P1 Student Notes PDF

Student
Notes
ACCA Paper P1
Professional Acccountant
For exams in December 2008
To be used with the BPP Study Text for exams in December 2008 and
June 2009 (2008 edition)
First edition 2008

ISBN 9780 7517 5713 2
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is available from the British Library
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2008
ii
CONTENTS
chapter 1
SCOPE OF CORPORATE GOVERNANCE
page 1
chapter 2
APPROACHES TO CORPORATE GOVERNANCE
page 17
chapter 3
CORPORATE GOVERNANCE PRACTICE AND
REPORTING
page 33
chapter 4
INTERNAL CONTROL SYSTEMS
page 49
chapter 5
INTERNAL ENVIRONMENT AND OBJECTIVE
SETTING
page 63
chapter 7
RISK RESPONSE AND CONTROL
ACTIVITIES
page 87
chapter 8
INFORMATION, COMMUNICATION AND
MONITORING
page 95
chapter 9
ETHICS
page 109
chapter 10
ETHICS AND PROFESSIONAL PRACTICE
page 119
chapter 11
CORPORATE SOCIAL RESPONSIBILITY
page 133
chapter 6
EVENT IDENTIFICATION AND RISK
ASSESSMENT
page 77
Introduction
iii
iv
chapter 1
DEFINITION
CONCEPTS
AGENCY
STAKEHOLDERS
MAIN ISSUES
This chapter sets out the foundations of good corporate

governance, defining what corporate governance is and
whom good corporate governance serves. You may
need to consider the conflicting interests of
stakeholders and how stakeholders can control
managers/directors. We also summarise major issues
in corporate governance.
SCOPE OF
CORPORATE
GOVERNANCE
DEFINITION
Definition
Concepts
Agency
Stakeholders
Main issues
Corporate governance is the system by which organisations are directed and controlled. It is a set of
relationships between directors, shareholders and other stakeholders.
Risk management
and reduction
Appropriate control
systems
Framework to
pursue strategy
Corporate governance
Guards against
misuse of resource
Spirit of codes
Accountability to
stakeholders
Context
Good corporate governance enables investors to feel confident that their investment is wellmanaged and will not be lost as a result of bad decisions, poor management control or greed of the
directors.
Learning example 1.1

10 years ago a fund manager invested $15m in the shares of CAET Corporation, a successful retail
clothing chain. Today the investment is worth only $3m.
What could have gone wrong at CAET Corporation?
What difference could having a better accounting function at CAET Corporation over the past 10
years have made?
Solution 1.1
1: Scope of corporate governance
CONCEPTS
Definition
Concepts
Agency
Stakeholders
Main issues
Fairness
Take into account all stakeholders with legitimate interests
Transparency
Openness, disclosure in financial statements, press releases, websites
Independence
Need for independent non-executive directors who can monitor without

conflicts of interest
Probity
Truth-telling/not misleading
Responsibility
Management responsible for organisation, means of corrective action and

penalising mismanagement
Accountability
Directors answerable for consequences of actions, to shareholders and

stakeholders (?)
Reputation
Jeopardised by poor risk management/corporate governance, may impact

commercially
Judgement
Taking decisions that enhance organisations prosperity
Integrity
Straightforward dealing and completeness, basis of trust
Context
These terms are used in many documents relating to corporate governance and laying down the
responsibilities of directors and others.

The ACCA Rulebook has a Code of Ethics and Conduct for members that lays down five fundamental
principles:
Integrity
Straightforward and honest in all professional and business

relationships fair dealing and truthful.
Objectivity
Should not allow bias, conflicts of interest or undue influence of

others to override professional or business judgements.
Professional competence and

due care
Maintain professional knowledge and skill at a level to ensure that

a client or employer receives competent professional service.
Confidentiality
Respect the confidentiality of information acquired as a result of

professional and business relationships and not disclose any such
information to third parties nor use to their personal advantage.
Professional behaviour
Comply with relevant laws and regulations and avoid any action
that discredits the profession.
Explain why these fundamental principles are important:

(a)
(b)
Running an accounting practice

To the accounting profession as a whole
Solution 1.2
AGENCY
Definition
Concepts
Stakeholders
Main issues
Agency
Agency in corporate governance
Agency is acting on behalf of another (principal) in

dealing with others.
Directors (agents) run company on behalf of

shareholders (principals).
Agency costs are the monies and resources

expended by principal in monitoring agent.
Agency problem how to prevent directors excessively

rewarding themselves/
underperforming.
Agents responsibilities

Agency
Accountability
Fiduciary duty (trust and care)
Personal performance
Obedience
Skill
No conflict of interest
Confidentiality
Handing over benefits
Main solution is to link reward with company

performance:
Profit related pay
Shares
Share option plans
Transaction costs theory

Companies seek to keep business dealings in-house,
managers act opportunistically in their own interests.
Context
Directors and management are agents of shareholders (principals). The principal agent problem
refers to the difficulty faced by shareholders in ensuring that management dont use the firms
money and assets for their own ends.

What would be the indicators of directors misusing their position as agents?
Solution 1.3
STAKEHOLDERS
Definition
Concepts
Stakeholders
Level of interest
Low
Stakeholder theory
Power
Organisations have responsibilities to broad

range of stakeholders. Stockholder view that
company just responsible to shareholders is
wrong as modern corporations are very large
and social/political/legal impact is therefore great.
A:
B:
C:
D:
Normative view ethical/philanthropic

responsibilities as well as economic/legal
Main issues
Stakeholder power mapping
Stakeholders are groups or individuals whose

interests are directly affected by the activities of
a firm or organisation.
Instrumental view mainly economic

responsibilities with aim of maximising profits
Stakeholders
Agency
Low
High
High
A
minimal effort
keep informed, as can influence more powerful stakeholders
keep satisfied
strategy must be acceptable
Results of mapping

Corporate governance accommodates views

Repositioning of stakeholders
Identify change blockers/facilitators
Assess legitimacy/urgency
Context
Because firms affect peoples lives, some believe that management should accommodate the
interests of more than just shareholders when running companies.

The Board of a medium-sized private company is considering becoming fully listed on the stock
market. The family that presently holds 100% of share capital will have their holdings diluted down
to 30% as more shares are issued and capital is raised.
Classify the following using stakeholder mapping and justify your decision.
(a)
(b)
(c)
(d)
Employees of the company

The family that owns the shares at present
The Stock Market's regulators
Customers of the company
Solution 1.4
STAKEHOLDERS
Definition
Concepts
Stakeholders
Main issues
Proximity to organisation
Primary and secondary stakeholders
Internal employees/management
Primary need participation to continue as going

concern (customers, suppliers, government)
Connected shareholders, customers, suppliers,

lenders, trade unions, competitors
External government, local government, public,
pressure groups, opinion leaders
Narrow and wide stakeholders
Secondary their ceasing to participate wont affect

continued existence (government, managers)
Active and passive stakeholders
Narrow most affected by organisations strategy

(shareholders, employees, suppliers, major customers)
Active seek to participate in organisation's

activities (managers, shareholders, regulators,
pressure groups)
Wide less affected by organisations strategy

(government, less significant customers, community)
Passive dont seek to participate in policy-making

(shareholders, local communities, government)
Voluntary and involuntary stakeholders
Legitimacy of stakeholders
Voluntary those who voluntarily have involvement

with the organisation employees, customers,
suppliers, shareholders
Legitimate valid claims
Involuntary engage with the organisation without

choosing to do so neighbours, wider public
Who decides legitimacy?
Recognition of stakeholders
Knowledge of stakeholders
Recognised Managers consider interests and views

when deciding strategy
Known Existence known to organisation
Unrecognised Managers don't consider claims when

deciding strategy
10
Agency
Illegitimate invalid claims
On what basis?
Unknown Existence unknown to organsiation

(wildlife, communities affected by suppliers)
Context
These are examples of stakeholders and the different ways to classify them.

The Board of a hotel company is considering acquiring land in an unspoiled area of great natural
beauty to build a hotel and shopping complex, the first of its kind in the country.
Classify the affected stakeholders using the stakeholder power mapping matrix.
Tutor note. The value of this exercise will be in the application of ICE and what power and interest
each stakeholder has. A good approach is to draw up the matrix and fill it in from class suggestions.
The solution below is merely our suggestion.
Solution 1.5
11
STAKEHOLDERS
Definition
Directors
Secretary
Sub-board management
Employees
Trade unions
Suppliers
Customers
External auditors
Regulators
Government
Stock exchanges
Institutional investors
12
Concepts
Agency
Stakeholders
Main issues
Executive full-time managers, non-executive monitoring

Arranges board meetings, deals with documents and registers, general administration,
reports to chairman
Impact of governance upon their position including their chances of becoming
directors
Commitment, interest in pay and conditions, need to comply with control systems and
adopt culture
Pay, prospects plus working conditions of members, concerned with poor board
communication, lax risk and control environment
Co-operation needed for just-in-time supply, poor payment record leads to credit
restriction and poor service
Increased expectations, power to shop elsewhere, ability to make views known, ethical
requirements
Independence required to supply confidence in information, need for audit committee

to reinforce position
Establish rules and standards, carry out inspections. May be enforcement costs or
regulatory capture, domination of regulator by regulated
Establish overall control climate, influence investors through taxes, encourge private
shareholdings, provide subsidies and investment trusts
Companies raise money, investors transfer shares, provide regulatory framework for
governance
Can influence prices, avoid speculative shares, want short-term profits, can influence
companies through meetings and voting, able to take direct action if dissatisfied
Context
These are examples of stakeholders and why they are important to organisations.
13
MAIN ISSUES
Definition
14
Concepts
Agency
Stakeholders
Main issues
Duties of directors
Directors remuneration
Corporate governance guidelines reinforce legal and

fiduciary duties to act in companys best interests,
use powers for proper purpose, avoid conflicts of
interest and exercise duty of care.
Directors being paid undeserved and excessive

remuneration and bonuses. Allegations that directors
have been rewarded for making losses.
Board composition
Board supervision
Need to avoid domination by single individual/small

group of executive directors.
Need for board to meet regularly to consider effectively

organisations activities, risks and control systems.
Accounting and auditing
Corporate social responsibility
Greater transparency and reliability of accounts,

decreasing investor risks. Tougher auditing standards
and requirements for auditors to avoid conflicts of
interest.
Builds on stakeholders debate, what responsibilities

should organisation and board fulfil.
Context
These are the main techniques used to assure proper corporate governance. They will be examined
in detail in later chapter.
15
Reinforcement
Using Chapter 1 of your Study Text
16
Expand notes on corporate governance concepts (Section 1.2), fiduciary

responsibility (Section 2.2) and stakeholders (Sections 3.10 3.26)
Attempt questions Mendelows matrix and Concepts in Chapter 1
Attempt Quick Quiz
Attempt Question 1 Bonus schemes from Exam Question Bank at the back of
your Study Text
chapter 2
DEVELOPMENT OF GUIDANCE
BASIS OF GUIDANCE
MAJOR GOVERNANCE CODES
SARBANES-OXLEY
CONTRIBUTION OF CODES
In this chapter we summarise the factors that have

influenced the ways corporate governance has
developed. You may be asked about these in part (a) of
a question before you consider specific corporate
governance arrangements later in the question. We
also give details of the major worldwide codes,
particularly those that have international impact.
Corporate social responsibility is a major topic in this
exam, and the themes we cover will occur in many
questions.
APPROACHES
TO CORPORATE
GOVERNANCE
17
DEVELOPMENT OF GUIDANCE
Development of
guidance
Internationalisation
Basis of
guidance
Major
governance codes
Investor treatment
Sarbanes-Oxley
Financial reporting
weaknesses
Individual country
characteristics
Corporate social
responsibility
Corporate scandals
Governance development
Openness
Integrity
Main goals
18
Contribution
of codes
Accountability
Context
Most codes and rules on corporate governance have developed since 1990. Understanding the
regulations and differences between them can be helped by understanding the circumstances under
which they developed.

Go to www.wikipedia.org and search the following terms. Make brief notes on the scandals, noting
in particular the date, the name of the CEO and the financial practices that were concealed and
which led to the scandal.
(a)
Parmalat
(b)
Enron
(c)
II Robert Maxwell
Solution 2.1
2: Approaches to corporate governance
19
BASIS OF GUIDANCE
Development of
guidance
Basis of
guidance
Major
governance codes
Sarbanes-Oxley
Principles-based approach
Most corporate governance codes have been drawn up
on the basis of a principles-based approach with broad
guidelines supplemented by limited specific
requirements. Danger may be that over-broad principles
are not strong enough.
Contribution
of codes
Corporate social
responsibility
Advantages of principles

Avoids inflexible rules

Less burdensome
Allows scope for development
Comply or explain
Emphasis on investor judgement
Insider systems
Outsider systems
Most companies listed on stock exchange are controlled

by a few individuals.
Shareholdings are widely dispersed, manager/owner

separation.
Outsider
Advantages/Disadvantages
Robust
governance
regime

Strong owner-manager links
Hostile takeover threat constrains management
Longer-term view
Agency problem
Discrimination v minority
Short-term priorities
Lack of monitoring/governance
Insider
20
Context
Corporate governance develops to keep pace with changes in firms behaviour and the economic
contexts that firms operate in. This leads some countries to prefer the certainty of a system based
on strict rules. Others prefer the adaptability and flexibility of codes based on principles.

Consider the advantages listed for principles-based approaches opposite. Use them to help you.
(a)
(b)
List the disadvantages of rule-based approaches.

Suggest advantages of rule-based approaches.
Solution 2.2
21
MAJOR GOVERNANCE CODES
Basis of
guidance
Development of
guidance
Major
governance codes
Contribution
of codes
Corporate social
responsibility
Cadbury report
Combined Code
Report aims to address weaknesses in director-auditor

arrangements, particularly perception that auditors
often capitulate to directors. Code of Best Practice
covers role of the board, audit, financial reporting and
shareholder relations.
Code derives from Cadbury, Greenbury and Hampel

reports, supplemented by:
Greenbury report
Non-executive directors determine executive directors
remuneration and service contracts limited to one year.
Turnbull report risk and internal control

Smith report audit committees
Higgs report non-executive directors
King report
Principles-based approach, requiring companies to

comply with, or explain departure from, best practice.
South African report, advocating integrated approach

to variety of stakeholders and importance of social
and environmental as well as economic activities.
Report emphasises need for shareholder activism and
disclosure as regulatory measure.
OECD principles
ICGN report
Organisation for Economic Co-operation and

Development produced non-binding principles to
address the interests of global investors. Companies
should work towards achieving principles, and
principles are guidelines for individual countries to
develop own codes
International Corporate Governance Network has

provided practical guidance for boards to operate
efficiently and compete for scarce capital.
Hampel report
Principles
22
Sarbanes-Oxley
Shareholder participation and voting on directors
Shareholder/stakeholder rights
Equitable treatment of all shareholders
Stakeholders rights protected
Timely/accurate disclosure of material matters
Board responsible for strategy and monitoring
Board should act with due diligence and in companys

best interests
ICGN guidance

Boards role in strategy/monitoring emphasised

Directors need appropriate skills/experience
Directors show independent judgement
Directors fulfil fiduciary duties
Formal process of director evaluation
Shareholders voting rights protected
Major changes require shareholder approval
Returns benchmarked v similar equity cos
Full disclosure of voting rights
Code of ethics
Need to manage stakeholder relationships productively
Context
The Examiner may require you to cite particular codes as examples.

Explain the reasons for the growth of codes of corporate governance since 1990.
Solution 2.3
23
SARBANES-OXLEY
Development of
guidance
Basis of
guidance
Major
governance codes
Sarbanes-Oxley
The Sarbanes-Oxley Act was a response to the
collapse of Enron, one of Americas biggest companies.
The Act is more prescriptive than codes in other
jurisdictions, impacting on disclosures, audits, ethics
and directors share trading.
Auditing requirements
The non-audit services auditors can provide are
significantly restricted and auditors are subject to
various other rules:
Compulsory partner rotation
Retention of audit papers
Quality control standards
Review internal control systems
Contribution
of codes
Corporate social
responsibility
Weaknesses at Enron

Lack of transparency in accounts

Non-executive directors weak
Lack of external audit scrutiny
Directors use of inside information
Dishonesty and law-breaking
Corporate responsibility
Chief executive/chief finance officer certify:
Appropriateness of accounts
Accounts fairly reflect operations and financial
condition
If accounts have to be restated, they forfeit their
bonuses.
Audit committees
Internal control reports
Every listed company should have an audit

committee consisting of independent directors, with
member(s) with financial expertise. Audit committee
should be responsible for:
Annual accounts must contain internal control reports

that:
Appointment, compensation and oversight of

auditors
Discussing key accounting policies with auditors
Setting up complaints mechanisms
24
Sarbanes-Oxley
State management responsibility for control

structure/financial reporting procedures
Assess effectiveness of control structure/financial
reporting procedures (with audit report)
State whether code of conduct for senior financial
officers has been adopted
Whistleblowing
Off-balance sheet transactions
Employees/auditors will be granted whistleblowing

protection if they disclose private employer
information to parties involved in a fraud claim.
There should be appropriate disclosure of material offbalance sheet transactions.
Context
Sarbanes-Oxley Act 2002 is a statutory or rules-based framework of corporate governance that was
introduced to stop a repeat of the abuses that came to light when Enron collapsed in November
2001.

Compare the provisions of the Sarbanes-Oxley Act with the UKs Combined Code and identify any
areas in which SOX has provisions not in the Combined Code.
Solution 2.4
25
CONTRIBUTION OF CODES
Development of
guidance
Highlighted
advantages of good
governance
Major
governance codes
Sarbanes-Oxley
Emphasised key
dangers
Contribution
of codes
Corporate social
responsibility
Provided
benchmarks
Contribution of codes
Promoted good
practice
26
Basis of
guidance
Emphasised
accountability
Stressed
transparency
Context
Having codes of corporate governance has raised investor awareness of the things to watch out for
and to guard against in the behaviour of the boards they appoint.
27

28
Development of
guidance
Basis of
guidance
Major
governance codes
Sarbanes-Oxley
Contribution
of codes
Corporate social
responsibility
Significance of responsibility
CSR and stakeholders
Large businesses in particular face expectations that

they will act in a socially responsible fashion.
Businesses benefit from goodwill and other aspects

of society and therefore owe those particularly
affected by their activities certain duties in return.
Carrolls model
Four levels of responsibilities:

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

Collaboration time-consuming and expensive
Culture clashes with certain stakeholders
Collaboration on some issues, conflict on
others
Lack of consensus between different
stakeholders
Context
Most corporate governance seeks to protect the interests of the shareholder against poor
management of businesses. Corporate Social Responsibility (CSR) considers managements
responsibility for protecting and advancing the interests of the wider society.

Classify the following statements using the Carroll model.
(a)
We believe in giving something back to the community providing the firm can afford it.
(b)
Our CSR statement is just something to attract the customers that care about those things.
(c)
We are proud that our new factory, as well as cutting our costs, has allowed us to give
decent housing and education to families in a developing country.
Solution 2.5
29

30
Development of
guidance
Basis of
guidance
Major
governance codes
Sarbanes-Oxley
Contribution
of codes
Corporate social
responsibility
Ownership responsibilities
By buying shares, shareholders buy a responsibility to
ensure that company is managed in ways consistent
with public welfare. Ownership responsibilities of institutional shareholders have been stressed, institutional
shareholders large % shareholdings meaning they
should be actively involved and pressure managers.
Ownership view problems
Shareholders with small % holdings arent
influential
Shareholders can easily dispose of shares and
this loosens feelings of obligation
Impact of CSR
Objectives
Mission statements
Ethical codes
Governance codes
Stakeholder board representation
Corporate social reporting
Context
This deals with the issue of whether firms should be run in just the selfish interests of the investors
or for society as a whole.

Cafdirect plc is a UK listed company that imports, roasts and distributes coffee beans, cocoa and
tea to consumers via conventional supermarkets and shops to rival the products from traditional
providers like Nestle, General Foods and Kenco. Its website www.cafedirect.co.uk states:
In 2004, we successfully executed the UKs biggest ethical public share issue to become a
publicly listed company, raising 5 million from 4,500 investors. The opportunity enabled our
grower partners, consumers, employees and founders to own a share in the company and to be
directly connected to each other.
Today we work with 39 grower organisations across 13 developing countries,
encompassing 264, 666 farmers and directly improving the lives of more than 1.4 million
people.
Cafdirect is the innovative result of Oxfam, Equal Exchange, Traidcraft, and Twin Tradings
decision to bypass the conventional market and buy coffee direct from disadvantaged growers in
developing countries. Since 2000 alone we have invested more than 3.3 million of our
profits directly into the businesses and communities of our growers, and paid more than
13 million over and above market prices for our raw materials.
Assess Cafdirect from the perspective of wider ownership responsibilities.
Solution 2.6
31
Reinforcement
32
Scan and note principles v rules, insider v outsider system (Section 1)
Learn detail of these codes (Section 2)
Learn the detail of Sarbanes-Oxley Act 2002 (Section 3)
Attempt Questions Combined Code and Writing a code in Chapter 2
Attempt Quick Quiz
Attempt Question 2 Cedric Coffee from Exam Question Bank at the back of
your Study Text
chapter 3
ROLE OF BOARD
BOARD MEMBERSHIP
NON-EXECUTIVE DIRECTORS
DIRECTORS' REMUNERATION
STAKEHOLDER RELATIONSHIPS
REPORTING
Corporate governance practice is a key area in this

syllabus, and you can expect many questions on
whether an organisation is following good practice.
CORPORATE
GOVERNANCE
PRACTICE AND
REPORTING
33
ROLE OF BOARD
Role of board
Board
membership
Directors
remuneration
Non-executive
directors
Scope of boards role

The board should have a formal schedule of matters
reserved to it for decisions. Board is also responsible
for overseeing strategy, monitoring risk, control
systems and management, and ensuring effective
communication.
Nomination of directors
Nomination committee should oversee appointments
and make recommendations to the board. Needs to
consider:

34
Executives/non-executives
Gaps in current boards skills
Expanding board diversity
Continuity and succession planning
Stakeholder
relationships
Reporting
Matters for board decision

Mergers and takeovers

Acquisitions/disposals of major assets
Investments
Capital projects
Loans/borrowing facilities
Major foreign currency transactions
Legal and regulatory frameworks

Legal responsibilities
Avoidance of conflict of interest
Time limits on appointments
Limits on service contracts
Departures from office
Insider dealing
Context
The Board is the controlling mind of the business. It is supposed to control the business rather
than control the day-to-day operations. For the governance of the business to be adequate the
Board must have the right members, the right to take important decisions, and to be aware of its
legal and regulatory duties.

Advise a director on their legal or regulatory duty in the following circumstances:
(a)
He holds shares in the company but has seen a profit forecast that means profits and share
price will probably fall in the near future.
(b)
He has taken up a non-executive directorship with one of the firms suppliers.
(c)
He has been recently convicted of a serious criminal offence involving privately obtaining
bank loans by deception.
Solution 3.1
3: Corporate governance practice and reporting
35
ROLE OF BOARD
CPD and appraisals

All board members should have training covering
strategy, management, legal responsibilities and
company related issues.
There should be annual appraisals of the performance
of the whole board and of individual directors.
Multi-tier boards
Companies in some countries are run by two or more
boards, often with supervisory/management role split.
36
Board appraisal

Performance against objectives

Contribution to strategy/environment
Response to problems
Considering right matters
Communication
Effectiveness of board committees
Quality of feedback
Adequacy of decision-making
Advantages of multi-tier boards
Disadvantages of multi-tier boards

Supervisors/supervised separation
Deters management fraud
Better links with stakeholders
Better use of non-executive time
Lack of accountability
Dont receive information from managers
Supervisory board decision-making restricted
Less effective at questioning managers
Context
This develops the issue of ensuring the effectiveness of the Board. Board effectiveness will be
influenced by how able the Board members are (CPD), how in-touch with the business they are
(unitary v multi-tier) and whether they are monitored (appraisal).

A recent report on European corporate governance states:
Germany's supervisory boards, normally made up of 20 non-executive directors, are required by
law and are meant to oversee a management board as part of a two-tier system to bring stability
and long-term perspective. In practice they have few foreigners on them just 7% compared with
Switzerland's 45%. This leaves an elite group of German non-executive directors, often sitting on
each other's boards, to run most of Germany's top companies. They have the fewest meetings a
year and are paid the third-most in Europe. The main issues are all discussed and agreed by
shareholder representatives beforehand, reducing the effectiveness of meetings hugely.
Evaluate German Supervisory Boards using the headings of
(a)
(b)
(c)
(d)
Principal agent problem

Effectiveness of corporate governance
Board diversity
Stakeholder representation
Solution 3.2
37
BOARD MEMBERSHIP
Role of board
Board
membership
Non-executive
directors
Stakeholder
relationships
Reporting
Board membership
Division of responsibilities
Companies need to consider optimum

size, balance of executive and nonexecutive directors, and diversity of
membership.
No one individual should have unfettered control. Ideally chairman and

chief executive should be different people; if not there should be a strong
independent element on the board with a recognised senior member.
Board committees supervise specific

areas, doesnt absolve main board
from overall responsibilities. Key
committees:

Nomination
Internal audit
Remuneration
Risk management
(this chapter)
(Chapter 8)
(this chapter)
(Chapter 5)
Responsibilities of CEO
Responsibilities of chairman
Board committees
38
Directors
remuneration
Running board
Accurate board information
Effective shareholder
communication

New director induction

Board appraisal
Board development
Signing off accounts

Strategic development
Investment analysis
Risk management
Recommendations to
board committees
Context
Segregation of duties is a well-known internal control. This principle applies to Boards too.

Norman Meany is the Executive Chairman of a company that is about to seek a Stock Market listing.
He also holds 30% of the issued shares. He founded the company 25 years ago to provide language
tuition and in the last 10 years has opened private schools. During this time he was the Managing
Director but, shortly before listing last year, changed to Chairman and appointed his deputy to the
role of CEO. The Company has a strategy to expand into other areas of education by acquisition
including running pre-school nurseries and professional training. There are 2 non-executive
directors on the 10 person board. One is a politician involved in education, whom the Chairman
believes may be helpful in getting education contracts, and the other is a partner with the firms
corporate lawyers.
Evaluate the corporate governance of this company.
Solution 3.3
39
NON-EXECUTIVE DIRECTORS
40
Role of board
Board
membership
Directors
remuneration
Non-executive
directors
Stakeholder
relationships
Reporting
Non-executive directors (NEDs)
Number of NEDs
NEDs have no executive (managerial) responsibilities.

They should provide balance and help to reduce
conflict between executive directors and shareholders.
Majority of NEDs should be independent.
USA/UK Independent NEDs at least half of board,

others sufficient for views to carry weight.
Independence of NEDs
Role:
Strategy
Scrutiny

Risk management
Board personnel
No business/financial/other connection
No share options/pensions
Appointment for specified term
Ability to take independent advice
Advantages of NEDs
Disadvantages of NEDs
External experience and knowledge

Wider perspective
Comfort for investors
Confidant/enabler
Board members but objective

Independence?
Restricted recruitment
Difficult to impose views
Cant prevent problems
Limited time
Context
Non-Executive Directors are required by most, codes of corporate governance around the world.
They are supposed to represent shareholders' long-term interests and also to bring extra skills and
knowledge to the Board.

Describe why the following might reduce the value of having NEDs on the Board.
(a)
Board meetings are infrequent and the agenda and papers are circulated at the start of the
Board meeting by the Company Secretary.
(b)
Two of the NEDs have retired from work and use the money they get from being NEDs to
supplement their pensions.
(c)
One of the NEDs runs a specialist consultancy and has received additional fees from the
company for providing consultancy advice to the company.
(d)
Most of the NEDs have been in their present roles since the company was listed 12 years
ago.
Solution 3.4
41
DIRECTORS' REMUNERATION
Role of board
Board
membership
Principles
Directors remuneration set by independent board
members
Bonuses related to measurable performance/enhanced
shareholder value
Full transparency in annual accounts
Remuneration committee
Committee of independent NEDs determining:
Remuneration policy
Specific remuneration packages
Shares granted on condition cant be sold

Share options purchased at specified exercise
price, encouragement to improve companys
performance and hence share prices, options
(and shares) to be held for certain length of time
Benefits-in-kind is cost excessive and how
comparable are they with what employees are
given
Pensions best practice to make only basic
salary pensionable
Reporting
Consider and disclose:

Remuneration policy
Arrangements for individual directors
Consider allowing members to vote on
remuneration statement in accounts.
Service contracts
If service contracts are too long, premature termination
may mean significant payments. Service contracts
shouldnt be > 12 months normally.
Elements of remuneration package

Basic salary in contract of employment
Stakeholder
relationships
Remuneration statement
UKs Greenbury committee suggests:
Performance-related bonuses limited possibly

to maximum % of pay, shouldnt be given for
transactions?
42
Directors
remuneration
Non-executive
directors
Factors affecting remuneration levels

Need to attract directors

Interests of stakeholders
Weighting and phasing of different parts of package
Director/manager differentials
Impact of director/manager resigning
Performance measures
Performance measures

Variety of financial/non-financial measures

Focus on current performance
Avoid short-termism
Reward individual effort
Context
The problem of fat cat directors awarding themselves excessive pay rises, often while the share
price has been falling, has been seen as the most obvious abuse by directors of their position in the
principal agent problem.

Identify potential dysfunctional consequences of the following elements of remuneration for a 59
year old Sales Director (treat each separately)
(a)
Bonuses are capped at 10% of his salary.
(b)
Bonuses are paid for annual increase in sales volume.
(c)
Annual pension will be equal to 70% of final year earnings, including bonuses.
(d)
Share options at $1.50 are due to crystallise in 1 years time. Companys share price is
presently $0.90.
Solution 3.5
43
STAKEHOLDER RELATIONSHIPS
Role of board
Board
membership
Directors
remuneration
Non-executive
directors
Stakeholder
relationships
Relationships with shareholders
Relationships with stakeholders
Directors should be held accountable by requiring

them to submit to regular re-election (every three
years). Boards should consider relationships with all
shareholders, particularly institutional shareholders.
OECD stresses role of:
Proxy voting
Myners report addresses problems with administering
proxy votes and misuse of proxy votes. Recommends:
Clear agreements between beneficial owners and
investment managers
Stock lending shouldnt happen
Electronic voting
Poll (including proxies) for all general meeting
resolutions
Notice > 20 days

before

Employees
Creditors
Suppliers
Investors
Government
Position of stakeholders should be:

Protected by law
Enhanced by participation (eg employees share
ownership, profit-sharing arrangements, seat on
board)
Business
presentation
Question and
answer sessions
General meetings
Shareholders vote on
substantially
separate issues
44
Reporting
Shareholders vote on
report and accounts
Context
The rights of shareholders are mainly exercised at General Meetings where they vote on
resolutions, appoint directors, and question the Board. They can only do this if the GMs are run in a
way that encourages and permits voting and scrutiny. Without these a crucial safeguard for
shareholders is lost.
45
REPORTING
Role of board
Board
membership
Non-executive
directors
Directors
remuneration
Stakeholder
relationships
Reporting
Reporting
London Stock Exchange requires:
Narrative statement of how principles in
Combined Code have been applied
Statement of compliance/details of reasons
for non-compliance
Voluntary disclosures
Disclosures above statutory/best practice minimum.
Disclosures should follow certain principles:

46
Planned process
Transparency in disclosures made
Consultation with users
All relevant information considered
Disclosures subject to review
Major disclosures
Board composition, directors, NEDs, evaluation
of board performance
Committee reports
Relations with auditors and shareholders
Review of internal controls
Going concern
Sustainability reporting
OFR
Context
The safeguard of transparency requires that the Board discloses information on the Boards
conduct and on the condition of the company to shareholders. Frameworks of corporate
governance, such as financial reporting standards and codes of corporate governance, lay down
provisions for reporting and disclosure.

The following is an extract from the statement of a UK company about its non-compliance with the
2007 Combined Code during part of its financial year.
For a period during the year the Company did not fully comply with the recommendations of the
Combined Code. In the period from 25 August to the date of this report:
(a)
The Audit Committee did not have a Chairman and comprised only two Directors, neither of
whom have recent and relevant financial experience. However, Mr XXX acted as Chairman at
meetings and at least one of the Company's other independent Non-Executive Directors who have
recent and relevant financial experience was also in attendance at all meetings of the Committee.
This ensured that at least two independent Non-Executive Directors attended each meeting.
(b)
The Remuneration Committee comprised only two Directors. However, at least one of the
Company's other independent Non-Executive Directors attended meetings of the Committee
thus ensuring at least three independent Non-Executive Directors attended each meeting.
(c)
If the criteria for determining independence suggested by the Combined Code were applied,
less than half of each of the Board and Nomination Committee (in each case excluding the
Chairman) were independent. However, the Board's own view was that at least half of the
Board and Nomination Committee (excluding the Chairman) was independent, because it
regards Mr YYY as independent.
Discuss why each of these disclosures of non-compliance might cause investors concern.
What practical steps could be taken by shareholders or the stock market to force compliance with
the Combined Code?
Solution 3.6
47
Reinforcement
Scan and note responsibilities of
48
Directors (Sections 1.8 to 1.9.9)

The Chairman and the CEO (Section 2.2)
Non-executive directors (Sections 2.5 to 2.8)
Scan and note the elements of remuneration packages and the role of the
Remuneration Committee (Section 3)
Scan and note the issues surrounding proxy votes (Section 4.4)
Scan and note reporting requirements (Section 5.3)
Attempt question Codes and corporate governance in Chapter 3
Attempt Quick Quiz
Attempt Q3 Peter Postgate from Exam Question Bank at the back of your
Study Text
chapter 4
CONTROL SYSTEMS
NATURE OF RISKS
CONTROL FRAMEWORK
CONTROL LIMITATIONS
ENTERPRISE RISK MANAGEMENT
In this chapter we look at the key elements of sound

control systems. The overall environment and ethos of
organisation is as important as the specific procedures.
The risks organisations face should have a significant
impact upon the control frameworks they adopt.
INTERNAL
CONTROL
SYSTEMS
49
CONTROL SYSTEMS
Control
systems
Nature of risks
Elements of control systems

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

Process of control within system.
Identification of system objectives
Setting targets for system objectives
Measuring system achievements/outputs
Comparing achievements with targets
Identifying corrective action
Implementing corrective action
50
Control
framework
Control
limitations
Enterprise risk
management
Control systems and risks

Objectives
Nature/extent of
risks
Acceptable risks
Likelihood risks
materialise
Ability to reduce
risks
Costs/benefits of
controls
Changes in risk
conditions
Characteristics of control systems

Ease of target
achievement
Qualitative/
quantitative
measures
Short/long-term
measures
Consistency of
measures
Management
intervention
Automatic control
mechanisms
Reliance on social
relationships
Context
'Control' can be understood as mechanisms to help ensure things go according to plan. This
chapter introduces the main theories of control.

Consider a hospital.
(a)
Identify how a cybernetic control system might be used to ensure that patients are given the
right medication.
(b)
What control mechanisms exist in a hospital to ensure that patients receive adequate and
appropriate treatment?
Solution 4.1
4: Internal control systems
51
NATURE OF RISKS
Control
systems
Nature of risks
Risk classification
Risks can be classified in various ways:
Fundamental affects society in general
Particular individual in control
Speculative good or bad consequences
Pure only outcomes harmful
Risk and uncertainty

Uncertainty means possible outcomes and/or chances
of each occurring are unknown.
Risk and return

Businesses may tolerate higher risk levels provided
they can receive a higher return. Value driver analysis
identifies risk-return links.
52
Control
framework
Control
limitations
Enterprise risk
management
Benefits of risk management

Predictability of cash flows

Limitation of effects of bad events
Increased shareholder confidence
Weigh costs
Risk and corporate governance

Corporate governance reports aim to address
shareholder concerns that directors are not
achieving adequate returns for risks incurred and
provide mechanisms for controlling directors who
are taking excessive risks. Directors responsibility
for monitoring and disclosing risk management is
stressed.
Context
During the last decade of the 20th Century the subject of risk became important to management
due to the recognition that complex technologies and global operations meant that business was
getting more prone to disasters. However the belief grew that that risk could be managed by
appropriate responses. Pressure grew on Boards to consider risks and to disclose them and the
strategies for dealing with them.

The Board of a listed company is considering investing funds into developing a capacity to offer
holidays on space stations orbiting the Earth.
Evaluate how shareholders might respond to this decision under the following circumstances (treat
each separately):
(a)
Management is proposing selling-off most of the firms assets in stable industries like food
processing to raise funds to invest in this venture.
(b)
Most of the shares are held in investment funds that specialise in investing in high technology
businesses.
(c)
The project is a joint venture with over 100 other firms so the amount being invested is small
in comparison to the total assets of the firm and there is good evidence that the project will
yield very good returns.
(d)
Most of the firms shares are held by pension funds.
Solution 4.2
53
CONTROL FRAMEWORK
Control
systems
Nature of risks
Control
framework
Control
limitations
CONTROL FRAMEWORK
Control environment
Control procedures
Features of controls
Facilitate effective and efficient operation

Appropriate response to risks (safeguarding of assets, liability management)
Ensure quality of reporting (maintenance of records, generation of relevant
information)
Ensure compliance with laws and regulations
Embedded in operations
Form part of culture
Capable of quick response
54
Enterprise risk
management
Context
This illustrates the principle that the control environment and procedures should be sufficient to
deal with the issues and risks in the business environment in which they operate.

Suggest control procedures for dealing with each of the following risks in a firms business
environment.
Most of the customers pay in cash
There is high staff turnover in the industry
Individual inventory items are of high value
A lot of firms in the industry have been sued by dissatisfied customers
There is a lot of dangerous machinery and chemicals involved in the process
Solution 4.3
55
CONTROL LIMITATIONS
Control
systems
Costs > benefits
Nature of risks
Control
framework
Human error/Fraud
Control
limitations
Enterprise risk
management
Employee collusion
LIMITATIONS OF CONTROLS
Management
bypass
56
Designed for routine

transactions
Depend on method
of data processing
Context
Controls are very often designed to reduce rather than eliminate the chances of risks
materialising. How effective controls are will often depend on the abilities, attitudes and honesty of
those operating controls. These are all factors connected with the internal environment and culture,
which will be covered in Chapter 5.

The board of Arlo has decided to outsource some of its manufacturing operations to a supplier
based on a different continent, in order to save costs. Arlo has always tightly controlled its
manufacturing processes that are located in its own country, with an emphasis on producing what
customers want, rigorous quality control and close monitoring of employees to ensure they produce
what is required.
Why might Arlo have difficulty maintaining the same level of control over the activities of its
overseas supplier?
Solution 4.4
57

58
Control
systems
Control
framework
Nature of risks
Enterprise risk management (ERM)

ERM is framework suggested by COSO for dealing
with risk. It is a fundamental process, operated at
organisation level, that helps staff understand risks,
responsibilities and authority levels. ERM should:

Apply in strategy setting

Apply in all areas and over whole organisation
Identify events affecting entity
Manage risk according to risk appetite
Provide reasonable assurance
Support organisational objectives
Control
limitations
Enterprise risk
management
ERM benefits

Align risk appetite and strategy

Link growth, risk and return
Choose best risk response
Minimise surprises and losses
Manage risks over whole organisation
Allows organisation to seize opportunities
COSOs Enterprise Risk Management framework
Context
The ERM was developed in the US by the Committee Of Sponsoring Organisations (COSO) the coordinating body for professional accountants in the US. The model is popular and is being
implemented by businesses throughout the world that wish to attract funds from US investors.
59

60
CIMAs risk management cycle
Context
CIMA is the UK-based Chartered Institute of Management Accountants. The risk management cycle
it has developed is an alternative set of steps from those outlined in COSOs ERM.
61
Reinforcement
62
Scan and note on control systems (Sections 1 to 4)
Attempt Questions Risks and Models in Chapter 4
Attempt Quick Quiz
Attempt Question 4 New trainees from Exam Question Bank at the back of
your Study Text
chapter 5
RISK ATTRIBUTES
STAKEHOLDERS AND RISKS
INTERNAL ENVIRONMENT
RISK MANAGEMENT RESPONSIBILITIES
OBJECTIVE SETTING
This chapter covers the underlying factors that help

determine how organisations respond to the risks they
take. These factors include attitudes to risk, the
environment and culture, and the organisational
structure including responsibilities for dealing with
risks.
INTERNAL
ENVIRONMENT
AND
OBJECTIVE
SETTING
63
RISK ATTRIBUTES
Risk attributes
Stakeholders
and risk
Emotional satisfaction
Personal views
Internal
environment
Risk management
responsibilites
Risk/return

Shareholder requirements
Objective
setting
Size
Structure
Development
Past experience
Organisational influences
Risk attributes
64
National influences
Cultural influences
Government protection

Fatalist (no control)

Hierarchist (formal procedure)
Individualist (wish to control)
Egalitarian (sharing/transfer)
Context
This diagram seeks to answer the question what influences the amount of risk that management is
willing to take?. This is quite an academic topic but it is examinable.

AAA Group was a private UK company established 30 years ago by a high-profile and popular
entrepreneur, Mr X. During 30 years of growth AAA developed into a business that included
telephones and home media, airlines, rail transport, and financial services. Most shares were held
by Mr X although some were held by rich personal friends of his. At his retirement Mr X sold the
company to SSS, a US listed corporation, that owns railroads. The management of SSS has been
astonished to find a absence of risk management methods in AAA such as very few formal
budgetary systems, a willingness to invest considerable sums of money in business ideas with only
sparse business plans, and a history of failed business ideas amongst the small number of very
successful ventures.
Identify reasons for the different management attitudes to risk between AAA and SSS.
Solution 5.1
5: Internal environment and objective setting
65
STAKEHOLDERS AND RISK
Risk attributes
Shareholders
Debt providers
Employees
Suppliers
Customers
Wider community
66
Internal
environment
Stakeholders
and risk
R
I
S
K
C
O
N
C
E
R
N
S

Risk management
responsibilites
Dividend impact
Capital gain impact
Dependent on their risk appetite
Threat to repayment
Security imposed
Threat of other debts
Job threats
Health and safety worries
Ability to take action
Losses on sales
Unwilling credit suppliers
Disruption of relationships
Delivery failures
Lack of value
Poor quality
Poor employment policies
Adverse impact on the environment
Objective
setting
Context
Risk appetite was discussed in Chapter 4. Risk concerns of stakeholders is a connected topic.
67
Risk attributes
Internal
environment
Internal/control environment
The control environment is the attitude, awareness and
actions of management in relation to internal controls,
providing the background for the operation of other
controls.

Clear risk management strategies

Culture/code of conduct/HRM/reward systems support
objectives and risk limitation
Senior management commitment to competence,
integrity and trust
Clear authority and responsibility
Communication procedures
Staff have knowledge, skills and tools
Risk management
responsibilites
Objective
setting
Elements of internal environment

Strong internal environment

68
Stakeholders
and risk
Managements philosophy and operating style

Organisational structure
Methods of imposing control
Integrity, ethical values and competence
Risk environment

Risk management philosophy

Risk appetite
Integrity
Ethics
Organisational environment
Context
The diagram makes clear that control environment means two things:
1
It is the overall framework that is a necessary support for the controls designed to counter
risks.
It may be the source of some controls, for example a professional culture provides control in
a professional practise such as accounting, law or medicine..
69
Risk attributes
Internal
environment
Risk management
responsibilites
Objective
setting
Embedding risk awareness
Risk register
Risk assessment should evolve into a consistent activity

embedded across all processes, focus on:
Formal collection of risk and response information.

Register lists and prioritises risks, and specifies
responsible individuals and action taken.
Threats to shareholders/stakeholders (future growth

opportunities/core business)
Consistent action-orientated risk assessment
Changing risk culture

70
Stakeholders
and risk
Internal communications programme

Training
Involvement in risk identification
Incentives
Key personnel persuasion
Infrastructure support
Risk policy statement

Definitions and objectives

Regulatory requirements
Links to strategic decision-making
Key areas
Risk classification
Risk responsibilities
Important controls
Assurance reporting
Training
Context
Management cannot afford to hope that risks never come true. Neither can they hope to know
about every potential risk and deal with it as it arises. By then it would be too late. Therefore
cultivating risk awareness at all levels throughout the business, and plans and people to deal with
it, is essential. This section explains how to do it.

Suggest ways in which the Risk Committee of a large listed corporation with 100 shops might
embed risk awareness of matters such as customer safety, thefts of inventory, injuries at work and
loss of business due to competitive action.
Note: this question is not asking you for ways to eliminate the risks. It is asking you how
management can ensure these risks are noticed and reported by divisional managers and staff and
guarded against by them in their day-to-day activities.
Solution 5.2
71
RISK MANAGEMENT RESPONSIBILITIES

72
Risk attributes
Stakeholders
and risk
Internal
environment
Risk management
responsibilites
Objective
setting
Board
Determines risk management strategy and monitors overall risks, sets

and reviews internal control
Senior managers
Build on boards overall framework, specifying risk management

methods and co-ordinate responses
Internal audit
Audit risk management process/key risk area controls
External audit
Audit risk areas that impact materially on financial statements
Line managers
Identify and evaluate risks in their areas, use performance

indicators for monitoring, implement responses
Staff
Follow risk management procedures, have good understanding,

report dangers
Risk management committee
Risk management personnel
Specialist committee of directors, separate from

audit committee, responsible for monitoring and
supervising risk identification and management.
Risk specialist consultant called in to advise on particular

aspects of risk management
Risk manager employee with specific responsibility for
dealing appropriately with risks
Risk management function employees in larger
organisations
Can be staffed by executive directors

Allows audit committee to concentrate on
financial risks
Role of RM function
Role of RM committee
Determine risk management
strategy/policy
Review reports on risk
Monitor overall exposure
Monitor changes in circumstances
Assess effectiveness of RM systems
Review statement on internal control

Helping determine risk management strategies

Champions of risk management
Building risk awareness culture
Establishing risk policy and structures
Developing and reviewing risk management processes
Co-ordinating functional responses
Preparing report for board/shareholders
Context
Risk management needs people to carry it out. This section introduces their roles and the roles of
the Risk Committee which, in some jurisdictions, is required by codes of corporate governance.
73
OBJECTIVE SETTING
Risk attributes
Mission
A general objective, visionary, often unwritten and
very open-ended, without any time limit for
achievement.
Objective setting and risk

Strategic objectives and mission will influence risk
management.
However businesses should also determine risk
appetite (willingness to take risks) and risk
strategy.
These in turn should influence business objectives.
Businesses should take a portfolio view of risks,
looking at relevant risks over the whole organisation.
74
Internal
environment
Stakeholders
and risk
Risk management
responsibilites
Objective
setting
COSO model

Strategic high level goals, support mission

Operational effectiveness and efficiency
Reporting reliability
Compliance with applicable laws
Corporate objectives

Profitability
Market share
Growth
Cash flow
Customer satisfaction
Quality
Added value
Context
Objective setting links in with the recommendation of corporate governance about the board
keeping control of the company and making sure that it takes decisions on key matters

What obstacles might prevent the board of a company from ensuring that there are effective links
between the objectives it sets and the management of its risks?
Solution 5.3
75
Reinforcement
76
Scan and note risk and the organisation (Section 1)
Scan and note attitudes to risk of different stakeholders (Section 2)
Scan and note features of internal environment (Section 3)
Expand notes on embedding risk awareness and assessment (Session 4)
Scan and note risk management responsibilities (Section 5)
Scan and note different kinds of objectives (Section 6)
Attempt Questions Organisational problems and Risk culture in Chapter 5
Attempt Quick Quiz
Attempt Question 5, Widmerpool, from Exam Question Bank at the back of

your Study Text
chapter 6
STRATEGIC AND OPERATIONAL RISKS
TYPES OF RISKS
RISK ASSESSMENT
In this chapter we look at the risks that organisations

face. We draw various important distinctions between
different kinds of risk, and emphasise the link between
risk and return. We also look at examples of the key
risks that organisations have to counter.
EVENT
IDENTIFICATION
AND RISK
ASSESSMENT
77
STRATEGIC AND OPERATIONAL RISKS

78
Strategic and
operational risks
Types of risks
Risk assessment
Strategic risks
Operational risks
Fundamental risks to organisations profits/existence

arising from the sector its in and the nature of what it
does. Strategic risks arise out of decisions about
resources, products, acquisitions and investments.
Risks of loss from failures in internal business and

control processes.
Factors affecting strategic risks

Stakeholders
State of economy
Nature of industries/markets
Level of competition
Availability/price of resources
Flexibility of production
Ability to innovate/R&D
Stage of product life cycle
Examples

IT failures
Human error
Loss of key staff
Fraud
Business interruptions
Internal audit weaknesses
Context
Distinguishing a strategic from an operational risk is important for two reasons:
The origins of the risk will be different eg strategic risk usually results from decisions made
by the Board.
The ways to manage the risk will be different eg operational risk can be managed by
workplace procedures and backup systems.

A food and household goods store has been very successful in its home country and is now
considering expanding operations abroad, developing a home delivery service for food and larger
household goods and replacing cashiers with a technology that allows customers to check-out and
pay for their shopping electronically.
Identify additional risks arising from these management decisions and classify them into Strategic
and Operational (some risks may be both).
Solution 6.1
6: Event identification and risk assessment
79
TYPES OF RISKS
Strategic and
operational risks
Financial risks

Legal and political risks

Legal risks include fines or threats of closedown, or
incurring costs to fight legal actions.
Risk of loss to business arising out of environmental

effects of operations. Organisations could suffer
fines, bad publicity, non-co-operation. Risks include
pollution and disruption to local community through
traffic organisation generates.
Technological risks
Risks include loss of employees time because of

injury and having to pay compensation or legal
costs due to breaches. Risks arise because of
lack of policy, poor culture, lack of emergency
procedures, failure to deal with hazards.
80
Inappropriate gearing structure

Lack of long-term capital
Fraud and misuse of funds
Currency, interest and market risk
Credit and liquidity risks
Environmental risks
Political risk is the risk that political action will affect

position and value of organisation. Examples
include quotas, tariffs, exchange controls and
nationalisation.
Health and safety risks
Risk assessment
Examples of financial risks
Threats to organisations continued existence through

lack of available funds.
Risks of loss to the organisation through the

inadequacies of, or disruption to, its IT systems
and resources.
Types of risks
Examples of technological risks

Physical damages through fire/flood/adverse weather

Human sabotage
Accidental disruption
Human error
Malfunctioning hardware/software
Dishonest use of systems
Viruses and hacking
Knowledge management risks

Risks of losses due to failure to secure knowledge
resources adequately. Risks include abuse of intellectual
property, power failures leading to loss of information, loss
of key staff.
Context
The remainder of this chapter introduces several sources of risk. Firms face these in different
combinations according to the business they do. There is no universally accepted categorisation of
risks. Some of the risks overlap the categories stated here.

A commercial bank offers banking services through branches, on-line and via call centres situated in
another country. It invests customers funds into investments to gain a return and lends funds to
borrowers at interest. Banks have been criticised for high account charges allegedly maintained by
an illegal cartel arrangement between them. Many customers like to withdraw cash from hole on
the wall Automated Teller Machines (ATMs) which must be stocked daily with cash brought to the
branch by armoured security vehicle.
Identify the risks to which the bank is subject and classify them using the headings in the notes.
Solution 6.2
81
TYPES OF RISKS
Strategic and
operational risks
Fraud risks
Risks of loss through fraudulent activities of employees
or managers. Fraud risks are often increased by poor
corporate governance procedures, allowing senior staff
to commit fraud because mechanisms to challenge
their behaviour are ineffective.
Property risks
Risks from damage, destruction or theft of property.
Dangers include fire, wind, water leakage and
vandalism.
Disruption risks
Risk assessment
Signs of fraud risks

Questionable management
integrity/competence

Excessive financial reporting pressures

Poorly designed systems
Unusual transactions or trends
Problems in obtaining sufficient appropriate
audit evidence
Problems with IT systems
Resource wastage risks
Risk of disruption to operations caused by IT failures,

employee problems, supplier loss, legal action.
Risks include incurring excessive costs (poor

procurement) or waste of employees time and
resources.
Trading risks
Organisational risks
Risks of disruption in the course of trade.
Risks that members/employees of an organisation

will behave in ways detrimental to the organisation,
eg failure to adapt to change.
Physical goods/documentation lost/stolen

Trade customer refuses goods/cancels order
Liquidity inability to finance activities
Reputation risks
Product risks
Risk of loss of reputation arising from adverse

consequences of another risk.
Risks of financial loss due to producing a poor quality

product.
Poor reputation
Need to compensate dissatisfied customers
Crystallisation of risks
Possible loss of sales
Poor customer service
Need for expenditure on quality control procedures
Failure to innovate
Poor ethics
82
Types of risks
Context
This identifies and explains further types of risk.

The bank described in Learning Example 6.2 above owns and operates branches in main cities and
towns. Its staff are members of a single trade union, the Union of Bank Workers. Some staff are trained
to offer financial advice on investments such as pensions and life assurance and the bank is regulated for
the conduct of investment business by the relevant government appointed bodies. Despite offering
incentives for using the on-line banking customers still seem to prefer conducting business (and
conversations) at branches and receiving bank statements thorough the post each month. Extensive
training has been given to staff under a group-wide Work Smarter initiative to encourage them to
handle customers more quickly and to migrate them to paperless banking. The bank has been in the
news recently because it holds a lot of so-called Third World Debt and the debtor nations are pressing
to have these debts set aside to enable them to retain capital for development.
Identify the risks to which the bank is subject and classify them using the headings in the notes.
Solution 6.3
83
RISK ASSESMENT
Strategic and
operational risks
Types of risks
Risk assessment
Risk identification
Risk analysis
Need to know whether likely perils are present and

be aware of possibility of unlikely risks.
Difficult to forecast financial effects of disaster,

particularly to include all likely costs arising.
Risk condition identification
Event identification
Physical inspection
External events of economic conditions
Enquiries
Internal events eg human errors
Brainstorming
Conditions resulting in risks
Checklists
Trends and root causes
Benchmarking
Event interdependencies
Risk profiling
Risk quantification
Use likelihood/consequences matrix as basis for

setting priorities for risk management.
Need an idea of possible results or losses, together

with distributions and confidence limits.
Key calculations

Average or expected result or loss

Frequency of losses
Chances of losses
Largest predictable loss
Risk consolidation
Need to aggregate at organisation level risks
identified and quantified at corporate level.
84
Context
This page includes the five steps of risk analysis. Codes of corporate governance now specify that
Boards must have a risk management process in place. This will be the subject of Chapter 7. But
the process draws on the risk analysis process here as one of its main steps.

You will need to use your own paper for this Learning example.
Consider the place that you are studying in and its risks.
(a)
Identify at least 8 risks
(b)
Assess the potential impacts of those risks if they were to crystallise and assign each one a
value between 0 and 10 with 10 reflecting a catastrophic impact
(c)
Assess the likelihood of each risk and assign it a number between 0 and 10 with 10 meaning
its bound to happen one day
(d)
Map the risks on a likelihood/consequences matrix
Now compare your matrix with other students'.
Solution 6.4
85
Reinforcement
86
Scan and note Sections 1 to 3
Attempt Questions Health and safety, Procurement fraud, Managing risk,

Significant risks and, Risk management techniques in Chapter 6.
Attempt Quick Quiz
Attempt Question 6 Pacific Group from Exam Question Bank at the back of
your Study Text
chapter 7
RISK RESPONSES
CONTROL ACTIVITIES
In this very important chapter, we deal with how risks

are managed, in particular how risks are reduced by
control activities.
RISK RESPONSE
AND CONTROL
ACTIVITIES
87
RISK RESPONSES
Risk
responses
Control
activities
Likelihood/Consequences matrix
Consequences
L
i
k
e
l
i
h
o
o
d
88
Low
High
Low
High
Accept
Transfer/Share
Cost of action/benefits
Insurance/contingency planning
Reduce
Avoid
Controls to limit risk

occurence/impact
Immediate action required,

possible abandonment of activities
Context
The likelihood/consequences matrix was introduced in Chapter 6 as a risk profiling device. Here it
identifies appropriate risk management responses to treat each level of risk.
The four risk management strategies are extremely important.

ZAB is a listed company that sells cheap fashionable clothing to households in western Europe
through large stores in the main towns and cities.
Classify each of the following decisions into one of the four risk management strategies.
(a)
Decision to rely on foreign manufacturers rather than make the clothes themselves in case of
bad sales in particular years.
(b)
Signing up to the ethical trade initiative to avoid media criticism for selling the products of
exploited labour.
(c)
Employment of security guards in stores to watch for customers stealing items.
(d)
Decision to stock a wide range of designs but in small quantities if the firms buying team
decide to stock product lines that are not popular with customers.
(e)
Decision not to charge customers for plastic carrier bags despite these costing ZAB money to
buy and possibly incurring additional costs for recycling.
(f)
Decision to take out short leases on shops when they first open in case they are not
successful.
(g)
Offering staff contracts for only a minimum number of hours each week and supplementing
this with additional overtime hours in the busy seasons.
Solution 7.1
7: Risk response and control activities
89
CONTROL ACTIVITIES
90
Risk
responses
Classification of controls
Corporate are general policy, culture, values, overall
monitoring
Management include planning, performance monitoring,
risk evaluation
Administrative include organisation structure, authority
and reporting lines, communication channels
Accounting are recording of transactions and
safeguarding records, transactions and assets
Prevent stop errors happening including checks of
documentation before payment/deliveries made
Detect pick up errors
Correct minimise or negate errors eg back-up
Non-discretionary cant be bypassed
General relate to environment
Control
activities
Types of control procedure

Approval and control of documents
Controls over computerised applications and IT
environment
Checking arithmetical accuracy
Control accounts
Trial balances
Reconciliations
Physical counts
Comparing internal and external data
Limiting direct physical access
Context
Control procedures are things that are done routinely in a business.

Classify the following examples of controls into Corporate, Management, & Administrative and
explain your reasoning. Some may be examples of more than one classification.
(a)
(b)
(c)
(d)
(e)
(f)
Submission of timesheets by staff showing the time spent on pieces of work

Security patrols around the building
Budgets and variance analysis
Appointment of non-executive directors
Succession planning for board members, management and staff
Creation of a Risk Committee
Solution 7.2
91
CONTROL ACTIVITIES
Risk
responses
Assurance from internal controls
Benefits of controls
Internal controls can only provide

reasonable assurance that management
objectives will be achieved, because of their
limitations.
Benefits may be financial

(less costs)
Benefits may be non-financial
(efficiency and effectiveness improvements, less internal
audit resource required)
Costs of controls
Costs include direct costs (salary), opportunity
costs (time) and perhaps reduced flexibility,
responsiveness and creativity.
92
Control
activities
Benefits v costs
Difficult to estimate risk exposure
Difficult to estimate impact of controls
Comparison of financial costs v non-financial benefits
Context
Controls reduce risks but they also need resources to implement them. Specifying that eight people
must be used to lift each television from the assembly line in a factory would probably eliminate
any risk of a claim against the employer for back injury. But it would be an excessively expensive
control measure.

For each of the following control problems suggest and identify the costs of
(i)
(ii)
Changes to internal controls

Changes to risk management strategy
(a)
Agents of a household insurance company collect payments door-to-door alone. Several have
reported being assaulted and robbed.
(b)
An exporting company has found that shipments to a particular country are sometimes lost
or, once delivered, the customer disappears without paying.
Solution 7.3
93
Reinforcement
94
Expand notes on risk management strategies (Section 1)
Expand notes on classification of control activities (Section 2)
Attempt Questions Supplier risk reduction, Prevent controls, Response to

risks and SPAMSOAP in Chapter 7
Attempt Quick Quiz
Attempt Question 7, Azure Airline, from Exam Question Bank at the back of
your Study Text
chapter 8
INTERNAL COMMUNICATION
MONITORING
INTERNAL AUDIT
AUDIT COMMITTEE
BOARD REVIEW AND REPORTING
This chapter emphasises the importance of information

flows and communication between managers and staff.
The principles of good communication also apply to
formal reports in the accounts on risk and internal
control. The chapter also covers the monitoring
activities required to ensure control systems remain
effective.
INFORMATION,
COMMUNICATION
AND MONITORING
95
INTERNAL COMMUNICATION
96
Internal
communication
Monitoring
Internal audit
Audit committee
Board review
and reporting
Directors information requirements
Communication of policies
Directors need information about risks linked to

achievement of organisations objectives and
control mechanisms that should respond to
changes in business environment.
Directors should:
Turnbull report recommends policies are communicated in

following areas:
Customer relations
Service levels
Health, safety and environment
Asset security and business continuity
Expenditure
Accounting, financial and other reporting
Compare different sources of data

Consider adequacy of communication
channels
Provide feedback
Review management/information systems
Communication methods

Guidance from chief executive

Circulation of risk policies
Staff involvement in policy development
Workshops and training
Whistleblowing procedures
Context
The Board is the controlling mind of the company. But information and communication with the
rest of the business are its nervous system.
Upward communication tells the directors what is going on in divisions and where matters may
need attention.
Downward communication is the way that Board decisions are passed to divisions and made the
responsibility of individual managers.
Therefore a sign of good corporate governance is good communication systems and regular review
of the adequacy of these.

A listed utilities company (provides gas and electricity to homes & businesses) has a new CEO who
wishes to ensure good upward and downward communications in the areas outlined by the Turnbull
report in the UK.
For each area recommend steps that could be taken to improve downward communication to
control the area and upward communication to help the Board monitor it.
Solution 8.1
8: Information, communication and monitoring
97
MONITORING
Internal
communication
Monitoring
Internal audit
Audit committee
Board review
and reporting
Monitoring ensures that internal controls continue to operate effectively. This process involves
assessment by appropriate personnel of the design and operation of controls on a timely basis and
taking necessary actions.
Elements of monitoring
Key elements
Ongoing monitoring includes routine, day-to-day

reviews.
Separate evaluation includes annual review of
controls plus internal audit evaluations.
Effective monitoring involves review of key features of

control systems:
Effective/efficient monitoring
Strong control environment
Prioritisation
Communication structure/reporting
98

Control baseline
Change identification process
Change management process
Control reconfirmation
Effective monitoring by managers requires

competence and objectivity. Boards need to receive
regular reports that monitoring is taking place.
Context
Monitoring is bound up with the controls in the SPAMSOAP mnemonic of supervision (ongoing
monitoring) and management (separate evaluation), as well as the work of internal audit.i

What are the stages of an effective process for identifying and managing change in a business?
Solution 8.2
99
INTERNAL AUDIT
Internal
communication
Monitoring
Audit committee
Internal audit
Board review
and reporting
Internal audit
Internal audit is an independent appraisal activity established within an organisation which examines and
evaluates the adequacy and effectiveness of other controls.
Need for internal audit
Internal audit areas
Need will depend on complexity of activities, number of

employees, also cost-benefit considerations. Necessary
when:

Changes in organisational structure

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

Financial and operating information
Economy, efficiency and effectiveness
Compliance with laws and regulations
Safeguarding of assets
Implementation of organisations objectives
Risk identification and management
Special investigations
Objectives depend on information and recommendations

required by organisation.
Independence
IA should be independent of activities and
management being audited.
Objectivity
Impartiality
Threats to independence
Threats include involvement in systems design and
consultancy, familiarity with other staff and reporting
to finance director whose activities are being audited.
Unbiased views
Valid opinion
Dealing with threats

IA staff dont audit their previous departments

IA staff dont audit systems they designed
Unrestricted access to records, staff, personnel
Rotation of IA staff
Access to all areas

Relevant skills
Audit senior managers
100
I
n
d
e
p
e
n
d
e
n
c
e
Context
Internal audit is a 'control of controls', it seeks to assess the quality of internal controls. This
examination requires you to show a broader understanding of control than you will have gained
from your audit studies. Likewise internal audit may have a broader scope than you may have
realised. As a control of controls IA staff should not be responsible for setting up or operating the
systems and controls they audit.

XYZ plc is a recently listed company that is using the capital it raised to grow rapidly and expand
abroad. At a recent Board meeting of XYZ plc its Finance Director expressed the view that there was
no need to create an internal audit function because it would cost a lot of money and that there had
been no problems with the external auditors in the past. Therefore he didnt think it would justify its
costs by the audit fees it would save. He also commented that he was overloaded already and didnt
need to have the added responsibility of having internal audit reporting to him or bothering his
staff.
You are a non-executive director of XYZ plc. Outline the arguments you would use to justify setting
up an internal audit function at XYZ plc.
Solution 8.3
101
AUDIT COMMITTEE
Internal
communication
Monitoring
Role of internal audit committee

The audit committees work should improve public
confidence in corporate governance, by helping to
create a climate of control and improving the quality of
financial reporting. The committee should also:
Enable NEDs to play positive role
Help finance director
Strengthen position and independence of external
auditors
Internal audit committee membership

Audit committee should consist of independent nonexecutive directors and should include member(s)
with significant and recent financial experience.
102
Internal audit
Audit committee
Board review
and reporting
Duties of internal audit committee

Review of financial statements including changes
in policies, judgemental areas, compliance
Relationship with external auditors including
appointment/removal, independence, scope, liaison
Review of internal audit including standards,
scope, resources, reporting, work plans, liaison with
external auditors, results
Review of internal control including systems
adequacy, legal compliance, fraud risk, auditors
reports, disclosures
Review of risk management
Investigations
Context
The Internal Audit Committee is another name for the Audit Committee that most listed companies
are obliged to establish to comply with codes of corporate governance. It is in this chapter because
IA ultimately reports to, and is monitored by, the firms Audit Committee.

Explain why each of the following examples may indicate a lack of independence in the IA function
(a)
IA relies on getting staff for 6 months at a time from a fast-track training scheme for young
accounting and management trainees. These trainees are rotated between parts of the
business to give them experience before they have to apply for permanent posts with an
operating division once they qualify.
(b)
IA has a reputation for being a career backwater in the firm.
(c)
IA has a reputation for being a stepping stone on the way to a job in the main finance
function.
(d)
The recently appointed Head of IA had previously been responsible for the implementation of
the new computerised accounting and production management system.
Solution 8.4
103

104
Internal
communication

Monitoring
Strategic
Identifying,
Consequences/likelihoods evaluating and
Risks
Audit committee
Internal audit
Control system
effectiveness
Board review
and reporting
Actions to
reduce risk
Need for more

monitoring
managing risks
Regular review
Risk assessment

Control
environment/activities
Clear objectives
Assessment of significant
risks

Acceptable risks

understood

Risk management policy

Effective culture
Senior management
commitment
Clear authority lines
Communication
Information and
communication

Quality of reports
Changing information needs
Balanced reporting?
Whistleblowing channels
Monitoring

Effective processes
Flexibility
Follow-up
Significant event
reporting
Context
Internal controls need constant maintenance to perfect and to adapt them. Codes of corporate
governance state this should be conducted at least annually
105

106
Internal
communication
Monitoring
Internal audit
Audit committee
Board review
and reporting
Annual review of controls
Reporting on risk management
Review should be wider-ranging than normal review,

covering:
Changes in risks faced
Changes in organisations ability to respond to risks
Scope and quality of managements monitoring of risk
and internal control
Work of/need for internal audit
Extent and frequency of reports to board
Significant controls, failings and weaknesses
Board should disclose existence of process for

managing risks, how the board reviewed the effectiveness of the process and whether the process
accords with the Turnbull guidance.
Contents of report

Responsibility for internal control

Responsibility for review of effectiveness
System manages, not eliminates, risk
System provides reasonable assurance v
loss
Summary of review
Process for dealing with problems
Weaknesses resulting in material losses
Context
This returns us to the key issues of disclosure by the Board and the principles, in principles-based
systems, of comply or explain.

The following complaints were made by a large UK investment fund management firm concerned
about the implementation of risk reporting in the UK following the Turnbull report.
Discuss how reporting on risks and internal controls may be improved and the drawbacks of doing this.
We believe the main failing in the implementation of the Turnbull guidance is the reporting of risk
management and internal control effectiveness. The majority of disclosures provide little value to
investors. Few extend far beyond a close reproduction of paragraph 37 of the Turnbull guidance whether
or not the company runs significant risks through the nature of its business. Rarely is there a useful
disclosure of a risk and of how the company is mitigating that risk, even at the highest of levels.
We suspect that concerns regarding liability of directors and the need to have process assessed by
auditors, and their concerns about liability, are among the reasons lying behind the current poor
disclosures made under the Turnbull guidance as it currently stands.
We would welcome companies highlighting perhaps four or five key areas of risk and giving a brief
insight (no more than a single paragraph) into the framework in place to manage those risks. A
safeguard paragraph along the lines of paragraph 37 could then follow this, rather than following an
assurance statement which at present provides little assurance.
We believe that such disclosures would fulfil the risk disclosure requirements of the guidelines drawn up
by institutional investors which have come to be known as the ABI guidelines on Social, Environmental &
Ethical risk. These disclosures would enable the owners of businesses to gain assurance that key risks
are being managed effectively and so encourage investment as well as helping institutional investors
discharge their fiduciary duty to oversee their clients long-term investments.
Solution 8.5
107
Reinforcement
108
Scan and note information and communications (Sections 1 and 2)
Expand notes on monitoring (Sections 3 and 4)
Scan and note the role of internal audit, focusing on threats to independence
(Section 5)
Expand notes on Audit Committee (Section 6)
Expand notes on management review and reporting (Section 7)
Attempt Questions Internal control review and Turnbull in Chapter 8
Attempt Quick Quiz
Attempt Question 8, Governance and controls, from Exam Question Bank at

the back of your Study Text
chapter 9
ETHICAL THEORIES
INDIVIDUAL INFLUENCES
SITUATIONAL INFLUENCES
APPROACHING ETHICAL PROBLEMS
Don't think of this chapter as too theoretical. You may

see questions where you have to determine what would
influence an individual's ethical decision making.
ETHICS
109
ETHICAL THEORIES
Ethical theories
Situational
influences
Approaching
ethical problems
Lack of objective standards
Objective standards
Non-cognitivism no possibility of acquiring objective

knowledge of moral principles.
Moral relativism right and wrong are culturally
determined.
Cognitivism objective, universal principles exist and

can be known, ethics can be regarded as absolute.
Deontological ethics
Teleological ethics
Kant stated that acts can be judged in advance by

moral criteria:
Moral judgements based on outcomes or

consequences. Utilitarianism means acting for the
greatest good to the greatest number.
Do what others should be doing

Treat people as autonomous beings and not as
means to an end
Act as if acting in accordance with universal laws
Egoism
Act is ethically justified if decision-makers pursue
short-term desires or long-term interests (justification
for free market).
110
Individual
influences
Pluralism
Different views may exist but it should be possible to
reach a consensus; morality is a social phenomenon.
Context
This section goes beyond the ethics of professions like accountancy to consider what makes a good
decision good. The practical value of this discussion to the Professional Accountant is:
A very important control is being able to trust staff to act ethically but do they understand
the same thing by ethical as management does?
What is regarded as ethical business around the world may vary and getting it wrong could
lose business or cause offence, even imprisonment.

WWW is a global construction company that is seeking to win contracts to build roads and bridges
in a foreign country. The Sales Director has reported that a government minister in the country has
told him that WWW will get the contract providing an amount equivalent to 10% of the contract
value is paid into his private bank account.
Identify the ethical position belonging to each of the following directors.
(a)
We should agree to the payment because at least we will build the roads and bridges
properly which is more than can be said for the other bidders and they would certainly pay
the bribe.
(b)
We should not pay the money. Its a bribe and it means that our company would be helping
the minister abuse his position as an elected officer of the people.
(c)
We should not pay the money, despite it being a very good contract, because it breaks our
rules on not paying inducements that on the whole avoid our sales team from getting
involved in offering bribes all over the place.
(d)
We should agree to the payment because the winning of the contract will improve our share
price and our share options fall due soon.
(e)
We should not pay the money because we wouldnt like it if our government ministers took
bribes and left us paying too much for roads and bridges.
(f)
We should pay the money because in that part of the world it's how business is done and
everyone knows it. Not paying would look like an insult to the minister and his country.
Solution 9.1
9: Ethics
111
INDIVIDUAL INFLUENCES
Ethical theories
Situational
influences
Approaching
ethical problems
National and cultural beliefs
Psychological factors
Differences lie in four main areas.

Role of individual v collective good
Acceptance of power distribution
Desire to avoid uncertainty
Masculinity v femininity (money/possessions v
people/relationships)
Focus is on how people think and how they decide

what is morally right and wrong.
Education and employment
Locus of control
Influence individuals believe they have over their own
lives.
Internal individuals have significant influence
External lives shaped by luck/ circumstances
Peoples education/work background seems to be more

significant with globalisation.
Moral development
Morality
Kohlbergs three levels ethics determined by:

1 Rewards/punishments (Pre-conventional)
Actions are influenced not only by peoples own

integrity but also how much awareness they have of
their actions moral consequences.
112
Individual
influences
Others expectations (Conventional)
Individuals own decisions (Post-conventional)
Context
These are the sources of moral beliefs and how we account for the different moral behaviour of
others.

GGG is a public practice which has just completed the audit of a major client. Unfortunately the
audit team reports that it found it impossible to get clear and satisfactory answers from
management on a technical issue which could potentially materially affect the final accounts if it
was adverse.
Three partners of GGG are discussing the question of whether to qualify the audit report. Place each
on Kohlbergs three levels.
Partner A
This is a very good company and a good client. There is very little chance of anyone
losing any money or us getting criticised if we go ahead and sign.
Partner B
I agree with Partner A but for a different reason. If we qualify the report it will cause
the clients share price to fall and they will start to lose investors and clients. We will
damage a good business and cause people to lose their jobs for the sake of a small
accounting technicality that really doesnt matter.
Partner C
I agree with you both but I cant go along with the idea of signing. The whole reason
investors accept accounts is because firms like GGG have independently audited them.
If we simply turn a blind eye to this and bend the rules we undermine the whole basis
of our profession and betray public confidence.
Solution 9.2
9: Ethics
113
SITUATIONAL INFLUENCES
Ethical theories
Individual
influences
Approaching
ethical problems
Moral intensity
Moral framing
Can be used to decide how ethically significant an

issue is.
How issues are perceived in organisations. Use of

language can be important (fairness/honesty), but also
significant is the degree to which managers are willing
to frame issues in moral terms.
Criteria

Magnitude of consequences
Societys view of problem
Probability of effect
Speed consequences will occur
Nearness of those affected
Level of suffering of those affected
National/cultural context
Ethical decision may be shaped by nation in which it
happens.
Organisational culture
Basic assumptions that define organisations view of
itself and its environment.
Components of organisational culture

Values
Beliefs
Behaviours
Taken for granted assumptions
Systems of reward
Bureaucracy
Ethical positions can be affected for better or worse by

remuneration.
Basis of reward may encourage undesirable practices
Failing to reward/punishing ethical behaviour may
deter it
A system including detailed rules and procedures,

that underpins reward and authority systems.
Authority
Managers can encourage good or bad behaviour by the
example they set, whether they set targets that encourage
poor behaviour, or fail to stop unethical behaviour.
Work roles
The work role individuals have will determine what they
believe to be ethical.
114
Situational
influences
Bureaucracy characteristics

Rules override individual beliefs

Morality in terms of following procedures
Distancing individuals from consequences
Denial of individuals moral status
Organisational field
Organisations share a common business
environment, and hence common norms and
values.
Context
Regardless of our own ethical stance on something we often have to make judgements about the
character of others before we can rely on them and the information they give us. We are like judges
and juries, sometimes we only have the word of another to go on to make our decisions, so we will
ask what kind of person are they?

You are the compliance officer of a large global investment bank. You have been asked to consider
a series of disciplinary charges against staff who are at present suspended. The options open to you
are:
(1)
Dismiss the individual as no longer a fit and proper person to work in the bank conducting
investment business.
(2)
Reinstate them having judged their offence to have been trivial and excusable.
(3)
Discipline them by giving them a formal warning and/or switching them to duties where they
are unlikely to be able to present a risk to the bank.
(a)
A client manager who has used the banks credit card to pay for an expensive romantic
dinner with their partner and then claimed it was dinner with a client. The compliance officer
has been told by the Client Director that he tends to ignore this sort of thing providing its
not too expensive or too often.
(b)
One of the bank receptionists has been convicted and fined for travelling on local transport
without a valid ticket (fare dodging).
(c)
A member of staff in a branch abroad has been taking large amounts of time away from work
allegedly due to ill health. Investigations reveal that she has been well but that she has been
spending the days caring for the family of her sister who has been unwell. The member of
staff has offered the excuse that in her culture it is expected that she would come to her
sisters aid and put family before any other ties.
(d)
A senior manager in the corporate finance department who had been advising a large client
on their plan to mount a takeover bid for a rival had secretly been buying shares in the
target in the days before the bid, and telling his friends to do the same. This has had the
result that the regulator has commenced an investigation into suspicious price movements
before the bid.
Solution 9.3
9: Ethics
115
APPROACHING ETHICAL PROBLEMS

116
Ethical theories
How to gain marks

Marks will be awarded for:
Analysis of the situation
Recognition of ethical issues
Explanations of relevant ethical guidance
Making clear, logical and appropriate
recommendations
Justifying recommendations in practical business
and ethical terms
Individual
influences
Situational
influences
Approaching
ethical problems
Tuckers model of decision-making

Profitable
Legal
Fair
Right
Sustainable
American Accounting Association

Facts
Ethical issues
Norms/principles/
values
Alternative courses
of action
Best course of
action
Consequences
Decision
Context
The topics on this page are all specifically mentioned in the syllabus.

Using the approach of the AAA and Tuckers five questions, recommend what should be done in the
following situation.
Following protests at the dismissal of a junior accountant M at his practice the managing partner
has investigated and discovered the following facts:
M was dismissed following an argument with a senior client manager, B, about a corporate client,
GGG. The reason for his dismissal was recorded as gross misconduct due to disobeying Bs
instructions to stop asking questions at GGG.
GGG became a client 10 years ago and since then has been managed by B who has held all the
meetings with the client. GGG provides about 25% of income to the practise for audit and other
services.
M was the first new member of the GGG audit team since the contract was won. M complained to B
that he could not get access to some of GGGs accounts or answers to questions. The CFO of GGG
had become involved and at one point shouted at M that the CEO would speak to B and ensure that
M was punished for being impertinent. The audit of GGG has been concluded and the conclusion has
been that GGGs accounts can be signed off as true and fair.
Solution 9.4
9: Ethics
117
Reinforcement
118
Expand notes on ethical theories (Sections 1 2)
Work through the examples on ethics (Sections 3 4)
Attempt Questions Ethical issues, Kohlbergs framework, Relationships,

Cunning plan, AAA model, Tuckers 5 question model, and Kohlberg and
Tucker in Chapter 9
Attempt Quick Quiz
Attempt Question 9 Pogles from Exam Question Bank at the back of your
Study Text
chapter 10
COMPANY CODES
PROFESSIONAL CODES
THREATS AND SAFEGUARDS
ACCOUNTANTS IN BUSINESS
PUBLIC INTEREST
In this chapter we focus on professional and business

ethics. Knowledge of the ethical threats is as important
as it was in earlier auditing papers, and you need to
adopt a logical approach to solving ethical dilemmas.
However, in this paper it's also important to understand
why codes take the form they do and how much impact
they have.
ETHICS AND
PROFESSIONAL
PRACTICE
119
COMPANY CODES
Company codes
Professional
codes
Threats and
safeguards
Code of conduct
Other measures
120
Public interest
Contents of codes
Code sets out expectations of ways employees will

behave.
However, issuing a code isnt enough, the code needs to
be backed by:
Commitment of senior management
Staff understanding of importance of ethics
Staff commitment to ethics

Accountants
in business
Detailed guidance
Recruitment/Selection/Induction
Training
Reward schemes
Whistle-blowing procedures
Ethical departments/audits

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

Codes may be seen as inflexible and unfair sets of
rules, that are not relevant to the ethical situations
employees encounter.
Context
Corporate codes of conduct are used by many commercial and public service organisations to
outline managements' expectations of the conduct of staff towards each other, towards clients and
suppliers, and towards issues that could pose risk to the organisation.

ZZZ is a listed company that owns television channels and newspapers around the world. Its
Chairman is a flamboyant and controversial figure in the politics of ZZZs home country who
following his facelift, and despite being married, is regularly seen in the company of female models
and actresses. Journalists who have left ZZZ complain that their articles were changed to remove
criticism of the Chairman and of his other businesses and to promote his business and political
interests. Finance staff who asked questions about peculiar transactions with the Chairman's
political allies have often been transferred or demoted. The male-dominated culture inside ZZZ
reflects the culture of its home country. Office walls often have pictures of scantily clad female
models and the male staff pass comments on the appearance of their female colleagues. Privately
they circulate pornographic jokes and pictures using ZZZs IT systems, sometimes offending female
staff with these. There are very few female middle managers and no women on the Corporate
Board, which is dominated by men who are the personal friends of the Chairman. Several of the
non-executive directors are political figures from whom the Chairman has needed favours in the
past.
List areas that ZZZs corporate code of conduct should cover to improve the situation and suggest
problems that might be encountered in making it effective.
Solution 10.1
10: Ethics and professional practice
121
PROFESSIONAL CODES
Company codes
Professional
codes
Accountants
in business
Public interest
Professional codes
Fundamental principles
Professional codes stress the

importance of the public interest.
Most then set out:
Fundamental principles
Conceptual framework
Threats to compliance
Safeguards
Integrity straightforwardness/honesty
Objectivity avoid influence by bias/conflicts of interest/undue influence
Professional competence/due care maintain knowledge/comply with
standards
Confidentiality dont disclose to third parties unless legal/professional
duty
Professional behaviour avoid actions discrediting profession
Advantages
Principles-based codes
Disadvantages
Onus on active thought

Avoids over-narrow legalism
Flexibility for different situations
Responsive to change
Can include prohibitions/minimum standards
122
Threats and
safeguards

Cannot include all dilemmas

Good understanding of principles required
International codes v regional expectations
Difficult to enforce legally
If voluntary, cannot insist on compliance
Context
Accountants and professionals from other disciplines such as law or medicine will have professional
codes. They modify behaviour and its in the public interest that they are maintained.

You are an accountant with GGG, a public practice. Identify which fundamental principles are
compromised by each of the following observations.
(a)
You are frequently asked to complete taxation computations, but you have no experience of
taxation other than what you learned 2 years ago during your ACCA studies.
(b)
ZZZ charges in 30 minute units so that even the shortest telephone call to a client causes a
charge on their account. Sometimes an hour of your work leads to 4 hours being charged to
different clients.
(c)
A partner has asked you to monitor a particular client because he is concerned that they are
running into difficulty and the partner arranged their bank loans for them. He has promised
to alert the bank if things start to get bad.
(d)
The practice refers private clients to one particular financial adviser for help with specialist
areas such as personal investments and borrowing.
(e)
You have been given a list of clients who partners feel are low value. You have been told to
ignore phone calls from them and to only do their work where all other work has been
completed.
Solution 10.2
123
Company codes
T
H
R
E
A
T
S
Professional
codes
Self-interest
Self-review
Advocacy
Familiarity
Intimidation
Accountants
in business
Public interest
Professional safeguards

Dealing with ethical problems

Consider:
Facts
Ethical issues/threats
Related fundamental principles
Internal procedures
Alternative courses of action/safeguards
124
Threats and
safeguards
Entry requirements
Training requirements
CPD requirements
Professional standards
Professional monitoring
Disciplinary procedures
External review
Safeguards in practice

Peer review
Independent consultation
Partner/staff rotation
Discussion/disclosure to audit committee
Reperformance by another firm
Context
The topics on this page are all specifically mentioned in the syllabus. The five threats will be
covered in detail on the next page.
125
Company codes
Professional
codes
Threats and
safeguards
Public interest
Familiarity threat
Advocacy threat
Where accountants take clients part, act as their
advocate or will only earn fees from client if
successful outcome is achieved (contingent fees).
Examples include provision of legal service and
corporate finance advice.

These can arise from accountants acting for clients

with whom they are in dispute, eg over quality of
work. It can also arise through disputes between two
clients for whom accountants are acting.
Family relationships between client and firm

Personal relationships between client and firm
Long association with client
Recent service with client
Future employment with client
Intimidation threat
Conflicts of interest
126
Accountants
in business

Close business relationships

Family relationships
Personal relationships
Staff employed by client
Litigation
Context
This describes the main threats to the independence of a professional practise.

For each of the following situations, identify the threat to independence and suggest potential
remedies.
(a)
A bank has requested a reference from the firm about a client that is seeking additional
funding. The client promises to be a very valuable client if the business succeeds in raising
extra funds.
(b)
The client has told the firm that it has received a cheaper quote from a rival for conducting
the annual audit and that it is considering changing auditor next year.
(c)
The firm has been asked to conduct an internal audit for the client of the effectiveness of a
recent IT investment. The IT investment was project managed by the consulting division of
the accounting practice.
(d)
A partner at the office conducting the audit holds 20% of the equity of the client.
(e)
The Managing Partner and the Chairman of the client often play golf together.
Solution 10.3
127
ACCOUNTANTS IN BUSINESS
128
Company codes
Professional
codes
Professional and employment obligations
Threats and
safeguards
Accountants
in business
Public interest
Workplace safeguards
Accountants should fulfil legal and ethical obligations,

including confidentiality. However accountants may be Employer's oversight systems
pressurised to act illegally or unethically, including
Employer's ethics and conduct programmes
being responsible for misleading information.
Ethical leadership
HR/training procedures
Control/monitoring procedures
Information should describe clearly nature of
Communication
business transactions, classify and record information
Whistleblowing
in timely and proper manner, and represent facts
Consultation
accurately.
Preparation and reporting of information
Acting with expertise
Financial interests
Competent performance by accountant may be

threatened by lack of time, lack of information,
insufficient training, inadequate resources.
Share ownership, share options and profit-related

bonuses provide incentives to manipulate information.
Accountants may be offered inducements to act illegally.
Context
The ethical threats facing accountants in business are broader than threats to independence; they
include issues connected with preparing information and matters of judgment in management
situations.
The professional safeguards listed previously still apply here.

Should any element of accountants remuneration package be related to profits earned by their
employer or company value? Does this represent too great a temptation to distort profits?
Solution 10.4
129
PUBLIC INTEREST
Company codes
Professional
codes
Accountants
in business
Threats and
safeguards
Public interest
Public interest
Professionalism
The collective well-being of the community of people

and institutions the accountant serves. But lack of
statutory definition can make it difficult to enforce.
Critics have claimed profession acts against public
interest in a number of ways.
Compliance with relevant laws and regulations, and

avoidance of actions that may bring discredit on
profession.
Influence of profession
Against public interest
Accounting standards allow excessive leeway
Ineffective auditing standards
Emphasise confidentiality over public interest
130
Critics have accused the profession of:

Getting the numbers wrong
Failing to realise the assumptions used in
preparing accounts support a capitalistauthoritarian view of society
Context
Here we are asking the broader question what does the accountancy profession contribute to
society? The second question follows which is whether the accountancy professions ethics actually
serve the public interest.

Evaluate the following three statements about the accounting profession:
(a)
The accounting profession, and its high standards of professionalism, are in the public
interest. Without professional accounting managers wouldnt have the management
information to run their businesses, investors wouldnt be able to judge the effectiveness of
the management of the businesses they have invested in, and governments wouldnt receive
the tax to which the public is entitled.
(b)
The accounting profession spends a lot of its time advising managers on how to make the
performance of their firms look better than it really is and on ways to avoid paying tax.
Accountants are just guns for hire to the highest bidder.
(c)
A capitalist system is one where the owners of business use their power to exploit the people
they employ to make profit and, as we can see, they exploit the environment too. By not
questioning this state of affairs the accounting profession is part of the conspiracy.
Solution 10.5
131
Reinforcement
132
Scan and note corporate codes of ethics (Section 1)
Expand notes on professional codes of ethics (Section 2)
Expand notes on independence and conflicts of interest (Section 3)
Scan and note threats to accountants in business (Section 4)
Expand notes on professions and the public interest (Section 5)
Attempt Questions Code of ethics, Employee behaviour, and Stakeholders

in Chapter 10
Attempt Quick Quiz
Attempt Question 10 Independence from Exam Question Bank at the back of

your Study Text
chapter 11
CORPORATE CITIZENSHIP
ETHICAL STANCES
SOCIAL RESPONSIBILITY
SOCIAL AND ENVIRONMENTAL IMPACTS
SOCIAL AND ENVIRONMENTAL AUDITS
In this chapter we examine organisations' impact upon

the natural and human environment. This has been
highlighted as an important topic and it illustrates how
various aspects of control system (management
systems, internal audit and external reporting) are
applied.
CORPORATE
SOCIAL
RESPONSIBILITY
133
CORPORATE CITIZENSHIP
134
Corporate
citizenship
Ethical
stances
Corporate citizenship
Social
responsibility
Social and
environmental impacts
Social and
environmental audits
Core principles
The business strategy shaping the values underpinning mission and choices made as the
corporation engages with society. Corporate
social responsibility discussions are often in
terms of corporate citizenship.
Minimising harm
Maximising benefit
Accountability and responsiveness to stakeholders
Limited view
Voluntary philantrophy, corporate citizen engages with local communities and

employees, partly at least for self-interest.
Equivalent view
Focus on a broad range of stakeholders and response to demands of society and

legal requirements.
Extended view
Active social and political citizenship, promotion of social, civil and political rights,
filling void caused by lack of government action.
Context
Corporate citizenship is an alternative way of classifying corporate social responsibility. Citizenship
stance may be a response to the demands of society and the need to fill vacuums caused by lack of
government action.

What view of corporate citizenship does the following requirement in the 2006 UK Companies Act (s
172) promote:
A director of a company must act in the way he considers would be most likely to promote the
success of the company for the benefit of its members as a whole, and in doing so have regard to:
(a) The likely consequences of any decision in the long-term
(b) The interests of the companys employees
(c) The need to foster the companys business relationship with suppliers, customers and
others
(d) The impact of the companys operations on the community and the environment
(e) The desirability of the company maintaining a reputation for high standards of business
conduct
(f) The need to act fairly between members of the company.
Solution 11.1
11: Corporate social responsibility
135
ETHICAL STANCES
Corporate
citizenship
Ethical
stances
Social
responsibility
Minimum compliance
Government imposes wider constraints
Social and
Social and
Wider view of ethical responses

Better for reputation
Prevents more legal regulation
Short-term shareholder
interest
Long-term shareholder
interest
Ethical stance
Multiple stakeholder
Building relationships
Which stakeholders?
Which obligations?
136
Shaper of society
Constitution requirements
Accountability
Financial viability
Context
Ethical stance is how the firm views its responsibilities to shareholders and the broader society and
environment. This diagram presents four levels of potential ethical stance. You should remind
yourself of the Chapter 2 discussions of CSR when considering the multiple stakeholder and shaper
of society perspectives.

Using the model of Johnson, Scholes and Whittington, identify the ethical stance of the firms, from
the following extracts from corporate mission statements.
(a)
We seek partnerships with suppliers, clients, our employees and the local community as key
stakeholders in our activities and beneficiaries of our success.
(b)
Our policy of sourcing locally where possible to cut emissions from transport, and paying fair
trade prices for all imported products means that by shopping with us you can make a real
difference to the lives of your community and of the world. And because we are owned by
our customers you can get a share of the profits too.
(c)
Our profits are achieved with due regard to the legislation and regulations of the societies in
which we operate.
(d)
At present there are no viable alternatives to the use of carbon fuels to meet the energy
needs of society. But in the long run alternatives must be found. That is why we devote
significant amounts of investment into the search for, and commercialisation of, viable
sustainable alternatives to oil, gas and coal.
Solution 11.2
137
SOCIAL RESPONSIBILITY
138
Corporate
citizenship
Ethical
stances
Social
responsibility
Social and
Social and
Pristine capitalists
Private property rights paramount, companies exist to make profits

and achieve economic efficiency
Expedients
Acknowledgement of business excesses, acceptance of limited social

and moral responsibilities
Social contract proponents
Survival depends on delivery of benefits to society/groups that

determine its power, behaviour adheres to society norms
Social ecologists
Modification needed of economic processes, resulting in resource

exhaustion, waste, pollution
Socialists
Societys framework should promote equality, not requirements of

capitalism
Radical feminists
Need for emphasis on feminine values such as co-operation and

reflection, fundamental readjustment of society required
Deep ecologists
Human rights to existence dont exceed other species rights.

Economic systems should not trade species survival v economic
imperatives
Context
This model explains the viewpoints of the population on the responsibilities of business. In trying to
satisfy stakeholders management should be aware of the likely expectations and perspectives of
these stakeholders.

You are a member of the Board of an international pharmaceutical research and production
company. For each group quoted below, identify their perspective using the model of Gray, Owen
and Adams.
(a)
Testing your products on helpless animals is wrong. You wouldnt test them on your children!
The principle is the same.
(b)
You make huge profits from your patents. But the poor need those drugs too. Governments
should abolish your patents or force you to cut your prices.
(c)
Stop the charitable work. Its governments job to bind the wounds of society. Just
concentrate on selling them the bandages.
(d)
The problem with your industry is that you try to solve illnesses by attacking the symptoms
rather than the causes and make money by doing so. Many natural remedies are better and
work with the body in harmony. But you cant bottle them so you ignore and trivialise them.
(e)
Selling antibiotics to put into animal feed means that eventually germs will become resistant
to them and they wont be able to treat illness any more. We have to change farming
methods to eliminate the overcrowding that makes the spread of infection such a problem.
(f)
It wont be long until people get fed up with your tinkering with nature to make profits for
yourself at the expense of our world. There will be a backlash against your industry.
(g)
I understand that you have to make money to cover the costs of your R&D but the very poor
nations need your drugs and cant afford them. Have you considered donating some supplies
of the most badly-needed drugs to the World Health Organisation?
Solution 11.3
139

140
Corporate
citizenship
Social
responsibility
Ethical
stances
Depletion of
natural resources
Creating conditions
leading to acid rain
Social and
Air and water

emissions
Adverse visual and

aural impacts
How organisations affect

the environment
Negative health
impacts
Waste
disposal
Environmental costs
Waste management
Remediation
Compliance activities
Permit fees
Environmental training
R&D
Maintenance
Legal costs
Environmental assurance bonds
Environmental certification
Natural resource inputs
Record keeping and reporting
Social and
Contribution to
climate change
Lowering local
quality of life
Contingencies
X
X
X
X
X
X
X
X
X
X
X
X
__
X
__
__

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

Increasingly stakeholders are aware of environmental
impacts and require businesses to do more to deal
with them. Being known as a poor corporate citizen
can pose a serious reputation risk.
Context
This is a return to the issue of CSR. This chapter deals with the impact on accounting and the
professional accountant.

Using the categories on the page, plus any other ideas that come to your mind, identify the
negative environmental impacts of an automobile manufacturer on the environment.
Solution 11.4
141

142
Corporate
citizenship
Social
responsibility
Ethical
stances
Sustainability
Sustainability is ensuring that economic
development meets the needs of the present
without compromising the future.
Sustainability for organisations means
developing strategies by which an organisation only uses resources at rate that can be
replenished, and emissions of waste dont
exceed environments ability to absorb them.
Social and
For whom?
Other species
% of current population
In what way?
Natural/social/economic
How long?
Availability of raw materials
Dependent on climate change
At what cost?
Presentation
Substitution/compensation possible
Weak sustainability
Strong sustainability

Social and
Fundamental change in perceptions required

Harmony with natural world
Sustain all species
Continue to pursue economic growth?
Brundtland report

Catastrophe prevention
Sustaining humanity
Regulate resource usage
Maintenance of existing system
Bruntland and sustainability
World Commission on Environment and

Development reported in 1987. Committee reported
sustainable development was possible, provided
governments considered:
Access to resources
Distribution of costs and benefits
Demographic changes v productive potential
Brundtland report emphasised two key concepts.

Needs especially essential needs of world's poor
Limitations imposed by technology and social
organisations
Requirements for sustainable development

Political system
Economic system
Social system
Production system
Technological system
International system
Administrative system
ensures effective participation in decision-making

generates surpluses on self-reliant and sustainable basis
solves problems arising from development
preserves ecological base
searches for new solutions
fosters sustainable trade and finance
is flexible and can self-correct
Context
Sustainable businesses are an ideal. However many firms seek to progress towards it and, by doing
so, gain the support of green investors and the support of governments and avoidance of
legislation.

The global holiday travel industry encourages the use of building of airports for airlines to take
holidaymakers to resorts that have often been artificially created at locations where they displace
local people and natural life, compete for water with farmers and despoil the environment with their
appearance and waste. The impact of a tourist industry arriving at a new location is often the
distortion or destruction of the local way of life.
Explain steps the global tourist industry take to become more sustainable.
Solution 11.5
143
Social AND environmental impacts

144
The Global Reporting Initiative aims to develop Sustainability Reporting Guidelines for organisations to use
when reporting on economic, environmental and social dimensions of their activities, products and services.
Full cost accounting
GRI indicators
Full cost accounting ultimately allows the incorporation of all costs/benefits into accounting equation,
including environmental and social externalities.

Sustainability report

Vision and strategy

Profile
Governance structure and management
systems
GRI content index
Performance indicators

Direct economic impact on key stakeholders

Environmental use of natural resources, emissions,
transport usage, compliance with standards
Labour practices employment practices, health and
safety, training, diversity
Human rights strategy, non-discrimination, workers
rights, low-paid labour
Society community contribution, political activities,
competitive attitudes
Products customer health and safety, advertising,
privacy
Context
The GRI is a body that has produced guidelines on how firms can disclose their sustainability
performance. Adopting the guidelines is voluntary but at present more than 1000 firms in 80
countries have done so.
145

146
Corporate
citizenship
Ethical
stances
Social
responsibility
Social and
Social and
EMAS
ISO Environmental management system
Emphasis on verified improvement and disclosure.

Requirements include:
ISO standards state that an environmental management

system should comprise:

Environmental policy statement

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

A basis for future action, based on reliable data and
setting specific targets.
Internal statement tailored to organisations
requirement and mission
External charter adoption compliance with
objective standards, allows international
comparisons

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

Control systems should cover relevant functions and
activities:

Policy development and objectives

Life-cycle assessment
Compliance
Waste and pollution minimisation
R&D
Performance reporting
Context
EMAS (Eco-management and audit scheme) is a European Union initiative which has been most
popular in the eco-conscious Germany. The International Standards Organisation ISO 14000 is an
international standard that deals with the same issues.
147

148
Corporate
citizenship
Ethical
stances
Social
responsibility
Rationale
Social and
Social and
Consistency with
mission of
organisation
Social audits
Objectives and
priorities
Degree of
company action
Social audits can concentrate on a specific decision (disinvestment) or aspects of an organisations activities
(direct impacts upon the local community).
Context
Social audits consider the impact of the organisations activities and decisions on society as a whole,
rather than just the natural environment. They stem from a concern with stakeholder
accountability.

The management of a national newspaper has decided to develop accounts of its social impact as
part of its general commitment to corporate social responsibility.
Using the following headings indicate the matters that it could include in its social report.
1
2
3
4
5
Environmental impact
Employment
Influence on political and social events
Contribution to the quality of life
Contribution to justice and fairness
Solution 11.6
149

150
Corporate
citizenship
Ethical
stances
Social
responsibility
Social and
Social and
Environmental audit
Audit review
Assesses how organisation is safeguarding the environment. It should enhance management control of
environmental practice and compliance with internal
policies and external reputation.
Auditors will concentrate on a number of aspects of the

control environment which impacts upon an organisations environmental impact:
Types of audit
Environmental impact assessment of major
projects
Surveys of organisations impact
SWOT analysis
Quality management programme
Eco-audit
BS7750 compliance
Supplier audits

Board knowledge
Compliance procedures
Environmental information systems
Performance targets and review
Implementation of previous recommendations
True and fair reporting
Audit work
Review of evidence of environmental impact

Assessment of environmental policy
Detailed testing of adherence to policy
Context
The social and environmental reports described are often audited by external bodies, including the
firms accountants. Therefore the accounting profession must become able to audit these.
151
Reinforcement
152
Scan and note corporate citizenship (Section 1)
Expand notes on Gray, Owen and Adams social responsibility stances (Section 2)
Expand notes on environmental impacts and sustainability (Sections 3 4)
Expand notes on environmental management systems (Section 5)
Scan and note social and environmental audits (Section 6)
Attempt Questions Gray, Owen and Adams, Gray, Owen and Adams 2,
Indicators, Full cost accounting and Ways of doing business in Chapter 11
Attempt Quick Quiz
Attempt Question 11 Loxwood from Exam Question Bank at the back of your
Study Text
Answer bank
Solution 1.1
Loss of strategic control
Couldnt cope with competitors or new technologies

Bad investment decisions eg. acquisitions
Loss of management control
Costs out of control

Poor marketing and purchasing decisions
Loss of key management talent
Shops give bad experience to customers
Loss of investor support
Due to above: plus

Appointment of unsuitable board
Loss of key board members
Failure to achieve promised profits
Board believed to be lining their own pockets
Better accounting
Controlled costs and revenues better

Reviewed investor relations to maintain support
Greater participation in management
Solution 1.2
(a)
(b)
To gain trust of clients of the firm
To avoid being sued for misconduct
To encourage users of information to rely on it (eg, courts, taxation authorities,

regulators)
To ensure public confidence in the profession

To provide professional bodies with grounds for disciplining unethical members
Solution 1.3
Failing to notify or to consult investors on major decisions
Withholding information about the business and decisions
Excessive pay to directors
Large amount of share options granted to board at bargain prices
Unjustifiable use of company flats, cars, planes etc
Lavish expense accounts and glamorous business trips
Vanity investments such as on HQ buildings and high profile acquisitions
Golden parachutes at retirement/dismissal such as several years pay and guaranteed

pensions
Close relations with political and celebrity figures backed up by charitable giving by the
firm they manage
Solution 1.4
(a)
Employees. Keep informed: low power due to not being on board. High interest as the
change affects their jobs and they may want to subscribe for shares.
(b)
Family. Key players: they can vote for or against flotation and they have high interest
due to effect on their power and wealth.
(c)
Stock market. Key players: can admit to market or refuse listing. Interested in listed
firms being well governed.
(d)
Customers. Minimal effort: no power to back or block and limited interest in legal status
of firm.
Solution 1.5
Minimal effort
Keep informed
Casual staff at other hotels
Investors in annual report
External auditors
Staff build support and some may apply for

promotion to jobs there
Media will encourage new investors
Transport firms & suppliers will need to plan
how to get tourists to resort and provide
supplies
Holiday firms will be needed to attract
bookings
Keep satisfied
Key players
Environmentalists will seek to block

development or seek assurances
Directors they will make the final decision
Local people will balance effect on community

with jobs and tourist spending
Tourists and shoppers the complex will need
to meet their needs if it is to succeed
Institutional investors voting power and

concerned at effect of risk on share price
Government will want jobs and revenues and
will need to give planning permission
Answer Bank
Solution 2.1
Parmalat
Enron
Robert Maxwell
Italian dairy firm hit scandal in 2003.
Chairman and CEO was Calisto Tanzi, charged with fraud and moneylaundering.
Tanzi put Parmalat funds into family-owned tourism and football

activities.
Covered up 14bn hole in accounts by forged bonds and also issuing

financial assets to itself via off-shore investment firms it owned.
US energy & telecoms company filed for bankruptcy November 2001 in a

scandal that also destroyed its accountants and auditors, Arthur Andersen
after stock fell from $90 to $0 in a year the largest bankruptcy in
history.
CEO Kenneth Lay, his family and other directors accused of insider
dealing (talking up stock price whilst also secretly selling it).
Balance sheet recorded proceeds from risky energy deals (derivatives) as

assets and borrowed against them.
Losses hidden in accounts of off-shore subsidiaries.
Arthur Andersen helped create this structure whilst also auditing it and
ignoring the overall situation.
UK newspaper and publishing magnate who died suddenly in 1991 shortly

before his empire collapsed because banks would not renew its debt.
Investigators discovered acquisitions and debt payments had been

financed with money from employees pension funds which had also been
used to buy Maxwell shares to prop up the companys falling share price
against which debt was secured.
Solution 2.2
Disadvantages of rulebased approaches
Advantages of rulebased approaches
Can be inflexible
Creates an expensive regulatory burden on firms and markets
Rigid and unable to develop without the passage of new laws or

regulations
Firms cannot avoid regulations even if they are unreasonable
Investor opinion overruled by regulators and courts who may

not be the experts
Management clear on where the lines are drawn
No danger of slackening off of regulation or firms ignoring it
Investors safeguarded by professional regulators
Solution 2.3
The main reasons for the growth of codes since 1990 are:
1.
Responses to the scandals and collapses of business corporations

Examples of this have included the Cadbury Report (1992) which sought to limit the
power of CEOs in the wake of the scandal of Robert Maxwell in 1991, who had used
company and pension fund money to fund his lifestyle and ambitions. The SarbanesOxley Act in 2002 followed the collapse of Enron in 2001 and sought to improve
internal controls, stop auditors facing conflicts of interest and ensure that CEOs and
Finance Directors (Officers) take responsibility for accounts.
2.
Globalisation of investment
Countries wishing to attract funds for their firms needed to make their regulatory
frameworks attractive to international investors. This led to the OECD Principles and the
ICGN report.
3.
Local political changes

The change in economic systems towards market economies in Eastern Europe and China
has led to the need for better corporate governance. In South Africa the King Reports
(1994 & 2002) sought to ensure a more integrated approach to stakeholders in order to
support social change and to make investment in the country acceptable to foreign
investors.
Solution 2.4
The main extra provisions in SOX are:
Codes of conduct for senior financial officers
Regulation of audits including rotation of audit partners
Protection of whistleblowers
Requirement that CEO and CFO take personal responsibility for the accuracy of accounts
Solution 2.5
(a)
Philanthropic
(b)
Economic
(c)
Philanthropic
Solution 2.6
Ownership responsibilities: Cafdirect demonstrates that investors are prepared to sacrifice
potential profits to do good.
Answer Bank
Solution 3.1
(a)
He should not sell shares on the basis of this information because he would be breaking
the law on insider dealing.
(b)
Potential conflict of interest. He should have sought the permission of the Chairman
before taking up appointment. He must now disclose it to the Board and be prepared to
resign the non-executive position if instructed to do so.
(c)
This will probably debar him from being a director under legislation. He should
immediately tender his resignation from the Board to avoid bringing it into disrepute.
Solution 3.2
(a)
The excessive pay seems to be an abuse by agents of principals. The elite group appears
to be protecting its own interests and not the interests of owners.
(b)
Poor. Infrequent meetings, lack of independence and lack of open discussions are bad
signs.
(c)
Many German firms have global operations and customers. There should be more nonGerman perspectives on the supervisory boards.
(d)
Weak, it seems to be just owners and labour. The labour representatives also seem
excluded.
Solution 3.3
Corporate governance is poor for the following reasons:
(a)
The Chairman is not independent. This means he will still be mainly concerned with
running the business. He also has no experience of running a listed company or of the
areas of business the company is planning to enter.
(b)
The CEO has not been appointed by independent NEDs. The CEO is obviously under the
control of the Chairman and not an independent voice.
(c)
NEDs constitute 20% of the board, which is too little. The politician has been appointed
for the wrong reasons and may lack experience, whilst the lawyer is not independent
because his firm receives work from the Company, given to them by the Chairman.
Solution 3.4
(a)
The NEDs have insufficient time to prepare for meetings and so cannot receive
independent advice or ask penetrating questions.
(b)
Dependence on the fees means they would not be prepared to resign on principle if the
Board was doing wrong, and may avoid rocking the boat to help them get nominated and
re-appointed.
(c)
This compromises her independence if the fees received are a substantial part of her
income. She may play along with the CEO in order to get more consultancy work.
(b)
This suggests a lack of fresh ideas coming in. Also danger they may feel need to cover up
for past mistakes by siding with management. The Combined Code suggests that nonexecutive directors who have served for more than nine years would not normally be
classed as independent.
Solution 3.5
A problem with all the remuneration elements are that they are based on financial performance
only and so will not motivate the Sales Director to manage his sales team well or conduct his
other responsibilities as a director.
(a)
This is not sufficient to motivate him to work hard as the cap means it will make little
difference to his standard of living.
(b)
Increasing sales volume may not increase profits if it has been achieved by price cutting
or high promotional spend. There is also a danger that sales may be increased in the
short-run by misleading customers by encouraging the sales team to book sales before
the year-end with non-creditworthy customers, or agreeing with customers to cancel
sales immediately after the year-end.
(c)
This could encourage reckless behaviour to boost earnings, and encourage the early
retirement of the director following a particularly good year to maximise his pension.
(d)
This is not very motivational as there is very little chance the firm could increase its share
price to $1.50 in a single year. It also doesnt help retain the director if these are the only
share options he has.
Solution 3.6
(a)
It suggests that the board has ticked-the-box on having an Audit Committee but it
doesnt seem to be a very effective one. No chair, no knowledge and no NEDs.
(b)
This appears to have consisted of NEDs, which is appropriate. Having only 2 members
could lead to deadlock or, if it doesn't, the fact that it doesnt could suggest they were
merely there to sign-off on the recommendations of the Board.
(c)
This means that there is not a sufficient independent element on the Board and Nomination
committee. Therefore the main Board could protect itself by vetoing the nomination of
directors that could demand change. In addition the company is neither complying nor
explaining. It states that it regards Mr YYY as independent, but it does not attempt to justify
the difference between its interpretation of independence and the definition in the
Combined Code.
The shareholders can ask questions of the Board at a GM which could embarrass the Board. If they
grouped together they could try to force a resolution to dismiss Board members or appoint additional
directors. The stock market could threaten suspension of the companys shares although this is
unlikely.
Answer Bank
Solution 4.1
(a)
Objective or plan: doctor sets by prescribing certain medication at certain intervals.

System: medication is received from pharmacy and checked (input), administered
(process) and patients condition improves (output).
Sensor: patients record is updated each time the dose is given and for the results of
tests on pulse, temperature etc.
Comparator: senior medical staff review the patient record regularly to check that the
medication is being given and the patient is improving.
Effector: doctor may instruct changes to medication if patient not responding as
planned. Hospital management may discipline staff if it is discovered that medication has
not been given when planned.
(b)
Human resource controls: selection and training of medical staff.

Administrative controls: management of admissions and beds, scheduling of operating
theatres, security of dispensary.
Management controls: supervision of staff, review of management information.
Ethical codes: policies of the hospital, professional ethics of medical staff.
External controls: regulatory inspections, professional bodies disciplining medical staff,
market forces and need to attract patients, litigation by patients for negligence.
Note: The last two of these are not internal controls. They are external and part of the control
environment. If they are strong enough they may reduce the need for so many internal controls.
Solution 4.2
(a)
The project risk exceeds the risk appetite of the shareholders. The existing shareholders
have deliberately invested in stable industries and not in risky industries. They will
probably sell their shares and cause the share price to fall or put pressure on the Board to
oppose the sell-off.
(b)
The project may be appropriate for the risk appetite of investors. High technology is an
industry characterised by large investments with high risks but also potentially high
returns if successful. These investors will probably support the decision.
(c)
This suggests a balanced risk/return profile which may satisfy most investors.
(d)
The project will probably exceed the risk appetite of investors and lead to a fall in the
share price. Pension funds need regular reliable income and stable share prices to ensure
the value of the funds remain high. They cannot afford to leave retired people with no
income by having lost it in risky investments.
Solution 4.3
Business environment
Control procedure (student to add

suggestions)
Most of the customers pay in cash
Regular reconciliations
Separate cashier to handle money
Close observation of staff
There is high staff turnover in this

industry
Introduce loyalty-based bonuses

Ensure regular induction & training programmes
Have clear succession planning for staff
Individual inventory items are of high

value
Ensure good physical security

Inventory only issued to authorised signatories
Close stock control to avoid over-ordering

A lot of firms in the industry have been
sued by dissatisfied customers
Ensure clients wishes are written down and signedoff by client

Appoint client care manager to each client
Establish an internal complaints procedure
Take legal advice on compliance and at early stage
of any dispute
There is a lot of dangerous machinery

and chemicals involved in the process
Training of all staff in relevant safety matters

Appointment of a Health and Safety officer in each
factory
Contingency plans in place for spillages and injuries
Insure firm against liability for injury
Solution 4.4
Possible difficulties include:
Cultural difficulties; management structures and attitudes may differ in the overseas
supplier, also attitudes to quality
Arlo does not have direct control over the suppliers workers as they are employed by the
supplier
Quality review; does Arlo incur costs through sending its own staff out to review the
suppliers activities, or does it rely on the quality procedures operated by its supplier
Communication problems; the supplier may be unwilling to give Arlo bad news
Answer Bank
Solution 5.1
(a)
The personal views and influence of Mr X will have determined AAA's attitude to risk and
he is an entrepreneur who is willing to take risks. SSS has shareholders who would
punish a board that took too many risks and had too many failed business ventures. The
SSS board members will be cautious, in order to ensure they remain on the board.
(b)
Different shareholder requirements. AAAs shareholders are obviously risk seeking

because they know and support Mr X. SSSs shareholders, by purchasing railroad stock,
have shown a preference for an established industry.
(c)
Organisational influences. AAA is smaller and it has diverse businesses. It has a history of
growth by trial and error. Risk taking is in its culture and reflected in its lack of control
systems.
(d)
Cultural influences. AAA has been characterised by an individualist culture based on Mr X.

SSS is more likely to operate a hierarchist culture.
(e)
National influences. SSS is subject to strict US codes on corporate governance and

internal control.
Solution 5.2
(a)
Establish requirement that management at each store have a monthly staff meeting at
which risk is an agenda item and staff are informed of risks that are emerging (eg a new
credit card hoax) and where they can report risks.
(b)
Hold regular fire drills and evacuations to show how serious a fire would be.
(c)
Notices in staff rooms depicting symptoms of particular risks (eg. how to spot a thief, the
signs to look for in strain injuries).
(d)
Allow staff time to conduct mystery shopper visits to rivals and other stores in their own
company and to report on what they experienced.
(e)
Instruct all management and staff to complete a personal risk assessment questionnaire
and return to HQ.
(f)
Base bonus payments for managers and staff in part on carrying out risk management
procedures (eg meetings, attending courses).
(g)
Notify managers of flying visits or mystery shopper tests to assess risk management at
each store and depot.
Solution 5.3
10
Failure of the board to understand all the risks the business faces (this ties in with board
recruitment and education discussed in Chapter 3)
Failure of the board discuss key risks for long enough often enough
Managers and staff being able to take significant risks without the boards knowledge
Failure of intelligence to predict key future risks and how their consequences will impact
upon competitive strategies
Information about the ways risks are being managed
Solution 6.1
Strategic risks
Exposure of the firm to the economies and competition of new countries
Possibility of losing customers who reject the new check-out technology
Financial failure of home delivery service
Neglect of core business due to devoting resources and management attention to foreign
development
Operational risks
Shortages of supply due to problems with assuring supply chain in foreign countries
Breakdown of new check-outs leaving the store unable to take money
Fraud by customers not declaring all the goods they have taken from the shelves
Collisions and injuries caused by home delivery vehicles
Solution 6.2
Financial risks
Value of investments fluctuate
Debtors default on borrowings
Loss of earnings due to changes in the interest rate
Legal and
political risks
Increased regulation over banks and charges
Costs of defending legal actions against them for alleged cartel and
fines if convicted
Environmental
risks
Bad publicity over charges
Criticism for congestion caused by customers vehicles and security

vans
Technological
risks
Breakdown of telephone links to call centre
Hacking of bank website
Breakdown of ATMs
Fraud by call centre or IT staff
Health and
safety risks
Harm to staff from attacks by bank robbers
Injury to staff from excessive use of IT systems or headsets
Knowledge
management
risks
Leaks of customer account information to outsiders
Improper denial of credit or account information to customers
Solution 6.3
Fraud risks
Property risks
Disruption
risks
Card readers and cloning enabling fraudulent withdrawals from ATMs
Staff embezzling bank or customer funds
Bogus clients obtaining loans
Fire or flood at branches
Vandalism to ATMs
Forced removal of ATMs using mechanical excavators
Breakdown of IT systems (same as technology risks)
Strike action by unionised staff closing branches
Severe weather making it impossible for staff and customers to get to

branches
Answer Bank
11
Resource
wastage risks
Trading risks
Product risks
Organisational
risks
Reputation
risks
Failure of electricity supply in area of branch necessitating its closure
Costs of printing and posting statements to customers
Costs of on-line banking service if customers are not using it
Staff time in holding conversations with customers
Costs of branches if customers can be persuaded to use call centres

and on-line systems
Possibility that payments on foreign debt will be delayed and harm

cash flow of bank
Possible repudiation of debt by debtor nations
Loss of loans to dubious foreign customers
Legal liability for misselling investments to customers
Increasing costs of complying with regulations on investment products
Armed hold-ups of branches due to large amounts of cash held there
Refusal of staff to comply with work smarter initiative
Potential loss of control over foreign call centre
Perceived as vulnerable to credit crunch
Lack of security of customer information
Giving poor advice
Solution 6.4
This is an individual exercise. There is no debrief for this Learning example.
12
Solution 7.1
(a)
Reduction. This reduces ZABs fixed costs.
(b)
Reduction. Having signed it enables ZAB to rebut allegations.
(c)
Reduction. Should reduce losses by deterring & catching thieves.
(d)
Reduction.
(e)
Acceptance. Presumably the costs are less than the benefits of customer goodwill and
promotion on the bags
(f)
Transfer. If it fails the empty store will soon be the lessors problem.
(g)
Transfer. Staff are taking the risk of low pay during quiet seasons.
Solution 7.2
(a)
This is an administrative control to ensure correct staff utilisation and perhaps to

construct management accounts and fee invoices. It may also be a management control
if it assesses the effectiveness of a staff member or the profitability of particular products
or clients.
(b)
This is an administrative control.
(c)
This is a management control because it is used to manage business units and

responsibility centres
(d)
This is a corporate control because it applies to the corporate board.
(e)
This is a control at all three levels.
(f)
This is a corporate control but the risk committee may require that risk committees be
set up at divisional and workplace level too and these would be managerial and
administrative controls.
Solution 7.3
(a)
(i)
Send two agents to collect to deter assailants and to provide a witness. This will
double the costs of collecting payments.
Introduce procedures that agents can carry no more than a certain amount of
takings on them before they must deposit the rest in a secure place in their vehicle
or at a bank. This will reduce losses. Costs will be for the secure places and from
the reduced efficiency of agents because they have to break off from collecting
regularly.
Employ bodyguards/armoured cars etc possible but expensive and bad for
reputation.
(b)
(ii)
Abandon collections and insist households pay through banks. Cost will be loss of
some clients and need for chasing of non-payers. Also redundancy payments to
agents and possible loss of selling opportunities.
(i)
Improve product documentation and tracking. This will increase administrative

costs.
Insure consignments. The costs will be the insurance premium and costs of
pursuing claims.
Improve credit checks on customers. This will increase administration costs and
also mean they cease supplying some customers
(ii)
Cease business with the country. Cost will be loss of all future earnings from there.
Only sell to country through third party firms and leave them to take the risks. This
will reduce profit margin on the product.
Answer Bank
13
Solution 8.1
Customer relations: Downward communication could be setting of service standards and KPIs,
provision of training, creation of new key account manager roles, and initiatives like awards for
customer service champion of the month, posters emphasising customer is king. Upward
communication could be reports on KPIs, regular board report from head of customer relations,
mystery shopper reports, regular reports on customer turnover with reasons for loss, reports on
reasons for complaints to industry watchdog by customers.
Service levels: Downward communication of importance via setting key targets for reducing
outages, quicker response to requests for service/repairs. Upward communication via reports on
power performance against targets and special reports of serious outages or problems.
Health, safety and environment: Downward communication includes clear commitment from
CEO to the importance of this, instruction to managers to create health and safety committees
at workplace level, provision of training, posters to remind, discipline for breaches of
regulations. Upward communication would be performance against targets, results of IA
assessments, specific reports on incidents.
Asset security and business continuity: Downward would include making staff personally
responsible for tools etc, requirement for managers to submit risk assessments, policies on
personal security, employment of business continuity consultants to work with divisional
managers to develop plans, policies on succession and backup. Upward communication includes
IA reports.
Expenditure: Downward communication includes setting of maximum expenditure limits,
centralisation of payments, tight budgets, refusal of expenditure requests, requirement for
business case for spending. Upward communication would be budget reports and reports on
progress of major projects (eg. pipelines)
Accounting, financial and other reporting: Downward would be installation of particular
programmes, documentation and procedures, notification of adoption of particular conventions,
creation of IA. Upward would be regular accounting reports, IA reports, and reports from
external auditors.
Solution 8.2
A good example is the systems development lifecycle, applying to developments in
computerised systems.
SYSTEMS DEVELOPMENT LIFE CYCLE
Feasibility study
Briefly review the existing system
Systems
investigation
Obtain details of current requirements and user needs such as data

volumes, processing cycles and timescales
Identify possible alternative solutions
Identify current problems and restrictions

Systems
analysis
Consider why current methods are used and identify better alternatives
Systems design
Determine what inputs, processing and storage facilities are necessary to

produce the outputs required
Consider matters such as program design, file design and security
Prepare a detailed specification of the new system
Test system fully
14
Systems
implementation
Write or acquire software, test it, convert files, install hardware and start
running the new system
Review and
maintenance
Ensure that the new system meets current objectives, and that it continues
to do so
Solution 8.3
The main arguments you could have included are:
Having IA will be recommended or required by the codes on corporate governance that

listed companies must abide by
IA shouldn't report to him if it is to be independent
IA should report to the Audit Committee to help it do its work. It is for the Audit
Committee to decide whether IA is needed or not
If he is overloaded, this may indicate that the growth of XYZ plc is straining its internal
controls and that a review by IA is needed
Operating abroad represents a change to risk and to organisational structure that may
defeat the present internal controls
The benefits of IA can go beyond just reducing the audit fee and include identifying cost
savings and reducing the risks of fines for non-compliance
The scope of IA can go beyond financial controls and these other controls need
monitoring too
IA could be carried out by an external provider to reduce the fixed costs of having a
permanent IA function
Solution 8.4
(a)
It indicates a lack of experience amongst IA staff. IA seemingly battles for resources and
has no career staff of its own. The trainees may wish to gain the favour of the divisions
they audit to get jobs there later (or these jobs may be held out as inducements). It will
be very difficult to conduct audit planning with shifting staffing and lack of chance to
develop their skills.
(b)
This suggests that the culture does not hold IA in high regard and so internal controls will
not be strengthened by fear of it. The danger is that IA cant recruit or keep the best
staff. This will reduce the quality of its work.
(c)
This means that its scope is principally financial controls and it suggests that staff may be
tempted to go easy on departments in which they hope to get a job.
(d)
The Head of Department created the system he is now auditing. He may be blind to
deficiencies of the system because of his preconceptions and/or he may wish to suppress
criticism of it because it reflects badly on him. His staff may also not wish to be seen to
criticise it in case it affects their careers in IA.
Solution 8.5
Methods of improvement:
Lay down stricter guidelines on what should be disclosed (such as key controls, methods
used to assess controls and key weaknesses found and remedies applied) rather than
simply require statement of compliance.
Extend scope of external audit to include audit of business and other risks beyond simply
risks to financial statements.
Require boards to publish a list of key risks and how they are managed.
Drawbacks:
Will increase costs of compliance, particularly if external auditors have to validate.
Firm may lose commercial confidentiality over its affairs in the interests of transparency.
Management may follow more risk-averse strategies and so miss potential gains.
Answer Bank
15
Solution 9.1
(a)
(b)
(c)
(d)
(e)
(f)
Teleological/act utilitarian best outcome for majority from the decision.

Deontological/absolutist rejection of corruption as always wrong.
Teleological/rule utilitarian abide by the rules that bring the best outcomes overall.
Egoist based on personal benefit.
Deontological/Kantian do as you would be done by.
Moral relativist adopt the ethics of the country you are dealing with.
Solution 9.2
Partner A
Level 1 pre-conventional: he would exhibit moral behaviour only if he feared

punishment for not doing so and not because he understands the moral issues.
Partner B
Level 3 post-conventional: she has considered the broader moral issues and is
challenging the conventions and making her own decision rather than accepting
convention.
Partner C
Level 2 conventional: she recognises that ethics are part of a social contract.
GGG has a duty to the public otherwise it has no right to exist as an auditor.
Solution 9.3
(a)
Discipline client manager and consider disciplining the Client Director for misuse of funds
to improve moral framing.
(b)
Reinstate low moral intensity offence and they have already been punished.
(c)
Dismiss or discipline depending on banks ethical stance and views on national diversity.
(d)
Dismiss. Very high moral intensity and significant reputation risk. No mitigating factors.
Solution 9.4
Facts: as given
Ethical issues: fairness/rightness of treatment of M, integrity and independence of the audit of
GGG.
Norms/principles/values: self-interest due to reliance on GGG for income, familiarity of
relationship between B and GGG, intimidation of M by GGG, profitability of GGG's contract.
Alternative courses of action. Do nothing and sign accounts, reinstate M, further
investigation of GGG, discipline B, remove B as client manager, revolve audit team, investigate
involvement of audit partner (has B been supervised at all?)
Best course of action: reinstate M or compensate, discipline B and audit partner, further
investigation of GGG by new audit team, write to Chair of GGG complaining at intimidation,
introduce safeguards, reduce reliance on GGG.
Consequences: avoid audit risk and potential problems from professional monitoring, avoid
litigation from and exposure by M. But may lose GGG, valuable client, and could raise further
questions about the past audits.
Decision: adopt best course of action.
16
Solution 10.1
Code of conduct should cover:
Treatment of colleagues, including making clear that sexism is prohibited

Independence of editorial policy and fairness in reporting
Misuse of IT systems
Whistleblower procedures
Equal opportunities policy for appointments
The control environment at ZZZ will work against the success of this code due to the national
culture and the behaviour of the Chairman which seems to condone such sexist behaviour. The
lack of independence on the board means that there is no-one for the whistleblowers to report
to in confidence. There will be the suspicion that any code of conduct will not be implemented or
supported by management.
Solution 10.2
(a)
Professional competence/due care may be breached by you unless you make your
reservations clear to your manager. The practice will breach its obligation unless the work
is checked by a competent person.
(b)
Integrity, although the practice may argue that this charging structure was clear in the
letter of engagement. However such a structure appears to breach the principal of
professional behaviour.
(c)
Confidentiality, assuming this was not specifically agreed to by the client as a condition
of obtaining the loan. Also professional behaviour depending on how much of an
advocate the partner was for the client when getting the loan.
(d)
Objectivity as the practice may not be sure that this is the best adviser for each and
every client. Possibly confidentiality if the practice passes over client names to the
adviser without permission of the client.
(e)
Professional behaviour as clients have a right to expect their concerns to be dealt with
in a reasonable time.
Solution 10.3
(a)
Advocacy threat but also possibly self-interest. The reference could be biased to help
the client to get the funding. The reference could be externally reviewed or the
relationship disclosed to the bank (which presumably they realise already).
(b)
Intimidation threat and also self-interest. The present audit and future audits may be
soft to keep client happy or superficial to save costs and so allow a competitive fee to be
charged. Stay with original audit plan and give clear account for time spent to client.
Consider review of audit plan for next year.
(c)
Self-review threat: if it can be shown that there is not proper independence from the
consulting division. Check independence or decline request.
(d)
Self-interest threat: the partner and their staff should be excluded from the audit
process and not allowed to see the papers or report.
(e)
Familiarity threat: however this does not appear to be a significant problem (assuming
the Managing Partner has no connection with the audit) for now, so no action needed.
Solution 10.4
Saying that accountants cant be rewarded in this way puts accountants in much the same
position as non-executive directors. The problem is the fees non-executive directors are paid
are unlikely to be their main source of income unlike accountants. Also accountants are not just
responsible for producing published accounts for external investors; other responsibilities may
include providing advice on the financial implications and risks connected with major
Answer Bank
17
investments. It seems unfair to exclude accountants from the rewards derived from the profits
generated by those investments, if those investments are successful.
The case for limits on the remuneration packages of accountants whose role is to scrutinise and
challenge information appears to be stronger, particularly internal auditors. Remember also that
bonuses do not need to be linked to the companys performance; they can be generated by
good performance in other ways.
Solution 10.5
18
(a)
This is the perspective of the profession itself. The requirement that members of
accounting bodies adhere to ethical codes, and can be disciplined and even expelled for
not doing so are ways for the profession to ensure this. Certainly without such
professional conduct the work and word of accountants would become devalued and it
would adversely affect the smooth conduct of the market economy, investment and
public finance.
(b)
Accountants in industry must obey management instructions so far as they dont conflict
with their legal and professional obligations. Financial reports on companies performance
are usually audited by members of the profession and an independent view expressed.
But the Enron collapse showed that sometimes members of the profession have allowed
this independence to become blurred and this was not in the public interest. This has led
to the profession being regulated by codes on corporate governance. Tax avoidance is
legitimate as it stays within the taxation legislation and sometimes has the effects the
government intended such as channelling funds to good causes to avoid tax. It acts as a
discipline to ensure taxation legislation is better drafted. Tax evasion is wrong because it
means breaking the law and the profession should not be party to this. But there is some
truth in the argument that richer people can seem to pay less tax because they can hire
better advisers.
(c)
Accountants dont support just capitalism. There have been accountants in feudal and
communist systems too and the state employs a lot of accountants. Accountants are not
responsible for changing economic systems but even so they have developed techniques
of environmental accounting.
Solution 11.1
This provision has been the subject of some debate. One view is that the key phrase is benefit
of its members, implying a limited view of citizenship. However some critics have argued that
the section lists so many factors to consider that it effectively implies an equivalent view.
Solution 11.2
(a)
Multiple stakeholder stance
(b)
Shaper of society stance
(c)
Short-term shareholder interest stance
(d)
Long-term shareholder interest stance
Solution 11.3
(a)
(b)
(c)
(d)
(e)
(f)
(g)
Deep ecologist
Socialist
Pristine capitalist
Radical feminist
Social ecologist
Social contract proponent
Expedients
Solution 11.4
Visual impacts of automobile plants, supplier industries, road expansion and scrap heaps.
Noise from production of automobiles and from road noise from their use.
Emissions from automobile plant and from vehicles themselves. Pollution from spillages in
the oil industry.
Carbon dioxide emissions from the factory and from the cars themselves. Roads and
parking spaces reducing ability of ground to absorb suns rays.
Increased congestion and atmospheric pollution from road traffic, despoiling of natural
habitat around oil wells and refineries, loss of sea life from tanker spillages.
Injury and death due to road accidents, respiratory illnesses, poisoned water sources
from decaying cars.
Waste disposal problems from end-of-lifecycle cars, disposal of worn tyres, disposal of oil
and lubricants polluting water.
Acid rain created from nitrogen oxide and sulphur dioxide created by burning fuel.
Depletion of natural resources through dependence on oil for fuel and materials use of
metal ores.
Solution 11.5
Steps could include:
Insistence that airlines switch to eco-fuels, more efficient aircraft and plant trees to offset
emissions of greenhouse gases
Sell eco-tourist holidays that make their minimum impact on local environment a selling
point
Give preference to local suppliers for food, excursions etc
Answer Bank
19
Increase holidays nearer to home
Encourage bio-diversity in hotels such as in the planting of hotel gardens
Ensure local communities, rather than greedy governments, are involved in making
choices about where hotels can be built and facilities sited
Contribute funds to improve local facilities such as fresh water and housing
Lay down requirements for waste disposal
Provide information to tourists on local economy and culture and encourage respect for it
Solution 11.6
Environmental impact
Switching to digital methods to reduce use of paper and transportation

Sourcing of newsprint paper and use of sustainable forests
Emissions and impacts of transportation
Energy usage and conservation
Appointments of staff with environmental responsibilities
Employment
Jobs created, gained, lost

Breakdown of workforce by gender, ethnic background, age and disability
Number of staff receiving personal improvement/development activities
Influence on political and social events
Summary numbers of stories/articles carried by subject

Commendations received
Case studies of particular campaigns and outcomes
Amount and balance of political reporting broken down between parties or issues
Contribution to the quality of life
Summary numbers of articles by topic

Specific new sections introduced
Awards won
Percentage of page space taken up by advertising
Amount of space given at nil cost to good causes
Contribution to justice and fairness
20
Summary of editorial policy

Relations with communities
Employment policies
FOR EXAMS IN
DECEMBER 2008
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Tel: +44 (0)20 8740 2211
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First edition 2008

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BPP Learning Media Ltd

This chapter sets out the foundations of good corporate

Learning example 1.1

1: Scope of corporate governance

Take into account all stakeholders with legitimate interests

Openness, disclosure in financial statements, press releases, websites

Need for independent non-executive directors who can monitor without

Management responsible for organisation, means of corrective action and

Directors answerable for consequences of actions, to shareholders and

Jeopardised by poor risk management/corporate governance, may impact

Taking decisions that enhance organisations prosperity

Straightforward dealing and completeness, basis of trust

Learning example 1.2

Straightforward and honest in all professional and business

Should not allow bias, conflicts of interest or undue influence of

Professional competence and

Maintain professional knowledge and skill at a level to ensure that

Respect the confidentiality of information acquired as a result of

Explain why these fundamental principles are important:

Running an accounting practice

1: Scope of corporate governance

Agency in corporate governance

Agency is acting on behalf of another (principal) in

Directors (agents) run company on behalf of

Agency costs are the monies and resources

Agency problem how to prevent directors excessively

Main solution is to link reward with company

Transaction costs theory

Learning example 1.3

1: Scope of corporate governance

Organisations have responsibilities to broad

Normative view ethical/philanthropic

Stakeholder power mapping

Stakeholders are groups or individuals whose

Instrumental view mainly economic

Corporate governance accommodates views

Learning example 1.4

Employees of the company

1: Scope of corporate governance

Primary and secondary stakeholders

Primary need participation to continue as going

Connected shareholders, customers, suppliers,

Narrow and wide stakeholders

Secondary their ceasing to participate wont affect

Active and passive stakeholders

Narrow most affected by organisations strategy

Active seek to participate in organisation's

Wide less affected by organisations strategy

Passive dont seek to participate in policy-making

Voluntary and involuntary stakeholders

Voluntary those who voluntarily have involvement

Legitimate valid claims

Involuntary engage with the organisation without

Who decides legitimacy?

Recognised Managers consider interests and views

Known Existence known to organisation

Unrecognised Managers don't consider claims when

Illegitimate invalid claims

Unknown Existence unknown to organsiation