P1CN PDF

Governance, Risk and Ethics
Paper P1
Course Notes
(ANP113)
For BPP Students Only

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P1 Governance, Risk and Ethics
Study Programme
Step 1 – Taught Phase Study Programme
Page
Introduction to the paper and the course................................................................................................................. 4
1 Scope of corporate governance ................................................................................................................... 11
2 Approaches to corporate governance .......................................................................................................... 23
3 Corporate governance practice and reporting .............................................................................................. 35
Checkpoint 1 Additional Study Guidance and Progress Test 51
4 Internal control systems................................................................................................................................ 67

5 Risk attitudes and internal environment ....................................................................................................... 73
6 Business risks .............................................................................................................................................. 83
7 Risk assessment and response.................................................................................................................... 91
8 Information, communication and monitoring............................................................................................... 101
9 Personal ethics........................................................................................................................................... 123

10 Ethics and professional practice................................................................................................................. 135
11 Corporate social responsibility and environmental reporting...................................................................... 145
12 Answers to Lecture Examples .................................................................................................................... 171

13 Question and Answer bank ........................................................................................................................ 189
14 Appendix A: Pilot Paper questions and solutions ....................................................................................... 213
15 Appendix B: Information about M&S (Day 2 lecture examples) ................................................................. 229
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INTRODUCTION
Introduction to Paper P1 Governance, Risk and Ethics
Overall aim of the syllabus

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

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

Papers
Online ethics module Governance, Risk Audit & Assurance

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

A2 Agency relationships and theories Chapters 1 & 2
A3 The board of directors Chapter 3
A4 Board committees Chapter 3
A5 Directors’ remuneration Chapter 3
A6 Different approaches to corporate governance Chapter 2
A7 Corporate governance and corporate social responsibility Chapter 11
A8 Governance: reporting and disclosure Chapter 8
B Internal control and review
B1 Management control systems in corporate governance Chapter 4

B2 Internal control, audit and compliance in corporate governance Chapters 7 & 8
B3 Internal control and reporting Chapter 8
B4 Management information in audit and internal control Chapters 8
C Identifying and assessing risk
C1 Risk and the risk management process Chapter 5 & 6

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

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

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

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

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

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

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

Syllabus learning How syllabus outcomes Example past paper
outcomes are examined questions
Define and explain the Relevant to a broad December 2012 Q2a (10
meaning of corporate requirement marks) explaining the meaning
governance of governance and how it helps
avoid corporate failure
December 2007 Q1d, Q2b,
Q3b, Q4c
Analyse the purposes and Relevant to a broad Relevant 1 mark point in:
objectives of corporate requirement December 2007 Q3b Seamus
governance O’Brien
Explain, and apply in the Any of the principles can be Transparency - June 2011 Q3b
context of corporate tested for between 4 to 10 (8 marks) HHO
governance, the key marks Independence – June 2012
underpinning concepts. Q2a (8 marks)
Explain, and analyse the Relevant to a broad June 2012 Q1 d) (18 marks)
issues raised by, the requirement applying Mendelow to consider
development of the joint stock how owners are influenced by
company as the dominant form a key stakeholders
of business organisation and December 2007 Q1a
the separation of ownership Worldwide Minerals
and control over business
activity
Define agency theory Part of a requirement June 2010 Q1c (10 marks)
required a detailed
examination of agency theory
in a public company and how it
differs in private companies
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1: SCOPE OF CORPORATE GOVERNANCE
Overview
Scope of corporate governance
Definition of corporate
governance
Principles
Theories Stakeholder Models
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1 Definition of corporate governance

1.1 Corporate governance can be defined as: a set of relationships between a company’s
directors, its shareholders and other stakeholders. It also provides structure through
which the objectives of the company are set, and the means of obtaining these
objectives and monitoring performance are determined (OECD).
Corporate governance is the system by which organisations are directed and
controlled. (Cadbury report)
1.2 Corporate governance is a fundamental internal control system ensuring the best interests
of the company are serviced in the most efficient and effective manner.
Lecture example 1 Exam skills
Required
Identify the benefits to any business of applying a corporate governance framework.
Solution
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1.3 For corporate governance to be effective it must be embedded as a feature of the inherent
business culture, i.e. the way business is conducted.
1.4 In the exam you may also need to ascertain whether or not the governance procedures in
use in a particular company are in line with best practice (covered later).
1.5 The following diagram illustrates the 9 core principles that underlie good corporate
governance.
Qualities that ensure the Qualities that ensure honest

best decisions are made. and transparent disclosures
 Integrity  Openness
 Fairness  Probity
 Judgement  Responsibility
 Independence  Accountability
 Reputation
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1.6 Integrity: Straightforward dealing and completeness; high moral character; honesty.
1.7 Fairness: Respecting the rights and views of any group with a legitimate interest.
1.8 Judgement: Making decisions that enhance the organisation’s prosperity.
1.9 Independence: Having only limited or strictly controlled links to the organisation.
1.10 Openness: Disclosure, including voluntary disclosure of reliable information.
1.11 Probity: Truthful and not misleading.
1.12 Responsibility: Systematic correction of errors, failures or mismanagement.
1.13 Accountability: Answerable for the consequences of actions.
1.14 Reputation: Other people’s perception or expectations. A valuable asset of the

organisation.
2 Corporate governance and agency theory

2.1 Agency theory is used to study the problems of motivation and control when a principal
needs the help of an agent to carry out activities.
2.2 Agency theory would describe the shareholders in a company as the principals, with the
board their agents who are empowered to act in their interests.
2.3 In practice the powers of shareholders tend to be very restricted. They normally have no
right to inspect the books of account, and forecasts of future prospects are gleaned from the
annual report and accounts, stockbrokers’ reports and media sources. There is an
information asymmetry; the agent has more information than the principal.
The diagram below illustrates how agency works in practice:
Self-interest Self-interest
appoints AGENT
PRINCIPAL
(shareholder) (directors/ managers/
employees)
Detailed information
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The agency problem
2.4 Agency theory assumes that agent and principal act in their own self-interest. These
interests may conflict. The agency problem in joint stock companies derives from the
principals (shareholders) not being able to run the business themselves and therefore
having to rely on agents (directors) to do so for them.
2.5 The separation of ownership from management can cause issues if there is a breach of trust
by directors either by intentional action, omission, neglect, or incompetence.
Lecture example 2 Exam standard question
Required
Identify some reasons why shareholders might become concerned about the management of an
organisation in which they hold an investment.
Solution
The agency solution

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

3.1 Transaction cost theory provides an explanation of why organisations like companies exist,
rather than all transactions being carried out between individual entrepreneurs.
3.2 Companies will try to keep as many transactions as possible in-house in order to;
(a) Reduce uncertainties about dealing with suppliers,
(b) Avoid high purchase prices, and
(c) Manage quality.
To achieve this, companies will seek vertical integration (i.e. they will purchase suppliers or
producers later in the production process).
3.3 Transaction cost theory also states that managers organise their transactions to pursue their
own objectives. They are influenced by
(a) The amounts that they personally will gain,
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(b) The probability of bad behaviour being discovered, and

(c) The extent to which their actions are tolerated or encouraged in corporate culture.
3.4 The implications of transaction cost theory are that management tend to play safe, and
concentrate on easily understood markets and individual transactions they can easily
control. The focus on low-risk activities may discourage potential investors who are looking
for a large return. Alternatively shareholders dissatisfied with low profits may seek greater
involvement in governance.
3.5 This extends the idea of the agency problem. It explains why the agency problem is more
severe the larger an organisation becomes.
4 Stakeholders in corporate governance

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

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

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

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

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

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

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

Syllabus learning outcomes examined questions
Describe and compare the Rules and principles are tested December 2011 Q2a (12 marks)
essentials of rules and regularly. The focus tends to be distinguish between rules and
principles-based approaches to on distinguishing between the principles based approaches,
corporate governance two approaches. then apply to scenario
December 2012 Q2b (8 marks]
explain the differences then
consider ‘comply or explain
Describe and critically evaluate This requirement might be set in December 2007 Q3c tested
the reasons behind the the context of developing national variation of codes (8
development and use of codes countries marks) Seamus O’Brien. These
of practice in corporate more theoretical style
governance (acknowledging discussion questions have
national differences and become far less popular in
convergence) recent sittings
Discuss and critically assess the ‘Stakeholders’ is a topic that has December 2012 Q4b
concept of stakeholders and been tested regularly. As well importance of identifying
stakeholding in organisations as forming substantial (10 mark) stakeholders when making
and how this can affect strategy requirements on its own the strategic decisions (8 marks)
and corporate governance idea of stakeholder is often December 2012 Q4c considers
relevant to broader requirement. stakeholder claims and how
they differ (12 marks)
June 2010 Q1a distinguish
between voluntary and
involuntary stakeholders at a
nuclear power stations (12
marks)
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2: APPROACHES TO CORPORATE GOVERNANCE
Overview
Approaches to corporate
governance
Corporate ownership Principles or Rules?
Principles-based approach Rules-based approaches
Major corporate scandals Major corporate scandals
Global influences UK Corporate Governance US Sarbanes-Oxley Act 2002

Code 2010
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1 Principles or rules?
1.1 The big debate about corporate governance globally is whether the guidance should in the
form of principles or detailed rules and regulations.
Principles-based approach Rules-based approach

Features Sets out broad principles (eg “The Organisations are required to
Board should be effective”) comply with a detailed and rigid
supported by guidance. code.
Works on a comply or explain Non-compliance cannot be
basis, with any departure from the justified. A company has either
specific provisions of codes succeeded or failed in complying.
requiring an explanation
Allows investors to decide if they Investors tend to rely on a third
agree that departure from the code party (eg SEC) to penalise the
is appropriate company for non-compliance.
Benefits Allows for greater flexibility and Easier compliance with the rules,
potential cost savings as they are unambiguous, and can
Applies across different legal be evidenced
jurisdictions, which makes the Provides a consistent minimum
governance of a multi-national standard of governance for
business more effective investors confidence
Forces both boards and
shareholders to think about the
consequence of governance
arrangements
Disadvantages The principles are so broad that Allows no leeway or deviation,
they are of very little use as a irrespective of how illogical the
guide to best corporate situation is.
governance practice. Enforcement can be difficult for
Investors cannot be confident of situations that are not covered
consistency in approach explicitly in the rules.
Incorrectly viewed as voluntary

Where you find Favoured in legal jurisdictions Favoured in legal jurisdictions (and
them where the governing bodies of cultures) that lay great emphasis
stock markets have had the prime on obeying the letter of the law
role in setting standards for rather than the spirit of it.
companies to follow.
Examples UK Corporate Governance Code USA Sarbanes-Oxley Act 2002
2010 (SOx)
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2 Influence of ownership on corporate governance

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

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

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

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

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

 Risk management
 Internal control
Smith Report 2003

 Role of audit committees
Higgs Report 2003

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

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

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

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

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

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

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

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

(a) It is not strong enough on some issues, and at the same time over-rigid on others.
(b) Directors may avoid consulting lawyers if they believe that SOx could override lawyer-
client privilege.
(c) A SOx compliance industry has sprung up.
(d) Companies are turning away from the US stock markets and towards other markets.
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6 Chapter summary
1 Principles or Principles based practice outlines core principles to ensure

rules good corporate guidance. Departures from best practice have
to be disclosed (‘comply or explain’) and investors then take
appropriate action.
The advantages of principles are; flexibility, adaptability, avoids
‘loopholes’.
Rules based practice requires compliance with a detailed code.
Compliance in full is mandatory. Non-compliance is penalised
often by a regulator.
The advantages of rules are; unambiguous, easier to monitor.
2 Ownership Insider organisations (eg family firms) have reduced agency
costs and often arise in jurisdictions with weak minority interest
protection.
Outsider organisations dominate in the US and UK and are
characterised by many small investors and institutional
investors.
3 Corporate The UK Corporate Governance Code (2010) covers directors,
governance in remuneration, accounting and controls, auditors and
the UK institutional investors.
It is supported by guidance (such as the Turnbull Report).
Corporate Governance emerged as an issue in the early
1990’s following corporate failures such as Polly Peck and
Mirror Group (unfettered power of dominant directors) and later
Barings Bank (poor internal controls).
4 Corporate The South African King Report was published after the collapse
governance in of apartheid. It emphasises fairness to all groups in society and
other economic wellbeing,
jurisdictions The OECD and ICGN both issue guidance which is useful
where no local code is available.
5 The Sarbanes The Sarbanes Oxley Act (SOx) is the US rules based code
Oxley Act 2002 enacted after the collapse of Enron and WorldCom.
Its main provisions cover the audit profession, audit
committees, internal controls, CEO and CFO responsibility for
financial statements, plus many detailed provisions such as full
disclosure of off-balance sheet finance.
Sarbanes Oxley affects all companies listed on US stock
exchanges and their subsidiaries.
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END OF CHAPTER
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Corporate governance
practice and reporting

Syllabus learning How syllabus outcomes Example past paper
outcomes are examined questions
Explain and evaluate the roles Useful for general questions June 2011 Q1di (8 marks)
and responsibilities of boards about corporate governance roles of a CEO in specific
of directors circumstance
Dec 2009 (9 marks) role of a
non executive chairman
Describe the characteristics, Substantial questions on the December 2007 Q3a & b (13
board composition and types role of NEDs marks)
of directors
Describe and analyse the Aspects of the legal framework June 2008 Q3c (5 marks)
general principles of the legal could form a 5 mark part of a
frameworks within which question
directors operate on boards
Explain and evaluate the role Different committees have June 2008 Q3b (8 marks)
and purpose of the main board formed regular question
committees in effective requirements for 8 to 12 marks
corporate governance
Describe and assess the This topic can be the basis of December 2011 Q3a (10
principles of remuneration a question requirement marks) purpose and factors
influencing the reward
package of a CEO
Explain and assess the Issues of disclosure are June 2008 Q3a (relevant 2
general principles of potentially relevant within a marks)
disclosure and communication broader question requirement
with shareholder
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3: CORPORATE GOVERNANCE PRACTICE AND REPORTING
Overview
Corporate governance
Practice Structure Reporting
The role of the board Governance disclosures
Example of CG best
practice – 2010 UK Code
 Section A – Leadership
 Section B – Effectiveness
 Section C – Accountability
 Section D – Remuneration
 Section E – Relations with
Shareholders
Non-executive directors Committees
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1 The role of the board

1.1 The board
(a) Is collectively responsible for promoting the success of the company by directing and
supervising the company’s affairs.
(b) Provides entrepreneurial leadership of the company, within a framework of prudent
and effective controls, which enable risk to be assessed and managed.
(c) Should set the company’s strategic aims, ensure that the necessary financial and
human resources are in place for the company to meet its objectives and review
management performance.
2 Effectiveness of boards
2.1 To remain effective, directors should extend their knowledge and skills continuously.
2.2 Significant issues that professional development should cover on a regular basis include:
Strategic
planning
Audit
practice and Financial
procedures management
TRAINING AND
Legal and DEVELOPMENT
regulatory
issues Human
resource
issues
Risk
management Corporate
governance
2.3 An appraisal of the board's performance is an important control over it, aimed at improving
board effectiveness, maximising strengths and tackling weaknesses. It should be seen as
an essential part of the feedback process within the company and may prompt the board to
change its methods and/or objectives.
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2.4 All directors should be individually appraised; criteria that could be applied include:
Independent
and
innovative
thinking
Continuous Familiarity
professional with business
development and industry
information
APPRAISAL
CRITERIA
Contribution Active
towards participation
business in all
development business
Positive and
enthusiastic
committee
work
(Extract from 2010 UK Corporate Governance Code)

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

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

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

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

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

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

(a) Strategy. contributing to, and challenging the direction of, strategy.
(b) Scrutiny. NEDs should scrutinise the performance of management in meeting goals
and objectives, monitor the reporting of performance. They should represent the
shareholders' interests to ensure agency issues don't arise to reduce shareholder
value. (See Chapter 1)
(c) Risk. NEDs should satisfy themselves that financial information is accurate and that
financial controls and systems of risk management are robust.
(d) People. NEDs are responsible for determining appropriate levels of remuneration for
executives, and are key figures in the appointment and removal of senior managers
and in succession planning.
4.4 The main advantages of bringing NED's onto a board are as follows:
 external expertise and experience
 wider perspective
 independent and objective view
 compliance with corporate governance codes
 assurance to, and confidence for, 3rd parties.
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4.5 The key problems with NED's tend to centre around 2 issues:
 Lack of true independence
 Lack of effectiveness.
Required
Explain reasons why NEDs may not be sufficiently independent or effective.
Recommend ways in which organisations can attempt to overcome both these problems.
Solution
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5 Unitary and multi-tier boards

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

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

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

A statement that Remuneration,
the company is a Audit & Nomination
going concern committees
GOVERNANCE
DISCLOSURES
Details of relations
A statement on with auditors
relations and including reasons
dialogue with for change
shareholders
A statement that the
directors have
reviewed the
effectiveness of
internal controls
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Lecture example 6
Suggest some key elements to be included in:
'Information about the board of directors.'
'A statement on relations and dialogue with shareholders.'
Solution
'Information about the board of directors.'
'A statement on relations and dialogue with shareholders.'
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8 Chapter summary
1 The role of the board The board act as agents for the shareholders. They
provide leadership and establish strategies to ensure
that the company achieves its objectives.
2 Effectiveness of boards The first principle in CC10 is that the board should be
effective. This requires training and development of
board members and appraisal of the performance of
the whole board and of individual members.
3 Board membership and The board should be balanced. The Chairman of the
roles board runs the board and the CEO who should be a
different person runs the company.
4 Non-executive directors NEDs are not involved in the day to day running of
the company. Ideally they should be independent.
They have four main roles; scrutinising the decisions
and disclosures of the board; advising objectively on
strategy, risk and people (remuneration and
nominations).
5 Unitary and multi-tier A single board can speed up decision making and
boards ensure uniformity of authority and responsibility.
Multi-tier boards are common in continental Europe
and are a good way of widening participation in
strategic decisions. The supervisory board often
includes employee or union representatives.
6 Directors’ remuneration Basic salary, benefits and pensions are not related to
performance and should be sufficient to recruit and
retain the right people.
Performance Related Remuneration should be
designed to align the director’s interests to the
objectives of the company. They can relate to KPIs.
7 Governance disclosures The disclosure required will depend on the corporate

governance regime. In a principles-based regime the
disclosure should be adequate to allow the investors
to make informed decisions about corporate
governance. (Comply or explain).
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END OF CHAPTER
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Checkpoint 1 – Progress Review
To reinforce your learning to date you should now follow the study guidance in the
following pages. On completion, your progress towards full exam preparation will be:
Take some time to reflect on the knowledge and skills you covered during Stage 1. If you feel you
need further clarification on any of the key areas listed below you can use the on-line lecture for
the relevant chapter. The Course Notes section for each chapter (starting overleaf) provides
helpful guidance (and time commitments) on how to focus your review on the key learning points in
your notes.
Key messages from Stage 1

Stage 1 covers the core knowledge for this paper. You can expect material from the first three
chapters to account for a substantial number of the marks in the 50 mark compulsory scenario
question.
Key knowledge
 Agency theory
 Stakeholders
 Rules-based v principles based frameworks of corporate governance
 An overview of the contents of the Sarbanes-Oxley provisions (will not be examined in any
detail)
 An overview of the principles of good corporate governance (using the UK Corporate
Governance Code as a model of good practice)
Key skills
 Understanding the question verbs
 Keep focussed on the question asked
 Tailoring your knowledge to the question asked
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CHECKPOINT 1
Checkpoint 1 – Study Support

Chapter 1 – Scope of corporate governance 80 mins
Key areas
 Scope of governance
 Agency theory
 Stakeholder theory
Course Notes
 Read the Examiners articles on stakeholders which are available on the ACCA
website at 15 mins
http://www.accaglobal.com/students/student_accountant/archive/2008/82/3054
356
886 and
369
Question Practice
 Attempt Question 1 (Core Principles) from the Course Note Question Bank.
This question is a chance for you to make sure that you can paraphrase the 40 mins
definitions of the core principles (fairness, openness etc) and perhaps more
importantly be able to explain why they are important. Its is very likely that you
will be asked in the exam to define and explain the importance of one or more
of these principles.
Additional Resources
Real-life examples
 In the Real-life examples section you will find Case 1 about the 5 mins
Enron/Andersen scandal and Case 5 about the Parmalat/Deloitte scandal. In
both of these cases management perpetrated frauds aided or undiscovered by
the auditors.
10 mins
Study Text
 If you found question 1 (Core Principles) hard then read through section 1.2 in
the Study Text. This is a key area that will be examined! 5 mins
 Read section 2.2.2 to make sure you understand the phrase fiduciary duty.
5 mins
 Read section 4.13 if you are unsure about the impact of institutional investors
in corporate governance.
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CHECKPOINT 1
Chapter 2 – Approaches to corporate governance 95 mins
Key areas
 Major global corporate governance regimes
Course Notes
 Try to remember the advantages of a principles based approach and a rules
based approach. Check in the course notes to see if you remembered them 5 mins
all.
 Read the examiner’s article about rules v principles which is available on the 5 mins
ACCA website at
513
Question Practice
 Attempt Question 2 (Frameworks, Codes and Systems) from the Course 30 mins
Notes Question Bank. This will reinforce your knowledge of rules and
principles based systems. 30 mins
 Attempt Question 2 (Cedric Coffee) from the Study Text Question Bank. The
examiner has previously covered international codes.
Real-life examples
 Case 3 discusses the reasons for the 2007 Combined Code review which
ultimately saw very little changes made in the 2008 (and 2010) issue of the 5 mins
Code.
Study Text
 Read sections 2.5 to 2.11 which considers how international conventions have 10 mins
been drawn up to guide and set global governance standards?
 Review section 3 on Sarbanes-Oxley, as it is probably the most influential
corporate governance regulation in the world due to the business reach of the 10 mins
US. (lf you want to find out more about Enron. ‘Enron, Anatomy of Greed’ by
Brian Cruver is an entertaining read. Enron also inspired a film “Enron - The
Smartest Guys in the Room” directed by Alex Gibney).
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CHECKPOINT 1
Chapter 3 – Corporate governance practice and reporting 160 mins
Key areas
A large chapter covering the detail of governance practice
 The board and its various sub-committees
 Non-executive directors
 Directors’ remuneration
Course Notes
 Review the whole chapter as it’s important that you understand the requirements 10 mins
of the UK Corporate Governance Code as an example of good Corporate
Governance. For each section try and think how each element of Corporate
Governance best practice links to integrity, accountability and reputation.
Question Practice
 Question 3 (Non-executive directors) from the Course Notes Question Bank
30 mins
covers an area that the examiner keeps returning to.
 Question 5 (Caius plc) from the Course Notes Question Bank - a good 30 mins
question to get you thinking about practical ways in which a company can
implement good corporate governance practice.
Extra if time available: 30 mins

 Question 1 (Bonus schemes) from the Study Text Question Bank is a good
alternative to the course notes question Caius plc
30 mins
 Question 3 (Peter Postgate) from the Study Text Question Bank is a good
question about the independence of NEDs
Study Text
 Read section 1.7 and review the associated case study. One of the 10 mins
dysfunctional boards described could form the basis for a question.
 Read through the UK Corporate Governance Code (You don’t need to know
it word for word but you should have read through it at least once). It is 10 mins
available online at http://www.frc.org.uk/corporate/ukcgcode.cfm
Real-life examples 10 mins
 Cases 2, 4 and 6 discuss some of the issues around the Higgs report and
selection of directors.
 If you want news about the most recent corporate governance issues from
around the world you could search on Twitter using the hashtag #corpgov
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CHECKPOINT 1
Checkpoint 1 – Progress Test

Having completed the Study Support guidance contained on pages 12 to 14, you are now ready to
attempt Checkpoint 1 - Progress Test. You should aim to complete the test in 30 minutes. If you
find it takes you significantly longer to do so then please contact your course tutor for guidance.
The multiple choice questions contained within Checkpoint 1 - Progress Test will thoroughly test
your understanding of the material and your ability to perform the required calculations. Note that
the P1 exam does not contain multiple choice questions. The five short written questions that
follow will test your ability to apply your knowledge. These skills will prove important when
answering exam standard questions.
It is important that you continually review your progress (solutions are on page 20) and revise
further any areas where you feel your understanding is weak.
A Multiple choice questions (10 questions – approximate time 15

minutes)
1 The best description of an insider (or relationship-based) model of corporate ownership is
one where most companies listed on the local stock exchange are owned and controlled by:
A members of the same family
B a small number of major shareholders
C a large number of minor shareholders
D shareholders largely represented by the workforce
2 According to Mendelow how should a business deal with a stakeholder such as an

institutional shareholder, who can exert a high level of power and influence on the business,
but has little interest in how the results are achieved?
A Keep informed
B Keep satisfied
C Ensure strategies are acceptable to them
D Little or no action required
3 Under the provisions of the Sarbanes-Oxley Act 2002, who should certify the
appropriateness of the financial statements?
A Audit Committee
B Chief Executive Officer and Audit Committee
C Chief Executive Officer and Chief Finance Officer
D Public Company Accounting Oversight Board
4 Which of the following statement best describes a principles based approach to corporate
governance?
A It works on a comply or explain basis
B Allows no leeway or deviation
C Easier compliance as things can be easily evidenced
D Places emphasis on definite achievements rather than control systems
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CHECKPOINT 1
5 Which is the correct chronological order for the publishing of UK corporate governance
reports?
A Cadbury – Hampel- Greenbury - Turnbull
B Greenbury – Cadbury – Hampel - Turnbull
C Cadbury – Greenbury – Hampel - Turnbull
D Cadbury – Greenbury – Turnbull - Hampel
6 Which of the following is the responsibility of the Chairman of the board rather than the Chief
Executive Officer?
A Business strategy
B Risk management
C Communication with shareholders
D Investment and financing
7 In compliance with the reporting requirement on director’s remuneration, which of the

following does not have to be disclosed in the annual report and accounts?
A The duration of director’s contracts together with notice periods
B Summarised information for individual directors
C Performance conditions attached to individual packages
D The overall remuneration policy
8 What is the primary role of external auditors?

A To ensure compliance with companies’ legislation
B To scrutinise accounting records so as to report on the truth and farness of the
financial statements to shareholders
C To improve an organisation's operations and performance
D To safeguard corporate assets
9 The audit committee does not assume which of the following responsibilities?
A Review of the adequacy internal control systems
B Consider the recommendations of the external auditors in the management letter
C Review of financial statements
D Setting of remuneration and reward packages for all directors
10 When reviewing the work of internal audit, the audit committee should consider including the
following aspects.
I Standards (including objectivity, technical knowledge and professional standards)
II Work plan, especially review of controls and coverage of high-risk areas
III Sufficiency and capability of resources
IV Reporting arrangements
A I, II and IV
B I, III and IV
C II, III and IV
D I, II, III and IV
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CHECKPOINT 1
B Short written questions (5 questions – approximate time 15 minutes)

1 Explain agency theory, and how it relates to corporate governance.
2 Distinguish between the purpose of internal audit and external audit.
3 Identify the NINE core principles of corporate governance
4 Identify FOUR roles of non-executive directors.
5 Identify SIX corporate governance disclosures that should be included within the annual
report.
END OF PROGRESS TEST
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CHECKPOINT 1
Checkpoint 1 – Progress Test solutions
Section A
1 B Insider (or relationship-based) systems are where most companies listed on the local
stock exchange are owned and controlled by a small number of major shareholders.
The shareholders may be members of the company’s founding families, banks, other
companies or the government.
2 B Keep satisfied, see Mendelow’s matrix below:
Level of interest
Low High
Low
Little effort Keep informed
Power
Ensure strategy
Keep satisfied
acceptable
High
3 C The Sarbanes-Oxley Act 2002 requires the Chief Executive Officer and the Chief
Finance Officer to certify the appropriateness of the financial statements.
4 A A principles based approach to corporate governance works on a comply or explain
basis. This means that should a firm have just reasons not to comply fully with
corporate governance principles and practice; it can deviate from them provided it can
explain the rationale.
5 C The correct chronological order for the publishing of UK corporate governance reports
is: Cadbury 1992 – Greenbury 1995 – Hampel 1998 - Turnbull 1998.
6 C The Chairman of the board is responsible for communication with shareholders, as

this role encompasses all aspects of board management.
7 B Summarised information for individual directors does not have to be disclosed in the
annual report and accounts; this is because detailed disclosures of the remuneration
package of all directors must be published.
8 B It could be argued that external auditors provide a variety of assurance services to

their clients, however their principle role is to scrutinise accounting records so as to
report on the truth and farness of the financial statements to shareholders in
compliance with the Companies Act.
9 D The audit committee is responsible for many things, however it is the role of the
remuneration committee to set remuneration and reward packages for all directors.
10 D When reviewing the work of internal audit the audit committee should consider all of
those areas mentioned.
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CHECKPOINT 1
Section B
1 Agency theory involves the relationship between a Principal and an Agent
In the context of corporate governance, agency theory defines the relationship between
directors and the shareholders. It clearly illustrates that both expressed and implied authority
is given to the board. Actions should always be conducted in the best interests of the
shareholders, to whom directors have a fiduciary duty.
The protection afforded by the fiduciary duty is required because the agent has more
information than the principal and unless checked will be inclined to act in their own self-
interest.
2  Internal audit is an activity designed to add value and improve an organisation's

operations and performance.
 External audit is an exercise to enable auditors to express an opinion on the financial
statements.
3 The 9 core principles of corporate governance are:
1. Integrity
2. Fairness
3. Judgement
4. Independence
5. Openness
6. Probity
7. Responsibility
8. Accountability
9. Reputation
4 The role of non-executive directors includes
 Contributing to, and challenging the direction of, strategy.
 Scrutinising the performance of management in meeting goals and objectives, monitor
the reporting of performance. They should represent the shareholders' interests to
ensure agency issues don't arise to reduce shareholder value.
 Satisfy themselves that financial information is accurate and that financial controls and
systems of risk management are robust.
 Determining appropriate levels of remuneration for executives, and are key figures in the
appointment and removal of senior managers and in succession planning.
5 The annual report should include the following governance issues (you were asked to
identify six).
 A statement on relations and dialogue with shareholders
 A statement that the directors have reviewed the effectiveness of internal controls
 Details of relations with auditors including reasons for change
 Reports from the Remuneration, Audit and Nomination committees
 A statement that the company is a going concern
 Environmental and sustainability reporting
 Information about the board of directors
 An operating and financial review (OFR)
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CHECKPOINT 1
Checkpoint 1 – Real-life examples
Case 1 – An industry still skulking in the shadow of Enron

F I N A N C I A L T I M E S [ J U L Y 2 0 0 6 ]
By Barney Jopson
The long shadow of Enron lingers over the accountancy profession. The energy trader dragged
down Andersen; which sold it a racy mix of audit and consulting services; and in doing so focused
attention on the profit-seeking instincts of accountants.
A backlash against commercial conflicts of interest soon followed in 2002, but the UK audit
watchdog revealed this month [July 2006] that the big four accountancy firms have failed to prove
they can control them. The comments from the Financial Reporting Council struck at the heart of a
perceived tension between accountants' twin goals of optimising earnings and doing rigorous
audits.
The FRC focused on problems inside the audit divisions of PwC, Ernst & Young, KPMG and
Deloitte. Others are concerned about links between audit and non-audit work, which have become
sensitive again as the firms move back into consulting.
Arthur Wyatt, a former veteran of Andersen in the US, sees the issues as part of a deeper
historical shift. Surveying four decades of change in a 2003 speech, he said: "Just as greed
appears to have been the driving force at many of the companies that have failed or had significant
restructurings, greed became a force to contend with in the accounting firms. The cultures of the
firms had gradually changed from a central emphasis on delivering professional services in a
professional manner to an emphasis on growing revenues and profitability."
Such comments lead some to ask whether accountancy firms in their current form; a series of
profit-making partnerships that do auditing alongside more lucrative non-audit work; are best
placed to guarantee the accuracy of financial statements.
The FRC avoided such fundamental questions as it presented the results of its second annual
inspections, but it was blunt in its criticism of the big four. They had made only limited progress in
restraining "profit-seeking", it said, in spite of instructions to reorder their priorities last year. Sir
John Bourn, chairman of the FRC's professional oversight board, said that while senior
accountants talked the talk on audit quality, "the emphasis isn't always underlined at the working
level".
Some firms had not included clear quality performance indicators in their appraisal systems and
others had failed to ensure individual partners were assessed against them, the FRC said.
Remuneration and partner promotions were not linked to audit quality measures, but to commercial
objectives.
The conclusions did not surprise Laurie Young, an author, consultant and former PwC partner. "I
think this is institutional rather than individual," he says. "Most auditors will err on the side of
integrity, but there is an institutional bias towards maintaining the ludicrously high earnings of this
oligopoly."
The big four posted profits per partner in their most recent financial years that ranged from
£545,000 at KPMG to £702,000 at Deloitte.
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CHECKPOINT 1
As PwC, KPMG and Ernst & Young move back into consulting; Deloitte never left; they say the
provision of non-audit services to audit clients is becoming a thing of the past.
But the FRC said it had found evidence of non-audit services being sold to audit clients in
contravention of the regulator's ethical guidelines. Sir John said he was concerned that a 25-year-
old auditor seeking to please his or her boss could best do so by fostering a client's interest in a
new service line rather than offering an exemplary piece of auditing.
Big four partners reject the suggestion of an inherent conflict between their commercial goals and
their public interest responsibilities. Richard Bennison, head of UK audit at KPMG, defends the
need for high profits and salaries. "I believe the best quality audits are done by highly motivated,
intelligent people, and for that you need to enable partners to share in the success of the whole
firm," he says.
Peter Wyman, head of professional affairs at PwC, says: "It's been PwC's long-term policy to
differentiate ourselves with the quality of our people and the work we produce. That brings in
clients and fees and the commercial side will then look after itself."
Sceptics have proposed nationalising auditing, or ditching it entirely and asking companies to
insure their financial statements instead. Sir John is not entertaining such possibilities. Indeed, he
agreed that quality and commercialism could be "two sides of the same coin".
But in a telling echo of one of Mr Wyatt's phrases, the FRC report said "cultural changes" were
needed within the firms. If cultures won't change, it is the structure of the audit system that must.
Case 2 – Boardroom shake-up: quality of recruiting services is set to

improve
F I N A N C I A L T I M E S [ J A N U A R Y 2 0 0 3 ]
Marianne Brun-Rovet
City headhunters rejoiced at the Higgs review's recommendations for more and better non-
executive directors, saying this would boost demand for their services and improve the quality of
recruitment.
Ashleigh Summerfield, partner at Egon Zehnder, said: "It's got to be good for business".
The Higgs suggestion that companies should cast the net wider to look for skills better matched to
job requirements would mean an increase in the net numbers of applicants considered, he
predicted. "The number of obviously famous people will be counterbalanced by the number of less
visible people. This will make our job in some senses easier by bringing new people on the radar
screen."
The qualities required would also change as the assumption that a great chief executive made a
good chairman was challenged.
Peter Breen, senior partner at Heidrick and Struggles, was relieved that the review had not just
stressed the restrictive "Sarbanes-Oxley dimension" of boardroom shake-ups - which would have
made recruitment more difficult.
"There must be less of the lining-up of the usual suspects," said Mr Breen. His company preferred
the US expression "outside independent director".
Samuel Johar of Buchanan, Harvey & Co called for any changes to allow companies a "significant
transitional period".
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CHECKPOINT 1
"The pool of non-executives must expand. A mass scramble for more non-executives will not be
good for businesses, if what they want is quality." In the US where there were more non-executives
on companies' boards than executives, this had not always promoted good corporate governance.
Case 3 – Fear of 'box ticking' sees FRC launch review of corporate

governance code
F I N A N C I A L T I M E S [ A P R I L 2 0 0 7 ]
By Jonathan Moules
The Financial Reporting Council has launched a review of the combined code on corporate
governance after concerns that its effectiveness is being undermined by "box ticking" and that it
places an unfair burden on small business.
Sir Christopher Hogg, FRC chairman, said there was no presumption the current consultation
exercise would lead to changes in the code.
"The feedback we have received to date suggests that, while there are some points of concern, the
code is working reasonably well and having a broadly beneficial impact," he said.
But the FRC fears that there may be an element of box-ticking by investors, who lack the time to
analyse the decisions of all the companies they invest in, and by companies that may feel
compelled to comply to avoid having to explain their decision not to abide by usual procedure.
The code militates against companies allowing chief executives to become chairmen and against
boards being dominated by executive rather than non-executive directors. However, it accepts it
may sometimes be appropriate to breach normal guidelines under a "comply or explain"
mechanism.
The FRC also acknowledged that the potential compliance costs were proportionately higher for
smaller companies. "If these are considered to outweigh the benefits associated with the code,
there may be an argument on regulatory impact grounds for some modification to what is required
from smaller companies," it said.
The Association of British Insurers, which represents about a fifth of UK shareholders, welcomed
the opportunity to "drill down a bit" and see how the code is working in practice.
Peter Montagnon, ABI director of investment affairs, said: "Our sense is that it is working
reasonably well and that we are getting dialogue with companies on explanations, which I think, is
helpful to both companies and shareholders."
He added that ABI research had found no evidence of box-ticking by investors. "We can see no
need for a major rewrite of the code." He also cautioned against creating less burdensome rules
for smaller companies. "I would be nervous about anything that leads to a carve out for smaller
companies," he said.
The FRC is seeking the views of listed companies, investors and others by July [2007] will publish
its findings before the end of the year [2007].
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CHECKPOINT 1
Case 4 – Outrageous, unacceptable - and then just normal corporate

governance two years after Higgs
F I N A N C I A L T I M E S [ O C T O B E R 2 0 0 5 ]
By Martin Dickson
History demonstrates again and again that today's outrageous idea, threatening the very fabric of
civilisation, quickly becomes tomorrow's normality.
So it goes in the world of corporate governance. When the Cadbury report, which established the
first set of coherent rules, was published in the early 1990s it was widely attacked as a threat to the
unitary board, but then quietly adopted.
The Higgs report of two years ago was roundly denounced in similar terms by certain captains of
industry - many of whom had clearly not read it. But shorn of a few infelicitous suggestions, and
incorporated into a new combined governance code, it now seems to be working fairly well,
according to many middle-of-the-road directors and investors.
Companies are gradually complying. Where they do not, but offer reasonable explanations,
shareholders are on the whole engaging their brains and making considered judgments, rather
than just ticking the "oppose" box.
This, however, is not to suggest that all is for the best in the best of all possible worlds. There are
still some irritating friction points in the code. So it is useful that the Financial Reporting Council,
responsible for its wording, is conducting a post-Higgs review.
The Association of British Insurers, one of most important institutional voices in the debate,
yesterday proposed various tweaks that deserve adoption.
These range from permitting the chairman to serve on the remuneration committee (pay and
strategic goals are intimately connected these days) to a softening of the bar on someone being
chairman of two FTSE 100 companies (as long as they have the time).
Perhaps the biggest complaint of company chairmen is that the code insists non-executive
directors must be removed after nine years. But it does not. It merely says boards must consider
whether they are still independent, and make them subject to annual re-election. These are not
unreasonable reality checks - provided shareholders do not treat them too prescriptively.
Significantly, the ABI also wants the FRC to emphasise "the importance of entrepreneurial
leadership".
There is little evidence to suggest that the combined code, on its own, is stifling entrepreneurship,
but the growing weight of public accountability and exposure needs watching.
Case 5 – Court rules on Parmalat settlement

F I N A N C I A L T I M E S [ F E B R U A R Y 2 0 0 7 ]
By Adrian Michaels
Deloitte secured a court ruling on Tuesday which allows its $149m settlement with Parmalat to go
ahead. But a New York judge at the same time handed other groups being sued by the Italian dairy
company a significant bargaining chip.
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CHECKPOINT 1
Deloitte, the audit firm, agreed to pay the money as part of efforts by new management at
Parmalat to recover billions of dollars from groups it alleges helped prolong fraud at the company
before its collapse in 2003. Deloitte did not admit any wrongdoing.
Deloitte could have walked away from the deal unless it was given protection from the court
against some categories of further claims. That protection was granted on Tuesday, but the judge
said the amount the audit firm was paying would have to figure in calculations in any future
apportionment of blame at trial.
The judge's opinion could be a blow to Enrico Bondi, Parmalat's chief executive, who is perceived
to have allowed Deloitte to settle for a relatively small amount while still hoping to recoup billions of
dollars from institutions such as Bank of America and Citigroup.
Bank of America, legal experts said on Tuesday, may be more inclined to go to trial rather than
settle. Even if the bank were to be found guilty of wrongdoing, which it contests, then the amount
of liability would be influenced by the amount Deloitte paid and the percentage of blame for the
wrongdoing attributed to Deloitte.
Equally, the experts said, Bank of America and others could still seek to settle, but for considerably
less than Mr Bondi has been seeking.
Bank of America called the Deloitte judgment a "fair and equitable ruling that comports with
established legal practice".
Another challenging recommendation is that the incentives to misstate financial information should
be reduced. Mr Buffett memorably characterised this problem as one in which "managers who
always promise to 'make the numbers' will at some point be tempted to 'make up the numbers'."
We recommend that companies refrain from providing the market with forecasts of profits that
assume unrealistic precision. No business operates in the sort of tranquil and entirely predictable
world where pinpoint accuracy can be either promised or achieved.
Although the issues that need to be dealt with in order to regain public trust are wider than just
audit, there is undoubtedly a strong case to be made for improving the quality of audit. Much can
be done within audit firms - for example, sending clear messages from the top that quality matters
to the firm more than anything else.
Backed up by strengthened review processes to make sure audit partners are still doing the job
properly and a stronger and more open relationship with the audit committee - including the subject
of independence - the issue of quality will return to the heart of every audit. Public trust will not be
regained by financial reporting until there is a widespread belief in the honesty and transparency of
all participants in the financial reporting process.
Quite simply, publicly available codes of conduct for financial analysts, lawyers and investment
banks and public relations companies must be developed, covering their involvement in financial
reporting, and their application must be monitored. The duty of all these participants to ensure that
public reporting presents information fairly should override all other duties of the individuals and
firms concerned.
Here are two examples of what this would mean in practice.
First, where a lawyer takes a position of advocacy, that advice should include a summary of the
significant issues raised so that the board can sensibly evaluate that advice.
Second, credit agencies should be required to disclose their criteria and their evaluation processes
as well as the quality control procedures they adopt.
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CHECKPOINT 1
The taskforce sets a challenging agenda for reform. Even in countries such as the UK, where
many of our recommendations are already best practice, there is more to do; and we must support
the adoption of these provisions across the world.
Failure to tackle these issues will perpetuate the current loss of faith in financial reporting, add to
the cost of capital and continue to reduce our economic productivity. There is too much at stake for
us to allow this to happen.
Case 6 – UBS to replace four directors

F I N A N C I A L T I M E S [ J U L Y 2 0 0 8 ]
By Haig Simonian in Zurich

UBS on Tuesday cleared out a third of its board of directors, making room for up to four
newcomers with significant financial experience to help guide Europe’s biggest casualty of the US
subprime turmoil.
The move came as Daniel Zuberbühler, director of the Swiss Federal Banking commission,
stepped up pressure on UBS and Credit Suisse, the country’s two biggest banks, to accept higher
capital targets than their foreign peers because of their importance for the economy.
“There is good reason to be tougher with [UBS and Credit Suisse] and single them out for special
treatment,” Mr Zuberbühler told Reuters.
Both banks have resisted calls for tougher controls because of the disadvantage they would face
compared with foreign rivals.
UBS said the departures of Stephan Haeringer, Rolf Meyer, Peter Spuhler and Lawrence
Weinbach from its board would come at a special shareholders’ meeting on October 2. Sergio
Marchionne, deputy chairman of UBS, was named senior independent director.
Peter Kurer, UBS chairman, told the FT that he wanted to strengthen the board with independent
figures with top class financial or audit experience, adding: “Everybody on the board will be
independent, apart from me. The search process is well advanced,” he said.
The changes will help to address criticisms of the bank’s corporate governance, which may have
contributed to its losses of about $38bn since the subprime crisis started. This criticism focused on
an over powerful “chairman’s office” round Marcel Ospel, its former leader.
UBS shares continued their steep falls in spite of the board changes, dropping 5.3 per cent to
SFr20.30. Shares remained under pressure from sector concerns and worries that UBS faced
additional write downs of between $2.5bn and $7.5bn in the second quarter. Results for the period
are due on August 12.
Sentiment was also hit by a further challenge to the bank’s offshore banking activities after news
that a federal court in Miami granted an order to allow the Internal Revenue Service to serve a so-
called John Doe summons on the bank.
This is used to obtain information about possible tax fraud. The approval directs the bank to
produce records identifying US taxpayers with accounts at UBS in Switzerland. They had elected
to have their accounts remain hidden from the IRS, under a procedure used by banks in
agreement with the US authorities.
UBS on Tuesday said it was “working diligently” with Swiss and US authorities.
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CHECKPOINT 1
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Internal control systems

Define and explain internal Relevant to a broad requirement December 2007 Q1d Worldwide
management control Minerals
Explain and explore the The importance / objectives / June 2012 Q1c (12 marks)
importance and objectives of purpose of internal controls are purposes and challenges of
internal control and risk tested regularly. The objectives internal control.December 2008
management in corporate can be applied to elements of Q3 a & b (20 marks) define
governance internal control as well as whole control objectives and then
systems consider broader organisational
factors and control
arrangements
Identify and assess the See above December 2012 Q3b (10 marks)
importance of elements or identifying specific deficiencies
components of internal control in an internal control system
systems
Define and explain risk in the You could be asked to discuss December 2012 Q1d i) (8
context of corporate governance how the board identifies, marks) part of an article
evaluates and manages risk. distinguishing between types of
risk and how a situation is
strategic [i.e. board level]
Describe and evaluate a You may need to describe December 2012 Q1d ii) (9
framework for board level something like the COSO marks) part of an article
consideration of risk framework or the likelihood / covering board responsibilities
impact matrix depending on for internal control
context.
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4: INTERNAL CONTROL SYSTEMS
Overview
Internal control systems
Frameworks
Objectives
Elements
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1 Internal control frameworks

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

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

management
3.1 COSO and Turnbull both identify various elements of internal control / enterprise risk
management. COSO is more systematic in its recognition of those elements.
COSO Turnbull
Internal Environment Control Environment
Objective Setting
Event Identification
Risk Assessment
Risk Response
Control Activities Control Activities
Information and Communication Information and communication processes
Monitoring Processes for monitoring continuing effectiveness of

the Internal Control System
Policies, processes, tasks, behaviours and other
aspects
3.2 COSO uses a diagram called the COSO Enterprise Risk Management (ERM) cube to
describe how the elements of the framework, the objectives of the framework and the levels
of an organisation fit together.
While the COSO cube is unlikely to be examined in detail, it does provide a framework for
identifying and managing risk.
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3.3 ERM should help organisations in the following way:

1. Alignment of risk appetite and strategy
2. Enhance risk response decisions
3. Reduce operational surprises and losses
4. Identify and manage multiple and cross-enterprise risks
5. Seize business opportunities
6. Improve the deployment of capital
3.4 The main ERM elements will be covered in Chapters 5 to 8 as they provide a useful
framework for considering both risk and control.
4 Chapter summary
1 Internal control Internal control frameworks cover the control

frameworks environment and control procedures.
Two key frameworks are COSO a US framework
and the Turnbull Guidance which supports the UK’s
Corporate Governance Code.
2 Objectives of internal The five main purposes of internal control systems
controls are to help a company: achieve objectives efficiently
and effectively; respond to risk; ensure the quality of
reporting; ensure compliance; and safeguard
assets.
3 Elements of internal
control / enterprise risk
management
The COSO cube contains all the elements

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

Identify, and assess the impact upon, Relevant to a broad December 2007 Q2a
the stakeholders involved in business requirement Southern Continents
risk
Explain the importance of risk Relevant to a broad December 2007 Q2b
awareness at all levels in an requirement Southern Continents
organisation
Describe and analyse the concept of You could be asked how risk December 2010 (15 marks)
embedding risk in an organisation’s could be embedded importance and methods of
systems and procedures embedding risk awareness,
together with obstacles to
embedding risk awareness
Describe and evaluate the concept of You could be asked how risk December 2007 Q2b (5
embedding risk in an organisation’s could be embedded marks) Southern Continents
culture and values December 2009 Q4a and b
Explain and evaluate the different You may have to consider June 2012 Q1a (6 marks)
attitudes towards risk and how these different stakeholders and their explanation and
can affect strategy attitudes to risk demonstration of risk
appetite
Explain and assess the necessity of Relevant to broad requirement
incurring risk as part of competitively
managing a business organisation
Explain risk appetite and how this You could be asked to describe
affects risk policy risk appetite in the context of a
scenario
Evaluate the difficulties of risk This could be relevant to a December 2011 Q1 c (8
perception including the concepts of broader requirement marks) including as part of a
objective and subjective risk broader statement from the
perception CEO
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5: RISK ATTITUDES AND INTERNAL ENVIRONMENT
Overview
Risk Attitudes
Control environment
Risk Appetite Sound System
Stakeholder Attitude Embedding risk awareness
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1 Control (or internal) environment

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

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

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

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

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

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

Define and compare (distinguish You might be asked to December 2009 Q1a Mock 3
between) strategic and distinguish between then two Q1
operational risks types of risk or give examples of December 2008 Q1b Swan Hill
either strategic or operational
December 2012 Q1d
risks
Define and explain the sources You could be asked to identify Pilot Paper Q1b Chemco (6
and impacts of common risks in a scenario or to define marks)
business risks, including and discuss a specific risk like Pilot Paper Q4b FF Co (8
industry or sector specific risks reputation risk or market risk. marks)
December 08 Q3 Gluck &
Goodman
June 2009 Q4c H&Z
Describe and evaluate the This is likely to be tested in a December 2011 Q3 (10 marks)
nature and importance of scenario where information understanding the nature of
business and financial risks about different potential risks market risk and how it can best
will be given be managed
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6: BUSINESS RISKS
Overview
Business risk
Part of COSO
Events Categorising Risk
Scope Function
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6: BUSINESS RISKS
1 Event identification
1.1 The diagram above illustrates how risk identification fits into the COSO ERM framework.
1.2 Risk identification is a continuous (iterative) process.
1.3 Risks once identified can be included within the firm’s risk register and kept under review.
2 Risk events
2.1 A key aspect of risk identification emphasised in the COSO ERM Framework is the
identification of events that could impact upon implementation of strategy or achievement of
a firm’s objectives.
2.2 Such events could include:

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

4.1 Strategic risks are those risks that relate to the fundamental long term decisions that
directors take about the future of an organisation.
4.2 The most significant risks are focused on the impact they would have on the company's
ability to survive in the long term.
Required
Give an example of each of the following 'strategic' risk categories:
Solution
Technology
Product
Resources
Competition
Investment
Reputation
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6: BUSINESS RISKS
4.3 The main differences between strategic and operational risks relate to:
(a) Scope of impact

(b) Source of risk
(c) Duration of impact
(d) Scale of financial and resource consequences
4.4 Operational risk is the risk of loss from a failure of internal business and control processes
and will affect day to day operations.
4.5 Operational risk includes losses arising from:
(a) Internal control

(b) Audit inadequacies
(c) Human errors
(d) Fraud
(e) Business interruption
(f) Loss of key personnel
5 Classification of risk
5.1 There are many different types of risks faced by organisations, particularly those with
commercial or international activities.
Required
Explain the following types of risk using an example if appropriate.
Solution
Currency risk
Credit risk
Environmental risk
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6: BUSINESS RISKS
Probity risk
Knowledge management risk
Outsourcing risk
Derivatives risk
Market risk
5.2 The nature of these risks can be classified under the several key headings, as illustrated
below. You could be expected to identify and discuss a broad range in an exam question.
Financial Legal
Physical
Product Political
Economic
Property (inc RISK
intellectual) CLASSIFICATION
Environmental
Fraud
Technological
Organisational
Knowledge
Reputation management
Trade (inc
FOREX)
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6: BUSINESS RISKS
6 Chapter summary
1 Event identification Risk identification is an element of the COSO Enterprise

Risk Management (ERM) cube and is a continuous
process.
2 Risk events Risk can arise from internal or external events. Trends,
interdependencies and escalation triggers can give insight
into potential risks.
3 Categorising risk Risks are categorised in order to manage them more
effectively. They should be dealt with at an appropriate
level within the organisation and by people with
appropriate technical expertise.
4 Strategic and Strategic risks arise from fundamental long term
operational risks decisions. Operational risks are what can go wrong on a
day-to-day basis.
5 Classification of risk Common risks faced by businesses include;
– market
– credit
– liquidity
– technological
– legal
– health, safety and environmental
– reputation
– business probity
– derivatives
– market
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6: BUSINESS RISKS
END OF CHAPTER
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Risk assessment and
response

How syllabus outcomes Example past paper
Syllabus learning outcomes are examined questions
Explore and evaluate the The importance of internal December 2007 Q1d Worldwide
effectiveness of internal control control systems and Minerals (6 marks)
systems suggestions for improvement June 2009 Q1b Global Bank
could form a substantial part December 2009 Q1b
of a question.
Explain and analyse the concepts of The TARA grid has been June 2011 virtually all this
assessing the severity and tested in detail regularly. question offered marks for
probability of risk events understanding and applying risk
assessment
June 2008 Q1b Rowlands and
Medeleev (6 marks) and Q1c (9
marks)
December 2008 Q2 Chen
Products
Explain and analyse the concepts of You could be asked to December 2007 Q2a Southern
spreading and diversifying risk and suggest appropriate Continents (6 marks)
when this would be appropriate responses to identified risks.
Explain and assess the importance You may have to identify December 2007 Q2a Southern
of risk transference, avoidance, when risks should be Continents (3 marks)
reduction and acceptance avoided.
Explain and assess the ALARP
principle in risk assessment and
how this relates to severity and
probability
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7: RISK ASSESSMENT AND RESPONSE
Overview
Risk Response
Risk assessment Risk quantification
Risk profiling
Control procedures
Risk consolidation
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1 Risk assessment
1.1 The COSO cube broadly identifies key steps of assessing risks.
1.2 Those steps are:

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

risk.
Consequences (hazard)
Low High
Low
ACCEPT TRANSFER
Likelihood
High REDUCE AVOID
5.4 Some businesses face risks which are high likelihood and high consequence. If this arises out of their
core business they are unlikely to avoid it.. The concept of ALARP (as low as reasonably possible)
is a way of considering the trade off between the costs of mitigating the risk and the assessment of the
risk.
5.5 The level of risk considered ‘as low as reasonably practicable’ may be a good compromise.
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Among the risks that M&S faces you may have identified the following:
(a) Theft of inventory
(b) Under / overstocking specific lines from the women’s fashion ranges
(c) Failure of the EFTPOS system (the technology to record credit and debit card transactions
electronically and to maintain the computerised inventory records)
(d) An economic downturn resulting in lower rates of sales growth.
(e) New competitor undercutting on price.
Required
Assess each risk and discuss an appropriate strategy for responding to the risk.
Solution
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6 Controls (methods of risk reduction)

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

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

Describe the function and Questions might ask for the factors December 2008 Q3 Gluck and
importance of internal audit to consider when setting up IA Goodman
Explain and evaluate the This could be relevant to a broad December 2008 Q3 Gluck and
importance of compliance and the requirement or you could be asked Goodman
role of the internal audit committee to describe the role of IC
in internal control
Define and describe management Role of chief executive in internal June 2012 Q2b & c (17 marks) role
responsibilities in risk management control of the risk committee and how they
differ in different sized companies
June 2009 Q1e Global Bank
Explain and evaluate the role of the Risk management roles have been June 2009 Q4a and c H and Z
risk committee and risk manager in tested in detail
identifying and monitoring risk
Describe and assess the need to You would be asked to describe June 2008 Q4b (8 marks) & c (4
report on internal controls to the contents of a typical report. marks) West vs Leroi
shareholders and the content of a December 2012 Q3b (10 marks)
report on internal control and audit this part of significant a broader
question on internal control failure
Explain and assess the need for Relevant to a broad requirement December 2007 Q4d Football Club
adequate information flows to December 2009 Q1d
management for the purposes of
the management of internal control
and risk
Evaluate the qualities and You may have to describe the December 2012 Q3c (10 marks)
characteristics of information qualitative characteristics of discuss general qualities of good
required in internal control and risk information on controls, risk or information and ways of improving
management and monitoring monitoring information flow
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8: INFORMATION, COMMUNICATION AND MONITORING
Overview
Monitoring
Roles
Audit committee Risk committee External Reporting
Turnbull SOX
Role of internal audit Risk manager Review of Internal Control
Information
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1 Information
1.1 In order to fulfil their duties effectively the board of directors (and sub committees) need a
wide range of information.
1.2 Information should be characterised as:

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

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

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

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

Required
Highlight the parts of the report that are fulfilling the directors’ obligations to report on risk and
internal control.
Solution
(The following checklist contains all the elements required by Turnbull and Governance Code
2010).
Report Contents 
The existence of a process for managing risk
How the board has reviewed the effectiveness of the process
That the process accords with the guidance (CC06 & Turnbull)
Formally acknowledge the boards responsibility for internal control and review
An explanation that the system manages but does not eliminate risk
A summary of the process for reviewing internal controls
Information about material weaknesses
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7 Chapter summary
1 Information The board are ultimately responsible for the internal

requirements of the control system. They are responsible for reporting to the
board shareholders on the risks and controls and so require
information to do so.
2 Communication Internal communication is vital for ensuring staff are
informed.
3 Internal control and Three independent NEDs (one with financial expertise)
monitoring form the audit committee. They review financial
statements, oversee internal audit and deal with the
appointment and remuneration of external auditors.
They have to check the independence of external audit
and determine the company’s policy for non-audit work.
(Under SOx most non-audit work is not permitted.)
The audit committee decide if an internal audit function
is required. They monitor the work of internal audit. The
objectives of internal audit are the same as all other
controls (safeguard assets etc).
Internal audit should report to the audit committee (or the
main board) in order to ensure their independence.
4 Risk committee The risk committee sets policies on the extent and
categories of acceptable risk. The risk committee can
include executive directors.
5 Risk manager A risk manager is usually a technical expert. There role
can extend from developing risk policies to dealing with
insurance companies.
6 External reporting Directors report annually to shareholders on risk and
controls. The contents of the report will cover their
responsibilities for managing risk and for the internal
control system, include a review of effectiveness and
report on any major changes and material weaknesses.
END OF CHAPTER
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your notes.

Having learnt in Stage 1 the importance of risk management as a key theme of good corporate
governance, Stage 2 introduces frameworks in which to implement risk management within an
organisation.
Key knowledge
The objectives of internal controls (from Turnbull and COSO)
How risks are assessed based on likelihood and consequence and how this assessment fits into
the broader process of risk management.
Generic responses to risk (TARA)
What the audit committee and internal audit do
What the risk committee and risk manager do
What is in a report to shareholders on internal control and risk
Key skills
You need to be able to pick out risks from a scenario.
You need to be able to assess (profile) those risks.
You need to be able to describe suitable controls to respond to risks or to internal control failings.
These will usually need to be at a strategic level (rather than the detailed controls appropriate in
your F8 Audit and Assurance exam)
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CHECKPOINT 2
Chapter 4 – Internal control systems 30 mins

Key areas
 Turnbull Report
 The COSO framework
Course Notes
 Review the chapter ensuring you understand how corporate governance and 5 mins
internal controls systems are linked.
 Try to remember the objectives of an internal control system in section 2.1
5 mins
and ensure you understand these
Real-life examples
 Case 7 is an article about the RBS takeover of ABN AMRO and is a great 5 mins
example of a lack of strategic controls in place.
Study Text
5 mins
 Review section 2 on internal control frameworks to consolidate your
understanding of COSO.
10 mins
 Have a look at the diagrams in section 4.3. You should be aware that COSO
is not the only model for risk management.
Chapter 5 – Risk attitudes and internal environment 65 mins
Key areas
 Risk appetite
 Risk awareness culture
Course Notes
 Ensure you are comfortable with the idea of ‘embedding risk’ in section 6 and
think about what it would mean if an organisation wanted to achieve this. 5 mins
Question Practice
 Question 5 (Widmerpool) from the Study Text Question Bank is an exam 40 mins
standard question. This is an important question to attempt because
candidates in the exam find it hard to write well focussed answers on the
cultural aspects of risk.
Study Text
 Read sections 1.1 to 1.8, which describes influences on attitude to risk. 10 mins
 Review section 4, without becoming too bogged down in all the cultural 10 mins
theories.
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CHECKPOINT 2
Chapter 6 – Business risks 85 mins
Key areas
 The various categories of risk
Course Notes
 Read the article on the ACCA website which covers the differences between 10 mins
strategic and operational risks
7531
5 mins
 Make a note of any of the risks mentioned in the chapter that you are
unfamiliar with and ensure understanding.
Question Practice
 Bullet point an answer to Question 6 (Types of risk) from the Course Notes 30 mins
Question Bank without using the notes. This is an ideal chance to see if you
can recall the key types of risk and to ensure you understand the link between
risk management and Corporate Governance
40 mins
 Q7 (Azure Airline) asks you to explain some business risks. You may wish to
attempt part (b) after you have reminded yourself about Chapter 7.
Chapter 7 – Risk assessment and response 45 mins
Key areas
 The risk management process
 Risk assessment
 Controls
Course Notes
 Make sure you can remember the different steps in risk assessment. Many 5 mins
exam questions expect you to be able to talk about this list
 Get comfortable with the TARA model for risk strategies including being able 10 mins
to reproduce the matrix.
Question Practice
 Question 7 (COSO Framework) is a good question for ensuring that you can 30 mins
recall the appropriate risk responses.
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CHECKPOINT 2
Chapter 8 – Information, communication and monitoring 65 mins
Key areas
 Roles of board and management in risk management
 Audit committee
 Internal audit
 Risk committee
 Reporting requirements
Course Notes
 Ensure you are happy with the expectations of the audit committee and 5 mins
internal audit in terms of their make up and role in risk management.
Question Practice
 Attempt question 8 (Audit process) from the Course Notes Question Bank if 30 mins
your knowledge from F8 Audit and Assurance is rusty.
 Attempt Question 8 (Governance and controls) from the Study Text Question 30 mins
Bank. Reporting questions are usually relatively straightforward in the exam
as there are often several marks for pure recall of knowledge.
On completion of Stages 1 & 2 (including Progress Tests 1 & 2)

you are ready to attempt Course Exam 1. Course Exam 1 is not in
the format of the real exam but does test with exam standard
requirements.
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CHECKPOINT 2

A Multiple choice questions (10 questions – approximate time 15 minutes)
1 What is the control environment?

A Practices and procedures necessary to ensure control systems actually work
B General attitude of management towards control
C An organisation’s approach to managing its direct environmental costs
D The physical internal control systems configuration
2 Which of the following statements best describes uncertainty?

A You do not know the possible and/or the chances of each outcome occurring
B A condition in which there exists a quantifiable dispersion in the possible results of
any activity
C The impact of external regulation on risk management policies
D The downside or negative aspect of risk
3 Which of the following is not a classification for internal control procedures?

A Corporate controls
B Management controls
C Transaction controls
D Functional controls
4 Operational risk does not include losses arising from

A fraud
B competitive pricing
C human error
D IT failures
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CHECKPOINT 2
5 Risk analysis is made up of five stages, which one is missing?

 Identification
 Assessment
 Profiling
 ?
 Consolidation
A Evaluation
B Positioning
C Quantification
D Minimisation
6 An event is something that could impact upon implementation of strategy or achievement of

objectives. Which of the following best describes an internal event?
A Economic changes, political developments or technological advances
B Equipment problems, human error or difficulties with products
C Levels being reached that require immediate action
D A decision to defer investment in an improved distribution system
7 Enterprise risk management [ERM]

I is a process effected by an entity's board of directors, management and other
personnel, applied in strategy setting and across the enterprise
II is a specialist IT system designed to capture all aspects of an organisation’s activities,
so that they can be effectively managed
III should identify potential events that may affect the organisation and manage risks to
be within its risk appetite, whilst providing reasonable assurance regarding the
achievement of entity objectives
IV is a modern approach to the management of a risk that views the organisation as an
enterprise, and as such should adopt an entrepreneurial approach to risk
management
A I and II
B I and III
C II and III
D III and IV
8 The Turnbull Report recommends that the board should

A regularly receive and review reports on risk management and internal control
B annually receive and review reports on risk management and internal control
C receive and review reports on risk management and internal control during the
external audit process
D receive and review reports on risk management and internal control monthly
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CHECKPOINT 2
9 Inculcating risk awareness into an organisation’s culture is best achieved by

A well developed rules and regulations
B top-down communications
C formal reporting regime
D developing suitable risk management information systems
10 What is the principal aim of the COSO framework?

A Allocate and utilise resources efficiently
B Link corporate objectives with risk management
C Enhance overall business performance
D Standardise governance reporting systems

1 What is required to ensure that the internal audit function operates effectively?
2 Identify TEN ways in which risk could be classified for any commercial organisation.
3 Which organisational measures for spreading ownership of risk management does the
COSO framework recommend?
4 What does the internal control framework mnemonic SPAMSOAP stand for?
5 Draw the likelihood/consequences risk assessment matrix.
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CHECKPOINT 2
Section A
1 B The control environment can be described as the general attitude of management
towards control, it is the firm’s cultural disposition towards the management of risk
and sets the tone for the control procedures adopted.
2 A Whereas risk is a condition in which there exists a quantifiable dispersion in the
possible results of any activity, uncertainty means that you do not know the impact
and/or the chances of each outcome occurring.
3 D Functional controls is not a classification for internal control procedures, however this
does not mean that control procedures are not adopted at the functions (or
operational) level as this is obviously not the case.
4 B Competitive pricing is likely to have strategic implications rather than operational. This
is because setting the wrong price could damage a firm’s competitive position and
ultimately result in it failing to achieve its business strategy and deliver its corporate
objectives.
5 C Risk analysis is made up of the following five stages.
 Identification
 Assessment
 Profiling
 Quantification
 Consolidation
6 B An internal event can include equipment problems, human error or difficulties with
products, in effect anything internal to the organisation which management have no
power to control.
7 B Enterprise risk management [ERM] is a process, effected by an entity's board of
directors, management and other personnel, applied in strategy setting and across
the enterprise and should identify potential events that may affect the organisation
and manage risks to be within its risk appetite, whilst providing reasonable assurance
regarding the achievement of entity objectives.
8 A The Turnbull Report recommends that the board should regularly receive and review
reports on risk management and internal control. An annual review would be too
infrequent, a monthly review would be too prescriptive and by the time external
auditors arrive it’s too late!
9 B Inculcating risk awareness into an organisation’s culture can be achieved in many
ways, but one thing that is pre-requisite is top level management commitmentwhich
can only be facilitated by top-down communications.
10 B The Committee of Sponsoring Organisations (COSO) of the Treadway Commission

devised an internationally recognised control framework, which aims to link corporate
objectives with risk management.
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CHECKPOINT 2
Section B
1 To ensure the effectiveness of internal audit the following is required.
 A clearly stated purpose, with explicit and implied authority
 Planned activities with adequate levels of resource
 Access to all areas of the organisation
 Complete and accurate information
 Approved policies and procedures
 Competent staff with the necessary skills, and a programme for staff development
 Co-ordination with external auditors
 A quality assurance system.
2 Ten ways in which risk could be classified are

 Financial
 Legal
 Political
 Physical
 Technological
 Fraud
 Competitive
 Reputational
 Environmental
 Human
3 The COSO framework recommends that

 Risk management should be an explicit part of everyone's job description.
 Personnel should understand the need to resist pressure from superiors to participate
in improper activities and that channels outside normal reporting lines should be
available to permit reporting such circumstances.
 Training is of course essential, especially for new employees and for all employees
when new procedures are introduced.
 If people are given responsibility for dealing with specific risks, they will have to take
an active role in risk management.
4 Segregation of duties
Physical measures
Authorisation and approval
Management
Supervision
Organisation
Arithmetical and accounting
Personnel
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CHECKPOINT 2
5
Consequences (impact)
Low High
Low
Likelihood (risk probability)
Accept Transfer
Reduce Avoid
High
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CHECKPOINT 2
Case 7 - FSA inquiry into RBS purchase of ABN Amro

T H E T E L E G R A P H [ A U G U S T 2 0 0 9 ]
By Rowena Mason and Jamie Dunkley

The Financial Services Authority has launched an official review into Royal Bank of Scotland's
debt-laden acquisition of ABN Amro the year before it had to be bailed out by the taxpayer. The
regulator notified RBS in April of its intention to conduct the review, which will scrutinise the bank's
capital raising last year.
It is understood that the review will look into the "whys and wherefores" of RBS's battle with
Barclays to buy the investment bank for €71bn (£63bn) at the top of the market. It is likely to
include a close look at what due diligence was performed.
The FSA's supervisory review was revealed in the notes of RBS's half-year results last month.
The acquisition of ABN Amro has been widely blamed for heaping RBS with debt and depleting its
capital resources so that it was badly placed to withstand the credit crisis.
The bank, which was the largest to be propped up by the Treasury, reported a record £40bn loss
for 2008 in February – the biggest in UK corporate history. A large part of its writedowns were
related to the ill-fated decision to buy the investment bank.
Stephen Hester, the chief executive of RBS, who joined after its part-nationalisation, said in April
that the bank will take at least three to five years to recover from the attempted integration of ABN
Amro assets that were instrumental in damaging the bank's balance sheet.
RBS, which is now 70pc owned by the state, has unveiled a sweeping restructuring plan.
As many as 20,000 jobs could be lost after the bank said it planned to cut costs by £2.5bn.
A spokesman for RBS would only say that the bank is co-operating fully with the regulator's review.
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CHECKPOINT 2
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Personal ethics

Explain and distinguish between You may be asked for December 2012 Q1b (10 marks)
the ethical theories of relativism definitions and then to apply the distinguish between the relativist
and absolutism theories in a scenario and absolutist approaches
June 2008 Q2c (6 marks) Anne
Hayes
Explain, in an accounting and You need to be able to describe June 2009 Q1a Global Bank
governance context, Kohlberg’s the levels and identify at which June 2011 Q1 b (12 marks)
stages of human moral level different people in a explanation and application of
development scenario are operating.. Kohlberg’s theory
Describe and distinguish You need to be able to explain Pilot Paper Q3c (7 marks)
between deontological and what these technical terms Professor Cheung
teleological/consequentialist mean and apply them in a December 2008 Q4(c) Hogg
approaches to ethics scenario, Products
Apply commonly used ethical You could be asked to recall the December 2012 Q4a (10 marks)
decision-making models in different elements of the models application of the Tucker model
accounting and professional and apply them in a scenario, to scenario
contexts: American Accounting December 2009 Q1a application
Association model, Tucker’s 5- of the AAA model
question model
Explain and analyse the content Kohlberg is a useful tool which December 2007 Q4c Football
and nature of ethical decision can be useful as a relevant point Club
making using content from in a broad requirement.
Kohlberg’s framework as
appropriate
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9: PERSONAL ETHICS
Overview
Ethics and the public interest
Ethics
Ethical theories Kohlberg's stages of human

moral development
Models of ethical conflict

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

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

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

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

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

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

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

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

2.1 Kohlberg describes the development of individuals’ ethical reasoning in terms of
progression through three levels with two planes within each level. These levels can be
related to ethical behaviour.
2.2 They show the reasoning process of individuals; it is possible that individuals at different
levels will make the same moral decisions, but they will do so as a result of different
reasoning processes.
2.3 Kohlberg emphasises how the decision is reached, not what is decided.
Level 1 Pre-conventional
 Obedience and Punishment: suggests that obedience is
compelled by the threat or application of punishment
 Individualism, Instrumentalism, and Exchange considers that
right behaviour means acting in one's own best interests
Level 2 Conventional
 Peer pressure view; is an attitude that seeks to do what will gain
the approval of others
 Law and Order means abiding by the law and responding to the
obligations of duty
Level 3 Post-conventional
 Social Contract is an understanding of social mutuality and a
genuine interest in the welfare of others
 Principled conscience is based on respect for universal
principles and the demands of individual conscience
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3 Frameworks for ethical conflict resolution

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

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

3.3 Tucker’s 5 question model is a benchmark against which to test the ethicality of a decision.
Ask yourself, is the decision:
(a) Profitable?
(b) Legal?
(c) Fair and equitable?
(d) Right, which is prone to subjective judgement?
(e) Sustainable or environmentally sound?
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Lecture example 3 Group discussion
Southern Construction, started as a small family-run business in the 1980s. John Falshaw, the
founder and self-appointed chairman of the board, foresaw rapid expansion and so decided that
the firm should go public. The timing of this decision was unfortunate as it coincided with an
economic recession, which hit the building trade very hard. The strain was too much and Falshaw
suffered a massive heart attack, and was forced to retire.
In the past Falshaw had run things with a heavy hand and things were done his way or not at all!
The board served as a ‘rubber stamp’ for his decisions, and as a result, financial and operational
controls were weak or non-existent.
The new chairman was trying desperately to maintain existing levels of financing. However, the
firm’s bank was very unsettled by recent events, and insisted that Southern Construction plc recruit
some non-executive directors to strengthen the effectiveness of the board.
Thomas Edwards FCCA had recently retired as financial controller of a large engineering
company. He was delighted when he was approached by the chairman of Southern Construction
plc with the offer of becoming a non-executive director and chair of the yet to be established audit
committee. On accepting the position, the head of internal audit, Mary Flanagan, was instructed to
report directly to Edwards. New internal controls were instituted and additional internal audit staff
were recruited.
One day Mary Flanagan reported that her team had found that a salesman had been submitting
false expenses vouchers running into thousands of pounds. Mary, who had a reputation for
integrity and thoroughness, was particularly upset because the actions were a clear violation of the
Southern Construction Code of Ethics and Conduct. The salesman in question was Elmer
Pearson. When asked what should be done with Pearson, she responded, “The penalty called for
submitting false expense claims is summary dismissal – no exceptions”.
It transpired that Pearson would go out with another sales rep, and then both would submit an
expenses claim for the same trip. Internal audit had unearthed dozens of vouchers like this, some
even claiming for imaginary trips.
Edwards was concerned about the reaction of the bank if they learned about the fraudulent activity.
Later that day, Flanagan phoned Edwards at home. She sounded upset, but wanted to talk. “I’m
confused” she said, “my loyalties are being pulled in so many directions, I don’t know what to
think”. She went on to point out that she had known Pearson for over 10 years, and he had always
been friendly and helpful to her. She wondered if long service and loyalty to the firm deserved
special consideration.
The following day Edwards confronted Pearson. Pearson admitted to the double billing and
imaginary trips. When he was accused of clearly violating the Code, he said “you dictate my
resignation, I’ll sign it and be out of here tonight”. Edwards responded to this by advising Pearson
that if any criminal activity were involved, it wouldn’t stop there.
To this, Pearson looked incredulous and began to argue his case strongly. He was currently
working on a big deal with a Japanese businessman – a market Southern Construction had been
trying to crack for some time. His budget has been cut to the bone, so he used the money from the
expenses subterfuge to finance the sales pitch. All that is left on a $10 million deal is for the papers
to be signed and Pearson was the only man who had developed the personal relationship with the
Japanese businessman to secure this.
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Edwards sat in his office pondering about what to. The bank has just been on the phone
requesting a meeting next week to discuss progress in strengthening the controls within the
business.
Required
Using the AAA model, advise Edwards on what to do.
Evaluate your final recommendation using Tucker's 5 questions.
Solution
AAA Model
1. What are the facts of the case?
2. What are the ethical issues in the case?
3. What are the norms, principles and values related to the case?
4. What are the alternative courses of action?
5. What is the best course of action that is consistent with the norms, principles and values
identified?
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9: PERSONAL ETHICS
6. What are the consequences of each course of action?
7. What is the decision?
Tucker 5 Questions
 Profitable?
 Legal?
 Fair?
 Right?
 Sustainable?
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4 Chapter summary
1 Ethical theories Ethics is concerned with issues of right and wrong.

Relativism is the belief that ideas of right and wrong are
subjective. Relativism contrasts with absolutism, the belief
that there are universal, objective moral truths.
Deontological ethics establishes rules for how you should or
should not act depending on the rightness of the action.
Teleological or consequentialist ethics looks beyond the
action to the outcome. This approach can be split into two,
utilitarianism which makes judgements based on the
greatest good and egoism which makes judgements based
on the consequences for the individual (the thief’s rule).
2 Kohlberg’s Kohlberg describes the development of individuals’ ethical
stages of human reasoning through three stages or levels.
moral Pre-conventional: reward/punishment and self-interest
development
Conventional: “good boy/girl” and legal or social conventions
Post-conventional: concern for others and principled
conscience
3 Frameworks for The IFAC and American Accounting Association Models
ethical conflict cover broadly the same issues. Consideration should be
resolution given to: the facts, the ethical issues, fundamental
principles, internal procedures, alternatives.
Tuckers 5 questions are, is the decision: Profitable? Legal?
Fair? Right? Sustainable?
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END OF CHAPTER
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Ethics and professional
practice

Explain and explore the nature of a You could be asked explicitly or as December 2012 Q1c (9 marks)
profession and professionalism part of a broader requirement to examines the professional and
including the public interest explore the public interest ethical behaviour of the FD
June 2009 Q2a Policy speech
June 2010 Q4 Happy & Healthy
Analyse the role of accounting as a You could be asked to explore the June 2009 Q2c Policy speech
profession in society value of the accounting profession
from different perspectives
Describe and explore and areas You could be asked to explain what December 2011 Q1a (10 marks)
covered by corporate codes of would be in a code of ethics purpose and application of a
ethics corporate code in the oil industry
Describe, assess the content of, You should be able to recall the Integrity Dec 2009 Q3a
and principles behind, professional principles of professional ethics
codes of ethics
Describe and assess the codes of You should be able to se the Pilot Paper Q3a (11 marks)
ethics relevant to accounting ethical principles in a scenario Professor Cheung
professionals such as IFAC or Pilot Paper Q4c (4 marks) FF Co
professional body codes, eg ACCA
Explain and evaluate the nature of You should be able to discuss June 2012 Q3b) application of
impacts of ethical threats and ethical threats arising in a scenario ethical safeguards
safeguards June 2009 Q2b Policy speech
Describe and discuss rules-based Relevant in a broad requirement Pilot Paper Q3a Professor Cheung
and principles-based approaches
to resolving ethical dilemmas
encountered in professional
accounting
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10: ETHICS AND PROFESSIONAL PRACTICE
Overview
Ethics and professional

practice
Accountants and the public

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

(a) Using different departments in the firm to carry out the work
(b) Making full disclosure to the client’s audit committee
(c) Withdrawal from an engagement if the risk to independence is considered too great.
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Familiarity threat
4.7 Familiarity threat is where independence is jeopardised by the audit firm and its staff
becoming over familiar with the client and its staff. As a result they may become too
sympathetic to their views and interests.
Intimidation threat
4.8 An intimidation threat arises when a professional accountant is deterred from acting
objectively by threats, actual or perceived. Situations which might create intimidation threats
include:
(a) Threats of dismissal.
(b) Threats of litigation.
(c) Pressure to reduce fees or the extent of work performed.
5 Chapter summary
1 Professions and the Professions and professional bodies have a dual role,
public interest protecting the interests of their members and
protecting the public interest. Professionalism means
avoiding actions which would discredit the
accountancy profession. Acting in the public interest
means acting for the welfare of society as a whole.
This may conflict with detailed professional ethical
duties such as the duty of confidentiality.
2 Corporate codes of Ethical codes set out the company’s core values and
ethics usually contain detailed guidance about issues like
anti-competitive practices and bribes/gifts. To be
effective they need board level commitment,
communicating, monitoring and sanctions.
Failures of codes are that they can contradict actual
practice.
3 IFAC professional code The IFAC code is a principles based code. The
of ethics ACCA’s code is broadly based on the IFAC code.
The fundamental principals are:
– Professional competence and due care
– Integrity
– Professional Behaviour
– Confidentiality
– Objectivity
4 Threats to compliance The threats to independence are: self-interest, self
with the fundamental review, advocacy, association / familiarity and
principles for intimidation. Safeguards are put in place to counter
accountants in practice these threats.
END OF CHAPTER
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Corporate social
responsibility and
environmental reporting

Describe and evaluate You may have to construct December 2011 Q4 a (10
constructions of the corporate arguments from a particular marks) explanation and
and personal ethical stance ethical perspective. Gray, application to Gray, Owen &
Owen & Adams is a particular Adams’ theory
favourite of the examiner December 2008 Q1 Swan Hill
June 2009 Q2c Policy speech
Explain and explore social Relevant in a broad requirement December 2007 Q4c Football
responsibility in the context of club
corporate governance
Describe and assess the social You may need to define Pilot Paper Q1e (2 marks)
and environmental effects that environmental or social footprint ChemCo
economic activity can have (in an asses it in the context of a June 2008 Q1d (8 marks)
terms of social and scenario Rowlands and Medeleev
environmental footprints)
Explain and assess the concept You should be prepared to Pilot Paper Q1e (4 marks)
of sustainability and evaluate define sustainability and explain Chemco
the issues concerning how it applies in the context of a June 2008 Q1d (3 marks)
accounting for sustainability scenario. Rowlands and Medeleev
Explain the nature of social and You might have to discuss the Dec 2009 4c Saltoc
environmental audit and contents of a risk audit and the
evaluate the contribution it can case for an external provider
make to the development of
environmental accounting
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11: CORPORATE SOCIAL RESPONSIBILITY
Overview
Corporate Social
Responsibility
CSR Corporate CSR Stances CSR Viewpoints

Citizenship
Social and environmental issues
Social issues Sustainability Environmental issues
Social audit Environmental costs
Environmental management
systems
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1 Organisations' ethical/ social responsibility stances

1.1 Corporate social responsibility is a concept whereby organisations consider the interests of
society by taking responsibility for the impact of their activities on wider stakeholders.
1.2 This obligation can be seen to extend beyond statutory obligations to comply with
legislation.
CSR (Carroll) Corporate citizenship Ethical Stances 7 Social
(Matten et al) (Johnson & Scholes) Responsibility
Viewpoints (Gray
Owen & Adams)
Economic Limited view Short-term Pristine capitalists:

To shareholders consists of limited shareholder Business has no
wanting projects undertaken interest, It is for moral responsibilities
dividends/capital in the business’s self- government alone to beyond their
gains, to employees interest. The impose wider obligations to
wanting fair main stakeholder constraints on shareholders and
employment, to groups that the corporate creditors.
customers wanting corporation engages governance. This
good quality products with are local minimalist approach
Expedients social
communities and would accept a duty
responsibility may be
employees. of obedience to the
appropriate if it is in
demands of the law,
the business’s
but would not
economic interests.
undertake to comply
with any less
substantial rules of
conduct.
Legal Equivalent view is Long-term Proponents of the

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

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

Charitable donations, although it is aim to promote
contributions to local accepted that this feminine values such
communities, and role is largely the as co-operation
providing employees preserve of public
with the chances to sector organisations.
Deep ecologists
improve their own (greens) suggest that
lives man has no greater
rights to resources or
life than other
species.
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Lecture example 1
Proponents of CSR argue that there is a strong business case for considering stakeholders,
whereas critics argue that CSR distracts from the fundamental economic role of businesses.
Required
Identify some arguments supporting the case both for and against CSR. (You may want to
consider what might motivate an interest in CSR.)
Solution
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2 Sustainability
2.1 Sustainability means limiting the use of depleting resources to a level that can be
replenished.
2.2 Sustainable development is development that meets the needs of the present without
compromising the ability of future generations to meet their own needs.
2.3 When considering sustainability a number of questions need to be considered:
Sustainable
by whom?
Sustainable at Sustainable
what cost? for whom?
SUSTAINABILITY
ISSUES
Sustainable for Sustainable

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

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

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

Social Footprint
3.1 Social footprint is a measure of the impact or effect that an entity can have on a given set
of concerns or stakeholder interests.
3.2 It is the impact on people, society and the wellbeing of communities. Impacts can be
positive such as job creation and community benefits) or negative, such as when a plant
closure increases unemployment and the local community suffers.
Social Accounting
3.3 Social accounting is a concept describing the communication of social and environmental
effects of a company's economic actions to stakeholders.
3.4 A number of reporting guidelines have been developed to serve as frameworks eg.
 ISO 14000 Environmental Management Standard
 Global Report Initiative (GRI) sustainability reporting guidelines.
 AA1000 Standard – based on triple bottom line (3BL) reporting
 FTSE4 Good index
Lecture example 2
Triple bottom line accounting clearly describes the goal of CSR.
Required
Suggest some areas that a company might report on under the headings below.
Solution
People (social)
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Planet (environment)
Profit (business)
4 Environmental reporting Global Reporting Initiative

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

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

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

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

(a) An environmental policy containing commitments to comply with legislation and
achieve continuous environmental performance improvement
(b) An on-site environmental review
(c) An environmental management system that is based on the review and the
company’s environmental policy
(d) Environmental audits at sites at least every three years
(e) Audit results to form the basis of setting environmental objectives and the revision of
the environmental policy to achieve those objectives
(f) A public environmental statement validated by accredited environmental verifiers
containing detailed disclosures about policy, management systems and performance
in areas such as pollution, waste, raw material usage, energy, water and noise
ISO 14000
5.3 ISO 14000 provides a general framework on which a number of specific standards have
been based (the ISO family of standards).
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5.4 ISO 14001 prescribes that an environmental management system must comprise:
(a) An environmental policy statement, which should be the basis for future action. It
needs therefore to be based on reliable data, and allow for the development of
specific targets.
(b) Assessment of environmental aspects and legal and voluntary obligations.
(c) A management system ensuring effective monitoring and reporting on environmental
compliance.
(d) Internal audits and reports to senior management.
(e) A public declaration that ISO 14001 is being complied with.
Lecture example 3
Required
Identify the business benefits of an organisation achieving external accreditation for its CSR
activities.
Solution
6 Social and environmental audits

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

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

how well an entity, its management and equipment are performing, with the aim of helping to
safeguard the environment by facilitating management control of environmental practices
and assessing compliance with entity policies and external regulations.
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6 Chapter summary
1 Organisations’ ethical There are four different models which identify different
and social positions that can be taken. They broadly cover
responsibility stances stances of narrow economic self interest, wider social
obligations, and a more principled ethical stance
through to a philanthropic position. (Carroll’s CSR)
The other models are: Corporate Citizenship (limited,
equivalent and extended views); Ethical Stances
(Shot-term shareholder, long-term shareholder,
stakeholder and shaper of society); and Gray, Owen
& Adams 7 positions (Pristine Capitalist, Expedient,
Social Contract, Social Ecologist, Socialist, Radical
Feminist and Deep Ecologist)
2 Sustainability Businesses are concerned with their social and
environmental impact on current and future
generations because of the potential effect on their
reputation, potential costs and because of the
likelihood of increased legal controls.
Impact is measured in terms of footprints.
3 Social accounting, Organisations can opt to follow different guidelines.
auditing and reporting
4 Environmental The growing impact of the GRI on business
reporting organisations and how this can prove advantageous
in many ways, including governance.
5 Environmental EMAS is a voluntary scheme based on improving
management systems targets, inspection and verification of performance.
ISO 14000 provides a prescription for an
environmental management system.
6 Social and Social audits usually focus on checks as to whether a
environmental audits company has met previously stated social policies.
Environmental audits can range in scope from
mandatory Environmental Impact Assessments
required for many large scale projects to
environmental SWOT analysis as part of wider
strategic planning.
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END OF CHAPTER
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your notes.

Stage 3 covers two key syllabus areas: ethics and corporate social responsibility. As this is one of
the final hurdles before becoming a professional accountant, it is important that you are equipped
with the skills required to deal with the many ethical dilemmas you will face in your professional
life. It is also important that as a professional in business you are aware of topical issues and the
impact of your business on other entities, hence the need for an understanding of corporate social
responsibility.
Key knowledge
Ethical theories
The AAA and Tuckers 5 question models of ethical decision making
Professional accountants responsibilities to the public interest
Why the ethical principles (Objectivity, professional competence etc) are important
What CSR is and CSR stances and viewpoints
Sustainability and environmental impact
Key skills
Being able to apply the theories to practical scenarios.
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CHECKPOINT 3

85 mins
Chapter 9 – Personal ethics
Key areas
 Ethical theories
 Kohlberg’s stages of human moral development
 Ethical conflict resolution
Course Notes
 Carefully re-read the whole chapter as this is likely to be new material to you, 15 mins
and the variety of ethical theories and frameworks are all highly examinable.
 Read the examiner’s article on ethical decision making which is available on the
ACCA website at 10 mins
49
Question Practice
 Attempt Question 9 (Pogles) from the Study Text Question Bank. This question 40 mins
is on ethical decision making which the examiner published an article on.
Real-life examples
 Case 10 gives an example of the ethical dilemmas faced by clothing retailers. 5 mins
You could also consider the ethical dilemma that you as a consumer also have.
 Case 8 shows how Kohlberg’s theories are used to analyse the ethical decision 5 mins
making process,
Study Text
 Section 2.2 describes some of the individual influences that will affect people’s 5 mins
ethical behaviour
 Section 2.5 and 2.6 contain some other factors that will affect ethical behaviour. 5 mins
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Chapter 10 – Ethics and professional practice 115 mins
Key areas
 The public interest
 Ethical codes
 Threats to professional independence
Course Notes
 Learn and understand the fundamental principles according to the ACCA
ethical code along with the threats to these principles. 5 mins
Question Practice
 Question 9 (Ethical considerations) from the Course Notes Question Bank 40 mins
poses the kind of ethical problem that the examiner may give you.
 You have now covered all the material required to attempt Question 11 (Franks
60 mins
& Fisher) from the Course Notes Question Bank. This is an exam standard
section B question written by the examiner. It is challenging and covers a
range or different types of requirements commonly used by the examiner.
Once you have attempted this you should then use the on-line debrief to
review your answer.
Study Text
 Section 1 has some more detail about company codes of ethics. 10 mins
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CHECKPOINT 3
Chapter 11 – Corporate social responsibility 100 mins
Key areas
 Social issues
 Environmental issues
 Environmental issues
 Sustainability
Course Notes
 Ensure you have an understanding of the different stances with regard to 10 mins
corporate social responsibility. The 2 key sets of theorists to learn are Gray,
Owen & Adams and Johnson & Scholes as these are both explicitly mentioned
in the syllabus guide.
 Read the examiner’s article on risk and environmental auditing which can be
found on the ACCA website: 10 mins
969
 Read the examiner’s article on environmental reporting which can be found on
the ACCA website: http://www.accaglobal.com/en/student/qualification-
resources/acca-qualification/acca-exams/p1-exams/exams-p13.html
Question Practice
 Question 10 (Corporate Citizenship) from the Course Notes Question Bank is a 30 mins
mix of theory and common sense that is typical of this paper.
 Question 11 (Loxwood) from the Study Text Question Bank. This question
30 mins
covers a mix of syllabus areas and requires detailed knowledge of the Gray,
Owen and Adam viewpoints, which you may wish to briefly review before
attempting it.
Real-life examples
 Case 9 looks at how the issue of ‘sustainability’ can heavily impact a 5 mins
company’s strategy. If you to follow up to date developments in CSR a good
approach is to search on Twitter using the hashtag #csr
5 mins
Study Text
5 mins
 Briefly review section 1 which covers corporate citizenship in a great deal of
detail. 5 mins
Section 2.1 covers the ethical stances and their significance.
Section 4.1.1 has information about the UN’s Brundtland report on
sustainability.
On completion of this final Stage (including Progress Test) you are

ready to attempt Course Exam 2
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A Multiple choice questions (10 questions – approximate time 15

minutes)
1 The board should disclose as a minimum in the accounts
I The existence of a process for managing risks
II How the board has reviewed the effectiveness of the process
III That the process accords with the guidance in the Turnbull Report?
IV Attest that the external auditors have validates the effectiveness of internal control
systems
A I, II and III
B II, III and IV
C I, III and IV
D I, II, III and IV
2 The ethical stance of an organisation is described by Johnson and Scholes as

A an organisation’s generally accepted view on issues such as child labour and the
depletion of natural resources
B the basic minimum an organisation is willing to go in pursuance of issues other than
those which will maximise long term shareholder value
C the extent to which an organisation will exceed its minimum obligation to stakeholders
D the importance that ethics play in an organisation’s cultural position
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3 Social ecologists believe that

A business activities result in resource exhaustion, waste and pollution must be
modified, so organisations must be socially responsible
B man has no greater rights to resources or life than other species
C firms should conform with the ethical norms in society, because there is effectively a
contract or agreement between the organisations and those who are affected by their
decisions
D business relationships involve manipulation and oppression, and seek to promote
egalitarian equality
4 Situations where the audit firm assume the client’s part in a dispute, e.g. when a firm acts
as an expert witness in a court case can present which of the following conflict of interest
A Self-interest
B Self-review
C Advocacy
D Familiarity
5 Which of the following form part of Tucker’s 5-question model in determining the ethicality of
a decision?
I Profitable
II Legal
III Fair and equitable
IV Sustainable or environmentally sound
A I, III and IV
B I, II and IV
C II, III and IV
D I, II, III and IV
6 Which of the following is a disadvantage of full cost accounting?

A Significant information gathering costs
B Increases environmental footprint
C Cannot identify the full extent of environmental footprint
D Ignores environmental costs
7 What is the international standard equivalent of BS 7750 (environmental management and

audit systems)?
A ISO 5001
B ISO 12001
C ISO 14001
D ISO 19001
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8 Examples of factors used to determine a firm’s environmental footprint include

I depletion of natural resources
II noise and aesthetic impacts
III residual air and water emissions
IV uncompensated health effects
A I, III and IV
B I, II and III
C II, III and IV
D I, II, III and IV
9 Which of the following describes the higher plane at the pre-conventional level according
Kohlberg’s theory of human moral development?
A Obedience and Punishment
B Individualism, Instrumentalism, and Exchange
C Law and Order
D Social Contract
10 The hypothetical imperative under deontology

A defines a course of action in terms of acting in accordance with moral duty without
reference to outcomes, desire or motive
B lays down a course of action to achieve a certain result
C accepts that different views may exist on morality, but suggests a consensus may be
able to be reached in certain situations
D states that an act is ethically justified if decision-makers freely decide to pursue their
own short-term desires or their long-term interests. The subject of all ethical decisions
is the self.

1 What does the ACCURATE mnemonic stand for?
2 What should the annual review of internal control procedures include, according to the
Turnbull report?
3 Suggest FOUR criticisms of Lawrence Kohlberg’s Theory of Human Moral Development
4 Describe the THREE views of corporate leadership as determined by Matten et al.
5 What are the FIVE tiers of cost required to develop full cost accounting?
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Section A
1 A The board should disclose as a minimum in the accounts
 The existence of a process for managing risks
 How the board has reviewed the effectiveness of the process
 That the process accords with the Turnbull Report guidance
2 C The ethical stance of an organisation is described by Johnson and Scholes as the

extent to which an organisation will exceed its minimum obligation to stakeholders.
3 A Social ecologists believe that business activities result in resource exhaustion, waste
and pollution must be modified, so organisations must be socially responsible.
4 C Advocacy describes the potential conflict of interest that exists where an audit firm
assume the client’s part in a dispute.
5 D Tucker’s 5-question model in determining the ethicality of a decision includes

 Profitable
 Legal
 Fair and equitable
 Sustainable or environmentally sound
6 A Significant information-gathering costs is a disadvantage, whereas all of the others

are completely wrong as their reverse represents an advantage of full cost
accounting.
7 C ISO 14001 is the equivalent of BS 7750
8 D Examples of factors used to determine a firm’s environmental footprint include all four
elements, i.e.
 Depletion of natural resources
 Noise and aesthetic impacts
 Residual air and water emissions
 Uncompensated health effects
9 B Individualism, Instrumentalism, and Exchange describe the higher plane at the pre-
conventional level according Kohlberg’s theory of human moral development.
10 B The hypothetical imperative under deontology lays down a course of action to achieve
a certain result.
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Section B
1 Good quality information can be described using the following characteristics:
Accurate
Complete
Cost-beneficial
User targeted
Relevant to task
Authoritative
Timely
Easy to use
2 According to Turnbull, the annual review should cover
 Changes since the last formal risk assessment
 The company's ability to respond to changes in its business environment
 The scope and quality of management's monitoring of risk and internal control, and of the
work of internal audit
 The extent and frequency of reports to the board
 Significant controls, failings and weaknesses which have, or might have, material impacts
upon the accounts
3 Criticisms of Kohlberg’s theory include
 It is based on the perceived principles of so-called ‘typical’ American males such as
fairness, impartiality, rights, maintenance of rules.
 It ignores more natural female traits such as ethic care, empathy, harmony and
interdependent relationships.
 The framework is based on his own value judgements.
 It assumes that moral action is primarily decided by formal reasoning.
 Individuals do not necessarily progress through the stages during their lives, and even
if they do progress, it may only be in certain situations; they may use different
methods of moral reasoning inside and outside the workplace.
4 Matten’s views of corporate social responsibility are
 Limited view is based on voluntary philanthropy undertaken in the business’s interests.
 Equivalent view is based on a wider general definition of corporate social responsibility
that is partly voluntary and partly imposed.
 Extended view is based round a partly voluntary, partly imposed view of active social
and political citizenship.
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5 Full cost accounting uses the following tiers of cost.

Tier 0 Usual costs Basic capital and revenue costs
Tier 1 Hidden costs Costs usually included as overheads, e.g. costs of
management systems and safety
Tier 2 Liability costs Contingent liability costs, e.g. fines
Tier 3 Less tangible costs Costs of poor environmental management, e.g. loss
of goodwill of customers and suppliers, reputation
risk
Tier 4 Environment focused Costs that ensure that project has zero
costs environmental effect
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Case 8 – Lawrence Kohlberg’s stages of human moral development

P U B L I S H E D R E S E A R C H [ 1 9 5 8 &
1 9 6 3 ]
Kohlberg's sought to understand how human beings develop morally during their lifespan. He
decided to conduct his research on children, because he believed that they would not have
developed any preconceived notions and so their responses would be more ‘natural’. His research
sample comprised 72 boys, aged 13, 13 and 16, from both middle- and lower-class families in
Chicago. This research was later extended to include other groups of children.
He interviewed each child individually, presenting them with a series of moral dilemmas for them to
respond to. The most famous dilemma he set was as follow:
The Heinz dilemma scenarios
1 A woman was near death from a unique kind of cancer. There is a drug that might save her.
The drug costs $4,000 per dosage. The sick woman's husband, Heinz, went to everyone he
knew to borrow the money and tried every legal means, but he could only get together about
$2,000. He asked the doctor scientist who discovered the drug for a discount or let him pay
later. But the doctor scientist refused.
Question: Should Heinz break into the laboratory to steal the drug for his wife?
2 Heinz broke into the laboratory and stole the drug. The next day, the newspapers reported
the break-in and theft. Brown, a police officer and a friend of Heinz remembered seeing
Heinz last evening, behaving suspiciously near the laboratory. Later that night, he saw
Heinz running away from the laboratory.
Question: Should Brown report what he saw?
3 Officer Brown reported what he saw. Heinz was arrested and brought to court. If convicted,
he faces up to two years' jail. Heinz was found guilty.
Question: Should the judge sentence Heinz to prison?
Kohlberg was not really interested in whether the child responded “yes" or "no" to this dilemma but
his or her reasoning behind their answer. In effect he wanted to understand why the child thought
Heinz should or should not have stolen the drug.
Kohlberg classified the various responses into six stages of reasoning at three levels. He believed
that individuals could only progress through these stages one stage at a time, as they could only
comprehend a moral rationale one stage above their own.
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Case 9 – Ford to develop 'sustainability strategy'

F I N A N C I A L T I M E S [ A P R I L 2 0 0 7 ]
By John Reed
Ford Motor has promoted an executive to a top-level environmental remit in another reflection of
green issues' elevation to the top of the US car industry's agenda.
Susan Cischke will be responsible for establishing a "long-range sustainability strategy" and
environmental and safety policy for the company, reporting to Alan Mulally, Ford's president and
chief executive. Ms Cischke formerly reported to Ford's head of corporate affairs as head of Ford's
environmental and safety engineering.
Europe's main carmakers mostly already have board-level executives with environmental
responsibilities.
The Detroit-area carmakers are stepping up their environmental efforts amid a shift in political and
public opinion in the U.S. on the issues of global warming and energy security. Mr Mulally, a former
senior executive at Boeing, said he believed that the "vast majority of data" pointed to "global
warming… that comes from greenhouse gases."
"In the court of public opinion, we've moved to the place that we all agree this is an issue and we
all want to do something about it," he said.
Ford is also a leading carmaker in Europe, where lawmakers recently agreed to hold the car
industry to much tighter carbon dioxide emissions standards by 2012. Ford said Ms Cischke would
be charged with ensuring that Ford's products "meet or exceed all safety and environmental
regulations worldwide. "
Green groups have criticised Ford, along with General Motors and DaimlerChrysler's Chrysler unit of
making too many gas-guzzling, high-emission large vehicles and lagging behind Japanese and
European competitors in developing cleaner cars. Some of Ford's current vehicles do not meet US
fuel-efficiency standards.
Alongside tightening environmental regulations, alternative-fuel cars are becoming a top-drawer
business issue for the industry as they develop competing technologies involving hybrid engines,
hydrogen, or biofuels. Ms Cischke said she would work closely with Derrick Kuzak, head of Ford's
global product development, and others to help build "sustainable technologies."
All of the new technologies have disadvantages, and entail large research and development costs.
Ford, which is in the midst of a radical downsizing and restructuring plan, has resisted cutting its
research and development budget despite record financial losses.
Case 10 – Apple
In 2010 Apple was at the centre of publicity about employee suicides at a manufacturing company,
Foxconn, which made Apple products. In early 2012 Apple’s response has been to become a
member of the Fair Labor Association and publish details about its supply chain.
http://www.wired.co.uk/news/archive/2012-01/16/apple-unveils-suppliers-joins-fla
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Let BPP Professional Education

help you with your revision
You have now completed the very important Taught Phase of your studies. You have built core
skills and have tested these using course exams and practice questions. You now need to focus
on developing new skills to address the ultimate test – the exam itself.
Phase 2 – Revision
Revision courses
Our Revision Courses, available in the period running up to the exam, will focus on one objective –
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written by the examiner you’ll learn the unique exam skills for each paper. We will teach you how
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 Pick up easy marks for that paper
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This phase allows you to perfect your exam technique, giving you the confidence you need to
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Question Days
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Final Mock with Online Debrief

You will receive an exam standard mock to attempt in your own time, suggested solutions, marking
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Note. Question Days or the Final Mock with Online debrief are not a substitute for a revision
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Answers to
Lecture Examples
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12: ANSWERS TO LECTURE EXAMPLES
Chapter 1
Answer to Lecture Example 1
Improved risk management. The reduction of downside risk will reduce business losses.
Overall business performance is enhanced by focusing attention on areas of critical importance.
Defines clear accountability for executive decision making.
It provides both an appropriate and adequate system of internal control, which permeates the organisation
from top to bottom.
Best practice guidelines are applied by management, who therefore strive to improve their performance.
Encourages ethical behaviour and corporate social responsibility.
Safeguards the firm from misuse of business assets, both tangible and intangible.
Can attract new investment, particularly in developing countries.

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

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

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

The benefits of international codes of corporate governance include
(a) It provides a standardised approach which helps multi-national companies to enforce consistent
codes across their operations.
(b) It gives investors the understanding and therefore confidence to invest in global capital markets.
(c) It makes it easier for countries to implement corporate governance codes since they are not
having to produce their own codes from scratch.
(d) It ensures a minimum level of corporate governance.
A number of problems have been identified with international codes of corporate governance.
(a) International principles represent a lowest common denominator of general, fairly banal and
meaningless principles.
(b) Any attempt to strengthen the principles will be extremely difficult because of global differences
in legal structures, financial systems and structures of corporate ownership, culture and economic
factors.
(c) As international guidance has to be based on best practice in a number of regimes, development
will always lag behind changes in the most advanced regimes.
(d) The codes have no legislative power.
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Chapter 3
(a) Leadership
(b) Independence (an appropriate balance of executive and non-executive directors)
(c) A suitable balance of skills and experience
(d) Diverse backgrounds in order to represent different stakeholder groups.
(e) Integrity, probity and fairness in order to manage any conflicts of interest.
(f) Good communications between members and to stakeholders.
(g) Equal participation in robust discussions.

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

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

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

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

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

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

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

Risk committee
Executive directors
 Knowledge of company
 Risk – key concern
 Remuneration can be linked to risk management
 Supports strategic planning
Non-executive directors
 Independence/objectivity
 External experience
 No financial gains linked to decision
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 Assess risks
 Review risk register
 Advise board
 Review findings of internal audit
 Set risk policy
 Ensure risk management system exists
Chapter 6
 Lack of investment in IT (Technology)
 Product failure/recall (Product)
 Lack of availability of staff (Resources)
 Fall in share price (Investment)
 Adverse PR/press (Reputation)
 New entrant (Competition)
 Failed project (Product/Competition/Reputation/Investment/Technology/Product)

Currency risk: Exposure to adverse movements in exchange rates making sales less valuable
or increasing costs.
Credit risk Lack of necessary assets/reputation to obtain financing.
Environmental risk: Risk of damaging environment through business activities.
Probity risk: Risk of dishonest or unethical behaviour in an organisation
Knowledge mgt risk: Loss or lack of access to necessary information.
Outsourcing risk: Lock in to unsuitable supplier
Derivatives risk: Sustaining large losses due to falling value of financial instruments.
Market risk: A risk or loss due to an adverse move in the market value of an asset – a stock,
resource, commodity or underlying derivative.
Chapter 7
Who How How often
Board  Forecasting Monthly?
NED's  Scenario building Quarterly?
Risk committee  Variance analysis Annually?
Audit committee  Competitor analysis
Audit dept  Observation
Managers and employees  Meetings/discussions
Consultants  Interviews/questionnaires
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Year Discount factor PV of initial PV of variable PV of cash PV of net cash

8% investment costs inflows flow
$,000 $,000 $,000 $,000
0 1.000 (6,000) (6000)
1 0.926 (1,389) 4,630 3241
2 0.857 (1,286) 4285 3000
(6,000) (2,675) 8,915 241
(a) Selling price
Sensitivity = 241 / 8,915 = 3%

(b) Variable costs
Sensitivity = 241 / 2,675 = 9%

Changes in the selling price of this product are a higher risk than changes in the variable costs, as the
selling price only needs to fall by 3% (the equivalent of $241,000) to make the project only break-even.
Variable costs would need to rise by nearly 10% for the project to only break-even.

(a) Theft of Inventory
Each individual theft is likely to have a very small impact on the company, however cumulatively
the total value of inventory stolen is likely to be significant. Although it is unlikely to be so large as
to put the company at risk there is obviously the potential for cost savings.
The likelihood of inventory being stolen (assuming that there are no controls in place) is high, as
there has to be access to the public to the items held so they can choose their purchases.
This risk should be reduced through controls such as security guards, security tags on the items
for sale, limits on the numbers of items that can be taken into changing rooms where thieves
might have the time to remove tags, cctv in store to aid recovery and prosecution, well advertised
policies about prosecuting thieves. It is unlikely that insurers would cover losses from shoplifting.
On the other hand theft of inventory from warehouses and shops outside trading hours are less
likely to occur but the value of goods taken at one time is likely to be larger. The most appropriate
strategy would be to secure the premises and insure against these thefts.
(b) Under/overstocking specific lines from the women’s fashion range.
The impact of understocking lines is lost sales and possibly loss of customer loyalty. It is more
likely to occur if there is an unexpected celebrity or media endorsement of a particular line.
The impact of overstocking lines is lower margins. There is also the impact on the brand image of
having not been “in fashion”.
The likelihood of misjudging stock levels depends on the company’s experience at picking lines
which its customers will want, and in anticipating the volume of the market overall. For well
established retailers who understand their customers this should be a low likelihood. (Monsoon
however misjudged the popularity of the poncho a few years ago and overstocked).
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This should be a low likelihood, low impact risk for an experienced retailer and so should be
accepted.
(c) Failure of the EFTPOS system.
The impact of the EFTPOS system failing would be that the store (or stores) could not make credit
card sales (unless it had manual back ups) and would not be able to record data about lines sold.
The likelihood of the EFTPOS system failing would depend on how robust the system was. One
would assume that a company would not implement an EFTPOS system until it was reasonably
certain that it would not fail.
This would therefore be a low likelihood, high impact risk.
The company should ensure that there are adequate controls to minimise the risk of the system
failing and then insure for any loss suffered if it did fail.
(d) An economic downturn resulting in lower sales growth.
Currently there is a high likelihood of an economic downturn. The impact on a retail business like
M&S would be high since all but basic clothes and the type of food sold by M&S are discretionary
purchases rather than necessities. High impact, high probability risks should be avoided. It would
be a bad time to set up a business using the same model as M&S. M&S however cannot easily
avoid this risk so have to accept it.
Chapter 8
Internal (formal) External (formal)
Management accounts Market research
HR reports Company accounts
Variances Benchmarking
Exception reports Analysis reports
Internal (informal) External (informal)

Complaints Press/PR
Feedback Internet/competitors websites
Employee opinion

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

Report Contents 
The existence of a process for managing Page 44 of M&S’s annual report, shaded paragraph
risk – Risk Assessment
How the board has reviewed the Page 44 of M&S’s annual report, shaded paragraph
effectiveness of the process – Risk Assessment. “Every six months the Board
reviews the Group Risk Profile”
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That the process accords with the Page 44 – This process “accords with the Internal
guidance (CC06 & Turnbull) Control Guidance for directors ion the Code
produced by the Financial Reporting Council”
Page 46 “the Group’s system of internal control
which are in compliance with the Turnbull Guidance
2005”
Formally acknowledge the boards Page 43 of the M&S’s annual report –
responsibility for internal control and Accountability and Audit 2nd paragraph – “the Board
review has overall responsibility…”
An explanation that the system manages Page 43 of the M&S’s annual report –
but does not eliminate risk Accountability and Audit 3rd paragraph – “Because
of the limitations that are inherent…”
A summary of the process for reviewing Page 46 of M&S’s annual report
internal controls
Information about material weaknesses There is no information about material weaknesses
presumably because none have been found.
Chapter 9
Merits
(a) Relativism highlights differences in cultural beliefs; for example all cultures may say that it is
wrong to kill innocents, but different cultures may have different beliefs about who innocents
actually are.
(b) Whereas differing absolutist beliefs tend to result in moral conflict between people; relativist ethics
should act to resolve such conflicts.
(c) In the modern business environment where the global economy prevails business is conducted in
many different countries (and cultures), adopting a relativist approach presumes more flexibility
and thereby greater success.
(d) Relativism highlights our cognitive bias in observing with our senses (we see only what we know
and understand) and our notational bias (what we measure without using our senses is subject to
the bias of the measurement methods used).
Demerits
(a) Strong relativism is a based on a fundamental contradiction; the statement that ‘All statements are
relative’ is itself an absolute, non-relative statement. However, it is possible to argue that some
universal truths exist, but deny other supposedly objective truths.
(b) A common criticism of relativism is that it leads to a philosophy of ‘anything goes’, denying the
existence of morality and permitting activities that are harmful to others.
(c) Some critics have argued for the existence of natural absolute moral laws.
(d) Ideas such as objectivity and final truth do have value.
(e) If it’s valid to say that everyone’s differing opinions are right, then it’s equally valid to say that
everyone’s differing opinions are wrong. This can lead to immense confusion and disagreement,
and breakdown in communication and trust.
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 Age
 Experience
 Size of organisation
 Backgrounds
 Education
 Nationalities
 Religions
 Market stakeholders
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Using the AAA model:
1 What are the facts?
The facts as we know it from the scenario are as follows:
– Edwards has knowingly broken the rules
– Misappropriation of shareholders funds has occurred
– Control systems (budgeting and expense checking) have failed
2 What are the ethical issues?
There are a range of ethical issues which could be considered here:
– Should Pearson be punished even if he has acted for the greater good of the
organisation? (utilitarianism)
– Does Edwards need to be ‘seen’ to do the right thing?
– Should Edwards conceal the issue from key stakeholders regardless of how he chooses to
act? (Transparency issues)
– If the behaviour is widespread, should Edwards be treated as a scapegoat?
– Should loyalty affect a decision?
3 What are the norms, principles and values?
Normal business practice might be to:
– Recognise that he has acted within accepted norms
– Punish stealing/rule breaking whatever the circumstances
– Deal with any tricky situation in house if there is no legal reason to disclose
– Consider the wider impact of a rash decision i.e. – he is a key member of the team and so
sacking him could make the situation worse
4 What are the alternative courses of action?
Options include:
– Sack Edwards
– Suspend pending further investigation
– Interview him and accept his version
– Investigate the extent of the losses before deciding what to do
– Verbal warning but ask him to continue to work with client
– Demote/remove authority
– Keep in position but reduce authorisation limits
– Do nothing
FOR EACH OPTION YOU WOULD NEED TO BE ABLE TO EXPLAIN THE CONSEQUENCES (i.e the
impact the options would have on stakeholders) e.g. the IA department, the bank, the rest of the sales
team.
This would be step 6 of the AAA model
5. and 7. What is the best course of action and what is the decision?
The final section of an answer should include a justification of which action you would take, and why you
would take it. You could also enhance your justification by relating it to appropriate ethical theory.
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Tucker’s 5 question model

Based on a solution which suggests that the best action would be to discipline Edwards internally but
leave him in his role to continue to develop the business with the client:
Is the decision profitable?
YES –Pearson knows the business, the client and the systems. He has not stolen for personal gain, so
shows commitment to the organisation and will continue to do so.
Is the decision legal?
YES – Pearson has bent the company rules but has not acted broken any laws. If he has the paperwork
to prove that he has not taken any money for his own gain, the company can deal with the situation as it
sees fit, and in the best interests of the shareholders
Is the decision fair and equitable?
To whom? Stakeholders or mainly shareholders?
Probably yes as the company will not lose a key client. Some stakeholders such as the IA department will
have to be consulted.
Is the decision right?
This is the most ethical question, and raises the issue of doing the right thing out of a sense of duty
(deontology) or acting based on outcome (teleology). In this case if no-one has been harmed then the
decision to retain him is right.
Is the decision sustainable?
Does the decision allow the business to continue?
This is a problem potentially, as any decision about a major event sets a precedent. If control systems are
changed as a result of this problem, and systems are improved then potentially the business can
continue. Financial sustainability is improved if the deal is won.
Conclusion
The decision appears to be acceptable.
NB. IN AN EXAM QUESTION OF THIS NATURE YOU WILL NEED TO SHOW THAT YOU CAN ARGUE
A CASE AND JUSTIFY YOUR POINT OF VIEW. THERE IS NO ONE RIGHT ANSWER SO YOURS
MIGHT BE VERY DIFFERENT TO THIS
Chapter 10
(a) Clear commitment from management
(b) Recruitment and selection policies and procedures
(c) Careful induction
(d) Staff training and workshops
(e) Terms contained with contracts of employment
(f) Objectives setting (Management by Objectives)
(g) Staff appraisal and reporting systems
(h) Remuneration and reward schemes
(i) Sanctions for clear breach of ethical rules
(j) Ethical (internal) audit
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Benefits Development
Guidance Consultation
Clarity Base on existing codes (eg ACCA)
Replace/reduce rules Provide examples
Communication to stakeholders Test on employees
Chapter 11
Business case for CSR Business case against CSR
– Builds reputation – Organisations are responsible to shareholders
– Attracts investors/employees/customers  CSR is 'stealing' their funds
– Can be a source of competitive advantage – Benefits do not outweigh costs
– Can tie into branding – Time consuming
– Pre-empts legislation – Seen as PR only (most stakeholders will be
– Unregulated therefore easy to incorporate cynical)

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

– Good PR
– Credibility
– Receive advice and support
END OF ANSWERS TO LECTURE EXAMPLES

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Question and
Answer bank
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Index to Question and
Answer bank
Page
Questions Answers
1 ...................................................................................................................................... Core principles........... 189 193
2 ...........................................................................................................Frameworks, codes and systems........ ..189 194
3 ..................................................................................................... ………….Non-executive directors............... 189 196
4 ............................................................................................................................. …..Board of directors.......... 190 198
5 .............................................................................................................................................…Caius plc.......... 190 199
6 ...........................................................................................................................................Types of risk.......... 190 200
7 ..................................................................................................................................COSO Framework.......... 190 203
8 ......................................................................................................................................... Audit process.......... 191 204
9 ............................................................................................................................ Ethical considerations.......... 191 205
10 ........................................................................................................................... Corporate citizenship.......... 192 207
11………………………………………………………………………………………………….Franks & Fisher …… .192 209
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13: QUESTION AND ANSWER BANK
Questions
1 Core principles
The core principles of corporate governance are: integrity, fairness, judgement, independence,
openness, probity, responsibility, accountability and reputation.
Required
(a) Define each of the core principles of corporate governance in your own words. (9 marks)
(b) Explain the importance of each of the principles in the context of corporate governance.(16 marks)
(Total = 25 marks)
2 Frameworks, codes and systems

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

The board of Franks & Fisher, a large manufacturing company, decided to set up an internal control and
audit function. The proposal was to appoint an internal auditor at mid-management level and also to
establish a board level internal audit committee made up mainly of non-executive directors.
The initiative to do so was driven by a recent period of rapid growth. The company had taken on many
more activities as a result of growth in its product range. The board decided that the increased size and
complexity of its operations created the need for greater control over internal activities and that an internal
audit function was a good way forward. The need was highlighted by a recent event where internal quality
standards were not enforced, resulting in the stoppage of a production line for several hours. The
production director angrily described the stoppage as 'entirely avoidable' and the finance director, Jason
Kumas, said that the stoppage had been very costly.
Mr Kumas said that there were problems with internal control in a number of areas of the company's
operations and that there was a great need for internal audit. He said that as the head of the company's
accounting and finance function, the new internal auditor should report to him. The reasons for this, he
said, were because as an accountant, he was already familiar with auditing procedure and the fact that he
already had information on budgets and other 'control' information that the internal auditor would need.
It was decided that the new internal auditor needed to be a person of some experience and with enough
personality not to be intimidated nor diverted by other department heads who might find the internal
audits an inconvenience. One debate the board had was whether it would be better to recruit to the
position from inside or outside the company. A second argument was over the limits of authority that the
internal auditor might be given. It was pointed out that while the board considered the role of internal audit
to be very important, it didn't want it to interfere with the activities of other departments to the point where
their operational effectiveness was reduced.
Required
(a) Explain, with reference to the case, the factors that are typically considered when deciding to
establish internal audit in an organisation. (10 marks)
(b) Construct the argument in favour of appointing the new internal auditor from outside the company
rather than promoting internally. (6 marks)
(c) Critically evaluate Mr Kumas's belief that the internal auditor should report to him as finance
director. (4 marks)
(d) Define 'objectivity' and describe characteristics that might demonstrate an internal auditor's
professional objectivity. (5 marks)
(Total = 25 marks)
ENDOF
END OFQUESTION
ANSWER BANK
BANK
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Answers
1 Core principles
Integrity means being honest and straightforward. It suggests a wholeness which could imply a
characteristic that is as important to maintain in ones personal life as in ones professional or business
dealings.
In the context of corporate governance, corporations and directors are expected to act with integrity
towards shareholders and other stakeholders. Directors sometimes seek to defend their actions by
claiming that they acted with integrity. This can be taken to mean that they are acting in the best interests
of others rather than from personal self interest.
Fairness means considering the views and claims of all those with a reasonable claim against the
company.
Fairness is important in corporate governance because directors have to balance the competing claims of
different stakeholder groups. While directors have a legal fiduciary duty towards the shareholders of the
company they have a moral and social obligation to other groups.
Judgement means demonstrating effective decision making.
Directors are expected to do their best to protect their shareholders investment and indeed to generate a
return on that investment. They do so by making sound strategic decisions that will be profitable for the
company in the long term.
Independence in the context of both directors and auditors means having minimal links to the company.
It is important to have independent directors represented on the board in order to maintain objectivity in
strategic decision making and in scrutinising the performance of the company and their fellow directors.
This means that investors can be confident that the decision making process is not unduly influenced by
self interest.
Openness or transparency means disclosing information that people outside the organisation can rely on.
Openness is important in terms of reporting performance (financial and non-financial) so that investors
and other interested parties can make informed decisions. It is also important in terms of the procedures
that a company adopts so for example it is more transparent and consequently fairer to ask independent
directors to nominate new board members through an agreed robust process than to ask shareholders
with a significant holding to nominate their own candidate.
Probity means honesty (from the latin word for honest, probus) but it also signifies virtue and integrity. In
particular it is mentioned as a characteristic important for those business dealings which are not covered
by legal obligations.
In the context of corporate governance it is establishing the need to go beyond contractual and legal
obligations to deal fairly and honestly and establishing wider moral obligations. In the context of risk
management probity risk is defined as the risk that the company won’t “do the right thing”.
Responsibility means acknowledging and seeking to remedy problems. There is an suggestion that it is
the imposition of a wider obligation than that imposed by law.
In the context of corporate governance one might take on wider responsibility through acknowledging
ones obligations to stakeholders other than just the shareholders or alternatively by increasing ones
obligations towards shareholders.
Accountability means an obligation to explain the outcome of ones actions.
In the context of corporate governance directors have to make account to the shareholders to explain
what they have done with their investment. They have to declare whether they have made profits or
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losses. Accountability could be considered in terms of the mandatory disclosures that are required from
companies and their directors.
Reputation means the perception that others have about you.
Investors price the shares of a company based on their perceptions of its future profitability, their
perceptions of its risk and their perceptions about the capabilities and characteristics of the directors. SO
the share price is entirely founded on perceptions. Events which damage the reputation of the company
will inevitably have an effect on share price.
Tutorial Note: In the real exam you should expect to have to define and explain the importance of one or
two of these principles. It is likely that there will be two marks available for a well explained definition of a
core principle. There could then be anything from 2 to 10 marks for an explanation of its importance.
Often there are clues in the scenario as to the importance of a core principle and often there are marks
available for applying the principle to the facts of the scenario.
2 Frameworks, codes and systems

(a) In recent years a number of factors have influenced the introduction of a variety of frameworks,
codes and systems of corporate governance throughout the world. The factors are discussed
below:
(i) One of the factors giving rise to the pressure for better corporate governance was concern
that some large companies were not providing fair accounts, with profits and asset values
being, in some cases, artificially inflated. In the late 1980s there were a number of well-
publicised corporate failures, which were unexpected, as the audited financial statements
had given no indication of such problems. There was a view that the external auditors
were unable to perform their function properly perhaps because a powerful or
unscrupulous chief executive could keep information away from them.
(ii) There have also been criticisms that the external auditors of a company are not always as
independent as they should be or as the shareholders believe them to be. This was often
the case due to the fact that the auditors relied on the company not just for the audit fee
but also for substantial fees for other consultancy work throughout the year.
(iii) Allied to these concerns were concerns that some large companies were being run for the
benefit of the directors of the companies rather than for the shareholders. These concerns
raised questions about the conflict of interest between the board of directors and the
shareholders and there was particular concern about too much power being in the hands
of one individual or a small number of individuals. This was particularly the case where
one powerful individual held the posts of both chairman and chief executive and where
boards of directors lacked balance.
(iv) There was also an issue with directors' remuneration, which was often viewed, as
excessive whether the company was only performing no differently from an average
company or indeed was performing badly.
(v) In the light of many corporate failures, concern was also expressed about the board's
knowledge and handling of the risks that faced the business and of the adequacy of
internal control systems within companies.
(vi) As there was a trend towards global investment many large institutions, particularly in the
US and also in the UK, were seeking to invest substantial funds in companies in other
countries. In many instances there were concerns about the lack of shareholder rights and
of disregard for minority shareholders rights shown by major shareholders or the boards of
these companies.
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(b) In the UK the Principles of Good Governance have now been brought together in the voluntary
Combined Code.
This Code has stemmed from a number of other codes, reports and frameworks:
 The Cadbury Code on the financial aspects of corporate governance
 The Greenbury Committee report on directors' remuneration
 The Hampel Committee report on corporate governance
 The Turnbull report on internal control and financial reporting
 The Smith guidance on audit committees
 The Higgs review of the role and effectiveness of non-executive directors, followed by the
Tyson report on the recruitment and development of non-executive directors
The Financial Reporting Council published the latest version of the combined Code in 2006. The
main requirements of the Combined Code have attempted to address many of the concerns,
which led to these successive frameworks, codes and systems of corporate governance.
Here are some examples.
(i) The concerns regarding the board of directors and directors' powers are central to the
Combined Code. Every listed company should be headed by an effective board, which
should lead and control the company. The two key tasks at the top of every listed company
are the running of the board, and the executive responsibility of the running of the
company.
(ii) The board should include a balance of executive and non-executive directors (including
independent non-executives) such that no individual or small group of individuals can
dominate the board's decision making. It is recommended that non-executive directors
should comprise at least half the board.
(iii) There should be formal and transparent procedures for the appointment of new directors
to the board and all directors should be required to submit themselves for re-election at
regular intervals and at least every three years.
(iv) The level of remuneration paid to directors should be sufficient to attract and retain the
directors needed to run the company successfully but companies should avoid paying
more than is necessary for this purpose. A proportion of executive directors' remuneration
should be structured so as to link rewards to corporate and individual performance. The
board should set up a remuneration committee of independent non-executive directors
who will devise schemes of remuneration, which will be recommended to the board.
(v) The board should present balanced and understandable assessment of the company's
position and prospects. The directors should explain their responsibility for preparing the
accounts and there should be a statement from the auditors about their reporting
responsibilities.
(vi) The board should maintain a sound system of internal control to safeguard the
shareholders' investment and the company's assets. The directors should, at least
annually, conduct a review of the effectiveness of the systems of internal controls and
should report to the shareholders that they have done this. The review should cover all
controls including financial, operational and compliance controls and risk management.
Companies who do not have an internal audit function should from time to time review the
need for one.
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(vii) The board should establish formal and transparent arrangements for considering how they
should apply the financial reporting and internal control principles and for maintaining an
appropriate relationship with the company's auditors. The audit committee should be made
up of at least three non-executive directors and this committee's duties include keeping
under review the scope and results of the audit and its cost effectiveness and the
independence and objectivity of the auditors. Where the auditors also supply a substantial
volume of non-audit services to the company the committee should keep the nature and
extent of such services under review.
(viii) Companies should be ready to enter into a dialogue with institutional shareholders based
on the mutual understanding of objectives. Boards should use the AGM to communicate
with private investors and to encourage their participation.
(a) Non-independent NEDs
A NED is not independent if he or she is on the board representing the interests of a major
shareholder, because the views given by the director will be made in the best interests of that
shareholder. Similarly it is debateable whether a director is independent when he or she has a
close relationship with the company or any other executive director. For example a former chief
executive of the company might be given a non-executive role after retirement. He would not be
independent.
Independent NEDs
In contrast an independent NED is a person who has no connection with the company other than
as a non-executive director, and who should be able to give an independent opinion on the affairs
of the company, without influence form any other director or shareholder.
(b) Conflicts of interest
A potential conflict of interest occurs when the executive director or senior management of a
company might be inclined to take decisions that would not be in the interests of the company’s
shareholders. Although there are several areas where a conflict of interest could arise, the major
problem areas are those of remuneration of the directors and senior managers, financial reporting
and nominations of new board members.
Remuneration
If executive directors are allowed to decide their own remuneration, they could be inclined to pay
themselves as much as possible, without having to hold themselves to account or justify their high
pay. Where incentive schemes are in place, there is a risk that incentive schemes devised by the
executive directors for themselves will be linked to achieving performance targets that are not
necessarily in the shareholders’ interests. For example rewarding directors with a bonus for
achieving profit growth is of no value to shareholders if the result is higher business risk and a
lower share price.
Remuneration Committee
Corporate governance in may countries, such as the UK’s Combined Code, calls for a
remuneration committee of the board to be established to decide on directors’ pay, including
incentive schemes, and for this committee to comprise at least three, or in the case of smaller
companies two, members, who should all be independent non-executive directors.
The remuneration committee should have delegated responsibility for setting remuneration for all
executive directors and the chairman, including pension rights and any compensation payments.
The committee should also recommend and monitor the level and structure of remuneration for
senior management. The NEDs should in principle, be able to devise fair remuneration packages
that include an incentive element, in which the performance targets bring the objectives of the
executive directors more into line with those of he shareholders.
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Financial Reporting
A second potential area for conflict of interest is financial reporting. The executive directors might
be tempted to window dress the results if the company, in order to present the financial results in
a way that reflects better on themselves and their achievements.
Audit Committee
There should be an audit committee of the board, consisting of non-executive directors, whose
task should be to consider issues relating to financial reporting and financial control systems. This
committee should be responsible for maintaining regular liaison with the external auditors. The
Combined Code says that the audit committee should comprise at least three or in the case of
small companies, two members, who should all be independent NEDs. The board should satisfy
itself that at least one member of the audit committee has recent and relevant financial
experience.
Nominations to the board
A third potential area for conflict is nominations of new board members. A powerful chairman or
chief executive could be tempted to appoint their supporters or ‘yes’ men to the board, and so
strengthen their position on the board. The combined code recommends that there should be a
nominations committee of the board manned by NEDs.
Other areas
Other areas of potential conflict of interest can be identified, such as succession planning, and the
board’s decisions on making acquisitions or in preparing defences against a takeover bid. In each
of these areas NEDs should be able to provide a counter balance to the self –interested views f
executive directors.
(c) Share Payments
In many companies, NEDs receive a fixed cash payment for their services, without any incentives.
However some companies pay their NEDs in shares.
They would argue that the more equity the NEDs hold, the more likely they will be to look at
issues from the point of view of the shareholders. There is a risk that a NED holding shares could
be more concerned with short-term movements in the share price and the opportunity of making a
short term profit from selling their shares. However, a suitable precaution against this could be to
obtain the agreement of a NED not to sell his or her shares until after leaving the board.
Share Options
The argument that NEDs should be rewarded with share options is more contentious, but it has
been widely practised in the UK and is even more common in the US. The argument against
rewarding NEDs with share options is that this form of remuneration could align the interests of
the NEDs more closely with the executive directors, who also hold share options. NEDs should
give independent advice, and it can be argued that it is therefore not appropriate to incentivise
them in the same way as the executives.
The Combined Code points out that holding of share options could be relevant to the
determination of a non-executive director’s independence. It states that remuneration for non-
executive directors should not include share options. If, exceptionally, options are granted,
shareholder approval should be sought in advance and any share acquired by exercise of the
options should be held until at least one year after the non-executive director leaves the board.
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4 Board of directors
REPORT
To: Board of directors
From: Consultant
Date: December X4
Subject: Board of directors and committees
Chairman
The Combined Code on Corporate Governance states that there should be a clear division between the
chief executive of the company, who has executive responsibility for running the company's business,
and the chairman of the board of directors who is responsible for running the board.
The main roles of the chairman should be to:
 Run the board and set its agenda
 Ensure that all members of the board receive accurate, timely and relevant information
 Encourage the active participation of all members of the board
 Ensure that adequate time is allowed for the discussion of complex or contentious issues
 Ensure that the performance of individual directors and the board as a whole, together with its
committees, are evaluated at least once a year
 Ensure that there is a suitable induction programme for new directors
 Identify any development needs of individual directors
 Ensure effective communication with shareholders and major investors
Non-executive directors
The board should include a balance of executive and non-executive directors and the role of the non-
executive directors should include the following elements.
 Being independent in judgement and possessing an inquiring mind
 Being well informed about the company and the environment within which it operates
 Having a strong command of issues relevant to the business
 Constructively challenging proposals on strategy and helping to develop such proposals
 Scrutinising the performance of management and monitoring reports on that performance
 Ensuring that sufficient, accurate, clear and timely information is provided to the board in advance
of meetings
 Satisfying themselves of the integrity of the financial controls and information
 Satisfying themselves that the risk management systems are robust and defensible
 Determining appropriate levels of remuneration for executive directors
 Playing an important role in the appointment and removal of directors and in succession planning
 Understanding the views of major investors
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Remuneration committee
The remuneration committee should be made up of non-executive directors as it is responsible for setting
the remuneration for all executive directors, the chairman and the company secretary.
As well as this basic responsibility the remuneration committee has other duties.
 To determine targets for any performance related pay schemes
 To determine the policy for pension arrangements for executive directors
 To ensure that any contractual terms on termination and payments made are fair both to the
company and the individual
 To determine the total individual remuneration package for each executive director including
bonuses, incentive payments and share options
 To agree the policy for authorising expense claims from the chief executive and chairman
 To ensure that all required disclosures for remuneration matters are fulfilled
Nomination committee
The Combined Code requires that there should be formal, rigorous and transparent procedures for the
appointment of new directors to the board. The nomination committee, made up of a majority of
independent non-executive directors, can carry out this role. The main duties of this committee are to:
 Evaluate the current balance of skills, knowledge and experience on the board and with this in
mind to prepare a description of the role and capabilities required for a particular appointment
 Consider candidates from a wide range of backgrounds
 Review the time required from a non-executive director annually
 Assess whether the non-executive directors are spending enough time to fulfil their duties
 Consider succession planning and in particular what skills and expertise are needed, given the
challenges and opportunities facing the company
 Prepare a statement for the annual report including the process used for appointments and
explains if external advice or advertising has been used. The statement should also state the
membership of the committee, and the number of committee meetings attended over the year.
5 Caius plc
Tutor's note. A good guideline for this type of question would be the key points relating to directors
remuneration from the Combined Code. This will give you most of the key areas that require to be
discussed.
To: Board of Directors of Caius plc

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

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

 The type of industries/markets within which the business operates – the extent to which sales are
vulnerable to changes in fashion, technology etc
 The state of the economy
 The actions of competitors
 The actions of unions or impact of government legislation
 The stage in a product's life cycle, with high risks in the introductory and declining stages
 The dependence upon inputs with fluctuating prices, e.g. wheat, oil etc
 The level of operating gearing – the proportion of fixed costs in total costs – the higher the level,
the greater sales need to be made to break even
 The flexibility of production processes to adapt to different specifications or products
Trading risks
Both domestic and international traders will face trading risks, although those faced by the latter will
generally be greater due to the increased distances and times involved. The types of trading risk include:
 Physical risk – the risk of goods being lost or stolen in transit, or the documents accompanying the
goods going astray
 Credit risk – the possibility of payment default by the customer. This is discussed further below.
 Trade risk – the risk of the customer refusing to accept the goods on delivery (due to sub-
standard/ inappropriate goods or other reasons), or the cancellation of the order in transit
 Liquidity risk – the inability to finance the credit
Cultural, country and political risk
Where a business trades with, or invests in, a foreign country cultural risk is introduced by the existence
of different customs, laws and language. Communication between parties can be hindered, and potential
deals put into jeopardy by ignorance of the expected manner in which such transactions should be
conducted. Country risk is the risk associated with undertaking transactions with, or holding assets in, a
particular country. Sources of risk might be political, economic or regulatory instability affecting overseas
taxation, repatriation of profits, nationalisation, currency instability etc. Political risk is the risk that political
action (exchange controls, tax changes, pricing regulations etc) will affect the position and value of a
company.
Currency risk
Currency risk is the possibility of loss or gain due to future changes in exchange rates. When a firm
trades with an overseas supplier or customer, and the invoice is in the overseas currency, it will expose
itself to exchange rate or currency risk. Movements in the foreign exchange rates will create risk in the
settlement of the debt – i.e. the final amount payable/receivable in the home currency will be uncertain at
the time of entering into the transaction.
Investment in a foreign country or borrowing in a foreign currency will also carry this risk.
Interest rate risk
As with foreign exchange rates, future interest rates cannot be easily predicted. If a firm has a significant
amount of variable (floating)-rate debt, interest rate movements will give rise to uncertainty about the cost
of servicing this debt.
Conversely, if a company uses a lot of fixed-rate debt, it will lose out if interest rates begin to fall.
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Technological risk
All businesses depend to some extent on technology, either in the support of its business activities (e.g.
the computers used by the accounts, stores and treasury departments), or more directly in its production
or marketing activities.
As technology evolves and develops, firms can find themselves using out of date equipment and
marketing methods, which may leave them at a competitive disadvantage. Products in a high-tech
industry have very short life cycles, and a firm must recognise and plan for continual replacement and
upgrading of products if it is not to lose market share.
Fraud risk
All businesses run the risk of loss through the fraudulent activities of its employees, including
management.
How the codes of corporate governance can assist in managing the risks
Corporate governance is concerned with the control and influence exerted over a company's operations
and its employees by the decisions of top management, usually the board of directors.
The codes of corporate governance are guidelines and recommendations developed over a number of
years by various committees and researchers (Cadbury, Greenbury, Hampel, Higgs, and Smith) and now
incorporated in the UK into the Combined Code published in July 2003 by the Financial Reporting
Council.
A significant element of the Code is concerned with the way internal controls are implemented and
reviewed in order that such risks as those outlined above would be managed. The code includes the
Turnbull report (Internal Control: Guidance for Directors on the Combined Code).
The Turnbull report included recommendations that:
 Management should identify and evaluate the risks to which they will be exposed in the
achievement of their corporate objectives. These will include both the traditional areas of risk
discussed above, but also those increasingly arising from intangible assets, such as reputation
and branding.
 Risk control should be embedded in the culture and processes of the business, rather than
being the subject of a completely separate management system. Each person in the organisation
should be aware of, and manage, the significant risks related to the tasks they perform.
 Directors should continually review and monitor risk control issues. It should regularly review
reports on internal control from line managers and, where appropriate, from internal auditors
and other specialists.
 Regular discussion of risk and control issues at board meetings should be encouraged.
 Risk analysis and assessment should form part of the evaluation of every major capital
investment or proposed acquisition.
 Financial risk analysis will very much depend upon commercial judgement, but the following
questions may be used as a framework for the assessment of their impact on company value:
– What is the effect on present and future cash flow?
– What is the effect on the underlying present and future profitability of the business?
– What is the effect on the underlying present and future liquidity and value of assets
employed in the business?
– What is the effect on the present and future debt structure of the business?
– The relative likelihood of the events giving rise to the risks also needs to be assessed.
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– This can then be combined with the level of impact to prioritise the risks.
– High impact, high likelihood immediate action required
– High impact, low likelihood contingency plan needed
– Low impact, high likelihood consider taking action
– Low impact, low likelihood no action now, but review periodically
Once risks have been prioritised, management needs to decide what to do about them, and how they can
be managed and monitored in the future.
Strategies for management of a given risk include:
 Acceptance
 Transfer e.g. by insurance or joint venture
 Elimination by hedging, or ceasing the activity/operation
 Control by building in operational controls
7 COSO Framework
(a) Avoidance means exiting the activities that give rise to risk. Risk avoidance may involve
disposing of a business unit, product line, or geographical segment, or simply deciding not to
engage in new initiatives/activities that would give rise to the risks.
If reduction is the chosen response then action is taken to reduce risk likelihood or impact, or
both. This typically involves any of a large number of everyday business decisions, including
diversifying product offerings, establishing operational limits for activities, establishing more
effective business processes, enhancing management involvement in decision making and
monitoring, rebalancing the entity’s portfolio of assets to reduce exposure to certain types of
losses, or reallocating capital among operating units.
Sharing entails reducing risk likelihood or impact by transferring or otherwise sharing a portion
of the risk. Common techniques include purchasing insurance products, engaging in hedging
transactions, entering into joint ventures or partnerships, sharing risk through contractual
agreements with customers, vendors, or other business partners, or outsourcing an activity.
If acceptance is the chosen response no action is taken to affect risk likelihood or impact: the risk
is accepted because it already conforms to the entity’s risk tolerances. The entity may have self-
insured against loss, or it may rely upon natural offsets within a portfolio.
(b) Control activities are the actions of people to implement policies, directly or through application of
technology, in such a way as to help ensure that management’s risk responses are carried out.
Many procedures are commonly performed by personnel at various organisational levels that
serve to enforce adherence to established action plans and to keep entities on track toward
achieving their objectives.
Here are some examples.
 Top-level reviews – Senior management reviews actual performance versus budgets,
forecasts, prior periods, and competitors. Major initiatives, such as marketing thrusts,
improved production processes, and cost containment or reduction programmes, are
tracked to measure the extent to which targets are being reached.
 Direct functional or activity management – Managers running functions or activities
review performance reports. For example, a manager responsible for a bank’s consumer
loans will review reports by branch, region, and loan type, checking summaries and
identifying trends, and relating results to macro-economic statistics and targets. Managers
will also focus on compliance issues, for example reviewing reports required by regulators
on new deposits over specified amounts.
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 Information processing – A variety of controls are performed to check accuracy,

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

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

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

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

Part of internal audit's work will be on the finance function for which Mr Kumas is responsible. If
Mr Kumas is in charge of internal audit as well, he may be able to ensure that internal audit
coverage of the finance function and his own work is not as rigorous as it should be, and may be
able to water down or suppress adverse audit findings.
Using Mr Kumas' help
Even if internal audit did not report to Mr Kumas, he would still have to supply them with the
budgets and other control information he has and generally provide assistance. However
internal auditors should not rely on him for audit knowledge as they should themselves possess
sufficient knowledge and experience to carry out their responsibilities effectively.
(d) Definition of objectivity
Objectivity means not letting bias, conflict or undue influence of others to override
professional or business judgements. It implies detachment and not letting personal feelings
intrude into professional judgements.
Demonstrating objectivity
Lack of favouritism
Internal auditors should not accept gifts nor undue favours from the departments that they are
auditing.
Fairness
Internal auditors should avoid the perception that they are out to 'hit' certain individuals or
departments. They should not take sides, not being influenced by office politics in determining
the work carried out and the reports given.
Not responding to intimidation
Internal auditors should choose which areas to audit based on their objectives and risk analysis,
and not be kept away from certain areas by aggressive managers. Internal audit should also
cover the whole management process and not just audit the operational areas.
Valid opinion
Internal auditors should aim to deliver a report that satisfies the needs of their principal (the audit
committee).This means producing a report based on all relevant factors rather than one
designed to please operational departments.
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END OF ANSWER BANK

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Appendix A: Pilot
paper questions and
answers
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14: APPENDIX A: PILOT PAPER QUESTIONS AND ANSWERS
Pilot paper
Paper P1
Governance, Risk and Ethics

Time allowed
Reading and planning: 15 minutes
Writing: 3 hours
This paper is divided into two sections:
Section A – This ONE question is compulsory and MUST be attempted
Section B – TWO questions ONLY to be attempted
Do NOT open this paper until instructed by the supervisor.
During reading and planning time only the question paper may be annotated. You must NOT write in your
answer booklet until instructed by the supervisor.
This question paper must not be removed from the examination hall.
Warning
The pilot paper cannot cover all of the syllabus nor can it include examples of every type of question that will be
included in the actual exam. You may see questions in the exam that you think are more difficult than any you
see in the pilot paper.
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SECTION A: This question is compulsory and MUST be

attempted
Question 1
Chemco is a well-established listed European chemical company involved in research into, and the production of,
a range of chemicals used in industries such as agrochemicals, oil and gas, paint, plastics and building materials.
A strategic priority recognised by the Chemco board some time ago was to increase its international presence as
a means of gaining international market share and servicing its increasingly geographically dispersed customer
base. The Chemco board, which operated as a unitary structure, identified JPX as a possible acquisition target
because of its good product ‘fit’ with Chemco and the fact that its geographical coverage would significantly
strengthen Chemco’s internationalisation strategy. Based outside Europe in a region of growth in the chemical
industry, JPX was seen by analysts as a good opportunity for Chemco, especially as JPX’s recent flotation had
provided potential access to a controlling shareholding through the regional stock market where JPX operated.
When the board of Chemco met to discuss the proposed acquisition of JPX, a number of issues were tabled for
discussion. Bill White, Chemco’s chief executive, had overseen the research process that had identified JPX as a
potential acquisition target. He was driving the process and wanted the Chemco board of directors to approve the
next move, which was to begin the valuation process with a view to making an offer to JPX’s shareholders. Bill
said that the strategic benefits of this acquisition was in increasing overseas market share and gaining
economies of scale.
While Chemco was a public company, JPX had been family owned and operated for most of its thirty-five year
history. Seventy-five percent of the share capital was floated on its own country’s stock exchange two years ago,
but Leena Sharif, Chemco’s company secretary, suggested that the corporate governance requirements in JPX’s
country were not as rigorous as in many parts of the world. She also suggested that the family business culture
was still present in JPX and pointed out that it operated a two-tier board with members of the family on the upper
tier. At the last annual general meeting, observers noticed that the JPX board, mainly consisting of family
members, had ‘dominated discussions’ and had discouraged the expression of views from the company’s
external shareholders. JPX had no non-executive directors and none of the board committee structure that many
listed companies like Chemco had in place. Bill reported that although JPX’s department heads were all
directors, they were not invited to attend board meetings when strategy and management monitoring issues were
being discussed. They were, he said, treated more like middle management by the upper tier of the JPX board
and that important views may not be being heard when devising strategy. Leena suggested that these features
made the JPX board’s upper tier less externally accountable and less likely to take advice when making
decisions. She said that board accountability was fundamental to public trust and that JPX’s board might do well
to recognise this, especially if the acquisition were to go ahead.
Chemco’s finance director, Susan Brown advised caution over the whole acquisition proposal. She saw the
proposal as being very risky. In addition to the uncertainties over exposure to foreign markets, she believed that
Chemco would also have difficulties with integrating JPX into the Chemco culture and structure. While Chemco
was fully compliant with corporate governance best practice, the country in which JPX was based had few
corporate governance requirements. Manprit Randhawa, Chemco’s operations director, asked Bill if he knew
anything about JPX’s risk exposure. Manprit suggested that the acquisition of JPX might expose Chemco to a
number of risks that could not only affect the success of the proposed acquisition but also, potentially, Chemco
itself. Bill replied that he would look at the risks in more detail if the Chemco board agreed to take the proposal
forward to its next stage.
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Finance director Susan Brown, had obtained the most recent annual report for JPX and highlighted what she
considered to be an interesting, but unexplained, comment about ‘negative local environmental impact’ in its
accounts. She asked chief executive Bill White if he could find out what the comment meant and whether JPX
had any plans to make provision for any environmental impact. Bill White was able to report, based on his
previous dealings with JPX, that it did not produce any voluntary environmental reporting. The Chemco board
broadly supported the idea of environmental reporting although company secretary Leena Sharif recently told Bill
White that she was unaware of the meaning of the terms ‘environmental footprint’ and ‘environmental reporting’
and so couldn’t say whether she was supportive or not. It was agreed, however, that relevant information on
JPX’s environmental performance and risk would be necessary if the acquisition went ahead.
Required
(a) Evaluate JPX’s current corporate governance arrangements and explain why they are likely to be
considered inadequate by the Chemco board. (10 marks)
(b) Manprit suggested that the acquisition of JPX might expose Chemco to a number of risks. Illustrating from
the case as required, identify the risks that Chemco might incur in acquiring JPX and explain how risk can
be assessed. (15 marks)
(c) Construct the case for JPX adopting a unitary board structure after the proposed acquisition. Your answer
should include an explanation of the advantages of unitary boards and a convincing case FOR the JPX
board changing to a unitary structure. (10 marks)
(d) Explain FOUR roles of non-executive directors (NEDs) and assess the specific contributions that NEDs
could make to improve the governance of the JPX board. (7 marks)
(e) Write a memo to Leena Sharif defining ‘environmental footprint’ and briefly explaining the importance of
environmental reporting for JPX. (8 marks)
(Total = 50 marks)
Question 1
This question is an example of what’s likely to be a common type of question on this paper, evaluate the
inadequacies and suggest improvements. However parts (c) and (d) are quite specific about which areas you
have to discuss, indicating you need a detailed knowledge of corporate governance issues to underpin your
discussions. The question part on risk is mixed in with this discussion on corporate governance, indicating how
different parts of the syllabus will be combined in the case study question.
This question covers material from a number of chapters, and you can expect Question 1 to be drawn from areas
covered across the whole of your Study Text.
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Section B: TWO questions ONLY to be attempted
Question 2
In a recent case, it emerged that Frank Finn, a sales director at ABC Co, had been awarded a substantial over-
inflation annual basic pay award with no apparent link to performance. When a major institutional shareholder,
Swanland Investments, looked into the issue, it emerged that Mr Finn had a cross directorship with Joe Ng, an
executive director of DEF Co. Mr Ng was a non-executive director of ABC and chairman of its remunerations
committee. Swanland Investments argued at the annual general meeting that there was “a problem with the
independence” of Mr Ng and further, that Mr Finn’s remuneration package as a sales director was considered to
be poorly aligned to Swanland’s interests because it was too much weighted by basic pay and contained
inadequate levels of incentive.
Swanland Investments proposed that the composition of Mr Finn’s remuneration package be reconsidered by the
remunerations committee and that Mr Ng should not be present during the discussion. Another of the larger
institutional shareholders, Hanoi House, objected to this, proposing instead that Mr Ng and Mr Finn both resign
from their respective non-executive directorships as there was “clear evidence of malpractice”. Swanland
considered this too radical a step, as Mr Ng’s input was, in its opinion, valuable on ABC’s board.
Required
(a) Explain FOUR roles of a remuneration committee and how the cross directorship undermines these roles
at ABC Co. (12 marks)
(b) Swanland Investments believed Mr Finn’s remuneration package to be ‘poorly aligned’ to its interests.
With reference to the different components of a director’s remuneration package, explain how Mr Finn’s
remuneration might be more aligned to shareholders’ interests at ABC Co.
(8 marks)
(c) Evaluate the proposal from Hanoi House that both Mr Ng and Mr Finn be required to resign from their
respective non-executive positions. (5 marks)
(Total = 25 marks)
Question 2
This question has some similiarities to Question 1, requiring knowledge of specific areas of good corporate
governance practice and application of that knowledge to identify weaknesses and recommend improvements.
Ethics part (c) is only worth 5 marks; you may well encounter more complex ethical situations requiring
discussion worth more marks.
Chapter 3 of your Study Text thoroughly covers the issues involved in this question.
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Question 3
At a recent conference on corporate social responsibility, one speaker (Professor Cheung) argued that
professional codes of ethics for accountants were not as useful as some have claimed because:
“they assume professional accountants to be rules-driven, when in fact most professionals are more driven by
principles that guide and underpin all aspects of professional behaviour, including professional ethics.”
When quizzed from the audience about his views on the usefulness of professional codes of ethics, Professor
Cheung suggested that the costs of writing, implementing, disseminating and monitoring ethical codes
outweighed their usefulness. He said that as long as professional accountants personally observe the highest
values of probity and integrity then there is no need for detailed codes of ethics.
Required
(a) Critically evaluate Professor Cheung’s views on codes of professional ethics. Use examples of ethical
codes, where appropriate, to illustrate your answer. (12 marks)
(b) With reference to Professor Cheung’s comments, explain what is meant by ‘integrity’ and assess its
importance as an underlying principle in corporate governance. (7 marks)
(c) Explain and contrast a deontological with a consequentialist based approach to business ethics.
(6 marks)
(Total = 25 marks)
Question 3
More an essay than a scenario-based question, but a clear illustration that you will be expected to discuss ethical
theory without necessarily having to apply it to a practical scenario.
Chapter 11 of your Study Text covers the areas you need to discuss in this question.
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Question 4
As part of a review of its internal control systems, the board of FF co, a large textiles company, has sought your
advice as a senior accountant in the company.
FF’s stated objective has always been to adopt the highest standards of internal control because it believes that
by doing so it will not only provide shareholders with confidence in its governance but also enhance its overall
reputation with all stakeholders. In recent years, however, FF’s reputation for internal control has been damaged
somewhat by a qualified audit statement last year (over issues of compliance with financial standards) and an
unfortunate internal incident the year prior to that. This incident concerned an employee, Miss Osula, expressing
concern about the compliance of one of the company’s products with an international standard on fire safety. She
raised the issue with her immediate manager but he said, according to Miss Osula, that it wasn’t his job to report
her concerns to senior management. When she failed to obtain a response herself from senior management, she
decided to report the lack of compliance to the press. This significantly embarrassed the company and led to a
substantial deterioration in FF’s reputation.
The specifics of the above case concerned a fabric produced by FF Co, which, in order to comply with an
international fire safety standard, was required to resist fire for ten minutes when in contact with a direct flame.
According to Miss Osula, who was a member of the quality control staff, FF was allowing material rated at only
five minutes' fire resistance to be sold labelled as ten-minute rated. In her statement to the press, Miss Osula
said that there was a culture of carelessness in FF and that this was only one example of the way the company
approached issues such as international fire safety standards.
Required
(a) Describe how the internal control systems at FF Co differ from a ‘sound’ system of internal control, such
as that set out in the Turnbull guidance, for example. (10 marks)
(b) Define ‘reputation risk’ and evaluate the potential effects of FF’s poor reputation on its financial situation.
(8 marks)
(c) Explain, with reference to FF as appropriate, the ethical responsibilities of a professional accountant both
as an employee and as a professional. (7 marks)
(Total = 25 marks)
Question 4
An illustration that Section B questions may cover topics from across the syllabus, even though there isn’t the
emphasis that there is for Section A questions on linking those different areas. Again part (a) is an identify the
problems requirement, although here you aren’t expected to recommend improvements in detail. Part (b)
illustrates that you might be asked questions about a specific risk rather than be expected to cover the range of
key risks that an organisation faces.
Chapters 4, 6 and 11 of your Study Text between them deal with the issues you need to include.
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END OF APPENDIX A
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Appendix B:
Information about
M&S
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15: APPENDIX B: INFORMATION ABOUT M&S
Background information and report extracts for Marks

and Spencer plc
Background information
Marks and Spencer is an iconic British retailer, one of the best known names on the British high street. In its
2008 annual report the company reported group sales of £9,022 million from its 622 UK stores and 278 overseas
stores.
The company sells clothing, food and furniture.
Brief History
1880s and 1890s: Having started trading from a market stall in Leeds the founder Michael Marks moved to
Manchester and in 1894 went into partnership with Tom Spencer.
1900s: Tom Spencer died in 1905 (although he had not been an active partner in the business for a while) and
Michael Marks in 1907. Michael was succeeded in the business by his son Simon, still only in his late teens.
1920s to 1950s: The business bought direct from manufacturers with whom it established good, if slightly
paternalistic relationships. There was a similar tone in the staff welfare introduced in the 1930s. In 1926 the
company went public although the family retained a high level of power.
1960s and 1970s: The charismatic Chairman Simon Marks died in 1964, succeeded by family member Israel
Seiff.
1980s and 1990s: Derek Rayner became the first Chairman from outside the founding families. He was
Chairman from 1984 to 1991 and oversaw the acquisition of the American company Brooks Brothers in 1988
(subsequently sold in 2001). He took steps to secure his successor Richard Greenbury by appointing him CEO
in 1988. Richard Greenbury was Chairman (and CEO) until 1999. In 1998 M&S was the first British retailer to
make pre-tax profits of more than £1billion.
2000s: Following Richard Greenbury’s departure the company suffered a slump in its fortunes. There were
problems in the board room and shareholders were keen to know who to blame for the company’s problems.
Some believed the problems stemmed from decisions made by Richard Greenbury. The company finally started
accepting credit cards (other than its own store card) in early 2000. Stuart Rose the current CEO is credited
with turning the business around following his appointment in 2004.
2008: In early 2008 the business was criticised when it was announced that Stuart Rose was to be elevated to
the position of Executive Chairman (ie joint CEO/Chairman). There was also criticism after it emerged that he
had invested money in a business belonging to one of the non-executive directors. The company announced
disappointing trading results on 1 July 2008 and saw the value of its shares fall by nearly a quarter in one day (to
£2.40 having reached a peak of £7.66 in May 2007) although its profits after tax were an impressive £821 million
for the year to 29/3/08 (£660 million in the previous year).
2010: In May 2010 Marc Bolland replaced Stuart Rose as CEO. Stuart Rose remained as Chairman until a
successor, Robert Swanwell was appointed in January 2011. Marc Bolland is a NED at Manpower Inc and
Robert Swanwell serves as a NED at HMV Group plc.
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Extract from Marks and Spencer’s Annual Report 2011
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BPP House, Aldine Place, London W12 8AA

Tel: 0845 0751 100 (for orders within the UK)
Tel: +44 (0)20 8740 2211
Fax: +44 (0)20 8740 1184
www.bpp.com/learningmedia
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Governance, Risk and Ethics

For BPP Students Only

Q - I’ve seen a chapter once – how should I use the

I really like the fact that you can

Q - I haven’t received my log-on details, or have

Improving study material and removing errors

Checkpoint 1 Additional Study Guidance and Progress Test 51

4 Internal control systems................................................................................................................................ 67

Checkpoint 2 Additional Study Guidance and Progress Test 111

9 Personal ethics........................................................................................................................................... 123

Checkpoint 3 Additional Study Guidance and Progress Test 157

12 Answers to Lecture Examples .................................................................................................................... 171

Introduction to Paper P1 Governance, Risk and Ethics

Overall aim of the syllabus

A Governance and responsibility

Links with other papers Professional

Online ethics module Governance, Risk Audit & Assurance

Taught Phase Aims

Achieving ACCA's Study Guide Outcomes

A Governance and responsibility

A1 The scope of governance Chapter 1

B Internal control and review

B1 Management control systems in corporate governance Chapter 4

C Identifying and assessing risk

C1 Risk and the risk management process Chapter 5 & 6

D1 Targeting and monitoring risk Chapters 7 & 8

E Professional ethics and values

E1 Ethical theories Chapter 9

Assessment methods and format of the exam

Format of the Exam Marks

Time pressure warning

Section reference in the Study Text

Key skills required to pass

Skill 1 – Effective use of reading time

Skill 2 – Accurate analysis of a question's requirements

B C Skill 3 – Planning a well structured answer

Skill 4 – Communication and presentation skills

Skill 5 – Time management

How have the syllabus learning outcomes been examined?

Scope of corporate governance

Theories Stakeholder Models

1 Definition of corporate governance

Lecture example 1 Exam skills

Qualities that ensure the Qualities that ensure honest

1.8 Judgement: Making decisions that enhance the organisation’s prosperity.

1.10 Openness: Disclosure, including voluntary disclosure of reliable information.

1.11 Probity: Truthful and not misleading.

1.12 Responsibility: Systematic correction of errors, failures or mismanagement.

1.13 Accountability: Answerable for the consequences of actions.

1.14 Reputation: Other people’s perception or expectations. A valuable asset of the

2 Corporate governance and agency theory

The agency problem

Lecture example 2 Exam standard question

The agency solution

Lecture example 3 Exam standard question

3 Transaction cost theory

(b) The probability of bad behaviour being discovered, and

4 Stakeholders in corporate governance

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

Stakeholder group Members

Minimal Effort Keep Informed

Keep Satisfied Key Players