P1 Course 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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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
3
37
Corporate governance practice and reporting......................................................................... 39

4
5
6
55
Internal control systems........................................................................................................... 57

Risk attitudes and internal environment .................................................................................. 63
Risks........................................................................................................................................ 73

7
8
81
Risk assessment and response............................................................................................... 83

Information, communication and monitoring ........................................................................... 93

9
103
Personal ethics ...................................................................................................................... 105
115
10 Professional ethics ................................................................................................................ 117

11 Corporate social responsibility............................................................................................... 129
12
13
14
15
16
143
Answers to Lecture Examples............................................................................................... 145

Question and Answer bank ................................................................................................... 161
Appendix A: Pilot paper questions and answers ................................................................... 189
Appendix B: Information about M&S (Day 2 lecture examples) ............................................ 199
Written Assessment Questions ............................................................................................. 215
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
BPPs 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.
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
B
C
D
E
Governance and responsibility

Internal control and review
Identifying and assessing risk
Controlling risk
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 accountants 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
Online ethics
module
Professional
Papers
Governance, Risk
and Ethics (P1)
Audit &
Assurance (F8)
Accountant in
Business (F1)
This diagram shows where direct (solid line arrows) and indirect (dashed line arrows) links exist
between this paper and other papers that may precede or follow it.
The Governance, Risk and Ethics syllabus assumes some of the knowledge acquired in papers F1
Accountant in Business but develops and applies this further and in greater depth. There is also
the presumption that students will have completed the online ethics module. The ACCA consider
Paper P1 Governance, Risk and Ethics to be the gateway paper to Professional level studies, as it
provides valuable information for all other papers.
5
INTRODUCTION
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

B
Chapter 2
Internal control and review
B1 Management control systems in corporate governance

B2 Internal control, audit and compliance in corporate governance
B3 Internal control and reporting
Chapter 8
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

D
Chapters 7, 8 & 10
Chapters 4 & 8
B4 Management information in audit and internal control

C
Chapter 4
Chapters 4, 5, 6, 7 & 8
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
INTRODUCTION
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

E6 Ethical characteristics of professionalism
E7 Integrated reporting and sustainability issues in the conduct of
business
Chapter 10
Chapters 9 & 10
Chapter 11
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 subdivided 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

attempted
2 25
Each question will have its own small scenario; therefore all answers
must apply knowledge in context. Each question will be sub-divided
into several requirements; there are usually at least three
requirements in each question.
Questions will be drawn from any part of the syllabus, but each one
is likely to focus on one or two specific areas in detail.
100
INTRODUCTION
Key to icons
The following icons appear in this set of study notes
Real-life examples
For further details see your Checkpoint Guidance
Section reference in the Study Text

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

Our analysis of the examiners 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
2 Accurate analysis of
presentation skills
a questions
requirements
3 Planning a
well structured
answer
A
B
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.
A
B
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.
12
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

corporate governance
December 2012 Q2a (10 marks) explaining the meaning

of governance and how it helps avoid corporate failure
Analyse the purposes and objectives of June 2013 Q4a (7 marks) discussing the general
purposes of governance codes for listed companies
Explain, and apply in the context of
corporate governance, the key
underpinning concepts.
Accountability December 2014 part of Q1dii (6 marks)

Judgement and reputation June 2014, explanations as
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

by, the development of the joint stock
company as the dominant form of
business organisation and the
separation of ownership and control
over business activity
June 2012 Q1d (18 marks) applying Mendelow to

consider how owners are influenced by a key
stakeholders
Define and explore agency theory
December 2013 definition, part of Q2b (10 marks)
December 2007 Q1a (10 marks) on how transparency

affects reporting within governance
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
influence of institutional investors in
governance (pension funds, insurance
companies and mutual funds)
December 2014 Q3c (6 marks) explaining conflict of

interest when a potential director owns shares in a
supplier
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
Definition of corporate governance
1.1
Corporate governance can be defined as: a set of relationships between a companys

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

best decisions are made.
Qualities that ensure honest

and transparent disclosures
Integrity
Fairness
Judgement
Independence
Scepticism
Reputation
16
Transparency
Probity
Responsibility
Accountability
Innovation

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 organisations 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 peoples perceptions or expectations: a valuable asset of any organisation.
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
appoints
PRINCIPAL
AGENT
(directors/ managers/
employees)
(shareholder)
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:
2.8
(a)
Verify what the board is doing, partly because the board has access to more
information about its activities than the principal does; and
(b)
Introduce mechanisms to control the activities of the board, without preventing it from
functioning effectively.
Any steps taken by shareholders are likely to incur agency costs.

18
Lecture example 3
Required
Suggest some ways in which shareholders can monitor and control a board of directors.
Solution
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)
(b)
(c)
Reduce uncertainties about dealing with suppliers,

Avoid high purchase prices, and
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)
(b)
(c)
The amounts that they personally will gain,

The probability of bad behaviour being discovered, and
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.
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.

Members
Internal
Connected
External
Employees, management, the board

Shareholders, customers, suppliers, lenders
The government, local government, the public,
pressure groups, the media, competition, trade unions
Mendelow classifies stakeholders on a matrix [below] whose axes are power held and
likelihood of showing an interest in the organisations activities. These factors will help
define the type of relationship the organisation should seek with its stakeholders, and how it
should view their concerns.
Level of interest
Low
High
Low
Minimal Effort
Keep Informed
Keep Satisfied
Key Players
Power
4.3
Stakeholder group
High
20

4.4
Another way of viewing stakeholders is as follows:

Stakeholder group
Members
Active
Those who seek to participate in the organisations activities.

This includes managers and some shareholders, but may
also include other groups such as regulators and pressure
groups.
Those who do not seek to participate in policy-making, such
as most shareholders, local communities and government.
Passive
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.
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
duties of
directors
Compulsory
voluntary
best practice
Directors
remuneration
and reward
Corporate social
responsibility
MAJOR
ISSUES
Board
composition
and balance
Business
ethics
Rights and
responsibilities
of shareholders
Risk management
and internal
control
22
Reliability
of financial
reporting
Chapter summary
Section Topic
Summary
Corporate Governance is concerned with the structures,

processes and relationships that are fundamental to the
company's objectives.
Definitions and
fundamental
principles
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 selfinterest 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.
Transaction cost
theory
Transaction Cost Theory extends agency theory to managers

and employees.
Stakeholders
Stakeholders are any group that affects or is affected by the

company.
Stakeholder claims are what the stakeholder wants.
Mendelows grid is used to assess suitable responses:
ignore, inform, satisfy or key player.
Attitudes to stakeholders can be described as normative or
instrumental.
Issues in
corporate
governance
Major issues have arisen out of corporate scandals. Try and

keep an eye on emerging issues by reviewing quality
newspapers or news websites.
23
END OF CHAPTER
24
Approaches to corporate
governance
Describe and compare the essentials

of rules and principles-based
approaches to corporate governance
December 2013 Q2a (7 marks) and December 2011

Q2a (12 marks) distinguish between rules and principles
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

reasons behind the development and
use of codes of practice in corporate
governance (acknowledging national
differences and convergence)
June 2013 Q4a (7 marks) definition and purposes of a

code of corporate governance
Discuss and critically assess the

concept of stakeholders and
stakeholding in organisations and how
this can affect strategy and corporate
governance
December 2014 Q1a (7 marks) conflicting stakeholder

claims
December 2007 Q3c (8 marks) national variation of

codes
December 2012 Q4b (8 marks) importance of identifying

stakeholders when making strategic decisions
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 SarbanesOxley Act (2002) as an example of a

rules-based approach to corporate
governance
June 2014 Q4c (9 marks) compulsory reporting of

internal controls like s.404 to prevent failure
Define and distinguish between

mandatory and voluntary disclosure
June 2014 Q2c (9 marks) usefulness of voluntary and

mandatory reporting disclosures to a personal investor
Distinguish between unitary and twotier boards structures
June 2012 Q4c (7 marks) distinguishing between both

and discussing difficulties of implementing
December 2013 Q2c (8 marks) exempting small

companies from full s.404 reporting
Describe, compare and contrast various December 2014 Q2 (10+9+6 marks) considering public
public, private, charity and NGOs
sector governance in a failing school
Evaluate governance and the role of
politics in public sector organisations
vs private companies
June 2011 Q3a (9 marks) differences between charities

and listed companies, including governance
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
Code
US Sarbanes-Oxley Act
Public sector governance
26
Principles or rules?
1.1
The big debate about corporate governance globally is whether the guidance should in the
form of principles or detailed rules and regulations.
Features
Benefits
Rules-based approach
Sets out broad principles (eg 'The

Board should be effective')
supported by guidance.
Organisations are required to

comply with a detailed and rigid
code.
Works on a comply or explain

basis, with any departure from the
specific provisions of codes
requiring an explanation
Non-compliance cannot be
justified. A company has either
succeeded or failed in complying.
Allows investors to decide if they

agree that departure from the code
is appropriate
Investors tend to rely on a third

party (eg SEC) to penalise the
company for non-compliance.
Allows for greater flexibility and

potential cost savings
Easier compliance with the rules,

as they are unambiguous, and can
be evidenced
Applies across different legal

jurisdictions, which makes the
governance of a multi-national
business more effective
Provides a consistent minimum

standard of governance for
investors confidence
Forces both boards and

shareholders to think about the
consequence of governance
arrangements
Disadvantages
The principles are so broad that

they are of very little use as a
guide to best corporate
governance practice.
Investors cannot be confident of
consistency in approach
Allows no leeway or deviation,

irrespective of how illogical the
situation is.
Enforcement can be difficult for
situations that are not covered
explicitly in the rules.
Incorrectly viewed as voluntary

Where you find
them
Favoured in legal jurisdictions

where the governing bodies of
stock markets have had the prime
role in setting standards for
companies to follow.
Favoured in legal jurisdictions (and

cultures) that lay great emphasis
on obeying the letter of the law
rather than the spirit of it.
Examples
UK Corporate Governance Code

2010
USA Sarbanes-Oxley Act 2002

(SOx)
27
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 companys founding families, banks, other companies
or the government.
2.3
The reason for the concentration of share ownership is the legal system.
Advantages
Disadvantages
It is easier to establish ties between owners

and managers; therefore the agency
problem is reduced.
There may be discrimination against

minority shareholders.
It is easier to influence management, policy

and strategy through dialogue.
Insider systems tend not to develop more

formal governance structures until they are
forced to.
A smaller base of shareholders may be

more willing to take a long-term strategic
view of their investment.
May be reluctant to employ outsiders in

influential positions and recruit independent
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

management has provided an impetus for
the development of more robust legal and
governance regimes to protect
shareholders.
Companies are more likely to have an

agency problem and significant agency
costs.
Shareholders have voting rights that they

can use to exercise control.
The larger shareholders in these regimes

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
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
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
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
Lecture example 2
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
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

requirement to ensure their internal controls
are properly documented and tested
Around 1,500 non-US companies list their

shares in the US. They are covered by the
provisions of SOx
For accountancy firms, SOx has formally

stripped them of almost all non-audit
revenue streams that they used to derive
from their audit clients
The US being such a significant influence

worldwide, SOx is likely to persuade other
countries to adopt a rules-based approach
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 lawyerclient privilege.
(c)
A SOx compliance industry has sprung up.
(d)
Companies are turning away from the US stock markets and towards other markets.
33
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:
Purposes and
objectives
Private sector
Public sector
Charitable
Profit
Public goods or
services not
delivered by the
private sector
Meeting a need not provided by either

public or private sectors (the so-called
'third sector') such as health, relief,
education and support
Market
(what are they for?)
Performance
(how is success
measured?)
Ownership
(who owns them?)
Stakeholders
(including lobby
groups)
(who also holds an
interest in them?)
NGO/QuANGO*
Value for money

Agency-driven,
but usually profit (3 Es)
and market share Meeting social
needs
Value for money

(3 Es)
Partners,
shareholders and
lenders
Taxpayer
Independent
(with some
philanthropic
influence)
Lobby groups
may influence
government
policy to support
their own aims
(both for and
against)
Population (local
and national)
Trustees
Taxpayers may
lobby for better
use of their taxes
Pressure groups to stop action that

may have initially led to the creation
of the charity/NGO
Meeting own
needs
More tailored
results than
charities or the
public sector
could deliver
Can be state or
government
owned
Population (local and national)
* 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:
Strategic
objectives
Private sector
Public sector
Profit and/or market share
Achievement of State-defined
service delivery to meet social need
Anything else in their incorporation

documents
Securing value for money with

taxpayers funds
Leadership
Board of directors (influenced by

shareholders)
Delegated authority from State

(based on principles of public life)
Governance
Principles or rules-based in order to

satisfy shareholders
Reporting to an oversight body

(such as a board of governors)
External audit (for entities above

certain thresholds)
External audit and political (as well

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
Chapter summary
Section Topic
Summary
Principles based practice outlines core principles to ensure

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.
Principles or
rules
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.
Corporate
governance in
the UK
The UK Corporate Governance Code covers directors,

remuneration, accounting and controls, auditors and
institutional investors. It is supported by guidance (such as the
Turnbull Report).
Corporate Governance emerged as an issue in the early
1990s following corporate failures such as Polly Peck and
Mirror Group (unfettered power of dominant directors) and later
Barings Bank (poor internal controls).
Corporate
governance in
other
jurisdictions
The South African King Report was published after the collapse
of apartheid. It emphasises fairness to all groups in society and
economic wellbeing.
The Sarbanes
Oxley Act
The Sarbanes Oxley Act (SOx) is the US rules based code

enacted after the collapse of Enron and WorldCom which
affects all companies listed on US stock exchanges and their
subsidiaries.
The OECD (governments) and ICGN (investors) both issue

guidance which is useful where no local code is available.
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
governance
Public and private sector entities, plus charities and NGOs, all
have different goals so their governance must reflect that.
END OF CHAPTER
36
You have now covered the Topic that will be assessed in Step 1 of your Achievement Ladder.
It is vital in terms of your progress towards exam readiness that you attempt this Step in the near future.
You will receive feedback on your performance, and you can use the wide range of online resources and
ongoing BPP support to help address any improvement areas. This will help you to tailor your learning
exactly to your own individual requirements.
Course notes
chapter
Topic name
Subtopic/Chapter name
Scope of corporate
governance
governance
Approaches to corporate governance
37
Achievement Ladder
38
Corporate governance
practice and reporting
Explain and evaluate the roles

and responsibilities of boards of
directors, including differences
between CEO and chairman and
training and appraisal of all
directors (including NEDs)
December 2014 Q3a (10 marks) suitability for taking CEO role
December 2014 Q4c (6 marks) and June 2012 Q4b (8 marks)
on the advantages of CPD and induction for directors
December 2011 Q2b (8 marks) separate Chair/CEO
June 2011 Q1di (8 marks) CEO role managing risks
June 2009 Q1e (10 marks) criticism of CEO on I/Cs
Describe and analyse the

general principles of the legal
frameworks within which
directors operate on boards
December 2013 Q4a (3+5 marks) how directors can leave the
service of a board (theory and practice)
Explain and evaluate the role

and purpose of the main board
committees in effective
December 2013 Q3a (8 marks) and June 2008 Q3b (8 marks)

on nomination committees
Explain and assess the effect of

various components of
remuneration packages on
directors behaviour
June 2013 Q4b (8 marks) constructing a package that retains

directors but encourages growth
June 2008 Q3c (5 marks) on retirement by rotation
June 2010 Q2a (10 marks) criticising a remuneration

committee
December 2011 Q3a (10 marks) purpose and factors

influencing the reward package of a CEO
Explain and assess the general

principles of disclosure and
communication with
shareholders
June 2011 Q1d (8+6 marks) CEO defending position
Describe and assess the

purposes, roles and
responsibilities of Non-Exec
Directors
December 2014 Q3b (9 marks) benefits of suitable NEDs and

difficulties encountered during recruitment
June 2013 Q4c (10 marks) on roles of NEDs plus discussion of
elements of their remuneration
December 2010 Q3a&b (8+7 marks) NED issues
December 2013 Q1c (10 marks) on labour market conditions
relative to high rewards for a new CEO
Explain legal, ethical,

competitive and regulatory
issues of directors remuneration
Explain diversity and evaluate
issues relating to diversity on
boards of directors
June 2008 Q3a&B (4+5 marks) on Chairmans lack of action

and communication with shareholders
December 2013 Q3b (8 marks) explaining the advantages of

diversity (in line with article content)
39
3: CORPORATE GOVERNANCE PRACTICE AND REPORTING
Overview
Boards of directors
Board effectiveness
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
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 companys 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 companys strategic aims, ensure that the necessary financial and
human resources are in place for the company to meet its objectives and review
management performance.
Effectiveness of boards
2.1
To remain effective, directors should extend their knowledge and skills continuously.
2.2
Significant issues that professional development should cover on a regular basis include:
Strategic
planning
Audit
practice and
procedures
Legal and
regulatory
issues
Financial
management
TRAINING AND
DEVELOPMENT
Human
resource
issues
Risk
management
2.3
Corporate
governance
An appraisal of the board's performance is an important control over it, aimed at improving
board effectiveness, maximising strengths and tackling weaknesses. It should be seen as
an essential part of the feedback process within the company and may prompt the board to
change its methods and/or objectives.
41
2.4
All directors should be individually appraised; criteria that could be applied include:
Continuous
professional
development
Independent
and
innovative
thinking
Familiarity
with business
and industry
information
APPRAISAL
CRITERIA
Active
participation
in all
business
Contribution
towards
business
development
Positive and
enthusiastic
committee
work
Lecture example 1
(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
Board membership and roles
3.1
Key issues for consideration for board membership are:
3.2
(a)
Size the balance needs to be struck between the benefits of having varied views
and opinions, alongside the need for coherence of decision-making.
(b)
Inside/outside mix the split between executive decision-making directors and nonexecutive directors. Independent non-executive directors have a key role in
governance. Their number and status should mean that their views carry significant
weight.
(c)
Diversity mix in terms of gender, ethnicity, backgrounds, experience, etc.
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
the board
Responsibilities of the chief executive

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
timely information
Providing accurate and timely information
Ensuring effective communication with

shareholders and that their views are
communicated to the board as a whole.
Communicating effectively with significant

stakeholders
Facilitate effective contribution from NEDS,

ensure constructive relations between
execs and NEDs
Facilitate the effective implementation of

board decisions.
Take the lead in providing an induction

programme for new directors and in board
development
Cooperate in induction and development.
Meet with the NEDs without the executives

present
Cooperate by providing any necessary

resources.
Facilitating board appraisal
Cooperate in board appraisal.
Encouraging active engagement by all the

members of the board
Cooperate with all the members of the

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 examiners 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

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

for overseeing risk
management. (See chapter 5)
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:
4.4
(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.
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.
Lecture example 3
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
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

responsibility for management of the
company and strategic performance
A NED or independent director cannot be

expected to both manage and monitor
A single board promotes easier cooperation and co-ordination
The time requirements on non-executive

directors may be onerous
The presence of NEDs should lead to

better decisions being made
There is no specific provision for

employees to be represented on the
management board
Independent NEDs are less likely to be

excluded from decision-making and given
restricted access to information
Emphasises the divide between the

shareholders and the directors
5.2
In some countries (eg Germany) the board is split into multi-tiers, separating the executive
from other directors (and senior management). This structure is also common in not-forprofit organisations.
5.3
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.
Lecture example 4
Required
Evaluate the case for and against operating a two-tier board structure.
Solution
For
48
(8 marks)
Against
Directors' remuneration
6.1
The purpose of directors remuneration is to be sufficient to:
6.2
(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.
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
Lecture example 5
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.
Governance disclosures
7.1
Annual reports should disclose whether the organisation has complied with governance
regulations and codes.
7.2
Governance disclosures should include:

Information
about the
board of
directors
Environmental
reporting
A statement that
the company is a
going concern
GOVERNANCE
DISCLOSURES
A statement on
relations and
dialogue with
shareholders
An operating
and financial
review (OFR)
Reports from the

Remuneration,
Audit & Nomination
committees
Details of relations
with auditors
including reasons
for change
A statement that the
directors have
reviewed the
effectiveness of
internal controls
51
Lecture example 6
Suggest some key elements to be included in:
'Information about the board of directors.'
'A statement on relations and dialogue with shareholders.'
Solution
'Information about the board of directors.'
'A statement on relations and dialogue with shareholders.'
52
Chapter summary
Section Topic
Summary
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.
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.
Board membership and

roles
The board should be balanced. The Chairman of the

board runs the board and the CEO who should be a
different person runs the company.
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).
Unitary and multi-tier

boards
A single board can speed up decision making and

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.
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 directors interests to the
objectives of the company. They can relate to KPIs.
Governance disclosures
53
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).
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
Topic name
Scope of corporate
governance
governance
Corporate governance practice and

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
objectives of internal control and risk
management in corporate governance
June 2012 Q1c (12 marks) purposes and

challenges of internal control.
Identify and assess the importance of elements

or components of internal control systems
December 2014 Q4b (9 marks) on why internal

controls can never be guaranteed to be
effective despite their cost
December 2008 Q3a&b (5+5+10 marks) define

control objectives and then consider broader
organisational factors and control arrangements
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

article distinguishing between types of risk and
how a situation is strategic [ie board level]
Describe and evaluate a framework for board

level consideration of risk
December 2012 Q1d ii) (9 marks) part of an

article covering board responsibilities for
internal control
Explain and assess how internal controls

underpin and provide information for accurate
financial reporting
June 2013 Q2c (6 marks) how effective internal

controls can provide assurance on the integrity
of financial reporting
57
4: INTERNAL CONTROL SYSTEMS
Overview
Frameworks
Objectives
Elements
58
Internal control frameworks
1.1
Definition: Internal control is a process affected by an entitys 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 UKs 2010 Corporate Governance Code. Principle C2 of the
Code is that 'The Board should maintain sound risk management and internal control
systems'.
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 companys system of internal control has a key role in the management of risks that
are significant to the fulfilment of its business objectives.
Since profits are in part the reward for successful risk taking, the purpose of internal
controls is to manage and control risk appropriately rather than to eliminate it.
Effectiveness and efficiency of operations.
Ensure the reliability of internal and external reporting.
Assist compliance with laws and regulations.
Safeguard the shareholders investment and the companys assets.
2.2
More practically, internal controls should help organisations to counter risk, maintain the
quality of financial reporting and ensure compliance.
2.3
They provide reasonable assurance that organisations will achieve their objectives.
59
Lecture example 1
Class discussion
Appendix B gives some background information about the UK high street retailer Marks and
Spencer (M&S).
Required
Evaluate the importance of effective internal controls to different stakeholder groups for a large
retail organisation such as M&S.
Solution
60
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.
nc
Control Environment
Risk Assessment
Control Activities
Entity Level
Division
Operation Unit
Function
Co
pl
ia
tin
or
er
Op
Re
p
ns
io
at
While the COSO cube is unlikely to be examined in detail, it does provide a framework for
identifying and managing risk.
Information & Communication

Monitoring Activities
3.3
ERM should help organisations in the following way:

1.
2.
3.
4.
5.
6.
Alignment of risk appetite and strategy

Enhance risk response decisions
Reduce operational surprises and losses
Identify and manage multiple and cross-enterprise risks
Seize business opportunities
Improve the deployment of capital
61
Chapter summary
Section Topic
Summary
Internal control frameworks cover the control

environment and control procedures.
Internal control
frameworks
Two key frameworks are COSO a US framework

and the Turnbull Guidance which supports the UKs
Corporate Governance Code.
nc
e
ia
m
pl
Op
Control Environment
Risk Assessment
Control Activities
Entity Level
Division
Operation Unit
Function
ns
tio
a
er
Elements of internal
control / enterprise risk
management
Co
The five main purposes of internal control systems

are to help a company: achieve objectives efficiently
and effectively; respond to risk; ensure the quality of
reporting; ensure compliance; and safeguard
assets.
tin
Objectives of internal
controls
or
Re
p

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

stakeholders involved in business risk
December 2012 Q4b (8 marks) on the

importance of recognising all stakeholders as
part of decisions
June 2011 Q2d (6 marks) there should be a
culture of risks awareness at all levels
June 2013 Q3c (6 marks) on how risk
management can be embedded in a bank
December 2010 (15 marks) importance and
methods of embedding risk awareness,
together with obstacles to embedding risk
awareness
December 2009 Q4a&b (6+8 marks) describe
and assess ability to implement December 2007
Q2b (5 marks) getting risk awareness
embedded in company culture
June 2012 Q1a (6 marks) explanation and
demonstration of risk appetite
December 2007 Q2c (12 marks) on why some
risks cannot be avoided, they will just need to
be managed
June 2014 Q2a (part of 8 marks) explaining
impact on a personal investor
December 2011 Q1c (8 marks) including
differences as part of a broader statement on
internal control failures from the CEO
June 2011 Q2a (part of 8 marks) on why risks
are dynamic and need to be assessed regularly
Explain the importance of risk awareness at all

levels in an organisation
Describe and analyse the concept of
embedding risk in an organisations systems
and procedures
Describe and evaluate the concept of

embedding risk in an organisations culture and
values
Explain and evaluate the different attitudes
towards risk and how these can affect strategy
Explain and assess the necessity of incurring
risk as part of competitively managing a
business organisation
Explain risk appetite and how this affects risk
policy
Evaluate the difficulties of risk perception
including the concepts of objective and
subjective risk perception
Explain the dynamic nature of risk assessment
63
5: RISK ATTITUDES AND INTERNAL ENVIRONMENT
Overview
Risk Attitudes and internal
environment
Control environment
Risk Appetite
Sound System
Stakeholder Attitude
Embedding risk awareness
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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)
(b)
(c)
(d)
(e)
1.4
Corporate culture or tone of the organisation

Management style including risk management philosophy
Organisational structure
Risk appetite
Integrity and ethical values
Turnbull considers the following when reviewing the control environment:

(a)
(b)
(c)
(d)
(e)
Senior management commitment

Clear strategy
Strong business culture
Clear definition of authority, responsibility and accountability
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.
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
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.
Lecture example 1
Class discussion
Required
Suggest some reasons why organisations face risks on a daily basis.
Consider why organisations might seek to increase the risk they face.
Solution
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 companys
strategy. These groups are:
(a)
(b)
(c)
(d)
(e)
Shareholders
Debt providers
Employees
Customers
Government, regulatory and other bodies.
66
Lecture example 2
Class discussion
Appendix B gives some background information about M&S. Different stakeholder groups can
affect or be affected by the risk management strategy at M&S.
Required
For each stakeholder group evaluate their attitude towards risk-taking by the company.
Solution
Shareholders
Debt providers
Employees
Customers
Government, regulatory and other bodies
67
'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 companys board of a risk based
approach to establishing a sound system of internal control'.
Embedding risk
6.1
Risk should be embedded in the companys:

(a)
(b)
Systems and procedures;

Culture and values.
Lecture example 3
Required
Recommend practical ways in which risk awareness can be embedded in an organisation at
different levels.
Solution
68
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.
69
Lecture example 5
Exam style question
Required
Identify some tasks which a risk committee should fulfil.
Solution
70
Chapter summary
Section Topic
Summary
Control environment
COSO and Turnbull both identify culture and

management as contributing to the control environment.
Objective setting
Objectives for an organisation should support an

organisation's mission and should be consistent with its
risk appetite.
Risk appetite
Risk appetite is a measure of the companys capacity to

accept risk and depends on attitudes to risk and the risks
already accepted by the company.
Stakeholder
Responses to risk
The stakeholder groups who might affect corporate

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.
Sound systems of
internal control
Per Turnbull sound controls are embedded, cultural,

and responsive to risks and weaknesses.
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.
Risk management
responsibilities
Risk management must be 'owned' for it to be effective.
71
END OF CHAPTER
72
Risks

Define and compare (distinguish between)

strategic and operational risks
June 2013 Q1c (part of 10 marks) on how

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

common business risks, including industry or
sector specific risks
Exchange rate risk, supply risk and international

political risk December 2014 Q1c (9 marks)
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

importance of business and financial risks
December 2011 Q3 (10 marks) understanding

the nature of market risk and how it can best be
managed
Explain and evaluate the concepts of related

and correlated risk factors
June 2013 Q1a (part of 10 marks) requiring a

brief explanation of correlation between legal
and reputation risk
73
6: RISKS
Overview
Risks
Part of COSO
Categorising Risk
Events
Scope
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6: RISKS

Event identification
1.1
The diagram above illustrates how risk identification fits into the COSO ERM framework.
1.2
Risk identification is a continuous (iterative) process.
1.3
Risks once identified can be included within the firms risk register and kept under review.
Risk events
2.1
A key aspect of risk identification emphasised in the COSO ERM Framework is the
identification of events that could impact upon implementation of strategy or achievement of
a firms objectives.
2.2
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
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.
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.
Lecture example 1
Class discussion
Required
Give an example of each of the following 'strategic' risk categories:
Solution
Technology
Product
Resources
Competition
Investment
Reputation
4.3
The main differences between strategic and operational risks relate to:
(a)
(b)
(c)
(d)
Scope of impact
Source of risk
Duration of impact
Scale of financial and resource consequences
76
6: RISKS
4.4
Operational risk is the risk of loss from a failure of internal business and control processes
and will affect day to day operations.
4.5
Operational risk includes losses arising from:

(a)
(b)
(c)
(d)
(e)
(f)
Internal control
Audit inadequacies
Human errors
Fraud
Business interruption
Loss of key personnel
Classification of risk
5.1
There are many different types of risks faced by organisations, particularly those with
commercial or international activities.
Lecture example 2
Exam style question
Required
Explain the following types of risk using an example if appropriate.
Solution
Market risk
Credit risk
Liquidity risk
Legal risk
Health, safety and environmental risk
Reputation risk
Business probity risk
Derivatives risk
77
6: RISKS
Physical
Financial
Product
Legal
Political
Property (inc
intellectual)
RISK
CLASSIFICATION
Economic
Environmental
Fraud
Technological
Organisational
Knowledge
management
Reputation
Trade (inc
FOREX)
78
6: RISKS
Chapter summary
Section Topic
Summary
Event identification
Risk identification is an element of the COSO Enterprise

Risk Management (ERM) cube and is a continuous
process.
Risk events
Risk can arise from internal or external events. Trends,

interdependencies and escalation triggers can give insight
into potential risks.
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.
Strategic and
operational risks
Strategic risks arise from fundamental long term

decisions. Operational risks are what can go wrong on a
day-to-day basis.
Classification of risk
Common risks faced by businesses include:
79
Market
Credit
Liquidity
Technological
Legal
Health, safety and environmental
Reputation
Business probity
Derivatives
6: RISKS
END OF CHAPTER
80
topics.
Course notes
chapter
Topic name
Scope of corporate
governance
governance

reporting
Internal control and risk

attitudes
Risk attitudes and internal environment
Risks
Risks
81
Achievement Ladder
82
Risk assessment and

response

Explore and evaluate the effectiveness of

internal control systems
December 2009 Q1b (12 marks) and June 2009 Q1b

(10 marks) on internal control failures
December 2007 Q1d (6 marks) why robust internal
controls are important
Explain and analyse the concepts of

assessing the severity and probability of
risk events
Explain and analyse the concepts of
spreading and diversifying risk and when
this would be appropriate
Explain and assess the importance of risk
transference, avoidance, reduction and
acceptance
June 2011 Q2 (25 marks) both risks and controls

December 2008 Q2b (10 marks) and June 2008
Q1b&c (6+9 marks) on risk assessment using TARA
December 2012 Q1b (10 marks) explaining the term
'risk diversification' and why it would be very difficult
to attempt in practice
December 2007 Q2a (12 marks) on using the TARA
model
Explain and assess the ALARP principle in December 2011 Q1civ explaining why ALARP means
risk assessment and how this relates to
further health and safety failures cannot be prevented
severity and probability
December 2007 Q2c (12 marks) on CEO rewards
Explain the sources, and assess the
importance of, accurate information for
risk management
December 2013 Q1b (10 marks) assessing four risks

and explaining why subjective judgement may limit
the accuracy of risk assessment
Explain the importance and nature of

management responses to changing risk
assessments
June 2013 Q3a (8 marks) explain risk assessment

and discuss its need to be continuous and ongoing
Identify and assess how business

organisations use policies and techniques
to mitigate various types of business and
financial risks
June 2013 Q3c (part of 10 marks) on how financial

risks can be managed by a bank
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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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)
(b)
(c)
Who should do it?

How it should be done?
How often it should be done?
85
Lecture example 1
Class discussion
Required
Identify some ideas to answer the questions identified above.
Solution
(a)
Who?
(b)
How?
(c)
How often?
Risk profiling
2.1
Having assessed the risk it can be mapped onto a grid of impact and likelihood
Likelihood
High
Low
Low
High
Impact
2.2
The risk tolerance boundary reflects the companys 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.
Risk quantification
3.1
Risks that require more analysis will be quantified, where possible results and losses are
considered.
3.2
Techniques for carrying out risk quantification include sensitivity analysis and accounting
ratios. Although unlikely to be directly tested in the exam understanding the quantifiable
effect on business is key to scoring good marks.
Lecture example 2
Class discussion
Calcit is a company hoping to launch a new product. The initial investment of $6m will generate
revenues of $5m in each of the next two years. The variable costs are expected to be $1.5m per
annum in the next two years. Calcits cost of capital is 8%.
Required
Assess whether the project is more sensitive to the risks associated with variable costs or price.
Solution
87
Risk consolidation
4.1
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 companys objectives and with its risk appetite.
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
ACCEPT
TRANSFER
REDUCE
AVOID
Low
Likelihood
(frequency)
High
5.4
Some businesses face risks which are high likelihood and high consequence. If this arises
out of their core business they are unlikely to avoid it. The concept of ALARP (as low as
reasonably possible) is a way of considering the trade off between the costs of mitigating
the risk and the assessment of the risk.
5.5
The level of risk considered as low as reasonably practicable may be a good compromise.
88
Lecture example 3
Class discussion
Among the risks that M&S faces you may have identified the following:
(a)
Theft of inventory
(b)
Under/overstocking specific lines from the womens 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.
89
Controls (methods of risk reduction)
6.1
Controls can be operated at different levels of the business:
6.2
(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)
You could use the mnemonic SPAMSOAP to help generate ideas for specific controls.
Segregation of duties, with no one person having total control of an area eg the
chairman/CEO roles should be split (Cadbury)
Physical measures to secure the custody of assets eg access control to buildings
Authorisation and approval of all business activities by appropriate persons
eg non-executive directors to decide directors pay and sit on a remuneration committee
Management should provide control through analysis and review of accounts eg tasking
internal audit
Supervision of the recording and operations of day-to-day transactions eg budget
monitoring through exception or variance reports
Organisation identifies reporting lines, levels of authority and responsibility. This ensures
everyone is aware of their control (and other) responsibilities, especially in ensuring
adherence to management policies eg enabling named staff to act independently within
areas of delegated power
Arithmetical and accounting to check the correct and accurate recording and processing of
transactions eg bank account reconciliation
Personnel Attention should be given to selection, training and qualifications of personnel,
as well as personal qualities eg checking reference during a recruitment process.
90
Chapter summary
Section Topic
Summary
Risk assessment
Organisations may have a formal process/department
Risk profiling
Risk will be considered and analysed so that the directors

can decide how to respond.
Risk quantification
Management accounting techniques will be used to try to

put a value on a risk.
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.
Risk response
The 'TARA' model highlights 4 potential responses to a risk.
Controls (methods Suitable controls should be chosen which best mitigate or

of risk reduction)
reduce a known risk.
91
END OF CHAPTER
92
Information,
communication and
monitoring

Describe the function and importance of

internal audit
December 2014 Q4a (10 marks) the case for establishing

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

compliance and the role of the internal audit
committee in internal control
June 2013 Q2b (12 marks) on audit committees
Define and describe management

responsibilities in risk management
June 2012 Q2b & c (17 marks) role of the risk committee
and how they differ in different sized companies
December 2008 Q3b (10 marks) criticising internal audit

and internal control arrangements in a company
June 2009 Q1e (10 marks) on the role of the CEO in

internal control
Explain and evaluate the role of the risk
committee and risk manager in identifying and
monitoring risk
June 2009 Q4a&c (4+7 marks) describing the risk

managers role and evaluating the commercial directors
view of risk management
Describe and assess the need to report on

internal controls to shareholders and the
content of a report on internal control and
audit, including internal and external risk
auditing in monitoring risk
December 2013 Q1d (8+8 marks) on risk audits
Explain and assess the need for adequate

information flows to management for the
purposes of the management of internal
control and risk
December 2009 Q1d (6 marks) on the importance of

possessing all relevant risk and control information
Evaluate the qualities and characteristics of

information required in internal control and risk
management and monitoring
December 2012 Q3c (10 marks) discuss general qualities

of good information and ways of improving information
flow
Describe the process and importance of

externally reporting on internal control and risk
December 2010 Q1cii (8 marks) on mandatory external

reporting of internal financial controls and risks
December 2012 Q3b (10 marks) as part of a broader

question on internal control failure
June 2008 Q4b&c (8+4 marks) on external reporting of
internal controls and their suitability for SMEs
December 2007 Q4a (10 marks) on the importance of

identifying all stakeholders before proceeding with projects
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8: INFORMATION, COMMUNICATION AND MONITORING
Overview
Information, communication and
monitoring
Information
Communication
Monitoring
Committees
Internal audit
Risk manager
94
External reporting
Control Environment
Risk Assessment
Control Activities
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Information
1.1
In order to fulfil their duties effectively the board of directors (and sub committees) need a
wide range of information.
1.2
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
Communication
2.1
The board must make sure that staff abilities and attitudes are suitable, and that everyone
has access to appropriate organisational information.
Lecture example 2
Required
Suggest ways in which directors can both inform and influence staff.
Solution
96
Monitoring
3.1
The board of directors is responsible for the companys system of internal control. This
includes doing the following:
(a)
(b)
(c)
3.2
In determining policies for internal control the board should consider:

(a)
(b)
(c)
(d)
(e)
(f)
3.3
The nature and extent of risks

The extent of acceptable risks
The categories of acceptable risk
The likelihood of the risk materialising
The companys ability to reduce the incidence and impact of risks
The cost of operating particular control relative to the benefits.
It is the role of management to implement board policies on risk and control:

(a)
(b)
(c)
3.4
Setting appropriate policies

Seeking regular assurance
Ensuring effective risk management.
Identify and evaluate risks;

Operate the system of internal control;
Monitor the effectiveness of the system of internal control.
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 &
Reviewing
3.9
Financial
statements
Price sensitive
information
Internal financial
controls
Independence of
external auditors
Policy setting
Overseeing
Effective internal
audit
Appointment of
external auditors
Remuneration of
external auditors
Non audit service

provided by
external auditors
(NB most are
barred under
SOx)
The audit committee is the body responsible for whistleblower procedures within the
company. They have to ensure that any problems will be brought to their attention.
3.10 As part of their role of monitoring internal audit, the audit committee should carry out a
formal annual review of internal audit. If there is no internal audit function present, the audit
committee should consider annually whether there is still no need for internal audit or if one
might now be required.
3.11 According to Turnbull the factors that will influence this decision are:
Company Size
Company
Complexity
Unexpected risk
events
Cost v benefit
analysis
Problems in the
internal control
3.12 The Turnbull Report states that listed companies without an internal audit function should
annually review the need to have one.
98
Internal audit
3.13 Internal audit is a form of control put in place by the board in order to help achieve the
companys objectives.
3.14 Internal audit is an important part of the internal control system and it can therefore be
regarded as having the same objectives as the rest of the internal control system: ie
safeguarding assets; economy, efficiency & effectiveness of operations; reporting; and
compliance.
3.15 The internal audit department reports to the audit committee who will carry out an annual
review of the internal audit function covering:
(a)
(b)
(c)
(d)
Scope of work
Authority
Independence
Resources
3.16 As well as the objectives listed at 3.14 above the scope of the work performed by internal
audit can include:
(a)
(b)
(c)
Risk management processes

Value for money audits
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.
Risk committee
4.1
The risk committee may include executive and non-executive directors. It is often chaired by
the companys CEO. The risk committee was covered in detail in Chapter 5.
99
Risk manager
5.1
A risk manager needs to combine technical skills in credit, market and operational risk with
leadership and persuasive skills.
5.2
COSO lists their responsibilities as:

(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
Leadership of enterprise risk management

Establishing and promoting enterprise risk management
Developing polices
Common risk management policies
Establishing a common risk language
Dealing with insurance companies
Implementing risk indicators, (ie designing early warning systems)
Allocation of resources based on risk
Reporting to the CEO
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)
(b)
(c)
(d)
(e)
Changes since the last formal review

The companys ability to respond to changes in the business environment
The scope and quality of management monitoring (including internal audit)
The extent and frequency of reports to the board
Significant controls failing or weaknesses
100
Lecture example 3
Class discussion
Appendix B contains extracts from M&Ss 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
101
Chapter summary
Section Topic
Summary
Information
requirements of the
board
The board are ultimately responsible for the internal

control system. They are responsible for reporting to the
shareholders on the risks and controls and so require
information to do so.
Communication
Internal communication is vital for ensuring staff are

informed.
Internal control and

monitoring
Three independent NEDs (one with financial expertise)

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 companys 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.
Risk committee
The risk committee sets policies on the extent and

categories of acceptable risk. The risk committee can
include executive directors.
Risk manager
A risk manager is usually a technical expert. There role

can extend from developing risk policies to dealing with
insurance companies.
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
Topic name
Scope of corporate
governance
governance

reporting

attitudes
Risks
Risks
Risk assessment and

response
Information, communication
and monitoring

monitoring
103
Achievement Ladder
104
Personal ethics

Explain and distinguish between the ethical

theories of relativism and absolutism
December 2010 Q1b (10 marks) and June 2008

Q2c (6 marks) on how each would affect the
outcome of an ethical dilemma
Describe and distinguish between

deontological and
teleological/consequentialist approaches to
ethics
June 2013 Q1dii (10 marks) arguing against the

payment of a bribe to secure a business contract
December 2008 Q4c (9 marks) using both to
evaluate the belief that child labour is wrong
Pilot Paper Q3c (6 marks) explain and contrast
June 2009 Q1a (6+4+2 marks) theory and
application in a rogue trader scenario
Explain, in an accounting and governance

context, Kohlbergs stages of human moral
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 decisionmaking models in accounting and

professional contexts: American Accounting
Association model, Tuckers 5-question
model
Explain and analyse the content and nature of
ethical decision making using content from
Kohlbergs framework as appropriate
Tucker: December 2012 Q4a (10 marks) and

December 2008 Q1a (10 marks)
AAA: June 2012 Q1b (14 marks) and December
2009 Q1a (14 marks)
June 2014 Q4a (8 marks) explaining how to act
adopting both conventional and post-conventional
ethical assumptions
105
9: PERSONAL ETHICS
Overview
Personal ethics
Ethics
Ethical theories
Kohlberg's stages of human

moral development
Models of ethical conflict

resolution
106
9: PERSONAL ETHICS
Ethical theories
1.1
Ethics is:
(a)
(b)
(c)
(d)
Concerned with right and wrong, and how conduct is judged to be good or bad.
About how we should live our lives and, how we should behave towards other people.
Relevant to all forms of human activity, including the business world.
Problematic in business where the primary purpose is material gain.
Ethical absolutism
1.2
Absolutism is the view that there is an unchanging set of ethical principles that will apply in
all situations, at all times and in all societies.
1.3
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

unambiguous rules that people are able to
follow, knowing that their actions are right.
Absolutist ethics takes no account of

evolving norms within society and the
development of advances in morality.
The existence of absolute rules makes the

application of corporate governance and
comparing the performance of business
units more achievable.
Irrespective of the source of absolute

ethical principles, they are then subject to
human interpretation with the result that
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.
107
9: PERSONAL ETHICS
Lecture example 1
Required
Examine the relative merits and demerits of adopting an ethically relativist approach in business?
[8 marks]
Solution
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)
(b)
1.9
Applying the rule universally and consistently.

Rules should respect human dignity.
A criticism of deontological ethics is that you cannot take actions in a vacuum and must
have regard for their consequences. However, we cannot always know what the
consequences of our actions would be.
108
9: PERSONAL ETHICS
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.
Lecture example 2
Class discussion
Required
Identify some factors that will influence both an organisation's and an individual's ethical
perspective.
Solution
109
9: PERSONAL ETHICS
Kohlbergs 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
110
9: PERSONAL ETHICS
Lecture example 3
Class discussio n
GSA is a listed pharmaceutical company that operates across different countries but has its
headquarters in a European country. The company is considering the extension of one of its
production facilities but this will require the compulsory purchase of local houses for demolition in
order to accommodate the necessary building work. The new facility will be working on creating a
new chemical that is expected to significantly improve water purification in under-developed
countries. Home-owners have been approached for their initial responses about this proposal
before it is debated by the GSA board.
Required
(a)
Recommend how home-owners would respond using Deontological and both forms of
Teleological ethical principles.
Following some consultation, the decision to obtain a compulsory purchase order for land and
homes is adopted by the board despite mixed reactions from those affected. At a meeting of local
residents, three home-owners presented their views:
Bal pointed out that regardless of what the residents may want, they have an obligation to
under-developed countries to support this initiative and relocate.
Uwe said that it is 'just capitalism at work here' and people should accept it. He will be
pushing for the company to pay him as much money as possible for his house, which he
knows is in a poor state of repair but which he hopes will be overlooked.
Ming is a corporate lawyer who has obtained details of case law that sets a precedent about
how such compulsory purchase orders should be approached by both companies and
residents she suggest that this approach is followed regardless of what home-owners
want.
Required
(b)
Using the Kohlberg model, explain which level each of the three residents is operating at.
Solution
(a)
Deontological
Teleological
(b)
Bal
Uwe
Ming
111
9: PERSONAL ETHICS
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.
2.
3.
4.
5.
The facts
The ethical issues involved
Related fundamental principles
Established internal procedures
Alternative courses of action, considering the consequences of each
American Accounting Association model

3.2
The American Accounting Association (AAA) Model frames the ethical decision as a series
of answers to questions.
(a)
(b)
(c)
(d)
(e)
(f)
(g)
What are the facts of the case?

What are the ethical issues in the case?
What are the norms, principles and values related to the case?
What are the alternative courses of action?
What is the best course of action that is consistent with the norms, principles
and values identified?
What are the consequences of each course of action?
What is the decision?
Tuckers 5-question model

3.3
Tuckers 5 question model is a benchmark against which to test the ethicality of a decision.
Ask yourself, is the decision:
(a)
(b)
(c)
(d)
(e)
Profitable?
Legal?
Fair and equitable?
Right, which is prone to subjective judgement?
Sustainable or environmentally sound?
Lecture example 4
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 companys
products unless they voluntarily paid more corporate tax. GSAs Chief Executive Martyn Rice
agreed to respond to the media on behalf of the board.
112
9: PERSONAL ETHICS
Required
(a)
Recommend a response for the Chief Executive to make from the perspective of Absolutist
and Relativist ethical principles.
(b)
Assess the proposal to make no voluntary payment of corporate tax by the company using:
(i)
The AAA model
(ii)
Tuckers 5 questions
Solution
(a)
Absolutist
Relativist
(b)
(i)
(ii)
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)
(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
(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
Chapter summary
Section Topic
Summary
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.
Ethical theories
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 thiefs rule).
2
Kohlbergs
stages of human
moral
development
Kohlberg describes the development of individuals ethical

reasoning through three stages or levels.
Pre-conventional: reward/punishment and self-interest
Conventional: 'good boy/girl' and legal or social conventions
Post-conventional: concern for others and principled
conscience
Frameworks for
ethical conflict
resolution
The IFAC and American Accounting Association Models

cover broadly the same issues. Consideration should be
given to: the facts, the ethical issues, fundamental
principles, internal procedures, alternatives.
Tuckers 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
Topic name
Scope of corporate
governance
governance

reporting

attitudes
Risks
Risks
Risk assessment and

response
and monitoring

monitoring
Personal ethics
Personal ethics
115
Achievement Ladder
116
Professional ethics

Explain and explore the nature of a profession

and professionalism including the public
interest
June 2014 Q3c (9 marks) explain the public interest

December 2013 Q4c (9 marks) on how awareness of a
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?'
June 2010 Q4b (7 marks) and June 2009 Q2c (7 marks)
on the role society expects accountants to play
June 2014 Q1b (11 marks), June 2008 Q4a (9 marks) and
December 2011 Q1a (10 marks) codes and behaviour
Integrity: June 2013 Q1di (6 marks) and December 2009
Q3a (5 marks)
Pilot Paper Q3a (11 marks) Professor Cheung
Pilot Paper Q4c (4 marks) FF Co
Analyse the role of accounting as a profession

in society
Describe and explore and areas covered by
corporate codes of ethics
Describe, assess the content of, and
principles behind, professional codes of ethics
Describe and assess the codes of ethics
relevant to accounting professionals such as
IESBA (IFAC) or professional body codes
Explain and evaluate the nature of impacts of
ethical threats and safeguards, plus risks to
auditor independence
Describe and discuss rules-based and
principles-based approaches to resolving
ethical dilemmas encountered in professional
accounting
Describe and evaluate issues associated with
conflicts of interest and ethical conflict
resolution
Explain and explore bribery and corruption,
how they can be reduced and any barriers to
implementing such measures
June 2014 Q3a (8 marks) explanation and benefits

June 2012 Q3b application of ethical safeguards
June 2009 Q2b (5+8 marks) describe and assess threats
June 2014 Q4b (8 marks) construct an ethical case for
whistle-blowing the use of inferior meat in food products
June 2010 Q2c (5 marks) construct an ethical case for the
voluntary reduction of CEOs pension after failure
June 2012 Q3a (10 marks) and December 2010 Q3a (8
marks) explaining conflicts of interest
December 2014 Q1b (10 marks) explaining the impact of
corruption
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
IFAC ethical code
ACCA 'The Rule Book'
Threats of professional
independence
118
Corporate codes of ethics
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)
(b)
(c)
(d)
(e)
1.6
Financial accounting
Audit
Management accounting
Consulting
Taxation
The financial information included within accounts can have a number of impacts:
Mechanistic issues, where
the accounts are used to judge
the performance of a company
or its directors in line with a
regulation or contract.
Judgemental issues are

where the figures in the
accounts influence the
judgement of their users.
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
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.
Lecture example 1
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
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
framework
Disadvantages of a principles-based
framework
The onus is on the professional accountant

to think about relevant issues in a given
situation, rather than simply avoiding a
checklist of unacceptable actions.
Ethical codes cannot include all

circumstances and dilemmas, so
accountants need a very good
understanding of the underlying principles.
A framework prevents professionals

interpreting legalistic requirements narrowly
to get around the ethical requirements.
International codes cannot fully capture

regional cultural variations in beliefs and
practice.
It allows for variations, which is important

as situations differ.
Principles-based codes can be difficult to

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
3.4
3.5
Professional
competence and
due care
Members have a continuing duty to maintain professional knowledge

and skill at a level required to ensure that a client or employer
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
behaviour
Members should comply with relevant laws and regulations and

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.
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.
In the exam you may be required to evaluate the ethical behaviour of a professional
accountant using the fundamental principles (Q1c December 2012)
122
Lecture example 2
Required
Identify some benefits of adopting an ethical code, and recommend how an organisation might go
about developing one.
Solution
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 selfinterest threat to independence might arise.
Lowballing, when a firm

quotes a significantly
lower fee level for an
audit service
A partner or
employee on
the board of an
audit client
Family or close
personal relationships
Contingent fees
based on the
outcome of a
transaction
SELF INTEREST
THREAT
Client lends a material
sum of money to an
audit firm or member
of audit team
Client represents a large

proportion of a
firms/partners total fees
4.3
Valuable gift
and/or hospitality
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

had been recently employed by, or
otherwise involved with the client,
the audit firm should consider the
threat to independence arising
Having custody of an audit clients
assets, supervising client
employees in the performance of
their normal duties, and preparing
source documents on behalf of the
client also pose significant selfreview threats
Obtaining a quality control review of the

individuals work on the assignment
Discussing the issue with the audit committee
Removing the individual from the team
Ensuring non-audit team staff are used for these

roles
Involving an independent professional

accountant to advise
Quality control policies on what staff are and are

not allowed to do for clients
Making appropriate disclosures to those charged

with governance
Resigning from the audit engagement
Preparing accounting records and

financial statements, and then
auditing them
Using staff members other than audit team

members to carry out work
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
The firm should ensure that the client
acknowledges its responsibility for establishing,
maintaining and monitoring the system of
internal controls
Provision of internal audit services

to an external audit client is
permitted in most jurisdictions, but
not in the US under SarbanesOxley
Advocacy threat
4.5
An advocacy threat arises in certain situations where the audit firm assume the clients part
in a dispute or somehow acting as their advocate. The most obvious instances of this would
be when a firm acts as an expert witness in a court case.
4.6
Relevant safeguards might be:

(a)
Using different departments in the firm to carry out the work
(b)
Making full disclosure to the clients 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 firms experience in tax
advice can help identify any future tax loopholes. The engagement is very high-profile for your firm,
so it has been offered at a discount to the firms normal fees, although you understand that the
GSA board has indicated that it expects fees to stay low as it wants you to act as both internal and
external auditors in order to improve efficiencies.
You are in the corridor about to deliver coffee for a planning meeting between your firm and GSA
when you overhear the end of a conversation between the engagement partner and the Finance
Director in the meeting room: ...obviously, if the tax savings identified are sufficiently imaginative
and creative, there will be a special bonus for you, although this will need to be hushed up to
satisfy those who feel we should all now be acting in the public interest...
Required
(a)
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
Chapter summary
Section Topic
Summary
Professions and the

public interest
Professions and professional bodies have a dual role,

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.
Corporate codes of
ethics
Ethical codes set out the companys core values and

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.
IFAC professional code The IFAC code is a principles based code. The
of ethics
ACCAs code is broadly based on the IFAC code.
The fundamental principals are:
Professional competence and due care
Integrity
Professional Behaviour
Confidentiality
Objectivity
Threats to compliance
with the fundamental
principles for
accountants in practice
The threats to independence are: self-interest, self

review, advocacy, association/familiarity and
intimidation. Safeguards are put in place to counter
these threats.
END OF CHAPTER
128
Corporate social
responsibility

Describe and evaluate Gray, Owen and Adams

seven positions on social responsibility and
other constructions of the corporate and
personal ethical stance
December 2013 Q3c (9 marks) explaining how

corporate social responsibility and ethical
stance differ between a charity and a company
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

context of corporate governance and the
concept of the organisation as a corporate
citizen of society with rights and responsibilities
December 2014 Q1di (6 marks) on being a

corporate citizen
December 2014 Q2dii (part of 6 marks) and
June 2013 Q3b (7 marks) on fiduciary duty
December 2007 Q4c (7 marks) on fiduciary
responsibility
Explain and assess the concept of integrated

reporting and evaluate the issues concerning
accounting for sustainability (including
alternative definitions of capital)
December 2013 Q1ai (4 marks) contrasting

sustainability with economic sustainability
Describe and assess the social and

environmental effects that economic activity can
have (in terms of social and environmental
footprints and environmental reporting)
June 2013 Q1b (10 marks) and Pilot Paper Q1e

(4 marks) on the use and importance of
environmental reporting
June 2008 Q1d&e (3+8 marks) on sustainability

Pilot Paper Q1e (4 marks) defining
environmental footprint
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
and guiding principles of an integrated report
and discuss the usefulness of this information to
stakeholders
December 2014 Q1diii (8 marks) on basic

framework and potential benefits to
stakeholders of reporting on different capital
types
Explain the nature of social and environmental

audit and evaluate the contribution it can make
to the assurance of integrated reports
June 2014 Q3b (8 marks) on environmental

auditing and reporting as a way of
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
Citizenship
CSR Stances
CSR
Viewpoints
Social and Environmental

issues
Environmental
management systems
Sustainability and
environmental
footprint
Social footprint
Social and
environmental audits
Integrated reporting
131
Environmental
reporting & GRI
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
(Carroll)
Corporate
citizenship
(Matten et al)
Ethical Stances
(Johnson &
Scholes)
7 Social
Responsibility
Viewpoints
(Gray Owen &
Adams)
Economic
To shareholders
wanting
dividends/capital
gains, to employees
wanting fair
employment, to
customers wanting
good quality products
Legal
Obeying the law is a
requirement in all
societies, though legal
compliance imposes
greater burdens in
some societies rather
than others
Limited view
consists of limited
projects undertaken
in the businesss selfinterest.
The main
stakeholder groups
that the corporation
engages with are
local communities
and employees.
Equivalent view is
based on a wider
general definition of
corporate social
responsibility that is
partly voluntary and
partly imposed
132
Short-term
shareholder interest
Pristine capitalists:
Business has no
moral responsibilities
It is for government
alone to impose wider beyond their
obligations to
constraints on
shareholders and
corporate
creditors.
governance.
This minimalist
approach would
accept a duty of
obedience to the
demands of the law,
but would not
undertake to comply
with any less
substantial rules of
conduct.
Expedients:
Social responsibility
may be appropriate if
it is in the business
economic interests.
Long-term
shareholder interest
Proponents of the
social contract:
(a) Corporate image

may be enhanced by
an assumption of
wider responsibilities.
There is effectively a
contract or agreement
between the
organisations and
those who are
affected by their
decisions.
(b) The responsible

exercise of corporate
power may prevent a
build-up of social and
political pressure for
legal regulation.

Ethical
Companies are
required to act in a fair
and just way even if
the law does not
compel them to do so
Extended view will

promote:
Social rights of
citizens by provision
of, for example,
decent working
conditions
Civil rights, by
intervening to
promote citizens'
individual rights
themselves or to
pressurise
governments to
promote citizens'
rights
Political rights by
allowing individuals
to promote their
causes by using
corporate power.
Philanthropic
Multiple
shareholder
obligations
Accepting the
legitimacy of the
expectations and/or
claims of
stakeholders other
than shareholders
and build those
expectations into its
stated purposes.
This would be
because without
appropriate
relationships with
groups such as
suppliers, employers
and customers, the
organisation would
not be able to
function.
Shaper of society,
although it is
accepted that this
role is largely the
preserve of public
sector organisations.
Charitable donations,
contributions to local
communities, and
providing employees
with the chances to
improve their own
lives
133
Social ecologists
believe that business
activities result in
resource exhaustion;
waste and pollution
must therefore be
modified.
Organisations must
also be socially
responsible.
Socialists seek to
promote egalitarian
equality. Business
decision-making
should no longer be
determined by the
requirements of
capitalism and
materialism but
should promote
equality.
Radical feminists
aim to promote
feminine values such
as co-operation and
empathy
Deep ecologists
(greens) suggest that
man has no greater
rights to resources or
life than other species.
Lecture example 1
Classroom discussio n
Proponents of CSR argue that there is a strong business case for considering stakeholders,
whereas critics argue that CSR distracts from the fundamental economic role of businesses.
Required
Identify some arguments supporting the case both for and against CSR. (You may want to
consider what might motivate an interest in CSR.)
Solution
Lecture example 2
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 companys
products unless they voluntarily paid more corporate tax. GSAs Chief Executive Martyn Rice
agreed to respond to the media on behalf of the board.
Required
Recommend a response for the Chief Executive to make from each of the seven positions on CSR
suggested by Gray, Owen and Adams.
Solution
Pristine capitalist
Expedient
Social contract
Social ecologists
Socialist
Radical feminist
Deep ecologist
134
Sustainability
2.1
Sustainability means limiting the use of depleting resources to a level that can be
replenished.
2.2
Sustainable development is development that meets the needs of the present without
compromising the ability of future generations to meet their own needs.
2.3
When considering sustainability a number of questions need to be considered:
Sustainable
by whom?
Sustainable at
what cost?
Sustainable
for whom?
SUSTAINABILITY
ISSUES
Sustainable for
how long?
Sustainable
in what way?
2.4
A key issue is generational equity, ensuring that future generations are able to enjoy the
same environmental conditions, and in social terms per capita welfare is maintained or
increased.
2.5
The two approaches to sustainability are:
2.6
(a)
Weak sustainability believes that the focus should be on sustaining the human
species and the natural environment can be regarded as a resource. The weak
sustainability viewpoint tends to dominate discussion within the Western economic
viewpoint.
(b)
Strong sustainability stresses the need for harmony with the natural world; it is
important to sustain all species, not just the human race. They see a requirement for
fundamental change, including a change in how man perceives economic growth (and
whether it is pursued at all).
Environmental footprint is a measure of the impact that a particular businesss activities

have upon the environment including its resource environment and pollution emissions.
135

2.7
Examples of factors used to determine a firms environmental footprint include:

(a)
(b)
(c)
(d)
(e)
(f)
Depletion of natural resources

Noise and aesthetic impacts
Residual air and water emissions
Long-term waste disposal (exacerbated by excessive product packaging)
Uncompensated health effects
Change in the local quality of life (through for example, the impact of tourism)
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
Lecture example 3
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)
136
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 companys 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 companys directors and its shareholders (covered in Chapter 1).
Advantages of environmental reporting:

4.5
Environmental reporting has environmental, social and business benefits
Demonstrates the firms 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.
137
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

companys 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.
138
Lecture example 4
Required
Identify the benefits of an organisation achieving external accreditation for its CSR activities.
Solution
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.
139
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 organizations 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 organisations governance framework
and ethical values
Ability to understand and implement organisations 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

organisations 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 organisations social licence to operate.
7.3
There are a series of seven guiding principles that <IR> requires to be seen as meaningful:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
Strategic and forward-looking

Connectivity across all relationships that create value
Stakeholder relationships and how they work to create value
Materiality, disclosing those matters that substantially affect value creation
Reliability and completeness, avoiding any bias
Conciseness (to encourage people to read about <IR>)
Consistent and comparable presentation with other organisations and over time.
140
Lecture example 5
Required
For each of the following aspects of a companys operations, suggest the most appropriate form of
<IR> capital that could be used to monitor it.
Solution
Company operations
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 companys printed products
A scheme that allows employees to study for a qualification
141
Chapter summary
Section Topic
Summary
There are four different models which identify different

positions that can be taken. They broadly cover
stances of narrow economic self interest, wider social
obligations, and a more principled ethical stance
through to a philanthropic position. (Carrolls CSR)
Organisations ethical
and social
responsibility stances
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
4
Social accounting,
auditing and reporting
Environmental
reporting
Organisations can opt to follow different guidelines.
Environmental
management systems
EMAS is a voluntary scheme based on improving

targets, inspection and verification of performance.
The growing impact of the GRI on business

organisations and how this can prove advantageous
in many ways, including governance.
ISO 14000 provides a prescription for an

environmental management system.
6
Social and
environmental audits
Social audits usually focus on checks as to whether a

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.
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
142
In the final run up to your exam, you should attempt Step 6 as the final check that you are fully prepared
to move onto the revision phase of your studies. As a reminder, Step 6 must be completed and submitted
in order to be able to qualify for Pass Assurance. It is Written Assessment 2 and can also be found at the
back of these course notes.
It covers all the Topics in your course. As ever, you will receive feedback on your performance, and you
can use the wide range of online resources to help address any final areas where you need to fine tune
your knowledge or technique.
Course notes
chapter
Topic name
Scope of corporate
governance
governance

reporting

attitudes
Risks
Risks
Risk assessment and

response
and monitoring

monitoring
Personal ethics
Personal ethics
Professional ethics
Professional ethics
10
Corporate social responsibility Corporate social responsibility
143
11
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 Governments haste to make the
sale a success. While the Royal Mail presented a potentially significant liability on public sector
finances due to pension and operating deficits, it had started to show signs of recovery, prompting
calls that it was only sold to benefit investors and not the UK in general. Time will tell on this,
although in an industry where physical deliveries are being phased out in favour of digital products
books, music and other entertainments maybe this was a good deal after all. Source:
http://www.bbc.co.uk/news/28263467)
Outside the UK, privatisation remains a divisive issue from proposals to privatise six major
airports in India (http://timesofindia.indiatimes.com/business/india-business/Bidding-forprivatisation-of-6-airports-deferred-again/articleshow/30469979.cms) to the sale of state assets in
Brazil to support their economy (http://www.forbes.com/sites/kenrapoza/2012/08/10/brazil-opensroads-to-privatization/) and even massive investment by China in African infrastructure
(http://www.scmp.com/business/economy/article/1301343/natural-resources-oil-underwritechinese-investment-africa) the tension between public and private sector remains.
148
Chapter 3
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 boards strategy.
(c)
It reflects the reality that both jobs are demanding roles. In particular in large companies (eg
FTSE100 companies) it would be too demanding for one person to carry out both functions.
(d)
Having two different people in the role brings two different perspectives, two sets of experience
and skills and therefore improves decision making.
(e)
The separation of roles avoids the risk of conflicts of interest. The CEOs remuneration will contain
performance related bonuses. He may be inclined to take unacceptable risks to make sure that he
earns his bonus.
Accountability to shareholders
(a)
The board cannot make the CEO truly accountable for management if it is led by the CEO.
(b)
Separation of the roles means that the board is more able to express its concerns effectively by
providing a joint channel of reporting (the chairman) for the non-executive directors.
[Note: The UK Cadbury report recommends that if the posts were held by the same individual, there
should be a strong independent element on the board with a recognised senior member. The UK Higgs
report suggests that a senior independent non-executive director should be appointed who would be
available to shareholders who have concerns that were not resolved through the normal channels. The
UK Corporate Governance Code also suggests that the CEO should not go on to become chairman of the
same company. If a CEO did become chairman, the main risk is that he or she will interfere in matters
that are the responsibility of the new CEO and thus exercise undue influence over him or her.]

Independence
Length of service
Cross-directorships
Inflated pay
Share options
149
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 companys risk appetite and may choose to
invest elsewhere. Many of M&Ss small private investors do so out of loyalty and might be
expected to prefer a low risk investment. The second biggest investor is Legal & General who will
hold M&S shares as part of a balanced portfolio.
(b)
Debt providers are most concerned about the risk of non-payment and they can take various
actions with potentially serious consequences such as:
(c)
Employees will be concerned about threats to their job prospects (money, promotion, benefits
and satisfaction) and ultimately threats to the jobs themselves. The variety of actions employees
can take include:
(d)
Denial of credit
Higher interest charges,
Applying restrictive covenants
Requiring security (eg mortgage)
Putting the company into liquidation.
Pursuing of their own goals rather than shareholder interests

Industrial action,
Refusal to co-operate
Resignation
Customers will be concerned with threats to their getting the goods or services that they have
been promised, or not getting the value from the goods or services that they expect. The risk to
the firm is that they could take their business elsewhere. M&S built its reputation as a good value
brand and suffered in the 1990s when there was a perceived fall in quality.
152
(e)
Governments, regulatory and other bodies will be particularly concerned with risks that the
organisation does not act as a good corporate citizen, implementing for example, poor
employment or environmental policies. A number of the variety of actions that can be taken could
have serious consequences.
(f)
Government can impose tax increases or regulation or take legal action. Pressure groups tactics
can include publicity, direct action, sabotage or pressure on government or other stakeholders.
Training
Workshops
Monitoring
Shadowing
Ethical codes
Good leadership
Set up compliance/risk management department
Build risk identification into job descriptions
Create risk register

Risk committee
(a)
Executive directors
(b)
Knowledge of company
Risk key concern
Remuneration can be linked to risk management
Supports strategic planning
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)
153

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
Board
NED's
Risk committee
Audit committee
Audit dept
Managers and employees
Consultants
How often
Forecasting
Scenario building
Variance analysis
Competitor analysis
Observation
Meetings/discussions
Interviews/questionnaires
Monthly?
Quarterly?
Annually?

The net present value of the project requires of both years 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
(b) Under/overstocking
Not very likely but could
erode profits
borderline ACCEPT or
REDUCE
Likelihood
(frequency)
REDUCE
High
(a) Theft of inventory

Quite likely and could
erode profits ACCEPT,
REDUCE or TRANSFER?
(c) Failure of EFTPOS
Unlikely but high impact
REDUCE or TRANSFER?
TRANSFER
AVOID
(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)
Management accounts
HR reports
Variances
Exception reports
External (formal)
Market research
Company accounts
Benchmarking
Analysis reports
Internal (informal)
Complaints
Feedback
Employee opinion
External (informal)
Press/PR
Internet/competitors websites

Ethical code
Clear communication
Tone at the top, leading by example
Consultation
Incentives
155
Report Contents
The existence of a process for managing
risk
Page 45, within the section on Accountability

(paragraph 2)
How the board has reviewed the

effectiveness of the process
Page 45, within the section on Accountability

(paragraph 3)
That the process accords with the

guidance
Page 41, as part of the section illustrating the M&S

governance 'map'
Formally acknowledge the boards

responsibility for internal control and
review
Page 43, within the paragraph headed 'Monitoring

risk'
An explanation that the system manages

but does not eliminate risk
Not explicitly stated, but at the bottom of page 47,

there is an explanation that others may be present
A summary of the process for reviewing

internal controls
Mitigating activities on pages 46 and 47
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 its valid to say that everyones differing opinions are right, then its equally valid to say that
everyones differing opinions are wrong. This can lead to immense confusion and disagreement,
and breakdown in communication and trust.
156
Age
Experience
Size of organisation
Backgrounds
Education
Nationalities
Religions
Market stakeholders

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 peoples homes could save millions of lives in underdeveloped countries.
Teleological egoism While the new chemical is still relevant, the effect on themselves is what homeowners 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. Employeerelated 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

corporate tax.
Ethics The low rate of corporate tax paid is
unpopular among customers and critics, so paying
more may help the companys reputation in the
long term.
Norms What is GSAs past behaviour regarding
corporate tax? Has there been a precedent set by
either tax laws or case law? Has GSA signed up to
any corporate code of ethics (either internally or
within the industry) to set any expectation?
Alternatives GSA can either do nothing and be
unpopular or pay a voluntary amount of tax as an
apparent 'donation' and attempt to diffuse the
situation.
Advice consistent with norms Whatever past
behaviour GSA has adopted might inform future
actions, unless it can argue the circumstances are
different now. If there is a code that GSA has
signed up to, it should adopt what the spirit or letter
of the code demands.
Consequences Non-payment would lead to
further deterioration of GSAs reputation and
possible adverse sales impacts.
Payment would be a voluntary reduction of
shareholders funds, but would reduce the adverse
reputation and sales impact.
Decision It depends on the companys ethical
stance, but the global mood currently appears to
support voluntary payment of tax in such cases.
Profitable? Initially yes, as shareholders funds

have not been diverted to pay a voluntary sum
(however, paying tax voluntarily would reduce the
threat of a sales boycott which may offset any
payment made) so there may be a trade-off here.
Legal? Yes in either case (paying or not
paying tax) GSA is operating within the law.
Fair? GSA may establish how widespread the
use of such tax avoidance really is if others in the
same industry have also adopted this policy, it will
probably continue to feel there is 'safety in
numbers' (however, this will inevitably attract
criticism that as GSA can afford the best tax
experts to interpret the law, such advice is too
expensive for others, leading to inequity in tax
advice).
Right? Very difficult to call as there is such
resistance from the public, the continuing defence
of these actions as legal tax avoidance appears
unsustainable (see below).
Sustainable? There are no environmental
issues but this may affect profits in the longer term,
leading to questions over how economically
sustainable such a policy really is.
Chapter 10
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
Clear commitment from management

Recruitment and selection policies and procedures
Careful induction
Staff training and workshops
Terms contained with contracts of employment
Objectives setting (Management by Objectives)
Staff appraisal and reporting systems
Remuneration and reward schemes
Sanctions for clear breach of ethical rules
Ethical (internal) audit
158

Benefits
Guidance
Clarity
Replace/reduce rules
Communication to stakeholders
Development
Consultation
Base on existing codes (eg ACCA)
Provide examples
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 auditors 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
Attracts investors/employees/customers
Can be a source of competitive advantage
Can tie into branding
Pre-empts legislation
Unregulated therefore easy to incorporate
Organisations are responsible to shareholders

CSR is 'stealing' their funds
Benefits do not outweigh costs
Time consuming
Seen as PR only (most stakeholders will be
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

different platforms apps, PC and gaming consoles
Intellectual (software is specifically mentioned)
A term loan for expansion of manufacturing facilities
Financial (funds for use in production)
A publishing companys printed products
Natural (inputs to goods, plus printing leaves a

footprint from cartridges)
A scheme that allows employees to study for a

qualification
Human (either skills or motivation for staff)
END OF ANSWERS TO LECTURE EXAMPLES
160
Question and
Answer bank
161
Index to Question and

Answer bank
Page
Questions
1
2
3
4
5
6
7
8
9
10
11
12
Answers
Core principles....................................................................................................163......................... 168

Frameworks, codes and systems .......................................................................163......................... 169
Non-executive directors......................................................................................163......................... 171
Board of directors ...............................................................................................164......................... 173
Caius plc.............................................................................................................164......................... 174
Types of risk .......................................................................................................164......................... 175
COSO Framework..............................................................................................164......................... 178
Audit process......................................................................................................165......................... 179
Ethical considerations.........................................................................................165......................... 180
Corporate citizenship..........................................................................................166......................... 182
Franks & Fisher .................................................................................................166......................... 184
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)
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
Board of directors
Required
You are required to write a report to the board of directors of a new company, which outlines the following
areas.
(a)
(b)
(c)
(d)
The responsibilities of the chairman of the board

The role of the non-executive directors
The role of the remuneration committee
The role of the nomination committee
(25 marks)
Caius plc
Caius plc is seeking a listing on the London Stock Exchange. The directors of the company are aware
that certain listed companies have attracted considerable criticism in recent years over directors pay and
conditions. There have been claims in the media that the pay and conditions of some directors have been
far too generous and that the remuneration policies adopted by some companies have been far from
transparent. The directors of Caius plc are keen to ensure that, if the bid for a listing is successful, all
aspects relating to their pay and conditions must be in line with best practice.
Required
Write a report to the directors of Caius plc set out the policies and frameworks that should be adopted by
the company to ensure that directors pay and conditions are fair and transparent.
(25 marks)
Types of risk
Required
Define the main types of risks that a company faces, and explain how codes of corporate governance can
assist in managing these on a day-to-day basis.
(25 marks)
COSO Framework
Required
(a)
The COSO Enterprise Risk Management Framework says that, having assessed relevant risks;
management should determine how it would respond. Responses include risk avoidance,
reduction, sharing, and acceptance. Give brief examples of each of these responses.
(10 marks)
(b)
Management should identify control activities needed to help ensure that risk responses are
carried out properly and in a timely manner. Describe some examples of possible control
activities.
(15 marks)
(Total = 25 marks)
164
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)
Ethical considerations
You were appointed financial controller of a firm of builders' merchants almost a year ago, with the
prospect of becoming finance director if you performed well.
The problem customer
An old-established customer, a contractor, X Ltd, which has expanded to take on a very large contract, is
causing problems with delayed payments. X Ltd is a family firm, largely owned by its Managing
Director, Y.
Following a discussion at a management meeting, the sales director and a member of your staff visited
the customer with instructions to 'try and resolve the matter of delayed payments'.
The meeting
At the meeting, the sales director took the lead, having known Y for many years. Y provided the last
annual accounts and the latest management accounts and contract accounts. This one large contract that
X Ltd had undertaken represents some 70% of its current activity.
If all, or almost all, suppliers allow additional credit for material, and X Ltd uses its very limited remaining
bank facilities to pay the workforce, Y thinks the company should be able to complete the next stage of
the contract, get the architect to certify the work has been completed, and obtain a progress payment.
This would enable X Ltd to pay suppliers, get more materials, and finish the contract. However, Y
considers the company will make a significant loss on the contract and will only be able to trade on a
much-reduced scale thereafter.
The sales director suggested, and Y agreed, an arrangement by which Y would make a payment from
personal funds, against which your company would release materials to X Ltd. When it receives the
progress payment X Ltd will pay your company from its company's funds and reduce the amount owing to
well within normal terms. Your company will then repay Y the personal funds he has paid.
It was agreed that this arrangement should be discussed and agreed with your managing director in the
morning.
After the meeting
On his return, the sales director commented that this sort of arrangement was probably the only way of
getting any money back if X Ltd went into liquidation nothing would be recovered.
Later you received a telephone message that Z, the finance director of another firm of builders' merchants
and whom you know through ACCA branch meetings, has asked you to telephone urgently regarding the
credit status of X Ltd.
Required
Write a report to your managing director explaining the issues involved and recommending the action to
be taken on the account and on the telephone message.
(25 marks)
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10 Corporate citizenship
Required
Write a report to the directors of a UK public limited company explaining the following aspects of
corporate citizenship.
(a)
(b)
(c)
The concept of corporate citizenship

Ways in which social and environmental issues may affect companies
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)
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12 Southern Construction
Southern Construction, started as a small family-run business in the 1980s. John Falshaw, the founder
and self-appointed chairman of the board, foresaw rapid expansion and so decided that the firm should
go public. The timing of this decision was unfortunate as it coincided with an economic recession, which
hit the building trade very hard. The strain was too much and Falshaw suffered a massive heart attack,
and was forced to retire.
In the past Falshaw had run things with a heavy hand and things were done his way or not at all! The
board served as a rubber stamp for his decisions, and as a result, financial and operational controls
were weak or non-existent.
The new chairman was trying desperately to maintain existing levels of financing. However, the firms
bank was very unsettled by recent events, and insisted that Southern Construction plc recruit some nonexecutive directors to strengthen the effectiveness of the board.
Thomas Edwards FCCA had recently retired as financial controller of a large engineering company. He
was delighted when he was approached by the chairman of Southern Construction plc with the offer of
becoming a non-executive director and chair of the yet to be established audit committee. On accepting
the position, the head of internal audit, Mary Flanagan, was instructed to report directly to Edwards. New
internal controls were instituted and additional internal audit staff were recruited.
One day Mary Flanagan reported that her team had found that a salesman had been submitting false
expenses vouchers running into thousands of pounds. Mary, who had a reputation for integrity and
thoroughness, was particularly upset because the actions were a clear violation of the Southern
Construction Code of Ethics and Conduct. The salesman in question was Elmer Pearson. When asked
what should be done with Pearson, she responded, 'The penalty called for submitting false expense
claims is summary dismissal no exceptions'.
It transpired that Pearson would go out with another sales rep, and then both would submit an expenses
claim for the same trip. Internal audit had unearthed dozens of vouchers like this, some even claiming for
imaginary trips.
Edwards was concerned about the reaction of the bank if they learned about the fraudulent activity.
Later that day, Flanagan phoned Edwards at home. She sounded upset, but wanted to talk. Im
confused she said, my loyalties are being pulled in so many directions, I dont know what to think. She
went on to point out that she had known Pearson for over ten years, and he had always been friendly and
helpful to her. She wondered if long service and loyalty to the firm deserved special consideration.
The following day Edwards confronted Pearson. Pearson admitted to the double billing and imaginary
trips. When he was accused of clearly violating the Code, he said 'you dictate my resignation, Ill sign it
and be out of here tonight'. Edwards responded to this by advising Pearson that if any criminal activity
were involved, it wouldnt stop there.
To this, Pearson looked incredulous and began to argue his case strongly. He was currently working on a
big deal with a Japanese businessman a market Southern Construction had been trying to crack for
some time. His budget has been cut to the bone, so he used the money from the expenses subterfuge to
finance the sales pitch. All that is left on a $10 million deal is for the papers to be signed and Pearson was
the only man who had developed the personal relationship with the Japanese businessman to secure
this.
Edwards sat in his office pondering about what to. The bank has just been on the phone requesting a
meeting next week to discuss progress in strengthening the controls within the business.
Required
(a)
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
OFQUESTION
ANSWER BANK
END
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 wont 'do the right thing'.
Responsibility means acknowledging and seeking to remedy problems. There is a suggestion that it is the
imposition of a wider obligation than that imposed by law.
In the context of corporate governance one might take on wider responsibility through acknowledging
ones obligations to stakeholders other than just the shareholders or alternatively by increasing ones
obligations towards shareholders.
Accountability means an obligation to explain the outcome of ones actions.
In the context of corporate governance directors have to make account to the shareholders to explain
what they have done with their investment. They have to declare whether they have made profits or
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losses. Accountability could be considered in terms of the mandatory disclosures that are required from
companies and their directors.
Innovation means governance systems evolving over time to meet the changing needs of society.
Scepticism is the state of mid where you do not necessarily believe everything put before you but neither
do you disbelieve everything either it is the ability to retain an open mind whatever the situation.
Reputation means the perception that others have about you.
Investors price the shares of a company based on their perceptions of its future profitability, their
perceptions of its risk and their perceptions about the capabilities and characteristics of the directors. SO
the share price is entirely founded on perceptions. Events which damage the reputation of the company
will inevitably have an effect on share price.
Tutorial Note: In the real exam you should expect to have to define and explain the importance of one or
two of these principles. It is likely that there will be two marks available for a well explained definition of a
core principle. There could then be anything from 2 to 10 marks for an explanation of its importance.
Often there are clues in the scenario as to the importance of a core principle and often there are marks
available for applying the principle to the facts of the scenario.
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 wellpublicised corporate failures, which were unexpected, as the audited financial statements
had given no indication of such problems. There was a view that the external auditors
were unable to perform their function properly perhaps because a powerful or
unscrupulous chief executive could keep information away from them.
(ii)
There have also been criticisms that the external auditors of a company are not always as
independent as they should be or as the shareholders believe them to be. This was often
the case due to the fact that the auditors relied on the company not just for the audit fee
but also for substantial fees for other consultancy work throughout the year.
(iii)
Allied to these concerns were concerns that some large companies were being run for the
benefit of the directors of the companies rather than for the shareholders. These concerns
raised questions about the conflict of interest between the board of directors and the
shareholders and there was particular concern about too much power being in the hands
of one individual or a small number of individuals. This was particularly the case where
one powerful individual held the posts of both chairman and chief executive and where
boards of directors lacked balance.
(iv)
There was also an issue with directors' remuneration, which was often viewed, as
excessive whether the company was only performing no differently from an average
company or indeed was performing badly.
(v)
In the light of many corporate failures, concern was also expressed about the board's
knowledge and handling of the risks that faced the business and of the adequacy of
internal control systems within companies.
(vi)
As there was a trend towards global investment many large institutions, particularly in the
US and also in the UK, were seeking to invest substantial funds in companies in other
countries. In many instances there were concerns about the lack of shareholder rights and
169
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 companys
shareholders. Although there are several areas where a conflict of interest could arise, the major
problem areas are those of remuneration of the directors and senior managers, financial reporting
and nominations of new board members.
Remuneration
If executive directors are allowed to decide their own remuneration, they could be inclined to pay
themselves as much as possible, without having to hold themselves to account or justify their high
pay. Where incentive schemes are in place, there is a risk that incentive schemes devised by the
executive directors for themselves will be linked to achieving performance targets that are not
necessarily in the shareholders interests. For example rewarding directors with a bonus for
achieving profit growth is of no value to shareholders if the result is higher business risk and a
lower share price.
Remuneration Committee
Corporate governance in may countries, such as the UKs Corporate Governance Code, calls for
a remuneration committee of the board to be established to decide on directors pay, including
incentive schemes, and for this committee to comprise at least three, or in the case of smaller
companies two, members, who should all be independent non-executive directors.
The remuneration committee should have delegated responsibility for setting remuneration for all
executive directors and the chairman, including pension rights and any compensation payments.
The committee should also recommend and monitor the level and structure of remuneration for
senior management. The NEDs should in principle, be able to devise fair remuneration packages
that include an incentive element, in which the performance targets bring the objectives of the
executive directors more into line with those of he shareholders.
171
Financial Reporting
A second potential area for conflict of interest is financial reporting. The executive directors might
be tempted to window dress the results if the company, in order to present the financial results in
a way that reflects better on themselves and their achievements.
Audit Committee
There should be an audit committee of the board, consisting of non-executive directors, whose
task should be to consider issues relating to financial reporting and financial control systems. This
committee should be responsible for maintaining regular liaison with the external auditors. The UK
Code says that the audit committee should comprise at least three or in the case of small
companies, two members, who should all be independent NEDs. The board should satisfy itself
that at least one member of the audit committee has recent and relevant financial experience.
Nominations to the board
A third potential area for conflict is nominations of new board members. A powerful chairman or
chief executive could be tempted to appoint their supporters or yes men to the board, and so
strengthen their position on the board. The UK code recommends that there should be a
nominations committee of the board manned by NEDs.
Other areas
Other areas of potential conflict of interest can be identified, such as succession planning, and the
boards decisions on making acquisitions or in preparing defences against a takeover bid. In each
of these areas NEDs should be able to provide a counter balance to the self interested views of
executive directors.
(c)
Share Payments
In many companies, NEDs receive a fixed cash payment for their services, without any incentives.
However some companies pay their NEDs in shares.
They would argue that the more equity the NEDs hold, the more likely they will be to look at
issues from the point of view of the shareholders. There is a risk that a NED holding shares could
be more concerned with short-term movements in the share price and the opportunity of making a
short term profit from selling their shares. However, a suitable precaution against this could be to
obtain the agreement of a NED not to sell his or her shares until after leaving the board.
Share Options
The argument that NEDs should be rewarded with share options is more contentious, but it has
been widely practised in the UK and is even more common in the US. The argument against
rewarding NEDs with share options is that this form of remuneration could align the interests of
the NEDs more closely with the executive directors, who also hold share options. NEDs should
give independent advice, and it can be argued that it is therefore not appropriate to incentivise
them in the same way as the executives.
The UK Code points out that holding of share options could be relevant to the determination of a
non-executive directors independence. It states that remuneration for non-executive directors
should not include share options. If, exceptionally, options are granted, shareholder approval
should be sought in advance and any share acquired by exercise of the options should be held
until at least one year after the non-executive director leaves the board.
172
Board of directors
REPORT
To:
From:
Date:
Subject:
Board of directors
Consultant
December X4
Board of directors and committees
Chairman
The UK Corporate Governance Code states that there should be a clear division between the chief
executive of the company, who has executive responsibility for running the company's business, and the
chairman of the board of directors who is responsible for running the board.
The main roles of the chairman should be to:
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
The board should include a balance of executive and non-executive directors and the role of the nonexecutive directors should include the following elements.
Being 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
173
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.
Caius plc
Tutor's note. A good guideline for this type of question would be the key points relating to directors
remuneration from the UK Code. This will give you most of the key areas that require to be discussed.
To:
From:
Date:
Subject:
Board of Directors of Caius plc

Accountant
XXXX
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 directors obligations to mitigate loss.
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.
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.
175
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 substandard/ 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.
176
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
COSO Framework
(a)
Avoidance means exiting the activities that give rise to risk. Risk avoidance may involve
disposing of a business unit, product line, or geographical segment, or simply deciding not to
engage in new initiatives/activities that would give rise to the risks.
If reduction is the chosen response then action is taken to reduce risk likelihood or impact, or
both. This typically involves any of a large number of everyday business decisions, including
diversifying product offerings, establishing operational limits for activities, establishing more
effective business processes, enhancing management involvement in decision making and
monitoring, rebalancing the entitys portfolio of assets to reduce exposure to certain types of
losses, or reallocating capital among operating units.
Sharing entails reducing risk likelihood or impact by transferring or otherwise sharing a portion
of the risk. Common techniques include purchasing insurance products, engaging in hedging
transactions, entering into joint ventures or partnerships, sharing risk through contractual
agreements with customers, vendors, or other business partners, or outsourcing an activity.
If acceptance is the chosen response no action is taken to affect risk likelihood or impact: the risk
is accepted because it already conforms to the entitys risk tolerances. The entity may have selfinsured against loss, or it may rely upon natural offsets within a portfolio.
(b)
Control activities are the actions of people to implement policies, directly or through application of
technology, in such a way as to help ensure that managements risk responses are carried out.
Many procedures are commonly performed by personnel at various organisational levels that
serve to enforce adherence to established action plans and to keep entities on track toward
achieving their objectives.
Here are some examples.
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 banks 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 customers 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.
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.
Ethical considerations
To:
From:
Date:
Subject:
The Managing Director

The Financial Controller
XX.XX.XX
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)
(b)
That X Ltd can secure the support of its other creditors

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:
From:
Date:
Subject:
Directors
Consultant
Dec X4
Corporate citizenship
Introduction
Companies have choices as to how they manage their businesses. These choices can be many and
varied but the choices that are made can determine whether or not the company is seen as a good
citizen. Many of the world's companies are setting high standards of behaviour in many aspects of
business and in a wider social context.
Corporate citizenship
The concept of corporate citizenship recognises that there is a connection between the everyday
activities of companies and the well being of society as a whole. In recent years companies have adopted
a more comprehensive approach to corporate citizenship in general, and this includes social and
environmental responsibility.
Directors now accept that they are not only responsible to the shareholders the owners of the company
but also to a wider selection of other stakeholders which will include employees, customers, investors,
business partners, suppliers, the community and the government.
It can be argued that corporate citizenship is made up of three key components:
(1)
(2)
(3)
The basic values, policies and practices of a company and its business at home and abroad
The management of environmental and social issues within the value chain of business partners
The voluntary contributions made by a company to community development around the world
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

1 mark for each factor applicable to Franks & Fisher
7
3
(b)
(c)
(d)
1 mark for each relevant point identified and briefly described

1 marks for each relevant point made
2 marks for definition of objectivity
1 mark per relevant characteristic identified and briefly described
2
3
10
6
4
5
25
(a)
Turnbull report
The UK Turnbull report lists a number of considerations which will be taken into account when
deciding whether to establish an internal audit department; most are relevant here.
Scale and complexity of operations
This has clearly increased recently with rapid growth meaning more products and activities being
taken on, and possibly more that can go wrong. Internal audit review can act as a check on the
decision-making processes, that all the implications of the change in business have been fully
considered.
Number of employees
Increases in employee numbers are an indication of changes in size and the need for
development of human resource systems, which internal audit would wish to evaluate.
Changes in organisational systems
Overall control systems will have to develop, and internal audit will be an important part of this
change. Internal audit may be particularly needed as a check on the development of other parts of
the system; with rapid growth, there is a danger that information systems for example may not
develop in a way that is best for the company.
Changes in key risks
Changes in products and activities will bring changes in risks. There will be risks associated with
the production and sales of the new products, such as production stoppages, health and
safety considerations and distribution difficulties. There may also be changes in the general
risks that Franks and Fisher faces, with possibly the increased risk of inefficiencies and
diseconomies of scale. Internal audit can review the adequacy of the overall risk
management systems for coping with these changes and carry out work on specific areas of
high areas.
Problems with internal systems
The breakdown has highlighted possible problems with quality standards. The recent changes
may mean that they would be inadequate anyway even if rigorously enforced. However they
have not been employed conscientiously, and this calls into question whether other parts of the
control systems are working as effectively as they should be. Internal audit should definitely
investigate this.
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Unacceptable events
Clearly the production breakdown was an unacceptable event because of its consequences and
its avoidability. Franks and Fisher is trying to establish itself in various product markets and
therefore disruption in supply could have particularly serious consequences. If internal audit
recommendations can reduce the chances of this happening in future, clearly this will be a major
benefit.
Cost-benefit considerations
The fact that the board are talking about limiting internal audit's work may indicate that costbenefit considerations are significant. Fears that internal audit will interfere with operational
departments may well be exaggerated, and well-directed internal audit work should bring
benefits. However if internal audit's work is going to be seriously limited, it may not be worthwhile
employing an internal auditor.
(b)
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.
185
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
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?
186
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?
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

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)
Tuckers 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.
187
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
188
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:
Writing:
15 minutes
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 Chemcos internationalisation strategy. Based outside Europe in a region of growth in the chemical
industry, JPX was seen by analysts as a good opportunity for Chemco, especially as JPXs recent flotation had
provided potential access to a controlling shareholding through the regional stock market where JPX operated.
When the board of Chemco met to discuss the proposed acquisition of JPX, a number of issues were tabled for
discussion. Bill White, Chemcos chief executive, had overseen the research process that had identified JPX as a
potential acquisition target. He was driving the process and wanted the Chemco board of directors to approve the
next move, which was to begin the valuation process with a view to making an offer to JPXs shareholders. Bill
said that the strategic benefits of this acquisition was in increasing overseas market share and gaining
economies of scale.
While Chemco was a public company, JPX had been family owned and operated for most of its thirty-five year
history. Seventy-five percent of the share capital was floated on its own countrys stock exchange two years ago,
but Leena Sharif, Chemcos company secretary, suggested that the corporate governance requirements in JPXs
country were not as rigorous as in many parts of the world. She also suggested that the family business culture
was still present in JPX and pointed out that it operated a two-tier board with members of the family on the upper
tier. At the last annual general meeting, observers noticed that the JPX board, mainly consisting of family
members, had dominated discussions and had discouraged the expression of views from the companys
external shareholders. JPX had no non-executive directors and none of the board committee structure that many
190
listed companies like Chemco had in place. Bill reported that although JPXs department heads were all
directors, they were not invited to attend board meetings when strategy and management monitoring issues were
being discussed. They were, he said, treated more like middle management by the upper tier of the JPX board
and that important views may not be being heard when devising strategy. Leena suggested that these features
made the JPX boards upper tier less externally accountable and less likely to take advice when making
decisions. She said that board accountability was fundamental to public trust and that JPXs board might do well
to recognise this, especially if the acquisition were to go ahead.
Chemcos finance director, Susan Brown advised caution over the whole acquisition proposal. She saw the
proposal as being very risky. In addition to the uncertainties over exposure to foreign markets, she believed that
Chemco would also have difficulties with integrating JPX into the Chemco culture and structure. While Chemco
was fully compliant with corporate governance best practice, the country in which JPX was based had few
corporate governance requirements. Manprit Randhawa, Chemcos operations director, asked Bill if he knew
anything about JPXs risk exposure. Manprit suggested that the acquisition of JPX might expose Chemco to a
number of risks that could not only affect the success of the proposed acquisition but also, potentially, Chemco
itself. Bill replied that he would look at the risks in more detail if the Chemco board agreed to take the proposal
forward to its next stage.
Finance director Susan Brown, had obtained the most recent annual report for JPX and highlighted what she
considered to be an interesting, but unexplained, comment about negative local environmental impact in its
accounts. She asked chief executive Bill White if he could find out what the comment meant and whether JPX
had any plans to make provision for any environmental impact. Bill White was able to report, based on his
previous dealings with JPX, that it did not produce any voluntary environmental reporting. The Chemco board
broadly supported the idea of environmental reporting although company secretary Leena Sharif recently told Bill
White that she was unaware of the meaning of the terms environmental footprint and environmental reporting
and so couldnt say whether she was supportive or not. It was agreed, however, that relevant information on
JPXs environmental performance and risk would be necessary if the acquisition went ahead.
Required
(a)
Evaluate JPXs current corporate governance arrangements and explain why they are likely to be
considered inadequate by the Chemco board.
(10 marks)
(b)
Manprit suggested that the acquisition of JPX might expose Chemco to a number of risks. Illustrating from
the case as required, identify the risks that Chemco might incur in acquiring JPX and explain how risk can
be assessed.
(15 marks)
(c)
Construct the case for JPX adopting a unitary board structure after the proposed acquisition. Your answer
should include an explanation of the advantages of unitary boards and a convincing case FOR the JPX
board changing to a unitary structure.
(10 marks)
(d)
Explain FOUR roles of non-executive directors (NEDs) and assess the specific contributions that NEDs
could make to improve the governance of the JPX board.
(7 marks)
(e)
Write a memo to Leena Sharif defining environmental footprint and briefly explaining the importance of
environmental reporting for JPX.
(8 marks)
(Total = 50 marks)
Question 1
This question is an example of whats likely to be a common type of question on this paper, evaluate the
inadequacies and suggest improvements. However parts (c) and (d) are quite specific about which areas you
have to discuss, indicating you need a detailed knowledge of corporate governance issues to underpin your
discussions. The question part on risk is mixed in with this discussion on corporate governance, indicating how
different parts of the syllabus will be combined in the case study question.
This question covers material from a number of chapters, and you can expect Question 1 to be drawn from areas
covered across the whole of your Study Text.
191
Question 2
In a recent case, it emerged that Frank Finn, a sales director at ABC Co, had been awarded a substantial overinflation annual basic pay award with no apparent link to performance. When a major institutional shareholder,
Swanland Investments, looked into the issue, it emerged that Mr Finn had a cross directorship with Joe Ng, an
executive director of DEF Co. Mr Ng was a non-executive director of ABC and chairman of its remunerations
committee. Swanland Investments argued at the annual general meeting that there was 'a problem with the
independence' of Mr Ng and further, that Mr Finns remuneration package as a sales director was considered to
be poorly aligned to Swanlands interests because it was too much weighted by basic pay and contained
inadequate levels of incentive.
Swanland Investments proposed that the composition of Mr Finns remuneration package be reconsidered by the
remunerations committee and that Mr Ng should not be present during the discussion. Another of the larger
institutional shareholders, Hanoi House, objected to this, proposing instead that Mr Ng and Mr Finn both resign
from their respective non-executive directorships as there was 'clear evidence of malpractice'. Swanland
considered this too radical a step, as Mr Ngs input was, in its opinion, valuable on ABCs board.
Required
(a)
Explain FOUR roles of a remuneration committee and how the cross directorship undermines these roles
at ABC Co.
(12 marks)
(b)
Swanland Investments believed Mr Finns remuneration package to be poorly aligned to its interests.
With reference to the different components of a directors remuneration package, explain how Mr Finns
remuneration might be more aligned to shareholders interests at ABC Co.
(8 marks)
(c)
Evaluate the proposal from Hanoi House that both Mr Ng and Mr Finn be required to resign from their
respective non-executive positions.
(5 marks)
(Total = 25 marks)
Question 2
This question has some similarities to Question 1, requiring knowledge of specific areas of good corporate
governance practice and application of that knowledge to identify weaknesses and recommend improvements.
Ethics part (c) is only worth 5 marks; you may well encounter more complex ethical situations requiring
discussion worth more marks.
Chapter 3 of your Study Text thoroughly covers the issues involved in this question.
192
193
194
195
196
197
END OF APPENDIX A
198
Appendix B:
Information
about M&S
199
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 Greenburys departure the company suffered a slump in its fortunes. There were
problems in the board room and shareholders were keen to know who to blame for the companys problems.
Some believed the problems stemmed from decisions made by Richard Greenbury. The company finally started
accepting credit cards (other than its own store card) in early 2000. Stuart Rose the current CEO is credited with
turning the business around following his appointment in 2004.
2008: In early 2008 the business was criticised when it was announced that Stuart Rose was to be elevated to
the position of Executive Chairman (ie joint CEO/Chairman). There was also criticism after it emerged that he
had invested money in a business belonging to one of the non-executive directors. The company announced
disappointing trading results on 1 July 2008 and saw the value of its shares fall by nearly a quarter in one day (to
2.40 having reached a peak of 7.66 in May 2007) although its profits after tax were an impressive 821 million
for the year to 29/3/08 (660 million in the previous year).
2010: In May 2010 Marc Bolland replaced Stuart Rose as CEO. Stuart Rose remained as Chairman until a
successor, Robert Swanwell was appointed in January 2011. Marc Bolland is a NED at Manpower Inc and
Robert Swanwell serves as a NED at HMV Group plc.
200
Extract from Marks and Spencers Annual Report 2011
M&S page 38
201
M&S page 39
202
M&S page 40
203
M&S page 41
204
M&S page 42
205
M&S page 43
206
M&S page 44
207
M&S page 45
208
M&S page 46
209
M&S page 47
210
M&S page 48
211
M&S page 49
212
M&S page 50
213
M&S page 51
214
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ACCA PAPER P1
Written Assessment 1
RESULTS
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Total
% Mark
50
100%
Score
Date received: .........................................................................................

Date returned: .........................................................................................
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
Ticks in the left-hand boxes indicate a good aspect of your performance.
Tick in the right-hand boxes highlight areas you need to work on.
(Note: Boxes may be left empty if the comments are not applicable to your script)
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ACCA P1 GOVERNANCE, RISK

AND ETHICS
Achievement Ladder
Step 4 Questions
217
218
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 Waters operational
activities with the principles-based approach used for corporate governance of the company.
(8 marks)
(Total = 25 marks)
219
Question 2
Question text
Felicia Galka works as the risk manager for a large European listed company which operates public
transport (rail, bus and ferries) in and between several European countries. She recently attended an
international conference on risk management. Most of the conference delegates were risk managers
but found that they came from a wide range of backgrounds and that their roles differed widely from
one organisation to another.
Practically all the delegates attended the opening session on reputation risk, which was described as
the risk of risks.
Felecia also attended a session on probity risk and another on derivative risk. These had both been
recent issues for her employer as it had tendered bids to various governments awarding operating
licences for train and ferry routes and had been considering forward contracts to manage the risks of
fuel price increases.
While networking with other conference delegates the main focus of discussion was on the difficulty of
getting anybody else in their organisations to take risk seriously. A common them e was that the risk
managers were perceived as Health and Safety Police.
Required
(a) Define and explain the sources and impacts of the three common business risks discussed at the
conference seminars: reputation risk, probity risk and derivatives risk.
(12 marks)
(b) Explain and assess the role of the risk manager in identifying and monitoring risk.
(8 marks)
(c) Explain the importance of risk awareness at all levels in an organisation.
(5 marks)
(Total = 25 marks)
220
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Student name: ........................................................................................

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Company: .........................................................................
Date of birth: ........................................ 19......................
.................................................................................................................
Date of sitting: ..................................................................
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Written Assessment 2
RESULTS
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Q2
Q3
Q4
Maximum
40
20
20
20
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Date received: .........................................................................................

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Exam Identification Code
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ACP1CEQ(2A)13
Marker's assessment
Ticks in the left-hand boxes indicate a good aspect of your performance.
Tick in the right-hand boxes highlight areas you need to work on.
(Note: Boxes may be left empty if the comments are not applicable to your script)
Approach
Questions correctly interpreted
Good
performance
Relevant to
question
How to
improve
Improvement
needed
Careful reading
Review the definitions of
question words
Logical coherent answers
Practise planning and full

written answers
Technical content
Understanding of principles
Principles applied well to specific

problems
Reading your Study Text

More question practice
required
Computation
High standard of accuracy
Check your workings

Layout your workings clearly
Workings are easy to follow
Appearance/Layout
Label and cross reference
Text layout is clear and easy to follow
Neat handwriting
Use plenty of space
Use headings and
subheadings
Use short paragraphs
Calculations are easy to follow
Neat diagrams and tables

Workings labelled
Written style
Concise business style
Answering the question set
Short concise sentences
Think before you write
ACCA P1 GOVERNANCE, RISK

AND ETHICS
Achievement Ladder
Step 6 Questions
223
224
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
225
choice. Friar Holdings only needed to comply with the governance requirements that the board
thought were appropriate, and could list the disclosure requirements with which it had not complied.
Directors remuneration
Chris Friar said that his own salary would increase by 10%, and that he would speak separately with
each director, telling them what their salary would be for the following year. As well as basic salary
and bonuses (determined by Chris Friar on the basis of what he believes appropriate for each
director) directors also have pension contributions paid into a directors pension scheme. There is no
staff pension scheme in Friar Holdings. Chris Friar appraises all other directors using his own criteria
and his decisions on salary and bonuses are made on the basis of those appraisals.
Redevelopment of boat yard
Chris Friar proposed closing the Merman boatyard that was run by Renton Marine on the grounds that
it was earning insufficient return. As the boatyard was located on the banks of the River Humble,
Chris Friar proposed turning the site into luxury flats and a leisure complex. He commented that this
represented a major strategic opportunity for Friar Holdings. The shareholders would be happy with
the high expected return on investment and that many people would wish to buy luxury apartments
and use the leisure complex. Chris Friar commented that the development would also benefit the local
economy, providing jobs in the leisure complex and bringing more people into the area.
Shareholder concerns
At a recent board meeting of the Allied and Temple bank, concern was expressed about the attitudes
to corporate governance of the board of Friar Holdings, and the lack of communication that between
the board of Friar Holdings and the bank since the bank acquired its shareholding when Friar
Holdings was listed. The chairman of the bank also raised concerns about the proposed development,
since a leak to the local press had led to unfavourable publicity about the plan. The Allied and Temple
bank has marketed itself as the ethical bank and thus is very wary of maintaining investments that
may be connected with unethical behaviour.
The banks board is also aware of criticisms made by other institutional shareholders about the level
of remuneration paid to the directors of Friar Holdings.
As a result of its discussions, the banks board gave Sir James Soames, a member of the board,
responsibility for liasing with the board of Friar Holdings and communicating the banks concerns.
Required
(a) Evaluate Friar Holdings current corporate governance arrangements and explain why they are
likely to be considered inadequate by the Allied and Temple bank and other major shareholders.
Your answer should not include discussion of remuneration issues or communication with
shareholders.
(12 marks)
(b) Write a memo to Sir James Soames recommending improvements in Friar Holdings
arrangements for determining remuneration and remuneration policies.
(10 marks) (Including 2 professional marks)
(c) Discuss how the Allied and Temple bank and other institutional shareholders can increase their
influence over Friar Holdings.
(8 marks)
(d) Construct a case for the board of Friar Holdings taking into account additional stakeholder
interests to those currently being considered, when deciding whether and how to pursue the
proposed new development.
(10 marks) (Including 2 professional marks)
(Total = 40 marks)
226
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 its 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
banks 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 Banks 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.
227
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)
228
229
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Governance, Risk and Ethics

Improving study material and removing errors

P1 Governance, Risk and Ethics

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

Achievement Ladder Step 2

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

Achievement Ladder Step 3

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

Achievement Ladder Step 4

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

Achievement Ladder Step 5

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

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

Welcome to P1 Governance, Risk and Ethics

Introduction to Paper P1 Governance, Risk and Ethics

Governance and responsibility

Explain the role of the accountant in identifying and assessing risk

Demonstrate the application of professional values and judgement through an ethical

Links with other papers

Taught Phase Aims

Governance and responsibility

A1 The scope of governance

A2 Agency relationships and theories

A3 The board of directors

A6 Different approaches to corporate governance

A7 Corporate governance and corporate social responsibility

A8 Governance: reporting and disclosure

A9 Public sector governance

Internal control and review

B1 Management control systems in corporate governance

Identifying and assessing risk

C1 Risk and the risk management process

C3 Identification, assessment and measurement of risk

B4 Management information in audit and internal control

Controlling and managing risk

D1 Targeting and monitoring risk

D2 Methods of controlling and reducing risk

D3 Risk avoidance, retention and modelling

Professional values, ethics and social responsibility

E2 Different approaches to ethics and social responsibility

E3 Professions and the public interest

E4 Professional practice and codes of ethics

E5 Conflicts of interest and the consequences of unethical behaviour

Assessment methods and format of the exam

The paper is divided into two sections

This ONE question is compulsory and MUST be attempted

This question is based on a detailed scenario, which provides a

TWO optional questions from a choice of THREE are to be

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

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?

Example past paper questions

Define and explain the meaning of

December 2012 Q2a (10 marks) explaining the meaning

Accountability December 2014 part of Q1dii (6 marks)

Explain, and analyse the issues raised

June 2012 Q1d (18 marks) applying Mendelow to