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    CIMA MCS Mock Exam 1 wwwastranti.com » astranti financial training CIMA Managerial Case Study Mock Exam 1 Portafone Solutions " a) astranti CIMA MCS Mock Exam 1 www .astranti.com Section 1 To: Leo Chan - Senior From; Financial Manager Re: Audit Reports Ethical Princi an ‘Manager les and Di iplinary Process Audit Report: Ethical Principles Professional Behaviour ‘The willingness to use batteries before they were properly certified is a breach of the principle of professional behaviour. Using batteries which are not certified or falsely certified would be a conscious breach of the law governing health and safety. Effect on our reputation We would risk discrediting the company and, by implication, our clients e.g. network providers, by implicating them (albeit unwittingly) in this act. Part of the success of Portafone is likely to be built upon our reputation for producing reliable mobile phones as evidenced by our increasing sales. We cannot afford for our reputation to be negatively impacted, especially since we currently only manufacture mobile phones and therefore do not have any other source of revenue. Integrity ‘The use of batteries which are not certified would also breach the principle of integrity. It is dishonest, both to use the batteries without signed-off safety certification and to imply to clients that a batteries are fully certified, Objectivity ‘The willingness to continue the employment of the employee with a criminal conviction for fraud, in breach of the SLA’s commitment to clients such as network providers breaches the principle of objectivity. We should not deceive stakeholders even if we are doing so by omission of a material fact about a past error rather than a deliberate decision to mislead, Professional competence and due care ‘The failure to adequately vet the new employees also implies a breach of professional competence and due care. As directors, it is perfectly acceptable to delegate tasks to others, but directors always remain responsible, This situation has arisen because of a corporate failure to implement an important check. 7 » astranti ‘nancial training CIMA MCS Mock Exam 1 woww.astranti.com Developing a soun ethical culture to help prevent fraud Attitudes within an organisation often lay the foundation for a high or low fraud risk environment. Where miner unethical practices may be overlooked (e.g. petty theft, expenses frauds}, larger frauds committed by higher levels of management may also be treated in a similar lenient fashion. Evidently this emphasises the anger of not dealing with the issues highlighted by the audit report. Risk of ignoring ethical issues In this environment there may be a risk of total collapse of the organisation, either through a single catastrophic fraud or through the combined weight of many smaller frauds. Long term benefits of high ethical standards Organisations which have taken the time to consider where they stand on ethical ‘issues have come to realise that high ethical standards bring long term benefits as customers, suppliers, employees and the community realise that they are dealing with a trustworthy organisation, Indeed we encourage our managers to engage with the wider community; therefore we should already recognise the importance of being seen to bea trustworthy organisation. Consequences of dubious ethical practices Some organisations have realised that dubious ethical or fraudulent practices can’ cause serious adverse consequences to the people and organisations concerned when exposed. By not having robust ethical practices in place we risk damaging our reputation, Fraud risk and training twill Be important for us to raise awareness through a formal education and training programme as part of the averail risk management strategy, Particular attention should be paid to those mangers and staff operating in high-risk areas, such as procurement and bill paying and those with a role in the prevention and detection of fraud and indeed those staff responsible for safety checks, including “signing off” on safety checks. Disciplinary Process Accructal element of Human Resource Management is to have a robust control system in place that encourages all employees to behave in an acceptable way. For example within CIMAa’s framework of control, such a system will have two elements. 18 » astranti Frnanca een CIMA. MCS Mock Exam 1 www. astranti.com The two elements are, firstly, the control environment, where the organisation’s overall philosophy is explained and expectations are set; secondly there are the control procedures, where rules and guidelines are clearly defined. The control procedures include both disciplinary and grievance procedures. Control environment and procedures These two elements have certain similarities, i.e. they both aim to encourage acceptable behaviour. They are both designed to correct inappropriate behaviour where necessary. They both require strict guidelines, so that people knaw exactly what is expected of them. They both require an audit trail to ensure that fairness has been applied in all cases. It is perhaps because of their similarities that the two procedures can get confused. Disciplinary Procedure. Discipline can mean different things to different people. It can be thought of as the use of pawer or authority to compel us to act in a certain way. Alternatively, discipline can sometimes mean being punished for not doing something right and this appears to be the view of some members of the audit committee in relation to the alleged fraud by one employee in the sign-off of safety certificates for batteries. Establishing a framework Disciptine is not all about punishing people for getting things wrong; it’s about establishing a framework to help them get things right. In this case, the framework is the disciplinary procedure, where guidelines are set, without appearing dictatorial, to encourage staff to behave in an acceptable manner. Clear documentation ‘The clearer the disciplinary procedure and the better it is understood, the more likely it is that people will behave acceptably and ne corrective action will be required. As with all rules and guidelines, it's important that the organisation produces documentation that’s explicit about what is acceptable and what the consequences are if the rules and guidelines are not followed. Employer's role Its not sufficient simply to make people aware of the procedure; the employer has to ensure that all staff actually read and comprehend it. In this regard, many organisations require their emplayees to study the documentation and then answer a number of questions aimed at testing their understanding of the procedure. In this particular case we need to be clear whether we provided the individual. concerned with the appropriate documentation for their specific role. For example did we provide full details of the ‘sign off" procedure for the testing of suppliers batteries? ial » astranti sesiuoweseee ‘nancial ersining ‘CIMA MCS Mock Exam 1 www.astranti.com ‘Types of inappropriate behaviour ‘There are various types of behaviour that may be deemed inappropriate, ranging from minor infringements to serious breaches. They include, persistently arriving late for work and/or leaving early without approval, misusing company equipment, pilfering company property, acting inappropriately in meetings with clients, failing ‘to comply with health and safety regulations, making threats to colleagues, and in ‘our specific case the allegation that an employee may have committed fraud. Application of the ary procedure It's important that the disciplinary procedure can be applied to any form of ‘inappropriate behaviour that occurs, whether it’s trivial or grave. While specific steps can vary between organisations, the following is a typical sequence of events aimed at ensuring that a disciplinary matter is handled appropriatel Informal discussion: This is an “off the record” meeting between the individual ‘concemed and their manager. It is often used to deal with minar breaches, with ‘the intention of tackling the problem before it becomes more serious. ‘Verbal warning: This will occur if the breaches continue after the informal ‘discussion. The manager must however record that a verbal warning has been given. ‘Written warning: This will be invoked if the verbal warning has no effect. It will be put on the employee's record. Some organisations give only one written warning before moving on to the next step in the process, while others issue two. ‘Suspension: The employee will be removed from their duties, usually on full pay. ‘This step is intended as a temporary measure, often to give the individual time to reflect on their misdemeanour’s and give their manager time to conduct ‘comprehensive investigation. Demotion: This fs a more permanent sanction used in cases where the employee. has not brought their behaviour up to an acceptable standard after all the preceding steps. Dismissal: The ultimate step in the process results in the termination of the ‘employee’s contract of employment. It is important to deal with a breach of discipline at the appropriate stage to ensure fairness. In most cases, problems are resolved at an early stage so that the final steps are not necessary. However there may be instances where the process would start at one of the later steps. For example in relation to the alleged fraud if after further investigation it becomes clearer that fraud was carried out by this individual it may be appropriate ‘to suspend the individual on full pay until a more exhaustive inves carried out. ation is _ » astranti Financial ering CIMA MCS Mock Exam 1 ‘wwwr.astranti.com Right to appeal Whatever action is taken, it must always be in line with the guidelines documented. It is also important that the procedure sets out what the employee would need to do if they should decide to exercise their right to appeal. Benefits of disciplinary procedures ‘The benefits of having disciplinary procedures in place are that employees at all levels know what steps will be taken in the event of the disciplinary procedure being instigated and they should feel that there is a system in place that they can trust. For the employer, using the procedures appropriately should help to ensure it is meeting its legal obligations as an employer to provide such procedures and therefore should help to prevent the organisation's image from being tarnished. Regards Financial Manager a » astranti CIMA MCS Mock Exam 1 www.astranti.com Section 2 To: Leo Chan From: Financial Manager RE: Directors Performance / Remuneration and Executive Share Options Directors Performance Shareholder concerns ‘The shareholders are concerned by the fact that that the directors do not appear to suffer any personal loss when Portafone runs into difficulties. In this case one shareholder considers that the directors have made a serious error in not having an alterative supplier. Currently, the directors’ salaries are still paid regardless of the downturn in revenue arising from the loss of business due to the media article and the recall of 4g smartphones, Performance related pay: executive share options Replacing part of the existing salary scheme with options would add a performance-related element to directors’ remuneration. Share options allow the directors to benefit from any increase in the share price provided the share’s market value exceeds the exercise price. That aligns the interests of the directors with those of the shareholders because the options will expire worthless if the share price does not increase beyond the exercise price, Shareholders’ proposed model ‘The proposed model requires an increase in the share price of F51.10/3.10 = 35% over four years. That requires an average increase of roughly 9% per annum Achieving this size of increase in the share price would mean that Portafone would have recovered from the current drop in share price due to the impact of the recall of the 4g smartphones and associated drop in revenue. Risks of proposed model ‘There could be a risk that the directors will become fixated on the option scheme to the company’s detriment. For example, they could resist any attempt to remove ‘them from office because they do not wish to lose the value of any options that will then expire. » » astranti ‘ancl reining CIMA MCS Mock Exam 1 www-astranti.com Growth of 9% per annum is quite high, so the directors could be motivated to manipulate reports given that a consistent growth of 9% per annum could be difficult to achieve through good management alone. For example, directors could be motivated to try to manipulate the share price, timed to coincide with the exercise date of a tranche of executive share options, Non alignment of risks ‘The shareholders are concerned that the directors are unconcerned with the risks faced by Portaphone. That may mean that options will not fully align their interests because the directors will not participate fully in downside risks. The value of the options will fall to zero if the share price is less than or equal to the market price of the shares. Any further decline will cost the directors nothing further. Benefits of proposed executive share option model If the directors hold large numbers of options then they will have a financial incentive to maximise the share price. Provided the share price exceeds the exercise price at the relevant date the directors can exercise their options and buy shares for less than their market value, They will then either retain those shares as an investment or resell them at a guaranteed capital gain. If the share price does not rise during the vesting period then the directors will receive Little or no value and so they have a direct financial interest in achieving an increased share price. Encouraging directors to accept shareholder risks Any shareholder who wishes to achieve the best combination of risk and return should hold a diversified portfolio. One implication of that is that the shareholders are less concerned about total risk associated with any given investment in their portfolio. The shareholders do not care about unsystematic risks because they can protect themselves, but the directors do not have that luxury. Shareholder and director interests Each director has only one career and can only serve as an executive director for ‘one company at a time so diversification is impossible. An investment opportunity that would be attractive to the shareholders because the potential returns are high relative to systematic risks might be unacceptable te the directors because they will be exposed to the total risks should it go wrong. SEs » » astranti CIMA MCS Mock Exam 1 woww-astranti.com For example, a new product that fails might have a very limited impact on shareholder's total investment portfolios but could end the careers of the directors who were responsible for recommending that it should proceed. Conclusion If shareholders really wish to align the director's interests with their own they need to find some way to encourage the directors to accept the risks that they ‘would choose to accept for themselves. Unfortunately, there is no way to ensure that will always happen. The best that the shareholders can do is to find a way to encourage directors to take sensible risks and executive share options could provide part of the answer and therefore could be seen as a sensible response, Executive Share Options: Impact on Financial Statements Basic features of Executive Share Options An executive share option can be part of a manger’s remuneration package. The detailed workings of any scheme are decided by the company itself, but the general features involve the following aspects: Allocation of Options and Striking Price Each eligible manager is granted an allocation of options as part of their annual remuneration. The number of options will generally be decided by the remuneration committee. The options themselves will normally have a striking price that is equal to or slightly higher than the share price at the date the options are granted. Vesting Period ‘There is invariably a vesting period of a few years that must pass before the options can be exercised. If the manager resigns or leaves the company during that period then the options will lapse. The options can normally be exercised on a Specific date at the end of the vesting period. Valuing share options ‘The preparation of the financial statements will be complicated by the need to value the share options themselves. Generally, there are no identical financial instruments that are traded in observable markets and so establishing the value of these financial instruments will require some complex calculations based on estimates. The reported profit figure will, therefore, be open to challenge because of the range of outcomes that may be input in respect of the options. Assumptions and uncertainties Portafone will also have to determine the likelihood of board members remaining with the company for long enough for their options to vest. That will inject a 2s » astranti ‘nancial training CIMA MCS Mock Exam 1 www.astranti.com further set of assumptions and uncertainties associated with determining the expense in the statement of profit or loss. The cost of preparing and auditing the figures may increase because of the need to determine and audit these assumptions and estimates. In principle, replacing salary with an equivalent value in terms of share options will do nothing to reported earnings. The risks being borne by the directors could, however, lead to the directors negotiating a generous allocation of options that is, worth more than the salary being foregone. That would increase costs in the short term if the value attributed to the options at the grant date is significant. Dilution of Earnings per share (EPS) ‘The further matter would be the dilution of EPS. If the directors exercise their options then the number of shares in issue will increase and the directors will be paying for them at a discounted price. The shareholders will have to factor the impact of the dilutive effect of the options for their earnings per share. While any increase in the share price will be welcomed, it will be shared with the directors under the terms of the scheme. Cash-settled share-based payment A cash-settled share-based payment is made in cash, but the amount of cash is based on the value of an equity instrument (such as ordinary shares). In this vay, ‘the payment is in cash, but the final amount is determined by share price, which makes recognition and measurement more complex. Equity-settled share-based payment An equity-settled share-based payment is made without the medium of cash and directly paid in shares or share options. This means that the staff or supplier will receive payment for their services in the form of the equity of the business. Again, this raises complexities g due to the nature of the payment. Measurement With cash settled amounts, if there is a vesting period for the rights, the cost will be proportioned over the time period as is the case for equity based transactions, but the liability will need to be re-calculated based on the fair value at the reporting date. This is a change from equity settled transactions which just use the grant fair value with no additional re-measuring. Regards Financial Manager i d) astranti ‘irancial eaining CIMA MCS Mock Exam 1 www.astranti.com Section 3 - Solution Te: Leo Chan From: Finance Manager Re: Non-financial performance indicators and reducing costs Hi Leo, please find my report attached below as requested. Let me know if you need anything else. Non-financial performance indicators While the financial metrics we currently use offer us a good insight into our financial performance they also have their share of limitations. They consist of historical data only, whereas we need to be forward thinking. Financial metrics can also be manipulated through selection of accounting policies and they offer short term feedback only. For this reason many companies, including those in the smartphone industry, as demonstrated by the article about Foxconn, also employ non-financial indicators (NFPI’s) which are designed to measure progress towards long term goals. Advantages of NFPIs Forward loo e NFPis are forward looking, giving management an idea of future performance of all areas of the business and this is in contrast to financial indicators, which are generally backward leoking and which generally only cover the business as a whole. Ease of understanding NFPis are easily understood by all personnel. Non-financial managers will not understand financial ratios but will understand things like customer satisfaction and staff turnover very easily. This allows staff to see the progress the company is making and as a result may make them feel more appreciated and dedicated. Measures long term performance NFPIs could give us a good indication of long term performance, as opposed to financial indicators which are mostly focused on the short term. For example, customer satisfaction helps indicate the level of returning customers longer term. In addition, non-financial indicators cannot be easily manipulated through accounting policies. 2% » astranti Francil traning CIMA MCS Nock Exam 1 www.astranti

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