away from them.
(ii) There have also been criticisms that the external auditors of a company are not always as
independent as they should be or as the shareholders believe them to be. This was often
the case due to the fact that the auditors relied on the company not just for the audit fee
but also for substantial fees for other consultancy work throughout the year.
(iii) Allied to these concerns were concerns that some large companies were being run for the
benefit of the directors of the companies rather than for the shareholders. These concerns
raised questions about the conflict of interest between the board of directors and the
shareholders and there was particular concern about too much power being in the hands
of one individual or a small number of individuals. This was particularly the case where
one powerful individual held the posts of both chairman and chief executive and where
boards of directors lacked balance.
(iv) There was also an issue with directors' remuneration, which was often viewed, as
excessive whether the company was only performing no differently from an average
company or indeed was performing badly.
(v) In the light of many corporate failures, concern was also expressed about the board's
knowledge and handling of the risks that faced the business and of the adequacy of
internal control systems within companies.
(vi) As there was a trend towards global investment many large institutions, particularly in the
US and also in the UK, were seeking to invest substantial funds in companies in other
countries. In many instances there were concerns about the lack of shareholder rights and
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of disregard for minority shareholders rights shown by major shareholders or the boards of
these companies.
(b) In the UK the Principles of Good Governance have now been brought together in the voluntary UK
Code.
This Code has stemmed from a number of other codes, reports and frameworks:
 The Cadbury Code on the financial aspects of corporate governance
 The Greenbury Committee report on directors' remuneration
 The Hampel Committee report on corporate governance
 The Turnbull report on internal control and financial reporting
 The Smith guidance on audit committees
 The Higgs review of the role and effectiveness of non-executive directors, followed by the
Tyson report on the recruitment and development of non-executive directors
The Financial Reporting Council published the latest version of the Code in 2012. The main
requirements of the Code have attempted to address many of the concerns, which led to these
successive frameworks, codes and systems of corporate governance.
Here are some examples.
(i) The concerns regarding the board of directors and directors' powers are central to the
Code. Every listed company should be headed by an effective board, which should lead
and control the company. The two key tasks at the top of every listed company are the
running of the board, and the executive responsibility of the running of the company.
(ii) The board should include a balance of executive and non-executive directors (including
independent non-executives) such that no individual or small group of individuals can
dominate the board's decision making. It is recommended that non-executive directors
should comprise at least half the board.
(iii) There should be formal and transparent procedures for the appointment of new directors
to the board and all directors should be required to submit themselves for re-election at
regular intervals and at least every three years (some more frequently depending on the
type of entity).
(iv) The level of remuneration paid to directors should be sufficient to attract and retain the
directors needed to run the company successfully but companies should avoid paying
more than is necessary for this purpose. A proportion of executive directors' remuneration
should be structured so as to link rewards to corporate and individual performance. The
board should set up a remuneration committee of independent non-executive directors
who will devise schemes of remuneration, which will be recommended to the board.
(v) The board should present balanced and understandable assessment of the company's
position and prospects. The directors should explain their responsibility for preparing the
accounts and there should be a statement from the auditors about their reporting
responsibilities.
(vi) The board should maintain a sound system of internal control to safeguard the
shareholders' investment and the company's assets. The directors should, at least
annually, conduct a review of the effectiveness of the systems of internal controls and
should report to the shareholders that they have done this. The review should cover all
controls including financial, operational and compliance controls and risk management.
Companies who do not have an internal audit function should from time to time review the
need for one.
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(vii) The board should establish formal and transparent arrangements for considering how they
should apply the financial reporting and internal control principles and for maintaining an
appropriate relationship with the company's auditors. The audit committee should be made
up of at least three non-executive directors and this committee's duties include keeping
under review the scope and results of the audit and its cost effectiveness and the
independence and objectivity of the auditors. Where the auditors also supply a substantial
volume of non-audit services to the company the committee should keep the nature and
extent of such services under review.
(viii) Companies should be ready to enter into a dialogue with institutional shareholders based
on the mutual understanding of objectives. Boards should use the AGM to communicate
with private investors and to encourage their participation.
(a) Non-independent NEDs
A NED is not independent if he or she is on the board representing the interests of a major
shareholder, because the views given by the director will be made in the best interests of that
shareholder. Similarly it is debateable whether a director is independent when he or she has a
close relationship with the company or any other executive director. For example a former chief
executive of the company might be given a non-executive role after retirement. He would not be
independent.
Independent NEDs
In contrast an independent NED is a person who has no connection with the company other than
as a non-executive director, and who should be able to give an independent opinion on the affairs
of the company, without influence form any other director or shareholder.
(b) Conflicts of interest
A potential conflict of interest occurs when the executive director or senior management of a
company might be inclined to take decisions that would not be in the interests of the company’s
shareholders. Although there are several areas where a conflict of interest could arise, the major
problem areas are those of remuneration of the directors and senior managers, financial reporting
and nominations of new board members.
Remuneration
If executive directors are allowed to decide their own remuneration, they could be inclined to pay
themselves as much as possible, without having to hold themselves to account or justify their high
pay. Where incentive schemes are in place, there is a risk that incentive schemes devised by the
executive directors for themselves will be linked to achieving performance targets that are not
necessarily in the shareholders’ interests. For example rewarding directors with a bonus for
achieving profit growth is of no value to shareholders if the result is higher business risk and a
lower share price.
Remuneration Committee
Corporate governance in may countries, such as the UK’s Corporate Governance Code, calls for
a remuneration committee of the board to be established to decide on directors’ pay, including
incentive schemes, and for this committee to comprise at least three, or in the case of smaller
companies two, members, who should all be independent non-executive directors.
The remuneration committee should have delegated responsibility for setting remuneration for all
executive directors and the chairman, including pension rights and any compensation payments.
The committee should also recommend and monitor the level and structure of remuneration for
senior management. The NEDs should in principle, be able to devise fair remuneration packages
that include an incentive element, in which the performance targets bring the objectives of the
executive directors more into line with those of he shareholders.
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Financial Reporting
A second potential area for conflict of interest is financial reporting. The executive directors might
be tempted to window dress the results if the company, in order to present the financial results in
a way that reflects better on themselves and their achievements.
Audit Committee
There should be an audit committee of the board, consisting of non-executive directors, whose
task should be to consider issues relating to financial reporting and financial control systems. This
committee should be responsible for maintaining regular liaison with the external auditors. The UK
Code says that the audit committee should comprise at least three or in the case of small
companies, two members, who should all be independent NEDs. The board should satisfy itself
that at least one member of the audit committee has recent and relevant financial experience.
Nominations to the board
A third potential area for conflict is nominations of new board members. A powerful chairman or
chief executive could be tempted to appoint their supporters or ‘yes’ men to the board, and so
strengthen their position on the board. The UK code recommends that there should be a
nominations committee of the board manned by NEDs.
Other areas
Other areas of potential conflict of interest can be identified, such as succession planning, and the
board’s decisions on making acquisitions or in preparing defences against a takeover bid. In each
of these areas NEDs should be able to provide a counter balance to the self –interested views of
executive directors.
(c) Share Payments
In many companies, NEDs receive a fixed cash payment for their services, without any incentives.
However some companies pay their NEDs in shares.
They would argue that the more equity the NEDs hold, the more likely they will be to look at
issues from the point of view of the shareholders. There is a risk that a NED holding shares could
be more concerned with short-term movements in the share price and the opportunity of making a
short term profit from selling their shares. However, a suitable precaution against this could be to
obtain the agreement of a NED not to sell his or her shares until after leaving the board.
Share Options
The argument that NEDs should be rewarded with share options is more contentious, but it has
been widely practised in the UK and is even more common in the US. The argument against
rewarding NEDs with share options is that this form of remuneration could align the interests of
the NEDs more closely with the executive directors, who also hold share options. NEDs should
give independent advice, and it can be argued that it is therefore not appropriate to incentivise
them in the same way as the executives.
The UK Code points out that holding of share options could be relevant to the determination of a
non-executive director’s independence. It states that remuneration for non-executive directors
should not include share options. If, exceptionally, options are granted, shareholder approval
should be sought in advance and any share acquired by exercise of the options should be held
until at least one year after the non-executive director leaves the board.
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4 Board of directors
REPORT
To: Board of directors
From: Consultant
Date: December X4
Subject: Board of directors and committees
Chairman
The UK Corporate Governance Code states that there should be a clear division between the chief
executive of the company, who has executive responsibility for running the company's business, and the
chairman of the board of directors who is responsible for running the board.
The main roles of the chairman should be to:
 Run the board and set its agenda
 Ensure that all members of the board receive accurate, timely and relevant information
 Encourage the active participation of all members of the board
 Ensure that adequate time is allowed for the discussion of complex or contentious issues
 Ensure that the performance of individual directors and the board as a whole, together with its
committees, are evaluated at least once a year
 Ensure that there is a suitable induction programme for new directors
 Identify any development needs of individual directors
 Ensure effective communication with shareholders and major investors
Non-executive directors
The board should include a balance of executive and non-executive directors and the role of the non-
executive directors should include the following elements.
 Being independent in judgement and possessing an inquiring mind
 Being well informed about the company and the environment within which it operates
 Having a strong command of issues relevant to the business
 Constructively challenging proposals on strategy and helping to develop such proposals
 Scrutinising the performance of management and monitoring reports on that performance
 Ensuring that sufficient, accurate, clear and timely information is provided to the board in advance
of meetings
 Satisfying themselves of the integrity of the financial controls and information
 Satisfying themselves that the risk management systems are robust and defensible
 Determining appropriate levels of remuneration for executive directors
 Playing an important role in the appointment and removal of directors and in succession planning
 Understanding the views of major investors
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Remuneration committee
The remuneration committee should be made up of non-executive directors as it is responsible for setting
the remuneration for all executive directors, the chairman and the company secretary.
As well as this basic responsibility the remuneration committee has other duties.
 To determine targets for any performance related pay schemes
 To determine the policy for pension arrangements for executive directors
 To ensure that any contractual terms on termination and payments made are fair both to the
company and the individual
 To determine the total individual remuneration package for each executive director including
bonuses, incentive payments and share options
 To agree the policy for authorising expense claims from the chief executive and chairman
 To ensure that all required disclosures for remuneration matters are fulfilled
Nomination committee
The UK Code requires that there should be formal, rigorous and transparent procedures for the
appointment of new directors to the board. The nomination committee, made up of a majority of
independent non-executive directors, can carry out this role. The main duties of this committee are to:
 Evaluate the current balance of skills, knowledge and experience on the board and with this in
mind to prepare a description of the role and capabilities required for a particular appointment
 Consider candidates from a wide range of backgrounds
 Review the time required from a non-executive director annually
 Assess whether the non-executive directors are spending enough time to fulfil their duties
 Consider succession planning and in particular what skills and expertise are needed, given the
challenges and opportunities facing the company
 Prepare a statement for the annual report including the process used for appointments and
explains if external advice or advertising has been used. The statement should also state the
membership of the committee, and the number of committee meetings attended over the year.
5 Caius plc
Tutor's note. A good guideline for this type of question would be the key points relating to directors
remuneration from the UK Code. This will give you most of the key areas that require to be discussed.
To: Board of Directors of Caius plc

From: Accountant
Date: X–X–XX
Subject: Directors’ pay and conditions
In order to ensure that directors’ pay and conditions are fair and transparent the company should adopt
the following policies and frameworks.
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Level and make-up of remuneration

The level of remuneration offered to directors should be sufficient to attract, retain and motivate directors
of the quality required to run the company successfully. However, a company should avoid paying more
than is strictly necessary for this purpose. The levels of pay offered by other similar companies can be
considered but such comparisons should be used with caution.
A significant proportion of executive directors’ remuneration should be structured so as to link their
interests with those of the shareholders and give the directors keen incentives to perform to the highest
levels. Therefore, incentive schemes are acceptable but they must always be related to performance and
they must be geared to the long term rather than the short term. Where incentive schemes are used the
amount paid to the directors should be based upon them meeting or exceeding clearly defined targets.
Service contracts and compensation
Service contracts for directors are necessary but there must be a balance between the directors’ needs
and the interests of the shareholders. In general terms notice periods under contracts should be set at
one year or less. The board must be prepared to dismiss a director for poor performance and much
thought should be given to compensation commitments. The aim should be to avoid being seen to reward
poor performance by excessive compensation payments and the board should take a robust line on
reducing compensation to reflect a departing director’s obligations to mitigate loss.
Remuneration committee
The board should appoint a remuneration committee made up entirely of independent non-executive
directors. The aim of this is to ensure that there is a formal and transparent procedure for developing
policy on executive remuneration and for the remuneration packages of individual directors. Most
importantly no director should be involved in deciding his or her own remuneration.
Communication with shareholders
The remuneration committee should enter into communication with major shareholders about directors’
remuneration. Shareholders should be invited specifically to approve all new long-term incentive schemes
and significant changes to existing schemes. In the annual report of the company there should be a
report on the remuneration policy and details of the remuneration of each director. The chairman of the
remuneration committee should also attend the AGM and be prepared to answer any questions from
shareholders relating to directors’ remuneration.
6 Types of risk
There are many different types of risk faced by commercial organisations, particularly those with
international activities. They may be categorised under the following headings:
 General business risk
 Trading risk
 Cultural, country and political risk
 Currency (foreign exchange) risk
 Interest-rate risk
 Technological risk
 Fraud risk
General business risk
Business risk may be defined as the potential volatility of profits caused by the nature and type of the
business operations involved.
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Factors contributing to business risk will include:

 The type of industries/markets within which the business operates – the extent to which sales are
vulnerable to changes in fashion, technology etc
 The state of the economy
 The actions of competitors
 The actions of unions or impact of government legislation
 The stage in a product's life cycle, with high risks in the introductory and declining stages
 The dependence upon inputs with fluctuating prices, eg wheat, oil etc
 The level of operating gearing – the proportion of fixed costs in total costs – the higher the level,
the greater sales need to be made to break even
 The flexibility of production processes to adapt to different specifications or products
Trading risks
Both domestic and international traders will face trading risks, although those faced by the latter will
generally be greater due to the increased distances and times involved. The types of trading risk include:
 Physical risk – the risk of goods being lost or stolen in transit, or the documents accompanying the
goods going astray
 Credit risk – the possibility of payment default by the customer. This is discussed further below.
 Trade risk – the risk of the customer refusing to accept the goods on delivery (due to sub-
standard/ inappropriate goods or other reasons), or the cancellation of the order in transit
 Liquidity risk – the inability to finance the credit
Cultural, country and political risk
Where a business trades with, or invests in, a foreign country cultural risk is introduced by the existence
of different customs, laws and language. Communication between parties can be hindered, and potential
deals put into jeopardy by ignorance of the expected manner in which such transactions should be
conducted. Country risk is the risk associated with undertaking transactions with, or holding assets in, a
particular country. Sources of risk might be political, economic or regulatory instability affecting overseas
taxation, repatriation of profits, nationalisation, currency instability etc. Political risk is the risk that political
action (exchange controls, tax changes, pricing regulations etc) will affect the position and value of a
company.
Currency risk
Currency risk is the possibility of loss or gain due to future changes in exchange rates. When a firm
trades with an overseas supplier or customer, and the invoice is in the overseas currency, it will expose
itself to exchange rate or currency risk. Movements in the foreign exchange rates will create risk in the
settlement of the debt – ie the final amount payable/receivable in the home currency will be uncertain at
the time of entering into the transaction.
Investment in a foreign country or borrowing in a foreign currency will also carry this risk.
Interest rate risk
As with foreign exchange rates, future interest rates cannot be easily predicted. If a firm has a significant
amount of variable (floating)-rate debt, interest rate movements will give rise to uncertainty about the cost
of servicing this debt.
Conversely, if a company uses a lot of fixed-rate debt, it will lose out if interest rates begin to fall.
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Technological risk
All businesses depend to some extent on technology, either in the support of its business activities (eg
the computers used by the accounts, stores and treasury departments), or more directly in its production
or marketing activities.
As technology evolves and develops, firms can find themselves using out of date equipment and
marketing methods, which may leave them at a competitive disadvantage. Products in a high-tech
industry have very short life cycles, and a firm must recognise and plan for continual replacement and
upgrading of products if it is not to lose market share.
Fraud risk
All businesses run the risk of loss through the fraudulent activities of its employees, including
management.
How the codes of corporate governance can assist in managing the risks
Corporate governance is concerned with the control and influence exerted over a company's operations
and its employees by the decisions of top management, usually the board of directors.
The codes of corporate governance are guidelines and recommendations developed over a number of
years by various committees and researchers (Cadbury, Greenbury, Hampel, Higgs, and Smith) and now
incorporated in the UK into the Corporate Governance Code published in July 2012 by the Financial
Reporting Council.
A significant element of the Code is concerned with the way internal controls are implemented and
reviewed in order that such risks as those outlined above would be managed. The code includes the
Turnbull report.
The Turnbull report included recommendations that:
 Management should identify and evaluate the risks to which they will be exposed in the
achievement of their corporate objectives. These will include both the traditional areas of risk
discussed above, but also those increasingly arising from intangible assets, such as reputation
and branding.
 Risk control should be embedded in the culture and processes of the business, rather than
being the subject of a completely separate management system. Each person in the organisation
should be aware of, and manage, the significant risks related to the tasks they perform.
 Directors should continually review and monitor risk control issues. It should regularly review
reports on internal control from line managers and, where appropriate, from internal auditors
and other specialists.
 Regular discussion of risk and control issues at board meetings should be encouraged.
 Risk analysis and assessment should form part of the evaluation of every major capital
investment or proposed acquisition.
 Financial risk analysis will very much depend upon commercial judgement, but the following
questions may be used as a framework for the assessment of their impact on company value:
– What is the effect on present and future cash flow?
– What is the effect on the underlying present and future profitability of the business?
– What is the effect on the underlying present and future liquidity and value of assets
employed in the business?
– What is the effect on the present and future debt structure of the business?
– The relative likelihood of the events giving rise to the risks also needs to be assessed.
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– This can then be combined with the level of impact to prioritise the risks.
– High impact, high likelihood immediate action required
– High impact, low likelihood contingency plan needed
– Low impact, high likelihood consider taking action
– Low impact, low likelihood no action now, but review periodically
Once risks have been prioritised, management needs to decide what to do about them, and how they can
be managed and monitored in the future.
Strategies for management of a given risk include:
 Acceptance
 Transfer eg by insurance or joint venture
 Elimination by hedging, or ceasing the activity/operation
 Control by building in operational controls
7 COSO Framework
(a) Avoidance means exiting the activities that give rise to risk. Risk avoidance may involve
disposing of a business unit, product line, or geographical segment, or simply deciding not to
engage in new initiatives/activities that would give rise to the risks.
If reduction is the chosen response then action is taken to reduce risk likelihood or impact, or
both. This typically involves any of a large number of everyday business decisions, including
diversifying product offerings, establishing operational limits for activities, establishing more
effective business processes, enhancing management involvement in decision making and
monitoring, rebalancing the entity’s portfolio of assets to reduce exposure to certain types of
losses, or reallocating capital among operating units.
Sharing entails reducing risk likelihood or impact by transferring or otherwise sharing a portion
of the risk. Common techniques include purchasing insurance products, engaging in hedging
transactions, entering into joint ventures or partnerships, sharing risk through contractual
agreements with customers, vendors, or other business partners, or outsourcing an activity.
If acceptance is the chosen response no action is taken to affect risk likelihood or impact: the risk
is accepted because it already conforms to the entity’s risk tolerances. The entity may have self-
insured against loss, or it may rely upon natural offsets within a portfolio.
(b) Control activities are the actions of people to implement policies, directly or through application of
technology, in such a way as to help ensure that management’s risk responses are carried out.
Many procedures are commonly performed by personnel at various organisational levels that
serve to enforce adherence to established action plans and to keep entities on track toward
achieving their objectives.
Here are some examples.
 Top-level reviews – Senior management reviews actual performance versus budgets,
forecasts, prior periods, and competitors. Major initiatives, such as marketing thrusts,
improved production processes, and cost containment or reduction programmes, are
tracked to measure the extent to which targets are being reached.
 Direct functional or activity management – Managers running functions or activities
review performance reports. For example, a manager responsible for a bank’s consumer
loans will review reports by branch, region, and loan type, checking summaries and
identifying trends, and relating results to macro-economic statistics and targets. Managers
will also focus on compliance issues, for example reviewing reports required by regulators
on new deposits over specified amounts.
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 Information processing – A variety of controls are performed to check accuracy,

completeness, and authorisation of transactions. Data entered is subject to on-line edit
checks. A customer’s order, for example, is accepted only after reference to an approved
customer file and credit limit. Numerical sequences of transactions are accounted for, with
exceptions followed up and reported to supervisors. Development of new systems and
changes to existing ones are controlled, as is access to data, files, and programs.
 Physical controls – Equipment, inventories, securities, cash, and other assets are
physically secured and periodically counted and compared with amounts shown on control
records.
 Performance indicators – Relating different sets of data (operating or financial) to one
another, together with analyses of the relationships and investigative and corrective
actions, serves as a control activity. Performance indicators include, for example, staff
turnover rates by business unit. If they investigate unexpected results or unusual trends,
management may identify circumstances where an insufficient capacity to complete key
processes may mean that there is a risk that objectives have a lower likelihood of being
achieved.
 Segregation of duties – Duties are divided, or segregated, among different people to
reduce the risk of error or fraud. For instance, responsibilities for authorising transactions,
recording them, and handling the related asset are divided. A manager authorising credit
sales would not be responsible for maintaining accounts receivable records or handling
cash receipts. Similarly, salespeople would not have the ability to modify product price files
or commission rates.
8 Audit process
(a) The external audit process must demonstrate whether the financial statements show a “true and
fair view” of the financial position and performance of the company. The external auditors must
also report as to whether the financial statements have been prepared in accordance with relevant
statute and whether certain specifics have been complied with:
 The company has kept proper accounting records
 The auditors have received all of the information and explanations required to carry out
their audit
 The Directors' Report is consistent with the financial statements
 Information required by regulatory bodies has been disclosed.
The report to the shareholders by the external auditor is in the form of an opinion as to whether
the accounts show a true and fair view in the audit report. An unqualified opinion should give
shareholders and other users of the financial statements confidence in those financial statements
but it is not a guarantee from the auditors that the financial statements are totally correct.
During the course of the external audit the auditors will consider and test the internal accounting
systems of the company and make recommendations for improvements. However there is little
else that directly contributes towards the effective system of corporate governance as the auditor
is not required to consider whether the statements of the directors regarding internal controls are
comprehensive or comment on the effectiveness of the company's corporate governance
procedures or risk procedures.
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The internal audit function is not a legal requirement, but the board of directors may set up an
internal audit department after considering the costs and benefits. The work of internal auditors is
not set out in law but is decided upon by the board of directors or senior management. The work
of the internal audit function will therefore vary from company to company, but the following are
typical areas that the internal audit function may be required to consider.
 Testing and reporting on the internal control systems of the organisation
 Reviewing the adequacy of accounting and financial information
 Considering the effectiveness of risk management and risks control processes –
identifying weaknesses and recommending improvements
 Considering compliance procedures
 Identifying weaknesses in procedures and systems and recommending improvements
 Performing one-off projects determined by management
As the remit of the internal audit function is as wide as is necessary then this can be a valuable
resource to management, contributing towards an effective system of corporate governance.
(b) When the external auditors are carrying out their audit they will expect full co-operation from the
internal auditors. The internal auditors should ensure that the accounting and internal control
systems are operating satisfactorily but the external auditor will test those systems independently.
The external auditors will not tend to rely on the work of the internal auditors in general terms but
the work on systems, controls and procedures that have been carried out by the internal audit
function will be of some assistance to the external auditors in their role.
9 Ethical considerations
To: The Managing Director
From: The Financial Controller
Date: XX.XX.XX
Subject: Issues arising from the meeting with X Ltd regarding payment of their debt
This report assumes that you have read the enclosed documents prepared by the Sales Director
concerning her recent meeting with Y, the Managing Director of X Ltd. In brief, we are being asked to
supply further materials on credit to X Ltd on the understanding that this offers our best chance of being
paid both for long-outstanding existing debts and the further debts that will arise.
Firstly I need to point out that our Sales Director feels that we should accept what has been informally
agreed but she has openly admitted that she has difficulty in taking an objective view of the situation,
having done business with Y for many years.
However, the agreement that is being proposed leaves me with grave doubts, both on ethical grounds
and from the point of view of the business.
Our options are:
 To accept the agreement as proposed;
 To refuse the payment from Y but supply further materials in any case;
 To sue for payment or simply write off the debt.
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Accepting the agreement

This option puts us in a position where we are owed (and are at risk of losing) not only our existing debt of
£A but also a further amount (say £B, based on past trading experience).
I am not sure what the role of the personal payment is meant to be. It is not a bribe, although it has that
taste about it, since the intention is that it would be repaid. Presumably it is a sign of good faith, but why
not inject the funds directly into the company and pay off some debts now? If Y is not willing to risk
loaning the funds to his company, why should we be any more willing to take the risk of supplying further
goods?
In any case, recovery of our debt depends not only on our support but also that of all or almost all of X
Ltd's other suppliers. We have no guarantee that this support will be forthcoming. (Indeed, I have just
received a telephone message from another supplier indicating that they too are worried about X Ltd's
position, and asking for our view (see below).)
If the company is forced into liquidation by other creditors (or if X Ltd cannot complete the next stage of
the work) what are we expected to do about the personal payment? I am not sure how the law would view
it. It would put us in a more advantageous position than other creditors, but unfairly so.
There are other matters that cause me to have doubts.
 Why can X Ltd not obtain an advance from their bank against the promise of the next progress
payment? Has this option been attempted? If not, is the bank fully aware of the difficulties of X
Ltd?
 Are X Ltd already 'trading wrongfully', which is illegal? To knowingly enter into an agreement that
allows this to continue calls our own integrity into question.
Refuse the payment but supply the materials
This is a better option because it leaves us with a clear conscience regarding the payment, and does not
compromise Y in any way. The other problems remain, however.
We need to be assured:
(a) That X Ltd can secure the support of its other creditors
(b) That X Ltd really can complete the next stage of the contract
If we are satisfied on point (a), we could encourage X Ltd to enter into negotiations with all of its suppliers.
We can let it be known that we will be willing to help if others are: this will put X Ltd in a stronger position.
If X Ltd is able to get the level of support needed, this option is the one that I recommend.
If both you and Y agree to this I may have an immediate opportunity to help out, since (as I mentioned) I
have already had an enquiry from an acquaintance working for another supplier who will also, I think, be
keen to salvage something from the situation if at all possible.
Confidentiality is an issue at present, so for the time being I have sent a fax explaining that we are
currently negotiating with X Ltd and that I will be in touch once I know the outcome of our talks. (You will
realise that my own professional integrity could be compromised if I supply information that could be
considered misleading. I cannot simply ignore the enquiry or be cagey about it since this could itself be
construed as a 'bad' reference.)
Suing for payment or writing off the debt
Since we are unlikely to recover our debt this option will simply increase our loss because we will have to
pay legal costs. X Ltd may be counting on the fact that we know this.
One possible virtue of this option is that the threat of liquidation, or liquidation itself, may force Y to come
to an arrangement with all creditors if we are unable to persuade him to try this by other means.
Writing off the debt now has the virtue that we do not risk losing a further amount by supplying more
materials. On the down side, it could make us look 'soft' to other customers, and it is possibly unduly
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harsh not to give X Ltd a chance to recover the situation. It is not in our long-term interests for our
customers to go out of business.
I cannot recommend either of these options except in the very last resort.
Wider issues
We need to consider whether this situation has arisen due to problems with credit control on our part. It
could perhaps be argued that we should have worked more closely with X Ltd to prevent the problem
arising in the first place. We should have been aware that X Ltd was taking on a much larger contract
than it has previously been used to dealing with and we should have anticipated problems.
Over the next few days I shall be looking into ways in which our credit control systems can be adapted to
ensure that external matters such as this are taken into account.
10 Corporate citizenship
REPORT
To: Directors
From: Consultant
Date: Dec X4
Subject: Corporate citizenship
Introduction
Companies have choices as to how they manage their businesses. These choices can be many and
varied but the choices that are made can determine whether or not the company is seen as a good
citizen. Many of the world's companies are setting high standards of behaviour in many aspects of
business and in a wider social context.
Corporate citizenship
The concept of corporate citizenship recognises that there is a connection between the everyday
activities of companies and the well being of society as a whole. In recent years companies have adopted
a more comprehensive approach to corporate citizenship in general, and this includes social and
environmental responsibility.
Directors now accept that they are not only responsible to the shareholders – the owners of the company
– but also to a wider selection of other stakeholders which will include employees, customers, investors,
business partners, suppliers, the community and the government.
It can be argued that corporate citizenship is made up of three key components:
(1) The basic values, policies and practices of a company and its business at home and abroad
(2) The management of environmental and social issues within the value chain of business partners
(3) The voluntary contributions made by a company to community development around the world
Social and environmental issues that may affect companies
The types of social and environmental issues that may affect companies can most easily be considered
by taking a look at the various stakeholders in a company and issues that might affect the relationship of
the company with those stakeholders.
 Employees. Issues that may affect employees and the company's treatment of those employees
include wage rates, health and safety provisions, accident rates, training opportunities and how
changes such as downsizing and redundancies are handled.
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 Customers. Customers in global, competitive markets are increasingly concerned not only with
price but also value of goods and services. Quality issues are paramount to most companies
including how complaints are handled. Increasingly customers are also concerned with the
background to the goods they have purchased and the conditions under which they were
manufactured. In an age of environmental concerns customers are also concerned with factors
such as the safe disposal or recycling of products once used.
 Suppliers. The activities of one company will necessarily have a knock-on effect on other
companies with which it deals, in particular suppliers. Companies will be concerned about the
long-term stability of their suppliers, the sustainability of jobs at their suppliers and timely payment
of their suppliers.
 The community. Concerns here for a company will centre on charitable gifts and donations, the
support of employees providing charitable gifts or services, investment within the community and
the willingness to listen to community concerns and to enter into meaningful dialogue.
 Government. Many companies pay huge amounts of taxes, which are vital for the sustainability,
and growth of many countries and economies. Companies should be concerned with issues such
as fair transfer pricing policies and compliance with the laws and regulations of all the countries
within which they operate.
 Environment. Increasingly the general environment is being viewed as an additional stakeholder
and the quality of the management of environmental issues over the entire product life cycle will
be of great importance to companies.
Ethical issues that a board may face
Once it is accepted that modern day companies are not only in business to increase shareholder wealth
but also to protect and nurture society and the environment then there are many potential ethical issues
that may face a board of directors in their strategies and operational decision making.
Directors may need to consider all aspects of their value chain, both backward linkages and forward
linkages. Backward linkages may include ethical issues such as the conditions in which products are
made in many developing countries, ie low wages, poor conditions, child labour, etc as these are fast
becoming important issues for customers.
Manufacturers of products also have to accept that their responsibility in the customer's eyes does not
end with the sale of the product. Directors will need to consider their products over their entire life cycle
and in particular environmental issues such as the safe disposal of products, recycling of products and
the restoration of the environment when manufacture or use is complete.
Directors must also be concerned with social and ethical issues particularly in association with products
such as alcohol, cigarettes or pharmaceuticals. The directors of such companies will need to be
particularly aware of social responsibility issues such as under-age drinking, drink driving, the dangers of
smoking and the misuse of prescription pharmaceuticals. This will often affect the ways and methods in
which such goods are advertised.
Companies should also accept that they have ethical responsibilities towards their employees, particularly
in developing countries, in terms of wage rates, working conditions, provision of health care and pension
arrangements.
Directors of companies may find that they are faced with ethical decisions when considering voluntary
contributions to the societies in which they operate. Many donations promoting the common good may
have no apparent tangible benefits to the company itself but the reputation of being a 'caring company'
must not be under-estimated.
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11 Franks & Fisher
Marking scheme
Marks
(a) 1 mark for each factor identified and briefly discussed 7

1 mark for each factor applicable to Franks & Fisher 3
10
(b) 1 mark for each relevant point identified and briefly described 6
(c) 1 marks for each relevant point made 4
(d) 2 marks for definition of objectivity 2
1 mark per relevant characteristic identified and briefly described 3
5
25
(a) Turnbull report

The UK Turnbull report lists a number of considerations which will be taken into account when
deciding whether to establish an internal audit department; most are relevant here.
Scale and complexity of operations
This has clearly increased recently with rapid growth meaning more products and activities being
taken on, and possibly more that can go wrong. Internal audit review can act as a check on the
decision-making processes, that all the implications of the change in business have been fully
considered.
Number of employees
Increases in employee numbers are an indication of changes in size and the need for
development of human resource systems, which internal audit would wish to evaluate.
Changes in organisational systems
Overall control systems will have to develop, and internal audit will be an important part of this
change. Internal audit may be particularly needed as a check on the development of other parts of
the system; with rapid growth, there is a danger that information systems for example may not
develop in a way that is best for the company.
Changes in key risks
Changes in products and activities will bring changes in risks. There will be risks associated with
the production and sales of the new products, such as production stoppages, health and
safety considerations and distribution difficulties. There may also be changes in the general
risks that Franks and Fisher faces, with possibly the increased risk of inefficiencies and
diseconomies of scale. Internal audit can review the adequacy of the overall risk
management systems for coping with these changes and carry out work on specific areas of
high areas.
Problems with internal systems
The breakdown has highlighted possible problems with quality standards. The recent changes
may mean that they would be inadequate anyway even if rigorously enforced. However they
have not been employed conscientiously, and this calls into question whether other parts of the
control systems are working as effectively as they should be. Internal audit should definitely
investigate this.
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Unacceptable events
Clearly the production breakdown was an unacceptable event because of its consequences and
its avoidability. Franks and Fisher is trying to establish itself in various product markets and
therefore disruption in supply could have particularly serious consequences. If internal audit
recommendations can reduce the chances of this happening in future, clearly this will be a major
benefit.
Cost-benefit considerations
The fact that the board are talking about limiting internal audit's work may indicate that cost-
benefit considerations are significant. Fears that internal audit will interfere with operational
departments may well be exaggerated, and well-directed internal audit work should bring
benefits. However if internal audit's work is going to be seriously limited, it may not be worthwhile
employing an internal auditor.
(b) Arguments in favour of external recruitment
Other experience
An external recruit can bring fresh perspectives gained from working elsewhere. He can use his
experience of other organisations' problems to identify likely risk areas and recommend
practical solutions and best practice from elsewhere.
Independence of operational departments
An internal recruit is likely to have built up relationships and loyalties with people whom he has
already worked, perhaps owing people favours. Equally he could have grievances or have come
into conflict with other staff. These could compromise his independence when he comes to
audit their departments.
Prejudices and biases
An internal recruit is likely to have absorbed the perspectives and biases of the organisation.
He thus may be more inclined to treat certain individuals or departments strictly, whilst giving
others the benefit of the doubt when maybe that is not warranted.
Auditing own work
Recruiting internally could mean that the internal auditor has to audit the department for which
he worked, or even his own work. These would mean that he lacked the detachment
necessary to be objective. This would not be a danger with an external recruit not previously
involved with operations.
(c) Inappropriateness of reporting to Mr Kumas
There are a number of reasons why internal audit should not report to Mr Kumas.
Independence of internal audit
Internal audit's independence as a check on internal controls will be compromised by having to
report to Mr Kumas, because he has responsibility for operations as an executive director.
Instead internal audit should report to the chair of the audit committee, on the grounds he is, or
should be, an independent non-executive director with no operational responsibilities. The
corporate governance codes emphasise the importance of this.
Employment of internal audit
If internal auditors report to Mr Kumas, he will have responsibility for establishing their pay
and conditions. Thus they will have a significant personal interest in not producing adverse
findings and hence antagonising him.
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Work of internal audit

Part of internal audit's work will be on the finance function for which Mr Kumas is responsible. If
Mr Kumas is in charge of internal audit as well, he may be able to ensure that internal audit
coverage of the finance function and his own work is not as rigorous as it should be, and may be
able to water down or suppress adverse audit findings.
Using Mr Kumas' help
Even if internal audit did not report to Mr Kumas, he would still have to supply them with the
budgets and other control information he has and generally provide assistance. However
internal auditors should not rely on him for audit knowledge as they should themselves possess
sufficient knowledge and experience to carry out their responsibilities effectively.
(d) Definition of objectivity
Objectivity means not letting bias, conflict or undue influence of others to override
professional or business judgements. It implies detachment and not letting personal feelings
intrude into professional judgements.
Demonstrating objectivity
Lack of favouritism
Internal auditors should not accept gifts nor undue favours from the departments that they are
auditing.
Fairness
Internal auditors should avoid the perception that they are out to 'hit' certain individuals or
departments. They should not take sides, not being influenced by office politics in determining
the work carried out and the reports given.
Not responding to intimidation
Internal auditors should choose which areas to audit based on their objectives and risk analysis,
and not be kept away from certain areas by aggressive managers. Internal audit should also
cover the whole management process and not just audit the operational areas.
Valid opinion
Internal auditors should aim to deliver a report that satisfies the needs of their principal (the audit
committee).This means producing a report based on all relevant factors rather than one
designed to please operational departments.
12 Southern Construction
(a) Using the AAA model:
1 What are the facts?
The facts as we know it from the scenario are as follows:
– Edwards has knowingly broken the rules
– Misappropriation of shareholders funds has occurred
– Control systems (budgeting and expense checking) have failed
2 What are the ethical issues?
There are a range of ethical issues which could be considered here:
– Should Pearson be punished even if he has acted for the greater good of the
organisation? (utilitarianism)
– Does Edwards need to be ‘seen’ to do the right thing?
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– Should Edwards conceal the issue from key stakeholders regardless of how he
chooses to act? (Transparency issues)
– If the behaviour is widespread, should Edwards be treated as a scapegoat?
– Should loyalty affect a decision?
3 What are the norms, principles and values?
Normal business practice might be to:
– Recognise that he has acted within accepted norms
– Punish stealing/rule breaking whatever the circumstances
– Deal with any tricky situation in house if there is no legal reason to disclose
– Consider the wider impact of a rash decision ie – he is a key member of the team
and so sacking him could make the situation worse
4 What are the alternative courses of action?
Options include:
– Sack Edwards
– Suspend pending further investigation
– Interview him and accept his version
– Investigate the extent of the losses before deciding what to do
– Verbal warning but ask him to continue to work with client
– Demote/remove authority
– Keep in position but reduce authorisation limits
– Do nothing
FOR EACH OPTION YOU WOULD NEED TO BE ABLE TO EXPLAIN THE
CONSEQUENCES (ie the impact the options would have on stakeholders) eg the IA
department, the bank, the rest of the sales team.
This would be step 6 of the AAA model
5. and 7. What is the best course of action and what is the decision?
The final section of an answer should include a justification of which action you would take,
and why you would take it. You could also enhance your justification by relating it to
appropriate ethical theory.
(b) Tucker’s 5 question model
Based on a solution which suggests that the best action would be to discipline Edwards internally
but leave him in his role to continue to develop the business with the client:
Is the decision profitable?
YES – Pearson knows the business, the client and the systems. He has not stolen for personal
gain, so shows commitment to the organisation and will continue to do so.
Is the decision legal?
YES – Pearson has bent the company rules but has not acted broken any laws. If he has the
paperwork to prove that he has not taken any money for his own gain, the company can deal with
the situation as it sees fit, and in the best interests of the shareholders
Is the decision fair and equitable?
To whom? Stakeholders or mainly shareholders?
Probably yes as the company will not lose a key client. Some stakeholders such as the IA
department will have to be consulted.
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Is the decision right?

This is the most ethical question, and raises the issue of doing the right thing out of a sense of
duty (deontology) or acting based on outcome (teleology). In this case if no-one has been harmed
then the decision to retain him is right.
Is the decision sustainable?
Does the decision allow the business to continue?
This is a problem potentially, as any decision about a major event sets a precedent. If control
systems are changed as a result of this problem, and systems are improved then potentially the
business can continue. Financial sustainability is improved if the deal is won.
Conclusion
The decision appears to be acceptable.
NB. IN AN EXAM QUESTION OF THIS NATURE YOU WILL NEED TO SHOW THAT YOU CAN
ARGUE A CASE AND JUSTIFY YOUR POINT OF VIEW. THERE IS NO ONE RIGHT ANSWER
SO YOURS MIGHT BE VERY DIFFERENT TO THIS
END OF ANSWER BANK

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Appendix A:
Pilot paper questions
and answers
189
14: APPENDIX A: PILOT PAPER QUESTIONS AND ANSWERS
Pilot paper
Paper P1

Time allowed
Reading and planning: 15 minutes
Writing: 3 hours
This paper is divided into two sections:
Section A – This ONE question is compulsory and MUST be attempted
Section B – TWO questions ONLY to be attempted
Do NOT open this paper until instructed by the supervisor.
During reading and planning time only the question paper may be annotated. You must NOT write in your
answer booklet until instructed by the supervisor.
This question paper must not be removed from the examination hall.
Note: some questions from the original pilot paper have been removed from these notes to be used
elsewhere in your BPP materials. Those that remain are to be used on the taught phase of your studies.
Question 1
Chemco is a well-established listed European chemical company involved in research into, and the production of,
a range of chemicals used in industries such as agrochemicals, oil and gas, paint, plastics and building materials.
A strategic priority recognised by the Chemco board some time ago was to increase its international presence as
a means of gaining international market share and servicing its increasingly geographically dispersed customer
base. The Chemco board, which operated as a unitary structure, identified JPX as a possible acquisition target
because of its good product ‘fit’ with Chemco and the fact that its geographical coverage would significantly
strengthen 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
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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)
(d) Explain FOUR roles of non-executive directors (NEDs) and assess the specific contributions that NEDs
could make to improve the governance of the JPX board. (7 marks)
(e) Write a memo to Leena Sharif defining ‘environmental footprint’ and briefly explaining the importance of
environmental reporting for JPX. (8 marks)
(Total = 50 marks)
Question 1
This question is an example of what’s likely to be a common type of question on this paper, evaluate the
inadequacies and suggest improvements. However parts (c) and (d) are quite specific about which areas you
have to discuss, indicating you need a detailed knowledge of corporate governance issues to underpin your
discussions. The question part on risk is mixed in with this discussion on corporate governance, indicating how
different parts of the syllabus will be combined in the case study question.
This question covers material from a number of chapters, and you can expect Question 1 to be drawn from areas
covered across the whole of your Study Text.
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Question 2
In a recent case, it emerged that Frank Finn, a sales director at ABC Co, had been awarded a substantial over-
inflation annual basic pay award with no apparent link to performance. When a major institutional shareholder,
Swanland Investments, looked into the issue, it emerged that Mr Finn had a cross directorship with Joe Ng, an
executive director of DEF Co. Mr Ng was a non-executive director of ABC and chairman of its remunerations
committee. Swanland Investments argued at the annual general meeting that there was 'a problem with the
independence' of Mr Ng and further, that Mr Finn’s remuneration package as a sales director was considered to
be poorly aligned to Swanland’s interests because it was too much weighted by basic pay and contained
inadequate levels of incentive.
Swanland Investments proposed that the composition of Mr Finn’s remuneration package be reconsidered by the
remunerations committee and that Mr Ng should not be present during the discussion. Another of the larger
institutional shareholders, Hanoi House, objected to this, proposing instead that Mr Ng and Mr Finn both resign
from their respective non-executive directorships as there was 'clear evidence of malpractice'. Swanland
considered this too radical a step, as Mr Ng’s input was, in its opinion, valuable on ABC’s board.
Required
(a) Explain FOUR roles of a remuneration committee and how the cross directorship undermines these roles
at ABC Co. (12 marks)
(b) Swanland Investments believed Mr Finn’s remuneration package to be ‘poorly aligned’ to its interests.
With reference to the different components of a director’s remuneration package, explain how Mr Finn’s
remuneration might be more aligned to shareholders’ interests at ABC Co.
(8 marks)
(c) Evaluate the proposal from Hanoi House that both Mr Ng and Mr Finn be required to resign from their
respective non-executive positions. (5 marks)
(Total = 25 marks)
Question 2
This question has some similarities to Question 1, requiring knowledge of specific areas of good corporate
governance practice and application of that knowledge to identify weaknesses and recommend improvements.
Ethics part (c) is only worth 5 marks; you may well encounter more complex ethical situations requiring
discussion worth more marks.
Chapter 3 of your Study Text thoroughly covers the issues involved in this question.
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END OF APPENDIX A
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Appendix B:
Information
about M&S
199
15: APPENDIX B: INFORMATION ABOUT M&S
Background information and report extracts for Marks

and Spencer plc
Background information
Marks and Spencer is an iconic British retailer, one of the best known names on the British high street. In its
2008 annual report the company reported group sales of £9,022 million from its 622 UK stores and 278 overseas
stores.
The company sells clothing, food and furniture.
Brief History
1880s and 1890s: Having started trading from a market stall in Leeds the founder Michael Marks moved to
Manchester and in 1894 went into partnership with Tom Spencer.
1900s: Tom Spencer died in 1905 (although he had not been an active partner in the business for a while) and
Michael Marks in 1907. Michael was succeeded in the business by his son Simon, still only in his late teens.
1920s to 1950s: The business bought direct from manufacturers with whom it established good, if slightly
paternalistic relationships. There was a similar tone in the staff welfare introduced in the 1930s. In 1926 the
company went public although the family retained a high level of power.
1960s and 1970s: The charismatic Chairman Simon Marks died in 1964, succeeded by family member Israel
Seiff.
1980s and 1990s: Derek Rayner became the first Chairman from outside the founding families. He was
Chairman from 1984 to 1991 and oversaw the acquisition of the American company Brooks Brothers in 1988
(subsequently sold in 2001). He took steps to secure his successor Richard Greenbury by appointing him CEO in
1988. Richard Greenbury was Chairman (and CEO) until 1999. In 1998 M&S was the first British retailer to make
pre-tax profits of more than £1billion.
2000s: Following Richard Greenbury’s departure the company suffered a slump in its fortunes. There were
problems in the board room and shareholders were keen to know who to blame for the company’s problems.
Some believed the problems stemmed from decisions made by Richard Greenbury. The company finally started
accepting credit cards (other than its own store card) in early 2000. Stuart Rose the current CEO is credited with
turning the business around following his appointment in 2004.
2008: In early 2008 the business was criticised when it was announced that Stuart Rose was to be elevated to
the position of Executive Chairman (ie joint CEO/Chairman). There was also criticism after it emerged that he
had invested money in a business belonging to one of the non-executive directors. The company announced
disappointing trading results on 1 July 2008 and saw the value of its shares fall by nearly a quarter in one day (to
£2.40 having reached a peak of £7.66 in May 2007) although its profits after tax were an impressive £821 million
for the year to 29/3/08 (£660 million in the previous year).
2010: In May 2010 Marc Bolland replaced Stuart Rose as CEO. Stuart Rose remained as Chairman until a
successor, Robert Swanwell was appointed in January 2011. Marc Bolland is a NED at Manpower Inc and
Robert Swanwell serves as a NED at HMV Group plc.
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Extract from Marks and Spencer’s Annual Report 2011
M&S page 38
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M&S page 39
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M&S page 40
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M&S page 41
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M&S page 42
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M&S page 43
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M&S page 44
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M&S page 45
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M&S page 46
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M&S page 47
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M&S page 48
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M&S page 49
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ACCA PAPER P1 RESULTS

Question Maximum Score
Q1 25
Q2 25
Written Assessment 1
Date received: .........................................................................................
Date returned: ......................................................................................... Total 50

% Mark 100%
Marker's comments (completed by BPP Professional Education)

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ACCA P1 – Written Assessment 1

SEPT 15/AUG 16 EDITION
Marker's assessment
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Answering the question set
ACCA P1 GOVERNANCE, RISK
AND ETHICS
Achievement Ladder
Step 4 Questions
SEPT 15/AUG 16 EDITION 217

218 SEPT 15/AUG 16 EDITION
Governance, risk and ethics Achievement Step 4
Question 1
Question text
Sixstreams Water provides tap water and sewage services for about 10% of the population of the
European country in which it is based. Internationally it provides consultancy services to water
suppliers in developing countries. It is the monopoly supplier in the region in which it operates and
consequently is heavily regulated by the national government. It has been listed on a European stock
exchange for about 20 years. Perceived by investors as a low risk, low return investment its share
price and the volume of trading in its shares increased significantly following news that a water
supplier, TAP Water, based in East Asia was considering making a takeover offer for Sixstreams
Water.
On news of the takeover regional politicians voiced concerns about a business that was of such
importance to the region being controlled by a foreign company. However these concerns did not
prevent the takeover of Sixstreams by TAP Water going ahead some weeks later.
On acquiring Sixstreams Water, TAP Water have retained all the executive director s but have
replaced the non-executive directors with three new non-executives (NEDs) who are all executive
directors of the holding company TAP Water.
Required
(a) Explain the competing stakeholder claims of short-term shareholders, long-term investors and
customers of Sixstreams Water and recommend how conflicts between these claims should be
resolved. (12 marks)
(b) Briefly describe the role of non-executive directors and assess the decision to replace the NEDs
at Sixstreams. (5 marks)
(c) Compare and contrast the rules-based approach used to regulate Sixstreams Water’s operational
activities with the principles-based approach used for corporate governance of the company.
(8 marks)
(Total = 25 marks)

Question 2
Question text
Felicia Galka works as the risk manager for a large European listed company which operates public
transport (rail, bus and ferries) in and between several European countries. She recently attended an
international conference on risk management. Most of the conference delegates were risk managers
but found that they came from a wide range of backgrounds and that their roles differed widely from
one organisation to another.
Practically all the delegates attended the opening session on reputation risk, which was described as
the “risk of risks”.
Felecia also attended a session on probity risk and another on derivative risk. These had both been
recent issues for her employer as it had tendered bids to various governments awarding operating
licences for train and ferry routes and had been considering forward contracts to manage the risks of
fuel price increases.
While networking with other conference delegates the main focus of discussion was on the difficulty of
getting anybody else in their organisations to take risk seriously. A common them e was that the risk
managers were perceived as “Health and Safety Police”.
Required
(a) Define and explain the sources and impacts of the three common business risks discussed at the
conference seminars: reputation risk, probity risk and derivatives risk. (12 marks)
(b) Explain and assess the role of the risk manager in identifying and monitoring risk. (8 marks)
(c) Explain the importance of risk awareness at all levels in an organisation. (5 marks)
(Total = 25 marks)

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Student name: ........................................................................................
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Address: ..................................................................................................
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Postcode: ................................................................................................ Date sent: .........................................................................
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ACCA PROFESSIONAL LEVEL PAPER P1 RESULTS

Question Maximum Score
Q1 40
Q2 20
Written Assessment 2 Q3 20
Q4 20
Date received: .........................................................................................
Date returned: ......................................................................................... Total 80

% Mark 100%
Marker's comments (completed by BPP Professional Education)

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ACCA P1 – Written Assessment 2

Exam Identification Code ACP1CEQ(2A)13
AC13 – P1(2)
SEPT 15/AUG 16 EDITION
Marker's assessment
Ticks in the left-hand boxes indicate a good aspect of your performance. Relevant to How to
Tick in the right-hand boxes highlight areas you need to work on. question improve
(Note: Boxes may be left empty if the comments are not applicable to your script)
Approach Good Improvement

performance needed
Careful reading
Questions correctly interpreted
Review the definitions of
question words
Logical coherent answers Practise planning and full
written answers
Technical content
Understanding of principles Reading your Study Text
More question practice

Principles applied well to specific required
problems
Computation
Check your workings
High standard of accuracy
Layout your workings clearly

Workings are easy to follow
Label and cross reference
Appearance/Layout Neat handwriting

Use plenty of space
Text layout is clear and easy to follow Use headings and
subheadings
Use short paragraphs
Calculations are easy to follow Neat diagrams and tables

Workings labelled
Written style
Short concise sentences
Concise business style
Think before you write

Answering the question set
ACCA P1 GOVERNANCE, RISK
AND ETHICS
Achievement Ladder
Step 6 Questions

Governance, risk and ethics Achievement Step 6
Section A
Question 1 – this question is compulsory
Question text
Company details
Friar Holdings plc is a company based on the south coast of England specialising mainly in property
management, but with a large subsidiary, Renton Marine, specialising in boatbuilding. Friar Holdings
was floated on the Stock Exchange last year, and as a result its shareholding pattern changed,
although Chris Friar, its Chief Executive for the last ten years, still owns 22% of the issued share
capital. The Allied and Temple Merchant Bank owns 16% of the issued share capital and no other
shareholder owns more than 5%.
Board details
The board members of Friar Holdings are as follows:
• Chris Friar – Chief Executive
• Gordon Underwood – Finance Director
• Tim Heward – Operations Director
• Jane Heward – Sales Director
• Kim Majors – Marketing Director
• April Ralph – Non-Executive Director
• Lorna Wade – Non-Executive Director
• Tim Heward and Jane Heward are married, and April Ralph is engaged to be married to Chris
Friar.
April Ralph was previously Managing Director of Renton Marine until her resignation two years ago
when Renton Marine was acquired by Friar Holdings. Lorna Wade is Managing Director of Wade
Boats, a company that sells top-of-the range yachts and has been supplied by Renton Marine for a
number of years. Gordon Underwood is the only board member with significant financial experience
and a professional qualification.
Up until 18 months ago Gordon Underwood was the partner in charge of the audit of Friar Holdings
until he left the auditors and joined the board of Friar Holdings.
April Ralph and Lorna Wilde were appointed as non-executive directors when Friar Holdings obtained
a listing; the other directors have been directors for a number of years.
The only board committee is the audit committee chaired by Gordon Underwood, which also includes
April Ralph and Lorna Wilde. Friar Holdings’ small internal audit department reports to the audit
committee.
Friar Holdings is about to prepare its first accounts after having been floated.
The following issues were discussed at a recent board meeting.
Corporate governance disclosures
Gordon Underwood indicated that as a listed company, Friar Holdings would have to fulfil enhanced
legal and stock exchange disclosure requirements, including disclosing failures to fulfil corporate
governance disclosure requirements. Chris Friar commented that clearly the codes gave companies a

choice. Friar Holdings only needed to comply with the governance requirements that the board
thought were appropriate, and could list the disclosure requirements with which it had not complied.
Directors’ remuneration
Chris Friar said that his own salary would increase by 10%, and that he would speak separately with
each director, telling them what their salary would be for the following year. As well as basic salary
and bonuses (determined by Chris Friar on the basis of what he believes appropriate for each
director) directors also have pension contributions paid into a directors’ pension scheme. There is no
staff pension scheme in Friar Holdings. Chris Friar appraises all other directors using his own criteria
and his decisions on salary and bonuses are made on the basis of those appraisals.
Redevelopment of boat yard
Chris Friar proposed closing the Merman boatyard that was run by Renton Marine on the grounds that
it was earning insufficient return. As the boatyard was located on the banks of the River Humble,
Chris Friar proposed turning the site into luxury flats and a ‘leisure complex’. He commented that this
represented a major strategic opportunity for Friar Holdings. The shareholders would be happy with
the high expected return on investment and that many people would wish to buy luxury apartments
and use the leisure complex. Chris Friar commented that the development would also benefit the local
economy, providing jobs in the leisure complex and bringing more people into the area.
Shareholder concerns
At a recent board meeting of the Allied and Temple bank, concern was expressed about the attitudes
to corporate governance of the board of Friar Holdings, and the lack of communication that between
the board of Friar Holdings and the bank since the bank acquired its shareholding when Friar
Holdings was listed. The chairman of the bank also raised concerns about the proposed development,
since a leak to the local press had led to unfavourable publicity about the plan. The Allied and Temple
bank has marketed itself as ‘the ethical bank’ and thus is very wary of maintaining investments that
may be connected with unethical behaviour.
The bank’s board is also aware of criticisms made by other institutional shareholders about the level
of remuneration paid to the directors of Friar Holdings.
As a result of its discussions, the bank’s board gave Sir James Soames, a member of the board,
responsibility for liasing with the board of Friar Holdings and communicating the bank’s concerns.
Required
(a) Evaluate Friar Holdings’ current corporate governance arrangements and explain why they are
likely to be considered inadequate by the Allied and Temple bank and other major shareholders.
Your answer should not include discussion of remuneration issues or communication with
shareholders. (12 marks)
(b) Write a memo to Sir James Soames recommending improvements in Friar Holdings’
arrangements for determining remuneration and remuneration policies.
(10 marks) (Including 2 professional marks)
(c) Discuss how the Allied and Temple bank and other institutional shareholders can increase their
influence over Friar Holdings. (8 marks)
(d) Construct a case for the board of Friar Holdings taking into account additional stakeholder
interests to those currently being considered, when deciding whether and how to pursue the
proposed new development. (10 marks) (Including 2 professional marks)
(Total = 40 marks)

Section B – select TWO of the following questions only
Question 2
Question text
The board of Clover Bank Plc, a large national bank with a strong business and brand in it’s home
country are attending the monthly board meeting. One of the main items on the agenda is to approve
the acquisition of another big name financial institution in a neighbouring country. Frank Maul the
bank’s CEO puts forward his case for the acquisition emphasising that “As head of a strong banking
brand nationally, I believe Clover Bank could grow into a highly successful international organisation
and the current opportunity presents the perfect stepping stone to garner a foothold in the
international banking market”.
Errol Pink, one of the Non-Executive Directors of Clover Bank suggests that “if Clover are going to
adopt a strategy of growing a global presence then we need to check that our risk management
system is robust enough to cope with the increased risks this strategy brings”.
Required
(a) Distinguish between strategic and operational risks and identify and explain the main strategic
risks that Clover Bank may face as a result of the proposed acquisition. (10 marks)
(b) Assess how different board committees could contribute towards Clover Bank having robust risk
management. (6 marks)
(c) Define ‘probity risk’ and explain why it is important Clover Bank’s management consider this risk
when making competitive strategic decisions. (4 marks)
(Total = 20 marks)
Question 3
Question text
The chairman of a large financial services company, after discussion with the non-executive directors
and the Audit Committee, has become concerned that the company is taking too many risks in its
business operations.
The company has been very successful and has grown rapidly by being more innovative than its
competitors in designing and selling new products. These include investment and savings plans and
long-term loans to high-income individuals. This has been achieved in a decentralised environment by
rewarding product managers with substantial bonuses on current profits earned by products they
have designed and for which they are responsible. Sales executives have been rewarded by high
commissions on sales. The company has been successful in recruiting and retaining very able staff by
providing the highest rewards in the industry. Staff have the maximum freedom to maximise their
earnings.
Regulation of the industry has increased considerably, and is expected to increase further. There
have been no major problems with the regulatory authorities. However, following a series of minor
problems, some products have had to be withdrawn or modified and some sales staff have been
disciplined. The company has often been criticised by consumer organisations and journalists for its
treatment of customers, and its products appear poor value for money in comparative surveys.
The Chairman is proposing to introduce a company code of conduct with the aims of instilling ethical
values and helping the company appear in a better light in newspapers and surveys.

Required
As a consultant, prepare a report on this proposal for the Board. In your report:
(a) Explain, using examples of the statements found in ethical codes, the ways in which a code of
conduct can help to change organisational culture and encourage ethical behaviour. (7 marks)
(b) Advise the board on the steps that should be taken to enforce the code. (6 marks)
(c) Recommend any other changes, including possible control systems, that may be needed to
achieve the Chairman's aims. (7 marks)
(Total = 20 marks)
Question 4
Question text
'The Enron debacle is the latest reminder of the perniciousness of a business elite. Directors of Enron
made a huge amount of money from cooking the books and roasting the accounts. Non-executive
directors were the pals of directors, hired to put up the appearance of corporate accountability to
stakeholders, and collecting hefty fees for an odd day's work'. (Austin Mitchell MP, May 2002)
Required
(a) Explain the role of non-executive directors in the corporate governance of a listed company.
(7 marks)
(b) Discuss the potential problems associated with this role and suggest ways in which these may be
avoided. (8 marks)
Hammond Transport plc is shortly to seek a stock exchange listing and as a consequence is
improving its corporate governance. One step it is taking is setting up an audit committee. The
directors are currently interviewing potential non-executive directors and has been asking them their
views of what the responsibilities of non-executive directors and the audit committee should be.
Applicant 1 stated that she had read Austin Mitchell's views and fully agreed with them. In her opinion
non-executive directors were 'guardian angels' and as a result they should adopt an
uncompromisingly ethical approach to all their duties, particularly their work on the audit committee.
Applicant 2 stated that Austin Mitchell's views were good for quick quotes in the press. However 'in
the real world' away from politics, non-executive directors had to be primarily responsible for
promoting the company's interests – the job of directors was to direct the company towards
maximising its profits. The bigger the profits, the greater the benefits to more people. The financial
and opportunity costs of setting up the audit committee were only worthwhile if it could demonstrate its
recommendations had produced clear benefits.
Required
(c) Analyse the applicants' views on the responsibilities of the audit committee using the
deontological and utilitarian views of ethics. (5 marks)
(Total = 20 marks)

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Governance, Risk and Ethics

Achievement Ladder Step 1 37

3 Corporate governance practice and reporting......................................................................... 39

Achievement Ladder Step 2 55

4 Internal control systems........................................................................................................... 57

Achievement Ladder Step 3 81

7 Risk assessment and response............................................................................................... 83

Achievement Ladder Step 4 103

9 Personal ethics ...................................................................................................................... 105

Achievement Ladder Step 5 115

10 Professional ethics ................................................................................................................ 117

Achievement Ladder Step 6 143

12 Answers to Lecture Examples............................................................................................... 145

Welcome to P1 Governance, Risk and Ethics

Introduction to Paper P1 Governance, Risk and Ethics

Overall aim of the syllabus

A Governance and responsibility

Online ethics Governance, Risk Audit &

Taught Phase Aims

Achieving ACCA's Study Guide Outcomes

A Governance and responsibility

A1 The scope of governance Chapter 1

B Internal control and review

B1 Management control systems in corporate governance Chapter 4

C Identifying and assessing risk

C1 Risk and the risk management process Chapters 4, 5, 7 & 8

D Controlling and managing risk

D1 Targeting and monitoring risk Chapter 8

E Professional values, ethics and social responsibility

E1 Ethical theories Chapter 9

Assessment methods and format of the exam

Format of the Exam Marks

Section reference in the Study Text

Key skills required to pass

Skill 1 – Effective use of reading time

Skill 2 – Accurate analysis of a question's requirements

B C Skill 3 – Planning a well structured answer

Skill 4 – Communication and presentation skills

Skill 5 – Time management

How have the syllabus learning outcomes been examined?

Scope of corporate governance

Theories Stakeholder Models

1 Definition of corporate governance

Lecture example 1 Exam skills

Qualities that ensure the Qualities that ensure honest

1.6 Definitions of each of these:

Integrity: Straightforward dealing and completeness; high moral character; honesty

2 Corporate governance and agency theory

PRINCIPAL appoints AGENT

The agency problem

Lecture example 2 Exam standard question

The agency solution

Lecture example 3 Exam standard question

3 Transaction cost theory

4 Stakeholders in corporate governance

4.2 Stakeholders can be classified by their proximity to the organisation.

Stakeholder group Members

Minimal Effort Keep Informed

Keep Satisfied Key Players

4.4 Another way of viewing stakeholders is as follows:

Stakeholder group Members

Lecture example 4 Classroom discussion

Problems with stakeholder theory