Professional Documents
Culture Documents
EG 2022 (3rd Ed)
EG 2022 (3rd Ed)
ETHICS AND
GOVERNANCE
THIRD EDITION
Pdf_Folio:i
Published 2019 by John Wiley & Sons Australia, Ltd,
42 McDougall Street, Milton Qld 4064,
on behalf of CPA Australia Ltd,
ABN 64 008 392 452
First edition published January 2010, reprinted July 2010, revised January 2011, July 2011, reprinted January 2012,
July 2012, updated January 2013, reprinted July 2013, updated January 2014, reprinted July 2014, revised January 2015,
updated January 2016
Second edition published May 2018
Third edition published November 2019
© 2001–2019 CPA Australia Ltd (ABN 64 008 392 452). All rights reserved. This material is owned or licensed by CPA
Australia and is protected under Australian and international law. Except for personal and educational use in the CPA
Program, this material may not be reproduced or used in any other manner whatsoever without the express written
permission of CPA Australia. All reproduction requests should be made in writing and addressed to: Legal, CPA Australia,
Level 20, 28 Freshwater Place, Southbank, VIC 3006, or legal@cpaaustralia.com.au.
Edited and designed by John Wiley & Sons Australia, Ltd
Printed by Blue Star Print
ISBN 9780730381624
Authors
James Beck Managing Director, Effective Governance Pty Ltd
Courtney Clowes Director, KnowledgEquity
Craig Deegan Professor of Accounting, RMIT University
Patrick Gallagher Director, Governance Tax & Risk Pty Ltd
Alex Martin Manager Financial Policy, Australia and New Zealand Banking Group Ltd
Greg McLeod Senior Investigator, Australian Securities & Investments Commission
Tom Ravlic Consultant
Roger Simnett Professor, School of Accounting, University of New South Wales
Jennifer Tunny Senior Research Advisor, Effective Governance Pty Ltd
Advisory panel
James Beck (Effective Governance Pty Ltd)
Prof Thomas Clarke (University of Technology Sydney)
Dr Mary Dunkley (Swinburne University)
Alan Greenaway (Australian Pharmaceutical Industries)
Jennifer Lauber Patterson (Frontier Carbon Limited)
Mike Sewell (Clean Technology Innovation Centre)
Marcia O’Neill (Consultant)
Eva Tsahuridu (CPA Australia)
MODULE 2
Figures 2.1, 2.2, 2.3: © IFAC; Figure 2.4: © Table 1: The theoretical basis of the central ori-
entations of ethical leadership, from Eisenbeiss, SA 2012, ‘Re-thinking ethical leadership: An
interdisciplinary integrative approach’, The Leadership Quarterly, vol. 23, no. 5, pp. 791–808,
http://dx.doi.org/10.1016/j.leaqua.2012.03.001; Figure 2.6: © Sourced from the copyright owner,
Accounting Professional and Ethical Standards Board Limited (APESB) at November 2019. To ensure you
are aware of the latest information provided by APESB please visit www.apesb.org.au or contact APESB
directly; Figures 2.10, 2.11, Tables 2.2, 2.17: © CPA Australia; Tables 2.5, 2.6, 2.7, 2.9, 2.10, 2.12, 2.13,
2.14: © Sourced from the copyright owner, Accounting Professional and Ethical Standards Board Limited
(APESB) at November 2019. To ensure you are aware of the latest information provided by APESB
please visit www.apesb.org.au or contact APESB directly; Extracts: © Sourced from the copyright owner,
Accounting Professional and Ethical Standards Board Limited (APESB) at November 2019. To ensure
you are aware of the latest information provided by APESB please visit www.apesb.org.au or contact
APESB directly; © State of New South Wales Department of Premier and Cabinet 2019; © Christensen,
BA 1996, ‘Kidders theory of ethics’, Journal of the American Society of CLU & ChFC, 504, 29; © IFAC; ©
Commonwealth of Australia; © Supreme Court of Western Australia; © Australian Criminal Intelligence
Commission 2016; © Australian Securities & Investments Commission. Reproduced with permission.
MODULE 3
Figures 3.1, 3.4, Tables 3.1, 3.6, 3.7, 3.9: © CPA Australia; Figure 3.2: © This article was first published
by Thomson Reuters in the Corporate Governance framework, taken from Kiel, G & Nicholson, G et al.
2012, Directors at Work, Thomson Reuters, Sydney. For all subscription inquiries please phone, from
Australia: 1300 304 195, from Overseas: +61 2 8587 7980 or online at legal.thomsonreuters.com.au/search;
Figure 3.3: © Oxford University Press; Figure 3.5: © Copyright 2019 ASX Corporate Governance Council
Figure 3.6: © State of Victoria Victorian Public Sector Commission 2018; Table 3.5: © Bosch, H 1995,
Corporate Practices and Conduct, 3rd edn, Pitman, Melbourne, p. 9. Reproduced with permission;
Table 3.10: © Commonwealth of Australia 2019; Extracts: © United Nations Conference on Trade
and Development (UNCTD) 2006, ‘Guidance on Good Practices in Corporate Governance Disclosure’,
United Nations, pp. 3–4, accessed October 2015, http://unctad.org/en/docs/iteteb20063_en.pdf; © Copy-
right 2019 ASX Corporate Governance Council; © The UK Corporate Governance Code, Financial
Reporting Council 201. Reproduced with permission. Contains public sector information licensed under
the Open Government Licence v3.0; © State of New South Wales Department of Justice. For current
information go to www.justice.nsw.gov.au; © Jensen, M & Meckling, W 1976, ‘Theory of the firm:
Managerial behavior, agency costs and ownership structure’, Journal of Financial Economics, vol. 3, no. 4,
pp. 305–60; © Organisation for Economic Co-operation and Development; © Australian Shareholders
Association; © Commonwealth of Australia; © State of New South Wales Department of Justice. For
current information go to www.justice.nsw.gov.au; © Australian Securities & Investments Commission.
Reproduced with permission; © UK Financial Reporting Council; © Commonwealth of Australia 2018;
© John Halligan; © Commonwealth of Australia — Australian Public Service Commission APSC 2007,
Building Better Governance, Australian Government, accessed October 2015, www.apsc.gov.au/building-
better-governance; © Sourced from the Federal Register of Legislation at November 2019. For the latest
information on Australian Government law please go to www.legislation.gov.au.
Pdf_Folio:iii
ACKNOWLEDGEMENTS iii
MODULE 4
Figure 4.2: © Commonwealth of Australia 2018; Tables 4.3, 4.4, 4.6: © CPA Australia; Extracts:
© Kirkpatrick, G 2009, ‘The corporate governance lessons from the financial crisis’, OECD Journal:
Financial Market Trends, vol. 2009/1, accessed October 2015, www.oecd.org/daf/corporateaffairs/
corporategovernanceprinciples/42229620.pdf; © KPGM 2016; © ‘Penrice duo pass two-strike
spill’, Wen, P, The Age, 26/01/2013; © ‘Narev signals end to end CBA’s pay freeze’, Liondis,
G 2013, The Australian Financial Review, 19 August, accessed October 2019, www.afr.com;
© Australian Prudential Regulation Authority 2019; © Douglas McIntyre; © BHP Group Limited;
© ‘PwC, Centro pitch in for investor losses’, Harper, J, The Herald Sun, 11/05/2012; © Australian
Securities & Investments Commissions. Reproduced with Permission; © Parliament of Australia 2019;
© Australian Prudential Regulation Authority 2019; © IFAC; © Organisation for Economic Co-operation
and Development; © ‘Opaque charity sector under fire for accounting failures’,
Ferguson, A, The Australian Financial Review, 17/08/2015; © Commonwealth of Australia 2018;
© Fels, A 1999, ‘Compliance programs: The benefits for companies and their stakeholders’,
ACCC Journal, no. 24, pp. 14–18 © Commonwealth of Australia; © European Union, https://eur-
lex.europa.eu, 1998–2019; © United Nations Conference on Trade and Development (UNCTD)
2006, Guidance on Good Practices in Corporate Governance Disclosure, United Nations, pp. 3–4,
accessed October 2015, http://unctad.org/en/docs/iteteb20063_en.pdf; © Trade Practices Commission
1991, ‘Consumer protection advertising’, Information circular no. 10, Australian Government
Publishing Service, Canberra; © Commercial Bank of Australia Ltd v. Amadio 1983 151 CLR 447;
© ‘Alarm bells ringing on DJs takeover approach’, Smith, M, The Australian Financial Review,
29/06/2012; © ‘ASIC’s focus on insider trading pays off in Hanlong case’, Moran, S, The Australian,
01/08/2012; © ‘Stocks dealer jailed for insider trading, Drummond, A, The Sydney Morning Herald,
02/12/2010; © ‘Bribery/Anti-corruption: Shell’, Griffiths, C, The Lawyer, 18/03/2011; © Sard Verbinnen
& Co; © ‘News backs Murdoch despite shareholder threat’, Potter, B, The Australian Financial Review,
21/07/2011; © ‘Former Olympus chief warns on governance’, by Michiyo Nakamoto, Financial Times,
FT.COM, 20 April 2012. Used under licence from the Financial Times. All Rights Reserved; © Australian
Broadcasting Agency 2006; © Copyright 2019 ASX Corporate Governance Council; © New Zealand
Government; © Australian Fair Work Ombudsman.
MODULE 5
Figure 5.1: © United Nations; © Figures 5.3, 5.4, 5.5, Tables 5.1, 5.2: © CPA Australia; Figure 5.6:
© Natural Capital Coalition; Figure 5.8: © Task Force on Climate-related Financial Disclosures 2017;
Table 5.5: © GRI Standards 2016, GRI 101: Foundation, p. 7 www.globalreporting.org/standards/media/
1036/gri-101-foundation-2016.pdf; Extracts: © Commonwealth of Australia 2019. All legislation herein
is reproduced by permission but does not purport to be the official or authorised version. It is subject
to Commonwealth of Australia copyright. The Copyright Act 1968 permits certain reproduction and
publication of Commonwealth legislation. In particular, s.182A of the Act enables a complete copy to
be made by or on behalf of a particular person. For reproduction or publication beyond that permitted by
the Act, permission should be sought in writing from the Commonwealth available from the Australian
Accounting Standards Board. Requests in the first instance should be addressed to the National Director,
Australian Accounting Standards Board, PO Box 204, Collins Street West, Melbourne, Victoria, 8007;
© World Business Council on Sustainable Development; © Responsible Investment Association Aus-
tralasia; © Bank Australia; © Business Roundtable; © Crown and database right; © Commonwealth of
Australia; © Origin Energy; © European Union, https://eur-lex.europa.eu, 1998–2019; © Sourced from the
Federal Register of Legislation at September 2019. For the latest information on Australian Government
law please go to www.legislation.gov.au; © International Integrated Reporting Council; © OECD Pub-
lishing; © United Nations Global Compact; © World Resources Institute & World Business Council for
Sustainable Development 2005; © ISO International Standards Organization 2010, ISO 26000 Guidance
on Social Responsibility, accessed September 2015, www.iso.org/obp/ui/#iso:std:iso:26000:ed-1:v1:en;
© ‘Linking CSR performance with pay sends clear sustainability signal’, Yvo de Boer, The Guardian,
13/12/2013; © United Nations Division for Sustainable Development; © Pages 2 and 17 from IPCC, 2013:
Summary for Policymakers. In: Climate Change 2013: The Physical Science Basis. Working Group I Con-
tribution to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change [Stocker, TF,
D Qin, GK Plattner, M Tignor, SK Allen, J Boschung, A Nauels, Y Xia, V Bex and PM Midgley eds.].
Cambridge University Press, Cambridge, UK and New York, USA; © Australian Securities & Investments
Commissions. Reproduced with Permission.
Pdf_Folio:iv
iv ACKNOWLEDGEMENTS
BRIEF CONTENTS
Subject outline x
Glossary 366
Suggested answers 371
Index 407
Pdf_Folio:v
CONTENTS
Subject outline x 1.13 Capability considerations 37
Business leadership capabilities 37
MODULE 1 Technical skills, knowledge and
experience 37
Accounting and Society 1 Soft skills, knowledge and experience 38
Preview 1
TSKE and SSKE — career perspectives 38
Part A: Accountants as Members of a Summary 39
Profession 3 Review 40
Introduction 3 References 40
1.1 Public interest or self-interest? 3
Responsible decision making 3 MODULE 2
1.2 Enlightened self-interest 6
1.3 Ideals of accounting —
Ethics 42
entrepreneurialism and professionalism 6 Preview 42
1.4 What is a profession? 8 Part A: Professional Ethics 43
Self-regulation 9 Introduction 43
From self-regulation to a co-regulatory 2.1 Impact of ethical or unethical
process 10 decisions 43
1.5 What is a professional? 10 2.2 Ethics — an overview 44
1.6 The accounting profession — the 2.3 Ethical challenges within the
‘traditional’ view and the ‘market accounting profession 46
control’ view 11 Ethical challenges faced by members in
1.7 Trust and professions 11 practice and in business 46
1.8 Attributes of a profession 12 2.4 The accounting work environment 48
Summary 49
A systematic body of theory and
knowledge 12 Part B: Ethical Theories 51
An extensive education process 13 Introduction 51
An ideal of service to the community 13 2.5 Normative theories 51
A high degree of autonomy and Ethics of character 52
independence 14 Ethics of conduct 52
A code of ethics for members 15 2.6 Teleological (consequential) theories 52
A distinctive ethos or culture 16 Egoism 53
Application of professional judgment 16 Utilitarianism 54
The existence of a governing body 17 2.7 Deontological theories (duty based) 56
1.9 The profession’s regulatory process 18 Motive 56
Accounting Professional and Ethical Rights 56
Standards Board 18 Justice 57
The quality assurance process 19 2.8 Virtue ethics 58
Professional discipline 20 Moral agency 58
Summary 22 Summary 59
Part B: Interaction with Society 24 Part C: APES 110 Code of Ethics for
Introduction 24 Professional Accountants (including
1.10 Accounting roles, activities and Independence Standards) 60
relationships 24 Introduction 60
Relationships and roles 24 2.9 The public interest — ethics in
Accounting work environments 25 practice 61
1.11 Social impact of accounting 32 2.10 The APESB Code of Ethics (APES 110) 62
Social impact example — depreciation and Part 1 of the Code — fundamental
behaviour 32 principles and conceptual framework 63
1.12 Credibility of the profession 34 The conceptual framework (s. 120) 68
Credibility under challenge 34 Parts 2 and 3 of the Code — applying the
Key issues causing reduced credibility 34 Code to members in business and
Restoring credibility to accounting 36 public practice 74
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Part 4 of the Code — applying the 3.6 Corporate governance framework 141
conceptual framework in the context of Shareholders 141
audit, review and assurance The board 144
engagements 88 Auditors 150
2.11 Examples of ethical failures by Regulators 150
accountants 95 Stakeholders 152
Summary 97 Management 155
Part D: Ethical Decision Making 99 Summary 156
Introduction 99 Part C: International Perspectives on
2.12 Factors influencing decision making 100 Corporate Governance 158
Individual factors 100 Introduction 158
Organisational factors 101 3.7 Global push for improved governance 158
Professional factors 103 Specific Australian changes since
Societal factors 104 2001 160
2.13 Ethical decision-making models 105 3.8 Alternative international approaches to
APES GN 40 Ethical Conflicts in the governance 161
Workplace — Considerations for Market-based systems 162
Accountants in Business 106 Relationship-based systems — European
Philosophical model of ethical approaches 163
decision making 107 Relationship-based systems — Asian
American Accounting Association approaches 166
Model 108 Summary 169
Summary 110 Part D: Codes and Guidance 171
Review 111
Introduction 171
References 112
3.9 OECD Principles of Corporate
Ethics websites 113
Governance 171
MODULE 3 Principle I. Ensuring the basis for an
effective corporate governance
Governance Concepts 114 framework 171
Preview 114 Principle II. The rights and equitable
Part A: Corporations 116 treatment of shareholders and key
Introduction 116 ownership functions 172
3.1 Key features of corporations 116 Principle III. Institutional investors, stock
markets, and other intermediaries 173
Proprietary companies 117
Principle IV. The role of stakeholders in
Public companies 117
corporate governance 174
Proprietary vs public companies 117
Principle V. Disclosure and
3.2 Directors and other officers 119
transparency 174
Directors and their duties 119
Principle VI. The responsibilities of the
Examples of the exercise of directors’ board 175
duties 125
3.10 UK Financial Reporting Council
Director independence 127
Corporate Governance Code 176
Company secretaries and their duties 128
3.11 ASX Corporate Governance Council’s
3.3 Nature of corporations and division of
Principles and Recommendations 178
corporate powers 129
Understanding the ASX Principles 179
Shareholder powers 129
The ASX Principles and
Board powers 130 Recommendations 179
CEO powers 131 Summary 186
3.4 Theories of corporate governance 131 Part E: Non-corporates and Governance 187
Stewardship theory 132 Introduction 187
Agency theory 132 3.12 Family-owned businesses, and small
Agency issues and costs 133 and medium-sized enterprises 187
Other governance theories 135 3.13 Not-for-profit organisations 188
Summary 136 ACNC guidance 188
Part B: Corporate Governance 138 AICD guidance 190
Introduction 138 Diversity in the not-for-profit sector 190
3.5 Importance of governance 139
Governance and performance 140
Accountants and effective governance 140
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CONTENTS vii
3.14 Public sector enterprises 191 Consumers and customers 258
The uniqueness of the public sector 192 Summary 263
Guidance for public sector Part C: Protecting Financial Markets and
governance 193 Value in Corporations 265
3.15 Significance of the non-corporate Introduction 265
sector 195 4.8 Role of markets 265
Summary 196 The role of market regulators 266
Review 196 The role of information and the media 266
Appendix 3.1 197 The role of ratings agencies 268
References 204 4.9 Protecting financial markets 268
Insider trading 268
MODULE 4
Market manipulation 270
Governance in Practice 207 4.10 Representation 277
Preview 207 The representational role of institutional
Part A: Corporate Governance Success investors 279
Factors 208 Expanding ethics 282
Introduction 208 Whistleblower protection 283
Summary 286
4.1 Mitigating the risk of financial failure 208
Review 287
Common causes of corporate failure 208
References 287
Selection, monitoring, evaluation and
cessation of board appointments 211 MODULE 5
4.2 Diversity — fairness and performance 216
Adopting diversity 218 Corporate
Executive remuneration and Accountability 292
performance 218
Preview 292
Compliance with the Corporations Act 225
Part A: Financial Reporting and its Limitations 294
Auditing the financial statements 225
Introduction 294
Reviews of audit quality and audit
5.1 Scope of reporting 294
regulation 227
5.2 Elements of financial reporting 294
4.3 Improving corporate governance 229
5.3 The practice of discounting future cash
Risk management 229
flows 295
Independence of the chair of the
board 230 5.4 Relevance and faithful representation 296
Continued evolution of corporate 5.5 Focus on short-term results 296
governance 231 5.6 The entity assumption 297
4.4 Governance issues in the non- Summary 297
corporate sector 231 Part B: The Changing Reporting Landscape 298
Government bodies 231 Introduction 298
Charities and not-for-profit sector 232 5.7 Global financial crisis 298
Summary 235 5.8 Incentives tying sustainability issues
Part B: Operational Obligations and Oversight 237 to maximising the value of the
Introduction 237 organisation and shareholder
4.5 The legal system 237 wealth 299
The economy and the legal system 238 Brand and reputation 300
Legal compliance and governance 241 Risk management incentives 301
4.6 Obligations to employees 242 External benefits to companies from
Occupational health and safety 243 communicating through CSR reporting:
the relationship between CSR and the
Fair pay and working conditions 244
corporate cost of capital 302
Family and leave entitlements 245
5.9 Socially responsible investments 302
Ethical obligations — employee
Responsible investment 303
governance 246
Sustainable investment 303
4.7 Protecting the goods and services
Thematic investment 304
market 247
Impact investment 304
Workable competition 248
Social enterprises 304
Competition and stakeholders 248
5.10 Perceived corporate responsibilities
Regulating anti-competitive behaviour 250
and accountability 305
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viii CONTENTS
5.11 Corporate social responsibility 308 Emissions Reduction Fund and Climate
5.12 Externalities, potential government Solutions Fund 334
intervention and the role of Modern Slavery Act 2018 334
accounting 309 National Pollutant Inventory 335
Summary 311 Issues of disclosure for Australian
Part C: Theories Linked to CSR 313 mandatory reporting requirements 335
Introduction 313 European Union emissions trading
5.13 Enlightened self-interest 313 scheme 336
5.14 Stakeholder theory 314 5.25 Guidelines and non-mandatory
Who are stakeholders? 314 reporting 336
Normative stakeholder theory 314 The Global Reporting Initiative 339
Managerial stakeholder theory 315 Integrated reporting 340
5.15 Organisational legitimacy 315 Natural Capital Protocol 341
The social contract 315 OECD Guidelines for Multinational
Legitimacy theory 316 Enterprises 341
5.16 Institutional theory 316 CDP and the Climate Disclosure
Summary 317 Standards Board 342
Part D: The Emergence of CSR 319 United Nations Global Compact 343
Introduction 319 Equator Principles 344
5.17 Environmental sustainability 319 The Greenhouse Gas Protocol 345
5.18 Social sustainability 320 Sustainability Accounting Standards
5.19 Economic sustainability 321 Board 346
5.20 Linking environmental, economic and Dow Jones Sustainability Indices
(DJSI) 347
social sustainability 322
5.26 Other initiatives 347
5.21 The board of directors’ responsibility
Social audits 347
for sustainability and organisational
Corporate governance mechanisms aimed
initiatives 323
at improving social and environmental
5.22 Introduction to the key concepts 324
performance 349
Accountability 324
Environmental management
CSR 324 accounting 350
Sustainability 325 5.27 Surveys of current reporting practice 352
Sustainability reporting 325 5.28 Examples of best practice and
Natural capital 325 innovative reporting 353
Natural capital accounting 325 Summary 354
Integrated reporting 325 Part F: Climate Change Reporting 355
Integrated thinking 325 Introduction 355
5.23 What is measurable? 325 5.29 The international response to climate
Social reporting 326 change risk 355
Environmental reporting 327 5.30 Climate change accounting techniques 356
Economic reporting 328 5.31 Accounting for the levels of emissions 357
Summary 328 5.32 Corporate governance and climate
Part E: Corporate governance and CSR change 359
reporting 330 Summary 361
Introduction 330 Review 361
5.24 What is required? (mandatory reporting) 330 References 362
Requirements embodied within the Websites monitoring progress 365
Corporations Act and accounting
standards 331 Glossary 366
CSR-related corporate governance Suggested answers 371
disclosures 332 Index 407
National Greenhouse and Energy Reporting
Act 333
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CONTENTS ix
SUBJECT OUTLINE
INTRODUCTION
The purpose of this subject outline is to:
• provide important information to assist you in your studies
• define the aims, content and structure of the subject
• outline the learning materials and resources provided to support learning
• provide information about the exam and its structure.
The CPA Program is designed around five overarching learning objectives to produce future CPAs who
will be:
• technically skilled and solution driven
• strategic leaders and business partners in a global environment
• aware of the social impacts of accounting
• adaptable to change
• able to communicate and collaborate effectively.
SUBJECT DESCRIPTION
Ethics and Governance
Ethics and Governance is a core component of the knowledge and skill base of today’s professional
accountants. As key business decision-makers, accountants must be proficient in regulatory regimes,
compliance requirements, and governance mechanisms to ensure lawful, ethical and effective corporate
behaviour and operations. A better understanding of ethics and corporate governance frameworks and
mechanisms links with the various roles and responsibilities outlined in other subjects of the CPA Program.
From an individual perspective, this subject provides candidates with the analytical and decision-making
skills and knowledge to identify and resolve professional and ethical issues. The skills and knowledge
obtained in this unit are also important for subjects that specialise in the functional disciplines of accounting
such as Advanced Taxation, Financial Reporting, Strategic Management Accounting and Advanced Audit
and Assurance.
More than ever, today’s professional accountants are less involved in traditional accounting functions
and are more concerned with leadership and management. Today’s accountants are leaders in their field
providing key support to senior management and are directly involved in many important decisions. An
understanding of ethics and governance is essential to those in leadership roles, and to those who support
their leaders. This subject not only develops an awareness of corporate governance but also helps members
(and those whom they support) in discharging their stewardship functions.
Subject Aims
The aims of the subject are to:
• promote awareness of the ethical responsibilities of professional accountants, thereby enabling them to
identify and resolve ethical issues or conflicts throughout their career
• ensure professional accountants understand the importance of governance, including their role in
achieving effective governance
• improve understanding of the role of accounting, and of accountants, in providing information about
the social and environmental performance of an organisation.
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x SUBJECT OUTLINE
SUBJECT OVERVIEW
General Objectives
On completion of this subject, you should be able to:
• explain, from a global perspective, the nature of the accounting profession and the roles of professional
accountants
• apply the key professional responsibilities of an accountant from the perspective of a member of
CPA Australia
• explain the importance of ethics and professional judgment
• describe key governance and regulatory frameworks, including international perspectives on corporate
governance and the roles of various stakeholders
• explain the expectations placed on various internal and external stakeholders arising from organisational
governance responsibilities
• ascertain various compliance and regulatory regimes impacting the global business environment
• identify the strategic, leadership and global issues impacting accountants and the accounting profession
• describe the nature, role and importance of corporate social responsibility, including climate change and
sustainable development.
Module Descriptions
The subject is divided into five modules. A brief outline of each module is provided below.
Module 1: Accounting and Society
Increasingly, professional accounting involves much more than the application of technical knowledge.
Accountants are responsible for providing information and advice that supports important decisions that
affect organisations, people and their lives, and society as a whole. With the privileges and benefits that
accompany professional status come a variety of obligations, foremost of which is the obligation to put
the good of society ahead of personal interests.
This module considers what it means to be a professional accountant in the contemporary global business
context. It examines the wide range of capabilities and skills required, and the various environments in
which accountants work. There is a focus on the roles, relationships and activities of accountants and the
pressures that can challenge a professional accountant in their working life. There is also an emphasis on
what the profession must do to ensure it enjoys the confidence and trust of society and fulfils its role as a
positive social force.
Module 2: Ethics
This module explores the concept of ethics and ethical decision making in the professional and business
context. In other words, it discusses the practical implications of professional ethics based on the notion of
the public interest. The module provides an overview of various different theories on ethics, each of which
can provide perspective and insights that help guide accountants when considering and resolving complex
ethical dilemmas.
The module describes key aspects of the Code of Ethics for Professional Accountants (APES 110) and
demonstrates how to apply this Code when addressing specific ethical issues. The module also aims to
create an understanding of the individual, organisational, professional and societal factors that can exert
influence on an individual’s decision making.
Finally, the module examines decision-making models that provide a structured approach that can help
professional accountants to systematically analyse complex situations, exercise clear judgment and make
more consistent and justifiable decisions.
Module 3: Governance Concepts
Module 3 outlines the key features of the corporate form. These features combine to shape approaches
to corporate governance — the system in place to operate and control the corporation. Good corporate
governance is generally linked to good corporate performance. The nature of corporate governance,
theories of corporate governance and the key components generally found in corporate governance
frameworks are discussed. This includes consideration of relationships between companies, boards of
directors, managers and various other stakeholders.
Major codes and guidance on corporate governance in countries such as Australia and the UK are
considered, along with the role and impact of differing cultural approaches to corporate governance.
Governance in other sectors, including the public sector, is also reviewed.
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SUBJECT OUTLINE xi
The module highlights that professional accountants must have a strong understanding of governance
concepts in order to successfully fulfil their duties and obligations and add value to corporations and entities
of all types and sizes.
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Recommended proportion
Module of study time (%) Weighting (%)
2. Ethics 20 20
3. Governance Concepts 25 25
4. Governance in Practice 25 25
5. Corporate Accountability 15 15
100 100
Exam Structure
The Ethics and Governance exam is comprised of both multiple-choice and extended-response questions.
Multiple-choice questions include knowledge, application and problem-solving questions that are designed
to assess understanding of ethics, governance and corporate social responsibility content. Extended-
response questions will relate to the case studies provided in the exam. Candidates will be required to
comprehend case facts, recognise and isolate relevant issues, and critically analyse the facts presented and
apply them to the concepts in the study guide to reach a conclusion. The case studies will predominantly
require application and problem solving. Strategy, leadership and international business themes may
provide contexts for assessment in the exam.
Table 1 provides an indication of the approximate proportion of multiple-choice exam questions likely
to come from each part of the subject. The extended-response questions may be sourced from any module
of the study guide.
LEARNING MATERIALS
Module Structure
These study materials form your central reference in the Ethics and Governance subject.
Learning Objectives
A set of learning objectives is included for each module in the study guide. These objectives provide
a framework for the learning materials and identify the main focus of the module. The objectives also
describe what candidates should be able to do after completing the module.
Assumed Knowledge
Any knowledge that a candidate is assumed to have before beginning study of the module is noted.
Learning Resources
This section alerts you to some of the resources available to accompany this module on My Online Learning
and elsewhere online. Readings 1.1, 1.2, 1.3, 4.1 and 5.1 are not assessable.
Preview
The preview outlines what will be covered in the module and how it relates to other modules in the subject.
Study Material
The study material is divided into parts and sections that will help you conceptualise the content and study
it in manageable portions. It is also important to appreciate the cumulative nature of the subject and to
follow the given sequence as closely as possible.
Examples
Examples are included throughout the study materials to demonstrate how concepts are applied to real-
world scenarios.
Study Material Activities
Activities are included throughout the study materials to provide you with the opportunity, as you progress
through the subject, to assess your understanding of significant points and to stimulate further thinking
on particular issues. These activities are an integral part of your study and they should be fully utilised to
support your learning of the module content throughout the semester.
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SUBJECT OUTLINE xv
dPf_Folio:xvi
MODULE 1
ACCOUNTING AND
SOCIETY
LEARNING OBJECTIVES
LEARNING RESOURCES
PREVIEW
The accounting profession’s role in society is to be a trusted and reliable provider of information that
supports high-quality decision making. The term profession is in common usage, but it may not always be
appreciated exactly what distinguishes a profession from other occupations and what being a professional
means in terms of both obligations and benefits.
Part A of this module describes the key attributes of a profession and provides an in-depth look at what
it means to be a professional accountant. The work of accountants has a strong influence on decisions that
affect many aspects of society, particularly the allocation of resources, and thus the profession is expected
to act with integrity and in society’s best interests.
Foremost, accountants must comply with the framework of principles established by the profession,
including acting in accordance with appropriate standards of governance, accountability and ethics.
This requires a balance between potentially competing interests. The module examines different ways
of viewing and managing competing interests. Successfully managing the balance of self-interest and
public interest maintains a ‘social contract’ between the profession and society, whereby in return for
the value that the profession creates, society allows it the benefits of economic rewards, self-regulation
and autonomy.
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A failure to successfully balance interests results in withdrawal of some of these privileges. This module
examines how some failings in the performance of the profession have led to an increase in external
regulation to create a set of co-regulatory processes that are intended to strengthen the credibility of
the profession. In co-regulation, external regulation works alongside self-regulation of the profession,
which is based on professional and ethical standards, and the imposition of sanctions on those who breach
those standards.
While the role and activities of the accounting professional are changing in response to advances
in technologies such as artificial intelligence, the core notions of integrity, objectivity, professional
competence and due care, confidentiality and professional behaviour remain unchanged.
Part B of the module considers the various work environments, roles and activities of professional
accountants, and the relationships that are created through these roles. The roles accountants can hold
are diverse, and opportunities exist in many sectors and areas of expertise. Regardless of the specific
roles and activities undertaken by an accountant, they must continue to develop their technical skills,
knowledge and experience throughout their working life. In addition, to work effectively, particularly
as their career progresses and their responsibilities expand, accountants must add a portfolio of ‘soft
skills’ to their technical knowledge. These soft skills include communication, persuasion, negotiation and
leadership skills. As with their technical skills, accountants can develop these through experience and
formal continuing professional development activities.
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Governance
Accountability Ethics
Accountants should strive to base their decisions firmly on the principles of governance, accountability
and ethics. The ideal position for balanced decisions is to be at the centre of this figure where governance,
accountability and ethics interconnect. This requires accountants to be rigorous and professional in their
conduct. However, this does not always happen, as is the case described in example 1.1.
QUESTION 1.1
(a) To gain an understanding of the environment within which the accounting profession operates,
visit each of the listed websites in table 1.1 and state which section of the diagram in figure 1.1 it
belongs to.
(b) Visit IFAC’s website to determine the role of the following boards.
i. International Auditing and Assurance Standards Board (IAASB)
ii. International Ethics Standards Board for Accountants (IESBA)
iii. International Accounting Education Standards Board (IAESB)
(c) Begin work on a glossary of acronyms by including the acronyms in the list. Continue to update
this as the course progresses. The list of abbreviations in the back of the Financial Reporting
Council’s (FRC’s) annual report may assist with this.
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Corporations Act (2001) The Corporations Act is the legislation regulating companies
www.legislation.gov.au/Details/C2019C00216 and it also regulates aspects of work done by accounting
professionals. This includes the areas of audit, financial
report preparation and lodgement and insolvency. The roles
of directors and other company officers are also covered in
this legislation.
Competition and Consumer Act (2010) This act seeks to protect people by promoting competition,
www.legislation.gov.au/Details/C2019C00317 fair trading practices and regulation in the area of consumer
protection.
Privacy Act (1998) The Privacy Act regulates the privacy and the handling of
www.legislation.gov.au/Details/C2019C00241 personal information.
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A Costly Error
Three respondents (a consulting company, an accounting partnership, and an executive director and
partner) found themselves in a legal battle with a client, Neville’s Bus Service Pty Ltd (NBS), that cost
them $5.5 million following conduct that NBS alleged was fraudulent, in breach of contract, negligent and
in breach of provisions of Australian Consumer Law.
NBS used the consulting company to help it bid for a bus service tender. An error in calculations meant
that NBS had suffered financial losses, totalling in the first instance $660 000, which was the amount that
would have been added to the tender had the numbers been the subject of routine quality control checks.
NBS alleged that the partner, once the error was found, failed to notify the company. It was also alleged
that the partner actively attempted to conceal the error.
An error in a tender could create a situation where a company might run at a loss because the costs
associated with the novated leases was not included in calculating the bid that was submitted. The court
heard that the bid submitted by the company would still have succeeded if it had submitted an amended
tender bid.
The judgment for this case can be accessed here: www.judgments.fedcourt.gov.au/judgments/
Judgments/fca/single/2018/2018fca2098.
Source: Information from Zuchetti, A 2018, ‘Accountant sued for $5.5m for concealing error’, www.mybusiness.com.au/
management/5313-accountant-sued-5-5m-for-concealing-error.
We explore this concept again in module 5 in relation to a different question — why organisations make
the commitment to produce sustainability information and reports.
EXAMPLE 1.2
Excessive Fees
Liquidators John Sheahan and Ian Lock were ordered by a court to pay back $1.9 million plus interest
to companies they had been involved in liquidating after a court agreed that the fees charged by the two
liquidators were excessive.
The corporate regulator, the Australian Securities and Investments Commission (ASIC), took action
against the liquidators because the fees they were charging reduced the amount that was available to pay
the various creditors of the companies concerned.
The case concerned the liquidations of three companies. It was found that Sheahan and Lock had
charged more than they should have and spent more time than necessary on the jobs.
This meant that creditors of the businesses involved would be getting reduced returns as a result of the
funds that were claimed by the liquidators as remuneration.
A media release from the ASIC noted that the court slashed $1.9 million from the fees charged by the
liquidators. ‘Remuneration was fixed at $3.9 million compared to the $5.8 million sought by the liquidators,
a reduction of $1.9 million (33%),’ ASIC said.
‘To commence the process of determining the remuneration claim, His Honour stated that the charge
rates were excessive and ruled that the partner and manager rates were to be discounted by 20% and
the senior manager rates discounted by 10%. Other charge rates were not to be discounted.’
The insolvency practice told media representatives that it would review the outcome and decide whether
to appeal.
Source: Zuchetti, A 2019, ‘Liquidators ordered to repaid $1.9m plus interest’, www.mybusiness.com.au/management/5906-
liquidators-ordered-to-repay-1-9m-plus-interest; ASIC 2019, ‘Federal Court fixes liquidators’ remuneration for winding
up three Adelaide companies and orders them to repay $1.9m plus interest and ASIC’s costs’, https://asic.gov.au/about-
asic/news-centre/find-a-media-release/2019-releases/19-140mr-federal-court-fixes-liquidators-remuneration-for-winding-
up-three-adelaide-companies-and-orders-them-to-repay-19m-plus-interest-and-asic-s-costs.
EXAMPLE 1.3
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promises benefits
exchanges
Knowledge Privileges
Self-regulation
Skills Expertise
Associational control
Competencies
Autonomy Power
Values Norms
Exclusive rights
Behaviours
Public interest Occupational control
Control over market
Professional judgment
Reputation Social status
Activities
Economic rewards
Stereotypes Image
context
Source: Brourard, F, Merriddee, B, Durocher, S, Burocher Neison, L 2017, ‘Professional accountants’ identity formation: An
integrative framework’, Journal of Business Ethics, vol. 142, iss. 2, pp. 225–238.
However, when this social contract is broken, some of these benefits may be removed or modified. For
example, laws may change when the community, through its political representatives, believes that certain
functions need to be more tightly regulated.
Consider the change that brought auditing standards and auditing standard setting under the purview of
the FRC in 2004. The community, through its representatives elected to the Commonwealth Parliament,
decided that additional regulation of the auditing cohort of the accounting profession was necessary as a
result of the various corporate collapses in Australia and elsewhere in the early 2000s. The profession has
worked under a revised regime for setting auditing standards since that time.
QUESTION 1.2
Refer back to examples 1.2 and 1.3. For each example, explain how the accountant breached their
professional obligations and state the consequences of their actions. Use the main concepts from
figure 1.2 in your explanation.
SELF-REGULATION
Most of the time, professions are given permission to provide services to the public through some
regulatory process. For example, in many countries only doctors of medicine are allowed, by law, to
prescribe certain drugs.
Once accorded the relevant permissions, it is common for a profession to have a substantial degree of
independence or autonomy. This means they have a greater level of authority to set their own rules and
regulations and have less detailed government regulation.
The independence, or autonomy, to self-regulate commonly extends to membership and membership
rules of a profession. Professional bodies set the education requirements, professional ethical stan-
dards and disciplinary processes (which can be in addition to legal processes) for the members of
their profession.
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CONSIDER THIS
Why do you think it may be appropriate for a profession to publish the name of an accountant who has breached the
rules of a professional organisation such as CPA Australia?
EXAMPLE 1.4
Self-Interest
Andersen (previously Arthur Andersen, one of the world’s largest professional accounting firms) was the
auditor of HIH which was, until its failure, Australia’s largest insurance company. Its failure was rapid and
spectacular and took place at about the same time Enron failed in the US in 2001/2002. Arthur Andersen
audited Enron and WorldCom both of whom experienced major bankruptcies, despite clean audit reports.
As a result of a court case against Andersen’s role in the Enron failure, Andersen itself was put out of
business, despite the shell company winning the case on appeal. These three cases of HIH, Enron and
WorldCom were the most graphic illustrations of corporate failure in this period, and Arthur Anderson
featured in each of them (Jeter 2003; McLean & Elkind 2004; Westfield 2003).
In 2006, Allan noted in the Deakin Law Review that:
The independence of Andersen was also highly questionable. Three former partners of the firm sat on
the HIH board. One, who was the recipient of continuing benefits from Andersen, was made chairman
and was appointed to the audit committee only 17 months after his retirement. Another, who had been
the engagement partner, was made chief financial officer only the day after his resignation from the
firm. The third was appointed to the board only five months after his retirement having ‘played a
significant role in the audit of HIH for 25 years’ (Allan 2006, p. 144).
Examples such as this have a highly negative impact on the reputation of the accounting profession.
Therefore, it is not surprising that ‘images of altruism, ethical service and self-regulation were supplanted
by a portrayal of professions as self-interested collectives’ (West 2003, p. 21).
.......................................................................................................................................................................................
CONSIDER THIS
What actions should a profession take to ensure it preserves its relevance, credibility and the trust of the community?
.......................................................................................................................................................................................
CONSIDER THIS
Review Greenwood’s eight attributes of a profession. In light of the discussion so far and your professional
experiences, would you suggest adding any additional attributes?
Identify the relevant standard setting body within IFAC that is responsible for specifying the body
of knowledge required by professional accountants. Which documents contain this knowledge?
According to Buckley (1978), society grants the professions monopoly power over professional affairs
and the power to use this monopoly power as they see fit, as long as the power is used in the public interest.
Any profession that deliberately and consistently breaches this trust does so at its own risk. This trust is an
important part of the philosophical notion of a social contract. As Wilensky (1964, p. 140) observes, ‘any
profession that abandons the service ideal will very quickly lose the moral claim to professional status’.
Continued erosion of public trust by unethical behaviour may lead ultimately to extreme governmental
intervention in the profession’s affairs, with consequent reduction of autonomy, authority and reputation.
Therefore, each member of a profession has a responsibility, and an obligation, to behave in a manner that
maintains the reputation of the profession.
The APES 110 Code of ethics for professional accountants (2018) published by the Accounting
Professional and Ethical Standards Board (APESB) specifies the fundamental principles of acceptable
professional conduct for professional accountants. These are reviewed in detail in module 2.
To better understand the service ideal, we examine it from three perspectives:
• the wellbeing of society
• the pursuit of excellence
• community service.
.......................................................................................................................................................................................
CONSIDER THIS
Consider where you could provide service to the community once you have obtained your membership of CPA
Australia. Identify what benefits this would provide to you as an accountant and to the organisation you are supporting.
Are there any specific considerations that you should have with respect to the provision of that service?
QUESTION 1.4
Discuss whether acts of public service are considered to be purely political actions designed to
maintain the profession’s status in the eyes of the community.
EXAMPLE 1.5
Individual member autonomy is closely related to the concepts of professional judgment, adherence to
a code of professional conduct and professional independence.
The member must be allowed to use their professional judgment free from the direction or influence of
others, and detached from the risk of financial gain (or loss) as a result of the advice provided. The member
must also be free from fear of reprisals. In other words, the professional person’s judgment should be
autonomous in the literal sense of the term (i.e. governed by their own professional rules and laws and not
influenced by inappropriate outside interests). Autonomy, in this sense, implies a self-principled, ethical
and responsible approach by the member.
For a professional accountant in public practice, the specific attribute of independence becomes more
important in relation to the concepts of objectivity and integrity. At times the accountant may be torn
between meeting the requirements of the client to report in a given way and maintaining their own ethical
compass and professional obligations.
The ethics of the professional accountant can be tested in these circumstances, and maintaining
independence and autonomy from the client will help the professional accountant ensure the most
appropriate position is adopted.
QUESTION 1.5
Discuss four situations where accountants may apply professional judgment in the course of their
work irrespective of the environment in which they work.
QUESTION 1.6
CPA Australia has been discussing the impact of artificial intelligence (AI) on the account-
ing profession. Discuss the extent to which AI is predicted to affect professional judgment.
(www.cpaaustralia.com.au/podcast/artificial-intelligence-and-the-future-of-accounting)
Background
Earlier we highlighted that a high degree of autonomy is an important characteristic of a profession, and
noted how this attribute has been challenged by the regulators with the removal from the profession of
the powers to set accounting and auditing standards. As we have seen, these powers now reside with the
AASB and the AUASB. These two boards in turn report to the FRC.
In regard to auditing standards, the CLERP 9 legislation (Corporate Law Economic Reform Program
(Audit Reform and Corporate Disclosure) Act 2004 (Cwlth)) reconstituted the AUASB as a body corporate
under the Australian Securities and Investments Commission Act 2001 (Cwlth). Consequently, the AUASB
reports to the FRC and not to the professional accounting bodies.
Auditing standards have the force of law under the Corporations Act, which means registered auditors
have a legal duty to comply with auditing standards issued by the AUASB. The AUASB’s power
to approve legally enforceable standards means that all references to ethical requirements in auditing
standards will attract legal status. However, the AUASB has acknowledged that, while this will result in
professional standards having the force of law, it will not reduce or limit the profession’s own disciplinary
activities.
Once professional standards acquired the force of law for auditors, the profession sought a more
rigorous and transparent process for setting ethical requirements. On 4 November 2005, CPA Australia
and the ICAA announced the establishment of the APESB, an independent ethical standards board to
review and set the code of ethics and professional standards. The formation of the APESB effectively
transferred the setting of professional and ethical standards from the professional accounting bodies to an
independent body.
CPA Australia, CAANZ and the IPA are all members of the APESB. Members of these three
professional associations are required to abide by APESB standards.
The profession acknowledges that, in order to increase public confidence, it needs to open the
professional standard-setting process to greater public scrutiny. While the standards previously released
by CPA Australia were of a high standard and enforced through appropriate due processes, the profession
has an ongoing interest in improving the public’s perception of its professional standards. Any appearance
of self-interest should be removed and the standards should be written by an independent board.
The APESB comprises a technical board and a secretariat to enable it to fulfil this role. The technical
board consists of eight members, including two members from CPA Australia. It comprises representatives
from the public sector, corporate sector, audit profession, academia and the general public.
The APESB fulfils its role by:
• reviewing the professional and ethical standards on a yearly cycle, and monitoring the needs of the
accounting profession and the public for areas requiring new or updated professional and ethical
standards
• reviewing the implementation of new and amended professional and ethical standards within six months
of issue
• referring matters to the secretariat for research, direction and amendment
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QUESTION 1.7
Identify the precise wording of the ‘force of law’ provisions (s. 296, s. 307A) for accounting and
auditing standards in the Corporations Act.
Refer to: www.legislation.gov.au/Details/C2019C00216.
.......................................................................................................................................................................................
CONSIDER THIS
Think about the organisations where you have worked or currently work. What documentation is used to assure and
control the quality of the organisation’s outputs?
QUESTION 1.8
A merger is being finalised between your public practice and a firm that provides bookkeeping
services. As the partner in charge of quality control, you have not quite finalised your due diligence
on the policies and procedures designed to provide reasonable assurance that the firm and its
personnel comply with relevant ethical requirements.
You are confident that the bookkeeping firm’s policies and procedures are robust, but you have
not yet completed a review of them. You nevertheless assume that there are no issues, as the firm
being acquired only provides bookkeeping services.
A few months after the merger is completed, you receive a phone call from one of your clients.
Your client is concerned because an employee of your firm who performs bookkeeping services
has an interest in a business that is one of their major competitors.
Your client is particularly disturbed because they are in the middle of extremely confidential
business negotiations. The client wants guarantees that your employee will not have access to
any confidential information. You agree to investigate your client’s concerns (Sexton 2009).
Identify and describe the quality assurance and ethical issues arising from this scenario.
PROFESSIONAL DISCIPLINE
Professional and ethical standards aim to ensure that members of the accounting profession work to
the highest level of professionalism, providing a quality of service that achieves credibility among the
general public and gains their confidence. Members often face personal, financial and other pressures
that threaten their integrity and test their judgment. Unfortunately, in response to such pressures, some
members prioritise self-gain and overlook their duty to protect the interests of third parties and the
trust bestowed upon members by the public. It should be noted that no profession is totally free of
unscrupulous members.
Joining CPA Australia means committing to upholding the reputation of the CPA designation by
adhering to the obligations spelt out in CPA Australia’s Constitution and By-Laws, the Code of
Professional Conduct and applicable regulations. To ensure all members uphold these standards, CPA
Australia has a formal process that enables complaints about members to be heard and evaluated and,
where appropriate, disciplinary actions to be taken.
Investigations and disciplinary processes are guided by the principles of procedural fairness (the right
for a member to put forward their case), confidentiality, independence and the right to appeal.
CPA Australia has undertaken to act in the public interest and has an obligation to ensure that complaints
about members are investigated thoroughly, in an impartial and timely manner, at all times striving to
preserve the rights of members while acknowledging the public interest concerns of complainants.
Investigation and disciplinary procedures form an essential adjunct to the Code of Professional Conduct.
CPA Australia has placed due importance on the area of co-regulation and professional discipline by
establishing an elaborate set of rules and procedures to handle disciplinary matters.
Read clauses 39–43 of the current Constitution and Part 5 of the current By-laws. You can access
these documents via the following links.
• www.cpaaustralia.com.au/about-us/our-organisation/our-constitution
• www.cpaaustralia.com.au/about-us/our-organisation/our-bylaws
The process for dealing with member conduct is started when a complaint is made. A complaint may be
raised by any person including members of the public, members of CPA Australia or the General Manager
Professional Conduct (MPC) of CPA Australia.
Types of complaint identified in the Constitution of CPA Australia (clause 39) include:
• obtaining admission as a Member by improper means
• breaching the Constitution, By-laws or Code of Professional Conduct
• dishonourable practice or conduct that is derogatory to CPA members
• failing to observe a proper standard of professional care, skill or competence
• becoming insolvent
• being found to have acted dishonestly in any civil proceedings.
The complainant should first attempt to resolve the matter directly with the CPA Australia member.
Where this initial resolution attempt is unsuccessful, the complainant must lodge a written complaint
providing all necessary details, supported by documentary evidence.
All complaints are reviewed by the MPC. The MPC will determine whether the complaint is relevant
and, if it is, a file will be opened to address the issue. The complaint will be allocated to a Professional
Conduct Officer (PCO).
The PCO will contact the member against whom the complaint has been made and provide details of
the nature of the issue. The member will be asked to provide an explanation.
Once the PCO has completed the investigation, a report will be given to the MPC to enable a
recommendation to the Chief Executive Officer (CEO) of CPA Australia as to whether there is a case
to answer.
The CEO must determine whether there is a case to answer based on the MPC’s recommendation and
any relevant external advice. If the member is assessed as having a case to answer, the CEO must refer
the complaint to either the Disciplinary Tribunal or to a One Person Tribunal (OPT), depending on the
circumstances.
The member and complainant will be notified by the MPC that there is a case to answer and the MPC
will refer the case to an investigating case manager (ICM). The ICM will prepare written particulars of the
case and present the complaint at the hearing that will be conducted.
After the hearing of the case, a determination (decision) will be made and the member and complainant
will be advised of the outcome.
QUESTION 1.10
Locate CPA Australia’s Disciplinary Hearing Outcome reports. Is the member’s name always
published?
SUMMARY
The accounting profession is integral to the process of ensuring people have access to accurate and useful
financial information upon which to base their decisions. These decisions often relate to the allocation of
resources and have important consequences for society. To make appropriate decisions about the analysis
and presentation of information, the professional accountant needs to clearly understand what information
serves the public interest and to ensure this — rather than any sense of self-interest — guides their
professional conduct. Ultimately, the accounting profession will only retain its integrity and authority
by serving the wider public interest.
A profession such as accounting has a series of features that distinguish it from other occupations.
These include a specific body of knowledge obtained through formal qualifications from tertiary education
institutions and regular continuing professional development courses conducted by accounting bodies or
commercial training providers. A profession has as a core ideal the notion of service to the community. A
profession will typically have a code of ethics (for example, APES 110), a culture in which the exercise
of professional judgemnt is important and a governing body (for example, IFAC).
Professions often exhibit a high level of autonomy and self-regulation. In the case of accounting, a degree
of external regulation has been imposed in response to various failings in some parts of the profession.
This co-regulatory approach means that in addition to the self-regulation undertaken by the peak bodies
of the profession, legislation and external regulators also have a degree of power over the conduct of the
profession and its members.
As a professional accountancy organisation, CPA Australia has a constitution and disciplinary rules that
set down what the profession expects of its members. Members who are the subject of public complaints,
for example, may be subject to disciplinary action. This may result in penalties, including forfeiture of
membership, fines, additional professional development or a reprimand.
The key points covered in part A of this module, and the learning objective they align to, are as follows.
KEY POINTS
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Employers
Clients
Employees
Accountant
Peers Regulators
Peers include work colleagues, accountants in professional networks and other accountants who work
for the same client in a different aspect of accounting. Maintaining good-quality professional relationships
is an essential part of being a successful professional accountant.
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CPAs must be equipped with a range of skills to function as business leaders. Further, professional
capabilities are mobile, enabling accountants to work in different geographic locations, various work
environments and online. Each of the environments listed in table 1.2 is discussed in more detail in the
following sections.
Big Four accounting firms The ‘Big Four’, as they are known, are the four largest international
professional public practice firms that offer services in accountancy and
professional services in Australia and the world.
These firms are PwC (PricewaterhouseCoopers), Deloitte, EY (Ernst &
Young) and KPMG. The revenues of these firms have been reported to be
in the tens of billions. A significant but decreasing service line for the four
largest firms in the world is audit and assurance. These companies audit a
majority of the listed entities in Australia and overseas.
Their work often involves dealing with complex transactions that take
place across borders.
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(continued)
Second-tier accounting firms Mid-tier public practice firms operate on a smaller scale than the Big Four.
They generally have a number of offices in capital cities and large regional
centres, together with some level of international engagement, generally
through alliances or network affiliations.
Examples of these firms are Findex, BDO, Grant Thornton and
Pitcher Partners.
Small practices and sole practice This level of public practice includes the smaller accounting practices
operations with one professional accountant as practitioner or a team of professional
accountants and support staff.
Smaller accounting firms tend to be used by small and medium
enterprises (SMEs), which often have no statutory audit requirements.
Accordingly, these practices usually undertake compliance work that
is less related to audit (e.g. tax returns, standard accounting), and
increasingly business and IT advisory work.
Area Activity
Assurance and audit Financial statement attestation, in which the firm examines and attests to a company’s
financial statements. Other assurance services including assessing procedures and
controls relating to privacy and confidentiality, performance measurements, systems
reliability, information security and outsourced process controls.
Financial management Covers performance management, corporate governance, stakeholder relations, risk, as
well as the traditional financial controls.
Taxation services Covers company and individual taxation, fringe benefits tax (FBT), goods and services
tax (GST), capital gains tax (CGT) and international tax issues.
Forensic accounting Specialised area that involves engagement for legal issues including fraud, disputes
or litigation.
Insolvency Specialised area that involves engagements in personal insolvencies (bankruptcies) and
corporate insolvencies (administrations, liquidations and receiverships).
Internal audit services Systematic, disciplined approach to evaluating and enhancing risk management, control
and governance processes.
Business advising Assisting business managers to more successfully achieve value. The tasks involved
are varied, often reflecting that businesses have internally recognised weaknesses, or
have identified that objective external evaluations and contributions can be valuable.
Business advising can also extend to advice on business re-engineering, restructuring,
takeovers and mergers.
QUESTION 1.11
Why have SMEs not relied in the past on their external accountants for business advisory services?
Comment on whether this might now be changing or if this needs to change.
Role Responsibilities
Board member Elected to the board of directors to oversee the activities of the
company or organisation.
Finance director or chief financial officer Formulation, management and review of the financial and strategic
direction of the company or corporate group.
Financial accountant Preparation of general purpose financial reports, the annual report
and special purpose financial reports as required. May supervise a
team of accountants.
Risk manager Quality and risk management responsibility for the business.
Company secretary Reporting and regulatory compliance and ensuring, with the chair,
the efficient functioning of the board of directors.
The accounting functions within an SME are broadly the same as in a large business environment.
However, an SME-employed accountant may have to complete more detailed work because there will be
fewer (if any) support staff. Also, the number of areas they need to cover may be wider but have less
complexity compared to a large business environment.
At the same time, because they will know the business and typically be very close to the ownership
(in fact, may even be an owner) and senior management, the professional accountant in an SME will also
often be involved in a range of business decision activities.
An example of the differences in the roles performed by a professional accountant in a large business
compared to an SME is as follows.
• A large business may engage a management accountant whose sole responsibility is budgeting,
forecasting and reporting actual results compared to budget for one of its areas of operation.
• An SME may engage a finance manager who is responsible for their end-to-end accounting and finance
function — with responsibility for every function from petty cash to monthly reporting to the directors.
IFAC Research
The PAIB Committee of IFAC ‘provides leadership and guidance on relevant issues pertaining to
professional accountants in business and the business environments in which they work’ (IFAC 2013).
The PAIB Committee in 2005 developed an information paper titled The Roles and Domain of the
Professional Accountant in Business. This paper provides a description of the contemporary roles that
are PAIB.
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The PAIB Committee paper provides a description of activities listed in table 1.6.
Activity Examples
Communication Communicating financial reports and interacting with stakeholders so they can
understand the business and make informed choices.
Control Financial control, budgeting and forecasting, and the reduction of waste through
process analysis.
Source: Adapted from The Roles and Domain of the Professional Accountant in Business, Professional Accountants in Business
Committee, p. 4, IFAC in 2005 and is used with permission of IFAC, accessed October 2015, www.ifac.org/publications-
resources/roles-and-domain-professional-accountant-business.
We can link these IFAC activities to the roles identified earlier and the different sizes of private sector
businesses. For example, the measurement activity in a large business may be a management accountant
measuring the performance of international freight supplier contracts. In a small business, the measurement
activity may be the financial controller determining a breakeven sales figure.
In 2008, the PAIB Committee released another information paper titled The Crucial Roles of Pro-
fessional Accountants in Business in Mid-sized Enterprises (IFAC 2008). Understanding the role of
accounting in these enterprises is vital for the success of the enterprises and of economies reliant on
such enterprises.
For the paper, IFAC interviewed various accountants in mid-sized enterprises (MEs). The MEs were
chosen because they all had employed accountants, so the multi-dimensional role of the professional
accountant as an employee could be explored. The report summarises the interviews as follows.
Generating Value
The PAIBs featured in this report have identified numerous responsibilities that directly affect the current
and future success of the mid-sized enterprises in which they work . . .
Their most prevalent duties hinge on helping their companies to generate value by:
• establishing a common ‘performance language’ throughout the company so that everyone’s activities
are aligned with the vision and goals leadership has set;
• upholding business integrity;
• creating, implementing and improving management information systems to bolster strategy, planning,
decision making, execution and control activities;
• managing costs through rigorous planning, budgeting, forecasting and process improvement efforts;
• managing risk and handling business assurance;
• measuring and managing performance; and
• communicating financial and other performance information to internal and external stakeholders,
including regulatory authorities, lenders, bankers and investors in a manner that fosters trust (IFAC
2008, p. 6).
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QUESTION 1.12
Refer to reading 1.2. How did Roel van Veggel add value to André Rieu’s business?
EXAMPLE 1.6
ASIC’s Power
In its 2018–19 Annual Report, ASIC raised concerns about the value of assets in Myer Limited’s
financial report for the full-year ended 29 July 2017. These concerns included the reasonableness and
supportability of the cash flow forecasts used in testing the assets for impairment.
After ASIC raised these concerns, Myer announced its decision to write down the value of its goodwill
and brand name intangible assets by $515 million in its half-year financial report. Myer stated that this
write-down in the value of its assets reflected its adoption of lower cash flow forecasts, as well as the
deterioration in trading during the first half of the 2018 financial year.
The impairment of non-financial assets remains a focus in ASIC’s surveillance of financial reports.
Source: ASIC 2018, ‘Annual Report 2017–18’, p. 78, https://download.asic.gov.au/media/4922570/annual-report-2017-18-
published-31-october-2018-full.pdf.
ASIC also has an Audit Inspection Program under which it looks at a selection of audits of the financial
reports of public interest entities. Part of the 2017–2018 report is included in example 1.7.
EXAMPLE 1.7
Audit Deficiencies
We reviewed key audit areas in audit files at the largest six firms. In our view, in 20% of the key audit
areas that we reviewed, auditors did not obtain reasonable assurance that the financial report as a
whole was free of material misstatement. This compares to 23% in the previous 18-month period ended
31 December 2016 and represents a welcome reduction in the level of findings for the largest six firms.
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Creative Accounting
‘Creative accounting’ means using the choices available to present information in ways that do not clearly
represent reality, and which provide a distorted and often favourable view of the organisation.
Many accounting issues from the 1980s remain unresolved, including practices such as capitalisation
of interest expenditure, financial instrument valuation and risk management, formation expenditure being
treated as an asset, mining exploration expenses regularly being capitalised and related party transactions.
The words of Chambers, writing in 1973, are still current:
If due to the optional accounting rules available to them, the company managers and directors are
able to conceal the drift (in financial position), shareholders and creditors will continue to support,
and support with new money, companies that are weaker than their accounts represent them to be
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(Chambers 1973, p. 166).
QUESTION 1.13
Outline reasons why the four key issues identified by IFAC (2003) could reduce the profession’s
credibility. What strategies may be useful for reducing or eliminating these problems in future?
Example 1.8 details a case in which a company auditor has successfully identified fraud in an
organisation’s financial records and reported the matter to the regulators.
EXAMPLE 1.8
As we look at corporate failures over the last 30 years, it appears that too often the independence
and professional ethics of accountants failed. Instead, professionals left behind their standards in the
hope of becoming part of an economic revolution related to booming share market growth. The decade
beginning with the failures of 2001 to 2002 has seen the profession come under scrutiny to an extent never
previously seen.
The credibility of accounting as a profession of value has been very much ‘on the line’. Arguably, there
has been a diminution of public trust in the profession’s service ideal and a reduction in its former degree of
autonomy and independence. We now consider the response of the professions and government to restore
credibility to financial accounting, auditing and the accounting profession itself.
QUESTION 1.14
Reading 1.3, ‘How “soft skills” can boost your career’, was released in 2005 and is still relevant. It is
valuable in further discussing attributes of soft skills and how these can be important in successful
career development. You should study this now.
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KEY POINTS
REVIEW
This module explored what it means to be a professional accountant and the need to combine technical,
interpersonal and organisational skills with a commitment to the ethos and core values of the profession
in order to properly fulfil the demands and obligations of their role.
A recurring theme throughout this module has been the overarching obligation of the professional
accountant to put the public interest ahead of self-interest. This obligation guides the conduct of the
accounting profession in its work to provide useful information to support high-quality decision making.
Accountants must be capable of making professional ethical choices in complex circumstances that often
involve competing interests and degrees of uncertainty.
The accounting profession has been confronted with various challenges over the past few decades. This
module covered the responsibility that the accounting profession, in general, and professional accounting
organisations, in particular, have to respond to these challenges and ensure that society places value on and
benefits from the work of accounting professionals.
The core attributes of a profession represent and reflect both the value it creates and the way society
recognises this value. One core attribute is the privilege to self-regulate. CPA Australia has procedures
in place to ensure its members meet the required standards of professional conduct and the measures to
monitor and manage members’ conduct. Members can be subject to disciplinary action if allegations of
misconduct are proven against them and, in some cases, members may be struck off the membership
register. At present, accounting is co-regulatory, with external oversight imposed on the profession.
Professional accountants must be enquiring, innovative, measured and courageous in making ethically
sound, balanced professional judgments. To preserve the integrity of the profession and the trust of society,
acting in the public (rather than self) interest should be a fundamental goal of professional accountants.
REFERENCES
Abbott, A 2014, The system of professions: An essay on the division of expert labor, University of Chicago Press, Chicago,
pp. 8−9.
ACNC (Australian Charities and Not-for-profit Commission) 2019, ‘Australian charities report 2017’, Commonwealth of
Australia, accessed October 2019, www.acnc.gov.au/tools/reports/australian-charities-report-2017.
Allan, G 2006, ‘The HIH collapse: A costly catalyst for reform’, Deakin Law Review, vol. 11, no. 2, pp. 137–59.
APESB (Accounting Professional and Ethical Standards Board) 2018, APES 110 Code of ethics for professional accountants,
APESB, Melbourne, accessed July 2019, www.apesb.org.au/uploads/home/02112018000152_APES_110_
Restructured_Code_Nov_2018.pdf.
ASIC 2018, ‘Annual Report 2017–18’, accessed 2 September 2019, https://download.asic.gov.au/media/4922570/annual-report-
2017-18-published-31-october-2018-full.pdf.
—— 2019, ‘Audit inspection program report for 2017–18’, accessed 2 September 2019, https://download.asic.gov.au/media/
4990650/rep607-published-24-january-2019.pdf.
—— 2019, ‘Court enforceable undertaking prevents Gold Coast accountant from providing financial services’, accessed
September 2019, https://asic.gov.au/about-asic/news-centre/find-a-media-release/2019-releases/19-034mr-court-enforceable-
undertaking-prevents-gold-coast-accountant-from-providing-financial-services.
—— 2019, ‘Former chief financial officer convicted of causing false records and providing false information to company auditor’,
accessed September 2019, https://asic.gov.au/about-asic/news-centre/find-a-media-release/2019-releases/19-037mr-former-
chief-financial-officer-convicted-of-causing-false-records-and-providing-false-information-to-company-auditor.
—— 2019, ‘Federal Court fixes liquidators’ remuneration for winding up three Adelaide companies and orders them to repay
$1.9m plus interest and ASIC’s costs’ accessed September 2019, https://asic.gov.au/about-asic/news-centre/find-a-media-
release/2019-releases/19-140mr-federal-court-fixes-liquidators-remuneration-for-winding-up-three-adelaide-companies-and-
orders-them-to-repay-19m-plus-interest-and-asic-s-costs.
Australian Government 2014, ‘Financial system inquiry final report’, Australian Federal Government, accessed August 2015,
http://fsi.gov.au/publications/final-report.
Becker, EA 1982, ‘Is public accounting a profession?’, The Woman CPA, vol. 44, no. 4, pp. 2–4.
Blanthorne, C, Bhamornsiri, S & Guinn, RE 2005, ‘Are technical skills still important?’, The CPA Journal Online (New York State
Society of CPAs), March.
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ETHICS
LEARNING OBJECTIVES
ASSUMED KNOWLEDGE
LEARNING RESOURCES
Each of these resources is available on the APESB website at www.apesb.org.au. Candidates are encouraged
to download their own copy and read the guidance in full. Printing whole documents should not be necessary
except where you want to specifically focus on parts that will be examinable as noted throughout the text.
• APES 110 Code of Ethics for Professional Accountants (including Independence Standards) (APESB 2018)
• APES 230 Financial Planning Services (APESB 2013)
• APES GN 40 Ethical Conflicts in the Workplace—Considerations for Accountants in Business (APESB 2015)
PREVIEW
In module 1, we discussed what it means to be a professional accountant. We now extend this discussion to
examine the practical implications of professional ethics, based on the notions of the service ideal and the
public interest. Professional ethics extends beyond compliance with written codes and laws to also include
the ethical commitment of the professional person to act in the best interests of society.
Written codes and relevant rules establish the expectation and provide the principles for ethical
conduct. However, in practice many situations that involve ethical issues cannot be resolved by the simple
application of rules. Rather, the situation must be analysed from an ethics perspective to reach an ethical
decision. In this module, we discuss the notion of professional ethics and the analytical tools that guide
accountants and help them resolve ethical problems and dilemmas. These tools include a code of ethics
for professional accountants, philosophical theories of ethics and ethical decision-making frameworks.
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PART A: PROFESSIONAL ETHICS
INTRODUCTION
Ethics essentially deals with what is ‘right’ and ‘wrong’ and how people should act when faced with a
particular situation. The Chambers Dictionary defines ethics as ‘a code of behaviour considered correct’.
Professional ethics is the application of ethical principles or frameworks by professionals who have
an obligation to act in the interests of those who rely on their services as well as in the best interests
of the public. Ethical principles include integrity, objectivity, professional competence and due care,
confidentiality and professional behaviour. By acting ethically, professionals maintain the credibility of
the profession.
Any professional ethics framework adopted must be understood by members of the profession so that it
forms the basis for sound and consistent ethical behaviour. Later in this module, we will explore APES 110
Code of Ethics for Professional Accountants, the professional ethics framework issued by the Accounting
Professional Ethical Standards Board (APESB 2018).
The ethical responsibilities of a professional accountant include:
• the exercise of reasonable skills and diligence
• adherence to a professional code of ethics and standards
• the cautious application of relevant knowledge and experience
• professional scepticism to ensure that any observed discrepancies are properly followed up and
investigated.
A professional accountant is objective, takes full responsibility for the tasks they are entrusted to do,
adopts proper planning and control procedures, and possesses the integrity to maintain a professional
approach to work.
.......................................................................................................................................................................................
CONSIDER THIS
Reflect on what you understand to be the meaning of ethics at this point of your reading in the module. Write a note
somewhere. Come back to it at the conclusion of the module to see whether you would change what you have
written.
MODULE 2 Ethics 43
Another example of the way in which some entities behave that impacts on the broader community
is the failure of companies to report correctly in accordance with accounting standards. The Australian
Securities and Investments Commission (ASIC) conducts financial reporting surveillance and seeks
financial statement amendments from entities that failed to properly apply a particular accounting standard.
Accounting standards exist as a generally accepted set of principles for the preparation and presentation
of financial statements. Breaches of accounting standards result in a set of financial statements that a user,
irrespective of the stakeholder group to which they belong, may be misled. In circumstances where the
financial statements are relied on by an investor or other stakeholder, this can lead to incorrect judgments
being made about the governance of the entity or poor decisions about continuing investment in a business.
The regulator is empowered to request correction of the financial statements and, at times, court action can
be taken to penalise companies that have transgressed.
The impact of unethical decisions can be considered in relation to the whole profession and at the
individual level as well. The two levels are connected because the ethical failings of individual accountants
(who may suffer personal consequences as a result) also affect the overall profession, which suffers reduced
credibility and increased restrictions on its ability to act autonomously and to self-regulate.
Decisions that are not in line with accounting professional standards and legal obligations can result in
loss of membership, fines and even imprisonment. Therefore, it is important for professional accountants
to carefully assess decisions when faced with ethical choices to ensure the decisions they make are
satisfactory, both to other stakeholders and to themselves. Further examples are presented at the end of
this module.
A benefit of applying the frameworks that we will be describing in this module is that it helps us focus
not only on ourselves, but also on others who will be affected by our decisions. These frameworks can
guide the professional accountant to the most ethical decision, even when the most suitable option is not
readily apparent.
It is also appropriate to highlight the dilemma faced by managers who deal with the consequences of
unethical conduct by employees, contractors and others who are connected with the business. One model of
resolution that is worth noting was promoted by the late Doctor Rushworth Kidder, an ethicist (Christenson
1996). Doctor Kidder outlined a series of approaches to deal with ethical dilemmas in different parts of
life. These involved understanding that not all decisions by employers and others in authority relate to
things that are good or bad. The most challenging ethical dilemmas that a manager may face can be related
to deciding what to do when two outcomes can be deemed right. The Kidder approach is discussed in the
following section.
EXAMPLE 2.1
The James Hardie Group has also indicated . . . (including that it is under no legal obligation to do
so), that it is prepared to fund the future asbestos liabilities. In my opinion it is right that it should do
so (para. 1.23).
Source: Extract from © State of New South Wales
It is useful to consider the circumstances underlying the James Hardie case in the context of the work
of the late Dr Rushworth Kidder. Dr Kidder offered a different way of looking at ethical dilemmas in
circumstances where managers, parents and others struggled to identify the best course of action. The
Kidder philosophy identified four types of ethical dilemmas. These types were:
(1) Truth versus loyalty. You are a child. Your best friend has broken a window at school and has confessed
to you in confidence. The principal asks you if you know who did it. Do you tell the truth or evade the
question and remain loyal to your friend?
(2) Individual versus group. In wartime, a downed pilot is being hidden by the residents of a village
occupied by enemy soldiers. The soldiers will shoot one village resident every hour until the pilot
is surrendered. You are the mayor. Whose life do you save?
(3) Short-term versus long-term. You are a single parent with two small children. To qualify for a much
better position at work, you need an MBA which will require at least two years of classes and study
on nights and weekends. Where do you devote your time?
(4) Justice versus mercy. Your office manager confesses to you that she has been stealing money from the
office account to buy medicine for her ailing father. Her father has died, and she offers you a check
from the insurance proceeds to pay you back. After you cash the check, do you fire her or forgive her?
(Christenson & Burke 1996)
The categories put forward by Dr Kidder test what individuals believe is important in a specific situation.
These are not easy decisions. Consider the last category referring to the concept of ‘justice versus mercy’.
Terminating the employee for her conduct could be justified because the employee had been stealing funds
from the company, but is a more merciful approach, understanding the situation the employee was facing,
more appropriate here? Would the James Hardie case fall into the fourth category of justice versus mercy?
There was no obligation on the company to pay funds into a Foundation but is it right (morally correct)
that it did so?
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MODULE 2 Ethics 45
.......................................................................................................................................................................................
CONSIDER THIS
Consider the four categories of ethical dilemma described by Dr Kidder and identify a situation in your professional
and personal life in which you have confronted similar challenges. Reflect on how the issue was resolved and whether
you believe it was resolved in an appropriate way.
Issue
The research identified three key reasons why misconduct occurred within organisations, as shown in
figure 2.2. These were: pressures from clients (21.43%), conflicts of interest (18.91%) and pressure from
corporate management or a board of directors (17.65%).
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Cause
Pressure from client 21.43%
Conflict of interests 18.91%
The survey results detailed the most frequent responses of accountants to situations in which they
encounter ethical challenges. As shown in figure 2.3, accountants who report resisting pressure or saying
‘no’ made up 29.66% of the sample surveyed. Other strategies included the seeking of advice (16.35%),
educating fellow professionals (14.07%) and educating clients (11.79%).
Action
The research provides evidence that accountants encounter ethical challenges on a daily basis and an
examination of ethical and philosophical issues is not merely an academic exercise. Professionals must
ensure that they behave in a manner that is appropriate, irrespective of the context in which they work.
.......................................................................................................................................................................................
CONSIDER THIS
Visit the IFAC website and read the article in which the preceding survey results are published. Reflect on any
other issues you feel are of interest or that provoke further thought on your part. (www.ifac.org/global-knowledge-
gateway/ethics/discussion/assessing-and-improving-professional-accountants-ethical)
Examples 2.2 and 2.3 illustrate various situations encountered by professional accountants that highlight
the complexity of conflicts and choices that accountants face daily in their professional lives.
QUESTION 2.1
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MODULE 2 Ethics 47
EXAMPLE 2.2
Keep on Trucking
An entrepreneurial spirit, Jack Davis had moved out of his parents’ home at the age of 20, and into their
garage. He had successfully lobbied the local council to have the garage re-designated as a subplot of
his parents’ house, and hence a separate address: ‘303a’. As the area had mixed zoning, Jack began to
start a number of businesses. A voracious consumer of social media and online material, he was quick to
know what businesses might become fashionable, and set about creating low-cost start-ups, gathering
the requisite rights, and then selling them on.
Having gained sufficient capital in these ventures, Jack began his own ‘bricks and mortar’ business,
a Texas BBQ restaurant that would be delivered solely via food trucks. He refitted the unzoned ‘303a’
address as a smokehouse kitchen and bought two ageing trucks. Running a comprehensive social media
promotion for the business, Jack soon attracted investment, and decided to grow the business and seek
partnerships. Gil White, a friend who had recently completed his CPA, bought one of three 20% stakes in
the business and took over finance and accounting for the business.
Over the next six months the business expanded; Jack and Gil bought and refitted three more trucks
and took on several employees. At the end of this period, Jack prepared a memorandum for the partners,
recommending that they sell the business, as interest was high and they could probably net a considerable
profit. Gil was a little surprised, as the business seemed to be growing healthily. He asked Jack if it was
the best time to sell, and whether perhaps they should hang on to the business for another year or so.
Jack revealed that he’d heard rumours that there were plans to restrict the movements of food trucks,
heavily pushed by local restaurant owners who were feeling the pinch of the competition. This would likely
impact on the company’s viability in its expanded state. Gil realised that Jack was probably right, and that
exiting the business was the prudent move. Jack asked Gil to prepare the projected estimates in order to
begin the process of courting buyers. Gil pointed out that the estimates would depend heavily on whether
the council restricted food truck operations. Jack asked Gil to make no mention of the council plans, as
nothing was yet official, and few people were aware of the rumours. Jack had been closely monitoring local
government planning since having the garage re-designated. Furthermore, if they projected a downturn
in revenue then they would likely make a severe loss on the sale.
EXAMPLE 2.3
Sustainable Distribution
Dwyer worked as an auditor for several companies, but one source of regular work was a timber
decking business, Sustainable Solutions, an intergenerational family business now managed by two high
school friends. Jane also worked as a personal accountant for the two managers. A married couple,
Joe and Debbie Frazer, ran the company together after Joe’s father had retired from the position, until
Debbie largely retired to raise their two children. After steadily growing the business over more than a
decade, Joe and Debbie separated due to growing marital difficulties. In the following year Joe decided
to significantly expand the business, proposing the acquisition of a second distribution centre and to
expand the company’s fleet of light trucks, and sought Jane’s assistance in signing off on the proposal.
Jane looked at Joe’s projected estimates, and was not convinced. The proposal required significant
outlay on infrastructure, much of which would be borrowed against the value of the business. While
Sustainable Solutions maintained a constant client base, it was not clear that they could expand this
base proportionally to Joe’s proposed business expansion. Jane suspected that the move was intended to
embed Sustainable Solution’s current revenue in the new venture for the foreseeable future. She suspected
that Joe probably feared that a divorce may be imminent, involving a subsequent division of assets. By
taking on this debt, Joe could probably delay any division of revenue or company assets with Debbie.
Jane felt she had a duty to Debbie as much as Joe.
SUMMARY
The decisions made by professional accountants have consequences for themselves, the profession and
society. In this part of the module, we have described professional ethics as the application of ethical
principles and frameworks by professionals to guide their own behaviours. Ethical decisions are those
that support the overall objective of serving the interests of society. Unethical decisions undermine
the credibility of the entire profession and increase the likelihood that external regulators will impose
restrictions on the profession’s ability to act autonomously and self-regulate. For individuals engaging
in unethical conduct, consequences can include fines, loss of membership of the professional accounting
body and even imprisonment.
A career in the accounting profession will inevitably involve dealing with many ethical issues.
Key sources of pressure to act contrary to professional ethics include clients, corporate management
(e.g. the board of directors) and conflicts of interest. The most frequently encountered ethical issues revolve
around misleading reporting, fraud, tax evasion, lack of transparency and breaches of confidentiality.
Mere compliance with legal requirements does not ensure ethical behaviour. The use of a set of principles
provides the accountant with a clear and coherent basis for thoughts and actions, and a decision-making
framework guides the accountant to an ethical decision, even when uncertainty and conflicting interests
are involved.
To help with this, the next section provides a detailed overview of ethical theories, which is followed by a
practical examination of APES 110 Code of Ethics for Professional Accountants (including Independence
Standards).
While some of this discussion is quite theoretical, it is important for you to develop a clear
philosophy and understand your own ethical thoughts and approaches. You should consider each
theory carefully and identify which most closely aligns with your own view of what is ethical.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
MODULE 2 Ethics 49
• Unethical financial reporting misleads some stakeholders, leading to decisions different from those
that would be made with the true information.
• Both ethical and unethical reporting can have positive and negative consequences for various
stakeholders and the entity itself.
• Ethical financial advice puts the client’s interests ahead of the adviser’s interests. Unethical financial
advice may benefit the adviser at the expense of the client’s interests.
• Decision making by professional accountants that does not accord with the profession’s ethical
standards impacts negatively on the profession as a whole and on society’s trust in the profession.
This may result in increased external regulation.
• On an individual level, accountants that breach ethical standards may face penalties and lose their
membership of their accounting body.
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It is important to understand that there are other sources of ethical guidance, but that this part of
module 2 focuses on sources of Western ethical thought. In Western ethics, ethical theories are attempts to
either explain human behaviour as it is, which is called descriptive ethics, or provide a framework for how
people should behave, which is called normative ethics. One way of thinking about these approaches is
that any descriptive theory of ethical behaviour explains existing behaviour without necessarily seeking to
change it while normative ethical theories set norms for behaviour. In this course, the focus is on normative
theories of ethics.
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MODULE 2 Ethics 51
ETHICS OF CHARACTER
Ethics of character is also called virtue ethics. This is an area of ethical theory that calls upon people to
examine the various traits of individuals in order to determine whether they have behaved in a manner that
is wrong, based on that particular assessment. It has its origins in the thinking put forward by theorists
such as Aristotle. We will examine ethics of character in further detail later in this part of the module.
ETHICS OF CONDUCT
Ethics of conduct can be split into two prominent categories: teleological (or consequential) and
deontological (or non-consequential or duty-based). These two categories and the types of theories that
are classified within these categories are discussed in the following sections, but the key schools of thought
may be briefly summarised as follows.
• Teleological theories centre around the need for individuals and groups to consider the consequences
of actions. The ends justify the means. Two major theories in this category take alternative perspectives
on the object of the consequences/benefits.
– Egoism: focuses on taking actions that result in the best consequences for the individual taking the
action/making the decision.
– Utilitarianism: focuses on taking actions/making decisions that will result in the greatest good for the
greatest number of people, including possibly, but not necessarily, the person making the decision.
• Deontological theories centre round the need for individuals and groups to consider the intent of actions.
Some actions will never be justified despite potentially positive consequences and conversely some
actions may be justified despite the potentially negative consequences. Two major theories in this
category take alternative perspectives on what constitutes appropriate intentions.
– Rights: focuses on taking actions that intend to recognise the rights of the parties involved
– Justice: focuses on taking actions that intend to be fair and equitable to the parties involved.
Figure 2.5 illustrates the theories that fit into these two categories and two other key areas of moral
philosophy (ethics) — descriptive ethics and ethics of character.
Teleological Deontological
(Consequential) (Non-consequential) Virtue ethics
theories theories
There is no correct answer to these questions. Rather, these different approaches are represented by two
traditional teleological theories: egoism and utilitarianism. In brief, egoism evaluates the rightness of an
action from the perspective of the decision maker (self) whereas utilitarianism evaluates the rightness
of an action based on consequences for others. Because each person is a product of a number of
factors including education, culture and background, different individuals may choose to apply these
approaches differently. Remember that these theories are conceptual approaches to how we ‘ought to’
behave, not how we do behave. When it comes to making decisions, people are likely to make a decision
based on a mix of different types of ethical approaches, and their approach may also depend on the
particular situation.
EGOISM
An ethical egoist approach describes the idea that it is right for a person to pursue an action in their own
self-interest, assuming that everyone else is entitled to act in their own self-interest as well. As stated
previously, this is an ethical theory so, in reality, people are more likely to have a mix of different ethical
approaches. In this respect, ethical egoism is different from psychological egoism, which describes how
people tend to behave, without implying an ethical judgment about how they should behave.
Ethical egoists evaluate the rightness of a proposed action by choosing a course of action that maximises
the net positive benefits to themselves. An example of egoism would be a company that only releases
information or clarifies issues when it is in the company’s self-interest for the information to be released.
Such companies display ethical egoism when they support this behaviour as an appropriate general rule.
Based on the assumption that human beings tend to act in a way that brings them some form of happiness
or avoids some form of unhappiness, ethical egoism contends that this reality should be accepted as a
social norm.
The term ‘happiness’ has a number of connotations, but the characteristics of happiness generally include
a feeling of joy or delight, satisfaction or peace of mind, and the sense of achieving one’s goals or desires.
Correspondingly, unhappiness may be defined as a feeling of pain or sadness, frustration and the sense of
failure in achieving one’s goals or desires. Although this module refers to an egoist as a single person, the
term ‘egoist’ can also refer to a group of people or an organisation.
One difficulty with egoism is that acts of self-interest are commonly misunderstood as acts of selfishness.
According to this view, egoists are people who demonstrate a lack of concern for the well-being of
others and will justify questionable acts such as discrimination or dishonesty if they promote self-interest.
However, self-interest may also include concern for the well-being of others, and can sometimes contradict
selfishness. We use the term enlightened self-interest precisely to highlight situations where acting
selfishly may not be in our own self-interest.
EXAMPLE 2.4
Ethical egoism also contends that the pursuit of self-interest should be constrained by the law and the
conventions of fair play. Rules and legal systems exist to resolve conflict. It is, therefore, in the interests of
all parties to obey and accept the decision of arbitration systems because, without them, chaos will result.
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MODULE 2 Ethics 53
Thus, self-interest is not allowed to function unbridled by the law or the dictates of what is considered fair
competition. We can refer to this as restricted egoism.
Restricted egoism can be seen as an ethically more acceptable form of egoism. It sanctions corporate
self-interest and encourages competition to the extent that it leads to the maximisation of utility and is in
the interests of society as a whole.
UTILITARIANISM
According to the utilitarian (or utility) principle, determining good from bad, or right from wrong, is an
act or decision that produces the greatest benefit or pleasure for the greatest number of people. Similarly, if
harm is inevitable, the right course of action is the one that minimises harm or pain to the greatest number
of people. Under utilitarianism, pleasure and pain may be both mental and physical. As noted in the earlier
example, one of the problems that may arise is that an action that generates great benefit for many people
may also come at the cost or harm to smaller minority groups. This dilemma is often faced by governments,
but is also faced by organisations, which often need to make decisions that may benefit most employees
but may also have a negative impact on a few employees.
The utilitarian principle is attractive because it is easy to understand and provides a systematic approach
to problem resolution. Applying this principle to judgment, decision making and problem solving is a
process that relies on five basic steps.
1. Identify and articulate the ethical problem(s).
2. Identify all available courses of action that will resolve the situation.
3. Determine the foreseeable costs and benefits (short and long term) associated with each option.
4. Compare and weigh the ratio of good and bad outcomes associated with each option.
5. Select the option that will produce the greatest benefit for the greatest number of people.
While the process is conceptually simple, in certain circumstances it may lead to very complex
calculations.
A utilitarian analysis should be distinguished from a cost–benefit analysis that is normally applied in
business decisions. A cost–benefit analysis in business is generally weighed up in economic terms and
only as it relates to the decision maker and the employing organisation.
EXAMPLE 2.5
Benefits
Savings 180 burn deaths, 180 serious burn injuries, 2100 burned vehicles
Unit $200 000 per death, $67 000 per injury, $700 per vehicle
Total benefit 180 × ($200 000) + 180 × ($67 000) + 2100 × ($700) = $49.5 million
Costs
Total cost 11 000 000 × ($11) + 1 500 000 × ($11) = $137 million
Source: Hoffman WM 1982, ‘The Ford Pinto’, Business Ethics: Readings and Cases in Corporate Morality, McGraw-Hill
Book Company, New York, pp. 412–20.
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Stakeholders Pursuit of self-interest should not come at Produces the best overall consequences for
the expense of others. everyone concerned.
Pursuit of happiness is constrained by Greatest happiness rule may come at the
the law and the conventions of fair play cost of a minority.
(restricted egoism).
QUESTION 2.2
A candidate in the CPA program is explaining to a friend the concept of utilitarianism. In doing
so, the candidate defines utilitarianism as ‘an action that provides me with the greatest amount of
measurable monetary rewards over costs’.
Identify the problem(s) with this definition.
P d f_Folio:55
MODULE 2 Ethics 55
2.7 DEONTOLOGICAL THEORIES (DUTY BASED)
We now turn our attention to the main deontological theories. In contrast to teleology, a deontologist asserts
that there are more important considerations than outcomes. In fact, it is the intention behind the act itself
that is more important than the results of the act. To do justice to the complexities of professional life, it
is important to acknowledge that ethical decisions may be evaluated using a variety of criteria, and that
giving priority to consequences is only one criterion among others.
According to German philosopher Immanuel Kant (1724–1804), persons of goodwill are motivated by
a sense of duty to do the right thing. Therefore, what is important to a deontologist is the intention to do
the ‘right thing’, or the motivation to behave in an appropriate manner in accordance with a sense of duty.
Take the example of telling a lie. Some look to the consequences that are likely to flow from telling a
lie (a consequential analysis), whereas a deontologist would argue that it is always wrong to lie, whatever
the outcome(s).
MOTIVE
Deontology advocates that the motive is far more important than the action itself or its consequences.
Self-interest or emotion, rather than a sense of duty, are not appropriate motives for an ethical act. The
overriding value that guides duties, in Kant’s view, is respect for the human dignity of all involved.
Although the good consequences that result from an act may be the same regardless of its motive, it is
the desire to do the right thing for its own sake that makes it an ethical act and distinguishes it from an act
of selfishness. Therefore, actions are right, not because of their benefits but because of the nature of the
actions or the rules from which they derive.
There are two major concepts in relation to which duties may be examined: rights and justice.
RIGHTS
An ethical theory of rights contends that a good or correct decision is one that respects the rights of others.
Conversely, a decision is considered wrong if it violates the rights of a person or organisation.
A right is an entitlement that a person may have by virtue of a particular characteristic, role or condition
that defines them. For example, it is generally recognised that each person has a right to liberty, and
therefore no one should be enslaved.
While rights are not to be confused with duties or obligations, there is a close correlation between
a person’s rights and the duty or obligation of another not to interfere with or abuse these rights. In
accounting, a client can expect to have their right to confidentiality protected by their accountant, who
has a duty not to breach this right unless the need to serve the public interest supersedes it. A decision will
be considered ethical if the resulting actions do not offend the rights of anyone affected by that decision.
EXAMPLE 2.6
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Human Rights
Human rights, on the other hand, are more fundamental to society and relationships, and are the key to
maintaining social order. They are natural rights that apply to all people simply because they are human
beings. Some commonly recognised human rights are the:
• right to life
• freedom of choice
• right to the truth
• right to privacy
• freedom of speech.
One limitation of the rights principle is its inability to address conflicting rights and obligations. What
should one do when respecting one person’s rights contravenes the rights of another? Which rights should
be given preference? In Western societies, the right to free speech is often considered a fundamental human
right that should be respected. But what if allowing one person to express their views brings harm to
another? An important weakness of the rights principle is that it provides little guidance on how to prioritise
among different rights. A solution to this problem may be examining the freedoms and interests at stake
and deciding which one of all those considered is more essential to human dignity.
JUSTICE
Under principles of justice, an ethical decision is one that produces: (1) the fairest process by which any
person in a particular situation should be treated by others (procedural justice); or (2) the fairest distribution
of benefits and burdens among members of a group or community (distributive justice). Therefore, justice
theory is concerned with issues of fairness and equality.
Considering distributive justice, while it is generally unethical or unjust to have an unfair distribution
of benefits and burdens, there are different ways of deciding on what basis a fair distribution should be
conducted.
• Should each person receive an equal share? (equality principle)
• Should each person be rewarded for their individual effort or ability? (merit principle)
• Should each person receive a share based on need rather than ability? (needs principle)
EXAMPLE 2.7
Equality
Ravi and Delfina perform the same job functions to the same level. Distributive justice then commands that
they should receive equal benefits. Injustice occurs when Ravi receives more benefit because of irrelevant
concerns such as gender or race. However, if Ravi is more talented and works harder, the justice principle
dictates that Ravi should receive more. Therefore, justice is a function of contributions and rewards.
This example highlights a significant justice issue that exists in relation to the gender gap, where men
often receive higher wages than women for equivalent roles.
The principle of equality can be discussed in significantly different ways. Aristotle argued that fairness
does not mean treating everyone the same but acknowledging individual differences and allocating
resources to reflect these differences. In applying his account of fairness to workers with disabilities,
for example, treating equals equally and treating those who are unequal differently or unequally requires
that special provisions should be made for disabled workers to access and enjoy the use of workplace
facilities just as others do. Another qualified approach to equality is the difference principle (Rawls 1971),
which allows for unequal distribution of resources only in circumstances where this distribution works to
everyone’s advantage, including those placed in an inferior position by the inequality that results.
Pdf_Folio:57
MODULE 2 Ethics 57
Irrespective of the nuances involved, according to the principle of distributive justice, an ethical decision
is one that results in a fair and equal distribution of benefits and burdens.
A limitation of virtue ethics is that it does not always provide guidance when a person is faced with a
genuine ethical dilemma. Unlike traditional theories of ethics that emphasise a ‘right’ action, virtue ethics
emphasises the personal attributes that an ethical person should possess. However, it does not necessarily
make clear what one should do in a specific conflict situation.
MORAL AGENCY
A moral agent is a decision maker who has the ability to make moral judgments based on some notion of
right and wrong and is held accountable for these actions. Accountants are a class of professional that may
be regarded as being moral agents. They have a framework of ethics and are trained in the requirements
of their profession. They are capable of being held accountable for their actions and are less likely to be
able to claim that they lack an understanding or avoid responsibility.
Consider the various areas of guidance accountants use in everyday practice. Accountants understand
that financial statements are meant to be prepared in accordance with accounting standards. There is no
manner in which an accountant can claim to not know that accounting standards should apply. Auditors
know that auditing standards should be applied in the engagements they undertake. Accountants who are
liquidators also understand that there are legal and regulatory constraints on what they are able to do in
Pdf_Folio:58
QUESTION 2.3
Refer back to the Jack and Jane in examples 2.2 and 2.3. Each is acting from a particular ethical
perspective. For each, identify the ethical theory that they as moral agents could use to justify
their actions.
SUMMARY
We have now considered a broad range of ethical viewpoints, from those that focus on self-interest to those
that are linked to intention and motivation rather than outcomes.
From this discussion you should be aware that two people may come to very different answers about
what is ethical in a particular situation. You should also have a clearer understanding of your own ethical
philosophy. It is also useful to understand how other people may be making their decisions.
In the next section, we move away from the theoretical aspects of ethics to review APES 110, which
outlines the ethical principles guiding the behaviour of professional accountants.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
2.2 Discuss the key philosophical approaches to ethics and how these impact on the professional’s
ethical decision making.
• Normative theories set down principles that establish a norm for behaviour. These theories provide
a framework for judging right from wrong or good from bad.
• There are two categories of normative theories: teleological (or consequential) and deontological (or
duty based).
• Two theories in the teleological category are egoism and utilitarianism.
• Egoism has at the centre of its ethical approach that a person is right to pursue actions in their own
self-interest.
• Utilitarianism is a theory that gives primacy to actions which serve the greater good of a majority of
people, even though a minority may be adversely affected by decisions.
• Deontological theories are duty based and a central theorist in the deontological school of thought
is Kant. Two key theories in the deontological category are duties, and rights and justice.
• Virtue ethics, another ethical theory, comes from the tradition of Aristotle and centres around how a
person should be rather than what a person should do.
• Each of these philosophical standpoints is a way of viewing problems people confront each day. Each
philosophical approach offers a different perspective about how people should deal with dilemmas.
Professional ethics are built on principles that are drawn from general ethical theories.
• Professional accountants, in their role as moral agents, may use any one of these ethical theories
when making decisions involving ethical dilemmas, and be held accountable for their decisions.
P d f_Folio:59
MODULE 2 Ethics 59
PART C: APES 110 CODE OF ETHICS FOR
PROFESSIONAL ACCOUNTANTS
(INCLUDING INDEPENDENCE STANDARDS)
INTRODUCTION
In this section, we discuss the APES 110 Code of Ethics for Professional Accountants (including
Independence Standards) (APESB 2018), as at November 2018. It is referred to as the APES 110 because
it includes of amendments that have been made to the standard over time. It may also be referred to as
APES 110, the APESB Code of Ethics or ‘the Code’. The most recently issued version of the APESB
Code of Ethics can be found on the APESB website under ‘APES 100 Code of Ethics — effective from
1 January 2020’ at: www.apesb.org.au/page.php?id=12.
Candidates are not expected to print out the entire APESB Code of Ethics, although it may be
helpful to print sections that are referenced and/or discussed in the study guide. Unless specifically
noted, only the content in the study guide is examinable. You should, however, ensure that you
download a copy of the Code of Ethics so that you can refer to it during study.
The International Ethics Standards Board for Accountants (IESBA) develops and issues the Code of
Ethics for Professional Accountants. CPA Australia is a member body of the International Federation
of Accountants (IFAC) and, as such, cannot apply less stringent standards than those stated in the
IESBA Code.
The APESB, which issues the ethical and professional standards for CPA Australia, released the APESB
Code of Ethics, which incorporates the IESBA Code and was initially operative from 1 July 2006. The
current version of the APESB Code of Ethics was issued in November 2018. Australian-specific ethical
requirements that have been inserted into the APESB Code of Ethics are denoted with an ‘AUST’ prefix.
It is important to be aware of the hierarchy of ethical pronouncements issued by the APESB. Figure 2.6
illustrates the hierarchy, which is has at its apex the Code of Ethics that is supported by standards covering
specific topics, and guidance notes. The Code sets down the foundation principles on which other APESB
guidance is based.
Under paragraph R1.2 of the APESB Code of Ethics, ‘all Members in Australia shall comply with
APES 110 including when providing Professional Services in an honorary capacity’. Under paragraph
R1.3 of the Code, ‘all Members practising outside of Australia shall comply with APES 110 to the extent
to which they are not prevented from so doing by specific requirements of local laws and/or regulations’.
CPA Australia members must comply with the APESB Code of Ethics.
The APESB Code of Ethics expresses the distinguishing mark of the accounting profession, which
is its acceptance of the responsibility to act in the public interest. The Code highlights the fundamental
principles that apply to all aspects of a professional accountant’s work, and also provides guidance for
resolving conflicts of interest and other ethical situations that may arise from time to time.
To further clarify what it means to act in the public interest and, more explicitly, to outline the
members’ obligations that stem from this responsibility, the ‘Responding to Non-Compliance with Laws
and Regulations’ (NOCLAR) requirements were added in the APESB Code of Ethics in May 2017 and
became effective on 1 January 2018. NOCLAR allows members to report to an appropriate authority
an actual or suspected non-compliance with laws and regulations by a client or employer, when such a
disclosure is in the public interest, without breaching the duty of confidentiality. It provides proportional
requirements for members to follow depending on the professional activity or service they provide,
and clarifies that withdrawing from the engagement and professional relationship or resigning from
the employing organisation are not substitutes for the other actions that are required under NOCLAR.
Provisions related to NOCLAR are discussed further in this section.
By joining a profession, members agree to uphold its high ethical standards. The proper fulfilment of
the role of an accountant involves discharging one’s professional work responsibilities while ensuring
compliance with all the obligations included in the Code.
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APESB Standards
Conceptual Framework Members in All Members Members
• Principles based Public Practice in Business
• Mandatory for professional accountants
APES 300 APES 400
Standards series series
• Introduces principles
• Mandatory requirements in bold-type
APES 200
• Guidance and/or explanation in regular type
Series
Guidance notes
Guidance notes
• Do not introduce new principles
• Guidance on a specific matter on which Members in All Members Members
the principles are already stated in a Public Practice in Business
Standard
• Guidance is only in regular type
APES GN 30 APES GN 40
series series
APES GN 20
Series
Source:APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB,
Melbourne, www.apesb.org.au/uploads/standards/apesb_standards/ 23072019020747_APES_110_Restructured_Code_Nov_
2018.pdf.
Pdf_Folio:61
MODULE 2 Ethics 61
Safeguarding the public interest is an overriding responsibility that underpins all professional duties and
obligation. Members have a duty to a number of stakeholders, including clients, employers, shareholders
and the accounting community. For example, in preparing financial reports for a client, accountants have
a responsibility to the financial institutions from which client companies obtain finance. They also have a
responsibility to the client, who provides remuneration in return for diligent and competent service, and
to shareholders, who invest their trust in the external financial reports of the client company.
In cases where the accountant has obligations to more than one stakeholder, the question arises of to
whom the accountant owes their primary loyalty. In public practice, it is tempting to assume that the
accountant–client relationship is central to the function of accounting. In this view, no one else matters but
the client. Similarly, in the accountant–employer relationship, it may be presumed that accountants owe
their primary loyalty to their employers. Both views are incorrect.
The accountant’s primary duty is not to the client or the employer, but to the public. Therefore, emphasis
on the public interest extends to interests beyond the needs of an individual client or employer. In general,
it is assumed that the accountant is obligated to advance the interests of their client or employer, so long
as this does not conflict with the obligation to safeguard the public interest.
In addition to defining their obligations under the public interest, members of the accounting profession
must also understand what it means to serve the public interest. This encompasses the pursuit of excellence
for the benefit of others and includes integrity, objectivity, independence, confidentiality, adherence to
technical and professional standards, competence and due care, and ethical behaviour.
Consequently, serving the public interest relies on professional behaviour, underpinned by adherence
to the fundamental principles of professional conduct and a conceptual framework approach to applying
those principles. As a result, the Code of Ethics is relevant to all professional accountants. By applying the
Code of Ethics, professional accountants will be acting in the public interest.
QUESTION 2.4
Watch this IFAC recorded webinar introducing the new Code of Ethics and why the revisions made
to the standard exist. It is critical that all members understand the context of the Code of Ethics
and how it is intended to operate.
Watch the video: https://youtu.be/x5QWAiUemEY.
Imagine you are required to explain the Code to a new recruit in an office after watching the
webinar. (You may also need to refer to paragraphs 4, 11–15 in the Guide to the Code at the start of
APES 110.) Consider how you would describe:
(a) the purpose and importance of the Code
(b) the members to whom the Code applies
(c) whether the Code applies to members working in not-for-profit organisations
(d) the purpose of the letters R and A throughout the Code in various paragraphs
(e) the difference in interpretation and application of clauses in the Code that contain the words
‘shall’, ‘may’ and ‘might’.
dP f_Folio:62
FIGURE 2.7 The fundamental principles and where they are mentioned in the Code of Ethics
Professional competence
Integrity Objectivity
and due care
(s. 111) (s. 112)
(s. 113)
QUESTION 2.5
Access APES 110 and use your reading of section 110 to complete this question.
Each of the fundamental principles has a definition in paragraph 110.1 A1. Add the definitions to
table 2.3.
Definition
Integrity
Objectivity
Confidentiality
Professional behaviour
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MODULE 2 Ethics 63
As integrity is intrinsically linked with trust, the APESB Code of Ethics imposes an obligation on
accountants to be straightforward and honest in professional and business relationships (para. R111.1).
This means that accountants:
... shall not knowingly be associated with reports, returns, communications or other information where the
Member believes that the information:
(a) Contains a materially false or misleading statement;
(b) Contains statements or information provided recklessly; or
(c) Omits or obscures required information required where such omission or obscurity would be
misleading (para. R111.2).
EXAMPLE 2.8
Moral Courage
Michael Woodford, the CEO of Olympus, blew the whistle on an enormous USD$1.7 billion fraud, knowing
that this would cause personal hardship to himself. Instead of being rewarded, he was sacked and ended
up fearing for his life. Despite this, Woodford insists that he would take the same action again. However,
he also suggested that, based on his experience, he understood how hard it would be for a more junior
employee with responsibilities such as a family or mortgage to take the risk of disclosing problems to an
employer (Dugdale 2012).
MODULE 2 Ethics 65
their colleagues. This includes avoiding exaggerated claims about the services offered, qualifications or
experience, and avoiding disparaging references or unsubstantiated comparisons to the work of others
(para. R115.2).
QUESTION 2.6
Each statement in table 2.4 is aligned to one of the fundamental principles. Identify the principle
and add it next to the statement in the column on the right.
Statement Principle
This fundamental principle deals with implicit fair dealing and truthfulness.
Members shall avoid conduct that they know may discredit the profession.
dP f_Folio:66
The fundamental principles form the foundation of the Code of Ethics and are to be applied by all
members irrespective of the context in which they work. Specific guidance on how members who are
accountants in business or accountants in practice appear later in the module. Consider the issues related
to fundamental principles in the context of the Scott London case study which follows below.
EXAMPLE 2.9
QUESTION 2.7
(a) Who were the stakeholders (individuals or groups who have a stake in what happens), and how
were they affected by the actions of Scott London?
(b) Did London breach any of the fundamental principles of professional conduct contained in the
Code of Ethics? If so, state those principles and explain why you think they have been breached.
P d f_Folio:67
MODULE 2 Ethics 67
THE CONCEPTUAL FRAMEWORK (s. 120)
The conceptual framework approach, which relies on the application of key principles for decision making,
differs from rule-based codes, which require adherence to a set of specific rules in terms of the specific
actions that should or should not be taken. The problem with a code that is entirely rules-based is that it
becomes too prescriptive and too voluminous to be of practical use. Excessive prescription causes ethical
decision making to focus too much on whether the rule permits or prohibits a particular treatment or
behaviour, rather than using ethical judgment to determine whether a fundamental principle is protected.
For a principles-based code to be effective, it is useful to take a blended approach containing a mix of
broad principles and more specific guidance that is specific to areas of an accountants’ work and certain
tasks which together show how the conceptual framework applies in specific situations.
The conceptual framework (outlined in APES 110) that members are required to consider when
determining whether there are any threats to the fundamental principles is made up of three steps.
(a) Identify threats to compliance with the fundamental principles;
(b) Evaluate the threats identified; and
(c) Address the threats by eliminating or reducing them to an Acceptable Level (para. 120.2).
Members need to identify, evaluate and respond to any identified threat that may compromise compli-
ance with the fundamental principles. If the identified threats are significant, members must address them
by eliminating them or reduce them to an acceptable level, so that compliance is no longer compromised.
If accountants are unable to implement appropriate safeguards, they should either decline or discontinue
the specific professional service involved, or consider resigning from the client or employer. Figure 2.8
illustrates the conceptual framework approach.
Threat identified
Is the threat to No
fundamental principles No further action
significant?
Yes
Implement safeguard(s)
Is threat
Yes
mitigated to an
acceptable level?
No
Decline or discontinue
service, client or employer
Source: Delaportes et al. 2005, Ethics, Governance and Accountability: A Professional Perspective, John Wiley & Sons, Milton,
Queensland.
Pdf_Folio:68
QUESTION 2.9
Read paragraph 120.6 A3 carefully and name the threat that matches the definition given in
table 2.5.
Definition Threat
The threat that a Member will be deterred from acting objectively because
of actual or perceived pressures, including attempts to exercise undue
influence over the Member.
The threat that a Member will not appropriately evaluate the results of a
previous judgement made, or an activity performed by the Member, or by
another individual within the Member’s Firm or employing organisation,
on which the Member will rely when forming a judgement as part of
performing a current activity.
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
Example 2.10 illustrates the conceptual framework approach to compliance with the fundamental
principles of professional conduct.
EXAMPLE 2.10
MODULE 2 Ethics 69
acceptable level. One relevant safeguard includes consultation with superiors within the employing
organisation (such as the audit committee or other body responsible for governance), or with a relevant
professional body. If the threat cannot be mitigated to an acceptable level, the accountant should consider
discontinuing their service for the employer.
The specific nature of each threat will depend on the particular circumstances or relationships in which
it arises, and some may be difficult to categorise.
QUESTION 2.10
Categorise each of the threats in table 2.6 according to APES 110’s five categories.
TABLE 2.6 Examples of threats — accountants in business and accountants in public practice
Self-interest
Intimidation
Self-review
Familiarity
Advocacy
Circumstance
Members in Business
An audit team member having a long association with the audit client.
dP f_Folio:70
A Member having prepared the original data used to generate records that are ✓
the subject matter of the assurance engagement.
A Member being informed that a planned promotion will not occur unless the
Member agrees with an inappropriate accounting treatment.
Source:APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB,
Melbourne, www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_
2018.pdf.
MODULE 2 Ethics 71
TABLE 2.7 Considerations for evaluating threats
A member in business will need to evaluate threats Threats to fundamental principles will need to be
in the context of the engagement or task being evaluated with reference to the client and its operating
undertaken. environment and the firm (professional practice) and its
operating environment. Threat evaluation will also be
impacted by the nature of scope of service involved.
Assessments of threats will be impacted by the work Evaluation of threats by members in public practice
environment and factors to be considered may include will be dependent in part on the operating environment
the following. of the client and whether they are an audit client, an
• Leadership that stresses the importance of ethical assurance client or a non-assurance.
behaviour and the expectation that employees will The client’s governance structure and cultural tone
act in an ethical manner. may promote compliance with fundamental principles.
• Policies and procedures to empower and encourage Factors that may be considered include the following.
employees to communicate ethics issues that • The client requires appropriate individuals other than
concern them to senior levels of management management to ratify or approve the appointment of a
without fear of retribution. Firm to perform an engagement.
• Policies and procedures to implement and monitor • The client has competent employees with experience
the quality of employee performance. and seniority to make managerial decisions.
• Systems of corporate oversight or other oversight • The client has implemented internal procedures
structures and strong internal controls. that facilitate objective choices in tendering non-
• Recruitment procedures emphasising the assurance engagements.
importance of employing high calibre competent • The client has a corporate governance structure that
personnel. provides appropriate oversight and communications
• Timely communication of policies and procedures, regarding the Firm’s services.
including any changes to them, to all employees,
and appropriate training and education on such Evaluation of threats also need to take place in
policies and procedures. the context of the professional firm’s operating
• Ethics and code of conduct policies. environment. A member in practice may consider
the following factors when evaluating threats to
fundamental principles.
• Leadership of the Firm that promotes compliance
with the fundamental principles and establishes the
expectation that assurance team members will act in
the public interest.
• Policies or procedures for establishing and monitoring
compliance with the fundamental principles by all
personnel.
• Compensation, performance appraisal and
disciplinary policies and procedures that promote
compliance with the fundamental principles.
• Management of the reliance on revenue received from
a single client.
• The Engagement Partner having authority within the
firm for decisions concerning compliance with the
fundamental principles, including decisions about
accepting or providing services to a client.
• Educational, training and experience requirements.
• Processes to facilitate and address internal and
external concerns or complaints.
A member may need to reconsider threats to
fundamental principles when new information arises
that could impact the level of a threat or whether
safeguards could address the threat appropriately.
Examples of new information or changes in facts and
circumstances that might have an impact on threat
levels include:
• When the scope of a Professional Service
is expanded.
• When the client becomes a Listed Entity or acquires
another business unit
• When the Firm merges with another Firm.
Pdf_Folio:72
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB, Mel-
bourne, www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
Identification and evaluation are the first two steps in the process for dealing with threats to the
fundamental principles. A threat that is evaluated as not being at an acceptable level needs to be addressed.
This is the third step in applying the conceptual framework.
It should be noted that, if members are unable to eliminate the circumstances that gave rise to the threat
or find that safeguards will not bring the threat down to an acceptable level, the only option left is to decline
to engage in or to end a particular professional activity (para. 120.10 A1).
The safeguards to eliminate or reduce threats to the fundamental principles of professional conduct
generally fall into two broad categories: institutional safeguards, and safeguards in the work environment.
It should be noted that the standard tailors specific guidance for matters such as independence issues
(particularly relevant in the circumstances of audit and assurance engagements) and guidance related to
the way in which threats can be dealt with in a business or accounting practice environment.
The independence standards form Parts 4A and B of the Code while issues of specific relevance to
professional accountants in business are covered in Part 2, and public practice accountants will find
guidance in Part 3.
Examples of the kinds of safeguards that could be applied include:
1. Institutional safeguards created by the profession, legislation or regulation:
– educational, training and experience requirements for entry into the profession
– continuing professional development requirements
– corporate governance regulations
– professional standards
– professional or regulatory monitoring and disciplinary procedures.
2. Safeguards particular to the work environment:
– corporate oversight structures, strong internal controls, ethics and conduct programs and appropriate
disciplinary processes
– recruitment of high-calibre, competent staff and leadership that stresses ethical behaviour
– empowering and encouraging employees to communicate ethical issues to senior management,
without fear of retribution.
Some safeguards help to identify and deter unethical behaviour and apply across both categories. These
include effective, well-publicised policies that outline required behaviours, as well as disciplinary and
complaints systems that enable colleagues, employers, accountants or the public to draw attention to
unprofessional or unethical behaviour.
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MODULE 2 Ethics 73
Documentation and Advice
In applying the three steps of the conceptual framework, members are encouraged to document the process
and outcomes (para. 110.2 A3) and to consider consulting others (para. 110.2 A2) including:
• others within the firm or employing organisation
• those charged with governance
• a professional body
• a regulatory body
• legal counsel.
240 Financial interests, compensation and 330 Fees and other types of remuneration
incentives linked to financial reporting and
decision making
250 Inducements, including gifts and hospitality 340 Inducements, including gifts and hospitality
270 Pressure to breach the fundamental 360 Responding to non-compliance with laws
principles and regulations
Members in Business (para. 210.4 A1) Members in Practice (para. 310.4 A1)
Pdf_Folio:74
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB, Mel-
bourne, www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
The more direct the connection between the professional activity and a conflict of interest, the more
likely it is that there is no way of ensuring a risk is kept to an acceptable level. There is a need for businesses
and professional practices to ensure that they identify potential conflicts and decide on the best way to deal
with them. It is necessary in the cases of members in either business or public practice to ensure they review
all business engagements to assess them for any potential conflicts. Members in practice, in particular,
need to ensure they evaluate the nature of interests and relationships that exist between the various parties
involved, and whether there are implications of any service offering that is being considered.
There is a need to ensure that a conflict of interest is properly dealt with by putting in place safeguards
that may assist in mitigating or reducing threats to the fundamental principles to an acceptable level.
Safeguards that may be applied in business and practice in the context of minimising or preventing conflicts
of interests are presented in table 2.10.
• Restructuring or segregating certain responsibilities In the case of confidential client information that may
and duties. be a concern when dealing with clients in similar
• Obtaining appropriate oversight, for example, acting industries, for example, the Code suggests measures
under the supervision of an executive or such as the following.
non-executive Director. • The existence of separate practice areas for
• Withdrawing from the decision making process specialty functions within the Firm, which might
related to the matter giving rise to the conflict act as a barrier to the passing of confidential client
of interest. information between practice areas.
• Consulting with third parties, such as a professional • Policies and procedures to limit access to client files.
body, legal counsel or another Member. • Confidentiality agreements signed by personnel and
partners of the Firm.
(continued)
P df_Folio:75
MODULE 2 Ethics 75
TABLE 2.10 (continued)
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB, Mel-
bourne, www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
QUESTION 2.11
Francis is a member working in a practice that specialises in the provision of financial advice.
Toby and Francis are both directors and they are both engaged in providing financial advice to
clients. Francis and Toby discussed investment strategies appropriate for a new client that involved
property investments and Toby disclosed that he has interests in a property investment firm while
Francis has no shares or ownership in such an entity.
Determine the potential conflict that exists in this situation and suggest a strategy to reduce the
threat to fundamental principles to an acceptable level.
QUESTION 2.12
Celia is a director of a company that is a local uniform manufacturer but she is also on the
management committee of a local community group which has launched its annual fundraising
drive. Celia has mentioned the fundraising initiative to her board colleagues and suggested that
the business could benefit from being associated with a group that has an objective to help the
needy in the same area in which the company has its factory and corporate offices. Celia is an
accountant and has disclosed her interest as a member of the management committee.
The board of the uniform manufacturing company is considering the request. How should the
board deal with Celia’s suggestion?
QUESTION 2.13
You have been asked to audit Toytown Pty Ltd’s half-year financial statements.
• The company was last audited by Smith, Jones & Associates, which resigned as the auditor as a
result of the retirement of the only registered company auditor within the practice.
• For the last three years, Toytown has engaged Ace Tax Services, a firm of local CPAs, to prepare
corporate income tax returns and wishes this arrangement to continue.
Are you required by the APESB Code of Ethics to contact or obtain professional clearance from
each of the above accounting firms before accepting the appointment as auditor of the half-year
financial statements?
dP
f_Folio:76
A self-interest threat exists when a Member: Level of fees (para. 330.3 A2):
• Has a motive and opportunity to manipulate price- Level of fees may impact on a Member’s ability
sensitive information in order to gain financially. to perform services to appropriate professional
• Holds a Direct or Indirect Financial Interest in standards. If a fee quoted is too low if may be difficult
the employing organisation and the value of that for the Member to perform a service in accordance
Financial Interest might be directly affected by with technical and Professional Standards.
decisions made by the Member. Contingent fees (paras. 330.4 A1, AUST R330.4.1):
• Is eligible for a profit-related bonus and the value of Contingent fees are dependent on an outcome and
that bonus might be directly affected by decisions these may create a self-interest threat in circumstances
made by the Member. where a practitioner may not be objective in the
• Holds, directly or indirectly, deferred bonus share delivery of professional services. The Code prohibits
rights or share options in the employing organisation, contingent fees in the following types of services:
the value of which might be affected by decisions forensic accounting, valuation, insolvency, reporting
made by the Member. on prospective financial information, due diligence
• Participates in compensation arrangements which committee participation.
provide incentives to achieve targets or to support
efforts to maximise the value of the employing Referral fees (para. 330.5 A1):
organisation’s shares. An example of such an Referral fees may lead to a self-interest threat,
arrangement might be through participation especially in circumstances where fees are:
in incentive plans which are linked to certain • paid to another Member in Public Practice for
performance conditions being met. the purposes of obtaining new client work when
the client continues as a client of the Existing
Accountant but requires specialist services not
offered by that accountant
• a fee received for referring a continuing client to
another Member in Public Practice or other expert
where the Existing Accountant does not provide the
specific Professional Service required by the client.
• a commission received from a third party (for
example, a software vendor) in connection with the
sale of goods or services to a client.
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB, Mel-
bourne, www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
The Code requires members to evaluate the threats once they are identified as required by the conceptual
framework. Each member will have a slightly different way of evaluating threats and different ways of
implementing safeguards to avoid contravening the fundamental principles set down in APES 110. These
are outlined in table 2.12.
Pdf_Folio:77
MODULE 2 Ethics 77
TABLE 2.12 Safeguards to prevent self-interest threats
While the points that appear below are a part of Fees (para. 330.3 A4):
the evaluation of threats in a business setting, they • Adjusting the level of fees or the scope of the
can also be regarded as safeguards which may engagement.
restrict behaviour that is contrary to the fundamental • Having an appropriate reviewer review the work
principles. performed.
• Policies and procedures for a committee Contingent fees (para. 330.4 A3):
independent of management to determine the level • Having an appropriate reviewer who was not
or form of senior management remuneration. involved in performing the non-assurance service
• In accordance with any internal policies, disclosure review the work performed by the Member in Public
to those charged with governance of: Practice.
– all relevant interests • Obtaining an advance written agreement with the
– any plans to exercise entitlements or trade in client on the basis of remuneration.
relevant shares.
• Internal and external audit procedures that are Referral fees (para. 330.5 A2):
specific to address issues that give rise to the • Obtaining an advance agreement from the client for
financial interest. commission arrangements in connection with the
sale by another party of goods or services to the
client might address a self-interest threat.
• Disclosing to clients any referral fees or commission
arrangements paid to, or received from, another
Member in Public Practice or third party for
recommending services or products might address a
self-interest threat.
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB, Mel-
bourne, www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
.......................................................................................................................................................................................
CONSIDER THIS
Turn to s. 240 as it relates to members in business and s. 330, which covers the topics of fees for members in public
practice. Take note of the provisions related to the evaluation of threats and reflect on why those differences exist.
Pdf_Folio:78
Members in Business (para. 250.9 A3) Members in Practice (para. 340.9 A3)
• The nature, frequency, value and cumulative effect of • The nature, frequency, value and cumulative effect of
the Inducement. the Inducement.
• Timing of when the Inducement is offered relative to • Timing of when the Inducement is offered relative to
any action or decision that it might influence. any action or decision that it might influence.
• Whether the Inducement is a customary or cultural • Whether the Inducement is a customary or cultural
practice in the circumstances, for example, offering practice in the circumstances, for example, offering
a gift on the occasion of a religious holiday or a gift on the occasion of a religious holiday or
wedding. wedding.
• Whether the Inducement is an ancillary part of • Whether the Inducement is an ancillary part of
a Professional Activity, for example, offering or a professional service, for example, offering or
accepting lunch in connection with a business accepting lunch in connection with a business
meeting. meeting.
• Whether the offer of the Inducement is limited to an • Whether the offer of the Inducement is limited to an
individual recipient or available to a broader group. individual recipient or available to a broader group.
The broader group might be internal or external to The broader group might be internal or external to
the employing organisation, such as other customers the firm, such as other suppliers to the client.
or vendors.
• The roles and positions of the individuals offering or • The roles and positions of the individuals at the
being offered the Inducement. firm or the client offering or being offered the
Inducement.
• Whether the Member knows, or has reason to • Whether the Member in public practice knows, or
believe, that accepting the Inducement would breach has reason to believe, that accepting the Inducement
the policies and procedures of the counterparty’s would breach the policies and procedures of the
employing organisation. client.
• The degree of transparency with which the • The degree of transparency with which the
Inducement is offered. Inducement is offered.
(continued)
Pdf_Folio:79
MODULE 2 Ethics 79
TABLE 2.13 (continued)
Members in Business (para. 250.9 A3) Members in Practice (para. 340.9 A3)
• Whether the Inducement was required or requested • Whether the Inducement was required or requested
by the recipient. by the recipient.
• The known previous behaviour or reputation of the • The known previous behaviour or reputation of the
offeror. offeror.
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB, Mel-
bourne, www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
There are some safeguards that can be used to ensure that any threat to fundamental principles from
inducements irrespective of their nature is either eliminated or reduced to an acceptable level. These are
outlined in table 2.14.
Members in Business (para. 250.11 A6) Members in Practice (para. 340.11 A6)
• Being transparent with senior management or • Being transparent with senior management of the
Those Charged with Governance of the employing Firm or of the client about offering or accepting an
organisation of the Member or of the counterparty Inducement.
about offering or accepting an Inducement.
• Registering the Inducement in a log maintained by • Registering the Inducement in a log monitored by
the employing organisation of the Member or the senior management of the firm, another individual
counterparty. responsible for the Firm’s ethics compliance or
maintained by the client.
• Having an appropriate reviewer, who is not otherwise • Having an appropriate reviewer, who is not otherwise
involved in undertaking the Professional Activity, involved in providing the Professional Service, review
review any work performed or decisions made by the any work performed or decisions made by the
Member with respect to the individual or organisation Member in Public Practice with respect to the client
from which the Member accepted the Inducement. from which the Member accepted the Inducement.
• Donating the Inducement to charity after receipt and • Donating the Inducement to charity after receipt and
appropriately disclosing the donation, for example, appropriately disclosing the donation, for example, to
to Those Charged with Governance or the individual a member of senior management of the Firm or the
who offered the Inducement. individual who offered the inducement.
• Reimbursing the cost of the Inducement, such as • Reimbursing the cost of the Inducement, such as
hospitality, received. hospitality, received.
• As soon as possible, returning the Inducement, such • As soon as possible, returning the Inducement, such
as a gift, after it was initially accepted. as a gift, after it was initially accepted.
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB, Mel-
bourne, www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
QUESTION 2.14
Toby is working with an accounting firm providing consulting services to a manufacturing client
who repeatedly offers him hospitality at the football, tennis and the cricket. The output from his
consulting services is a report that needs to be seen as independent when it is completed and
lodged with a regulator.
Describe what Toby’s response should be to the client when a representative approaches him
with an offer of hospitality at sporting events. Name the threat and fundamental principle involved.
dP f_Folio:80
Muscle Adventures Ltd is looking for a new contractor to supply its photocopiers and associated
supplies. The company’s purchasing officer, Peter, a CPA, has a key role in organising the tender
and deciding on the successful party. He has been invited out to lunch and dinner by a company
that is considering tendering for services.
What kind of threat does this invitation pose to Peter given his role in the tendering process?
NOCLAR deals with how members must respond when they encounter or are made aware of non-
compliance or suspected non-compliance with laws and regulations in the course of carrying out
professional activities, to ensure that they act in the public interest.
If there are laws or regulations that specify how members should deal with non-compliance or suspected
non-compliance, members have the responsibility to be aware of and comply with them.
NOCLAR provides a framework for accountants in business so that they can fulfil their responsibility
to act in the public interest when responding to non-compliance:
(a) To comply with the fundamental principles of integrity and professional behaviour;
(b) By alerting management or, where appropriate, Those Charged with Governance of the employing
organisation/client, to seek to:
(i) Enable them to rectify, remediate or mitigate the consequences of the identified or suspected
NOCLAR; or
(ii) Deter the commission of the NOCLAR where it has not yet occurred; and
(c) To take such further action as appropriate in the public interest (paras. 260.4, 360.4).
Laws and regulations that are fundamental to the operations of the employing organisation or lead to
material penalties vary for each entity and context, and generally include:
• Fraud, corruption and bribery.
• Money laundering, terrorist financing and proceeds of crime.
• Securities markets and trading.
• Banking and other financial products and services.
• Data protection.
• Tax and pension liabilities and payments.
• Environmental protection.
• Public health and safety (paras. 260.5 A2, 360.5 A2).
The illustration in figure 2.9 provides an example of how the NOCLAR regime works. Notice that the
graphic has on the right-hand side a solid navy bar with the word ‘documentation’. It is critical to ensure
that details of all considerations are documented because the notes and records may be required later if
litigation becomes involved.
Pdf_Folio:81
MODULE 2 Ethics 81
FIGURE 2.9 Applying the NOCLAR regime
Documentation
Address the matter
NOCLAR provides a different and proportionate approach for senior accountants in business and
for accountants other than those in senior positions. Accountants in business must consider established
protocols and procedures, such as ethics and whistleblowing policies, when determining how to respond
to non-compliance with laws and regulations. There are core obligations that need to be followed by senior
accountants in business and also senior accountants in practice. These are set down in sequence.
QUESTION 2.16
Read the relevant parts of section 360 and complete the following.
(a) Fill in the missing items in table 2.15.
Steps for audits (paras. R360.10–360.28 A1) Steps for professional services other than
audits (paras. R360.29–360.40 A1)
5.
(b) What difference does the presence or possibility of an ‘imminent breach’ make to the process?
P d f_Folio:83
MODULE 2 Ethics 83
EXAMPLE 2.11
DDV Accounting
DDV Accounting offers accounting services to a number of small and medium enterprises. Over the past
five years it has managed the payroll for some restaurant chains and corner stores. One of its clients was
the fast-food chain Yummy Tummy. Three years ago, Yummy Tummy was audited by the relevant regulator
and found to have been underpaying its casual employees by thousands of dollars and non-compliant
with the relevant labour and employment conditions laws. DDV Accounting was informed by the regulator
and provided with information about the legal labour rates and conditions that apply in the jurisdiction.
Kath Omany, a CPA, has been working for DDV Accounting for four years. She has been responsible
for the services provided to Yummy Tummy for three and a half years. These services include managing
the chain’s payroll for its 287 employees. Kath is aware that the amounts paid to at least half of those
employees are well below the legal requirements. She became aware of this when she started providing
services to Yummy Tummy. She has not done anything about it because she did not, and does not, think
that the decisions made by her clients are her business. She believes that she is only obligated to complete
tasks requested by the client.
QUESTION 2.17
QUESTION 2.18
In your jurisdiction there is no legal requirement to keep client confidentiality under a relevant law
or regulation. However, in your professional services contract and terms of engagement there is a
confidentiality clause. Considering this, answer the following questions.
• Are you required to do anything if you identify or suspect a non-compliance with laws and
regulations?
• Are you protected if you do not comply with the confidentiality clause in your client contract and
terms of engagement?
The following sections deal with the topics that are specific to members in business.
EXAMPLE 2.12
Fortex
In the early nineties New Zealand meat processor Fortex failed owing more than $130m to creditors and
another $30m to farmers. The managing director was jailed for 6.5 years and the financial controller for
4 years (although this was later reduced on appeal). Both showed a distinct lack of integrity and were
convicted of fraud for:
• classifying $20m of loans as income
• overvaluing inventory by $25 by reclassifying lamb flaps as French cutlets
• recording $5m of false sales.
Source: Information from Hutching, C 2017, ‘Fortex boss spills beans about jail and return to business’, accessed August
2019, www.stuff.co.nz/business/97120854/fortex-boss-spills-beans-about-jail-time-and-return-to-business.
QUESTION 2.19
MODULE 2 Ethics 85
QUESTION 2.20
James Chan is a sole practitioner specialising in audit services. James has become interested in
assurance services for the elderly. He recently attended a presentation on care services for the
elderly and believes that this new assurance service will differentiate him from other practitioners
in the area and, therefore, offers a means to attract more clients.
James has placed a series of advertisements in the local press. The advertisements state that he
can provide expert reports to assure family members that proper care is provided to elderly family
members who are no longer totally independent.
Although James has no previous experience or training in this area, he believes that he can carry
out the work using traditional audit skills.
(a) What is the threat here and which principles are threatened?
(b) Advise James on how to address this threat.
QUESTION 2.21
The following sections deal with the topics that are specific to members in public practice.
Similarly, there may be a threat to professional competence and due care if an accountant accepts the
engagement before knowing all the facts regarding the client’s business. Thus, the matter becomes one of
competence, integrity and objectivity.
One problem inhibiting effective communication is that existing accountants are bound by the principle
of confidentiality. The extent to which the existing accountant can and should discuss the affairs of a
client with a proposed successor will ultimately depend on whether the client has granted permission
to do so, as well as the legal or ethical requirements relating to such communications and disclosure.
Circumstances where disclosure of confidential information is required or may otherwise be appropriate
are set out in an earlier section of the framework on confidentiality. Generally, a member will need to
obtain the client’s permission, preferably in writing, to communicate with the existing or predecessor
accountant (para. R320.7). The existing or predecessor accountant must provide information ‘honestly
and unambiguously’ (para. 320.5 A1) and should do so only with the client’s permission (para. 320.7 A1)
or under the circumstances set out in paragraph 114.1 A1 (para. 320.7 A2).
Referrals
Referrals occur when a client requires specialist advice in an area that is beyond the competence of their
existing accountant. In this case, the member or the client should engage another accountant with the
required expertise. A referral should not be seen as an invitation for the accountant who has received the
referred special assignment to ‘take over’ the client. The established relationship between the referring
accountant and the client is maintained.
The underlying issue with referrals is one of professional competence. Knowing the extent of one’s
own skills and when the skills of a more qualified expert are required is closely linked to the principle of
professional competence.
MODULE 2 Ethics 87
Custody of Client Assets (s. 350)
Unless permitted by law, accountants should not assume custody of client monies or other assets. Where
an accountant has been entrusted with money, they should make sure this is kept separate from other assets
and should only be used for its intended purpose (para. R350.3).
QUESTION 2.22
Using your understanding of the Code as it presently stands, answer the following.
• Does the Code of Ethics require a member in business to actively look for any noncompliance
with laws and regulations in the employing organisation?
• Does it require accountants to know laws and regulations that are not related to their role and
responsibilities?
Definition of Independence
The Code defines independence as being linked to both objectivity and integrity. It compises:
(a) Independence of mind – the state of mind that permits the expression of a conclusion without being
affected by influences that compromise professional judgement, thereby allowing an individual to act
with integrity, and exercise objectivity and professional scepticism.
(b) Independence in appearance – the avoidance of facts and circumstances that are so significant that a
reasonable and informed third party would be likely to conclude that a Firm’s or an Audit or Assurance
Team member’s integrity, objectivity or professional scepticism has been compromised (para. 290.6).
The Code of Ethics treats independence as a significant concern for accountants and there are two
sections in the Code that deal with independence in the context of specific engagements.
Part 4A deals with independence of audit and review engagements while Part 4B deals with indepen-
dence in the context of assurance engagements other than audit and review engagements. While you are
not expected to know this section in detail for examination purposes, it is important that you understand
the underlying principles embedded within these two sections of the Code of Ethics.
Parts 4A and 4B of the Code are comprehensive in their coverage of a range of independence-related
matters. It is not a requirement to print the whole section on independence. Parts 4A and 4B cover the
topics that appear in table 2.16.
dP f_Folio:88
Part 4A: Audit and review engagements Part 4B: Engagements other than audit and review
engagements
521 Family and personal relationships 922 Recent service with an assurance client
522 Recent service with an audit client 923 Serving as a director or officer of an
assurance client
523 Serving as a director or officer of an audit 924 Employment with an assurance client
client
524 Employment with an audit client 940 Long association of personnel with an
assurance client
540 Long association of personnel (including 990 Reports that include a restriction on use
partner rotation) with an audit client and distribution (assurance engagements
other than audit and review engagements)
MODULE 2 Ethics 89
provisions (ss. 800, 990) modify the rest of the provisions in Parts 4A and 4B. At this point, it is sufficient
to understand that reports that are ’special purpose’ need to be stated as such and that the intended users
of the reports need to be told about modified independence requirements that may apply. There is also a
need for users to be told what the limitations of the report may be and that they agree to the application of
any modifications to independence requirements.
In general, independence is equated with an attitude of objectivity (no bias, impartiality) and integrity
(honesty). This means adherence to the principles of integrity and objectivity is possible when indepen-
dence is achieved. According to this relationship, being independent, both in appearance and reality, will
assist in satisfying the principles of integrity and objectivity. Conversely, a breach of integrity or objectivity
may result when independence is lost.
QUESTION 2.23
Make a note of the definition of independence as it appears in APES 110 and write down the
fundamental principles with which independence is closely associated.
Being independent means that one is not only unbiased, impartial and objective but is also perceived
to be that way by third parties. Independence in appearance is the avoidance of facts and circumstances
where a reasonable and informed third party, having knowledge of all relevant information, including
any safeguards applied, would reasonably conclude that the accountant’s integrity or objectivity has
been compromised. While independence is applicable to all accounting professionals, independence is
especially important for members in public practice.
The rules pertaining to independence for members in public practice who perform audits are detailed
and technical. There are a large number of areas in which independence threats can emerge. CPA Australia
has produced a checklist (figure 2.10) to assist in determining whether the firm in which they are employed
complies with the independence rules, regulations and interpretations of CPA Australia and relevant
statutory bodies. Have another look at the list of topics in table 2.16. You will notice that the checklist
in figure 2.10 is a concise summary of the key areas that the ethical standard covers and appear in
table 2.16. The checklist is one method used to check whether employees comply with the guidance set
down in APES 110.
QUESTION 2.24
Reflect on each of the questions in the checklist in figure 2.10 and note which of the fundamental
principles you believe are breached by a member if they fail to respond in the negative to those
questions in the form.
dP f_Folio:90
Completion of this form provides data for determining that the practice is complying with the
independence rules, regulations and interpretations of CPA Australia and relevant statutory bodies.
Yes† No
❑ ❑ Do you have a direct or indirect material financial interest in a client or its subsidiaries/
affiliates?
❑ ❑ Do you have a financial interest in any major competitors, investees or affiliates of a client?
❑ ❑ Do you have any outside business relationship with a client or an officer, director or principal
shareholder having the objective of financial gain?
❑ ❑ Do you owe any client any amount, except as a normal customer, or in respect of a home loan
under normal lending conditions?
❑ ❑ Do you have the authority to sign cheques for a client, or make electronic payments on their
behalf?
❑ ❑ Are you connected with a client as a promoter, underwriter or voting trustee, director, officer
or in any capacity equivalent to a member of management or an employee?
❑ ❑ Do you serve as a director, trustee, officer or employee of a client?
❑ ❑ Has your spouse or minor child been employed by a client?
❑ ❑ Has anyone in your family been employed in any managerial position by a client?
❑ ❑ Are any billings delinquent for clients that are your responsibility?
❑ ❑ Have you received any benefits such as gifts or hospitality from a client, that are not
commensurate with normal courtesies of social life?
❑ ❑ Are there any other independence issues that you believe are relevant to disclose?
I have read the Independence Policy of the practice, and professional standards related to independence,
and I believe I understand them. I am in compliance except for the matters listed below.
Source: CPA Australia 2015, ‘Independence checklist for employees’, CPA Australia, accessed August 2018, www.cpaaustralia.
com.au/~/media/corporate/allfiles/document/professional-resources/practice-management/independence-checklist-for-employees.
doc.
Fees — large amounts in 410 Self-interest Fee dependence on specific clients can be reduced
fees from a specific client or by growing the client base.
intimidation
Compensation and 411 Self-interest Revising the compensation plan for the audit team
evaluation policies — member that has a selling obligation.
selling non-assurance Removing the individuals from the audit team.
services
Gifts and hospitality 420 Self-interest, Audit team members shall not accept gifts and
familiarity or hospitality unless they are trivial and inconsequential.
intimidation
(continued)
P df_Folio:91
MODULE 2 Ethics 91
TABLE 2.17 (continued)
Actual or threatened 430 Self-interest Removal of any audit team member that may be
litigation and involved in the litigation may eliminate threats.
intimidation A safeguard that could address these threats is for
work to be reviewed by an appropriate individual.
Financial interest in client 510 Self-interest Evaluation of the role of the person holding the
financial interest, the materiality and type of financial
interest.
Loans and guarantees 511 Self-interest Audit team members shall not accept loans or
guarantees from banks or institutions that are not
made under normal lending procedures, terms or
conditions.
Firms or networks firms can use a safeguard of having
work reviewed by an appropriate reviewer who is
not working for the firm or network firm that is the
beneficiary of the loan.
A family and personal 521 Self-interest, A wide spectrum of safeguards is available in this
relationship between a familiarity and section.
member of the audit team intimidation
and an officer of the client
Recent service with an 522 Self-interest, A wide spectrum of safeguards is available in this
audit client familiarity and section.
intimidation
Serving as a director or 523 Self-review The Code prohibits involvement on company boards
officer of an audit client and or the appointment as a company secretary.
self-interest
Long association 540 Familiarity or Changing the role of the individual on the audit team
of personnel self-interest or the nature and extent of the tasks the individual
performs.
Having an appropriate reviewer who was not an audit
team member review the work of the individual.
Performing regular independent internal or external
quality reviews of the engagement.
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QUESTION 2.25
Based on your reading so far, reflect on why you think the accounting professional believes certain
non-audit services create a threat to independence.
Assurance Engagements
Assurance services are related to services provided by members that provide users of specific reports or
information with confidence that the information is accurate. There is a similar framework in place for
dealing with threats to the fundamental principles in the Code. Firms conducting assurance engagements
are required to be independent and they are required to apply the conceptual framework set out in section
120 of the Code. Firms must identify, evaluate and address or treat independence threats in a similar fashion
to other threats described in the Code. Table 2.18 outlines some of the common threats and safeguards.
Fees 905 Self-interest or Increasing the client base of the partner to reduce
intimidation dependence on the assurance client.
Having an appropriate reviewer who was not an
assurance team member review the work.
Gifts and hospitality 906 Self-interest, The requirements in section 340 for members in
familiarity or practice should be considered in the context of
intimidation gifts and hospitality.
Financial interests 910 Self-interest Various safeguards and measures are outlined in
the Code for different kinds of financial interests.
Loans and guarantees 911 Self-interest Work done by people who have loans or
guarantees can be reviewed by an appropriate
reviewer who is not a member of the assurance
team from a network firm that is not the beneficiary
of the loan.
(continued)
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MODULE 2 Ethics 93
TABLE 2.18 (continued)
Business relationships 920 Self-interest or Eliminating or reducing the size of the transaction
intimidation involving the assurance team member.
Removing the individual from the assurance team.
Recent service with an 922 Self-interest, The assurance team should not include someone
assurance client self-review or who was employed as a director or officer of the
familiarity client.
A safeguard may be a review by an appropriate
reviewer of work performed by an assurance team
member.
Serving as a director or 923 Self-review and The Code prohibits serving as a director or officer.
officer of an assurance self-interest Guidance is provided in the code regarding
client the provision of non-assurance services to an
assurance client in the context of company
secretarial work or appointment.
Employment with an 924 Self-interest, Making arrangements such that the individual is
assurance client familiarity or not entitled to any benefits or payments from the
intimidation firm, unless made in accordance with fixed pre-
determinedarrangements.
Making arrangements such that any amount owed
to the individual is not material to the firm.
Modifying the plan for the assurance engagement.
Assigning to the assurance team individuals who
have sufficient experience relative to the individual
who has joined the client.
Having an appropriate reviewer review the work of
the former assurance team member.
Long association of 940 Familiarity or Changing the role of the individual on the
personnel with an self-interest assurance team or the nature and extent of the
assurance client tasks the individual performs.
Having an appropriate reviewer who was not an
assurance team member review the work of the
individual.
Performing regular independent internal or external
quality reviews of the engagement.
Provision of non-assurance 950 Various The Code provides guidance to members that
services to assurance relate to the provision of non-assurance services to
clients other than audit clients.
and review engagement It is for the firm concerned to review all of the non-
clients assurance engagements.
It is essential to read section 950 in its entirety so that you fully understand the ramifications of the
provision of certain non-assurance services where a practice is providing assurance services to a client.
Example 2.13 shows the problems relating to providing non-audit services to audit clients and a
preoccupation with profit.
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Arthur Andersen
Throughout the 1990s, accounting firms, including Arthur Andersen, offered consulting services along
with traditional auditing services, and discovered that consulting work was often more profitable. Critics
argue that the two services are incompatible as auditors verify and communicate to users the accuracy of
company reports, but, as the auditors were providing consulting services, they would be checking their
own work. Auditors must be independent of their clients, and consulting enmeshes them in their clients’
business in ways that compromise independence (Aronson 2002).
During the 1990s the firm separated into two units, Arthur Andersen and Andersen Consulting (known as
Andersen Worldwide). In 1996, Steve Samek ‘became the firm’s world-wide head of auditing, with indirect
responsibility for 40 000 people’. In the spring of 1998, he headed Arthur Andersen’s US operations, which
accounted for about half of the firm’s revenue. Mr Samek gave rousing speeches designed to inspire the
auditors to sell to their clients everything from tax services to consulting work (Brown & Dugan 2002).
Meanwhile, Andersen Consulting more than doubled its revenue to USD$3.1 billion, ‘bringing in 58%
of the overall firm’s revenues, and subsidizing the accountants to the tune of about $150 million a year’.
In 1997, Andersen Consulting partners ‘voted unanimously to split off entirely’ (Brown & Dugan 2002) and
changed its name to Accenture.
Arthur Andersen and Enron
According to reports, Enron paid Arthur Andersen USD$52 million in 2000. More than 50% (USD$27 mil-
lion) came from consulting services. Consequently, traditional auditing services, compared to consulting,
became less and less profitable and, unfortunately, seemingly less and less important to the firm.
Embroiled in the multi-billion-dollar bankruptcy of Enron, Arthur Andersen shared with its client the
accusation of not fully disclosing Enron’s financial position to investors. In the lead-up to pending
enquiries, Arthur Andersen destroyed (by shredding) a significant number of documents relating to the
Enron audit.
On 15 June 2002, Arthur Andersen was convicted of obstruction of justice for shredding documents
related to its audit of Enron. The firm ultimately lost its right to practice.
Arthur Andersen’s greatest foe was not the courts, but market forces and public perceptions (Simpson
2002). This included the termination of merger talks between Arthur Andersen and another major
accounting firm. Clients terminated their relationship with Arthur Andersen and many employees resigned.
The market and public imposed the ultimate penalty on Arthur Andersen, hastening its implosion in 2001
(Simpson 2002). On 31 May 2005, the Supreme Court of the United States unanimously overturned Arthur
Andersen’s conviction, due to flaws in the jury instructions. By this time it was too late for Arthur Andersen.
QUESTION 2.26
(a) Describe Arthur Andersen’s organisational culture and explain how the firm’s culture may have
contributed to its downfall.
(b) Explain why the provision of non-auditing services to an audit client may compromise the
auditor’s independence. In your answer, list two threats to the audit and explain why they are
threats.
(c) List the safeguards that Arthur Andersen might have employed to reduce the threat to an
acceptable level.
(d) Explain how Arthur Andersen failed to act according to the public interest principle.
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MODULE 2 Ethics 95
EXAMPLE 2.14
EXAMPLE 2.15
EXAMPLE 2.16
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SUMMARY
APES 110 Code of Ethics for Professional Accountants (including Independence Standards) is the ethical
framework for members of the accounting profession. The Code of Ethics:
• outlines fundamental principles of ethical professional behaviour
• lists the key threats to fundamental principles
• provides instances of guidance for specific common circumstances
• includes a conceptual framework that sets down a process by which members should deal with ethical
dilemmas that emerge throughout their professional and personal lives.
The inclusion of a conceptual framework avoids the need for volumes of rules to try to accommodate
every possible ethical issue that may arise.
Independence, which is defined as being both independence of mind and independence in appearance, is
handled in Parts 4A and 4B of the Code as it impacts on audit and review engagements and other assurance
engagements respectively. This guidance is provided to ensure that members in practice are able to resolve
possible threats to the fundamental principles of integrity and objectivity. An independent perspective on a
set of financial statements, or a specific set of facts in the case of an assurance project, is what the member
in practice is being paid to provide. Breaches of the fundamental principles can lead to the work done by
members in public being perceived to be compromised.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
2.3 Apply APES 110 Code of Ethics for Professional Accountants (including Independence
Standards).
• APES 110 is the ethical standard for accounting professionals in Australia.
• APES 110 is based on the international equivalent code that is issued by the International Federation
of Accountants
• By applying the Code of Ethics to their decisions and actions, professional accountants will be acting
in the public interest
• The Guide at the beginning of APES 110 instructs the professional accountant how the Code should
be read and used.
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MODULE 2 Ethics 97
• Part 1 of APES 110 reflects the profession’s recognition of its public interest responsibility, setting
out five fundamental principles for ethical conduct: integrity; objectivity; professional competence
and due care; confidentiality; and professional behaviour.
• Part 1 of APES 110 also includes a conceptual framework that provides a process for making ethical
decisions in any situation. The conceptual framework is made up of three steps: identifying threats,
evaluating threats, and addressing threats.
• Parts 2 and 3 of APES 110 set out ethical requirements for members in business and members in
public practice respectively, including guidance and safeguards to apply to specific circumstances
that members may commonly face.
• Part 2 of APES 110 provides guidance on ethical issues facing members in business related to:
conflicts of interest; preparation and presentation of information; acting with sufficient expertise;
financial interests, compensation and incentives linked to financial reporting and decision making;
inducements; responding to NOCLAR; and pressure to breach the fundamental principles.
• Part 3 of APES 110 provides guidance on ethical issues facing members in public practice related
to: conflicts of interest; professional appointments; second opinions; fees and other types of
remuneration; inducements; custody of client assets; and responding to NOCLAR.
• Parts 4A and 4B of APES 110 deal with the requirement for independence in audit, review and other
assurance engagements where a client is seeking an independent perspective.
• Special purpose reports may be subject to modified independence requirements. Users of the reports
must be told about those modifications.
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Societal
Professional
Organisational
Individual
PROBLEM
DECISION
Corporate
Cognitive
Culture
culture
Stress
Law
development
Moral development
Ethical courage
Codes
Significant others
Policies
Code of ethics
Decision making is the thought process necessary to select a course of action to achieve a desired result
from among two or more options. Put more simply, it involves making a purposeful choice from a set of
alternatives. Decision making with ethical implications is simply another form of problem solving. The
chief difference between decision making and ethical decision making is the consideration of ethical values
and implications in the selection of an appropriate alternative.
Therefore, ethical decision making is defined as reaching a responsible decision after taking into
consideration the general ethical beliefs of the individual, the ethical implications of a course of action,
and the norms and rules pertaining to the circumstances of the situation.
Example 2.17 highlights the issues involved in making an ethical decision. The rest of this module
examines the inputs to ethical decision making in greater detail and then examines several ethical decision-
making models.
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MODULE 2 Ethics 99
EXAMPLE 2.17
Whistleblowing
When accountants believe or suspect that unethical or illegal behaviour is occurring, they may be put
in a difficult position. Whistleblowing describes the action of bringing these concerns to the attention of
appropriate people. Whistleblowing should be seen as beneficial to the organisation as it helps identify
fraud and inappropriate behaviours and actions. However, it seems that in many organisations, managers
view whistleblowing ‘as a risk generator rather than an element of the risk management infrastructure’
(Tsahuridu 2011, p. 56). Rather than being a faithful servant, the whistleblower is perceived to be ‘against
the organisation’ and disloyal.
The Code of Ethics and its NOCLAR sections deal with how members should respond to non-
compliance with laws and regulations so that they act in the public interest.
............................................................................................................................................................................
CONSIDER THIS
Reflect on what role a member of CPA Australia may have in helping another professional deal with the question
of disclosing unethical or illegal behaviour.
INDIVIDUAL FACTORS
Arguably, the factor having most influence on a person’s decision making is their cognitive ability to judge
the ethical rightness of a situation. People have different levels of moral development. Some people are
selfish and may only act in the right way out of fear of punishment, rather than because it is the right thing to
do. Others (who are self-interested) may act appropriately in order to gain additional benefits from others.
Others may act in a particular way to gain approval from other people they see as significant to them.
Obeying the law and the rules also motivates many people, without much thought as to whether those
laws and rules are appropriate. Meanwhile, others may focus on acting based on intentions to do the right
thing — regardless of external factors such as peer approval or legal rules (Kohlberg 1981).
From this, we can summarise that people at different levels of moral development have varying capacities
to judge what is ethically right and so may react differently to a similar situation. Therefore, the higher a
person’s moral development, the less dependent that person is on outside influences and, hence, the more
that person is likely to behave autonomously and ethically.
Another factor influencing a person’s decision making is their development of ethical courage. Ethical
courage is the level of courage a person demonstrates in order to make difficult decisions and act upon these
decisions. Acting with courage means being straightforward and honest in all professional and business
relationships. Accountants face difficult situations and often have to make decisions, requiring them to
choose between the competing interests of clients, employers and the public.
A junior or recently qualified accountant may not be in a position to act with courage when faced with an
ethical situation due to a fear of superiors or the possible loss of employment. However, a more experienced
accountant may not hold such fears and will not be intimidated by demands from other people. The ability
to act with courage can be developed over time.
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ORGANISATIONAL FACTORS
Corporate culture is defined as patterns and rules that govern the behaviour of an organisation and its
employees. Corporate culture defines acceptable behaviour within an organisation. The culture of an
organisation may be formally expressed in the form of written policies and codes of ethics or may be
informally expressed through the words and actions of significant others.
A culture that lacks written policies and codes of ethics and accepts dishonesty and unethical conduct
may have a strong influence on a person’s ethical decision making. They may feel compelled to go along
with what is being done for fear of being excluded from the group.
In the 1960s the social psychology experiments of Solomon Ash, Stanley Milgram and Philip Zimbardo,
which investigated the effects of conformity, obedience to authority, assigned roles and situational
environments on our behaviour, showed how much our actions are influenced by the people, the authority
structures and the environment surrounding us. Similarly, organisational research finds that even honest
employees will behave in deviant ways if their environment, or management, encourages it. Pressure
to conform, excessive performance demands and unfair treatment have all been found to contribute to
organisational misconduct (Litsky, Eddlestone & Kidder 2006).
Unsupportive management styles and organisational cultures as well as hierarchical structures that are
not open to upwards communication can also lead to employee silence on issues such as supervisor
and colleague competence, dysfunctional organisational processes and working conditions. Fear of poor
treatment, negative labelling and distrust by colleagues as well as feelings of futility can prevent employees
notifying management of these problems, resulting in inefficiency, employee apathy and high turnover,
at considerable costs to the organisation (Milliken, Morrison & Hewlin 2003). This can be offset by
ensuring rules and procedures are perceived as fair and by managers establishing trusting relation-
ships with employees, including them in decision-making processes, setting measurable and attainable
goals, offering consistent performance evaluation, leading by example and creating ethical climates
(Litsky et al. 2006).
Top-tier management is considered the most influential factor in setting organisational values, which
in turn determines the culture that influences accountants’ behaviour. The actions and decisions of
management have a significant contribution to the culture and ethical approach of an organisation.
Schein (2004) identifies six areas in which such actions and decisions are most relevant.
• What leaders pay attention to, measure, and control on a regular basis.
• How leaders react to critical incidents and organizational crises.
• How leaders allocate resources.
• Deliberate role modelling, teaching, and coaching.
• How leaders allocate rewards and status.
• How leaders recruit, select, promote, and excommunicate.
There is a direct and positive relationship between the strength of the organisation’s culture and the
extent of that culture’s influence on ethical behaviour. A strong culture is likely to have more influence
on people’s daily decisions than a weak one. If the culture is strong and supports high ethical standards, it
should have a powerful and positive influence on employees’ behaviour. Conversely, a weak ethical culture
tends to have a negative influence on employees’ behaviour.
.......................................................................................................................................................................................
CONSIDER THIS
Commissioner Kenneth Hayne referred to a culture of greed causing problems in the financial services sector. His
observations related to behaviours that were related to bankers, financial planners, brokers and other intermediaries
adopting a ‘whatever it takes’ approach to getting commissions or bonuses for selling financial products to customers.
Reflect on the issues you believe Commissioner Hayne’s observation raises from an ethical standpoint?
Ethical climates, or cultures, have been found to affect various organisational outcomes (Simha &
Cullen 2012).
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EXAMPLE 2.18
Omega Finance
Omega Finance is a prominent accounting, auditing and financial advice company, frequently advertising
on television, social media and radio, emphasising their ability to offer solutions, ‘whatever the problem,
big or small’. Upon successfully gaining employment there shortly after gaining his CPA certification, Jerry
Black was surprised to find that for such a high-profile company, the number of employees was small.
After a few months working on individual and small business tax problems, he was reassigned to their
‘consultation and referrals’ department. It was explained to him that, due to the varied nature of the clients
that came to them, it was frequently necessary to refer them to a more specialised firm, in order to ensure
compliance with the Code of Ethics.
When jobs came in that were beyond the expertise of Omega’s own accountants, they were sent to the
referrals department with a synopsis of the relevant details and the kind of expertise required, and it was
the job of referrals to recommend an appropriate specialist and forward the account to them. Jerry was
surprised at the volume of referrals that came across his desk—it was clearly a substantial proportion of
the clients processed by the company. Furthermore, being new to the field, it was difficult to recommend
appropriate specialists for the referrals. Jerry had been reassured that his supervisor could help in this
regard, and so he frequently sought advice on appropriate referrals.
After a while, he noticed that the same names frequently came up in his supervisor’s recommendations,
though there were alternative companies that may have been better suited. He pointed this out, but
his supervisor simply told him that they had good working relationships with these companies, and
that it streamlined the process both for Omega and for their clients. Omega was transparent about the
referral commissions, or fees, received from the specialists to whom it referred these cases, and it was a
standardised rate, yet the sheer volume of referrals must have made the total commissions or fees received
from these companies sizeable. Jerry noticed also that following his query his caseload increased,
explained by management as due to an overall growth in client numbers, but Jerry had heard similar
stories from other employees. It was suspected that this was an informal punitive measure to discourage
employees from questioning managerial decisions and to restrict both their discretion and autonomy. One
consequence of this increase was a further reduction in the ability to examine alternative specialist options,
and the necessity to increase referrals to those companies already receiving considerable business
from Omega.
QUESTION 2.27
What is the effect of the culture at Omega Finance on the individual ethical decisions of the
employees such as Jerry? Can you think of any possible violations of the Code of Ethics these
decisions may present?
QUESTION 2.28
What reasons or factors can you think of that may cause an employee to compromise their personal
ethics in a corporate environment?
PROFESSIONAL FACTORS
In addition to individual and organisational factors influencing ethical decision making, accountants are
also influenced by their accountantship of a profession. We have already described the Code of Ethics in
detail and how accountants must follow the Code, which unites accountants by having a common set of
values and standards of behaviour.
The extent of the influence on decision making is dependent on the effectiveness of the Code. According
to the Code, accountants in business may hold a senior position.
The more senior the position of a Member, the greater will be the ability and opportunity to access
information, and to influence policies, decisions made and actions taken by others involved with the
employing organisation . . . Members are expected to encourage and promote an ethics-based culture in
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the organisation (para. 200.5 A3).
Why should accountants in business be accountable to a higher authority such as the professional
accounting bodies?
SOCIETAL FACTORS
Societal factors that influence decision making generally relate to the world we live in. These include the
laws that govern our behaviour and culture, which reflect the attitudes and values of the community.
Laws and Regulations
Laws and regulations are rules, established by the community through the legislature, that prohibit certain
actions. Laws are generally a reflection of societal attitudes, so for most people they will have minimal
impact on ethical behaviour other than maintaining order and resolving disputes when they arise.
QUESTION 2.30
Discuss whether decisions that are compliant with the law will always result in ethical decisions.
Culture
Understanding the culture of the community in which an organisation is operating is an essential first step
in identifying the effects that the attitudes and values of the community may have on how decisions are
made. Cultural values play an important role in the way business is conducted and in determining people’s
perceptions about what is important and what is not.
In ethics, cultural values have a major influence in determining what is considered proper and ethical
in a particular society. Ethical relativism holds that ethical behaviour is relative to the norms of one’s
culture. That is, whether an action is right or wrong depends on the ethical norms of the society in which
it is practised. If ethical relativism is accepted, the rightness or wrongness of an act depends on a society’s
norms and any act inconsistent with those norms is ethically wrong. Alternatively, an ethical act is one that
is consistent with the norms of society. Therefore, a person with good ethical intentions will be influenced
to act in accordance with society’s norms. A common saying describing the practice of relativism is ‘When
in Rome, do as the Romans do’.
Relativism is premised on the belief that there is no single ethical standard. While this is the major
premise of relativism, it is also the cause of its major criticism: there is no universal standard of right and
wrong that can be applied to all people at all times. In this sense, no guidance on accepted behaviour is
provided when there are divergent opinions within society or across societies. The same action may be
ethical in one society but unethical in another.
This is particularly important in multicultural societies and multinational companies where cultural
practices can directly or indirectly influence respective business behaviour, giving rise to possible conflicts
of opinion and ethical values. For the ethical relativist, there is no universal standard of right or wrong but
only the standard of a particular society. Therefore, unlike normative theories of ethics, there is no common
framework for resolving ethical dilemmas across different societies.
.......................................................................................................................................................................................
CONSIDER THIS
Identify an issue you have seen reported in the media that relates to differing cultural values as they relate to the
conduct or freedom of individuals. What, if any, are the risks in taking a relativist approach to an ethical or philosophical
debate?
QUESTION 2.31
You are an employee of a company operating in a culture where bribery is commonplace. You have
been offered a gift, but no favours have been sought. Returning the gift will offend the donor. What
should you do?
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Often, the decision maker may not have a sufficient knowledge base to make proper decisions,
particularly when faced with new and difficult situations. Although decision making that relies on the
application of decision rules may be justified on practical grounds, it might not be adequate from an ethical
point of view. Some situations may require a more systematic approach to problem resolution.
A more systematic approach is to use structured methods of decision making that help reduce the
potential for inappropriate and inconsistent decision-making processes and outcomes. These models are
often based on normative ethical theories and ask probing questions to help identify the underlying ethical
issues, as well as the outcomes that various choices will have on different stakeholders. This helps avoid the
problem of forgetting to consider the ramifications of a particular course of action or ignoring a minority
interest group.
We have already outlined the conceptual framework in the Code of Ethics. In this section we outline:
• the decision-making model that can be applied to the conceptual framework
• two additional models:
– the philosophical model
– the American Accounting Association model.
Each of these models is designed to help accountants make well-reasoned ethical decisions. A detailed
discussion of all ethical decision-making models is beyond the scope of this module.
The decision-making models will not guarantee the correct or ethical decision, but they reduce the
possibility of an incorrect or inappropriate decision being made. A decision-making model is likely to
lead to a more systematic analysis and comprehensible judgment, clearer reasons and a justifiable and
more defensible decision than would have otherwise been the case.
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Paragraph 4.2 of the guidance note outlines a structured approach to ethical decision making which
mirrors the conceptual framework in the Code of Ethics. The steps in the approach are:
i. Gather the facts and identify the problem or threat;
ii. Identify the fundamental principles involved;
iii. Identify the affected parties;
iv. Determine whether established organisational procedures and conflict resolution resources exist to
address the threat to compliance with the fundamental principles;
v. Identify the relevant parties who should be involved in the conflict resolution process;
vi. Discuss the ethical issue and the conflict with the relevant parties, and in accordance with the prescribed
procedures evaluate the significance of the threats identified and safeguards available;
vii. Consider courses of action and associated consequences;
viii. Consider whether to consult confidentially with external advisers such as an independent adviser, legal
advisor and/or the Professional Body to which the Member belongs;
ix. Consider whether to consult Those Charged with Governance;
x. Decide on an appropriate course of action;
xi. Document all enquiries and conclusions reached; and
xii. Implement the appropriate course of action. In the event that the Member believes that the threat to
compliance with the fundamental principles has not been satisfactorily resolved, the Member should
determine whether it is appropriate to resign.
The guidance note includes a flowchart that illustrates the steps. There are several things to notice about
this process as it is set down in the guidance note. It looks at the way in which a member investigating a
complaint or a potential breach of standards ought to undertake the fact finding process to determine what
had occurred and what the appropriate way may be to address the issue. It is another illustration of a way
in which ethical issues can be dealt with.
GN 40 also includes 21 case studies incorporating examples from commercial, public and not-for-
profit sectors where professional accountants in business encounter ethical conflicts in their workplace
that require application of the fundamental principles of the Code of Ethics.
QUESTION 2.32
Download a copy of GN 40 from the APESB website and complete the following.
(a) Read section 4.2.
(b) Select two case studies that appear in section 13 of GN 40.
(c) Apply the structured approach to the case study.
A solution is not provided for this question, so please self-assess your answer to (c) by comparing
your analysis of the case study to that given in GN 40.
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QUESTION 2.33
Alpha Ltd, a clothing manufacturer in Australia, has decided to outsource its clothing production
to a supplier in Bangladesh to take advantage of the relative strength of the Australian dollar and
lower operating costs.
The company identified a supplier, called Delta Ltd, which was capable of providing this work.
Delta Ltd had offered to do the work at a lower price than other competitors, and a review of the
work quality indicated that it was at a comparable and suitable level.
During a visit to the production factory, the Australian management team observed the working
arrangements, how the factory was set up, and discussed working conditions with local employees.
They noticed and were advised of potential work safety problems in relation to noise, fire and
ventilation. However, the managers of Delta Ltd explained that the factory was a typical example in
Bangladesh and that it was compliant with all relevant laws.
Using the philosophical model of ethical decision making, recommend whether Alpha Ltd should
work with Delta Ltd.
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DIGFX
DIGFX is an emerging 3D printing business. Having marshalled its initial finances successfully through
crowd sourcing, seeking investor finance and incorporating was a logical step. The main change required
by the transition from a small business to incorporated entity was to effect transparent financial reporting.
Jaqueline Chan found herself in her first full-time employment as DIGFX’s in-house accountant,
overviewing and finalising its accounts for the financial year and its projected estimated for the coming
financial year. This was part of a company-wide report to be disseminated to shareholders at the
AGM. While checking the projected estimates, however, Jaqueline noticed that DIGFX had included a
prospective deal with NovaTech, a biomedical supplies company researching new ways to manufacture
cardiac valves. Jacqueline was sure that she had overheard conversations regarding the deal, and that
it had been successfully made some weeks earlier. The deal guaranteed DIGFX a new revenue stream
from orders above those generated by their current clients. She brought this up with the company’s CFO,
Paul O’Brien, who passed it off lightly, saying that the deal was still being finalised, and that passing
the expected revenue into the next year’s expected revenue would release the pressure on the accounts
section to process the paperwork before the end of financial year, in which was in a week.
Jacqueline returned to preparing the report, but was concerned that shifting the expected revenue from
NovaTech to the coming financial year may violate tax law. Researching the matter further, she found her
suspicions confirmed: that even if the revenue from the deal had not as yet found its way into DIGFX’s
accounts, the deal’s confirmation required that the revenue generated be noted in the current report. She
emailed Paul to that effect, to ensure that she had covered all bases. Paul again thanked her for her
thoroughness and expressed interest in her findings, suggesting a meeting to discuss it further. Feeling
gratified that her efforts had been appreciated, Jacqueline was keen to meet soon enough to finalise the
accounts for the AGM report. Given time pressures, Paul suggested a working lunch.
Over lunch, Paul explained that they were in a bit of a bind. The 3D printing scene was one that
quickly evolved, and the deal with NovaTech guaranteed DIGFX the resources to properly update their
inventory to deal with the project they were taking on, so long as it was largely untaxed. The problem
was that if the revenue was counted in the current financial year, it would be heavily taxed. In the coming
financial year, however, the revenue could be offset against the cost of the upgraded printers, reducing
the taxable return on investment. Shifting the profits a year ahead would strongly affect DIGFX’s viability,
and hence the tenure of Jacqueline’s position. Furthermore, the contract had been kept word of mouth,
so there was (as yet) no written document to demonstrate that it had already been confirmed, and the
revenue guaranteed.
QUESTION 2.34
Apply the philosophical model of ethical decision making to the scenario. What would you do if you
were Jacqueline?
EXAMPLE 2.21
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QUESTION 2.35
What are the ethical issues in this context? What should Davis do? Use the American Accounting
Association (AAA) ethical decision-making framework in analysing this case.
EXAMPLE 2.22
Chain of Command
Jenna worked as an in-house accountant for a superannuation fund, Millennial Funds, and was part of a
team preparing estimated dividends over the coming financial year as part of the company’s prospectus.
While estimating the revenue to be raised via its investments, she noticed considerable investment in a
proposed coal mine in Queensland, the Deep Vein mine. She found this odd, as she knew Millennial had a
policy of diversified investment, and particular in limiting fossil fuel investment. Jenna knew that the coal
prices factored into the projected profitability of the proposed mine could not be guaranteed. Millennial’s
CFO had publicly stated that it planned to move to an investment distribution that capped investment
in fossil fuels at 20% of its portfolio. This new mine investment would place its investment in coal alone
above that 20% threshold.
Jenna revised the projected estimate in line with a more conservative ongoing value of coal. When
she submitted her revisions, the document was returned to her by her manager, pointing out what they
considered to be an error — her revised estimate of the mine’s projected revenues. She forwarded her
workings on the topic, but was sent a curt reply to use the value initially supplied by Deep Vein. The
superannuation market was competitive and Millennial couldn’t afford to lose accountants to their rivals.
Furthermore, Jenna’s performance review would be coming at the end of the year, and it would not help
that process if she’d been found to be unhelpful in these essential matters.
QUESTION 2.36
Apply the American Accounting Association model to this scenario. What action would you
recommend in this situation?
SUMMARY
Ethical theories and principles provide useful tools to resolve dilemmas that arise in practice or in work
places. It is important to recognise, however, that decision making occurs in the context of numerous
individual, organisational, professional and societal influences. Generally, individual and organisational
factors can have a more intense influence on decision making than professional factors. The better a
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KEY POINTS
REVIEW
Professional ethics requires the application of a set of principles or a framework to make decisions and
take actions that are in the best interests of the public, in accordance with the professional ideal to serve
society. APES 110 Code of Ethics for Professional Accountants (including Independence Standards) sets
out five fundamental principles for the ethical conduct of professional accountants: integrity; objectivity;
professional competence and due care; confidentiality; and professional behaviour. APES 110 also
includes a conceptual framework that provides a structured decision-making approach to deal with any
ethical dilemma that may confront an accountant in their professional life. In addition, specific guidance to
identify and safeguard against threats is included for members in business and members in public practice.
Finally, independence requirements are set out for accountants who engage in audit, review and other
assurance engagements.
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REFERENCES
ABC News 2010, ‘Jail for $30M fraud’, 13 May, accessed October 2019, www.abc.net.au/news/2010-05-13/jail-for-30m-
fraud/434568.
APESB (Accounting Professional and Ethical Standards Board) 2015, APES GN 40 Ethical Conflicts in the Workplace—
Considerations for Accountants in Business, www.apesb.org.au/uploads/standards/guidance_notes/28102015023502_Revised_
APES_GN_40_Oct_2015.pdf.
APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards), APESB,
Melbourne, September, accessed August 2019, www.apesb.org.au/uploads/home/02112018000152_APES_110_
Restructured_Code_Nov_2018.pdf.
Aronson, B 2002, ‘The Enron collapse and auditor independence: Why the SEC should go further in regulating accounting firms’,
FindLaw, 24 January, accessed November 2019, https://supreme.findlaw.com/legal-commentary/the-enron-collapse-and-auditor-
independence.html.
ASIC (Australian Securities and Investments Commission) 2007, ‘ASIC commences proceedings relating to James Hardie’, ASIC
Media Release, 15 February.
ASIC 2014, ‘14-127MR ASIC suspends former Banksia auditor for five years’, accessed June 2014, https://asic.gov.au/about-
asic/news-centre/find-a-media-release/2014-releases/14-127mr-asic-suspends-former-banksia-auditor-for-five-years.
Brown, K & Dugan, KN 2002, ‘Arthur Andersen’s fall from grace is a sad tale of greed and miscues’, The Wall Street Journal,
7 June.
Christensen, BA 1996, ‘Kidder’s theory of ethics’, Journal of the American Society of CLU & ChFC, vol. 50, no. 4, p. 29.
Cottell, PG & Perlin, TM 1990, ‘Accounting Ethics: A Practical Guide for Professionals’, Quorum Books, New York.
CPA Australia 2015, ‘Independence checklist for employees’, CPA Australia, accessed August 2018,
www.cpaaustralia.com.au/~/media/corporate/allfiles/document/professional-resources/practice-management/independence-
checklist-for-employees.doc.
Dellaportas, S, Alagiah, R, Gibson, K, Leung, P, Hutchinson, M & Van Homrigh, D 2005, Ethics, Governance and
Accountability: A Professional Perspective, John Wiley & Sons, Milton, Queensland.
Dellaportas, S, Cooper, B & Braica, P 2007, ‘Leadership, culture and employee deceit: The case of the National Australia Bank’,
Corporate Governance: An International Review, vol. 15, no. 6, pp. 1442–52.
Dent, G 2009, ‘Ethics offer an edge’, Business Review Weekly, April 30–June 3.
Doucet, MS & Ruland, RG 1994, ‘An exploration of the professional role: Necessary virtues for the public accountant’, Ethics in
Accounting, American Accounting Association, pp. 7–10.
Dugdale, L 2012, ‘Blowing the whistle on Olympus’, INTHEBLACK, 3 October, accessed October 2015,
www.intheblack.com/articles/2012/10/03/blowing-the-whistle-on-olympus.
Eisenbeiss, SA 2012, ‘Re-thinking ethical leadership: An interdisciplinary integrative approach’, The Leadership Quarterly,
vol. 23, no. 5, pp. 791–808. http://dx.doi.org/10.1016/j.leaqua.2012.03.001.
FBI 2013, ‘Former senior audit partner at KPMG charged in Los Angeles with insider trading’, April 2013, accessed October
2019, https://archives.fbi.gov/archives/losangeles/press-releases/2013/former-senior-audit-partner-at-kpmg-charged-in-los-
angeles-with-insider-trading.
Hoffman, WM 1982, ‘The Ford Pinto’, Business Ethics: Readings and Cases in Corporate Morality, McGraw-Hill Book
Company, New York, pp. 412–20.
Hofstede, G 1980, Culture’s Consequences: International Differences in Work-Related Values, Sage Publications, California.
ICAEW (The Institute of Chartered Accountants in England and Wales) 2007, ‘Information for Better Markets: Reporting with
Integrity’, ICAEW, London.
IFAC (International Federation of Accountants) 2010, ‘IFAC Policy Position Paper #4: A Public Interest Framework for the
Accountancy Profession’, IFAC, New York, accessed October 2015, www.ifac.org/sites/default/files/meetings/files/5892_0.pdf.
Jackson 2004, ‘The Report of The Special Commission of Inquiry into Medical Research and Compensation Foundation’,
September, accessed June 2014, www.dpc.nsw.gov.au/assets/dpc-nsw-gov-au/publications/Medical-Research-and-
Compensation-Foundation-listing-442/80be743ceb/Report-Part-A-Special-Commission-of-Inquiry-into-the-Medical-Research-
and-Compensation-Foundation.pdf.
Kohlberg, L 1981, ‘The philosophy of moral development: Moral stages and the idea of justice’, Essays in Moral Development,
vol. 1, Harper & Row, New York.
Pdf_Folio:112
ETHICS WEBSITES
USEFUL WEBSITES ON PROFESSIONAL AND BUSINESS ETHICS
• Accounting Professional & Ethical Standards Board, accessed September 2015, www.apesb.org.au
• The Ethics Centre, accessed September 2015, www.ethics.org.au
• International Federation of Accountants, www.ifac.org/system/files/publications/files/IAESB-Ethics-
Education-Toolkit-Introduction.pdf
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GOVERNANCE
CONCEPTS
LEARNING OBJECTIVES
ASSUMED KNOWLEDGE
LEARNING RESOURCES
PREVIEW
Governance is the system that is put in place to operate and control an organisation. With the advent of
the corporate structure, the resulting agency relationship between the company (or its owners) and those
who act on its behalf, and a spate of reasonably recent corporate failures, a form of governance known as
‘corporate governance’ has evolved.
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Part A of this module examines the nature and structure of corporations, the characteristics and duties
of directors and other officers, the division of power between owners and directors within a company and
what, theoretically, this division of power means for the governance of an organisation.
Part B of this module defines and discusses the importance of corporate governance and looks at the
key elements of a corporate governance framework that are common to most organisations.
Part C looks at the history of and differing international perspectives on corporate governance.
Part D examines the content and application of various corporate governance codes and principles.
Finally, part E examines governance in the small- and medium-sized enterprises (SME), and the
not-for-profit and public sectors.
Pdf_Folio:115
Pdf_Folio:116
Public (listed or unlisted) Limited by shares/ Ltd Limited (UK, Australia, India)
guarantee PLC Public Limited Company (UK)
Bhd Berhad (Malaysia)
Corp/Inc. Incorporated (US)
PT Tbk Perseroan Terbuka (Indonesia)
KK Kabushiki-Kaisha (Japan)
PROPRIETARY COMPANIES
Proprietary companies are the most commonly registered company type in Australia. Shares are held
privately by no more than 50 non-employee members. A proprietary company is not allowed to do
anything that would require disclosure to investors, including, offering securities for issue or sale to
the public. Proprietary companies may however issue shares to existing shareholders, employees or
subsidiary companies. They may also issue shares or corporate bonds to sophisticated or professional
investors, and as small-scale issues of not more than $2m in any 12-month period to no more than
20 people. Should a proprietary company fail to follow any of these rules, the Australian Securities and
Investments Commission (ASIC) may force it to change to a public company. Proprietary companies are
further subdivided into large and small proprietary companies. The financial reporting obligations for large
proprietary companies are different to those of small proprietary companies
QUESTION 3.1
Refer to s. 45A of the Corporations Act for the rules used to differentiate between large and small
proprietary companies.
PUBLIC COMPANIES
A public company is defined as a company that is not a proprietary company. It will have more than 50
members and may issue securities to the public. Public companies may apply to list on the Australian
Securities Exchange (ASX).
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Aspect of compliance Small proprietary company Large proprietary Public company Listed public company (disclosing entity)
company
Minimum number of One (one) (s. 201A (1)-(1A)) One (one) (s. 201A (1)-(1A)) Three (two) (s. 201A (2)) Three (two) (s. 201A (2))
directors (resident
in Australia)
Company secretary Optional (Part 2D.4) Optional (Part 2D.4) At least one who resides in At least one who resides in Australia (Part 2D.4)
Auditor/Audit report Only in certain circum- Yes, but ASIC may provide Yes, including independence Yes, including independence and rotation requirements
stances (s. 301(2)) relief in appropriate cases requirements (ss. 301, 307, (ss. 301, 307, 308, 309, Part 2M.4)
(ss. 301, 342(2)–(3), 308, Part 2M.4)
Part 2M.4)
Financial records Yes, electronic or convertible Yes, electronic or Yes, electronic or convertible Yes, electronic or convertible to hard copy, kept for 7 years
to hard copy, kept for convertible to hard copy, to hard copy, kept for 7 and either in English or a translation to be
7 years and either in English kept for 7 years and either years and either in English made available upon request (Part 2M.2)
or a translation to be made in English or a translation or a translation to be made
available upon request to be made available upon available upon request
(Part 2M.2) request (Part 2M.2) (Part 2M.2)
Reporting requirements Annual financial report and Annual financial report Annual financial report (s. 295) Annual and half-year financial report (ss. 295, 302-306) and
directors report only in some (s. 295) and directors report and directors report (ss. 298, directors report (ss. 298, 299, 299A, 300(1)–(13), 300A)
circumstances (ss. 292(2), (ss. 298, 299, 300(1)–(9)) 299, 300(1)–(13)) Financial report, auditor’s report and directors’ report to be
293, 294, 298(3)) Financial report, auditor’s presented at AGM (ss. 315, 317, and 250N)
Note that these do not need report and directors’ report to Submit annual and half yearly financial, directors and audit
to comply with accounting be presented at AGM (ss. 315, reports to ASIC (s. 319)
standards (s. 296(1A)). 317, and 250N)
ASX Listing requirements — Chapter 4 and Chapter 5
which include submission of quarterly returns to ASX for
some companies (mining, oil and gas, and those without a
record of revenue or profit).
Listed
company
Public
company
Structure
Large private
company
Small private
company
Low High
Regulation
Source: CPA Australia 2015.
QUESTION 3.2
Find and list the eligibility criteria for directors in the Corporations Act. Use ASIC’s list of
eligibility criteria at https://asic.gov.au/for-business/running-a-company/company-officeholder-
duties/your-company-and-the-law/#can-anyone-be-an-officeholder to confirm your list.
EXAMPLE 3.1
Advance Bank
Directors of Advance Bank Australia Ltd believed they were acting in the best interests of the corporation
in using the corporation’s funds in an election campaign to stop the nominees of FAI Insurances Ltd from
gaining a place on the board, and to return the current directors to the board.
The allegation was that the material sent to the shareholders included misleading and prejudicial material
that should not have been paid for by the corporation. The court decided that, although the directors acted
honestly and in good faith, they exceeded their power and used their power for an improper purpose. The
case highlights the position of directors who act beyond their power, however innocently (Advance Bank
Australia Ltd v. FAI Insurances Ltd (1987) 5 ACLC 725).
However, the requirement for continuous disclosure is not confined to financial information,
and includes any information that is expected to have a material effect on the price of securities. Further
explanation of the board becomes necessary in continuous disclosure regimes when a critical accounting
or material matter occurs that might have material impact on the financial and operating results of
the company.
Chapter 3 of the ASX Listing Rules (ASX 2014a) gives the following examples of information that
could be market sensitive:
• a transaction that will lead to a significant change in the nature or scale of the entity’s activities;
• a material mineral or hydrocarbon discovery;
• a material acquisition or disposal;
• the granting or withdrawal of a material licence;
• the entry into, variation or termination of a material agreement;
• becoming a plaintiff or defendant in a material law suit;
• the fact that the entity’s earnings will be materially different from market expectations;
• the appointment of a liquidator, administrator or receiver;
• the commission of an event of default under, or other event entitling a financier to terminate, a material
financing facility;
• under-subscriptions or over-subscriptions to an issue of securities (a proposed issue of securities is
separately notifiable to ASX under Listing Rule 3.10.3);
• giving or receiving a notice of intention to make a takeover; and
• any rating applied by a rating agency to an entity or its securities and any change to such a rating.
While understanding the broad principles and necessity of continuous disclosure, boards and directors
are often challenged on exactly when disclosure is required. The ASX (2014a) advises:
Once an entity is or becomes aware of any information concerning it that a reasonable person would expect
to have a material effect on the price or value of the entity’s securities the entity must immediately tell ASX
that information (Listing Rule 3.1 (p. 301)).
A listed entity should have a written policy directed to ensuring that it complies with this obligation so
that all investors have equal and timely access to material information concerning the entity – including its
financial position, performance, ownership and governance (Corporate Governance Recommendation 5.1
(p. 21)).
In designing its disclosure policy, a listed entity should have regard to ASX Listing Rules Guidance Note 8
Continuous Disclosure: Listing Rules 3.1 – 3.1B and to the 10 principles set out in ASIC Regulatory
Guide 62 Better disclosure for investors.
Further advice offered by the ASX (2014b) regarding the immediacy of the need for disclosure includes
when and where the information originated (rumours abound and need to be countered carefully); the
forewarning the entity had of the information and the need to verify the bona fides of the information; and
the need for an announcement to be drawn up that is accurate, complete and not misleading.
This provision also states that should a director rely on this defence, the burden of proof rests with
the director.
Unless the company can obtain sufficient finance or trade its way out of financial difficulty, the
options available to directors are to appoint a voluntary administrator or a liquidator. In a voluntary
administration, an independent and suitably qualified person will assume full control of the company to
try to work out a way to save either the company or the company’s business. If it isn’t possible to save
the company or its business, the aim is to administer the affairs of the company in a way that results in a
better return to creditors than they would have received if the company had instead been placed straight
into liquidation.
The purpose of liquidation of an insolvent company is to have an independent and suitably qualified
person (the liquidator) take control of the company so that its affairs can be wound up in an orderly and
fair way for the benefit of its creditors. There are also circumstances under which directors may find
themselves liable for insolvent trading and have judgments awarded against them. Example 3.2 presents
one such set of circumstances.
EXAMPLE 3.2
Mainzeal
A notable case in New Zealand, the Mainzeal case, is an example of a court deciding in February 2019 that
directors were liable for trading while insolvent and that the directors were to pay a penalty of $36 million.
Mainzeal was a construction company that was placed in the hands of liquidators in 2013 after it had built
up $110 million in debt to creditors. Former New Zealand Prime Minister, Dame Jenny Shipley, and other
directors were told they were to pay an amount capped at $6 million individually. The case illustrated the
need for directors to get proper legal advice as well as drawing attention to the fact that directors should
not use an auditor’s opinion that views the entity as a going concern as the sole basis for their assessment
for whether the entity is able to pay its debts as they fall due.
Source: Information from Dolor S 2019, ‘Mainzeal judgment highlights need for good corporate governance’, March,
New Zealand Lawyer, accessed October 2019, www.nzlawyermagazine.co.nz/news/mainzeal-judgment-highlights-need-for-
good-corporate-governance-260950.aspx.
............................................................................................................................................................................
CONSIDER THIS
What are the issues that you would consider important if you were a director contemplating whether your entity
was a going concern?
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EXAMPLE 3.3
Centro Case
The Centro case (ASIC v. Healey & Ors (2011) FCA 717) involved actions brought by the Australian
corporate regulator, ASIC, against certain executives and non-executive directors of the Centro group
of entities. The principal activities of the Centro group, the parent of which is listed on the ASX, involves
the ownership, management and development of shopping centres throughout Australia, New Zealand
and the United States, and the management of unlisted funds.
ASIC alleged that the defendants had contravened their statutory duties of care and diligence under the
Corporations Act in relation to their approval of the consolidated financial statements of the Centro group
for the year ended 30 June 2007. In particular, it was alleged that the consolidated financial statements
were incorrect as they incorrectly classified $1.5 billion of debt as non-current liabilities when in fact they
should have been classified as current liabilities.
Furthermore, it was alleged that the defendants had failed to disclose USD$1.75 billion of guarantees
as a material post balance date event in the financial statements of Centro. Centro’s auditor, Pricewater-
houseCoopers, did not identify any such errors in the financial statements of Centro.
In June 2011, Justice Middleton of the Federal Court of Australia (FCA) held that each of the directors
had breached their duty of care and diligence in relation to the Centro group of entities and had
failed to take all reasonable steps to ensure compliance with the financial reporting obligations of the
Corporations Act.
The directors were also found to have approved the financial statements of Centro without receiving a
CEO/CFO declaration that complied with section 295A of the Corporations Act. The court held that each
director knew or should have known of the extent of the relevant entities’ borrowings and maturity profiles
as well as the post balance date guarantees.
Key lessons for directors arising out of the Centro case include the following matters.
Duty of Care
The Centro case emphasises the duty of care expected of public company directors when they approve
financial statements. The directors should apply their minds to the proposed financial statements,
including a careful review of how the financial analysis is presented and the clarity of the accompanying
directors’ report.
The directors should determine whether the information contained in these documents is consistent
with their knowledge of the company’s affairs and that they do not omit material matters known, or that
should have been known, to the directors.
The directors should know enough about basic accounting concepts to enable them to carry out their
responsibilities adequately. Furthermore, they should make appropriate inquiries if they are uncertain.
Reliance on Others
The Centro directors argued that the Corporations Act permits reasonable reliance on others in the
discharge of their duties, and that they reasonably relied on Centro’s management and the external auditor
to ensure that the financial statements complied with relevant accounting standards.
The court found that the directors may rely on others, including management and external advisors,
who prepare financial statements and advise on accounting standards. Such reliance can exclude
independently verifying the information on which the advice is based, provided that there is no cause
for suspicion or circumstances demanding critical attention.
However, directors cannot substitute reliance on advice for their own attention and examination of
important matters within the board’s responsibilities (i.e. the directors must approach their tasks with
an enquiring mind). Therefore, the directors’ failure is not excused even if others on whom they relied fell
into error.
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Example 3.4 further illustrates the importance of directors not relying on others to avoid their duty to
use care, skill and diligence in their dealings with and on behalf of the corporation.
EXAMPLE 3.4
Following the Centro and James Hardie cases, detailed in examples 3.3 and 3.4, there are some non-
delegable duties and these apply to ‘business judgment’ decisions. While the area is unclear, it can be
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DIRECTOR INDEPENDENCE
It is crucial to appreciate the importance of independence in the role of directors. All independent directors
must be non-executive directors, but not all non-executive directors are independent. Sometimes people
confuse these two terms or use them interchangeably, but they are different.
The ASX Corporate Governance Council Recommendations (2019), which are now in their fourth
edition, provide the following commentary on independence and directors.
To describe a director as ‘independent’ carries with it a particular connotation that the director is not aligned
with the interests of management or a substantial holder and can and will bring an independent judgement
to bear on issues before the board.
It is an appellation that gives great comfort to security holders and not one that should be applied lightly.
A director of a listed entity should only be characterised and described as an independent director if he
or she is free of any interest, position or relationship that might influence, or reasonably be perceived to
influence, in a material respect their capacity to bring an independent judgement to bear on issues before
the board and to act in the best interests of the entity as a whole rather than in the interests of an individual
security holder or other party (ASX CGC 2019, p. 13).
Category Attributes
Executive directors Work for the company and are never independent
Non-executive directors Do not work in the organisation, but are not independent because of a particular
relationship
Independent non-executive Are free from influences that cause bias and exhibit the characteristics of
directors independence
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Even if a director is not independent, it is important to appreciate the concept and to ensure decisions
are made as impartially (i.e. as independently) as possible. This obligation is actually required by law in
most jurisdictions.
The identification of non-executive and independent directors is important. In Australia, for example,
Recommendation 2.3 of the ASX Corporate Governance Council Corporate Governance Principles and
Recommendations (ASX Principles) states that ‘a listed entity should disclose the names of the directors
considered by the board to be independent directors’ (ASX CGC 2019). It also provides a checklist of
factors to consider when assessing a director’s independence. There are similarities between these factors
and those from the FRC Code discussed earlier.
In addition to this, certain committees should only have independent or at least non-executive members
on them, this will be discussed in part D. The ASX Corporate Governance Council recommendations also
deal with the need to periodically review the tenure of directors to ensure that they maintain independence.
The recommendations suggest that the relationships, experience and tenure of directors should be reviewed
periodically to ensure that directors that are classified as being independent are able to continue to be
classified as independent. The commentary on Recommendation 2.3 describes in some detail what the
Corporate Governance Council expects of directors.
QUESTION 3.3
a) Download the two sets of governance guidance from the ASX Corporate Governance Council
and the UK FRC as per the links below.
– www.asx.com.au/documents/regulation/cgc-principles-and-recommendations-fourth-
edn.pdf
– www.frc.org.uk/getattachment/88bd8c45-50ea-4841-95b0-d2f4f48069a2/2018-UK-
Corporate-Governance-Code-FINAL.PDF
b) Take notes on similarities and differences between the ASX’s Box 2.3 and Provision 10 of the
UK FRC Code.
c) What does the Corporate Governance Council state that a board should do in relation to directors
whose tenure is more than 10 years?
The Small Business Guide in the Corporations Act (Volume 1, Chapter 1, Part 1.5, paragraph 5)
describes the responsibilities of a company secretary at the link below. Find the responsibilities as
described in the guide and ensure you note them.
See link at: www.legislation.gov.au/Details/C2019C00216/Html/Volume_1#_Toc13831317
SHAREHOLDER POWERS
Shareholders (or members, as they are referred to in the Corporations Act), are also given powers under the
Act. Generally, these powers include the power to appoint, remunerate and remove directors, call meetings,
call for and vote on resolutions, and seek redress from the courts.
Appointment of Directors
The Corporations Act states that directors can be appointed in two ways (ss. 201G, 201H):
• by resolution passed in a general meeting;
• by the directors of a company which is subject to confirmation by:
– a proprietary company via resolution within two months of the appointment; and
– a public company via resolution at the company’s next annual general meeting (AGM).
Once appointed (unless otherwise restricted), they can exercise all the powers conferred upon them by
the Corporations Act.
Remuneration
In public companies, shareholders generally approve the overall upper limit of (or increases to) director
remuneration. For listed companies, members at annual general meetings have the opportunity via
s. 250R(2) to adopt a company’s remuneration report, however, ‘this is advisory only and does not bind
the directors or the company’ (s. 250R (3)). Two successive ‘strikes’ (a ‘no’ vote of 25% or more to the
adoption of the remuneration report) gives members the opportunity to vote on a spill resolution. If the
resolution is passed by at least 50% of votes, all directors are forced to put themselves up for re-election
at a ‘spill meeting’, which must be held within 90 days of the spill resolution being passed (ss. 250U,
250V, 250W).
QUESTION 3.5
Find the sections from the Corporations Act listed in table 3.4 and fill in the other powers reserved
for shareholders.
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136
162
173(2)
201P
203D
208
234
246B
249D (1)
249N
251B
BOARD POWERS
The Corporations Act (s. 198A) states that ‘the business of a company is to be managed by or under the
direction of the directors’. The board of directors (the board) is the body that oversees the activities of
an organisation.
It is preferable that the roles and responsibilities of the board be explicitly set out in a written charter
or constitution. A significant court case in Australia regarding what boards should do has received
international recognition in the Anglo-American corporate world. In AWA Ltd v. Daniels (1992) 10
ACLC 933, Rogers C J concluded that the role of the board in modern companies is to set policy and
organisational objectives (performance) and then ensure adequate controls and review procedures are in
place (conformance) to ensure effective implementation by management (performance).
However, Rogers C J observed that the board is not in place to actually run the business itself. That
part of the governance process is delegated to the CEO, although the board must remain informed and is
responsible for taking timely action where fundamental CEO failures arise. Rogers C J stated:
The board of a large public corporation cannot manage the corporation’s day-to-day business. That function
must by business necessity be left to the corporation’s executives. If the director of a large public corporation
were to be immersed in the details of day-to-day operations, the director would be incapable of taking more
abstract, important decisions at board level (AWA Ltd v. Daniels (1992) 10 ACLC 933, p. 1013).
Therefore, directors are entitled to rely on management to manage the daily operational activities of
the corporation. The board need not be informed of these details and will expect the paid managers to
run the corporation according to strategies and policies set by the board. However, the board cannot leave
everything to the managers, as the board also has an ongoing oversight responsibility.
The board must ensure appropriate procedures are in place for risk management and internal controls,
and it must also ensure that it is informed of anything untoward or inappropriate in the operation of those
procedures. Any major operational issues will also be brought to the attention of the board for appropriate
consideration and decision.
Despite these expectations, in many high-profile corporate collapses, it is apparent that the board was not
informed about key business decisions or simply chose to comply with management. For example, in the
case of a former prominent Australian company, HIH Insurance, it was apparent that the major takeover of
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CEO POWERS
The CEO is responsible for the ongoing operations of the organisation. The CEO is usually a director of
the board as well, and because of this, may also be called the managing director or MD. In this capacity, the
CEO is easily identified as an agent of the board, with carefully defined responsibilities to make a range
of operational decisions as delegated by the board.
The CEO effectively has two roles, board member and CEO, and potentially two identifiable agency
relationships arise — one with shareholders and another with the board. This duality results in a series of
governance rules and laws designed to control problems that can arise.
The CEO, in conjunction with the management team, is responsible for constructing the strategies and
the significant policies of the company. However, this will be the result of boardroom deliberations in
which the CEO, as a director, will participate. When the process is completed to the satisfaction of the
board, the board will formally approve these corporate strategies and policies. The task of implementing
corporate strategies and policies rests with the CEO and the management team.
The CEO must keep the board informed on key issues relating to the management of the company — for
example, through monthly management reports to the board. These reports should include information on
performance and key risks, and also exceptional/significant events (such as the loss of a key customer). The
CEO also works with the board (primarily the chair) and the company secretary to prepare the agenda for
board meetings and to ensure that appropriate background information accompanies the agenda to enable
the board to make the right decisions.
STEWARDSHIP THEORY
Stewardship theory suggests that people in power (the agents or stewards) will act for the benefit of those
who have engaged them. Stewardship theory sees appointed directors as ‘stewards’ who carefully look
after the resources they have been trusted with. Rather than directors and managers as agents who act
in their own self-interest, these stewards are expected to naturally act favourably on behalf of the owners
(Donaldson & Davis 1991). Executive self-interest is not expected to interrupt corporate goals and genuine
stakeholder outcomes. In this situation, financial reports provide a formal means for the directors to declare
their stewardship obligations to the owners.
While stewardship theory accepts that directors must also consider the interests of groups other than
shareholders (i.e. stakeholders such as employees, suppliers, customers), the primary duty of directors is
for the interests of shareholders. The boundaries of corporate governance under stewardship theory are
therefore defined by the relationship between directors and shareholders.
The interests of other stakeholders are assumed to be addressed by relevant laws outside the boundaries
of corporate governance, such as consumer protection or competition laws. A strength of stewardship
theory is that it perceives directors as professionals able to demonstrate their commitment to the company
and its shareholders in a virtuous and capable way without constant oversight. One criticism of this theory
is the assumptions that good stewards do exist and that these stewards will maintain their virtues over
extended periods of time.
AGENCY THEORY
Agency theory takes the alternative view and assumes people have a self-interested egoist approach.
Agency theory views corporate governance through the relationship between agents and principals. At
its broadest level, agency consists of giving power to individuals or groups to act on behalf of others.
Agents are permitted to act in place of, and to make decisions for and on behalf of, the principals and to
comply with the terms of the agency and the rules applying to them.
While agents are expected to act on behalf of the principal, agency theory differs from stewardship theory
because it suggests the agent may not naturally act in the best interests of the principal. The underlying
assumption of agency theory is that all parties are rational utility maximisers, which means agents may
pursue different goals from those of the principals. Therefore, potential for conflict arises and mechanisms
such as corporate governance must be in place to ensure the agent acts appropriately.
Agents must therefore be aware of the concepts and principles of good governance, and to comply with
the terms of the agency and the rules applying to them. Jensen and Meckling define agency and comment
on its central problem.
We define an agency relationship as a contract under which one or more persons (the principal(s)) engage
another person (the agent) to perform some service on their behalf, which involves delegating some decision
making authority to the agent. If both parties to the relationship are utility maximizers, there is good reason
to believe that the agent will not always act in the best interests of the principal (Jensen & Meckling 1976,
p. 308).
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QUESTION 3.6
What is one major issue that arises from an agency relationship, where powers of control
are delegated?
Agency theory identifies three types of agency costs: monitoring costs, bonding costs and costs relating
to residual loss. These costs can arise as a result of:
• information asymmetry (where the agent has more information than the principal)
• poor communication
• poor understanding
• innocent and unintended self-interested behaviour by agents
• deliberate legal self-interested behaviour
• illegal self-interested behaviour by agents (e.g. fraud).
Monitoring Costs
Monitoring costs are incurred by principals because an agency relationship exists. Some monitoring costs
are compulsory, such as costs relating to annual reporting and external auditing. Other monitoring costs
are discretionary, such as the work required to construct and analyse activities according to a strategic or
balanced scorecard.
Bonding Costs
Bonding costs are costs incurred by the agent to demonstrate to the principal that they are goal
congruent. This may include voluntary restrictions on the agent’s behaviour or benefits to demonstrate
goal congruence, and are part of the explanation for the development of executive stock options and other
benefits that have significantly increased executive rewards in recent decades. An example of bonding
costs is provided later in example 3.5.
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EXAMPLE 3.5
Agency costs
Robert was the CEO of a large listed corporation. He had been in the position for many years. During his
tenure, a branch had opened near a popular seaside resort in Thailand. It was not profitable, but Robert
argued it was important and visited it several times each year. He would commonly take a holiday at the
same time at a nearby resort. The corporation would pay his hotel bills and travel costs.
Robert later retired and his position was advertised. Susan was interviewed by the board for the
position. Susan had sought extensive information about the corporation and had learned about Robert’s
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In example 3.5, Robert’s expenses are an example of residual loss. Susan’s behaviour demonstrates
voluntary restrictions accepted by Susan in order to show that she is bonded to the corporation. Restrictions
on freedoms are bonding costs borne by agents. In example 3.5, Susan will also bear a dollar cost if the
board does not approve the travel. Her willingness to undertake the overseas branch review is possibly
another bonding cost. Also, note that Susan has suggested extra duties to the chair. If performed, these
extra duties are a monitoring activity, the cost of which is borne by the principal.
Aside from self-interest, ineffective communication between principal and agent will result in residual
loss, as agents will not know or understand the principal’s goals — meaning that good goal congruence
will be highly unlikely.
When we consider remuneration issues, we might find that an agent who is highly bonded should be
remunerated more abundantly. The diminished residual loss and the reduced need to monitor a highly
bonded agent would seem to imply that the extra value available to the principal might, at least in part, be
made available as an extra reward to the good agent.
QUESTION 3.7
Describe key aspects of the principal and agent problems that exist within corporations and that
can result in loss of value for the shareholders.
Stakeholder Theory
This theory focuses on how managers in an entity, irrespective of its type, seek to manage their relationships
with all of their internal and external stakeholders. Internal stakeholders include the owners of an entity,
which can vary depending on entity structure or sector in which the entity operates, employees and
management. Each internal stakeholder group will require different responses from the entity in order
to fulfil their demands. It should be noted that shareholders may, at times, be seen as external stakeholders
even though they are owners of part of an entity.
External stakeholders are much broader. External stakeholders include customers, suppliers, creditors,
regulators and government. Each of these stakeholders has to be managed and satisfied in different ways.
It is worth noting that each stakeholder group does not have a relationship with the entity in a vacuum.
There may be competing interests that the entity must satisfy at the same time.
.......................................................................................................................................................................................
CONSIDER THIS
What tensions do you believe exist when an entity in the financial services sector considers its obligations to
shareholders and also customers?
CSR Theory
CSR theory deals with the concept that an entity and those employed by it should engage in activities and
promote causes and initiatives that are seen as providing a social benefit to the community. It is said that
the individuals working within the entity are then engaged, not just on the work they do within the entity,
but also with the broader community. It is also a way in which an entity emphasises its support of various
community-based causes.
.......................................................................................................................................................................................
CONSIDER THIS
Identify an entity and a charitable or social cause it has supported. What are the possible advantages or disadvantages
to the entity?
SUMMARY
Corporate law encompasses the body of law that regulates the operation of companies. In Australia, the
Corporations Act provides the framework of regulation for companies.
Corporate law defines company directors’ duties and sets out the rights of shareholders. Essential char-
acteristics of corporate law include the consideration of the corporation as having the legal capacity and
powers of both an individual and a body corporate. This enables the corporation to act as an autonomous
entity. Limited liability means the shareholders’ liability is limited to the value of their shares in the
corporation, and direction of the company is delegated to a board of directors. Within the different types
of corporate structure permitted by corporate law, there is the freedom of directors to govern by pursuing
the best interests of the corporation. A range of duties are imposed on directors and other officers to act
on behalf of the company to ensure their duties are carried out in accordance with the best interests of the
company. The Corporations Act also includes two protective provisions for directors (business judgment,
safe harbour).
Shareholders are unable to directly intervene in management decisions, but have power to appoint and
remove directors and determine their remuneration.
A range of theories offer different perspectives on corporate behaviour. A common theme among these
theories is a focus on the interaction of different actors in a corporation and the importance of different
groups in the chain of decision making. These theories are a useful way of reflecting on a company’s
obligations to various groups and individuals and hence can be used as problem-solving tools in business.
They should not be thought of as only academic undertakings.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
3.3 Describe the nature of corporations and the division of corporate powers.
• Corporations are artificial persons that have most of the rights and obligations of real people.
• Companies are a separate legal entity from their owners.
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The second section of this part of the module examines the key elements of a corporate governance
framework, but we will briefly explain the basic principles here. ‘Direction’ refers to steering the
organisation towards its performance goals. ‘Control’ relates, at least in part, to ensuring compliance
with rules. We use the word ‘corporate’ to indicate that we are focusing on the governance of corporate
or business organisations. This may be a formal corporate structure (e.g. company) or a non-corporate
entity such as an NFP organisation (e.g. charity or government entity) or an incorporated association
(e.g. sporting club). Note that the term ‘corporate governance’ is, in practice, also used by non-corporate
entities. The important thing to grasp is that all entities acting on behalf of the rights or interests of others
need to respect basic principles of governance if they are to act with integrity, authority and accountability.
It is important not to focus solely on the compliance and regulatory aspects of governance, which must
always be balanced with a focus on pursuing an effective strategy and successfully achieving organisational
goals and objectives. As such, corporate governance extends to both conformance with all the necessary
rules for the proper conduct of the organisation, including compliance with external regulations and internal
organisational policies, and performance, with a focus on economic success. If an organisation is a not-for-
profit entity, then its performance will relate to the economy, efficiency and effectiveness of its activities.
A large amount of discussion and effort in the governance area has focused on compliance rather than
performance. As a result, some people have argued that the term ‘corporate governance’ is limited and
solely focused on compliance, and that a different name, ‘enterprise governance’, is needed to describe
the broader focus on both conformance and performance. In this subject we take the perspective that this
is not necessary, and corporate governance is a broad enough term to capture both approaches.
Organisations need to demonstrate compliance and accountability to offer assurance to investors and
other stakeholders, and they need strategies to achieve higher performance if they are to offer the returns
and benefits that investors and stakeholders expect. Indeed, it is when accountability and strategy are well
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The Ethics and Governance subject emphasises the conformance aspect of governance. Both perfor-
mance and conformance are equally important, and performance aspects are covered in other subjects
of the CPA Program. However, it is important to appreciate the close relationship between strategy
and accountability: strategy without accountability may lead to recklessness, and accountability without
strategy may lead to paralysis (Clarke 2016).
Mr Tamaki’s speech was delivered in the year that the OECD published an updated version of its
corporate governance guidelines. The preface to the OECD’s guidelines acknowledges that:
international flows of capital enable companies to access financing from a much larger pool of investors
… If companies and countries are to reap the full benefits of the global capital market, and if they are to
attract long-term ‘patient’ capital, corporate governance arrangements must be credible, well understood
across borders and adhere to internationally accepted principles (OECD 2015).
.......................................................................................................................................................................................
CONSIDER THIS
Identify areas in the accounting discipline where authoritative guidance emanates from a global organisation. What
are your views on global consistency in guidance? Under what circumstances could divergence from global guidance
be appropriate?
At an organisational level, the behavioural styles and business management practices of managers (and
other employees) or directors can result in outcomes that are not in the best interests of shareholders
and other stakeholders. These situations can range from relatively minor technical breaches of policies or
practices, to more serious cases where excessive risk taking or poor controls place the ongoing survival of
the organisation at risk.
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OWNERS/MEMBERS
Governments — set the
legal and regulatory Confirm
environment appointment
Reporting and Appointment Reporting and
accountability and review accountability
Recommend External
Stakeholders — may set Set the appointment
BOARDS Auditor
specific requirements, frame- Reporting and
e.g. owners works accountability
Source: Kiel, G et al. 2012, Directors at Work, Thomson Reuters, Sydney. Reproduced with permission.
.......................................................................................................................................................................................
CONSIDER THIS
From figure 3.2 identify the components of the framework that have been covered in this module so far.
Although shareholders and boards have been examined in terms of their relative powers, this section
examines them in more detail followed by the other components of the corporate governance framework.
SHAREHOLDERS
Shareholders are the persons or entities who own a company and have an important part to play in corporate
governance. Shareholders elect directors to operate the business on their behalf and, therefore, should hold
them accountable for its success or failure. One needs to recognise that shareholders have delegated much
authority to the directors. This is the classic principal/agent relationship.
There are different kinds of shareholders that are involved in dealing with companies. These shareholders
are typically defined as:
• individual shareholders, or
• institutional shareholders.
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Individual Shareholders
The increase in the number of individuals holding shares is having far-reaching effects on companies.
A substantial number of these shareholders may be retired and have time to devote to the task of keeping
themselves informed. This has been facilitated by greater access to technology such as the internet.
In addition, there are organisations that represent the collective interests of smaller shareholders, such
as the Australian Shareholders’ Association (ASA), which has been active in striving for improvements in
the corporate governance of Australian companies (see example 3.6).
Individual shareholders want companies to be run efficiently and profitably, and for the companies to be
adequately supervised by the board. They also want honesty from directors and managers. To achieve these
objectives, shareholders are prepared to be more vocal. The media and the internet have provided vehicles
for shareholders to more publicly express their concerns regarding poor corporate governance practices.
EXAMPLE 3.6
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Information Asymmetry
Investor knowledge comes from individual research, shareholder activists and proxy advisers. Access to
knowledge may be limited to information which the company publishes or information which shareholders
or their representatives can encourage companies to share. In a perfect world, everyone would have
equal access to all information. However, there is often significant information asymmetry within the
company structure.
QUESTION 3.8
A recent example of information asymmetry that may have led to a moral hazard can be seen in the 2019
Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. An
excerpt from interim report is provided in example 3.7.
EXAMPLE 3.7
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THE BOARD
Boards and directors are the most significant components of corporate governance. It is essential to develop
a clear understanding of what a director is and what a board of directors is. The following description of a
company and the directors is useful in considering the role that directors play in an organisation.
A company may in many ways be likened to a human being. It has a brain and a nerve centre which controls
what it does. It also has hands which hold the tools and acts in accordance with directions from the centre.
Some of the people in the company are mere servants … who are nothing more than hands to do the work
and cannot be said to represent the mind or will. Others are directors and managers who represent the
directing mind and will of the company, and control what it does. The state of mind of these people is the
state of mind of the company and is treated by the law as such (L J HL Bolton Engineering Co. Ltd v. TJ
Graham & Sons Ltd [1957] 1 QB 159 at 179).
In this section we provide a considerable discussion about various aspects of this area, including the
main functions of the board of directors (see figure 3.3 and table 3.5) and various board committees.
.......................................................................................................................................................................................
CONSIDER THIS
As an exercise to assess your own financial reporting knowledge in preparation for advising a board or becoming a
board member, access and complete the ASIC quiz at https://asic.gov.au/regulatory-resources/financial-reporting-
and-audit/directors-and-financial-reporting/financial-reporting-quiz-for-directors.
Boards of directors are composed of a chair, executive directors (usually including the CEO) and non-
executive directors, some or all of whom may be independent.
Board Chair
Each board must have a chair. The role of the chair is to lead the board of directors, including determining
the board’s agenda, obtaining contributions from other board members as part of the board’s deliberations,
and monitoring and assessing the performance of the directors. This role is crucial in ensuring that the
board works effectively.
In some countries, it is important that the chair be independent (i.e. without any direct link to the
company), while in other countries this is not seen as critical. For example, in the United Kingdom (UK),
the largest listed companies are expected to have a chair who is independent at the time of appointment.
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Outward
looking
Providing Strategy
accountability formulation
Inward
looking
.......................................................................................................................................................................................
CONSIDER THIS
Choose two separate listed companies and find their board charters on their website. What are the features you
notice? How do they align with Tricker’s analysis of what boards should be doing as people in charge of governance?
Each item in the list of important board functions in table 3.5 has either a performance or
conformance focus.
Function Responsibilities
Monitoring and supervising • Taking steps designed to protect the company’s financial position and
its ability to meet its debts and other obligations as they fall due.
• Adopting an annual budget for the financial performance of the
company and monitoring results on a regular basis.
• Ensuring systems are in place that facilitate the effective monitoring and
management of the principal risks to which the company is exposed.
(continued)
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Function Responsibilities
Providing accountability • Determining that the company has instituted adequate reporting
systems and internal controls (both operational and financial) together
with appropriate monitoring of compliance activities.
• Determining that the company accounts conform with Australian
Accounting Standards and are true and fair.
• Determining that satisfactory arrangements are in place for auditing the
company’s financial affairs and that the scope of the external audit is
adequate.
• Selecting and recommending auditors to shareholders at general
meetings.
• Ensuring that the company has in place a policy that enables it to
communicate effectively with shareholders, other stakeholders and the
public generally.
Policy making • Establishing and monitoring policies directed at ensuring that the
company complies with the law and conforms to the highest standards
of financial and ethical behaviour.
• Selecting and, if necessary, replacing the CEO, setting an appropriate
remuneration package for the CEO, ensuring adequate succession plans
are in place for the CEO, and giving guidance on the appointment and
remuneration of other senior management positions.
• Adopting formal processes for the selection of new directors and
recommending them for the consideration of shareholders at general
meetings, with adequate information to allow shareholders to make
informed decisions.
• Reviewing the board’s own processes and effectiveness, and the
balance of competence on the board.
• Approving and working with and through the CEO.
• Adopting clearly defined delegations of authority from the board to the
chief executive officer (CEO) or a statement of matters reserved for
decision by the board.
• Agreeing on performance indicators with management.
*Bullet points identified by asterisk are not from the Bosch Report, but are added by the author of this text.
Source: Bosch, H 1995, Corporate Practices and Conduct, 3rd edn, Pitman, Melbourne, p. 9. Reproduced with permission.
QUESTION 3.9
Classify each of the board responsibilities above as having either a performance focus or a
conformance focus.
Nomination Committee
This committee is primarily responsible for recommending the succession procedures within an organi-
sation. Succession is the concept of identifying and selecting people who will replace senior staff when
they leave.
This committee, because of the skills each member acquires in this role, is valuable in assessing the
overall performance of the board and, sometimes, the performance of key executives. An important aspect
of succession responsibilities is recommending candidates for shareholders to vote on to the board as
directors. Given that boards comprise a balance of directors, including executives, it is appropriate for the
nomination committee to include executive directors.
Remuneration Committee
This committee deals with remuneration, especially for senior executives. Important aspects of remunera-
tion include what and how directors and executives are paid. It is apparent that this area is particularly
complex. One of the main causes of the GFC was the setting of inappropriate remuneration policies
that focused almost entirely on short-term revenue generation and marginalised the concern for risk
management. The sensitivity of setting a remuneration policy can be reduced if executives are not involved
in the committees that decide their remuneration. Furthermore, in order to ensure independence, it is
necessary that executives do not set the remuneration of independent directors.
Audit Committee
The audit committee is, in many ways, the most important in relation to the conformance aspects of
corporate governance. It is often considered the appropriate conduit between the company and the external
auditor, ensuring that the work of the external auditor maintains the utmost integrity and independence.
While this committee is recommended for all listed companies (and will be valuable in many others),
it can also be mandatory to have an audit committee. Listed entities in the S&P All Ordinaries Index
at the beginning of their financial year are required, under the listing rules, to have an audit committee
for that whole financial year. There are some tighter requirements for those listed entities that are on the
ASX 300 Index, which also includes that they must comply with the structure and disclosure requirements
of the audit committee recommendation.
To ensure the independence of the audit committee, it is recommended that the audit committee comprise
only non-executive members, with a majority being independent. An audit committee with no executives
means that communications with the external auditor at a formal level will take place without the CFO.
This is an important aspect of good governance at the auditing/reporting phase.
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EXAMPLE 3.8
The Enron case demonstrates that good governance is about far more than establishing board commit-
tees. The members of each committee need to demonstrate independence and be prepared to stand up
to management in the event of questionable practices. Moreover, they need to adopt a sceptical view of
management submissions and be prepared to delve deeper when they do not receive the answers they want
or they suspect something is not quite right. Clearly, the individual members of an audit committee are
required to be competent, experienced and even courageous in adequately performing such a key role.
QUESTION 3.10
Examine the Enron audit committee role and independence in light of the earlier discussion on the
benefits and limitations of audit committees. Evaluate the effectiveness of the committee and list
steps you would recommend to improve the Enron audit committee in this situation.
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AUDITORS
Most large organisations have an internal audit department, which generally reports directly to the audit
committee. Internal auditors undertake a variety of tasks that contribute to good corporate governance. In
general, the internal auditor plays an important role in ensuring that internal financial controls, compliance
controls, operational controls and risk management systems are operating effectively.
The external audit is also a vital part of the corporate governance process. Investors rely heavily
on information provided in financial reports. It is essential that these reports are accurate and free
from material misstatement. Accordingly, the capacity of external auditors to conduct a thorough and
independent review of the financial statements is the cornerstone of the corporate governance process.
‘Audit failure’ is the term used when an audit is deficient due to negligence, incompetence or lack of
independence by the auditor. While the vast majority of audits are conducted in a satisfactory manner,
regrettably, there are exceptions.
The external auditor, as an independent party with a detailed knowledge of the entity’s financial affairs,
is able to provide substantial advice to the audit committee. The external auditor may also assist the audit
committee by informing it of any developments such as legislative changes or new accounting standards.
It is also important that the external auditor should attend the full board meeting when the financial
statements are approved, to enable all directors to ask any questions they may have regarding the financial
statements or the audit process.
REGULATORS
Objective of Regulation
The business environment is increasingly competitive, with companies constantly trying to improve
performance. There are often strong incentives to achieve these objectives and, sometimes, questionable
methods may be used.
Effective regulation and enforcement is essential to ensure that companies can compete against each
other in a fair and reasonable manner. Failure to create such an environment can lead to poorer outcomes
for all stakeholders. ASIC states that the following are traits of a sound regulatory system, which are also
relevant internationally.
• Companies can get on with doing business confident that the same rules are applied to everybody. They
can seek capital in Australian markets at rates that are broadly competitive with leading world markets
and without paying a significant market risk premium.
• Financial products and services businesses can operate profitably and efficiently, while treating cus-
tomers honestly and fairly. Being in a well-regulated market helps them do business across borders.
• Financial markets are well respected and attractive internationally, and clean, fair and reliable.
• Everybody can find and understand their obligations.
• Investors and consumers participate confidently in our financial system, using reliable and trustworthy
information to make decisions, with ready access to suitable remedies if things go wrong.
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From this regulatory perspective, the purpose of regulation is to support free and open markets. Yet many
businesses and some economists argue that imposing restrictions on corporations’ activities, and the way
they are governed, stifles incentive, creativity and entrepreneurship. They believe that wealth creation is
maximised by allowing markets to be free of restrictions. Nobel prize–winning economist Milton Friedman
is of the view that ‘there is one and only one social responsibility of business — to use its resources and
engage in activities designed to increase its profits so long as it engages in open and free competition
without deception or fraud’ (Friedman 1970). However, critics ask: at the expense of whom?
Others argue that corporations do not exist in a vacuum. Instead, they are an integral part of society and
the focus should be much broader than just increasing profits and returns to shareholders.
Self-interest often appears to be the guiding philosophy of certain groups, even if they do appear to
be ideologically based. Business groups and trade associations that promote free markets and limited
regulation often are led by the vested interests, which can sometimes be inconsistent with the advocacy of
free markets. They may strongly favour government intervention, such as subsidies or tariffs, when it assists
that particular industry, while opposing government intervention elsewhere in the economy. Governments
may also advocate free trade while continuing to protect certain domestic industries for political purposes.
EXAMPLE 3.9
From this example, it is clear that the principles approach creates a broad guideline, which it is then
up to the company to apply in the most appropriate way. The rules-based approach gives very specific
instructions and must be complied with.
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Stakeholder Concept
The Anglo-American corporation law approach is that directors must act in the best interests of the
corporation as a whole. This means corporations are run according to corporate law duties in relation
to shareholders. However, this approach does not mean that a corporation should be run for the exclusive
benefit of its shareholders. Any director or senior manager who believes that acting according to this
approach will lead to long-term success and satisfactory corporate governance is mistaken. The success
of an organisation depends on the successful management of all the relationships an organisation has
with its stakeholders. The principal focus of our discussion in this module is on the Anglo-American
derivative duties approach to stakeholders. Stakeholder theory is considered further in module 5 as part of
the discussion of sustainability and social responsibility concerns.
Stakeholder Map
Stakeholders differ across organisations. Figure 3.4 provides a diagram of potential stakeholders that may
be of concern to an organisation and table 3.6 expands on the nature of each stakeholder relationship.
In any situation, some stakeholders will be more important than others to a particular corporation at a
particular time and, inevitably, this stakeholder map may omit relevant stakeholders. You should observe
that stakeholders are not only people or corporate entities — even the environment is a stakeholder (as a
corporation’s operations may have an effect on it). Notice also that competitors are treated as stakeholders
because there must be a commitment to open and fair competition in the market place, and if a competitor
undermines this, both producers and consumers suffer. Those affected by a particular corporation are
stakeholders of that corporation. Where a stakeholder’s interest is significant, corporations must manage
the relationship carefully.
Environment
Community
Agents
Government Owners
Employees
Consumers
Auditors Competitors
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Stakeholder Relationship Type and source of power Interest and influence Risk
Investors Owners who are a Legal power through the Corporations Act Return on investment Underperformance may mean withdrawal of
source of finance in Political power through institutional investors Satisfaction from ownership interest investment or investor pressure to remove
the form of equity directors.
Voting power at general meetings Investors can withdraw finance if they are
dissatisfied with the company’s processes.
Customers Purchasers of Political power through word of mouth, media Satisfaction with value from purchase Reputation risk management will be needed
goods or services and social media Dissatisfaction can lead to customers not if customers receive poor service or faulty
Economic power by spending elsewhere wanting to buy services and it may lead to products.
Legal power through the Competition and negative publicity by word of mouth or social
Consumer Act and the ACCC media.
Suppliers Supply goods/ Economic power by restricting supply Revenue from sales Directors may need to source other products
services Legal power through the Competition and Business relationship from other suppliers if the company fails to pay
Consumer Act and the ACCC the supplier for goods or services.
Poor experiences with a company may lead
to a refusal by a supplier to deal with the Faulty goods or services received from a
company. supplier may also lead to the company’s
reputation being damaged.
Lenders Supply funds Voting power by having a director on the board Revenues from interest Finance may be unobtainable if the company
Economic power by the lending terms and Lenders may choose not to lend depending on cannot pay back the principal plus interest.
conditions of the lending contract the credit rating of an entity.
Employees Provide labour Political power by withdrawal of labour Salaries and wages Poor management of employees can lead the
Legal power through the Fair work, Disability Job security board to see evidence of employee turnover.
and discrimination and Work health and Important life activity Misconduct by employees may lead the
safety Acts organisation to suffer reputational damage.
Employees can withdraw labour if conditions at
a workplace get worse.
Government Receive taxes Legal and political power through Acts of Source of revenue Boards may find an increase in regulatory risks
Impose regulations parliament Society’s interest that arise from new laws and regulation.
Provide general Economic power through the taxation system Economy Threat of regulatory enforcement directed at
infrastructure. boards where they or responsible staff fail to
Legal compliance comply
Government may choose to impose greater
regulation on a sector if specific companies are
perceived to be misbehaving.
Society Consume Political power by influencing politicians and Good corporate citizen Directors may bear the consequences for
Employees
These are important stakeholders in any corporate environment, which is why they are included in
figure 3.4. In increasingly knowledge-based businesses, it is the knowledge and skill of the employees
(including managers) that will be critical to the success of the company. In this sense, the employees
become the greatest asset (e.g. in professional service firms) and without this asset the company cannot
compete. In some jurisdictions, where dual board structures exist (e.g. Germany), employees may have
a more formal role on boards — especially on the lower-tier board. It is not uncommon for very senior
managers also to be on boards. For example, the CFO may well join the CEO on the board and will therefore
also possess the joint characteristic of being an executive and a director — and have the complex mix of
two sets of duties.
Importantly, in all jurisdictions, managers and employees alike are owed duties by corporations and,
in turn, owe duties to the corporation. For example, employees are entitled to safe working conditions
and holiday periods, while employers are entitled to expect diligent service and protections such as
confidentiality about commercially sensitive information.
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Consumers (Customers)
Consumers or customers are very important stakeholders. Corporations recognise that the long-term
support from consumers for their outputs will be important for value generation and corporate performance.
However, many managers and corporations succumb to the temptation to seek quick profits without proper
care for consumers and their long-term needs. Sometimes, there are even deliberate attempts to target
vulnerable consumers by deception and dishonesty. Consumer law is discussed in module 4.
For many businesses, the relationship with customers is changing. Rather than the customer being the
passive purchaser of a good or service, the customer’s views and ideas are actively canvassed as a means of
product and performance improvement. This can serve to deepen the relationship with customers and, in
some instances, customers become more active collaborators in the design of products and services. This
form of active customer intelligence and involvement is what is required in rapidly changing markets with
constant innovation.
MANAGEMENT
As has been emphasised in this module, in formal corporate governance principles, managers are the agents
of the board, responsible for pursuing the vision of the company as developed by the board, and fulfilling
the strategic direction determined by the board. The CEO in most companies is also a director and a member
of the board (and there are often other executive directors such as the CFO of the company). These executive
directors have a full role working with the board to advance strategic direction and establish the policy and
values of the company. Once these are decided, it is the manager’s duty to actively pursue these, and the
board’s role is to monitor the results for the business.
Of course, in reality the interface of governance and management is more complex. Often boards and
managers respect and understand the different roles, and have a commitment to make the relationship
work. However, sometimes tensions do emerge, for example, in the choice of strategy. Because of rapidly
changing markets and technology, boards often have to be continuously engaged in strategic decisions. At
times, managers may feel that the board is becoming too involved in the implementation of strategy when
it is the management team who have the operational experience required to guide strategies to success.
On other occasions, the board may feel that managers are making significant strategic decisions without
properly securing the approval of the board.
Skeet (2015) examines this issue from the perspective of both the board of directors and the management
team. When CEOs are asked what issues contribute to the board and management being at cross purposes,
they point to two main factors: directors acting ‘out of position’ and attempting to play a management
role; or a conflict of interest where, even if disclosed, directors are not able to place the interests of the
organisation above their own or those of the group they are representing.
Often what boards interpret as arrogance of the CEO and the management team can be, in reality, a
lack of experience, strategic direction differences or deceit. These can all lead to the management team
withholding information from the board. Board members should consider what information they do not
currently have and request this additional information if they feel the CEO or management team may be
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Operational Management
Management is at the sharp end of delivering the aspirations of the board for the company. Boards of
directors are often highly skilled at financial analysis, strategic thinking and policy development, but it
is the managers who have to implement all of these, which requires considerable intellectual, operational
and technical skills. It is management who must inspire employees with the goals of the enterprise, delight
customers with the quality of the product or service, convince suppliers and distributors that the company
deserves their full support, and keep stakeholders onside.
Ensuring that there is the energetic commitment of managers to their task of realising the vision of the
board and making a success of the company is ultimately the role of the CEO, who is the essential link
between the governance mechanisms and the operational mechanisms of the company.
SUMMARY
Governance is the means by which entities — in the case of corporate governance, corporations —
are directed and controlled, and accountability is assured. Governance relates to the responsibilities of
the board of directors towards investors and other stakeholders, and involves setting the objectives and
direction of the company. Governance is distinct from the day-to-day management of the enterprise, which
is the responsibility of executives.
Good corporate governance involves ensuring the corporation operates in the best interests of its
stakeholders. Good corporate governance is also linked to the ability to achieve the strategic goals of
the organisation. Accountants play an important role in good corporate governance by providing useful
information for decision making that ultimately results in value creation while maintaining controls that
ensure compliance.
The precise components of the system of corporate governance vary based on the nature of the
organisation, but there are several common key elements that make up a corporate governance framework.
These include external elements (governments, stakeholders, and industry/professional bodies), internal
elements (owners/members, boards, and management, led by a CEO) and the audit function.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
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Events Responses
1980s US US
• Savings and loan crisis (1986–1995) • Financial Institutions Reform, Recovery and
• Texaco bankruptcy (1987) Enforcement Act of 1989
• Stock market crash (1987)
Australia
• Ariadne collapse (1988)
• Rothwells Merchant Bank collapse (1989)
• Qintex collapse (1989)
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(continued)
Events Responses
UK UK
•GlaxoSmithKline bribery scandal (2014) • UK Corporate Governance Code (2010; 2012;
•Tesco accounting scandal (2014) 2014; 2016; 2018)
•Carillion collapse (2018) • FRC Guidance on Board Effectiveness (2018)
•British Steel collapse (2019) • UK Stewardship Code (2012; 2012)
US US
• Dynegy bankruptcy (2012) • Dodd-Frank Act of 2010
• Valeant Pharmaceuticals scandal (2015) • Report of the NSE Commission on Corporate
• Wells Fargo fake account scandal (2016) Governance (2010)
• Goldman Sachs 1MDB Malaysian sovereign • Commonsense Principles of Corporate
wealth fund scandal (2015–2019) Governance (2016)
• Boeing 737 Max scandal (2019) • ISG Corporate Governance Principles For US
Listed Companies (2017)
Australia Australia
•ANZ bank bill swap scandal (2016) • ASX Principles (2010; 2014; 2019)
•Dick Smith collapse (2016) • Corporations Amendment (Executive
•APRA Inquiry into CBA (2017) Remuneration) Act 2011
•Banking Royal Commission (2017–2018) • ACNC Governance Standards (2013; 2019)
• Banking Executive Accountability Regime
(BEAR) (2018)
• AICD NFP Principles (2019)
• Treasury Laws Amendment (Enhancing
Whistleblower Protections) Act 2019
(continued)
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Australia
New Zealand
MARKET-BASED SYSTEMS
The market-based systems of corporate governance in the US and the UK are the most established and
have had the greatest influence on the rest of the world. This is because of the historical strength of the
US and UK capital markets, and the growth of their investment institutions that have become increasingly
active internationally. This is the model that has been adopted in many other countries, including Australia
and New Zealand. The central characteristics of the market-based system are as follows:
• widespread equity ownership among individuals and institutional investors, with institutions often
having large shareholdings
• shareholder interests as the primary focus of company law
• an emphasis on minority shareholder protection in securities law and regulation
• stringent disclosure requirements.
In these countries, a growing amount of the national wealth is held by institutions, including:
• insurance companies
• pension funds
• mutual funds.
There has been considerable growth in the financial assets of institutional shareholders relative to GDP
over the last decade. Institutional shareholders have been the dominant owners of equity in the UK for some
time now, and they are achieving this position in the US as well. They are charged with the responsibility
of securing the maximum return on their investments for their beneficiaries, balancing risk and return over
time, and in accordance with their investment mandates.
In the past, institutional shareholders demonstrated little interest in influencing the companies they
invested in, employing strategies of portfolio diversification and indexation. However, more recently, there
has been evidence of institutional shareholders becoming more actively engaged.
The market-based system of corporate governance has been characterised as disclosure based, as the
numerous investors depend on access to a reliable and adequate flow of information to make informed
investment decisions. Regulation is intended to ensure all investors remain fully informed, and to prevent
privileged groups of shareholders sharing information only among themselves.
The role of the banks is less central in a market-based system of corporate governance. Normally, bank
finance is short term, and usually banks operate at arm’s length in their dealings with corporations. Equity
finance is seen as more important as a means of developing companies (Nestor & Thompson 2000, p. 7).
Under a market-based system, shareholders have the right to use their voting power to select the board
and decide on certain issues facing the company, such as the appointment of an external auditor. However,
in practice, fragmented investors rarely exercise this control when faced with an informed and determined
management.
In the past, investors who were dissatisfied with how a company was being managed and directed tended
to sell their shares in the company. When this happens in sufficient numbers, it can depress the share price
to the point where a company becomes a target for hostile takeover.
Moreover, many institutional shareholders have become so large that they need to invest in a large
number of companies to spread their risk. Some investors, such as pension funds and insurance companies,
being typical institutional investors, also need to take a longer-term view of their investments.
These factors, together with pressure from regulators and beneficiaries, are forcing more institutional
shareholders to practise ‘responsible investing’ and to become more engaged with companies they are
investing in. This means that, rather than just selling their shares when they are unhappy with the
management or board, they are using a range of strategies — such as private meetings, voting against
resolutions, and applying public pressure using the media.
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Why is disclosure important for the integrity of equity markets? In your answer, you should address
what occurs when information is monopolised by privileged groups.
The US is the world’s major capital market. It operates a market-based system that has some distinct
characteristics. In the US, the board of directors is entrusted with an important responsibility — to monitor
the company on behalf of shareholders. However, in the US, boards of directors are often dominated by
the company management.
As a consequence, there have been efforts to achieve greater accountability by requiring that boards
have a majority of independent non-executive directors. This is now required under the listing rules of
the two major stock markets in that country: the New York Stock Exchange (NYSE) and the NASDAQ.
(When NASDAQ was originally conceived in the 1970s, the acronym stood for the National Association
of Securities Dealers Automated Quotations. Since then it has been known for its listing of growth
companies.) Moreover, in the US, it is common for the chair of the board and the CEO to be the same
person. This practice differs from many other countries where these roles are expected to be separate.
To enhance the oversight function of boards and limit the powers of CEOs, committees were established
in the 1980s in US corporations to undertake critical tasks. These tasks included the remuneration of
executive directors, nomination of new board members and key decisions in respect of auditing. As a
result, most CEOs of large companies in the US could no longer decide their own pay, select their own
board and audit their own financial performance. However, in many companies, CEOs continued to wield
considerable power in the boardroom, partly because they also retained the role of chair.
Notwithstanding these developments, controversy still exists in relation to issues such as executive
remuneration. The GFC has placed the pay and performance of senior bank executives at the forefront
of public debate again. Many US banks that received government bailout monies continued to pay large
amounts to their key executives, despite their recent mediocre performance and seemingly excessive risk-
taking behaviours. The result was that the US Government announced that caps on executive pay and
bonuses would be placed on the salaries of CEOs of banks subject to taxpayer-funded bailouts.
Other checks on management include the more active role being played by institutional shareholders
and rules such as Sarbanes–Oxley. As previously noted, many of these large investors, such as CalPERS,
closely monitor the corporate governance practices of companies in which they invest. However, in
practice, shareholders in the US possess limited power to appoint or remove directors. This is because,
in a public company with widely dispersed share ownership, it is difficult and expensive for shareholders
to take all of the actions and achieve the necessary coordination to remove directors. There are also other
administrative hurdles.
QUESTION 3.12
Is interest in corporate governance regulation and legislation inevitably associated with recession,
market failure and corporate collapse, or is it possible to maintain attention on improving standards
of corporate governance at times of market expansion and business growth?
QUESTION 3.13
Identify the strengths and weaknesses of the market-based system of corporate governance as
practised in countries such as the US, UK and Australia.
Germany
The German business sector is typified by the following characteristics:
• a relatively strong concentration of ownership of individual enterprises
• the importance of small and medium-sized unincorporated companies
• a close correspondence between owners and managers
• the limited role played by the stock market.
The central characteristic of the corporate governance of German enterprises is their relationship-
based nature in which all interested stakeholders are able to monitor corporate performance. The German
Corporate Governance Code was first published in 2002 and has since been amended several times,
including in 2015. It stresses the need for transparency and clarifies shareholder rights in order to promote
the trust of investors and capital market development. It also seeks to enhance investors’ understanding
of the complex civil law–based corporate governance framework by setting out key principles in the one
document (Government Commission 2015). Moreover, the code’s ‘comply or explain principle’ seeks to
foster transparency by requiring an explanation from those corporations not complying with the provisions
of the code (Enriques & Volpin 2007).
France
France and Italy are the European countries with the smallest ownership of company shares by financial
institutions. The majority of shares have traditionally been owned by non-financial enterprises, which
reflects an elaborate structure of cross and circular ownership. That is, companies own one another’s shares
in a circular relationship. No external party can readily gain entry to the network, or seize control of any
entity in the network, and all of the member companies support one another against outsiders.
Another distinguishing feature of France is the concentration of ownership, which is higher than in any
other Group of Seven (G7) industrialised country, with the exception of Italy. In France, half the firms are
controlled by one single investor who owns the absolute majority of capital. On boards, the role of non-
executive directors is muted, as business tends to be dominated by the president directeur général (PDG)
who combines the functions of chair and CEO. The independence of the PDG is reinforced by the legal
notion that enterprises should pursue the intérêt social de l’entreprise (the social interest of the company).
This law is interpreted in two ways:
1. that management has to act in the interests of shareholders; but also
2. that management has to act in the interest of the enterprise (e.g. to ensure its survival) (OECD 1997,
p. 113).
QUESTION 3.14
Identify the advantages and disadvantages of the European relationship-based insider system of
corporate governance.
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Japan
The formal legal features of the Japanese corporate governance system resemble those in most other
advanced industrial countries. Corporate law in Japan was modelled, starting in 1899, on the German
system, with the establishment of limited liability corporations, typically with a two-tier board structure.
As in most OECD countries, the majority of enterprises are organised as public limited companies, though
in Japan, a significant number of medium-sized firms are private limited corporations.
The functioning of all of the major institutions and mechanisms of corporate governance, including
shareholders, banks and boards of directors, is different in Japan. For example, in the West, the board of
directors is largely appointed from outside the company and serves to monitor management. However,
in Japan, the main board of directors plays a more strategic and decision‐making role, and is more fully
drawn from the ranks of management who are employed by the company. Putting it simply, in the West,
the board members are outsiders representing the shareholders while, in Japan, the board members are
insiders leading management (Yasui 1999, p. 4).
A problem with this approach is that, over time, there is a tendency for boards to grow in size as more
managers need to be rewarded. The average board size in Japan is much larger than in the West, often with
around 20 directors, with some boards reaching as many as 40 members. As a result, most companies
form a board committee whereby some senior board members make all of the essential management
decisions, which are later ratified by the main board as a formality. Thus, the role of Japanese boards
may be considered superficial in supervising the executive management. In terms of responsibility for the
company, the Japanese main board’s role is limited. However, there is no doubt regarding the executive
management’s commitment to and responsibility for the company, which is often more intense than
anything experienced in the West.
The ownership structure of Japanese companies is also different from those in Western countries. Many
large companies are formed into what are termed keiretsus, which are essentially sets of companies with
interlocking business relationships and shareholdings. The major keiretsus are centred on one bank, which
lends money to the keiretsus member companies and holds equity positions in the companies.
Each bank has significant control over the companies in the keiretsus and acts as a monitoring entity and
as an emergency bail-out entity. Prominent keiretsus are Mitsubishi and Toyota. One effect of this structure
is to minimise the incidence of hostile takeovers. This concentrated pattern of shareholding has created
considerable stability, but at the potential expense of the market, due to corporate control being restricted.
Traditionally, keiretsus have put more emphasis on expanding their business rather than on seeking short-
term returns.
Though Japanese companies may be moving in the direction of the Anglo-Saxon model, this movement
is one of degree. The distinctive interrelated elements of the Japanese economic and social systems,
together with legal, regulatory, financial market and employment systems, will continue to have a powerful
effect. Though reforms are under way in the Japanese system of corporate governance, the progress has at
times been at only a gradual pace. The Japanese highly value their culture and institutions, and are not eager
to change them without fully understanding or accepting the reasons for change (Seki & Clarke 2014).
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CONSIDER THIS
Download a copy of the OECD Corporate Governance Factbook - 2019 and look at tables 2.1, 2.2 and 2.3. Choose
two countries* and compare their regulatory regime with that of Australia’s. What is different? What is the same?
Summarise the key differences you find in a note that does not exceed 300 words.
* Ensure that you choose at least one country that has a different regulatory culture to Australia’s.
See link at: www.oecd.org/daf/ca/corporate-governance-factbook.htm
QUESTION 3.15
Outline the benefits and costs of the family-based insider system of corporate governance
practised in Asia.
SUMMARY
Corporate governance practices change over time. In particular corporate collapses and financial crises tend
to trigger changes in rules and regulations that apply to the governance of corporations. Such changes in
recent decades have included legislative measures to tighten regulation of directors and other company
officers. One example of this is the Sarbanes–Oxley Act that was introduced in the US to improve
governance practices following the collapse of Enron and the implosion of major accounting firm Arthur
Andersen. Individually the UK and Australia developed guidance to ensure their regulatory literature had
some parity or similarity with the work done in the US.
The US, UK, Australia and New Zealand have market-based systems of corporate governance in which
shareholder interests have primacy. Various European and Asian countries have relationship-based systems
of corporate governance reflecting each country’s own cultures and financial traditions.
The European model of corporate governance tends to emphasise cooperation and consensus, in
contrast with the market-based system that emphasises competition. The European model places greater
importance on recognising the interests of a wider range of stakeholders, including communities, workers
and customers. Investment tends to be relatively stable compared to the market-based systems and thus
companies are generally less subject to the consequences of share market movements.
The Asian relationship-based model is based on the tradition of strong, close and personal relationships
between stakeholders, including owners, creditors, suppliers and customers, and even extending in some
cases to regulators. These close relationships can be seen to hinder transparency and accountability. The
1997 Asian financial crisis and GFC prompted reforms which are still underway, but involve increased
accountability and transparency, greater independence for regulators and developing a more robust form
of corporate governance.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
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In the discussion that follows we introduce each principle with its sub-principles.
A. The corporate governance framework should be developed with a view to its impact on overall economic
performance, market integrity and the incentives it creates for market participants and the promotion of
transparent and well-functioning markets.
B. The legal and regulatory requirements that affect corporate governance practices should be consistent
with the rule of law, transparent and enforceable.
C. The division of responsibilities among different authorities should be clearly articulated and designed
to serve the public interest.
D. Stock market regulation should support effective corporate governance.
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Source: OECD 2015, G20/OECD Principles of Corporate Governance, OECD Publishing, Paris, pp. 14–17, accessed October 2015,
www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf.
As the OECD advises governments on corporate governance, its focus here is on macro performance at
the market level. This acknowledges that the appropriate mix of legislation, regulation, self-regulation and
voluntary standards will vary across jurisdictions.
A. Basic shareholder rights should include the right to: 1) secure methods of ownership registration;
2) convey or transfer shares; 3) obtain relevant and material information on the corporation on a timely
and regular basis; 4) participate and vote in general shareholder meetings; 5) elect and remove members
of the board; and 6) share in the profits of the corporation.
B. Shareholders should be sufficiently informed about, and have the right to approve or participate in,
decisions concerning fundamental corporate changes such as: 1) amendments to the statutes, or articles
of incorporation or similar governing documents of the company; 2) the authorisation of additional
shares; and 3) extraordinary transactions, including the transfer of all or substantially all assets, that in
effect result in the sale of the company.
C. Shareholders should have the opportunity to participate effectively and vote in general shareholder
meetings and should be informed of the rules, including voting procedures, that govern general
shareholder meetings.
1. Shareholders should be furnished with sufficient and timely information concerning the date,
location and agenda of general meetings, as well as full and timely information regarding the issues
to be decided at the meeting.
2. Processes and procedures for general shareholder meetings should allow for equitable treatment of
all shareholders. Company procedures should not make it unduly difficult or expensive to cast votes.
3. Shareholders should have the opportunity to ask questions to the board, including questions relating
to the annual external audit, to place items on the agenda of general meetings, and to propose
resolutions, subject to reasonable limitations.
4. Effective shareholder participation in key corporate governance decisions, such as the nomination
and election of board members, should be facilitated. Shareholders should be able to make their
views known, including through votes at shareholder meetings, on the remuneration of board
members and/or key executives, as applicable. The equity component of compensation schemes
for board members and employees should be subject to shareholder approval.
5. Shareholders should be able to vote in person or in absentia, and equal effect should be given to
votes whether cast in person or in absentia.
6. Impediments to cross border voting should be eliminated.
D. Shareholders, including institutional shareholders, should be allowed to consult with each other on
issues concerning their basic shareholder rights as defined in the Principles, subject to exceptions to
prevent abuse.
E. All shareholders of the same series of a class should be treated equally. Capital structures and
arrangements that enable certain shareholders to obtain a degree of influence or control disproportionate
to their equity ownership should be disclosed.
1. Within any series of a class, all shares should carry the same rights. All investors should be able to
obtain information about the rights attached to all series and classes of shares before they purchase.
Any changes in economic or voting rights should be subject to approval by those classes of shares
which are negatively affected.
2. The disclosure of capital structures and control arrangements should be required.
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Source: OECD 2015, G20/OECD Principles of Corporate Governance, OECD Publishing, Paris, accessed October 2015,
www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf.
Within companies, shareholders are considered to be important stakeholders. Principle II concerns the
protection of shareholders’ rights and the ability of shareholders to influence the behaviour of corporations.
It lists some basic rights including obtaining relevant information, sharing in residual profits, participating
in basic decisions, fair and transparent treatment during changes of control and the fair operation of voting
rights. Shareholders, as the legal owners of corporations, should expect to be able to enjoy these rights in
all jurisdictions.
This principle emphasises that all shareholders, including minority and foreign shareholders, should
be treated equitably by controlling shareholders, boards and management. Transparency is required with
respect to distribution of voting rights and the way that voting rights are exercised. Insider trading and
abusive self-dealing are prohibited. There should be appropriate disclosure of all material interests that
managers and directors have in transactions or matters affecting the corporation.
A. Institutional investors acting in a fiduciary capacity should disclose their corporate governance and
voting policies with respect to their investments, including the procedures that they have in place for
deciding on the use of their voting rights.
B. Votes should be cast by custodians or nominees in line with the directions of the beneficial owner of the
shares.
C. Institutional investors acting in a fiduciary capacity should disclose how they manage material conflicts
of interest that may affect the exercise of key ownership rights regarding their investments.
D. The corporate governance framework should require that proxy advisors, analysts, brokers, rating
agencies and others that provide analysis or advice relevant to decisions by investors, disclose and
minimise conflicts of interest that might compromise the integrity of their analysis or advice.
E. Insider trading and market manipulation should be prohibited and the applicable rules enforced.
F. For companies who are listed in a jurisdiction other than their jurisdiction of incorporation, the applicable
corporate governance laws and regulations should be clearly disclosed. In the case of cross listings,
the criteria and procedure for recognising the listing requirements of the primary listing should be
transparent and documented.
G. Stock markets should provide fair and efficient price discovery as a means to help promote effective
corporate governance.
Source: OECD 2015, G20/OECD Principles of Corporate Governance, OECD Publishing, Paris, pp. 32–35, accessed October 2015,
www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf.
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A. The rights of stakeholders that are established by law or through mutual agreements are to be respected.
B. Where stakeholder interests are protected by law, stakeholders should have the opportunity to obtain
effective redress for violation of their rights.
C. Mechanisms for employee participation should be permitted to develop.
D. Where stakeholders participate in the corporate governance process, they should have access to relevant,
sufficient and reliable information on a timely and regular basis.
E. Stakeholders, including individual employees and their representative bodies, should be able to freely
communicate their concerns about illegal or unethical practices to the board and to the competent public
authorities and their rights should not be compromised for doing this.
F. The corporate governance framework should be complemented by an effective, efficient insolvency
framework and by effective enforcement of creditor rights.
Source: OECD 2015, G20/OECD Principles of Corporate Governance, OECD Publishing, Paris, p. 37, accessed October 2015,
www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf.
The OECD sees duties to stakeholders as an important and integral part of corporate governance. In
some countries, stakeholders who are not shareholders have significant influence (e.g. banks are involved
in Japanese companies and employees in German companies).
Under Anglo-American legal approaches, companies are run for shareholders, being the owners
of the companies, with the duty to stakeholders being a derivative of this primary duty. Under the
stakeholder model, there are arguably ‘direct duties’ to stakeholders, but the OECD recognises that duties
to stakeholders are only valid if also balanced against the duties and rights of shareholders (see Principle II).
The differences between ‘shareholder models’ and ‘stakeholder models’ are largely theoretical
in the global corporate world. We will consider this further when we explore the FRC Code and the
ASX Principles.
In developed economies where various stakeholders’ interests are protected by general community
laws (e.g. laws of contract, labour laws, health and safety laws, environmental laws) stakeholders’
rights may need little additional attention to satisfy OECD Principles. In less developed economies it
may be that corporations will have extra requirements imposed on them under the OECD Principles.
This is consistent with the ambition of the OECD that its guidelines should lead to improvements to
economies internationally.
A. Disclosure should include, but not be limited to, material information on:
1. The financial and operating results of the company.
2. Company objectives and non-financial information.
3. Major share ownership, including beneficial owners, and voting rights.
4. Remuneration of members of the board and key executives.
5. Information about board members, including their qualifications, the selection process, other
company directorships and whether they are regarded as independent by the board.
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Source: OECD 2015, G20/OECD Principles of Corporate Governance, OECD Publishing, Paris, pp. 42–49, accessed
October 2015, www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf.
In economies where freedom of accurate information and disclosure have not traditionally been
practised, the impact of Principle V will be immediately obvious.
A. Board members should act on a fully informed basis, in good faith, with due diligence and care, and in
the best interest of the company and the shareholders.
B. Where board decisions may affect different shareholder groups differently, the board should treat all
shareholders fairly.
C. The board should apply high ethical standards. It should take into account the interests of stakeholders.
D. The board should fulfil certain key functions, including:
1. Reviewing and guiding corporate strategy, major plans of action, risk management policies and
procedures, annual budgets and business plans; setting performance objectives; monitoring imple-
mentation and corporate performance; and overseeing major capital expenditures, acquisitions and
divestitures.
2. Monitoring the effectiveness of the company’s governance practices and making changes as needed.
3. Selecting, compensating, monitoring and, when necessary, replacing key executives and overseeing
succession planning.
4. Aligning key executive and board remuneration with the longer term interests of the company and
its shareholders.
5. Ensuring a formal and transparent board nomination and election process.
6. Monitoring and managing potential conflicts of interest of management, board members and
shareholders, including misuse of corporate assets and abuse in related party transactions.
7. Ensuring the integrity of the corporation’s accounting and financial reporting systems, including the
independent audit, and that appropriate systems of control are in place, in particular, systems for risk
management, financial and operational control, and compliance with the law and relevant standards.
8. Overseeing the process of disclosure and communications.
E. The board should be able to exercise objective independent judgement on corporate affairs.
1. Boards should consider assigning a sufficient number of non-executive board members capable
of exercising independent judgement to tasks where there is a potential for conflict of interest.
Examples of such key responsibilities are ensuring the integrity of financial and non-financial
reporting, the review of related party transactions, nomination of board members and key executives,
and board remuneration.
2. Boards should consider setting up specialised committees to support the full board in performing
its functions, particularly in respect to audit, and, depending upon the company’s size and risk
profile, also in respect to risk management and remuneration. When committees of the board
are established, their mandate, composition and working procedures should be well defined and
disclosed by the board.
Pdf_Folio:175
Source: OECD 2015, G20/OECD Principles of Corporate Governance, OECD Publishing, Paris, pp. 52–61, accessed
October 2015, www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf.
This principle states the OECD’s basic view on the board and its responsibilities. As a document for
global consumption, it states a series of general requirements but does not provide a detailed analysis of
the type we will see when we look at the UK FRC Corporate Governance Code or at the ASX corporate
governance guidelines.
QUESTION 3.16
Refer back to Principle II and discuss the potential for conflict between sub-principles A4 and G.
QUESTION 3.17
EXAMPLE 3.10
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QUESTION 3.18
QUESTION 3.19
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QUESTION 3.20
Choose a company that is listed on the ASX and review its disclosures on corporate governance
as you read through the principles and recommendations. Track the company’s disclosures in their
corporate governance statement and note where it complies with the corporate governance rules
and where you believe they fall short. The purpose of this exercise is to observe how a listed
company implements these guidelines.
P df_Folio:179
…
If the entity was in the S&P/ASX 300 Index at the commencement of the reporting period, the measurable
objective for achieving gender diversity in the composition of its board should be to have not less than 30%
of its directors of each gender within a specified period.
…
Recommendation 1.6
A listed entity should:
(a) have and disclose a process for periodically evaluating the performance of the board, its committees
and individual directors; and
(b) disclose for each reporting period whether a performance evaluation has been undertaken in accordance
with that process during or in respect of that period.
…
Recommendation 1.7
A listed entity should:
(a) have and disclose a process for evaluating the performance of its senior executives at least once every
reporting period; and
(b) disclose for each reporting period whether a performance evaluation has been undertaken in accordance
with that process during or in respect of that period.
Source: ASX CGC 2019, ‘Corporate Governance Principles and Recommendations’, 4th edn, pp. 6–11. © Copyright 2019 ASX
Corporate Governance Council.
In relation to Recommendation 1.6 the Governance Institute of Australia has published a Good
Governance Guide: Issues to consider in board evaluations. This is available at: www.asx.com.au/documents
/asx-compliance/issues-to-consider-in-board-evaluations.pdf.
…
Recommendation 2.4
A majority of the board of a listed entity should be independent directors.
…
Recommendation 2.5
The chair of the board of a listed entity should be an independent director and, in particular, should not be
the same person as the CEO of the entity.
…
Recommendation 2.6
A listed entity should have a program for inducting new directors and for periodically reviewing whether
there is a need for existing directors to undertake professional development to maintain the skills and
knowledge needed to perform their role as directors effectively.
Source: ASX CGC 2019, Corporate Governance Principles and Recommendations, 4th edn, pp. 12–15,. © Copyright 2019 ASX
Corporate Governance Council.
In relation to Recommendation 2.2 the Governance Institute of Australia has published a Good Gover-
nance Guide: Creating and disclosing a board skills matrix. This is available at: www.asx.com.au/documents
/asx-compliance/creating-disclosing-board-skills-matrix.pdf.
The recommendations of the ASX Corporate Governance Council are expanded on and supplemented
by materials published by other organisations. These organisations include:
• Governance Council of Australia, www.governanceinstitute.com.au
• Australian Institute of Company Directors (AICD), https://aicd.companydirectors.com.au
Boxes highlighting specific issues are also provided among the recommendations and principles.
For example, figure 3.5 shows Box 2.3, which was referred to in an earlier question and is linked to
Recommendation 2.3.
P d f_Folio:181
Source: ASX CGC 2019, Corporate Governance Principles and Recommendations, 4th edn, p. 14 © Copyright 2019 ASX
Corporate Governance Council.
One way to enhance company behaviour is to create formal codes of conduct. If these are carefully
considered and well-constructed, they will provide a far stronger basis for the implementation of good
business ethics. From that point of view, it will be necessary to ensure all staff are trained appropriately
in the ethical code of business conduct and then to ensure that the code is maintained and developed as
necessary according to business and environment changes.
Recommendation 3.4
A listed entity should:
(a) have and disclose an anti-bribery and corruption policy; and
(b) ensure that the board or a committee of the board is informed of any material breaches of that policy.
Source: ASX CGC 2019, Corporate Governance Principles and Recommendations, 4th edn, pp. 16–18 © Copyright 2019 ASX
Corporate Governance Council.
.......................................................................................................................................................................................
CONSIDER THIS
Refer to the ASX’s Corporate Governance Principles and Recommendations. If the organisation that you work for is
a listed company, compare your company’s whistleblower policy with the ASX’s suggestions in Box 3.3.
See link at: www.asx.com.au/documents/regulation/cgc-principles-and-recommendations-fourth-edn.pdf.
…
Recommendation 4.2
The board of a listed entity should, before it approves the entity’s financial statements for a financial
period, receive from its CEO and CFO a declaration that, in their opinion, the financial records of the entity
have been properly maintained and that the financial statements comply with the appropriate accounting
standards and give a true and fair view of the financial position and performance of the entity and that the
opinion has been formed on the basis of a sound system of risk management and internal control which is
operating effectively.
…
Recommendation 4.3
A listed entity should disclose its process to verify the integrity of any periodic corporate report48 it releases
to the market that is not audited or reviewed by an external auditor.
Source: ASX CGC 2019, ‘Corporate Governance Principles and Recommendations’, 4th edn, pp. 19–20 © Copyright 2019 ASX
Corporate Governance Council.
Under the ASX Listing Rules, audit committees are compulsory for all companies listed in the top 500
(Standard & Poor’s listing of the ASX) according to market capitalisation (i.e. total market value of the
shares). The Sarbanes–Oxley Act and the FRC Code both require at least one financial person on the board.
The ASX’s Recommendation 4.1 states:
The audit committee should be of sufficient size and independence, and its members between them should
have the accounting and financial expertise and a sufficient understanding of the industry in which the
entity operates, to be able to discharge the committee’s mandate effectively.
Arguably, it would be a poor board structure that did not select people with appropriate skills. One of
the greatest failures a true professional can make is to accept duties that are not within their capabilities.
It is strongly arguable that a director who, without appropriate skills, takes a place on an audit committee
would be making a negligent ‘business judgment’. Negligent business judgments can result in significant
legal difficulties for a director (and perhaps for the entire board) who act in this way.
Another feature of the Sarbanes–Oxley requirements that contrasts with the ASX Principles is that all
members of the audit committee must be independent at all times according to strict criteria. Furthermore,
Sarbanes–Oxley mandates that the primary external auditor relationship must be with the audit committee.
Note that these specific legislative requirements are not part of the framework in Australia or the UK.
Source: ASX CGC 2019, ‘Corporate Governance Principles and Recommendations’, 4th edn, pp. 21–22 © Copyright 2019 ASX
Corporate Governance Council.
Source: ASX CGC 2019, Corporate Governance Principles and Recommendations, 4th edn, pp. 23–25 © Copyright 2019 ASX
Corporate Governance Council.
(a) review the entity’s risk management framework at least annually to satisfy itself that it continues to be
sound and that the entity is operating with due regard to the risk appetite set by the board; and
(b) disclose, in relation to each reporting period, whether such a review has taken place.
…
Recommendation 7.3
A listed entity should disclose:
(a) if it has an internal audit function, how the function is structured and what role it performs; or
(b) if it does not have an internal audit function, that fact and the processes it employs for evaluating
and continually improving the effectiveness of its governance, risk management and internal control
processes.
…
Recommendation 7.4
A listed entity should disclose whether it has any material exposure to environmental or social risks and, if
it does, how it manages or intends to manage those risks.
Source: ASX CGC 2019, Corporate Governance Principles and Recommendations, 4th edn, pp. 26–28 © Copyright 2019 ASX
Corporate Governance Council.
Source: ASX CGC 2019, Corporate Governance Principles and Recommendations, 4th edn, pp. 29–30 © Copyright 2019 ASX
Corporate Governance Council.
Pdf_Folio:185
Source: ASX CGC 2019, Corporate Governance Principles and Recommendations, 4th edn, p. 32. © Copyright 2019 ASX Corporate
Governance Council.
.......................................................................................................................................................................................
CONSIDER THIS
Consider what you have noted throughout the financial statements in the company that you chose to examine in
question 3.20. What would you ask them to expand, remove or change as a result of your assessment of the quality
of their disclosure?
SUMMARY
Over time corporate governance guidance has been refined. Specifically the OECD Principles have been
used as the basis for codes of corporate governance developed in the UK and Australia.
These codes and the disclosures they recommend serve as benchmarks and information sources for
stakeholders seeking to evaluate the robustness of a company’s corporate governance standards.
The European and ASX codes are principles-based rather than rules-based. They require entities to
provide an explanation if particular provisions of best practice governance guidance are not followed.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
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ACNC GUIDANCE
ACNC guidance is specifically for charities and includes two sets of standards; one for charities operating
in Australian and a separate set for charities operating overseas.
Charities must meet the ACNC’s Governance Standards to be registered and remain registered with the
ACNC. The Governance Standards do not apply to a limited category of charities called ‘Basic Religious
Charities’ (ACNC n.d.).
Pdf_Folio:188
Source: Australian Charities and Not-for-profits Commission n.d. ACNC Governance Standards, accessed October 2019,
www.acnc.gov.au/for-charities/manage-your-charity/charity-governance/governance-standards.
.......................................................................................................................................................................................
CONSIDER THIS
Compare this list of duties to the list of director duties earlier in the module.
Pdf_Folio:189
Source: ACNC, n.d., The External Conduct Standards, accessed October 2019, www.acnc.gov.au/for-charities/manage-your-
charity/governance-hub/acnc-external-conduct-standards.
NFPs have different structures and the decision-making committee or board may have different names.
The notion of a responsible person, which is embedded in the ACNC’s standards and other materials, is
designed to capture all individuals that are responsible for the running of the entity subject to the ACNC’s
oversight. The term is similar to a phrase that occurs in auditing standards related to those in charge of
governance. It simply means the people who run the organisation.
AICD GUIDANCE
The AICD also provides governance principles for not-for-profit entities. The most recent (January
2019) edition contains 10 principles, and supporting practices and guidance for each principle.
This is available at https://aicd.companydirectors.com.au/-/media/cd2/resources/director-resources/not-
for-profit-resources/nfp-principles/pdf/06911-4-adv-nfp-governance-principles-report-a4-v11.ashx.
.......................................................................................................................................................................................
CONSIDER THIS
Compare the ASX Corporate Governance Principles to the snapshot of the AICD’s Governance principles, https://
aicd.companydirectors.com.au/-/media/cd2/resources/director-resources/not-for-profit-resources/nfp-principles/
pdf/06911-5-adv-nfp-governance-principles-summary-report-a4-web.ashx, and consider whether there is anything
in the latter that might be a useful addition to the former.
Good corporate governance in NFP organisations, therefore, has many similarities to profit-orientated
entities and, as a result, many NFP organisations are voluntarily complying with the corporate governance
guidelines applicable to for-profit entities.
EXAMPLE 3.11
QUESTION 3.21
How can the broad public service mission of public sector enterprises be focused and delivered
through better governance?
As a result of the widespread reform movement in the public sector in Australia and in other countries,
public organisations now have much more responsive governance, including autonomous boards with
independent directors responsible for strategies to meet clients’ needs, and with authority to distribute
resources appropriately (within agreed parameters).
Yet the public sector remains different in values, objectives and methods compared to the private sector:
• The public sector produces ‘public values’, promotes equity, and protects the collective interests (e.g.
about the environment and international relations) as well as market ones.
• The public sector operates in a complex decision-making environment, usually manages many and
diverse stakeholder interests and often considers short, medium, and long range effects of decisions
(inter-generational equity is one example).
• The public sector’s effectiveness often relies on the co-operative, as opposed to the competitive,
participation of others. Competition has a dysfunctional effect if applied inappropriately in the public
sector: examples include service duplication, loss of scale economies, the dismantling of collaborative
institutional arrangements, and the focusing on marketing at the expense of service delivery.
• The public sector uses diverse resources to achieve its policy ends, involving not only public money but,
significantly, public power as well (Halligan & Horrigan 2005, p. 16).
In the previous analysis, whatever delegated powers the board of a public organisation are given, there
is an obligation to work broadly within the framework of government policy, and to engage with other
public agencies in the achievement of policy goals, rather than pursuing separate institutional policies. Yet
‘the conventional spectrum of bureaucratisation, commercialisation, corporatisation and privatisation of
government entities still leaves much room for a multiplicity of governance arrangements at both sectoral
and organisational levels’ (Edwards et al. 2012, p. 175).
Example 3.12 illustrates the governance dilemmas frequently encountered in the public sector: pursuing
a much wider and more vital public purpose; enjoying a degree of autonomy, which must be exercised with
extreme care; and being subject to the ultimate sanction of the government, even if this is rarely, if ever,
exercised.
dPf_Folio:192
Domestic corporate governance codes or frameworks that specify the kind of behaviour that is expected
of individuals involved in the public sector exist across all jurisdictions. Some of these requirements
are stipulated by the Australia Public Sector Commission (APSC) in a range of publications on the
commission’s website, but there are various publications issued by Commonwealth, state and territory
government departments that articulate what constitutes acceptable conduct when reflecting on governance
of public sector entities.
The APSC published a guide in 2007 called Building Better Governance that outlined a series of
governance principles. These principles are consistent with those you may find in other governance
contexts, but tailored for the government sector. It defines public sector governance as being ‘the set of
responsibilities and practices, policies and procedures, exercised by an agency’s executive, to provide
strategic direction, ensure objectives are achieved, manage risks and use resources responsibly and with
accountability’. The guide also lays down two key components of good governance in the public sector.
These components as stated in Building Better Governance, which were also reflected in guidance
produced by the Australian National Audit Office in 2003, are:
• performance — how an agency uses governance arrangements to contribute to its overall performance
and the delivery of goods, services or programmes, and
• conformance — how an agency uses governance arrangements to ensure it meets the requirements of
the law, regulations, published standards and community expectations of probity, accountability and
openness.
In other words, performance means how well agencies performance as measured against their various
programme or service requirements and conformance covers how a government agency fulfils the role of
the public sector equivalent of the good corporate citizen.
There are six principles articulated in the 2007 guidance document that set down the core values for
public sector employees. These are:
Pdf_Folio:193
These principles are included in corporate governance frameworks issued by state and territory
government departments. One example is the Department of Education and Training in Queensland. It
published these principles as a focus for its employees within the department. Other states also have specific
guidelines. The Victorian Public Sector Commission (VPSC) has developed a framework that illustrates
the accountability of various groups of public servants. The framework is shown in figure 3.6.
Stakeholders Parliament
• Ministers and
departments
responsible for
functions affected Directions, delegations
by the operations of and advice
the public entity
• Public sector
organisations that
cooperate with the Portfolio Department Directions, priorities,
public entity Secretary, advice and reports
managers and staff
• Business partners
such as companies
and NGOs
Monitoring
• Local government
and advice
• Regulators
Portfolio Entities
Board Chief Executive Officer
Integrity bodies Chief Finance and Accounting Officer
Manager and staff
• IBAC
• Ombudsman
• Auditor-General
The VPSC states that there are a series of stakeholders involved in the running of any individual public
entity. The list of key parties involved, according to the Victorian authority is:
• a minister (and parliament) and those who support the minister directly
• a department (and departmental secretary)
• a public entity board and non-executive (and executive) board directors
Pdf_Folio:194
Source: Australian Bureau of Statistics, ABS Counts of Australian Businesses 8165.0, February 2016 and ASBFEO calculations
(excludes nano businesses with no GST role)
In addition, there is the public sector, which continues to have a substantial impact even after the episodes
of privatisation in recent decades. For example, there are government business enterprises, which remain
part of federal and state governments, and maintain governance accountability to the elected government,
such as the Australian Postal Corporation and the NBN Co Limited.
A further dimension of economic activity (which begins to merge with social, cultural and sporting
activity) is the work of NFP organisations. These are organisations that cannot distribute their earnings to
those who exercise control in the organisation, but are dedicated to a wider purpose (Hansmann 1980).
The Australian Charities and Not-for-Profits Commission (2019) said in a report that they had reviewed
around 47 000 annual information statements lodged by charities during 2017. The report also revealed
the following.
• Total revenue of $146.1 billion
• Government grants as a revenue source increased by $7 billion
• Donations and bequests as a revenue source totalled $9.9 billion
• 3.3 million volunteers across Australia’s charities
Pdf_Folio:195
• Most registered charities (36%) are ‘extra small’, a subset of small
It is clear from the above that the charitable and NFP sectors are large and a major part of the
economy. There is a need to ensure that governance processes of a similar stringency operate in the case
of government bodies, NFP organisations and charities because listed companies and private entities are
not the only entities that deal with the allocation of scarce resources on behalf of stakeholders.
SUMMARY
Non-corporate entities have governance principles that generally align with those applying to corporate
entities, but the context in which non-corporate entities operate is different and some special considerations
apply.
Family-owned businesses and many SMEs do not exhibit the separation of ownership and management
that occurs in large corporations. The owners and managers are often the same people. To overcome poten-
tial conflicts and ensure the business can cope with growth and increasing complexity, it is recommended
that formal management structures and processes are put in place to ensure good governance.
Guidance for non-corporate entities that are charities is available from the ACNC which, as the regulator
of the charities sector, requires entities to have appropriate governance systems in place. The Australian
Institute of Company Directors and a number of other sources provide guidance for other types of
NFP organisations.
Commonwealth, state and territory governments have public sector authorities (known as commissions)
that set the behavioural norms for public sector entity boards. There are values that are embedded in
government guidance that entities are encouraged to follow and implement to ensure they perform in
accordance with their operating charters as well as maintain a level of accountability.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
3.8 Analyse how robust governance is relevant to public sector and non-corporate entities.
• Governance standards for non-corporate bodies are generally aligned with corporate standards
although the context differs.
• The public sector has established hierarchies that require a chain of accountability within public
sector entities.
• The chain of accountability in public sector entities extends to the ministerial level and to the
parliament.
• In Australia, key documents are issued by each state and territory government that embed common
public sector values derived from Commonwealth publications.
• Private sector NFPs are accountable to their stakeholders and thus must demonstrate robust
governance, regardless of whether they are structured as a corporation. NFPs’ goals are often
different in nature to those of for-profit entities, but they must still demonstrate effective use of
resources in pursuing those goals.
• Family businesses and SMEs often lack the separation of ownership and management that
characterises large corporations. In order to deal with potential conflicts and adapt to changing
circumstances, such organisations should adopt a governance framework.
REVIEW
Governance refers to the system used to operate and control an organisation. This module explored the
importance of having clear principles in place for guiding organisations to achieve their objectives while
conforming to expected business behaviour and rules and respecting the right of stakeholders.
The module explained how various stakeholders perform their governance roles. Directors, with their
relevant duties and obligations, have the greatest role in governance, and also the power to have the
most impact on the organisation. Shareholders, auditors and regulators all have roles to play in the
dP f_Folio:196
APPENDIX 3.1
UNDERSTANDING THE UK FRC CORPORATE GOVERNANCE CODE
The 2018 version of the UK FRC Corporate Governance Code (FRC Code) is an important mechanism
designed to improve corporate governance from the conformance and performance perspectives. Although
it only formally applies in the UK, it has international importance. You will find it valuable to download
and review this document. Only the parts of the FRC Code that are reproduced in the Study Guide
(including this Appendix) are examinable.
The FRC Code (2018) is available online at: www.frc.org.uk/getattachment/88bd8c45-50ea-4841-95b0-
d2f4f48069a2/2018-UK-Corporate-Governance-Code-FINAL.pdf.
You should download a copy of the Code for your own reference so that you see the following elements
of the FRC Code in their full context. We are only examining relevant extracts from the FRC Code.
Governance and the FRC Code
The FRC Code applies in a similar fashion to the Corporate Governance Council recommendations issued
by the ASX Corporate Governance Council. The UK FRC advises entities reporting under the Code that
they must ‘report meaningfully when discussing the application of the principles and to avoid boilerplate
reporting’. In other words, the entities should report in a manner that tells the story of the entity rather than
produce template disclosures that could be applied in differing circumstances.
The ‘comply or explain’ approach is outlined on page 2 of the FRC Code and relevant sections are
reproduced below.
1. The effective application of the Principles should be supported by high-quality reporting on the
Provisions. These operate on a ‘comply or explain’ basis and companies should avoid a ‘tick-box
approach’. An alternative to complying with a Provision may be justified in particular circumstances
based on a range of factors, including the size, complexity, history and ownership structure of a company.
Explanations should set out the background, provide a clear rationale for the action the company is
taking, and explain the impact that the action has had. Where a departure from a Provision is intended
to be limited in time, the explanation should indicate when the company expects to conform to the
Provision. Explanations are a positive opportunity to communicate, not an onerous obligation.
2. In line with their responsibilities under the UK Stewardship Code, investors should engage constructively
and discuss with the company any departures from recommended practice. In their consideration of
explanations, investors and their advisors should pay due regard to a company’s individual circum-
stances. While they have every right to challenge explanations if they are unconvincing, these must not
be evaluated in a mechanistic way. Investors and their advisors should also give companies sufficient
time to respond to enquiries about corporate governance.
Source: FRC Code 2018, The UK Corporate Governance Code, FRC, p. 2. Reproduced with permission.
The Code as revised in 2018 by the UK FRC applied to all companies that have a premium listing
irrespective of whether they are incorporated within the UK or in another country. This means that an
Australian company, for example, that might be listed or considering getting a listing in the UK will need
to factor these guidelines into their regulatory risk management. The revised Code applies to accounting
periods or financial reporting periods beginning on or after 1 January 2019.
There are some specific provisions set down for the application of the Code to certain kinds of entities.
For parent companies with a premium listing, the board should ensure that there is adequate co-operation
within the group to enable it to discharge its governance responsibilities under the Code effectively. This
includes the communication of the parent company’s purpose, values and strategy.
Externally managed investment companies (which typically have a different board and company structure
that may affect the relevance of particular Principles) may wish to use the Association of Investment
Companies’ Corporate Governance Code to meet their obligations under the Code. In addition, the
Association of Financial Mutuals produces an annotated version of the Code for mutual insurers to use.
Source: FRC Code 2018, The UK Corporate Governance Code, FRC, p. 3. Reproduced with permission.
.......................................................................................................................................................................................
CONSIDER THIS
Reflect on whether the UK FRC Code is a document that covers all of the essential issues related to the governance
of an entity as you read through the principles.
Principles
A. A successful company is led by an effective and entrepreneurial board, whose role is to promote the
long-term sustainable success of the company, generating value for shareholders and contributing to
wider society.
B. The board should establish the company’s purpose, values and strategy, and satisfy itself that these
and its culture are aligned. All directors must act with integrity, lead by example and promote the
desired culture.
C. The board should ensure that the necessary resources are in place for the company to meet its objectives
and measure performance against them. The board should also establish a framework of prudent and
effective controls, which enable risk to be assessed and managed.
D. In order for the company to meet its responsibilities to shareholders and stakeholders, the board should
ensure effective engagement with, and encourage participation from, these parties.
E. The board should ensure that workforce policies and practices are consistent with the company’s values
and support its long-term sustainable success. The workforce should be able to raise any matters
of concern.
Provisions
1. The board should assess the basis on which the company generates and preserves value over the long-
term. It should describe in the annual report how opportunities and risks to the future success of the
business have been considered and addressed, the sustainability of the company’s business model and
how its governance contributes to the delivery of its strategy.
2. The board should assess and monitor culture. Where it is not satisfied that policy, practices or behaviour
throughout the business are aligned with the company’s purpose, values and strategy, it should seek
assurance that management has taken corrective action. The annual report should explain the board’s
activities and any action taken. In addition, it should include an explanation of the company’s approach
to investing in and rewarding its workforce.
Pdf_Folio:198
Principles
F. The chair leads the board and is responsible for its overall effectiveness in directing the company. They
should demonstrate objective judgement throughout their tenure and promote a culture of openness and
debate. In addition, the chair facilitates constructive board relations and the effective contribution of all
non-executive directors, and ensures that directors receive accurate, timely and clear information.
G. The board should include an appropriate combination of executive and non-executive (and, in particular,
independent non-executive) directors, such that no one individual or small group of individuals
dominates the board’s decision making. There should be a clear division of responsibilities between
the leadership of the board and the executive leadership of the company’s business.
H. Non-executive directors should have sufficient time to meet their board responsibilities. They should
provide constructive challenge, strategic guidance, offer specialist advice and hold management to
account.
I. The board, supported by the company secretary, should ensure that it has the policies, processes,
information, time and resources it needs in order to function effectively and efficiently.
Provisions
9. The chair should be independent on appointment when assessed against the circumstances set out in
Provision 10. The roles of chair and chief executive should not be exercised by the same individual.
A chief executive should not become chair of the same company. If, exceptionally, this is proposed
1 Details of significant votes against and related company updates are available on the Public Register maintained by The Investment
Association – www.theinvestmentassociation.org/publicregister.html.
2 The Companies (Miscellaneous Reporting) Regulations 2018 require directors to explain how they have had regard to various
matters in performing their duty to promote the success of the company in section 172 of the Companies Act 2006. The Financial
Reporting Council’s Guidance on the Strategic Report supports reporting on the legislative requirement.
3 See the Guidance on Board Effectiveness Section 1 for a description of ‘workforce’ in this context.
Pdf_Folio:199
Principles
J. Appointments to the board should be subject to a formal, rigorous and transparent procedure, and an
effective succession plan should be maintained for board and senior management.4 Both appointments
and succession plans should be based on merit and objective criteria5 and, within this context, should
promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths.
K. The board and its committees should have a combination of skills, experience and knowledge.
Consideration should be given to the length of service of the board as a whole and membership regularly
refreshed.
L. Annual evaluation of the board should consider its composition, diversity and how effectively members
work together to achieve objectives. Individual evaluation should demonstrate whether each director
continues to contribute effectively.
4 The definition of ‘senior management’ for this purpose should be the executive committee or the first layer of management below
board level, including the company secretary.
5 Which protect against discrimination for those with protected characteristics within the meaning of the Equalities Act 2010.
Pdf_Folio:200
Principles
M. The board should establish formal and transparent policies and procedures to ensure the independence
and effectiveness of internal and external audit functions and satisfy itself on the integrity of financial
and narrative statements.7
N. The board should present a fair, balanced and understandable assessment of the company’s position
and prospects.
O. The board should establish procedures to manage risk, oversee the internal control framework, and
determine the nature and extent of the principal risks the company is willing to take in order to achieve
its long-term strategic objectives.
Provisions
24. The board should establish an audit committee of independent non-executive directors, with a minimum
membership of three, or in the case of smaller companies, two.8 The chair of the board should not be a
member. The board should satisfy itself that at least one member has recent and relevant financial
experience. The committee as a whole shall have competence relevant to the sector in which the
company operates.
6 See footnote 4.
7 The board’s responsibility to present a fair, balanced and understandable assessment extends to interim and other price-sensitive
public records and reports to regulators, as well as to information required to be presented by statutory instruments.
8 A smaller company is one that is below the FTSE 350 throughout the year immediately prior to the reporting year.
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9 Principal risks should include, but are not necessarily limited to, those that could result in events or circumstances that might
threaten the company’s business model, future performance, solvency or liquidity and reputation. In deciding which risks are principal
risks companies should consider the potential impact and probability of the related events or circumstances, and the timescale over
which they may occur.
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Category 5 Remuneration
Principles
P. Remuneration policies and practices should be designed to support strategy and promote long-term
sustainable success. Executive remuneration should be aligned to company purpose and values, and be
clearly linked to the successful delivery of the company’s long-term strategy.
Q. A formal and transparent procedure for developing policy on executive remuneration and determining
director and senior management10 remuneration should be established. No director should be involved
in deciding their own remuneration outcome.
R. Directors should exercise independent judgement and discretion when authorising remuneration
outcomes, taking account of company and individual performance, and wider circumstances
Provisions
32. The board should establish a remuneration committee of independent non-executive directors, with a
minimum membership of three, or in the case of smaller companies, two.11 In addition, the chair of the
board can only be a member if they were independent on appointment and cannot chair the committee.
Before appointment as chair of the remuneration committee, the appointee should have served on a
remuneration committee for at least 12 months.
33. The remuneration committee should have delegated responsibility for determining the policy for
executive director remuneration and setting remuneration for the chair, executive directors and senior
management.12 It should review workforce13 remuneration and related policies and the alignment of
incentives and rewards with culture, taking these into account when setting the policy for executive
director remuneration.
34. The remuneration of non-executive directors should be determined in accordance with the Articles of
Association or, alternatively, by the board. Levels of remuneration for the chair and all non-executive
directors should reflect the time commitment and responsibilities of the role. Remuneration for all
non-executive directors should not include share options or other performance-related elements.
35. Where a remuneration consultant is appointed, this should be the responsibility of the remuneration
committee. The consultant should be identified in the annual report alongside a statement about any
other connection it has with the company or individual directors. Independent judgement should be
exercised when evaluating the advice of external third parties and when receiving views from executive
directors and senior management.14
36. Remuneration schemes should promote long-term shareholdings by executive directors that support
alignment with long-term shareholder interests. Share awards granted for this purpose should be
released for sale on a phased basis and be subject to a total vesting and holding period of five years or
more. The remuneration committee should develop a formal policy for post-employment shareholding
requirements encompassing both unvested and vested shares.
37. Remuneration schemes and policies should enable the use of discretion to override formulaic outcomes.
They should also include provisions that would enable the company to recover and/or withhold sums
or share awards and specify the circumstances in which it would be appropriate to do so.
38. Only basic salary should be pensionable. The pension contribution rates for executive directors, or
payments in lieu, should be aligned with those available to the workforce. The pension consequences
and associated costs of basic salary increases and any other changes in pensionable remuneration, or
contribution rates, particularly for directors close to retirement, should be carefully considered when
compared with workforce arrangements.
39. Notice or contract periods should be one year or less. If it is necessary to offer longer periods to new
directors recruited from outside the company, such periods should reduce to one year or less after the
initial period. The remuneration committee should ensure compensation commitments in directors’
terms of appointment do not reward poor performance. They should be robust in reducing compensation
to reflect departing directors’ obligations to mitigate loss.
10 See footnote 4.
11 See footnote 8.
12 See footnote 4.
13 See the Guidance on Board Effectiveness Section 5 for a description of ‘workforce’ in this context.
14
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See footnote 4.
REFERENCES
ABS (Australian Bureau of Statistics) 2016, 8165.0 — ‘Counts of Australian Businesses,including Entries and Exits’, 2011–2015,
accessed October 2019, www.abs.gov.au/AUSSTATS/abs@.nsf/allprimarymainfeatures/2545DEB9201F4573CA2580CD0017
3B2A?opendocument.
ABS (Australian Bureau of Statistics) 2014, 5256.0 — ‘Australian National Accounts: Non-Profit Institutions Satellite Account’,
2012–13, accessed October 2015, www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/5256.02012-13?OpenDocument.
ACNC (Australian Charities and Not-for-profits Commission) 2019, Australian Charities Report 2017, accessed October 2019,
www.acnc.gov.au/tools/reports/australian-charities-report-2017.
AICD (Australian Institute of Company Directors) 2019, Not-for-Profit Governance Principles, 2nd edn, Sydney, accessed
October 2019, https://aicd.companydirectors.com.au/-/media/cd2/resources/director-resources/not-for-profit-resources/nfp-
principles/pdf/06911-4-adv-nfp-governance-principles-report-a4-v11.ashx.
APSC (Australian Public Service Commission) 2007, ‘Building Better Governance, Australian Government’, accessed August
2019, www.apsc.gov.au/building-better-governance.
ASA (Australian Shareholders’ Association) 2019, ‘ASA to Vote Against the AMP Remuneration Report’, accessed October
2019, www.australianshareholders.com.au//common/Uploaded%20files/MEDIA%20RELEASES/MR_20190424_ASA_votes_
against_AMP_rem_report.pdf.
ASBFEO (Australian Small Business and Family Enterprise Ombudsman) 2016, Small Business Counts: Small Business in
the Australian Economy, accessed October 2019, www.asbfeo.gov.au/sites/default/files/Small_Business_Statistical_Report-
Final.pdf.
ASIC (Australian Securities and Investments Commission) 2006, ‘Better Regulation: ASIC Initiatives’, April, accessed October
2015, http://download.asic.gov.au/files/Better_regulation.pdf.
ASX (Australian Securities Exchange) 2014a, ‘ASX Listing Rules’, Chapter 3 ‘Continuous disclosure’, Sydney, accessed October
2015, www.asx.com.au/regulation/rules/asx-listing-rules.htm.
ASX 2014b, ‘Continuous Disclosure: An Abridged Guide’, Sydney, accessed October 2015, www.asx.com.au/documents/about/
abridged-continuous-disclosure-guide-clean-copy.pdf.
ASX CGC (ASX Corporate Governance Council) 2003, Principles of Good Corporate Governance and Best Practice Recommen-
dations (ASX Principles), Australian Securities Exchange, Sydney, accessed October 2015, www.asx.com.au/documents/asx-
compliance/principles-and-recommendations-march-2003.pdf.
ASX CGC 2019, Corporate Governance Principles and Recommendations, 4th edn, Australian Securities Exchange, Sydney,
accessed August 2019, www.asx.com.au/documents/asx-compliance/cgc-principles-and-recommendations-fourth-edn.pdf.
Bosch, H 1995, Corporate Practices and Conduct, 3rd edn, Pitman, Melbourne.
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GOVERNANCE IN
PRACTICE
LEARNING OBJECTIVES
ASSUMED KNOWLEDGE
LEARNING RESOURCES
PREVIEW
In module 3 we looked at the theory of corporate governance along with the key elements of a corporate
governance framework and guidelines for international best practice. In this module we will explore the
practical aspects of corporate governance. This relates to specific actions those charged with governance
can take to demonstrate accountability and achieve good corporate governance.
Corporate governance is a complex area both in theory and in practice, but it is central to achieving the
organisation’s objectives and being accountable to stakeholders. Corporations that have good corporate
governance are more likely to succeed in achieving their long-term goals.
This module explores the application of corporate governance principles. In particular, in this module
we will examine:
• the role of corporate governance in the prevention of corporate financial failure
• a board’s operational responsibilities including legislation in relation to stakeholders
• mechanisms for the protection of financial markets and the value of corporations.
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PART A: CORPORATE GOVERNANCE
SUCCESS FACTORS
INTRODUCTION
One practical outcome of poor corporate governance is the financial failure of the corporation. Boards are
charged with preventing this through adherence to good corporate governance practices. The following
areas all contribute to reducing the risk of financial failure:
• board selection (including ensuring diversity), operation, evaluation and departures
• executive remuneration and performance appraisal
• compliance with the Corporations Act 2001 (Cwlth)
• auditing the financial statements.
This part of the module will examine each of these areas in turn. We will begin with a discussion of
the make-up of the board of directors itself. Most of what corporate boards should be doing structurally is
contained within the Australian Securities Exchange (ASX) Corporate Governance Council’s Corporate
Governance Principles and Recommendations (ASX CGC 2019). Implementation of the principles is
another matter and is dependent on the quality of the board and making sure that there is a match
between what is required to govern the organisation and the attributes of directors. The ASX principles
are referenced where relevant in the following discussion.
Lamers (2009) also highlights the importance of cash flow in ensuring the ongoing viability of a
business. Dun & Bradstreet Chief Executive Officer (CEO) Christine Christian notes that businesses are
more likely to fail because of poor cash flow than poor sales, with this being more prevalent in times of
economic recession or downturn (Heaney 2011). National Credit Insurance (Brokers) Pty Ltd, which offers
insurance to protect companies in the event of bad debts in their debtors’ lists, reported a significant rise in
the number of claims against bad debtors following the global financial crisis (GFC), indicating businesses
were not prepared for the slowdown in the economy, resulting in a strain on cash flows (Lamers 2009).
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This highlights the importance of understanding agency theory and the related issues and costs.
According to Monks and Minow (2008), there has been significant abuse, not just by the directors, but
by all involved in the corporate governance process. This includes incompetence and negligence as well
as corruption by managers and directors as well as other peripheral players including securities analysts
and lawyers, accountants and financiers, and even shareholders.
The GFC provided a number of lessons for governance. The OECD identified that corporate governance
weaknesses in remuneration, risk management, board practices and the exercise of shareholder rights had
played an important role in the development of the financial crisis and that such weaknesses extended to
companies more generally (OECD 2010a, p. 3). These issues are explored further in the following extract
from an article that considers the corporate governance lessons from the GFC.
The financial crisis can be to an important extent attributed to failures and weaknesses in corporate
governance arrangements. When they were put to a test, corporate governance routines did not serve their
purpose to safeguard against excessive risk taking in a number of financial services companies.
A number of weaknesses have been apparent. The risk management systems have failed in many cases
due to corporate governance procedures rather than the inadequacy of computer models alone: information
about exposures in a number of cases did not reach the board and even senior levels of management, while
risk management was often activity rather than enterprise based.
These are board responsibilities. In other cases, boards had approved strategy but then did not establish
suitable metrics to monitor its implementation. Company disclosures about foreseeable risk factors and
about the systems in place for monitoring and managing risk have also left a lot to be desired even though
this is a key element of the Principles.
Accounting standards and regulatory requirements have also proved insufficient in some areas leading the
relevant standard setters to undertake a review.
Last but not least, remuneration systems have in a number of cases not been closely related to the strategy
and risk appetite of the company and its longer-term interests.
The Article also suggests that the importance of qualified board oversight, and robust risk management
including reference to widely accepted standards is not limited to financial institutions. It is also an essential,
but often neglected, governance aspect in large, complex non-financial companies.
Potential weaknesses in board composition and competence have been apparent for some time and widely
debated. The remuneration of boards and senior management also remains a highly controversial issue in
many OECD countries (Kirkpatrick 2009).
A KPMG guide to corporate collapses (KPMG 2016) also provides some insight into the key drivers
of certain corporate misadventures by analysing a series of case studies. The global firm summarises the
following factors as being principal causes of corporate failure:
1. Greed or sense of making magic happen
2. Over-ambitious corporate expansions leading to complex structures
3. Excessive debt to fund expansions or personal expenses
4. Incentives to management increase the motivation to commit fraud
5. Pressure to achieve market expectations
6. Corporate governance failures as a result of incompetent or ineffective boards and board committees
7. Sense of entitlement by senior management
8. Failure and override of internal controls
9. Manipulation of financial records and/or fraudulent financial reporting to disguise the true nature of
underlying problems (KPMG 2016).
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Remuneration
Two major issues arise in relation to the remuneration that senior executives receive.
First, there are concerns about the extent to which high executive earnings are linked to performance.
Remuneration methods may fail to achieve alignment or congruency between the agent and principal. They
may actually encourage the agent to behave in ways that the principal does not desire at all. This may
be the result of linking too much remuneration to excessive risk-taking, or to focusing remuneration too
closely on short-term performance while ignoring long-term sustainable and reliable growth and profits.
Yeoh (2016) emphasised the point in a paper on corporate governance failure that ‘executive compensation
schemes induced extreme risk-taking without punishing failures while focusing on short-term interests
without aligning with the long view of risk’.
Second, there is frequently shareholder concern regarding the total amount that executives receive,
which is often regarded as excessive and involves a residual loss agency cost. This cost is borne by the
shareholders whose returns are reduced by the payments received by senior executives. Despite constant
attempts by organisations and corporate governance advisory bodies, most attempts to manage and control
remuneration levels have not been successful.
A further problem that was emphasised throughout debates on misconduct in the financial services
sector were the incentives paid to financial services professionals for selling products. These featured
prominently in discussions related to the Hayne Royal Commission and were cited as a primary reason
why various acts of misconduct were committed. Incentives may lead to a skewing of decision making in an
inappropriate manner.
Wilful Blindness
‘Wilful blindness’ (or ‘wilful ignorance’) is a term that is sometimes used to refer to types of cases
involving serious corporate governance failure. Although it is not a formal legal term under, for example,
Australian or UK law, it is a term referred to in US legislation such as the US Foreign and Corrupt Practices
Act (1977) and the US Bankruptcy Code.
In essence, wilful blindness refers to situations where individuals seek to avoid their legal liability for
a wrongful act by deliberately putting themselves in a position where they are unaware of facts that will
make them liable. In US cases where defendants have sought to escape legal liability on this basis, the
courts have frequently rendered defendants liable on the basis that they could and should have known of
facts that, had they been acted upon, would have prevented the wrongful act.
The concept of wilful blindness was referred to in the case involving Enron CEOs Kenneth Lay and
Jeffrey Skilling. The Sarbanes–Oxley regulations aim to prevent this type of approach by requiring the
CEO and Chief Financial Officer (CFO) to sign off on the financial accounts and certify the appropriateness
of internal controls.
From a corporate governance perspective, allegations of wilful blindness can have serious reputational
consequences for the individuals and organisations concerned, and potentially serious legal consequences.
This highlights that it is important for directors and others to uphold ethics and follow good corporate
governance practices in order to prevent such incidents in the first place.
Appointment of Directors
Capable directors, properly appointed, are vital to the effective oversight of modern corporations. In
Australia, in common with most countries, only a natural person (i.e. a human being, in contrast to merely
a legal person) of at least 18 years of age can be formally appointed as a director. A person currently
disqualified ‘from managing a corporation’ cannot be appointed a director (and also cannot be appointed
as a senior executive).
Notwithstanding the various corporate governance recommendations discussed in module 3, in Australia
and some other jurisdictions, the law does not specify that directors must hold any particular qualifications
or capabilities. In contrast, the majority of executives who are also directors will be required to have
qualifications relevant to their appointed executive position. Further, while it is expected that those
recommending board appointments to shareholders (e.g. the nomination committee) will properly assess
each candidate before appointment (and reappointment in the case of incumbent directors), it is noteworthy
that some appointments seem to add little value to the corporation.
The appointment of directors is traditionally strongly influenced by the board, even though the
shareholders legally appoint directors. In most jurisdictions, the annual general meeting of shareholders
will vote in favour of candidates recommended by the board (or by the nomination committee). Indeed,
endorsed directors of ASX 200 companies have averaged about 95% of the vote in favour since 2000.
Where a ‘casual vacancy’ arises, it is common for the board to use its powers to appoint a director
immediately (for later ratification by shareholders’ vote at the next AGM). Rarely are shareholders
presented with a range of candidates from which to choose.
Election of Directors
There have been two approaches that have emerged for the election of directors. One of these approaches
is a ‘staggered’ approach to election of directors. The staggered approach is one that places a greater
emphasis on ensuring that there is some preservation of corporate memory and consistency of decision
making over time.
For a nine-member board over a three-year period, a staggered approach would look like the following.
• 2019: Board members 1, 2 and 3 are required to retire from their position and, if they want to re-join
the board, must be subject to a shareholder vote of approval.
• 2020: Board members 4, 5 and 6 are required to retire, and these directors also require a shareholder
vote of approval to re-join the board.
• 2021: Board members 7, 8 and 9 are required to retire and also require a shareholder vote of approval
to re-join the board.
The standard period of director appointment has tended to be around the three years in most countries —
with just a few directors being re-elected by shareholders each year under staggered voting. A three-year
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Departures
Directors may resign from their position during the current term or, alternatively, choose not to stand for
re-election at the end of their current board term. The resignation or death of a director will result in
a board vacancy that allows the board, if it chooses, to make a temporary appointment, subject to later
shareholder vote.
While a director’s resignation does not have the same negative connotations as a formal ‘removal’ or a
legal ‘disqualification’, it is important for shareholders to be informed of the reasons behind any particular
resignation. In Australia, shareholders and other stakeholders will normally be informed through ASX
disclosure processes or by the Australian Prudential Regulation Authority (APRA). Similar agencies exist
in many jurisdictions.
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Governance
Evaluate:
• corporate governance
guidelines
• committee charters
• codes of conduct and ethics
• whistleblower provisions
• control mechanisms.
The problem is that the real reasons for resignation are not usually known. Even if there is good reason
to believe that something is seriously wrong, resignation statements generally indicate such reasons as
‘health’ or to ‘pursue other interests’. Corporate governance can be greatly enhanced if directors who
resign on a point of principle follow the Bosch Committee recommendation and make their concerns
known either to shareholders or to the relevant regulator (Bosch 1995).
Removal
As with appointments of directors, in most jurisdictions a vote by shareholders at a general meeting can
also remove a director from office. Furthermore, in some countries, it may be possible for the remaining
directors to pass a resolution to remove a director, although there usually needs to be just cause to do so.
Removal of a director of a public company in Australia before their term has expired can only be by
a shareholders’ vote at a general meeting. Under Australian law, shareholders have three ways to force a
motion to remove individual directors by way of an ordinary resolution requiring support of 50% of the
votes cast.
Firstly, any individual or group of shareholders holding 5% of the votes can require the board to call an
extraordinary general meeting, and the meeting is held at the company’s expense.
Secondly, any individual or group of shareholders holding 5% of the votes are also able to call a general
meeting at their own expense, which is unlikely due to the substantial costs involved.
Thirdly, where a company has already called a general meeting, shareholders holding 5% of the votes
— or 100 members entitled to vote — can seek to give the company notice of a proposed resolution to be
put to the meeting, including removal of directors.
These processes can be difficult and costly exercises and should not be undertaken lightly. It is also
significant in a legal sense and local corporate regulators will usually require an explanation of the removal
of a director before their term expires. Such a vote commonly will require the support of larger institutional
shareholders if it is to be successful.
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The shareholders’ meeting to elect a new board must take place within 90 days. At this meeting, all
shareholders are permitted to vote, as the board represents all shareholders including KMP. The 90-day
period allows for new persons to nominate for appointment to the board by shareholders’ vote. Notably,
the law provides that at least two of the old directors (other than the managing director) are required to
continue in order to ensure continuity of the board.
This is an important new direction but, with this new power being given to shareholders in the search
for improved corporate governance, we must fully understand how the measures operate and how they
may be used. The newspaper report (Wen 2013) in example 4.1 describes the first board spill under the
two-strikes rules.
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QUESTION 4.1
Explain the significance of the shareholder vote in the ‘two-strikes’ rule and the fact that, at different
points, it includes 25% and 50% of ‘eligible votes’, and finally the participation of all shareholders
as a simple majority.
Disqualification
Disqualification from managing corporations in any circumstances, either as a director or as an officer,
depends on the existence of some element of legally defined commercially unacceptable behaviour or
legal wrongdoing. Specific ‘wrongs’ that may lead to disqualification include:
• responsibility for certain civil wrongs (which are specified in legislation)
• financial market misconduct
• responsibility for multiple insolvencies
• significant dishonest actions and corporate crimes
• civil and criminal wrongs in relation to anti-competitive conduct in markets for goods and services.
Disqualification may be ‘automatic’. In this case, circumstances surrounding a director may mean that,
without any formal declaration of disqualification occurring, a person is disqualified — typically for a
period of five years.
For example, a person who is declared bankrupt is automatically disqualified from continuing their
company directorships. Similarly, criminal offences involving breaches of laws governing corporations
will typically involve automatic disqualification. While the rules vary slightly across jurisdictions, the
underlying principles demonstrate great consistency internationally. In most jurisdictions, automatic
disqualification applies only where criminal breaches have been proven.
Disqualification may also occur because of an order of the court, where the misbehaviour of a director
or other senior officer is of a type that the courts are empowered to impose disqualification — with periods
of disqualification that could be as long as 20 years. The types of misbehaviour leading to court-ordered
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QUESTION 4.2
From the perspective of the disqualified person, what is the effect of being disqualified and what
is the key difference between disqualification that is ordered by the courts (or by ASIC) and a
disqualification that is automatic?
EXAMPLE 4.2
Location Multiple
EU Zone 142
Australia 197
China 268
UK 270
Canada 295
US 423
India 675
It is interesting to note that this table shows that, in the eurozone, the CEO remuneration package is
142 times that of a new graduate, and for Australia it is 197 times — which seem relatively moderate when
compared to the US figures. However, even in Europe, remuneration is a topic of debate. For example, on
14 June 2013, the Swiss Federal Council (the executive branch of the Swiss federal government) submitted
for public consultation a draft ordinance on ‘say-on-pay’ and excessive executive remuneration. The new
rules aim to limit excessive remuneration practices and boost shareholders’ roles and responsibilities
regarding remuneration matters. Bypassing this legislative approach, French corporations agreed to a new
code that includes a vote on executive remuneration for shareholders at annual general meetings, similar
to current practice in the UK and US (Carnegy 2013). While not legally binding, in the case of a negative
vote, the board would have to consult its remuneration committee and make public the action it intends to
take in response. As discussed earlier, the two-strike rule is exerting pressure on boards to ensure executive
remuneration is linked to performance and supported by shareholders.
A further brake on executive reward introduced recently in the US is an SEC requirement for companies
to disclose the ratio of CEO pay to ordinary workers in their company (SEC 2015). This pay ratio disclosure
highlights the frequent disparity between rapidly inflating CEO pay and average wages, which have
remained fairly static in most US corporations for many years.
The question, only very slowly being answered, is how far corporations can increase salaries without
creating community reactions that hurt themselves and shareholder wealth. The surge in procedures
designed to empower shareholders to control executive salaries and specific responses by governments
indicate that there is a limit — albeit a limit hard to state with any precision.
Performance-Based Remuneration
Payments to economic agents (in this case, executive directors and other managers — sometimes
also including other ‘incentivised’ employees) typically consist of ‘fixed’ and ‘at-risk’ remuneration
components. The fixed portion represents a base payment that is constant regardless of individual
and/or corporation performance, such as flat annual salaries and superannuation (i.e. retirement fund
contributions). The at-risk portion (i.e. failure to perform means that the recipient will suffer reduced or
non-payment) is based on the agent and/or entity reaching certain goals and performance benchmarks (both
short- and long-term). These benchmarks are often called key performance indicators (KPIs). In Australia,
short-term incentive payments tend to be paid annually and they are more likely to be cash based, whereas
long-term incentives are based over three to four years of performance and have a greater focus on shares
or options.
Remuneration of executives is often referred to as packaged (which can be very complex, partly for
tax reasons). The performance-related components of these packages can be especially complicated and
may consist of bonuses, shares and share options, other financial benefits, and even some types of private
expense reimbursements, such as allowances for a second home.
Performance payments should not just be a reward for past superior performance but should be designed
to motivate future performance. This motivation needs careful consideration because, recognising the
nature of agency theory, it is vital that the remuneration structure appropriately builds on the self-interest
of the manager(s). A good remuneration system will promote goal congruence between the managers, the
board and the shareholders, and will help avoid the worst aspects of agency costs.
Ideally, KPIs should not refer only to past performance but also to motivate and enhance future
performance. For example, share-based awards may be granted to certain executives for good past
performance, but may also include future performance conditions (including service conditions) that must
be satisfied before the executive becomes unconditionally entitled to the share-based award.
An area of recent strong attention relates to payments made upon early resignation from executive
responsibilities. Boards and their remuneration committees need to take great care to ensure that payments
made when executive directors and other senior executives retire or resign are in fact relevant to
performance, and that the concerns of shareholders and society generally are understood and addressed.
The concept of repayment of undeserved remuneration is another important control measure, sometimes
referred to a ‘clawback’. This concept is consistent with a rule in the US Sarbanes–Oxley Act 2002
and Provision 37 in the FRC Code. It is also seen in the current ASX Principles, in the commentary
to Recommendation 8.2, which states that the report should ‘include a summary of the entity’s policies
and practices regarding the deferral of performance-based remuneration and the reduction, cancellation or
clawback of performance-based remuneration in the event of serious misconduct or a material misstatement
in the entity’s financial statements’ (ASX CGC 2019, p. 30).
Australia’s prudential regulator, APRA, released a draft set of prudential requirements for remuneration
that reflected concerns expressed during the royal commission into misconduct in the financial services
sector chaired by Commissioner Kenneth Hayne. Commissioner Hayne’s concerns related to performance
based incentive payments being tied to financial success while being perceived to downplay the need for
advisers, bankers and other participants in the financial services sector to look after the welfare of the
consumer (APRA 2019a).
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The point suggesting that remuneration metrics ought to have a limited focus on share price and company
profits is seeking to directly address the concern raised in the interim and final reports of the Hayne
Royal Commission. Conversely, media reports have periodically suggested that approaches that do not
tie remuneration to financial success are disapproved of by shareholders and shareholder advocates.
Disclosure, Transparency and Remuneration
Increased reporting in relation to remuneration, especially to shareholders and others who are the intended
users of annual reports, is a growing trend internationally.
Best practice corporate governance requires that there should be transparency in setting directors’
remuneration. A key governance principle is that no individual should be involved in setting or determining
their own remuneration levels. This can become difficult when setting the chairman’s fee, although at
least Australian shareholders must approve the overall fee cap available to the non-executive directors.
To enhance the transparency of the remuneration-setting process, as we have already discussed, inter-
nationally, laws now require a remuneration report to be included within the annual directors’ report to
shareholders.
The Productivity Commission’s 2009 report on executive remuneration provides valuable discussion of
some international approaches to remuneration disclosure (some of which are undergoing further changes
to improve performance linkage and shareholder understandings and control). For example, the report
notes that in Germany, public limited corporations must provide a breakdown of total earnings of each
member of the management board. Corporations can opt out where three-quarters of shareholders vote to
do so and only for a maximum of five consecutive years (Productivity Commission 2009, p. 245). This is
part of an international trend towards requiring disclosure of executive remuneration (Right2Info n.d.).
In the US, the Securities and Exchange Commission (SEC) amended its rules in December 2006. It
required that executive remuneration be accompanied by a detailed explanation of the rationale for that
remuneration, to strengthen the communication with shareholders on remuneration issues. The Dodd–
Frank Act (US), effective from January 2011, has given shareholders a non-binding vote on top executive
compensation.
In the UK too, investors are better informed about how much directors have been and will be paid, along
with how pay relates to corporate performance. As a result, shareholders of the approximately 900 Main
Market companies (i.e. larger, more established corporations listed on the London Stock Exchange) will
be better prepared to hold companies to account, using clearer information on pay to exercise their new
legally binding vote on executive pay (BIS 2013).
Not everyone agrees with the strong emphasis on disclosure and reporting, as wide disclosure may not
always lead to the expected benefits. Some commentators argue that an increase in remuneration disclosure
has led to higher and, indeed, excessive levels of remuneration being paid to executives and some directors.
The argument is based on the premise that remuneration committees do not wish to be seen to be paying
less-than-average market remuneration. Therefore, as corporations seek to set their remuneration levels
slightly above the average, this leads to higher payments across the market incrementally over time. If
we accept these concerns as real, then it becomes apparent that the growing strength of direct shareholder
voting (as in the Australian two-strikes rule) is an important factor in controlling possible reporting-induced
salary growth.
Tightening Rules Regarding Remuneration — Australian Illustrations
As noted above, the two-strikes rule in Australia, along with its related reporting changes, is a direct
result of the 2009 Productivity Commission report on executive remuneration and is consistent with
general changes in other jurisdictions internationally. The changes include greater clarity in reporting
remuneration, including the true nature of current, past and future remuneration available to executives.
Shareholders should more easily be able to understand the real nature of remuneration and whether there
is a direct relationship with performance. If, contrary to recommendations, performance-related at-risk
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EXAMPLE 4.3
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Example 4.3 identifies the CEO of Cisco as the most overpaid CEO in terms of remuneration (compared
with stock performance). Cisco agreed to pay USD$5 billion for controversial News Corp subsidiary NDS
in early 2012 and its market capitalisation recovered to above USD$100 billion in August 2012.
There are many examples in the press illustrating the nature of the problem. Commonly, the reports
are accompanied by highly emotive language that illustrates the feelings held by many where corporate
excesses are represented. These excesses are most commonly represented by excessive remuneration and
that is where the most attention arises. Interestingly, other issues can be of concern too — including
the extent to which some executives and directors seem to seek power and/or self-publicity — although
controls on these additional excesses are as yet few.
In contrast to the previous discussion about perceived excessive remuneration, consider BHP (formerly
BHP Billiton).
EXAMPLE 4.4
BHP
In August 2012, the BHP CEO unveiled a USD$2.7 billion write-down and promptly declared he would
neither receive nor accept any short-term bonus for the 2011/12 financial year. This large multinational
corporation has the following key principles in its Remuneration Committee’s policy on remuneration.
In determining the policy, the Committee will take into account all factors which it deems necessary.
The objectives of the policy will be to:
• support the execution of the Group’s business strategy in accordance with a risk framework that
is appropriate for the organisation;
• provide competitive rewards to attract, motivate and retain highly skilled executives willing to work
around the world;
• apply demanding key performance indicators including financial and non-financial measures of
performance;
• link a large component of pay … to the creation of value for the Group’s shareholders …;
• ensure remuneration arrangements are equitable and facilitate the deployment of human resources
around the Group; and
• limit severance payments on termination to pre-established contractual arrangements that do not
commit the Group to making unjustified payments in the event of non-performance.
Source: BHP 2019, ‘Remuneration Committee Terms of Reference’, p. 2, accessed August 2019, www.bhp.com/-/
media/documents/ourapproach/governance/190812_remunerationcommitteetermsofreference.pdf?la=en.
QUESTION 4.3
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The auditing and accounting standards and their related rules, which are contained in laws, regulations
or supplementary guidance developed by standard setters, have become very important in recent years,
with a new focus on audit and audit committees, especially as part of international corporate governance
reforms. These reforms have been under development for a long time. The major impact of the GFC, and
the consequent turmoil in the banking sector internationally, prompted further emphasis on the need for
changes, which are ongoing. Boards and management in all corporations must understand the existing
rules at any time and also the changes as they occur.
Internal auditors are also important but they are very different and are not discussed further in this module
as they do not have, and cannot have, the same recognised actual independence. This lack of independence
comes from working as employees within the company and under the authority of senior management.
Boards must realise that this lack of independence exists and be aware of the potential pressures faced
by internal auditors from other employees and management that may affect their independence. Boards
should therefore consider the measures that can be taken to give the internal audit function some degree
of independence from management.
Note that various audits, including internal audit, are covered in detail in the Advanced Audit and
Assurance subject.
The international auditing standards state that the external auditor (referred to as the practitioner in the
auditing standards) of general purpose financial statements (annual and other reports) is required to express
an opinion, resulting from a professionally formed judgment, whether the reports and related information
are drawn up in accordance with an identified financial reporting framework. The reports themselves are
prepared by the responsible party (the board and senior management) based on proper operations within
the corporation, including the correct operation of the entire accounting system.
The auditor’s report is most importantly addressed to the ‘intended users’ — including the shareholders
and other users who, in the auditor’s professional judgment, objectively are relevant. The preparation of
the reports and the auditing of the reports are both required to comply with a relevant framework — most
commonly IFRS. The company prepares its systems and accounts so that the information is compliant with
the accounting standards.
The auditor then checks the systems and the information that results to ensure that the accounting
standards compliance required has been achieved. Professional scepticism is required by auditors to detect
instances of earnings management. ASIC in INFO 222 states that:
Exercising professional scepticism is a critical part of conducting quality audits. The auditor must critically
assess, with a questioning mind, the validity of the audit evidence obtained and management’s judgements
on accounting estimates and treatments.
Once checks have been completed, the auditor will give a statement of their professional-judgment–
based opinion, upon which intended users are entitled to rely. The auditor is obliged to obtain sufficient
appropriate evidence to support their opinion and a failure to do so can leave the auditor liable for not
identifying a risk of misstatement in the reports. This is why auditors can be liable where materially
misleading information results in, for example, loss to shareholders. Even so, the fundamental liability
for materially incorrect information being in the reports is that of the board and management.
Beyond this, the board must understand the importance of auditor independence. For example, when
the Enron failure occurred, one of the biggest issues related to the fact that the corporation’s auditor,
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EXAMPLE 4.5
QUESTION 4.4
What are some measures the board can undertake to enhance the likelihood of auditor
independence?
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RISK MANAGEMENT
Risk management enables a company to maximise opportunities and minimise losses (of all types) by
assessing the different types of risk and improving safety, quality and business performance.
Often, the result of risk assessment can enable the board to determine appropriate insurance cover, but
there will be occasions when no amount of insurance will protect the company. The successful management
of risk and the laying down of guidelines on how risk is to be assessed can have additional positive benefits.
The analysis of the data collected to enable the risks to be evaluated can lead to regular monitoring by
the board and management, thus raising their awareness of the issues involved for the company.
Risk management has been defined as ‘the culture, processes and structures which come together to
optimise the management of potential opportunities and adverse effects’ (Standards Australia 2004).
Within each organisation, the board must determine the framework it considers appropriate for the
company’s needs. Risk management is a process designed to serve a number of goals including to identify,
analyse, evaluate, treat, monitor and communicate the information gathered for the benefit of the company.
The nature of the data collected will depend very much on the activities undertaken by the company.
Risks may be associated with any activity, function or process of the company. For example, one type of
risk might stem from legal liability arising from the company’s conduct (e.g. the liability for environmental
damage in the 1984 Union Carbide gas disaster at Bhopal, India, or the BP oil spill in the Gulf of Mexico
in 2010).
Identifying, evaluating and addressing risk are essential features of modern management techniques.
The role of the board in understanding and dealing with enterprise risks has been well articulated in
many of the recommendations made by various committees over the years. The International Federation
of Accountants (IFAC) Professional Accountants in Business committee (PAIB) (IFAC 2004) identified
risk as being important for both performance and conformance aspects of governance.
The OECD (2010) specifically identified the failure to properly identify and manage risk as being
central to the GFC. The need for improvement is apparent from the large number of corporate and
government failures seen in the GFC period. Good risk control should give superior performance, but
bad risk understanding and practices have resulted in financial disasters. In Australia, APRA has instituted
a rigorous policy of risk management in major financial institutions which comprises:
systems for identifying, measuring, evaluating, monitoring, reporting, and controlling or mitigating
material risks that may affect its ability, or the ability of the group it heads, to meet its obligations to
depositors and/or policyholders. These systems, together with the structures, policies, processes and people
supporting them, comprise an institution’s risk management framework (APRA 2019b).
(IFAC 2018).
There is no imperative statement by the OECD that the chair should not also be the CEO. The fact that,
in many US corporations, ‘presidents’ are the chair and the CEO at the same time is perhaps an influencing
factor in the OECD conclusions. However, it seems that this policy of role separation is slowly achieving
traction even in the US. As noted earlier, there is a gradual trend in S&P 500 companies in the US towards
separating the roles of chair and CEO. Nonetheless, the importance of independence, or independence
protocols, is clearly identified in the US in Sarbanes–Oxley and in other governance systems principles.
Provision 9 in the UK FRC Governance Code states that the roles of the chair and CEO should not be
exercised by the same individual. In Australia, Recommendation 2.5 in the ASX CGC’s document states
that the chair of the board of a listed entity should be an independent director and, in particular, should not
be the same person as the CEO of the entity.
It is apparent that the public sector demands as much attention to governance, accountability and risk
management, and fraud detection as large, complex corporations in the market sector.
As one of the regulators for the charities sector ACNC regularly produces a summary of its compliance
activities. Their 2018 Charity Compliance Report (2019) includes an analysis of the concerns assessed
by the compliance team by risk type. Further analysis shows the risk category of potential breaches in
concerns assessed by the compliance team. These are both shown in figure 4.2. Note that a total of 85.5%
of the total potential breaches are related to the ACNC’s governance standards (ACNC 2019).
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Risk Category
Governance standard 1: Purposes and
not-for-profit nature of a registered charity — this
includes concerns such as private benefit or
failing to comply with its charitable purposes.
Governance standard 2: Accountability to
members — this includes concerns such as failing
to hold annual general meeting or not providing
sufficient information to its members.
2.4%
Governance standard 3: Compliance with
2.7% 4.7% Australian Laws — this includes concerns such
4.6%
as fraudulent or other criminal activity.
Governance standard 4: Suitability of
responsible persons — this includes concerns
such as disqualified persons being responsible
persons for charities.
41.2%
Governance standard 5: Duties of responsible
persons — this includes concerns such as financial
31.8% mismanagment, managing conflicts of interest.
Entitlement to registration: this includes
concerns such as sham charities, disqualifying
purposes or private benefit.
Non-compliance with record keeping
11.9% obligations: this includes concerns such
as a failure to keep adeguate financial or
0.3% operational records.
0.3% Non-compliance with reporting obligations:
this includes concerns such as a failure to
notify of changes to charity details, failure to
lodge annual information statement and errors
in financial reporting.
Concerns outside of the ACNC’s jurisdiction.
An earlier ACNC report (2014) offers three case studies illustrating problems of fraud, governance and
private benefit in charities, indicating that there can be multiple causes of concern. These are reproduced
in examples 4.6, 4.7 and 4.8.
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Fraud
An employee of a charity contacted the ACNC, concerned that a senior member of staff was using the
charity’s credit card to make private purchases, unrelated to the work of the charity.
The ACNC contacted the charity’s board about the allegations, and commenced working with the charity
as part of its investigation. As an initial step, the board removed the individual alleged to have made the
purchases, the purchases were admitted and the individual repaid some of the debts.
However, the ACNC investigation found that the theft of funds was more extensive and significant than
initially identified. The charity worked with the ACNC throughout the investigation, committed to dealing
with the matter and continuing their charitable endeavours. With the support of the ACNC, they worked
through the issues of governance that had allowed the theft to occur, and sought to implement changes
to address the identified vulnerabilities. At the ACNC’s behest the charity filed a report to the police so
that the alleged fraud could be investigated by the appropriate authority.
Source: ACNC 2014, An Overview of the First Year of Compliance Activity, 28 January 2014. © Commonwealth of
Australia 2014.
EXAMPLE 4.7
EXAMPLE 4.8
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These cases clearly illustrate that governance and fraud problems do occur in the charity and not-
for-profit sectors and that rigorous governance standards, financial reporting and accountability are as
imperative here as in corporations working in the market economy.
To this end ACNC has developed a self evaluation tool which can be downloaded and completed.
Although not assessable in this subject, if you are involved with the governance or audit of a charity it may
be a useful resource. It is available at: www.acnc.gov.au/for-charities/manage-your-charity/governance-
hub/governance-standards/self-evaluation-charities.
SUMMARY
Part A has examined the role of corporate governance and in particular a number of specific corporate
governance practices that are crucial to the corporation’s success. We began with a discussion of common
causes of and contributors to corporate failure. These include poor strategic decisions, greed, the pursuit
of power, overexpansion, overly dominant CEOs, the failure of internal controls and ineffective boards.
The selection and evaluation of the board is therefore a key factor in ensuring good corporate governance.
It is increasingly recognised that diversity in the members of the board of directors contributes to corporate
success. In addition, ensuring compliance with the Corporations Act and having financial statements
audited by an independent party help ensure good governance.
Each element of governance needs to be working properly to ensure that a company is run according
to best practice and that conduct within an entity is ethical. Failure at any level of a company’s internal
controls and other governance mechanisms could leave gaps for corporate misconduct to take place.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
4.1 Evaluate the implications of board diversity and executive remuneration in relation to corporate
governance including corporate performance.
• Company boards are composed of individuals elected by shareholders or members.
• It is beneficial for boards to maintain a degree of continuity to ensure corporate knowledge is not lost,
but it is also important to have some turnover of members so that fresh perspectives are brought in.
• Diversity in the membership of a board is linked with good corporate governance.
• Diversity refers to factors such as gender, age and race, as well diversity of experience and
qualifications. A diverse board composition allows for a broad range of ideas and input to be
considered.
• There is an increasing realisation that ensuring gender balance is one way to ensure a broad range
of perspectives can be taken into account.
• Remuneration of non-executive directors is designed to be a reasonable compensation for their time
and effort. It may also be linked to overall corporate success (such as indicated by the company
share price), but direct performance-related compensation is not used for non-executive directors
as it could compromise their independence.
• Executive directors and other employed management personnel often have part of their remuner-
ation linked to corporate performance (in general terms and in relation to more specific targets).
Performance-based remuneration is a crucial tool for aligning the actions of employees with the
goals of the company.
4.3 Identify aspects of corporate governance that arise in relation to audit responsibilities and
regulatory compliance.
• Companies in Australia are required to comply with the Corporations Act, which regulates many
aspects of companies, including aspects of financial statements and audit compliance.
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Before looking at these, this part of the module will provide a general overview of the Australian legal
system. The module will also look at the protections for consumers and the goods and services market
as a whole. These are given force by the Competition and Consumer Act 2010 (Cwlth) and the ACCC
(Australian Competition and Consumer Commission).
Vizard Case
‘Steve Vizard banned for 10 years and fined $390,000’
Mr Jeremy Cooper, Acting Chairman of the Australian Securities and Investments Commission (ASIC),
today announced that Mr Stephen William Vizard has been banned from managing any corporation for
10 years and ordered to pay pecuniary penalties of $390,000.
Justice Finkelstein of the Federal Court of Australia found that Mr Vizard had breached his duties
as a director of Telstra Corporation Limited (Telstra) on three occasions when he used confidential
Telstra information to trade in the shares of three listed public companies, Sausage Software Limited,
Computershare Limited and Keycorp Limited between March and July 2000.
‘ASIC welcomes the length of the banning, which sets a new benchmark for future civil penalty cases
that ASIC brings’, said Mr Cooper.
‘This means that Mr Vizard is disqualified from managing any corporation in Australia until July 2015.
‘It was a pre-meditated and cynical exploitation of a privileged position held by Mr Vizard and showed
a complete disdain for the confidentiality of the boardroom’, he said.
Source: ASIC (Australian Securities and Investments Commission) 2005, ‘Steve Vizard banned for 10 years and fined
$390,000’. © Australian Securities & Investments Commission. Reproduced with permission.
Mr Vizard was not subject to any criminal charges. He also was not subject to an action for insider
trading — on either a criminal or a civil basis. He was taken to court only in respect of civilly breaching
his duties as a director.
Traditionally, laws dealing with civil matters sought only to create civil outcomes and did not lead to
penalties. Almost always, laws that deal with civil issues will provide for compensation and redress for
victims of civil wrongs. This is pursued further in the following discussion.
EXAMPLE 4.10
Smith v Redflex
Job applicant Jessica Smith received a finding in her favour that included a recommendation she receive
$2500 in compensation after the Australian Human Rights Commission (AHRC) determined a potential
employer discriminated against her in the application process.
Smith had a criminal record with two offences — assault occasioning actual bodily harm and possession
of a prohibited drug — and it was confirmed that it was her criminal record and not any other factor such
as an inappropriate skill set that ruled her out of contention for a position with Redflex Traffic Systems
Pty Ltd.
The AHRC found that Redflex had discriminated against Smith given that it had failed to communicate
with her about her National Police Check that was done after they had given her an indication that she
had done well in the application process. Smith had contacted the company on several occasions and
went to the AHRC to resolve the impasse.
Amongst the issues that AHRC President Rosalind Croucher addressed in the decision on the Smith
matter was the fact that the offences that were in her criminal record could have been examined further
by the company before refusing to take Smith on as an employee.
‘The offence of “assault occasioning actual bodily harm” can cover a range of conduct, from the infliction
of temporary bruises and scratches, to more permanent injury. In November 2004, a conviction for “assault
occasioning actual bodily harm” was punishable by up to five years imprisonment,’ Croucher said. ‘That
Ms Smith was sentenced to community service, and not a custodial sentence, suggests that her offence
was considered to fall at the lower end of the scale of objective seriousness. Similarly, her second offence
of possession of marijuana was disposed of by the Local Court by way of a fine.’
Croucher noted that the two offences did not themselves constitute a reason in their own right for the
nonappointment of Smith to a role with the company.
‘In my view, without more, the existence of a nearly 12 year old conviction for the offence of ‘assault
occasioning actual bodily harm’ and a 9 year old offence for minor drug possession did not necessarily
mean that Ms Smith was untrustworthy or of bad character in 2016,’ Croucher said. ‘I am not satisfied
that, simply because Ms Smith committed these two offences, it inevitably followed that she could not
meet high standards of character and trustworthiness many years later.’
Source: Ms Jessica Smith v Redflex Traffic Systems Pty Ltd [2018] Aus HRC 125, www.humanrights.gov.au/our-
work/legal/publications/ms-jessica-smith-v-redflex-traffic-systems-pty-ltd-2018.
EXAMPLE 4.11
OHS Breach
A 72-year old owner of a scrap metal business was sentenced to six months jail and ordered to pay a
$10 000 fine for exposing people to risks on the site of her scrap metal enterprise.
The LaTrobe Valley Magistrate’s Court heard the matter concerning scrap metal entrepreneur Maria
Jackson on 19 December 2018. Jackson pleaded guilty to two charges under Victorian occupational
health and safety laws. These charges related to a failure to comply with her duty as a self-employed
person to not expose other people to risks from the work she does, which is covered by section 24 of the
Occupational Health and Safety Act 2004. The second charge related to an offence of recklessly engaging
in conduct that places or may place another person who is at a workplace in danger of serious injury, which
is in section 32 of that same piece of legislation.
Jackson was at the centre of an incident in February 2017 while driving a forklift. An individual died as a
result of falling from the forklift’s tynes that were about three metres from the ground. Both the deceased
person and a metal bin fell from the tynes. The bin struck the individual concerned.
The scrap metal business owner failed to check that the bin was properly secured before doing anything
with the bin.
The court also ordered Jackson to pay court costs as well as the previously mentioned $10 000 fine.
Source: Based on Zuchetti, A 2019, ‘Jail sentence for employer over workplace death’, January, accessed October 2019,
www.mybusiness.com.au/human-resources/5361-jail-sentence-for-employer-over-workplace-death.
EXAMPLE 4.12
EXAMPLE 4.13
Safecorp Security
The operator of two defunct security companies was hit with a $39 090 penalty for underpaying security
guards, according to a 3 July 2019 media statement issued by the Fair Work Ombudsman.
Sydney man John Lohr, who formerly operated Brookvale-based companies Safecorp Security Pty Ltd
and Safecorp Security Group Pty Ltd, was given the penalties by the Federal Circuit Court. The companies
are no longer operating.
There were 45 security guards employed on a casual basis at various sites and these guards were owed
a total of $35 540.84.
The guards were being paid flat hourly rates between $20 and $25 and these rates did not cover casual
loading, weekend, overtime and other circumstances in which a greater payment ought to have been
made. The penalty imposed on the former security business owner was to be used to pay all affected
individuals.
Source: Information from Australian Fair Work Ombudsman 2019, ‘Penalty for underpayment of Sydney security guards’,
3 July, media release, accessed October 2019, www.fairwork.gov.au/about-us/news-and-media-releases/2019-media-releases
/july-2019/20190703-safecorp-security-penalty-media-release.
EXAMPLE 4.14
EXAMPLE 4.15
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The lessons from the Pike River tragedy must not be forgotten … That would be the best way to
show respect for the 29 men who never returned home on 19 November 2010, and for their loved
ones who continue to suffer …
Protecting the health and safety of workers is not a peripheral business activity. It is part and parcel
of an organisation’s functions and should be embedded in an organisation’s strategies, policies and
operations.
This requires effective corporate governance. Governance failures have contributed to many
tragedies, including Pike River …
The board and directors are best placed to ensure that a company effectively manages health and
safety. They should provide the necessary leadership and are responsible for the major decisions
that most influence health and safety: the strategic direction, securing and allocating resources and
ensuring the company has appropriate people, systems and equipment.
Source: Royal Commission on the Pike River Coal Mine Tragedy 2012, ‘Report of the Royal Commission on the Pike River
Coal Mine Tragedy’, accessed October 2015, http://pikeriver.royalcommission.govt.nz/Final-Report.
Clearly, one of the major effects of poor employee relations is loss of the corporation’s reputation and,
with an increasingly vigilant media, loss of brand value, share value and the threat of greater attention from
regulators. You will also observe the ability of the law to ‘strike at the agents’ — and this is appropriate
because, as observed in module 3 and using Lord Denning’s words, they are the ‘directing mind and will’
of the corporation.
WORKABLE COMPETITION
While perfect competition is difficult to achieve, the concept sought by most modern economies (including
through sometimes complex government regulation) is workable or effective competition within an
economy. The requirements of workable or effective competition include the following.
• There should be a sufficient number of buyers and suppliers so that there are real alternatives.
• No individual trader should have the power to dictate to its rivals or be free of competitive pressure.
• New traders should be able to enter the market without facing artificial barriers.
• There should be no collusion on prices, customers or trading policy.
• Customers should be able to choose their supplier.
• No trader should have an advantage because of legal or political considerations.
Note that all of these concepts are dependent on identifying a relevant market — a combination of the
product market and the geographic market that is not always easy to identify. While economists debate
what comprises a market, we find that the decision is a matter to be decided in courts of law. In a relevant
case, the court will consider the arguments of two protagonists in the courtroom and make a rational,
balanced judgment (often including consideration of the views of experts). That judgment will be based
on the balance of probabilities according to the court, based on the facts given in evidence. For those who
are not experts or judges, we can make rational, balanced judgments about what comprises a market —
especially if we use the guidance that is available from previous court decisions (precedents).
In the case of Outboard Marine Australia Pty Ltd v. Hecar Investments No. 6 Pty Ltd (1982) 66 FLR
120, the head note to the judgment of CJ Bowen, J Fisher and J Fitzgerald states that ‘the correct approach
to determine the state of competition in a market is to undertake a detailed analysis of the market, the state
of competition therein, and the likely effect of the conduct upon competition in the market’. Being aware
that this is how market competition is determined in respect of any situation or any dispute is valuable
knowledge. There are many cases in various international jurisdictions that demonstrate the approach
described in the Hecar case.
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Australia Competition and Consumer Act 2010 Australian Competition and Consumer
Commission (ACCC)
Indonesia Law No. 5/1999 (Anti-Monopoly Practice Commission for the Supervision of
and Unfair Business Competition) Business Competition
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The prohibition on misuse of market power is aimed at preventing powerful entities from taking
advantage of that market power for the purpose of disadvantaging weaker organisations.
Strategies to increase profits and market share may include lower prices, better products or greater
levels of service. These strategies generate competition and are good for the consumer. However, some
corporations are able to obtain significant market power, for example, through their size, technology or
branding. It is not in the best interests of consumers to allow these corporations to compete so vigorously
that they use their market power to destroy, eliminate or harm competitors. Therefore, in many jurisdictions,
the use of market power for these purposes is not permitted.
As another example of regulation in this area, Article 102 (formerly Article 82) of the ‘Treaty on the
functioning of the European Union’ (EUR-Lex 2012), prohibits anti-competitive business practices that
threaten the internal market of the EU, harm consumers and small and medium-sized enterprises, and
reduce business efficiency. The relevant EU provisions are operationally almost identical to the provisions
in Australia and the US, and the treaty has strong universal application. Article 102 provides as follows:
Any abuse by one or more undertakings [organisations] of a dominant position within the internal market
or in a substantial part of it shall be prohibited as incompatible with the internal market insofar as it may
affect trade between Member States.
Such abuse may, in particular, consist of:
(a) directly or indirectly imposing unfair purchase or selling prices or other unfair trading conditions;
(b) limiting production, markets or technical development to the prejudice of consumers;
(c) applying dissimilar conditions to equivalent transactions with other trading parties, thereby placing
them at a competitive disadvantage;
(d) making the conclusion of contracts subject to acceptance by the other parties of supplementary
obligations which, by their nature or according to commercial usage, have no connection with the
subject of such contracts (EUR-Lex 2012).
As is apparent from the EU legislative approach, the main principle for establishing abuse of market
power focuses on whether a corporation that has market power has used that power to eliminate a
competitor or to prevent a competitor from entering or properly competing in a market for goods or
services.
A specific example of abuse of market power is known as predatory pricing. Predatory pricing is the
supply of goods or services below cost price over a period of time. While this looks beneficial to consumers,
it is an example of misuse of market power and is covered by specific provisions in many jurisdictions.
Predatory pricing is a prohibited activity because the likely real ambition is for powerful corporations to
eliminate less powerful competitors who cannot sustain the ongoing losses of competing at artificially low
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EXAMPLE 4.16
There appears to be a renewed international focus on this type of behaviour. We previously observed
some aspects of this in the EU law. Example 4.17 is based on the EU legislation.
EXAMPLE 4.17
Examples 4.18 and 4.19 examine ACCC actions in relation to price fixing and market dominance.
EXAMPLE 4.18
EXAMPLE 4.19
QUESTION 4.5
Markets work well when fair-dealing businesses are in open, vigorous competition with each other.
With reference to examples 4.16 and 4.17, complete the following.
(a) What are the corporate governance implications of these examples for a board?
(b) Do competition laws stifle a corporation’s ability to be competitive?
(c) In what ways can respect for competition law drive competitive advantage for individual
corporations?
EXAMPLE 4.20
Output Restrictions
Output restrictions refer to conduct where competitors agree to apply restrictions on output that will
cause shortages in markets and thus result in price rises. Such price rises will advantage suppliers and
are the reverse of a competitive situation where competitors help push prices down. An example of this
behaviour is the attempt to restrict the supply of oil to help maintain prices by the Organization of the
Petroleum Exporting Countries (OPEC) cartel. The benefit to the cartel and the cost to consumers are both
immediately apparent.
Bid-Rigging
Competitive tenders and quoting are used by customers to let suppliers compete vigorously against each
other to win work. Bid-rigging is where competitors collude when asked to tender or bid for work. To
ensure that prices are maintained, all competitors may agree to submit similar pricing, or allow one of the
competitors to win the work by having the rest of the cartel artificially inflate prices.
Price-Fixing
Price-fixing is where competitors collude to create common prices. An example of price-fixing could
be two competitors agreeing to supply goods to customers at the same price. An understanding between
competitors to stop discounting on a certain day might be less obvious, but it would also be price-fixing.
It does not matter if there is an unwritten agreement or a written agreement.
Effective competition should see consumers receiving lower prices and better-quality goods and
services. By fixing prices, competitors are able to maintain profits and have less incentive to improve their
efforts. This has a significant effect on competition and the penalties may be severe (see example 4.21).
When determining if price-fixing has taken place, we need to focus on identifying an agreement between
suppliers. This is important because there is one price-setting activity that may look unlawful, but is actually
permitted. This is so-called parallel conduct and price-following. An example of this occurring is evident
in parallel pricing, where Company Y sets its selling price at the same level and at the same time as
Company X without collusion. This may seem improbable, but can in fact be common. Corporate databases
are now very sophisticated and they will have the price of all competitors’ products in all markets, and will
employ this data independently in setting their own prices.
EXAMPLE 4.21
The case is an example of how the competitive rush by managers can see things go wrong. It
demonstrates how the law applies and it shows how rapid returns to good ethics, including providing swift
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EXAMPLE 4.22
EXAMPLE 4.23
As with all matters involving complex business arrangements, good governance and the law, it is
important to have good knowledge and understanding so that appropriate balanced professional judgments
can be formed. If boards and management cannot do this alone, then informed professionals must be
available to assist them. Informed professionals, such as CPAs, have an important part to play — but care
must be taken even by CPAs to ensure that they do not try to become legal advisers. Legal understandings
must be provided by professionally qualified legal advisers with relevant knowledge and experience.
Approvals Procedures
As discussed, in many jurisdictions, some anti-competitive behaviour is automatically illegal (‘per se
illegal’), while other behaviour is only illegal if it is shown to have a substantial effect on competition
in the market. As a result, there may be times when behaviour that is good for competition is automatically
illegal when it should be permitted. On other occasions, we might see conduct that appears to lessen
competition in a market — but which on another view can be regarded as pro competition. We observed
an example of this in the special treatment that may be required for franchising.
An example of where ‘per se illegal’ horizontal price-fixing between competitors might be useful for
consumers is setting the price for taxi fares. Instead of having to negotiate a fare each time you enter a taxi,
there is an established pricing structure in place (which in many jurisdictions is part of industry agreements
or regulations). The taxi structure of fixed prices will have been given regulatory approval through a formal
process of authorisation designed to stabilise the industry and give value to consumers.
As mentioned, franchisors often require franchisees to accept contractual terms that dictate, for example,
suppliers and products. While third-line forcing is regarded as lessening competition, the existence of many
businesses operating as franchises in fact adds greatly to overall competition in the economy.
To allow for necessary exceptions and orderly commerce, competition regulations usually provide the
opportunity for companies to apply for permission (called authorisations and notification in Australia) to
perform otherwise potentially unlawful activities without breaching the law.
Any such exception-approvals will be formally given by the local competition regulatory agency.
For example, the ACCC in Australia is specifically empowered to approve otherwise anti-competitive
arrangements on the basis of the public interest. (The ACCC will regard the creation of viable and/or
competitive markets as a public interest matter.) An example is provided in the second part of example 4.24.
Most jurisdictions also provide other exceptions to cartel regulations. These include exceptions related
to the activities of joint ventures, agreements between related bodies corporate and other collective
acquisitions of goods and services. These become very complex and require detailed legal advice.
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QUESTION 4.6
With reference to the first part of example 4.24, complete the following.
(a) Identify each individual or entity that may be in breach of the law.
(b) Identify the potential penalties that could apply.
(c) What would be the situation if Shark and Loose had never spoken to each other but, acting
alone, neither company would agree to reduce prices, so Goods stopped buying (and therefore
selling) the relevant product?
Law Description
Japan: In conjunction with other legislation, the Basic Act of 1968 makes illegal
The Consumer Protection Basic misleading information and representation. Other consumer protection
Act 1968 legislation deals with matters such as false labelling and false dealings
in relation to contracts (discussed later in this module under the heading
‘Unconscionable conduct’).
Australia: Provides that ‘A person must not, in trade or commerce, engage in conduct
The Australian Consumer Law that is misleading or deceptive or is likely to mislead or deceive’. This
(Schedule 2 in the prohibition is not limited to the supply of goods or services. It, in common
Competition and Consumer Act) with all the laws in this table, establishes an economy-wide requirement
s. 18 which corporate policies must recognise — and which will best be included in
appropriate corporate policies, set by boards.
EXAMPLE 4.25
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QUESTION 4.7
A large beverage manufacturer prepares a point-of-sale poster promoting its brand as ‘the country’s
highest carbohydrate sports drink’ with the claim this will stimulate endurance, and the statement
that this is based on an independent scientific analysis. While the brand in question did have a
higher carbohydrate content than all other brands analysed, the researchers responsible for the
analysis stated in their report that, in terms of improving stamina, any differences between brands
were statistically insignificant.
Has the advertiser engaged in misleading advertising? Also, would you consider an advertise-
ment such as this to be misleading conduct or a misleading statement (or likely to mislead or
deceive), and what impact will this have on the potential outcomes?
Puffery
Extreme exaggeration has been found not to be misleading in advertising, especially where the exaggera-
tion does not relate to objective facts. Such extreme subjective exaggeration is sometimes called puffery.
Puffery is acceptable because, if statements or representations really are puffery, the courts assume that
consumers could not possibly treat the exaggerations as serious, let alone be misled.
However, the line between obvious exaggeration and deceitful communication is not always clear. One
illustration where puffery was not allowed was a case where a car-rental company claimed to be the biggest
in luxury car rental. In fact, it was not, and being biggest is not subjective — it is an objective fact as to
whether a company is the biggest in an area of business.
In Australia, the long-held view of puffery is that:
The law does not prohibit imaginative advertising or the use of humour, cartoons, slogans etc. Regardless
of how the message is communicated the message itself should not be ‘misleading or deceptive’ or ‘likely
to mislead or deceive’ … Superlatives and comparatives that are self-evident exaggeration or puffing
are unlikely to mislead anyone … However, representations and claims that take on a factual character,
particularly in quality and price terms, may amount to a breach unless they are capable of substantiation
(Trade Practices Commission 1991, p. 16).
Note: The Trade Practices Commission was the predecessor of the ACCC.
Unconscionable Conduct
The area of unconscionable conduct is an important area of consumer protection that comprises laws
designed to stop consumers from being harmed by unfair or unfairly imposed or created contracts. These
contracts and the obligations arising from them will not be allowed where the circumstances make the
contracts or the consequences harsh or unfair, and involve a more powerful party taking advantage of
another weaker party. In many jurisdictions, contracts that display these features can be set aside.
Specific laws address this matter and understanding how the concept of unconscionable conduct
originated will assist in understanding what modern legislation seeks to achieve.
Stated simply, a written and signed contract traditionally said everything about the agreement between
the parties to the contract. Courts would look beyond the written contract only to review missing concepts
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EXAMPLE 4.26
Amadio Case
Legal Case Summary — Commercial Bank of Australia Ltd v. Amadio (1983) 151 CLR 447
Mr and Mrs Amadio guaranteed their son’s business loan from the Commercial Bank of Australia. To
provide the guarantee, they effectively provided the bank with promises to repay and a mortgage over
their home, which meant that if their son did not repay the loan as required, they would become fully
liable. The son did not repay the loan and the bank sought full payment from Mr and Mrs Amadio. The
case went to court and, on final appeal, Mr and Mrs Amadio became involved in an action in the High
Court of Australia. The High Court was very interested in the facts and in a majority decision (3:1) found
in favour of Mr and Mrs Amadio. In so doing, it created the modern concept of unconscionable conduct
in relation to contracts (especially written and signed contracts).
Facts that the High Court found indicative of unconscionable conduct included the following.
• Mr and Mrs Amadio spoke and understood little English (inability to understand the contract).
• Mr and Mrs Amadio did not seek independent advice and no such advice was suggested by the bank
(taking advantage of power).
• The bank was aware that the son’s business was in a difficult financial position at the time he sought the
guarantee and was also aware that Mr and Mrs Amadio did not know this (misuse of power relationship
and withholding relevant information).
• The bank did not advise Mr and Mrs Amadio of the true extent of the guarantee and that their liability
was unlimited. Mr and Mrs Amadio believed the liability was limited to AUD 50 000 (misuse of power
relationship and withholding relevant information).
Mason J. (a majority judgment) at p. 462 stated:
Relief on the ground of unconscionable conduct will be granted when unconscientious advantage
is taken of an innocent party whose will is overborne so that it is not independent and voluntary,
just as it will also be granted when such advantage is taken of an innocent party who though not
deprived of an independent and voluntary will, is unable to make a worthwhile judgment as to what
is in his best interests.
Source: Information from Commercial Bank of Australia Ltd. v. Amadio (1983) 151 CLR 447, accessed October 2019,
https://jade.io/article/67047.
This type of conduct is not limited to transactions with end consumers. It can also occur in business-to-
business transactions. In fact, a significant number of complaints relating to unconscionable conduct have
arisen out of contracts for services and goods including:
• commercial tenancy arrangements
• relationships between building contractors and sub-contractors
• franchising
• financial services contracts, including loan guarantees, small business loans and financial institutions
dealing with small business.
The tests for unconscionable conduct in the case of an ordinary domestic agreement include the
following.
• What was the relative strength of the bargaining power of the corporation and the consumer?
• Were the conditions imposed on the consumer reasonably necessary to protect the legitimate interests
of the corporation?
• Was the consumer able to understand the documents used?
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SUMMARY
Part B of the module focused on legal and regulatory obligations imposed on those charged with
the governance of a corporation. We began with a broad description of how the legal system applies
to companies and then examined specific areas of legal obligation to various stakeholders, beyond
shareholders, who are affected by corporate actions.
These include laws related to occupational health and safety, fair pay and work conditions, and family
and leave entitlements.
Another important aspect of the law as it applies to corporations is regulation of the market. This is
designed to promote effective and fair competition between businesses in order to contribute to an efficient
market for goods and services.
There is also a range of laws that relate to consumer protection to ensure businesses do not take advantage
of or ignore the rights of customers and consumers.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
4.2 Identify a range of operational responsibilities which affect some significant stakeholders and
that are important for good governance.
• Companies are subject to a series of laws and regulations that may be statute or common law.
• Statute law refers to law that has been codified in Acts of Parliament while common law is set down
in precedents of courts over a period of time.
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Australian Prudential APRA is responsible for regulating the banks and www.apra.gov.au
Regulatory Authority similar institutions.
Australian Securities The trading market where shares and other debt www.asx.com.au
Exchange or equity instruments in entities are bought and
sold. It administers listing rules and monitors
behaviour of market participants.
The Australian Securities and ASIC is responsible for the oversight of trading www.asic.gov.au
Investments Commission markets in Australia.
Reserve Bank of Australia The RBA sets interest rates and deals with ‘big www.rba.gov.au
picture’ monetary policy.
Each of these regulators plays a critical role in the market and there are tasks that each regulator performs
that are complimentary.
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CONSIDER THIS
Download the two-page summary from the link below. It describes the matters regulated by the ASX and those areas
for which ASIC has responsibility. Read through the comparison. Why is it important that both the ASX and ASIC play
a role in regulating continuous disclosure and market sensitive information by companies to the market.
See link at: www.asx.com.au/documents/about/corporations-act-vs-listing-rules-matters.pdf
EXAMPLE 4.27
Conspiracy theories have ranged from shell companies to a hedge fund stunt. The Australian
Securities and Investments Commission is understood to be looking into the matter. David Jones
admits it has no details of the … financial capacity [of the party making the approach] or its
management and has made clear the circumstances surrounding the approach. It will have to do
some fast talking if the approach turns out to be a fake (Smith 2012).
There are difficulties in the suggestion that, rather than disclose fully, the DJs board should have simply
said it had not received any serious approach from a credible buyer. The continuous disclosure obligations
requirements of the local stock exchange rules do require disclosure. This disclosure is especially important
where the share price may be affected — and takeovers nearly always drive changes in share prices. Failure
to disclose would potentially be an offence and shareholders have successfully sued for damages against
corporations that have not fully satisfied the continuous disclosure requirement. Given the circumstances,
it is understandable that DJs’ board acted by cautiously disclosing what, with the benefit of full hindsight,
we now can see was apparently a fake takeover bid.
In short, we see in example 4.27 that it seems highly likely that the DJs board did the correct thing.
Even so, the public debate is good for all boards to consider when constructing responses to circumstances
that may challenge good governance. The DJs case provides an interesting illustration of the way that the
internet can add to the work of boards and the difficulties of maintaining good corporate governance in
all circumstances.
Many examples demonstrate that media publicity can have profound effects on markets and prices.
It can sometimes impose pressure on corporations to improve their corporate governance. Boards and
managements of corporations are often fearful of criticism in the press. When asked which forces have the
greatest effect on governance and governance improvements, managers typically respond that the media
has the greatest immediate effect and that market responses from institutional shareholders are impossible
to ignore.
Another illustration of the role of media and publicity in relation to improving markets is perhaps far
more important — even today. More than 10 years ago, the Enron and WorldCom scandals raised questions
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INSIDER TRADING
As discussed in module 3, a key feature of public corporations is their separation of management and
ownership. Despite the requirements for continuous disclosure of relevant information, commercially
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QUESTION 4.8
Paroo is a director of Oorap Ltd, a listed corporation. In this capacity, she learned that Oorap was
about to be subject to a takeover bid. Paroo immediately started buying shares in Oorap so as to
be well placed when the market learned of the bid. She is now being investigated by the regulator.
Discuss the key problems faced by Paroo.
Understanding the rules is important, as financial markets operate under two governing theories:
efficiency of markets and investor confidence.
Efficiency is measured by the speed with which information provided to market participants is reflected
in the share price. Investor confidence revolves around the concept of a level playing field where everyone
has an equal opportunity to compete in the market.
It can be argued that when people with non-public, price-sensitive information use that information to
trade in securities in a market, such non-transparent conduct promotes short-term efficiency in the market
as market prices very quickly adjust to reflect the value of the security. This efficiency is at a high cost to
ethical investors, given those engaging in this form of market misconduct enter and then exit the markets
at prices that give them unfair gains based on their special knowledge. Any justification of insider trading
based on market efficiency is a fundamentally absurd proposition that is totally at odds with principles
applicable to professional accountants and ethical conduct.
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EXAMPLE 4.28
MARKET MANIPULATION
We looked briefly at the 2012 David Jones market events in example 4.27 as an example of market
manipulation. You will note that example 4.28 was discussed in the media as a type of market manipulation.
As Zhu was principally involved in insider trading, we can say that he was an inside trader. However,
given that Zhu misused information to make personal gains, it is understandable that even insider trading
is sometimes considered to be market manipulation.
For our purposes, it is better to consider insider trading as a separate wrong. So, excluding insider trading,
it is important to understand the nature of market manipulation and at least some of the ways in which it
may occur.
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EXAMPLE 4.29
QUESTION 4.9
In example 4.29, the judge noted that John Hartman was highly remunerated as an employee.
Discuss this factor and its potential relationship to the market manipulation involved. Why is
insider trading a relevant factor in this case?
There are many ways in which bribery, internationally one of the most significant forms of corruption,
may originate and be structured. Generally it involves the payment of money or the provision of benefits,
undertaken with a degree of secrecy, and intended to obtain benefits of some kind. Importantly, those
receiving the benefit use their position or knowledge to make a personal gain, by acting in the interests of the
person making the payment instead of acting according to their duty under their contract of employment.
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EXAMPLE 4.30
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In 2015 the Australian Senate began an inquiry into overseas bribery allegations regarding Australian
corporations. This included interviewing executives from Leighton Holdings and BHP, with the view that
the legislative frameworks for enforcement of an anti-foreign bribery regime were more effective in the
US and UK (McKenzie & Baker 2015).
The fight against corruption is difficult, especially where offshore, possibly self-interested, contractors
act on behalf of international corporations. Boards need to understand the issues involved in establishing
and ensuring sound corporate governance, including corruption compliance, otherwise the impact on
reputation and performance can be very high. With reference to example 4.30, note that, as early as
1999, Shell had in place a group-wide, well-written policy titled Dealing with Bribery and Corruption:
A Management Primer (Shell 2003). It includes a large amount of advice and numerous statements of Shell
policy, including recognition of the benefits of not being involved in any form of bribery. If the document
had been properly used and understood by its contractors, Shell would have confronted no problems. The
fact that a contractor perhaps was not aware of or ignored Shell policies created the problem faced by Shell.
There are strong international laws — for example in the UK where all bribes payable by British
corporations anywhere in the world are banned. Not even minor facilitation payments are allowed.
Rogue Trading
Rogue trading is discussed only briefly as it is a complex field. It is perhaps of more concern to financial
institutions than to boards in general — although it could happen in relation to a corporation’s finance risk
control (including hedges and options) or trades by or in a corporation’s own shares. Therefore, boards
should understand the issue as a matter of corporate governance generally, especially relating to finance
functions. This area is considered in some detail in the Financial Risk Management subject.
A rogue trader is normally an employee (or other authorised person) who engages in unauthorised
trading. The motivation may be personal gain or simply hubris — that is, excessive pride. Whatever the
motivation, rogue traders can sometimes create mayhem in financial markets generally.
One of the highest profile rogue trading events of all time related to the collapse of the centuries-old
Barings Bank. There, a single rogue trading employee, Nick Leeson in the Singapore office, was able to
run his own deals without any effective oversight from London. His losses on the bank’s behalf were huge
— totalling over USD$1.3 billion. It seems that Leeson was not forestalled in his actions in any timely
way. The main Barings Bank board was in London, far from the scene of Leeson’s trades; they were too
impressed by his apparent trading success, not knowledgeable enough about the trades he was making,
and too willing to accept his assurances. As a result, Barings Bank, one of the oldest banks in the world,
was bankrupted by the losses Leeson generated.
However, the assumption that rogue traders have acted alone, without the knowledge or acquiescence of
senior executives, is sometimes misleading. When failures occur, both financial institutions and the courts
often attach fault to particular individuals rather than the systems and culture of the institution itself.
The attempt to do this by the UK Financial Conduct Authority and JP Morgan Chase in the London
Whale case revealed how difficult those systems and culture are to resist. Action was dropped in August
2015 against the trader Bruno Iksil, whose bets on complex derivative contracts cost JP Morgan Chase
USD$6.2 billion in losses. Iksil acquired his oceanic nickname due to his trades that swamped the markets.
In the backwash, JP Morgan Chase agreed to pay USD$920 million to resolve litigation in New York and
London that they had misstated financial information, and due to a lack of internal controls prevented
traders from ‘fraudulently overvaluing investments’ (Stewart 2015).
Iksil was not convicted because, while he had engaged in high-risk trading, he did not conceal his
positions and had repeatedly discussed strategy with higher ranking executives. He had grown increasingly
uncomfortable with the favourable valuations the bank was reaching, and was recorded by the bank
referring to his boss stating ‘I can’t keep this going. I don’t know where he wants to stop, but it’s getting
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Ponzi Schemes
Ponzi schemes are named after Charles Ponzi who was involved in a very high-profile and widespread
fraud using a mechanism that had earlier origins. At their simplest, Ponzi schemes involve earlier investors
being given a return by simply diverting the capital contributions of later investors to the earlier investors.
In the early stages of a Ponzi scheme, amidst the excitement of receiving returns that are surprisingly high,
earlier investors are very happy and later investors join in by investing their money so they can also obtain
these large returns.
In fact, so happy are earlier investors that they often invest further sums or reinvest the actual returns
received. There comes a point where new investors are too few to sustain the returns. At this point, investors
commonly start seeking payments of their capital. The fraud becomes evident as there is no remaining
capital and the accounts underpinning performance are proven to have been fraudulent. At this time, it
usually becomes apparent that the creator of the scheme and key associates (who typically are the only
people aware of what was really happening) have taken steps to enrich themselves by further frauds —
including the personal use of large amounts of cash from the scheme. Example 4.31 describes a Ponzi
scheme that operated for decades and involved tens of billions of dollars.
The fact that these schemes occur somewhere every few years shows the impact of greed and gullibility
on investing communities. The reality of Ponzi schemes and the fact that they can harm individuals,
corporations, markets and have economy-wide impact, must be understood by directors and boards as
part of overall corporate governance knowledge.
EXAMPLE 4.31
Ponzi Scheme
The largest Ponzi scheme ever conducted was created by the American investor Bernie Madoff. In March
2009, in Manhattan, Madoff pleaded guilty to 11 federal felonies and admitted that he had turned his
wealth-management business into a huge Ponzi scheme. He defrauded thousands of investors of billions
of dollars in a scheme he said he’d been operating since the early 1990s. Federal investigators said the
fraud had more likely commenced in the mid-1980s and possibly even as far back as the 1970s.
According to those charged with recovering the victims’ money, Madoff’s investment operation was
probably never legitimate. Almost USD$65 billion was missing from client accounts, including fabricated
gains. Actual losses to investors was estimated by the trustee to be approximately USD$20 billion.
Madoff’s business, began deteriorating after the global financial crisis when clients requested a total of
USD$7 billion back in returns––and he only had USD$200 to USD$300 million left to give back to them.
One reason Madoff managed to remain undetected for so long –– even though several people had filed
reports to the SEC expressing their fear that he may be operating a Ponzi scheme –– was due to his wide
reputation and respected position in the financial industry. He had founded his own market-maker firm
in 1960, and assisted in the launching of the NASDAQ Stock Market. Madoff also sat on the board of
the National Association of Securities Dealers, and advised the Securities and Exchange Commission on
trading securities.
It is generally agreed that 70-year-old Madoff knew exactly what he was doing when he defrauded his
clients over several decades. Madoff was sentenced to 150 years in prison on 29 June 2009.
Phoenix Companies
A significant problem for corporate regulators relates to directors and sometimes larger shareholders who
control companies as de-facto directors without actually being appointed and who deliberately use limited
liability to avoid liabilities. Usually, this applies only within smaller corporations — normally private
corporations.
Typically, what occurs is that the directors/managers of the original corporation allow it to fail,
owing large amounts of money (often to tax authorities). A new corporation, operated by the same
directors/managers, is then created to carry on the existing business activity. The new corporation rises
from the ashes of the old and, using a term from Egyptian mythology, these new corporations are commonly
referred to as phoenix companies.
The directors/managers of the failed corporation step away from and leave unpaid the debts of the old
company. It is quite common for the phoenix company to be given a trading name that is similar to the
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4.10 REPRESENTATION
Throughout this module, we have discussed corporate governance relationships and rules and approaches
to make corporate governance better — both in conformance and performance.
We have seen that the most influential stakeholders within an organisation are the board and senior
managers of the corporation. However, there are many other stakeholders, as seen in module 3. The concept
of shareholders and who they are has been discussed at some length and, on many occasions the implicit
question of representation of shareholders in corporate decision making has arisen.
Interestingly, shareholders, who are regarded by the law as the ultimate owners with a variety of rights,
are correctly regarded as insiders who have connections with management and control. However, this
correct legal presumption is often not correct in practical terms, in spite of some increased power given to
shareholders in recent times.
In a large corporation, small shareholders have remarkably little influence on the direction of the
corporation and no real control, as individuals, over the decisions made by the board and management.
The opposite is true of large shareholders. They do have influence and often real control through board
positions and potential voting power at general meetings of the corporation. For example, in the US over
the past decade, hedge funds have played an increasingly important and high-profile role in the market, by
taking sizeable stakes in undervalued or struggling corporations and then agitating for change — typically
at the board and senior management level.
Therefore, while small shareholders can be regarded as being outside the corporation, large shareholders
are able to exert their influence inside the corporation. So significant is this fact that there is a model called
the outsider model, which recognises that large numbers of small shareholders are owners, but are still
outside in terms of any real control, since they have little representation in real terms.
By contrast, the insider system looks at those who have real power in the corporation. It especially refers
to those who have influence and power through relationships, as can be seen commonly in European and
Asian business structures. Interestingly, substantial shareholders in large and small corporations tend to
look more like insiders as they have real, share-based power, and therefore tend to be better represented in
corporate decision making.
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General meetings Each shareholder has a guaranteed right to attend and vote at the general meeting of
shareholders — including rights to vote in respect of executive remuneration.
Nominee director A director appointed to represent the interests of a large shareholder or a particular
group of shareholders. Such a person is unlikely to satisfy independence criteria.
They will also be faced with conflicts of interest, as their duty must be to the office
of director and not to the person who arranged their place on the board. Nominee
directors will eventually need to be voted onto the board by the shareholders, and
their duty will be to act in good faith in the best interests of the company and to act
for proper purposes. Nominee directors commonly face difficult conflicts of interest
as they in fact represent a single large interest and the law requires them to act for
all shareholders.
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There are also detailed sections for asset managers that include notions of asset managers needing to
use proxy votes and that they are in the business of managing the wealth of their clients irrespective of
whether their clients are individuals or institutions.
.......................................................................................................................................................................................
CONSIDER THIS
Read reading 4.1 ‘Open letter endorsing Commonsense Corporate Governance Principles’ and reflect on key points
throughout. Compare the role that an asset manager or institutional investor has when compared with the role of a
financial planner or personal financial adviser. How are these different?
An interesting question arises in relation to some institutional investors, such as CalPERS. These
organisations primarily exist in order to manage the wealth owned by others. They also act as pseudo-
market regulators and self-appointed arbiters of good corporate governance standards. The power and
activities of such institutional investors becomes complex. There is little doubt that the basic motivations
behind such approaches are sound. Also, the overall approaches of CalPERS do not seem to demonstrate
any failings.
However, as professionals, we need to look carefully at organisations such as CalPERS. It is likely that
decisions and approaches by such organisations towards corporate governance preferences will be driven
by the perceptions and preferences of the current managers within the relevant organisation at any time.
We need to be aware that these managers are at the same time, it seems, seeking returns for the wealth
owners and also seeking to influence global approaches to corporate governance. Difficulties — including
potential conflicts of interest — seem likely to arise, at least sometimes.
However, where a group of large institutional investors pool their capabilities in order to develop industry
standards, the likelihood of valuable generic outcomes surely must be greater. An example of this is the
Financial Services Council’s standards — which include a code of ethics, code of conduct and other
important guidance for investment managers (FSC n.d.).
Whether or not large institutional investors will always be best placed to comment on corporate
governance matters, there is no doubt that they can and do fill a role as valuable as shareholders. Their
relative size in the market, and their ability to comment where less powerful shareholders could not, can
be seen in example 4.32. The example deals with some publicly reported matters occurring within News
Corp. There, CalPERS is the institutional shareholder reported as expressing major concerns. CalPERS
states reservations about the approaches of the board of News Corp. The independent directors of News
Corp however state that they do not share the concerns so strongly felt by CalPERS.
As background to CalPERS’ concerns about News Corp, an Australian Financial Review article
identified that CalPERS ‘owns 5.49 million News Corp Class A (limited voting) and 1.38 million Class B
(full voting) shares, worth about USD$110 million. The Murdoch family controls 39% of News Corp’s
798 million voting shares’ (Potter 2011). The report also identifies that there are a further 1.82 billion
non-voting shares on issue by News Corp, of which the Murdoch family own relatively few. Reduced or
no-voting share rights are addressed by CalPERS in its suggestion that there is a corrupt voting structure.
Notwithstanding CalPERS’ stated concerns, we may assume that an entity buys shares with full
knowledge of their rights, including voting rights. Perhaps CalPERS’ stated concerns therefore may be
considered as in principle concerns relating to News Corp structures, as it may not seem valid to complain
about a specific circumstance that was voluntarily accepted with full information.
As you read example 4.32, you are expected to employ professional judgment in considering the facts.
For example, the independent directors of News Corp fully reject the criticisms of CalPERS, and we should
not dismiss this independent judgment as being of no importance.
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After surviving the immediate media storm following the revelations regarding the phone hacking
scandal in the United Kingdom, and the closure of the News of the World newspaper at the centre of the
controversy, Rupert Murdoch initially faced down the repeated market calls for him to step down as CEO
of News Corp (remaining in the role of the chair) and demands to separate the newspaper interests and
television and film interests of News Corp. Then, in 2013 Murdoch responded to the calls and formed two
companies with most of its television and film assets being included in a new company, 21st Century Fox.
The remaining 130 newspapers (including the Wall Street Journal and the Times of London), educational
businesses and other assets were established in a new company with the old name of News Corp (The
Economist 2013).
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QUESTION 4.10
EXPANDING ETHICS
It is becoming increasingly common for business codes of conduct to specify good business ethics. These
codes of conduct do not apply only to employees and managers. Codes of conduct need to deal with a vast
array of relationships and business matters.
One interesting expansion taking place is that many purchasers now insist that suppliers must display at
least minimum ethical standards. A powerful example occurred more than 10 years ago when the Finnish
company, Nokia, began sourcing large volumes of inputs from factories in developing economies. Nokia
took the approach that employees who worked in overseas factories to make goods that would be bought
and used by Nokia must work in good, safe working conditions and be paid appropriately. If a supplier
could not meet the minimum standards required by Nokia, then Nokia would not do business with them.
An extensive example of a code of ethics that has a broad array of internal and external stakeholder
governance requirements can be seen in HSBC’s ‘Ethical and environmental code of conduct for suppliers
of goods and services’ (HSBC 2018). Included in this code, for example, is a set of employment conditions
that suppliers need to comply with. As professional accountants, we can immediately see the importance
of meeting HSBC’s ethical rules if the supplier is to continue supplying to HSBC.
It is clear that good governance practices protect boards, management, shareholders and many other
stakeholders, including the financial markets and the economy. HSBC’s focus on ethical conduct is
part of the company’s commitment to meeting expectations, not only of its shareholders, but also of its
customers, regulators and society as a whole — that is, being a responsible corporate citizen (the subject of
module 5). Poor ethics, combined with unlawful behaviour, can damage corporations dramatically. For
example, recent public statements about Olympus Corporation have focused on impropriety within the
corporation and subsequent shareholder losses, as shown in example 4.33.
The Olympus case study illustrates the way that boards can dramatically mismanage — and the fact that
this mismanagement hurts corporations, shareholders and indeed entire economies by damaging financial
markets. The Financial Times article is one of many reports identifying that the board of Olympus was
involved in a major scandal. A fundamental cause appears to be the absence of independent directors
on the board, a practice that was widespread in the Japanese corporate governance system, though now
the Japanese code recommends companies accept at least one independent director. Even worse, the
report suggests that there is an apparent reluctance in Japan to lessen the power of entrenched non-
independent board and management structures. But, as with other countries, lessons have been learned
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EXAMPLE 4.33
Olympus Corporation
‘Former Olympus Chief Warns on Governance’
The former chief executive of Olympus, who blew the whistle on the company’s accounting fraud, said
the corporate culture and practices at the root of the scandal remain in place at the camera maker and
warned that Japan was missing an opportunity to adopt much needed corporate governance reforms.
‘I don’t think we have cleansed [Olympus],’ said Michael Woodford, the former president and CEO, who
was sacked after confronting top management about excessive payments related to the acquisition of UK
medical equipment maker Gyrus and others. ‘Nothing has changed and it is business as usual,’ he said.
Mr Woodford also warned that the Olympus affair was not over and pointed out the need to investigate
the more than 100 companies Olympus acquired under former chairman Tsuyoshi Kikukawa, who has
been arrested in connection with the fraud.
The former president and CEO said that while he was heading Olympus he had wanted to bring in
Kroll, the forensic specialist, to investigate whether the camera maker used other acquisitions to cover up
accounting irregularities. ‘I think a lot more scandal will come out.’
His comments came on the eve of Olympus’s extraordinary general meeting on Friday at which
shareholders will vote on the company’s new board as well as the restatement of its accounts.
Olympus has admitted to falsifying its accounts to cover up Y130 billion in losses incurred through bad
investments dating back to the 1990s.
Japanese police arrested three former executives of Olympus, including its former chairman, who are
suspected of involvement in the fraud, while Tokyo prosecutors last month indicted Olympus on violation
of the Financial Instruments and Exchange Law.
The Olympus scandal has shaken the Japanese business community and undermined foreign investor
confidence in the country’s capital markets.
Tsutomu Okubo, an upper house parliamentarian who chairs a ruling Democratic Party committee on
corporate governance reform, said earlier this week: ‘It is a serious matter. The Olympus affair attracted
much attention … and it is said that thinking on corporate governance in Japan is lax.’
The Democratic Party is preparing to submit legislation aimed at improving corporate governance but
it has been watered down due to opposition from the powerful business lobby Keidanren.
Speaking to the media, Mr Woodford said the choice of Olympus’s new chairman and other board
members and the process whereby new directors have been nominated indicated governance had not
been reformed at Olympus.
Two key appointees have close ties with Olympus’s main bank, Sumitomo Mitsui, while another has had
a long career with Bank of Tokyo Mitsubishi, making them insufficiently independent, he said.
‘The Olympus scandal would have been a wonderful opportunity to really get it right.’ Instead, he said,
investors hesitate to invest in Japan and question the integrity of company accounts. ‘Japan is seen to
be having more and more question marks,’ Mr Woodford said.
Source: Nakamoto, M 2012, ‘Former Olympus chief warns on governance’, Financial Times, 19 April. Used under licence
from the Financial Times. All Rights Reserved.
WHISTLEBLOWER PROTECTION
Whistleblowing can be defined as the ‘disclosure by organisation members (former or current) of illegal,
immoral or illegitimate practices under the control of their employers, to persons or organisations that
may be able to effect action’ (Miceli & Near 1984, p. 689). In many instances of substantial management
failures, including major occupational health and safety breaches, management frauds and other illegality,
the reports of whistleblowers have been the only mechanism that caused an investigation into inappropriate
actions or behaviour.
The growing incidence of corporate scandals and crashes over recent decades has resulted in an
international focus on developing laws and policies that encourage and protect whistleblowers. The
whistleblower, however, must take great care to act only within the legal protections provided by detailed
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It is not our task in this subject to consider the many different detailed legal rules that exist internationally.
However, as professional accountants, we must be able to handle the rules, or seek relevant guidance on
them, as they occur in our own jurisdictions. There will be important differences from one jurisdiction
to another. Boards and management must ensure that the rules are implemented appropriately within the
local rules and within the particular corporation.
The rules that apply under the Corporations Act, in common with whistleblower legislation internation-
ally, attempt to balance the value of whistleblowers and the need to protect their rights with the rights of
the corporation and the importance of confidentiality and good corporate governance. Equally, while it is
important that employees are free to blow the whistle, it is also important that malicious employees do not
have the opportunity to unfairly harm corporations and other stakeholders including shareholders, other
employees and customers.
EXAMPLE 4.34
Kerry O’Brien, presenter: Two rogue traders involved in a financial scandal at banking giant NAB are
behind bars tonight after a judge found they’d been enmeshed in a culture of malleable, profit-driven
morality that went off the rails. Senior trader David Bullen was sentenced today to a minimum of
2.5 years’ jail for his role in creating false profits on NAB’s foreign currency trading desk, which cost
the bank $360 million. And junior trader Vince Ficarra will serve a minimum of 15 months. They’re the
last two men of a trading-room team of four to receive jail terms over a scandal that severely damaged
NAB’s reputation and resulted in a major internal shake-up. With fascinating insights provided by
taped phone conversations of the dealers at work, Heather Ewart takes a look at their high-risk culture
and at whether other potential cowboys are likely to take a salutary lesson from the outcome.
Source: Ewart, H 2006, ‘Former NAB traders jailed’, 7.30 Report (TV program transcript), Australian Broadcasting
Corporation. Reproduced with permission.
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EXAMPLE 4.35
QUESTION 4.11
Briefly describe ‘whistleblowing’ and explain why whistleblower protection has become an impor-
tant component of good corporate governance.
Further, if Watkins was whistleblowing today, and in Australia, what guidance would you give to
her regarding her legal protection? Refer to ASIC’s Information Sheet 238 (ASIC 2019b).
SUMMARY
Part C began with an overview of financial markets, their regulation and the role of information within
the markets. The regulation of capital markets is both domestic and global and has become increasingly
complex over time. Various corporate collapses across the globe over the years have created tighter
regulations on companies but curbing market misconduct remains a challenge. Particular issues that can
affect the operation of the market include insider trading, market manipulation, bribery and corruption,
rogue trading, Ponzi schemes and the use of phoenix companies. Specific regulation (including protection
for whistleblowers) is in place to address these problems. The role of shareholders in ensuring appropriate
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KEY POINTS
4.6 Identify some important rules that exist for the protection of financial markets and the value of
corporations.
• Regulators administer laws that are designed to ensure markets are run in an orderly fashion with no
unfair advantages being given to any parties.
• ASIC administers the Corporations Act and also oversees the work of the ASX, which is the main
trading market for shares and other instruments.
• Both ASIC and the ASX have a responsibility for continuous disclosure given that disclosure must
be made to the market via the ASX and enforcement of the law is within ASIC’s remit.
• AUSTRAC regulates and oversees the collection of information from a range of market participants
to determine whether money laundering or terrorist financing has been taking place.
• The RBA regulates the market for clearance and settlements.
• APRA is the prudential regulator that provides institutions with a license or registration to operate as
lending bodies. It is responsible for regulating the way in which banks and similar institutions conduct
their business.
• The ASX Listing Rules specify the rules under which companies listed on the ASX exchange must
operate.
• Market manipulation laws exist in order to ensure that those who seek of engage in insider trading
and coordinate groups of people selling or buying stocks are prosecuted. These tactics are designed
to manipulate share prices artificially and often to the disadvantage of ordinary shareholders.
• Other actions that are prohibited by market protection rules include bribery and corruption, rogue
trading, Ponzi schemes and the use of phoenix companies.
• Australia has enacted legislation to protect whistleblowers who report corporate misconduct.
REVIEW
In this module, we have examined how corporate governance theories, principles and guidelines are put
into practice.
Part A of the module examined elements of good corporate governance that contribute to corporate
success, including the diversity of skills, experience and perspectives represented on the board of directors.
Part B of the module examined the operational responsibilities of the board, including compliance with
a range of legislation that covers matters such as employee rights, fair competition in the market, and
consumer protection.
The protection of the financial markets and the value of the corporation were the subjects of part C. In
particular, we examined the regulation of participants in the financial market to ensure the markets operate
fairly and efficiently. We also examined how shareholder rights are represented within the corporation, the
expanding role of ethics within corporations and measures in place to protect whistleblowers who expose
misconduct.
In combination, the above practices help those charged with corporate governance to demonstrate
accountability.
REFERENCES
30% Club 2019, ‘Who We Are’, accessed October 2019, https://30percentclub.org/about/who-we-are.
AASB (Australian Accounting Standards Board) 2010, ‘AASB 124 Related Party Disclosures’, accessed October 2015,
www.aasb.gov.au/admin/file/content102/c3/AASB124_12-05_ERDRjun10_07-09.pdf.
ACCC (Australian Consumer & Competition Commission) 2009, ‘ACCC Immunity Policy for Cartel Conduct’, accessed October
2015, www.accc.gov.au/system/files/Immunity%20policy%20for%20cartel%20conduct%20and%20interpretation%20
guidelines.pdf.
ACCC 2012a, ‘Malaysia Airlines Cargo Sdn Bhd penalised $6 million for price fixing cartel’, Media release, 14 June, accessed
October 2015, www.accc.gov.au/media-release/malaysia-airlines-cargo-sdn-bhd-penalised-6-million-for-price-fixing-cartel.
ACCC 2012b, ‘Chemical company admits engaging in resale price maintenance’, Media release NR 232/12, 2 November, accessed
October 2015, www.accc.gov.au/media-release/chemical-company-admits-engaging-in-resale-price-maintenance.
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CORPORATE
ACCOUNTABILITY
LEARNING OUTCOMES
ASSUMED KNOWLEDGE
LEARNING RESOURCES
• Reading 5.1: Climate change: Keynote address by John Price, Commissioner, Australian Securities and
Investments Commission, Centre for Policy Development: Financing a Sustainable Economy, Sydney,
Australia, 18 June 2018 (available on My Online Learning).
PREVIEW
Organisations are entrusted with significant resources and power, and have the ability to significantly
affect the economy, community and natural environment. As such, stakeholders require organisations to
be accountable for their actions, and reporting is one method to support this accountability. Traditionally,
organisations’ reporting has involved disclosure of information in financial reports primarily designed
to communicate financial information to shareholders and debt-holders. These reports are commonly
criticised as too narrow in scope to reveal the organisation’s impacts on the community and natural
environment. This module examines how reporting can provide a broader account of the organisation’s
impacts to inform the decisions of both internal and external stakeholders.
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Dwindling resources, damaged ecosystems and exploited labour are some of the reasons driving
stakeholders to demand greater corporate accountability, particularly in terms of sustainability.
In 2015, the United Nations adopted an agenda of 17 Sustainable Development Goals (UNSDG), shown
in figure 5.1. Sustainable development is a central concept in this module.
This definition is derived from the report Our Common Future (WCED 1987), also known as the
Brundtland Report. This definition, alongside the UNSDG, has helped frame the development of sus-
tainability reporting.
The disclosure of information about sustainability performance and processes has become so common
that it is now considered mainstream reporting by most major corporations around the world. This increase
in reporting about social and environmental impacts and performance occurred alongside an increase in
regulation worldwide.
This module builds an understanding of the demand for broader reporting on social, environmental and
sustainability impacts and the benefits and challenges of providing such reports.
Part A of the module discusses the limitations of financial reporting in relation to the recognition
of the social and environmental impacts of organisations. Part B then discusses the drivers for greater
accountability and the emergence of corporate social responsibility (CSR) reporting. Part C links this to
theories used to explain the need for social and environmental information. Part D presents a history of
CSR reporting and examines the extent to which some of the concepts related to social and environmental
performance are capable of being measured. Part E identifies the main mandatory reporting requirements
developed to ensure greater corporate accountability and discusses some of the more widely adopted or
higher profile non-mandatory reporting initiatives. Part F concludes the module with a review of reporting
practices related to climate change.
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This demonstrates that inherent in the nature of financial reporting is the focus on the rights of
shareholders, specifically those who are not involved in management, and who have limited power to
obtain information about the organisation. As such, shareholders, along with debt capital providers, are
the primary intended audience for financial reporting. The Conceptual Framework also states that other
users (such as members of the general public) are not the focus of this reporting (para. 1.10).
By emphasising the financial information relevant to capital providers, the Conceptual Framework
reflects a shareholder primacy perspective. This implies a very narrow interpretation of accountability,
restricting reporting only to those aspects associated with financial performance. However, focusing on
financial results alone has its limitations. For example, financial reporting alone cannot answer important
questions about social and environmental performance, including the following.
• How high is employee morale and turnover?
• Are customers being supplied with appropriate products and services?
• Is the supply chain operating ethically?
• Are the human rights of all people affected by the organisation being respected?
• How is the organisation managing its impact on the natural environment, e.g. in relation to climate
change?
This definition of expenses depends on the recognition of an asset or liability. Therefore, the depletion
of, or the impact on, these shared public goods by the corporation are not recognised as expenses. To many
people, the framing of these accounting elements represents a limitation of financial reporting. Deegan
(2012), for example, argues that:
Imagine that an entity destroys the quality of water in its local environment, thereby killing all local sea
creatures and coastal vegetation. Under conventional financial accounting, if the entity incurs no fines or
other related cash flows as a result of its actions, no externalities would be recognised. Reported profits,
calculated by applying generally accepted accounting principles, would not be directly affected, nor would
reported assets.
The reason no expenses would be recognised is that resources such as the local waterways are not controlled
by the reporting entity, and therefore they would not be recognised as the entity’s assets. Thus the use (or
abuse) of resources would go unrecognised. If conventional financial reporting practices were followed,
the performance of such an organisation could, depending on the financial transactions undertaken, be
portrayed as very successful (Deegan 2012, p. 1214).
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$ 100 m
10% discount rate: = $5.7 million
(1.10)30
$ 100 m
6% discount rate: = $17.4 million
(1.06)30
$ 100 m
1.4% discount rate: = $65.9 million
(1.014)30
For all five elements of financial accounting, both relevance and faithful representation are key
considerations as they are considered as fundamental qualitative characteristics of financial reporting.
This has significant ramifications for sustainability reporting issues. Measurement of impacts that relate
to sustainability issues can be complex and difficult, and questions are often raised over whether the
information prepared using many of the measures that are currently available achieves the standards of
faithful representation required of measurements used in financial accounting.
Take the example of a potential environmental liability such as clean-up after a chemical spill. If the
corporation argues that it cannot be reliably measured to ensure faithful representation, it may be left off
the balance sheet (para. 14(c) IAS 37). If it is not recognised as a liability, then associated expenses will
also not be recognised. The implication is that if it is not easily and reliably measured, then it cannot be
important. Nonetheless, that chemical spill may be very important indeed to many of the organisation’s
stakeholders as it may result in the increased likelihood of a loss of revenue and increased costs (of capital,
staff changes, fines, etc.) due to reputational damage.
SUMMARY
The Conceptual Framework defines the objective of financial reporting in terms of the provision of
financial information to support the decisions of providers of capital. Therefore, conventional financial
reports prepared for organisations by the accounting profession tend to give an account of the financial
performance of an entity over a specific period of time and the financial position of an entity at a point
in time.
The Conceptual Framework also defines the elements of financial reports in a way that excludes
recognition of many aspects of an organisation’s performance that are of interest to a broad range of
stakeholders. Such reports also focus on short-term results and tend to ignore the organisation’s impacts
on social, environmental and sustainability issues and therefore financial reports have serious limitations
in ensuring that an organisation can be held accountable for its actions that affect a diverse range
of stakeholders.
The next part of the module will examine how reporting is changing in response to some of these issues.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
5.5 Identify the limitations of conventional financial accounting in relation to the recognition of social
and environmental costs and benefits.
• The Conceptual Framework defines a scope of financial reporting focused on providing information
to capital providers.
• Financial reporting in accordance with accounting standards was never designed to cover areas
such as reporting on social and environmental matters.
• The financial reporting framework places emphasis on determining which assets and liabilities may
be recorded in the accounts based on strict criteria.
• The Conceptual Framework’s strict definition, recognition and measurement criteria for the key
elements of financial reporting mean organisations’ financial reports omit the externalities generated
in pursuits of profits.
• Periodic reporting may cause managers and board of directors of companies to have a sole focus
on financial targets rather than longer term social or environmental objectives.
• The focus on short-term results and the entity assumption that sets the foundation of financial
reporting do not allow for the full impact of an organisation on social and environmental issues to be
reflected in the financial reports.
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The main drivers of improvements in corporate governance requirements and corporate regulatory
change are often large corporate collapses and sovereign debt crises (when governments struggle to repay
their borrowings). During these times, the errors and mistakes of the past are often highlighted and the
resulting pain creates strong motivation for change. The GFC provided an even greater desire for change
due to the magnitude of the problems caused, as well as the many years it has taken for economies to
recover. The GFC also had a multinational effect, with problems in one nation or economic area adversely
affecting other regions. This has had a long-lasting effect on corporations and regulators, who are seeking
to avoid a recurrence of these problems.
The GFC significantly changed how people thought about business, and the wider society’s trust in
business leaders was seriously diminished as a result. As the GFC demonstrated, weakness in one of the
pillars of sustainability (see figure 5.3) can directly weaken the other pillars. One implication of this is
that society will increasingly come to expect greater disclosure related to other pillars of sustainability,
including environmental and social impacts, as well as governance information. This is often described
in terms of a social contract. A social contract is an implied (i.e. not official) agreement between an
organisation and society, and the terms of the social contract are the ways in which society expects the
organisation to operate — this concept is also frequently referred to as the community licence to operate.
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EXAMPLE 5.2
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SRI responds to a variety of different investor needs. Some investors look to sustainability factors to
provide information about the long-term health and stability of their investments and the market as a
whole. Others take this further still and regard SRI as an ideal about the way money should be used —
one way for people to combine their personal values with the resources available to them. This can also
mean that investment can be used to direct capital towards better-governed and better-managed companies
that are positioned to contribute to the goals of sustainable society. It was estimated in 2012 that at least
USD$13.6 trillion of professionally managed assets incorporate sustainability factors. By 2018 this had
risen to USD$30.7 trillion (Global Sustainable Investment Alliance 2013, 2018).
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Source:Adapted from Bridges Ventures 2012, ‘Sustainable & Impact Investment: How We Define the Market’, Bridges Ventures:
London, p. 3.
.......................................................................................................................................................................................
CONSIDER THIS
BlackRock is an advisory firm that specialises in socially responsible investments and it approaches the task of
investment and stewardship in a way that acknowledges all of the critical roles played by different actors in the chain
of activity.
Download and read the publication from BlackRock website below and make notes about the stakeholders as
described on page 2 of the publication. What in your view is unique about each?
See link at: www.blackrock.com/corporate/literature/whitepaper/viewpoint-investment-stewardship-ecosystem-
july-2018.pdf.
RESPONSIBLE INVESTMENT
Often based on concerns about risk, responsible investment considers a wide range of sustainability factors.
This can involve negative screening — avoiding investment in industries that have a negative impact on
society and the environment.
For example, the AMP Capital Responsible Ethical Leaders Balanced Fund demonstrates negative
screening by avoiding any investment in companies within sectors recognised to have high negative social
impact. This includes companies with a material exposure (i.e. 10% of their total revenue) to:
• tobacco
• nuclear power (including uranium)
• armaments
• gambling
• alcohol
• pornography
• fossil fuels (thermal coal and brown coal power generation) (AMP Capital 2019).
SUSTAINABLE INVESTMENT
Sustainable investment involves more of a focus on investment opportunities that create both social and
economic value. This may involve ‘best-in-class investment’ where investments are selected both for their
ability to generate economic returns and to perform better on sustainability indicators compared with their
peers in the same industry. It may also involve shareholder activism — where investors use an equity stake
in a company to change behaviour and decisions made in a company.
For example, Australian Ethical offers an Advocacy Fund and Advocacy Super option, and claims that:
We view active shareholder ownership and advocacy as the responsibility of ethical investors and key to
creating positive, sustainable change. The growing collaboration between like-minded groups on key issues
will have a dramatic impact on future corporate behaviour and performance in Australia and around the
world (Australian Ethical Super 2019).
To achieve this, Australian Ethical Super uses tools such as divestment, policy engagement and purchasing
small numbers of shares to actively engage with corporations. Another business that has a sustainability
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EXAMPLE 5.3
THEMATIC INVESTMENT
Thematic investment is investment that focuses on one issue or a cluster of issues where commercial growth
opportunities are created from social or environmental needs.
LeapFrog Investments demonstrates this approach. Leapfrog considers itself a ‘profit with purpose
investor’ that targets investments in financial products for underserved consumers. This includes micro-
finance and microinsurance in developing countries. They ‘seek investments in companies which deliver
superior financial and social returns’ (LeapFrog Investments 2019).
IMPACT INVESTMENT
Impact investment focuses on placing capital to actively create a social or environmental benefit. This may
require some financial trade-off.
An example of an Australian impact investment comes from the 2013 pilot Social Benefit Bond in
NSW. The Commonwealth Bank of Australia and Westpac Institutional Bank partnered as investors in
an impact investment to establish the Family Preservation Service, delivered by Australia’s first charity,
the Benevolent Society. The service focusses on reducing the number of family breakdowns and children
placed in the foster care system in New South Wales.
SOCIAL ENTERPRISES
Related to the concept of socially responsible investment is the concept of social enterprise as the potential
subject of such an investment. Social enterprises are business that are set up with the social objective in
mind. There are a series of models that have been identified: innovation model, employment model and
the ‘give back’ model.
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QUESTION 5.1
Islamic Finance can also be considered a socially responsible investment. Explore the website of
Crescent Wealth, https://crescentwealth.com.au/super/faqs.
What is Islamic Investing? How do you make sure that you invest Islamically?
In relation to organisations potentially embracing social responsibilities (i.e. CSR), Friedman further
stated:
Few trends could so thoroughly undermine the very foundation of our free society as the acceptance by
corporate officials of a social responsibility other than to make as much money for their stockholders as
possible. This is a fundamentally subversive doctrine (Friedman 1962, p. 133).
Consistent with the views of Friedman and the shareholder school of thought are those of many corporate
managers, who believe that maximising corporate profits is the main priority. Perhaps this focus on profits
is further strengthened by the fact that many corporate managers are directly remunerated on the basis
of profits (e.g. it is very common for managers to be rewarded by being given a specified percentage of
profits as part of their bonus structure). People who believe that the concentration on profits has not waned
in many organisations — even as the apparent emphasis on CSR has heightened — are often cynical of
corporate claims about being socially responsible.
An alternative view to that of Friedman is that organisations, public or private, earn their right to operate
within the community. This right is provided by the society in which they exist, and not solely by those
parties with a direct financial interest (such as the shareholders who directly benefit from increasing
profits), or by government. In addition to this right to operate provided by society, the privilege of
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QUESTION 5.2
If corporate managers adopted views consistent with those of Milton Friedman, do you think that
any quest towards sustainable development would be realistic? Give reasons for your answer.
To many people, the notions of a shareholder primacy perspective and corporate social responsibilities
are mutually exclusive. Clearly, focusing only on shareholders’ financial return is not consistent with the
concept of sustainable development. Sustainable development requires taking into account a business’s
environmental and social impact. It does not elevate short-term profit maximisation (and the maximisation
of shareholder value and, therefore, shareholders’ financial interests) to a higher position than considera-
tions of inter-generational and intra-generational equity. Whether corporations can be expected to place the
interests of others above those of their shareholders or have a moral obligation to take into consideration
their impact on a wider range of stakeholders is still a contested question.
Divergent views on the responsibilities (and accountabilities) of business are nothing new. The opinions
reproduced in table 5.1 were given during a debate in the 1930s; comments from this debate were
reproduced in a report issued by the Corporations and Markets Advisory Committee in 2006. They contrast
the views of Professor Adolf Berle, who embraced the shareholder primacy perspective, with those of
Professor Merrick Dodd, who embraced the view that organisations survive to the extent that they comply
with the social contract negotiated between the organisation and society (see table 5.1).
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• Investors, by way of their investment, are the group • Due to the protections and privileges provided by
risking their own capital. Therefore, it is only fair that the act of incorporation (e.g. limited liability and
the directors answer to them and to them only. perpetual succession), the duties owed by the
• Attempts to broaden responsibilities to a wider group organisation should not just be to shareholders.
of stakeholders may lead to reducing the level of There is also a duty to the broader community,
legal responsibilities directors owe to anyone. and it is fair to say that society should expect the
corporation to behave in the general public interest,
rather than in a purely self-interested, profit-focused
manner.
• Directors should, therefore, be permitted to take into
consideration a wider range of stakeholders than just
the shareholders.
A disparity of views still exists. There are many individuals who support a shareholder primacy
perspective of corporate operations, just as there are many who support a more socially constructed
perspective of business operations. An increasing number of corporate leaders believe that delivering long-
term financial returns to shareholders depends on taking into consideration the concerns of a wider range
of stakeholders.
It should be noted that Australian Corporations Law has only recently required corporations to consider
social and environmental impacts when making particular decisions. There are environmental reporting
requirements in paragraph 299(1)(f) of Corporations Act 2001 (Cwlth) and, arguably, when ESG issues are
material, they must also be included in the directors report pursuant to s. 299A. The Australian Securities
Exchange Corporate Governance Council’s (ASX CGC) Corporate Governance Principles and Recom-
mendations, which was reissued in its fourth edition in 2019, has recommendation 7.4 which requires that
an entity disclose any material exposures to economic, environmental and social sustainability risks and, if
it does, how it manages these risks. Another important piece of Australian legislation is the Modern Slavery
Act 2018 (Cwlth), which requires some entities to report on the risks of modern slavery in their operations
and supply chains and actions to address those risks (www.legislation.gov.au/Details/C2018A00153).
The major guiding legal principle pertaining to the responsibility of corporate officers in terms of the
strategies used to run a business is provided by s. 181(1) of the Corporations Act. This section, often
referred to as the ‘good faith requirement’, requires that:
A director or other officer of a corporation must exercise their powers and discharge their duties:
(a) in good faith in the best interests of the corporation; and
(b) for a proper purpose (s. 181(1)).
Central to this requirement is that the strategies employed by an organisation need to be in the best
interests of the organisation. Is social and environmental responsibility and an associated consideration of
a broad group of stakeholders in the best interests of an organisation? Perhaps company directors believe
there needs to be a clear link between the actions and the likelihood that corporate profits and value will
be positively influenced. Clearly, the good faith requirement provides some uncertainty for corporate
managers in determining the extent to which they can adopt policies that are perhaps only indirectly in
the best interests of the corporation. This limited approach to recognising broader accountability can be
contrasted with the more positive approach taken in the latest version of directors’ duties stated in UK
corporate law. These laws were updated in 2006 to include specific reference to employees, the community
and the environment.
Specifically, s. 172 of the UK Companies Act 2006 states the following.
Duty to promote the success of the company
(1) A director of a company must act in the way he considers, in good faith, would be most likely to
promote the success of the company for the benefit of its members as a whole, and in doing so have
regard (amongst other matters) to —
(a) the likely consequences of any decision in the long term,
(b) the interests of the company’s employees,
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There are alternative views about whether corporate managers are legally allowed to use shareholder
funds for non-business social endeavours. (The term ‘non-business’ does not encompass CSR-related
initiatives, which are clearly aligned with corporate strategy and expected to improve efficiency, reputation
and contribute to growth.) One view is that the best interests of the company necessarily require
corporations to consider the needs of a broad group of stakeholders and the environment, otherwise the
community will not support the organisation. This view would suggest that s. 181(1) of the Corporations
Act does not discourage sound social and environmental behaviour.
The counter view is that s. 181(1) actually discourages companies from considering the needs of
stakeholders (other than shareholders) and of the environment. That is, companies are legally bound to
maximise profits to shareholders. This view would suggest that, by publicly embracing CSR, companies
can publicly promote their social values, while in reality keeping their value in focus — this being the
company’s share price.
The shareholder primacy approach is increasingly being challenged by corporations’ non-financial and
indirect financial impact on society, including global warming, corporate environmental catastrophes and
human tragedies such as asbestos-related diseases. The 2010 BP oil spill in the Gulf of Mexico provides
an example of the serious consequences that can occur when things go wrong. That oil spill will have
a long-term effect on the environment and coastal communities around the Gulf. The costs and damage
associated with the spill will also affect the company and therefore its shareholders for the long term. This
is a good example of how issues can combine to create a disaster without any apparent illegal activities
taking place, and shows the importance of organisations being good corporate citizens.
QUESTION 5.3
Explain the nature of an externality. Think about an organisation you know and ask the following.
(a) What is at least one positive and one negative externality generated by the organisation and
who are the affected stakeholders?
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As investors seek to integrate information on sustainability factors into their investment decisions, this
has accounting implications, including the need for robust and reliable indicators of these factors.
Accounting has emerged as a critical component of addressing this challenge. It is often argued in
business that ‘we can’t manage what we can’t measure’ and most companies do not understand the
complexities of natural capital, nor do they have the approaches or tools for accounting for the natural
capital that their business draws upon. This is changing and some organisations have developed their own
modified techniques to quantify, price or otherwise account for natural capital externalities and therefore
deal with them strategically.
Initiatives such as the Natural Capital Coalition are also developing standardised methodologies for
quantifying or pricing natural capital in ways that can be easily integrated into existing organisational
practices and decision making. Our ability to account for different types of capital remains variable at this
stage, but thinking is advancing rapidly. Accountants are playing a critical role in the development of these
methods. The Natural Capital Coalition led a consortium of partners in a project to develop a harmonised
evaluation framework (including measurement, management, reporting and disclosure aspects) for natural
capital in business decision making called the Natural Capital Protocol, which was released in 2014.
Eventually, the development of these methodologies may allow us to develop aggregated measures of
natural capital (in a similar way to how GDP is used for economic measures), helping us to honestly answer
questions such as, ‘Are we truly sustainable?’
While we might attempt to describe various costs and benefits generated by an entity in qualitative
terms, many costs and benefits will not be recorded in financial terms. Because corporate profits do not
incorporate many externalities, we must treat such financial numbers with caution when considering the
overall performance of an entity.
Perhaps we can question whether a profitable company is also necessarily a ‘good’ company or extend
our assessment to include both its short-term and long-term profitability prospects if it is deemed by critical
stakeholders to be profiting at the expense of society. For example, a large financial institution may close
many smaller regional branches to reduce financial costs, which might improve financial performance
(e.g. reported profits). This measure of performance (profits) will not reflect many of the externalities
caused by the decision to close regional branches (e.g. the costs associated with unemployed workers
thereafter receiving benefits from government, or the inconvenience caused to regional communities from
no longer having a local bank).
At this stage, however, we should appreciate that in developing a CSR report, an organisation should
consider the various externalities caused by its operation and how it will disclose information about these
externalities. This will also involve identifying the potential stakeholders and how they are being affected.
The broad objectives driving any organisation to undertake sustainability reporting are wide ranging.
At one end, there could be an ethically motivated desire to be transparent about various aspects of its
performance as it affects various classes of stakeholders. At the other end is an economically focused
motive to use social and environmental reporting to protect or enhance shareholder value. The underlying
motives will directly shape the style of report that is presented and the audience it is intending to satisfy.
Once it is determined why an organisation decides to report, this decision will, in turn, inform the
decision as to whom any related information will be directed. Management could determine that the report
is produced to provide information for the interests of its shareholders, or for the interests of a broader
stakeholder community.
Once the target recipients of the report have been determined, management can then consider the
information demands or needs of these particular stakeholders. This will inform what information will
be disclosed and what issues the social and environmental reporting should address. Identifying what
issues an entity is held responsible and accountable for involves dialogue between the organisation and its
identified target stakeholders. Identifying the target stakeholders requires management to reflect in an open
way on the underlying motivations driving them to report: are they based on an accountability approach,
a managerial approach or somewhere in between?
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QUESTION 5.4
Explain how any assessment undertaken by management about why they are reporting will have
an effect on the audience for the reports (i.e. to whom they are reporting).
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CONSIDER THIS
Discuss the reasons why an entity would use non-mandatory reporting.
SUMMARY
Recognition of the limitations of conventional financial reporting has combined with various events and
forces to drive the development of reporting that supports a broader notion of corporate accountability. The
GFC reduced trust in business, which in turn increased the expectations on business to justify their social
licence to operate. In addition, it is increasingly recognised that organisations’ effects on the community
and environment directly affect corporate value, wealth creation, brand value and reputation. Organisations
that are able to demonstrate accountability in relation to community and environment factors and able to
display risk management approaches to issues such as climate change may be able to attract lower cost
capital, including from socially responsible investment funds.
While there is ongoing debate about which stakeholders have legitimate claims over an organisation,
many organisations have chosen to report more widely on social and environmental impacts. This is also
reflected in moves by governments and other regulators to require reporting beyond conventional financial
measures.
The accountant has an important role in this expanded form of corporate accountability. The accountant
must have the ability to make ethical decisions, understand the principles of corporate governance, be able
to balance the different and sometimes competing interests of an array of stakeholders, and be able to
develop legitimate ways to measure resources and externalities that have not conventionally been included
in reports.
The key points covered in this part, and the learning objective they align to, are listed below.
KEY POINTS
5.1 Explain the concept of social and environmental responsibility and its relevance to governance.
• There is increasing recognition that numerous stakeholders are affected by the actions of organisa-
tions and thus have a legitimate interest in those organisations.
• Organisations’ impacts on the community and the natural environment have become primary con-
cerns for many stakeholders and thus organisations and regulators have responded by developing
reporting that addresses issues beyond the financial information conventionally presented in financial
reports.
• Information on community and environmental impacts supports decision making by internal and
external stakeholders and helps the organisation maintain its implied social licence to operate.
5.2 Describe the obligations of corporations in relation to their social and environmental behaviours.
• It is increasingly believed that organisations must manage their social and environmental perfor-
mance as it affects their access to capital, their financial performance and their financial position
through factors such as reputation, risk, changing customer preferences, fines for non-compliance
with regulations, and the cost of remediating the natural environment.
• Organisations seek to obtain and keep an implied social licence to operate, which occurs when a
society accepts the organisation’s activities because they are beneficial and not detrimental to a
range of stakeholders, beyond shareholders.
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Ensuring that the needs of today’s world are met while at the same time ensuring that the ability for
future generations to meet their own needs is not compromised.
This definition is derived from the report, Our Common Future (WCED 1987, p. 16), also known as the Brundtland
Report. If organisations are guided in their CSR obligations by enlightened self-interest, could such organisations
also be seen as embracing sustainable development in the way it has been defined above, based on the Brundtland
Report? Are the two concepts compatible?
This theory therefore takes fewer cues from deontological theory, as it tends to see stakeholders as the
means to an end, rather than an end in themselves. In reality, organisations will often show both types of
justification for their reporting.
QUESTION 5.5
Following are two excerpts from the annual reports of two of Australia’s largest companies.
Consider the differences in how they view stakeholders.
Rio Tinto:
Rio Tinto has a clear purpose: as pioneers in metals and mining, we produce materials essential
for human progress. And by doing so efficiently and effectively, we aim to deliver superior
returns to our shareholders while safeguarding the environment and meeting our obligations
to wider society (Rio Tinto 2018, p. 6).
Stockland:
Stockland was founded in 1952 with a vision to ‘not merely achieve growth and profits but to
make a worthwhile contribution to the development of our cities and great country’. It is this
recognition, that business has more to offer society than profits alone, that has seen us endure
(Stockland n.d.).
Are these approaches more consistent with the enlightened self-interest theory or the normative
or managerial stakeholder theory?
LEGITIMACY THEORY
The main premise of legitimacy theory is that an organisation will take action to manage community
perceptions in order to survive. Corporations need to at least appear to be operating within the established
rules of society, that is, within the bounds of the social contract. When there is disparity between what the
organisation appears to be doing and the terms of its social contract, there will be a threat to its legitimacy,
and therefore to its future survival and success.
In this context, CSR is one strategic tool that organisations can use to influence the community’s
perceptions of them. Lindblom (1994) suggests a number of courses of action that organisations can take
to obtain, maintain or repair legitimacy.
• Change and inform — perform activities in a manner that is appropriate, given the expectations of
society, and then inform the relevant stakeholders about these actual behaviour changes, as well as the
performance results.
• Change perceptions without actual change — convince those who are evaluating the organisation that
change has occurred without actually changing performance, activities or behaviour.
• Deflect attention and manipulate perceptions — switch the focus away from areas of concern to other
issues where the organisation is performing well, and use emotional symbols and rhetoric to influence
expectations.
• Change criteria for evaluation — try and influence the levels of performance expected, and attempt to
highlight that certain criteria used by society are unreasonable (Lindblom 1994).
It is important to note that what is regarded as acceptable or legitimate behaviour will change over time,
as society changes. Behaviour that was once acceptable may later become unacceptable. The organisation
must continually adapt to maintain its status of legitimacy in society, and must also adapt to changes in the
social contract.
SUMMARY
There are numerous theories that help explore and explain the notion of corporate social responsibility.
Each theory is useful in that it offers a different perspective on CSR and thus offers different ways to
consider and understand CSR. Table 5.2 provides a summary of some of the key differences between
these theories.
It is important to realise that these theories are often complementary, and many overlap. Indeed, they are
frequently invoked together by corporations to explain their approach to corporate accountability. Finally,
it is also important to realise that theories are always subject to interpretation.
The key points covered in this part, and the learning objective they align to, are listed next.
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5.3 Discuss the different theoretical perspectives about what motivates organisations to present
social and environmental information.
• The theory of enlightened self-interest suggests organisations provide social and environmental
information to stakeholders if the organisation itself will benefit from doing so (e.g. by less regulation,
better reputation or improved access to capital).
• Stakeholder theory recognises that a wide range of stakeholders have some legitimate claim over
the organisation. This legitimacy may arise from the recognition that the stakeholders are affected
by the activities of the organisation or from the recognition that the stakeholders have power and
resources that can affect the organisation.
• Organisational legitimacy theory suggests the organisation needs to justify and earn its right to
operate given the impacts it can have on society and the environment. This right to operate is in
the form of a social licence, an implied agreement between the organisation and society that the
organisation will conduct in accordance with society’s expectations.
• Institutional theory suggests organisations’ behaviour tends to converge, so that as some organisa-
tions adopt CSR, other organisations will follow.
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EXAMPLE 5.4
Environmental Disasters
Bhopal, India, 1984
Over 500 000 people were exposed to highly toxic chemicals that leaked from a Union Carbide India Ltd
plant; an estimated 22 000 people died.
Chernobyl, Ukraine, 1986
A nuclear power plant accident killed over 4000 people, caused 350 000 people to be permanently
resettled, and is still associated with environmental contamination, illness, deformities and cancers.
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These environmental incidents are shocking, and have received considerable interest from society, the
media and government. However, it is not just disasters that have piqued society’s interest in environmental
sustainability. We are increasingly aware of the resource constraints and limitations of the world we live
in. For example, fresh water is a finite resource that is critical to life, but also underpins the productivity
of industrial, mining, agricultural and urban development. We are increasingly aware that our water
resources are limited; this represents a huge risk to human life and commercial activity. It is important
to note that, although businesses contribute to these problems, they may also have tools to address these
complex problems.
Some of the key environmental sustainability issues today include the following.
• Climate change. The change in global and regional climate patterns is associated with more intensive
emission of atmospheric carbon dioxide and other greenhouse gases resulting from the use of fossil
fuels. The role of business in resolving challenges associated with climate change is critical and this
involves but is not limited to a detailed review of business processes.
• Waste. Waste is the by-product of production that cannot be reprocessed, recovered or purified. As global
commercial activity escalates, more waste is produced and discarded or released into the environment
in a manner that can cause harmful change.
• Pollution. Businesses create pollution when production processes lead to the introduction of substances
or contaminants into the natural environment that can cause harmful effects.
• Biodiversity. This refers to ‘the variety of life on Earth. It is the variety within and between all
species of plants, animals and micro-organisms and the ecosystems within which they live and interact’
(WWF 2014). Ecosystems are complex and interdependent, so when a business affects one element of
an ecosystem, this can result in profound changes to other parts of that system.
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CONSIDER THIS
Identify and make note of two environmental disasters and the economic impact of these. Reflect on what these
events mean in a financial context for a company as well as other impacts (e.g. on share price or business reputation).
EXAMPLE 5.5
Sustainability
Environmental
Economic
Social
Most national and international initiatives, and many advocacy efforts, focus on only one pillar at a time.
For example, the United Nations Environmental Programme (UNEP) and the environmental protection
agencies (EPAs) of many nations focus on the environmental pillar. The World Trade Organization (WTO)
and the Organisation for Economic Cooperation and Development (OECD) focus mainly on economic
sustainability. A company or other reporting organisation that focuses on one pillar in isolation risks its
sustainable future and reputation. There may of course be different emphases that are appropriate, but an
organisation should consider all three pillars in its sustainable business strategy and risk management.
As the GFC demonstrated, weakness in one pillar can have consequences for the other pillars. As a
result of the GFC, many nations and states cut back or postponed stricter environmental laws or investment,
since their budgets were running deficits. Many environmental non-governmental organisations (NGOs)
saw their income fall, and income spent on social programs also declined.
These three pillars of sustainable development are often included in CSR reporting. Many organisations,
in their CSR reporting, will discuss their sustainability initiatives in accordance with these three pillars.
As we will see later in this module, the most widely used guidelines for sustainability reporting, the
Global Reporting Initiative (GRI), structure their sustainability indicators so as to provide insights into
an organisation’s significant economic, environmental and social impacts.
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ACCOUNTABILITY
Central to this module and directly tied to the decision to report information (whether it be CSR or financial
information) is the concept of accountability. We can define accountability as the duty to provide a report,
or an account, of the actions and decisions made about those areas of activity for which an organisation is
deemed to be responsible. These may be financial or non-financial and usually focus on the use of resources
that have been entrusted to an organisation’s care. If we are to accept that an entity has a responsibility (and
a duty of accountability) for its social and environmental performance, then we, as accountants, should
provide ‘an account’ (or report) of an organisation’s social and environmental performance — perhaps
by releasing a publicly available CSR report, including additional information in the annual report or
disclosing information online.
Therefore, a central aspect of corporate accountability and the role of corporate reporting is to inform
relevant stakeholders about the extent to which actions for which an organisation is deemed to be
responsible have been fulfilled. Reporting, whether it be CSR reporting or otherwise, is a vehicle for an
organisation to fulfil its requirement to be accountable.
CSR
For the purposes of this module we base our discussion of CSR on the following definition by the
Commission of European Communities (CEC), which states that CSR is:
A concept whereby companies integrate social and environmental concerns in their business operations and
in their interaction with their stakeholders on a voluntary basis. Being socially responsible means not only
fulfilling legal expectations, but also going beyond compliance and investing more into human capital, the
environment and the relations with stakeholders (CEC 2001, p. 6).
The above definition is consistent with the following definition of CSR provided by the World Business
Council on Sustainable Development (WBCSD 1999).
Corporate social responsibility is the continuing commitment by business to behave ethically and contribute
to economic development while improving the quality of life of the workforce and their families as well as
of the community and society at large (WBCSD, p. 3).
In practice, CSR can refer to a wide range of activities that an organisation can undertake, from
making donations to selected charities to undertaking sustainable activities, including reducing carbon
emissions from their operations. Commonly, the terms ‘CSR reporting’ and ‘sustainability reporting’ are
used interchangeably.
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SUSTAINABILITY REPORTING
Sustainability reporting is the process of producing a sustainability report (published by an organisation)
about the economic, environmental and social impacts caused by the organisation’s everyday activities.
Other aspects that are commonly expected of an organisation’s sustainability report include information
about the organisation’s values and governance model, and links between its corporate strategy and its
commitment to a sustainable global economy.
NATURAL CAPITAL
Natural capital can be understood as the world’s stocks of natural assets. It includes air, water, land, soil,
geology and biodiversity. It is a finite resource, and the demands of a growing and increasingly prosperous
global population means that escalating demands are being placed on an already overstretched resource.
INTEGRATED REPORTING
Integrated reporting is a process founded on integrated thinking (see below) that results in a periodic
integrated report by an organisation about aspects of its value-creation process. Bringing together the
main parties involved in corporate reporting, the International Integrated Reporting Council (IIRC) has
produced a conceptual framework for the preparation of a concise, user oriented corporate report entitled
an ‘integrated report’, which captures an organisation’s resources and relationships using a ‘six capitals
concept’ and requires a description of a company’s business model, allowing a better communication of
its value creation proposition over the short, medium and longer term.
INTEGRATED THINKING
An important component of integrated reporting is ‘integrated thinking’, which is ‘the active consideration
by a company of the relationships between its various operating and functional units and the capitals that the
organisation uses and affects’ (IIRC 2013, p. 2). Some of the expected advantages that an organisation gains
from undertaking integrated thinking are that it advances the alignment of the organisation’s strategic focus
with both its financial and non-financial performance. With greater comprehension of how a company
creates value and of the social and environmental impact of its activities, it is more likely that management
will recognise the imperative of integrating sustainability concerns into business strategies.
SOCIAL REPORTING
In general, there are some areas for which we have better developed measures for social issues. This
includes areas such as:
• labour practices and workplace — including diversity and equal opportunity, employment standards
and turnover, training and development
• human rights — including compliance with human rights Acts, policies and management of issues such
as freedom of association, collective bargaining, child labour and forced labour
• society — including investments in local communities, anti-corruption and anti-competitive behaviour
• product responsibilities — including customer health and safety, product labelling and ethical
marketing.
Further, many corporations often collect much of this information as standard practice anyway,
particularly in the areas of workplace and staff. This may include compliance with international labour
standards such as International Labour Organization (ILO) conventions, and some components of
balanced scorecards.
There are some areas in which social reporting and measurement is much harder.
• Social issues involve quality and subjectivity that can be hard to capture in quantitative or monetised
approaches. For example, a mining company may report that they provide education to 80% of
employees’ children in a mining community. However, this figure provides no indication of the quality
of that education, whether it meets the educational needs of children, or whether it remains culturally
acceptable. Nor does it inform us of why the remaining 20% have not received an education and what
the implications are.
• In CSR reporting, the concept of entity is relaxed. That is, corporations often need to report on value
created outside the organisation rather than just captured within the organisation. It can be hard to
identify what issues can be attributed to a particular organisation and not to others. For example, consider
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EXAMPLE 5.6
ENVIRONMENTAL REPORTING
Environmental reporting accounts for how corporations draw from and affect the natural environment.
In recent years, there have been important advances in developing standardised methodologies for
accounting for certain environmental aspects of business, such as greenhouse gas emissions. Nonetheless,
understanding and measuring environmental impact can be a very complex process. Further, there are
significant differences in the environmental impact of different industries.
The areas that have seen greater development of measurements and indicators include:
• materials usage and product resource consumption
• resource usage — including energy and water
• emissions, effluents and waste
• transport usage
• compliance with and breaches of mandatory and voluntary environmental regulations.
Some of these areas have relatively well established approaches; for example, the Intergovernmental
Panel on Climate Change has produced detailed methodological guidance for reporting on greenhouse
gas emissions.
Many corporations produce environmental measurement information, which is similar to social report-
ing, through existing voluntary and mandatory environmental regulations, such as the NGER Act and
federal and state/territory Environmental Protection Acts.
Environmental reporting is still a complex and challenging area, and some areas that have been identified
as needing further development include the following.
• Reporting on biodiversity (flora, fauna and ecosystems) is very challenging, particularly as there is no
generally accepted unit of measurement and reporting systems are often exploited.
• Similar to social reporting, environmental reporting includes measures of impact beyond the control of
the organisation. Measuring the environmental effect of supply chains increases the level of complexity
and scope of reporting.
• Many environmental estimates include discount rates for future impact (similar to discounting for the
time value of money). In an environmental context, applying a discount rate to future environmental
impact has ethical implications — that is, it suggests that future generations are less important than
current generations.
• Environmental impact measurement is often confined to and ‘siloed’ in particular areas (e.g. water use
and greenhouse gas emissions) and there is a need to determine how these different measures fit together
to provide an overall assessment of environmental impact.
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Puma
Puma is well known for its leadership in accounting for natural capital. In 2011, Puma started releasing its
environmental profit and loss account, where it quantified a wide range of environmental effects, including
water use, greenhouse gas emissions, land use, and waste associated with its supply chain, transport
networks, operations and manufacturing, particularly those associated with the leather and cotton used
to manufacture its products (https://about.puma.com/en/sustainability/environment).
QUESTION 5.6
Consider the differences in the potential environmental impact of a mining firm (e.g. BHP Group
Limited) compared with that of a professional services firm (e.g. EY).
ECONOMIC REPORTING
The final element of CSR refers to the sustainability of an organisation’s economic performance. This
includes financial performance measured by generally accepted accounting principles, but this by itself
may be too limited. What is often unreported, but is frequently desired by users of sustainability reports,
is the organisation’s contribution to the sustainability of a larger economic system. This can include a
wide variety of non-financial performance indicators and narratives, and is usually aimed at economic
performance, market presence and indirect economic impacts — the three categories of economic
sustainability used by the GRI in their G4 sustainability reporting guidelines. A study by Cohen and
colleagues (2012) identified the indicators most commonly reported in large public corporations. These
include (in order of their decreasing frequency):
• market share — referring to the percentage or size of market share for the company, division, unit or
particular products
• quality rankings — such as prizes or performance against particular benchmarks
• customer satisfaction — including describing customer service initiatives, loyalty, awards or campaigns.
• employee satisfaction — comparison of loyalty and awards and comparison to competitors
• turnover rates— employee turnover compared with competitors and industry averages
• innovation — describing innovations introduced across the organisation’s value chain. Innovation is
sometimes measured in monetary terms, such as the amount spent on research and development, or it
can be quantified, such as the number of patents awarded (Cohen et al. 2012).
QUESTION 5.7
Marks & Spencer, a UK-based retail company, produces an annual report based on its sustainability
strategy, known as Plan A. Review it here: https://corporate.marksandspencer.com/sustainability/
report2018
Scroll down the web page and look at the way in which the company reports its progress on key
indicators that fall in the various categories of wellbeing, community and planet.
Identify the grading scheme the company uses and evaluate whether you believe that is effective.
SUMMARY
Sustainability is the concept that actions today do not impact on the ability of future generations to
meet their needs. CSR reporting began to become widespread in the early 1990s when companies with
significant environmental impacts began releasing stand-alone reports on their environmental perfor-
mance. In the mid-1990s, various organisations started producing more information about their social
performance. More recently, most leading companies are producing ‘Sustainability reports’ or ‘Corporate
social responsibility reports’ that incorporate measures and narratives relating to economic, social and
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KEY POINTS
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FIGURE 5.4 Sections of an annual report where mandatory social and environmental reporting requirements
are normally reflected
Financial statements
In relation to reporting information about environmental performance, para. 299(1)(f) of the Corpora-
tions Act is relevant. This section requires that in the directors’ report, which must be included in the annual
report, directors must give details of the entity’s performance in relation to environmental regulations ‘if
the entity’s operations are subject to any particular and significant environmental regulation under a law
of the Commonwealth or of a State or Territory’. However, this section does not require corporations to
disclose the financial impact of non-compliance with environmental regulations.
Section 299A of the Corporations Act is also relevant. Under this provision, listed companies are
required to include in the directors’ report any information that shareholders would reasonably require
to make an informed assessment of the company’s:
• operations
• financial position
• business strategies and prospects for future financial years.
In March 2013, the Australian Securities and Investment Commission (ASIC) released a regulatory
guide on enhancing companies’ consistent conformity with operating and financial review (OFR) reporting
requirements under s. 299A(1) of the Corporations Act (ASIC 2013). Of specific interest is that an OFR
should include a discussion about environmental and other sustainability risks where those risks could
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The directive has a similar intent as other guidance that is provided in various jurisdictions — to ensure
that companies and other relevant entities provide higher quality non-financial information to stakeholders.
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The first annual reporting period began on 1 July 2008. Under the NGER Act, businesses are required
to apply for registration with the CER if they:
• are a constitutional corporation
• meet a reporting threshold for greenhouse gases or energy use or production for a reporting (financial)
year.
The NGER Act requires the ultimate Australian holding company of a corporate group to apply for
registration if its corporate group exceeds any one or more of the following thresholds for a financial year
as provided in table 5.3.
TABLE 5.3 National Greenhouse and Energy Reporting Act — reporting thresholds
Facility threshold 25 kilotonnes (kt) of 25kt of greenhouse gas 25kt of greenhouse gas
greenhouse gas emissions emissions (CO2 equivalent) emissions (CO2 equivalent)
(CO2 equivalent)
Corporate 125kt of greenhouse gas 87.5kt of greenhouse gas 50kt of greenhouse gas
threshold emissions (CO2 equivalent) emissions (CO2 equivalent) emissions (CO2 equivalent)
TABLE 5.4 Organisations developing guidance for non-mandatory reporting of CSR information
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Climate Disclosure The CDSB sets standards for disclosure as they www.cdsb.net
Standards Board relate to environmental issues.
(CDSB)
Natural Capital The Natural Capital Coalition authors the Natural https://naturalcapitalcoalition.org
Coalition Capital Protocol, which is a standardised
framework to help generate trusted, credible and
actionable information to inform decisions.
World Business More that 200 businesses are a part of this www.wbcsd.org
Council for council that has a mission to look at improving
Sustainable the use of sustainable development strategies
Development globally.
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CONSIDER THIS
Pick one of these organisations and look at the kinds of people or groups involved in your chosen organisation. What
guidance do they issue? What principles can you identify? Can you observe any linkages with other guidance with
which you might be familiar?
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FIGURE 5.5 The relationship between non-mandatory corporate social responsibility reporting guidelines and
the three pillars of sustainability
CSR reporting
Integrated reporting
Natural Capital
Protocol
OECD guidelines
CDP
UNGC
Equator Principles
GHG Protocol
Note: CDP = Carbon Disclosure Project, CSR = corporate social responsibility, UNGC = United National Global Compact, GHG
Protocol = Greenhouse Gas Protocol
Source: CPA Australia 2015.
Our discussion, while comprehensive, does not mean that we have referred to all the economic,
environmental and social sustainability reporting frameworks that are available.
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Reporting principles for defining report content Reporting principles for defining report quality
GRI 102 specifies the general disclosures that all reporters need to make while the 200, 300 and 400
series of standards set out the economic, environmental and social disclosures that need to be made for
specific topics.
Many organisations in Australia report in accordance with the GRI standards.
.......................................................................................................................................................................................
CONSIDER THIS
(a) Download GRI 101 and compare the reporting principles with the Conceptual Framework discussed in
part A.
(b) Choose the annual report of an ASX listed company and download GRI 102 to compare the requirements with
the disclosures made in the company’s annual report.
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INTEGRATED REPORTING
As a result of the recognition of the failings of traditional financial reporting, we have seen a significant
development in the evolution of corporate reporting, the integrated reporting initiative. The International
Integrated Reporting Committee (IIRC) was created in August 2010 as a joint Initiative of the Prince’s
Accounting for Sustainability Project and the GRI (IIRC 2010). According to the International <IR>
Framework of the IIRC, ‘An integrated report is a concise communication about how an organisation’s
strategy, governance, performance and prospects, in the context of its external environment, lead to the
creation of value in the short, medium and long term’ (IIRC 2013).
Many organisations produce an annual report with various items of financial information as required
by accounting standards, corporations law and securities exchange listing requirements together with a
separate CSR report. But there is often little or no connection between the various reports in order to tell
the coherent, concise value-creation story of the organisation.
Integrated reporting is consistent with numerous developments that are taking place in corporate
reporting around the world. It is a response to the limitations of traditional financial reporting that
we discussed earlier in this module. We are seeing greater demands for a broader set of information
relevant to stakeholders, consistent with a move away from the shareholder primacy perspective. A lot
of this is environmental and sustainability information that has been mandated, as discussed earlier in
this information. But integrated reporting is broader than this, and reflects an organisation’s drawing
from and interaction with all the resources and relationships that are important to that organisation in
creating value.
It is effectively argued by the IIRC that there is a need to transform corporate reporting so that various
types of relevant information for assessing and evaluating a company’s performance are reported in a
comprehensive and integrated way. Corporate reporting should follow directly from an organisation’s
corporate strategies and targets which in themselves need to be clearly elaborated. Integrated reporting
is not simply about combining the annual report with a CSR report — sustainability will need to be clearly
anchored in the overall business strategy and incorporated within key performance indicators.
The integrated report therefore aims to:
• improve the quality of information available to providers of financial capital to enable a more efficient
and productive allocation of capital;
• promote a more cohesive and efficient approach to corporate reporting that draws on different reporting
strands and communicates the full range of factors that materially affect the ability of an organisation to
create value over time;
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The last point made above is the importance of integrated thinking for an organisation, which was defined
earlier in this module. It is believed that a lot of the benefits of the integrated reporting initiative are due
to the improvement to internal decision making from adopting integrated thinking. Integrated thinking in
an organisation leads to integrated decision making and encourages management to undertake actions that
affect the ability of an organisation to create value over time (Adams 2013).
In December 2013, following extensive consultation and testing by businesses and investors in all
regions of the world, the IIRC released its integrated reporting framework. The purpose of the framework
is to establish guiding principles and content elements that govern the overall content of an integrated
report, and to explain the fundamental concepts that underpin them.
The International <IR> Framework is available at www.theiirc.org/wp-content/uploads/2013/
12/13-12-08-THE-INTERNATIONAL-IR-FRAMEWORK-2-1.pdf.
.......................................................................................................................................................................................
CONSIDER THIS
Download a copy of the English version of the Integrated <IR> Framework and compare its requirements to CPA Aus-
tralia’s 2018 Integrated Report (https://cpaaustraliaannualreport.partica.online/cpa/annual-report-2018/flipbook/1).
Despite the importance of natural capital to human well-being and economic prosperity, it rarely features
in corporate decision making. Instead, our economic and financial systems emphasise the short term, and
are based on the flawed assumption of infinite resources and ecosystem equilibrium.
In 2016, the Natural Capital Coalition launched the Natural Capital Protocol which ‘is a decision making
framework that enables organizations to identify, measure and value their direct and indirect impacts and
dependencies on natural capital.’ The framework includes four principles that are to be followed when
making a natural capital assessment. These are outlined in figure 5.6.
The framework itself is made up of four logical stages, the associated steps and the actions to take at
each step.
.......................................................................................................................................................................................
CONSIDER THIS
Access the Natural Capital Protocol, and for a company whose services that you use regularly, reflect on Step 6. Link
at: https://naturalcapitalcoalition.org/wp-content/uploads/2016/07/Framework_Book_2016-07-01-2.pdf
Ensure that you consider Use technically robust Ensure that all Ensure the data and
the most relevant issues (from a scientific and assumptions, data, methods used for an
throughout your natural economic perspective) caveats, and methods assessment are
capital assesment information, data and used are transparent, compatible with each
including the impacts methods that are also fit traceable, fully other and with the scope
and/or dependencies for purpose. documented, and of analysis, which
that are most material for repeatable. This allows depends on the overall
the business and its for eventual verification or objective and expected
stakeholders. audit, as required. application.
Adapted from WRI
Adapted from CDSB 2015
and WBCSD 2004
and WRI and WBCSD 2004. Adapted from GRI 2013.
and IIRC 2013.
Source: Natural Capital Coalition 2016, Natural Capital Protocol, accessed September 2019, https://naturalcapitalcoalition.org/
natural-capital-protocol.
The OECD Guidelines aim to promote positive contributions by enterprises to economic, environmental
and social progress worldwide.
The OECD Guidelines for Multinational Enterprises are recommendations addressed by governments to
multinational enterprises operating in or from adhering countries. They provide non-binding principles
and standards for responsible business conduct in a global context consistent with applicable laws and
internationally recognised standards. The guidelines are the only multilaterally agreed and comprehensive
code of responsible business conduct that governments have committed to promoting (OECD 2011, p. 3)
Within the OECD Guidelines, it is stated that enterprises should take into account the established
policies of the countries in which they operate and consider the views of other stakeholders. Enterprises
should contribute to economic, environmental and social progress with a view to achieving sustainable
development. In relation to the environmental obligations, the OECD Guidelines state:
Enterprises should, within the framework of laws, regulations and administrative practices in the countries
in which they operate, and in consideration of relevant international agreements, principles, objectives, and
standards, take due account of the need to protect the environment, public health and safety, and generally
to conduct their activities in a manner contributing to the wider goal of sustainable development (OECD
2011, p. 31).
The OECD Guidelines for Multinational Enterprises are available online at http://mneguidelines.
oecd.org. Interested candidates can review the guidelines to see which aspects relate to CSR issues.
Organisations wishing to publicly report their greenhouse gas emissions and climate change strategies
can do so through the CDP, and interested parties can conduct searches on the CDP website by company
name. Researchers within the CDP also use the Carbon Disclosure Leadership Index to score company
responses based on the quality of their reporting to CDP. According to the CDP website, the scores provide
a valuable perspective on the range and quality of companies’ responses.
While the CDP provides the structure for data collection and the content for reporting, the Climate Dis-
closure Standards Board (CDSB) through its reporting framework (https://www.cdsb.net/sites/default/files/
cdsb_framework_2.1.pdf), provides the guidance to communicate that content in mainstream reports.
Since CDSB’s inception in 2007, CDP has been providing its global secretariat, leading the strategy
delivery and managing the day-to-day work program on behalf of the consortium of business and
environment NGOs that make up the Board.
QUESTION 5.8
The CDP website features a quote from Douglas Flint, group chairman of HSBC Holdings PLC, in
which he states:
For HSBC, climate change is a cornerstone of our ongoing business strategy … The reporting
framework that CDP has pioneered over the past decade has helped us both as a respondent
and a signatory, to improve our understanding of the strategic risks and opportunities in this
area (CDP 2014b).
How important do you think the CDP framework is for the bank given the paragraph above?
Businesses become signatories to the United Nations Global Compact and demonstrate actions to
support the 10 principles by submitting formal ‘Communications on progress’ on an annual basis. The
United Nations Global Compact’s 10 principles are derived from:
• the Universal Declaration of Human Rights
• the International Labour Organization’s Declaration on Fundamental Principles and Rights at Work
• the Rio Declaration on Environment and Development
• the United Nations Convention Against Corruption.
The United Nations Global Compact asks companies to embrace, support and enact, within their sphere
of influence, a set of core principles in the areas of human rights, labour standards, the environment and
anti-corruption. The principles are as follows.
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A significant number of Australian organisations have signed up to the principles, including Telstra,
National Australia Bank, ANZ Bank, CPA Australia, Commonwealth Bank, BHP and Westpac.
The compact is also responsible for the setting of sustainable development goals (SDGs) that are related
to the key priorities the United Nations believes are critical to improve the quality of life for countries that
are less fortunate than countries such as Australia.
.......................................................................................................................................................................................
CONSIDER THIS
Visit the website of the UN Global Compact at www.unglobalcompact.org/sdgs and choose one of the SDGs outlined
in figure 5.1. Note the key points about the SDG you have chosen.
EQUATOR PRINCIPLES
When an organisation seeks to establish a particular project, it often requires project-specific financing. In
project financing the revenue generated by the project often serves as both the source of repayment and the
security for the loan. Power plants, mines and transportation infrastructure are examples of developments
that commonly use project financing (EP Association 2019).
There is a view among many people that an organisation providing finance (typically a financial
institution) for a project should take some responsibility and leadership in how the funding is being used
and the social, environmental and economic impact associated with the project. With this perspective in
mind, the Equator Principles (EP Association 2013, 2019) were developed.
The Equator Principles are a voluntary set of standards intended to act as a framework for financial
institutions to identify, assess and manage social and environmental risks in the projects they advise on
or consider financing. Specifically, the framework aims to ensure that negative impacts on communities,
ecosystems and the climate are, ideally, avoided or otherwise are minimised, mitigated or offset.
Originally launched in 2004, the Equator Principles have been revised over time, with the third version
released in 2013 and the fourth version expected to be released in 2019–20. The fourth version is proposed
to strengthen the way the principles deal with human rights issues, including impacts on Indigenous
peoples, and acknowledge that use of the Equator Principles can contribute towards efforts to mitigate
climate change in accordance with the Paris Agreement. Version 4 is also intended to result in improved
reporting on climate and biodiversity effects.
Equator Principles Financial Institutions (EPFIs) commit to not providing loans to projects where
the borrower will not or is unable to comply with the respective social and environmental policies and
procedures that are incorporated into the Equator Principles. The draft of Version 4 at the time of writing
provides for EPFIs to take remedial action should a project stray from the Equator Principles over the
course of the project life cycle.
The Equator Principles apply to all new EPFI project financings globally with total project capital costs
of USD$10 million or more, across all industry sectors. In addition, while the Equator Principles are not
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The GHG Protocol has been enhanced since its introduction in 2001 and each of the individual standards
and protocols in force at the time of writing is briefly described below (GHG Protocol n.d.).
The Corporate Accounting and Reporting Standard (Corporate Standard) provides methodologies for
businesses and other organisations to report their total emissions of greenhouse gases covered by the
Kyoto Protocol:
• CO2 (carbon dioxide)
• CH4 (methane)
• N2 O (nitrous oxide)
• HFCs (hydrofluorocarbons)
• PFCs (perfluorocarbons)
• SF6 (sulphur hexafluoride)
• NF3 (nitrogen trifluoride).
The Protocol for Project Accounting (Project Protocol) is a set of methods and principles to enable
organisations to quantify the greenhouse gas benefits of projects that aim to mitigate climate change by:
• reducing greenhouse gas emissions (e.g. using less fossil fuel–generated energy)
• removing greenhouse gases from the atmosphere (e.g. planting forests)
• storing greenhouse gases (e.g. growing forests or sequestering gases underground).
The Project Protocol is supported by industry-specific guidance for land use and forestry, and
electricity projects.
The Corporate Value Chain (Scope 3) Accounting and Reporting Standard enables companies to assess
the emissions impact of their entire value chain and thus identify which aspects present the most potential
for emission reductions. Scope 3 emissions are those generated by others in the wider economy as a
consequence of an organisation’s activities. An example would be emissions caused by airline travel
undertaken by an organisation’s staff in the course of their work activities. The standard provides a
method for accounting for scope 3 emissions upstream and downstream of a company’s operations and
facilitates partnering with suppliers and customers to reduce climate change impacts throughout the
value chain.
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The Foundation’s Sustainability Accounting Standards Board (SASB) has developed sustainability
disclosure standards for matters that are likely to have a material impact on an organisation’s financial
position or performance. It considers the focus on financially material issues to be a differentiating factor
from other sustainability reporting frameworks. Each SASB standard contains accounting metrics for the
relevant industry, a protocol for compiling data and activity metrics to normalise data.
The SASB Foundation asserts that use of its standards can help companies achieve greater transparency,
better communication with stakeholders, improved risk management, improved performance and increased
brand value. For investors, the benefits are seen to be enabling sustainability issues to be factored into deci-
sions and demonstrating compliance with the UN’s Principles for Responsible Investment. As of 2019, the
SASB has issued 77 industry-specific sustainability accounting standards. Information on SASB’s standard
development process can be found at www.sasb.org/standards/status-standards (SASB Foundation n.d.).
The SASB standards can be used by companies to implement principles-based frameworks, including
integrated reporting and the recommendations of the Task Force on Climate-related Financial Disclosures,
in order to report on sustainability issues that matter most to investors.
.......................................................................................................................................................................................
CONSIDER THIS
SASB’s standards focus on financially material sustainability issues. Visit the SASB Materiality Map website,
https://materiality.sasb.org. Choose one of the industries shown and note which issue categories are most likely
material/not material for most of the companies in that industry.
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QUESTION 5.9
This section has discussed a number of major reporting frameworks. Identify which of the
guidelines and non-mandatory initiatives constitute reporting frameworks, and outline the benefit
of such frameworks.
Social Responsibility
This social audit is benchmarked against ISO 26000, which outlines best practice in social responsibility.
This type of social audit measures an organisation’s performance in terms of sustainable development
and the welfare and health of society, alongside compliance with laws and regulations.
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Source: SGS 2019, ‘Sustainability: social audits’, accessed October 2019, www.sgs.com.au/en-gb/sustainability/social-
sustainability/audit-certification-and-verification/social-responsibility-audits/sgs-code-of-conduct-solution; Ethical Trade
Initiative 2019, ‘About ETI’, accessed October 2019, www.ethicaltrade.org.
The Body Shop was one of the early high-profile adopters of independently verified social audits in
Australia. Arguably, because The Body Shop relies relatively heavily on its reputation for superior social
and environmental performance, it is important to the business’s success to ensure that its stakeholders
believe it is operating ethically. The Body Shop based its social audits on surveys of thousands of
employees, consultants, suppliers and customers.
This process elicited feedback from key stakeholders about the company’s performance against the
values, and social and ethical standards that it sets for itself (The Body Shop 2012).
At this point, we reflect on the question of whether the results of a social audit can be considered to
represent accounting results. The answer to this returns to the link between accounting and accountability.
If an organisation believes it is accountable to particular stakeholder groups for certain aspects of its
performance, it would seem sensible to engage the stakeholders to find out whether they are satisfied with
the organisation’s performance, and the results of this engagement would form part of the organisation’s
account of its social performance.
Reflecting the interest in social accounting and social auditing, Social Accountability International
released a social accounting standard entitled the Social Accountability 8000 International Standard
(SAI 2014), which focuses on issues associated with human rights, health and safety, and equal oppor-
tunities. SA8000 is a voluntary standard that can be assured against, based on the principles of the UN
Universal Declaration of Human Rights, the International Labour Organization conventions, international
human rights norms and national labour laws.
The extent to which a social audit can be considered to represent accounting results needs to be assessed
in terms of the use of external benchmarks such as those in SA8000 and those described in figure 5.7 versus
the use of internal measures such as those used by The Body Shop.
QUESTION 5.10
(a) What is a social audit and why would an organisation undertake one?
(b) Would the results of a social audit be incorporated in an organisation’s CSR report?
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Arguably, a sound corporate management system should also link executive rewards to key social and
environmental performance indicators. That is, rather than focusing on reward structures that are tied to
measures of financial performance only (paying senior executives a bonus tied to profit, sales, return on
assets, and so forth), management’s bonuses could also be tied to social and environmental performance
indicators, for example, a reduction in emission levels or workplace injuries. The reporting of a link
between employee remuneration and performance on social and environmental issues is still found to
be rare for the largest 250 companies in the world.
Companies that clearly link employee remuneration to performance on social and environmental issues
send a strong signal to employees, investors and other stakeholders that they are serious about CR
[corporate responsibility] performance and ensuring the long term viability of the company. Yet only 10%
of the world’s largest companies (G250) currently provide a clear explanation in their reporting of how
remuneration is linked with CR performance.
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It is eye-opening to learn that worldwide so few companies link CSR performance to executive
remuneration, especially given the potential for social and environmental issues to affect the supply chain,
financial performance, reputation and the ultimate brand value of companies.
We would perhaps question an organisation’s commitment to a sustainability agenda if we were to find
that bonuses paid to senior executives were only tied to measures of financial performance. Sustainability
opportunities and risks spanning environmental, social or economic performance should be considered
as part of an enterprise-wide risk management framework, rather than as specific risks that are managed
outside the existing risk management strategy and framework and related policies.
An organisation that commits itself to a broad social responsibility agenda should consider putting in
place a suite of policies and procedures that help it achieve those objectives. These procedures can relate
to a variety of issues such as reporting policies, stakeholder engagement policies, employee remuneration
policies, waste management policies and so forth — all of which have been discussed.
The Association of International Certified Professional Accountants (AICPA) and the Chartered Institute
of Management Accountants (CIMA) adopt this definition (CGMA 2019). To assess costs correctly,
it is important to collect both financial and non-financial data (e.g. materials use, personnel hours and
other cost drivers). Environmental management accounting places a particular emphasis on materials and
materials-driven costs because the use of energy, water and materials, as well as the generation of waste
and emissions, is directly related to many of the effects organisations have on their environments.
Many organisations purchase energy, water and other materials to support their activities. For example,
in a manufacturing organisation, some of the purchased material is converted into a final product that is
delivered to customers. But most manufacturing operations also produce materials that were intended to
go into the final product but became waste instead because of operating inefficiencies or product quality
issues. Manufacturing operations also use energy, water and materials that are never intended to go into
the final product but were to manufacture the product (such as water to rinse out chemicals). Many of these
materials eventually become waste streams that must be managed. In addition, most organisations generate
greenhouse gas emissions as part of their operations, often through energy use, but potentially directly
as well.
One of the first steps required when implementing an environmental management accounting system is
to define which environmental costs will be accounted for (or managed).
AICPA and CIMA (CGMA 2019) categorise environmental costs as:
• prevention costs — associated with preventing adverse impacts on the environment
• appraisal costs — associated with assessing compliance with policies related to environmental
performance
• internal failure costs — associated with eliminating environmental impacts caused by the organisation
• external failure costs — associated with environmental damage caused outside the organisation.
Thus, the costs to be accounted for may be restricted to those currently recognised by an organisation
pursuant to ‘conventional’ accounting practices or they could be extended to include externalities. Where
focus is on costs currently being recognised, it might be that the way they are currently being accounted
for is impeding efforts to improve an organisation’s operations. It is possible for potentially important
environmental costs to be hidden in the accounting records, where a manager cannot find them easily. One
particularly common way in which environmental costs may be hidden is if they are assigned to overhead
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The accumulation of various costs (overheads) in overhead accounts is something that many of
us have been taught as part of our accounting education despite the fact that doing so can impede
our organisation’s ability to manage the consumption of various overheads, all of which may have
environmental consequences. That is, the practice of using overhead accounts can counter other initiatives
implemented to address CSR. Where a variety of costs are being accumulated in overhead accounts,
subsequent allocation of the accumulated costs to particular products are frequently made in terms
of such bases as sales volume, production output, floor space occupied by particular departments,
machine hours or labour hours. This might, however, be an inaccurate way to allocate some typical
environmental costs.
While making the task of cost allocation easier, using such simplistic allocation bases as those identified
above may lead to the misallocation of many costs, including those relating to the environment. An example
would be hazardous waste disposal costs, which could be high for a product line that uses hazardous
materials and low for one that does not. In this case, the allocation of hazardous waste disposal costs
on the basis of production volume would be inaccurate, as would be product pricing and other decisions
based on that information. The overarching benefit of environmental management accounting is better
informed decisions. More specifically, AICPA and CIMA (CGMA 2019) suggest the benefits of explicitly
identifying environmental costs are improved sales, reduced sales erosion, reduced costs (through reduced
waste), reduced costs of environmental remediation and improved reputation. Additional benefits could
include identifying opportunities that might lead to new revenues through recycling; pricing that more
accurately reflects the non-monetary costs of production; and the creation of societal benefits through
reduced environmental impacts.
Different approaches can be taken to resolve the issue of hidden environmental costs. One common
solution is to set up separate cost categories for the more obvious and discrete environmental management
activities. The less obvious costs that will still appear in other accounts will need to be more clearly
labelled as environmental so they can be traced more easily. An assessment of the relative importance
of environmental costs and cost drivers of different process and product lines, in line with the general
practice of activity-based costing (ABC), can help an organisation determine whether the cost allocation
bases being used are appropriate for those costs.
From the above discussion, we can see that simply changing the way we accumulate and allocate costs
can provide us with an enhanced ability to understand and control various environmental costs. Apart
from the way we accumulate costs, opportunities relating to reducing such things as waste can also be
enhanced if we classify particular costs differently. What should be understood at this point is that relatively
inexpensive changes to an entity’s accounting system can be made that might lead to real changes in the
ability to control resource usage.
Another potential problem with environmental management accounting is that accounting records do
not usually contain information on future environmental costs, even though they may be quite significant.
As outlined earlier, accounting records also lack many other less tangible environmental costs. An example
is costs incurred when a poor environmental performance results in lost sales to customers who care about
environmental issues. These types of costs may be difficult to estimate, but they can be both real and
significant to an organisation’s financial health.
What should be appreciated is that we, as accountants, can make modifications to our current accounting
systems to assist our organisations to act in a more environmentally responsible manner. Apart from
enabling better management within an organisation, such modifications will also enable us to provide
a better account of certain costs (e.g. waste) to external stakeholders.
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These awards might also serve to motivate organisations to improve the quality of information provided
and increase the number of companies making such disclosures. The awards aim to identify and reward
innovative attempts to report CSR-related information. The judging criteria of such awards can be used as
guidance in determining what and how to report.
The Works Design Communications (2018) business conducts an annual study on sustainability
reporting trends and best practice, which also serves as a guideline for companies seeking to undertake
innovative reporting. In 2018, the key findings were that use of the interactive features of PDFs had
improved markedly, improving accessibility; social media promotion of CSR reporting messages had
moved towards best practice; and reporting was increasingly aligned to key reporting frameworks.
Other innovative features identified were interviews with company CEOs; reporting against relevant UN
Sustainable Development Goals; and the use of icons, infographics and interactive visualisations.
The integrated reporting initiative also has an Emerging Integrated Reporting Database (IIRC n.d.) that
brings together extracts of reports that illustrate emerging practices in integrated reporting. This database
can be searched by industry, year or component of an integrated report. It is worthwhile accessing this
database and identifying the types of reporting extracts that are leading to best practice.
The above discussion shows the variety of reporting approaches being adopted to provide information
about the sustainability-related performance of organisations and highlights emerging innovations and best
practice. Many decisions are required to be made, which can be contrasted with financial reporting, where
the extent of regulation means that there is relatively limited scope for experimentation or innovation.
.......................................................................................................................................................................................
CONSIDER THIS
As can be seen from the previous material in this module there are a plethora of reporting frameworks. It seems
that some sort of order is going to be brought to the area with the advent of the Corporate Reporting Dialogue
initiative, which is designed to ‘respond to market calls for greater coherence, consistency and comparability between
corporate reporting frameworks, standards and related requirements’. Consultation has now finished on the initial
report to show ‘the linkages of the TCFD recommendations with the respective frameworks and the linkages between
frameworks’ (Corporate Reporting Dialogue 2019).
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KEY POINTS
5.6 Describe the mandatory reporting requirements for social and environmental performance
reporting.
• In Australia, a number of legislative and other requirements exist that mandate aspects of social and
environmental performance be reported in a variety of ways.
• The Corporations Act ss. 299(1)(f) and 299A imply aspects of CSR reporting and ASIC has issued
regulatory guidance noting that the operating and financial review required by s. 299A(1) should
include a discussion of sustainability risks. The Corporations Act also gives legal force to accounting
standards.
• Accounting standards IAS 37 and IAS 16 require aspects of CSR reporting.
• The ASX Corporate Governance Principles and Recommendations require listed entities to
disclose exposure to environmental and social risks.
• The NGER Act requires businesses that generate substantial greenhouse gas emissions or that
generate or consume substantial amounts of energy to report their emissions, energy production,
energy consumption and other information.
• The National Pollutant Inventory is a publicly accessible register of industrial pollution that is
informed by mandatory reports from various industrial facilities.
• The Modern Slavery Act requires certain entities to issue a modern slavery statement detailing their
efforts to identify and address instances of modern slavery (such as human trafficking or child labour)
in their operations or supply chain.
5.7 Describe the elements and frameworks of non-mandatory reporting for social and environmental
performance reporting.
• A range of voluntary frameworks exist to guide reporting of social and environmental performance
outside the mandatory requirements. Two of the most widely adopted are the GRI and IR frameworks.
• The Global Reporting Initiative issued guidance for the preparation of sustainability reports from 2000
and recently issued a set of formal standards for use by entities wishing to report in accordance with
GRI recommendations.
• The International Integrated Reporting Council has developed a set of Integrated Reporting <IR>
guidelines intended to support entities wishing to create a clear, easy-to-understand report that
communicates how strategy, governance and performance across a wide range of issues work
together to create value.
• Common to all of the non-mandatory reporting frameworks is the intention to create reports that
provide useful information about an organisation’s performance on social, environmental and other
issues to support decisions by internal and external stakeholders.
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As the IPCC’s Fifth Assessment Report emphasises, such temperature rises are likely to have dramatic
economic, environmental and social effects. The IPCC is working on the Sixth Assessment Report and
that is due for release in 2022.
There is increasing interest in reporting for issues related to climate change, including accounting for
greenhouse gas emissions and incorporating climate change risk into risk assessments. Reporting is also
required to support the operation of emissions trading schemes. The remainder of this module examines
the importance of accounting for climate change and the techniques used.
P
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Swiss ETS Switzerland Large industrial and energy- Entities must submit 2008−12:
(2008) intensive installations. an annual monitoring Voluntary
report based on self-
2013−20:
reported information
Mandatory
by 31 March.
for large
energy-
intensive
industries.
US EPA GHG United States Suppliers of certain products Reports are Mandatory
Reporting that would result in green- submitted annually
Program (2010) house emissions if released, to the EPA.
combusted or oxidised; Reporting is at the
direct-emitting source facility level, except
categories; and facilities that for certain suppliers
inject CO2 underground for of fossil fuels and
geologic sequestration or any industrial greenhouse
purpose other than geologic gases.
sequestration.
Tokyo Tokyo Large offices and factories. Entities must submit Mandatory
CapandTrade annual reports (fiscal
Program (2010) year) of their emission
reduction plans and
emissions reports.
KETS (2015) Republic of Korea Phase I (2015−17): heavy Annual reporting of Mandatory
emitters in the steel, cement, emissions by the end
petro-chemistry, refinery, of March.
power, building, waste sectors
and aviation industries.
Phase 2: 2018-2020: heat
and power, industry, building,
transportation, waste sector,
and public.
Source: ICAP (International Carbon Action Partnership) 2015, ‘Emissions Trading Worldwide: ICAP Status Report 2019’, accessed
August 2019, https://icapcarbonaction.com/status-report-2015.
The report also highlighted the recommendations of the Financial Stability Board’s (FSB) Task Force on
Climate-related Financial Disclosures report. The report details the four recommendations and supporting
disclosures.
Disclose the organisation’s Disclose the actual and Disclose how the organisation Disclose the metrics and
governance around climate- potential impacts of climate- identifies, assesses, and targets used to asses and
related risks and opportunities. related risks and opportunities manages climate-related risks. manage relevant climate-
on the organisation’s related risks and opportunities
businesses, strategy, and where such information is
financial planning where such material.
information is material.
b) Describe management’s role b) Describe the impact of b) Describe the organisation’s b) Disclose Scope 1, Scope 2,
in assessing and managing climate-related risks and processes for managing and, if appropriate, Scope 3
climate-related risks and opportunities on the climate-related risks. greenhouse gas (GHG)
opportunities. organisation’s businesses, emissions, and the related
strategy, and financial risks.
planning.
c) Describe the resilience of the c) Describe how processes for c) Describe the targets used by
organisation’s strategy, taking identifying, assessing, and the organisation to manage
into consideration different managing climate-related climate-related risks and
climate-related scenarios, risks are integrated into the opportunities and
including a 2ºC or lower organisation’s overall risk performance against targets.
scenario. management.
Source: TCFD 2017, ‘Final Report: Recommendations of the Task Force on Climate-related Financial Disclosures’, p. 14, accessed September 2019,
www.fsb-tcfd.org/wp-content/uploads/2017/06/FINAL-2017-TCFD-Report-11052018.pdf.
In a subsequent speech ASIC’s Commissioner stated ‘we encourage companies and directors to
carefully consider the TCFD’s report, not just in the disclosure context, but as a key resource to assist
in understanding, identifying and managing climate risk and opportunity’ (ASIC 2018b).
.......................................................................................................................................................................................
CONSIDER THIS
Read the speech delivered by John Price, ASIC Commissioner, on Climate Change in reading 5.1. Identify the key
areas of company operations that are affected by climate change. Reflect on why these elements are important.
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KEY POINTS
5.9 Explain the relevance of climate change to corporate accountability, and identify some related
measurement issues.
• The UNFCCC requires countries to report on their total greenhouse gas emissions and to take steps
to reduce emissions.
• In Australia, certain entities are required to report on their greenhouse gas emissions.
• In many countries, a price has been placed on emissions by way of an emissions trading scheme or
a carbon tax. These provide an incentive to reduce emissions.
• Climate change risks are a widespread concern and this has brought pressure on organisations to
be accountable for their contribution to climate change.
• Organisations that account for greenhouse gas emissions measure and report on emissions directly
generated by the organisation’s activities, created in the generation of power used by the organisa-
tion, and indirectly generated through ancillary activities.
• Organisations are able to choose how to account for and report their emissions. One common
framework is the GHG Protocol. The Climate Disclosure Standards Board also provides a framework
for emissions disclosures.
REVIEW
Organisations have increasingly accepted the need to be accountable to a wide range of stakeholders
who are concerned with many aspects of the performance of the organisation. One prominent way that
organisations have responded is through the adoption of CSR principles and associated reporting. The
development of such reporting reflects the need to achieve and demonstrate environmental, social and
economic sustainability. The need to report these issues has in turn generated demand for new reporting
frameworks.
There is no doubt that this aspect of an organisation’s reporting, both internally and externally, will
continue to grow in importance over time. CSR reporting is at the heart of enabling us to measure and
monitor our CSR impact, which is why governments and the international community are increasingly
expecting organisations to report this in a reliable and comprehensive manner.
As we have outlined, along with an expanded view of their corporate and social responsibilities,
organisations are increasingly making additional voluntary CSR disclosures. In fact, disclosing information
about various aspects of their sustainability performance has become so common that it is now considered
virtually mainstream reporting by most major corporations around the world. This is in response to
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REFERENCES
Adams, CA 2013, Understanding Integrated Reporting: The Concise Guide to Integrated Thinking and the Future of Corporate
Reporting, Greenleaf Publishing Limited, Sheffield, UK.
AMP Capital 2019, ‘What is Socially Responsible Investing?’, accessed September 2019,
www.ampcapital.com/content/dam/capital/02-global-files-only/02-esg-resources/what_is-socially-responsible-investing.pdf.
ARA (Australasian Reporting Awards) n.d., ‘About the ARA’, accessed October 2019, www.arawards.com.au/about.
ARA 2019, ‘2019 ARA award handbook’, accessed October 2019, www.arawards.com.au/images/2019/2019Handbook.pdf.
ASIC (Australian Securities and Investments Commission) 2013, ‘Regulatory Guide 247 Effective Disclosure in an Operating and
Financial Review’, accessed October 2015, http://asic.gov.au/regulatory-resources/find-a-document/regulatory-guides/rg-247-
effective-disclosure-in-an-operating-and-financial-review/.
ASIC 2018a, ‘Report 593: Climate risk Disclosure by Australia’s Listed Companies’, accessed October 2019,
https://download.asic.gov.au/media/4871341/rep593-published-20-september-2018.pdf.
ASIC 2018b, ‘Climate change: Keynote address by John Price, Commissioner, Australian Securities and Investment Commission’,
Centre for Policy Development: Financing a Sustainable Economy, Sydney, accessed October 2019, https://asic.gov.au/about-
asic/news-centre/speeches/climate-change/.
Australian Ethical Super 2019,‘Our advocacy’, accessed October 2019, www.australianethical.com.au/personal/ethical-
investing/our-approach/advocacy.
ASX CGC (Australian Securities Exchange Corporate Governance Council) 2019, Corporate Governance Principles and
Recommendations, 4th edn, Australian Securities Exchange, Sydney, accessed September 2019, www.asx.com.au/documents/
asx-compliance/cgc-principles-and-recommendations-fourth-edn.pdf.
Australian Department of the Environment and Energy 2015, ‘Emissions Reduction Fund’, Australian Government, accessed
October 2019, www.environment.gov.au/climate-change/publications/factsheet-emissions-reduction-fund.
Australian Department of the Environment and Energy 2019, ‘Climate Solutions Fund - Emissions Reduction Fund’, Australian
Government, accessed October 2019, www.environment.gov.au/climate-change/government/emissions-reduction-fund.
Australian Department of the Environment and Energy n.d., ‘Clean air’, Australian Government, accessed October 2015,
www.environment.gov.au/clean-air.
Australian Government 2018, ‘Modern Slavery Act’, https://www.legislation.gov.au/Details/C2018A00153.
B-Corp n.d., ‘2019 Best for the World’, accessed August 2019, www.bcorporation.net.
Bank Australia 2018, ‘Customer owned bank issues sustainability bond’, accessed August 2019, www.bankaust.com.au/about-
us/news/corporate2/australian-first-customer-owned-bank-issues-sustainability-bond.
Barraket, J, Mason, C & Blain, B 2016, ‘Finding Australia’s Social Enterprise Sector 2016: Final Report’, accessed October 2019,
www.socialtraders.com.au/wp-content/uploads/2016/07/FASES-2016-full-report-final.pdf.
BlackRock 2018, ‘The Investment Stewardship Ecosystem’, accessed September 2019,
www.blackrock.com/corporate/literature/whitepaper/viewpoint-investment-stewardship-ecosystem-july-2018.pdf.
Bridges Ventures 2012, ‘Sustainable & impact investment: How we define the market’, Bridges Ventures: London.
Business Roundtable 2019, ‘Our Commitment’, accessed September 2019, https://opportunity.businessroundtable.org/
ourcommitment.
CDP (Carbon Disclosure Project) 2014a, ‘What we do’, accessed October 2015, www.cdp.net/en-US/Pages/HomePage.aspx.
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366 GLOSSARY
Corporations Act Corporations Act 2001 (Cwlth)
co-regulation Regulation of a profession or other group of people that is undertaken by a professional
body or association and government organisations. Co-regulation reflects a shared regulatory
responsibility.
CPA Australia One of the three main accounting bodies in Australia.
criminal Someone who has been convicted of criminal offences.
criminal intent Intention to deliberately cause harm to another through the commission of a
criminal offence.
criminal liability Liability for offending in breach of provisions of criminal law.
criminal sanctions Punishment for criminal offending.
cultural diversity Existence of a variety of cultures within an organisation or the broader community.
cultural relativism A theory that behaviour must be examined or judged in the context of the culture in
which it takes place.
delegation The handing of responsibility by a board or senior management for certain tasks by others.
deontological Ethical theories that deal with decisions being made on the basis of duties and obligations.
director or officer An individual that has the responsibility for the affairs of a company incorporated
under the Corporations Act.
diversity The state of being diverse and of having variety. In a governance setting this usually equates to
ensuring there is a blend of genders, ages, experience and work backgrounds around a board table to
ensure a breadth of ideas can be presented during decision making.
duty of care The duty that directors and senior managers have for the welfare of employees and others
that engage with the entity for which they have governance responsibility.
economic stability An economic state in which there are only minor fluctuations.
egoism An ethical theory that treats self-interest as the key foundation of morality.
enlightened self-interest An ethical theory that says those who act in the interests of others are serving
their own interest at the same time.
environmental sustainability Responsible engagement with the environment to avoid unnecessary
depletion or degradation.
Equator Principles Principles for the management of risks associated with social and environmental
phenomena in project finance.
ethical egoism Self-interested ethics.
ethical relativism An ethical position that states that all points of view are valid and that individuals
determine what is moral and right for them.
ethical trading Trading that is done in accordance with certain principles such as ensuring that
companies from which products are sourced do not engage in child labour or present
environmental risks.
ethics Principles underlying the behaviour or conduct of individuals or groups.
ethical standards Standards stipulating the behaviour that is acceptable of people in certain professions.
exclusive dealing The situation where a company decides to deal only with certain customers or
geographic regions.
financial markets Markets on which shares and other kinds of equity are traded.
FRC Financial Reporting Council
goal congruence The alignment of a goal pursued by an agent with the strategies of a company board or
senior management of an entity.
governance The way entities police their own internal conduct.
GRI Global Reporting Initiative
heuristics The use of a practical method to solve problems in the moment rather than looking at
a framework.
humanistic perspective Humanism includes the notion that people can be responsible for their
own happiness.
IFAC International Federation of Accountants
IIRC International Integrated Reporting Council
insider trading The situation where people who have access to privileged commercial knowledge use it
to their own advantage before others can in the market place.
insolvent trading The state in which an entity is trading but is doing so illegally because it is unable to
meet its debt obligations.
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GLOSSARY 367
Integrated Reporting Broad-based reporting frameworks focused on financial and non-financial
information that is developed by the International Integrated Reporting Council.
IPA Institute of Public Accountants
ISO International Organisation for Standardisation
justice Just behaviour or treatment.
legitimacy theory A theory that deals with the concept that entities such as businesses have a social
contract to perform a range of actions in order to receive approval and other rewards.
limited liability The state in which shareholders or members of an entity are responsible for the
liabilities of an entity to the value of the shares they hold.
loss-leader A product or service that is used by a company as a way of introducing customers to a more
expensive good or service.
market based systems Systems of corporate structures that have outsiders or shareholders involved in
the ownership and governance of entities.
market manipulation Acts undertaken by a individuals or groups of individuals designed to manipulate
the stock market and cause individual company stocks to rise or fall depending on the nature of the
acts involved.
market sensitive Information that is deemed to be significant enough to cause share prices to rise or fall.
market sharing The practice where competitors may divide markets, customers and regions between
themselves to limit competition.
monetisation Turning an idea or concept into one that generates revenue.
monitoring costs Costs incurred by a principal in ensuring agents are doing what is asked of them and
behaving appropriately.
monopolist corporations Companies that are able to reduce supply below the competitive level in order
to maximise profits, including through artificially high prices.
morals Standards of behaviour expected.
narrative reporting Reporting that tells a story about an entity or an individual beyond
financial performance.
natural capital The stock of natural resources, for example, water, air and land.
naturalistic argument The naturalistic argument claims that nature has an intrinsic value and deserves
preservation for its own sake.
normative theories Ethical theories that seek to establish norms of behaviour rather than codify or
merely explain existing behaviour.
not-for-profit Legal or social entities formed for the purpose of producing goods or services, and whose
status does not permit them to be a source of income, profit or financial gain for the individuals or
organisations that establish, control or finance them.
output restrictions Conduct where competitors ‘agree’ to apply restrictions on output that will cause
shortages in markets and thus result in price rises.
philosophical Relating to the study of philosophy.
philosophy A particular system of thought or the study of systems of thought and ideas.
phoenix companies Companies that have emerged after the collapse of another company through
insolvency, often with the same directors and the same or similar line of business. These companies
often leave a trail of unpaid debt.
pollution Introduction into the environment of substances that have harmful or poisonous effects.
ponzi schemes Schemes involving earlier investors (potentially including through share-based
transactions) being given a return by simply diverting the capital contributions of later investors to the
earlier investors.
pools Organised groups of investors who agree to buy the shares of particular corporations and, as prices
rise due to growing market interest.
price-fixing Pricing agreements between competitors in order to ensure that they maintain their own
market share.
principals Key individuals or group of individuals involved in an agency relationship.
principles-based approach An approach to regulation or problem solving based on a conceptual
framework or broadly stated principles.
profession An occupational area or vocation that involves prolonged training and a formal qualification.
professional activity An activity requiring accountancy or related skills undertaken by a member,
including accounting, auditing, tax, management consulting and financial management.
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368 GLOSSARY
professional ethics Standards of behaviour expected of a profession or professions.
professional scepticism A state of mind where people (particularly auditors) are alert to the possibility
of half-truths, fraud and insufficiency of evidence.
proprietary companies A private company incorporated under the Corporations Act that can have no
more than 50 shareholders or members.
prospectus An offer document put to possible or existing investors for an offer of equity in a company.
public companies Companies incorporated under the Corporations Act that have more than 50
shareholders or members. They may also be listed on the ASX.
public interest Anything affecting the rights, health or finances of the public at large.
puffery Term used for advertising content that is misleading.
quantification Seeking evidence by quantifying or measuring in numbers.
relationship based systems Companies in this system rely for their governance on the representation of
interests on the board of directors such as workers, customers, banks, local communities and other
groups that have some ties to the entity.
remuneration Payments people receive for services performed for an entity, which may include
payments based on incentives.
resale price maintenance Retail price maintenance is when a supplier stipulates that the goods it
provides must only be resold at or above a certain minimum price.
residual costs or losses Costs that occur despite the fact that principals are doing their best to ensure
that the agents behave appropriately and in alignment with the corporate vision and objectives.
Principals cannot avoid losses irrespective of how well they monitor agents.
restricted egoism An ethical theory that relates to self-interest being the subject of morals, but is
constrained by laws and regulations.
right A moral or ethical entitlement.
rule-based codes Codes that are based on prescriptive behaviours.
rules-based approach An approach to regulation or problem solving based on the specification of
situation specific rules.
runs Phenomenon that involves groups of market participants who work together with the intention of
creating market effects by either buying shares or disseminating rumours in order to attract new buyers
into the market.
safeguards Actions, individually or in combination, that the member takes that effectively reduce
threats to compliance with the fundamental principles to an acceptable level.
SDGs Sustainable Development Goals
second opinion An opinion obtained to seek further assurance on whether an initial view on a matter
was reasonable.
self-regulation Measures a profession takes to regulate the conduct of its own members. This is in
contrast to regulation imposed by parliament and enforced by a regulator.
social sustainability Social sustainability is about identifying and managing business impacts, both
positive and negative, on people.
stakeholder A person or group with an interest in an issue or organisation.
stewardship theory A theory that suggests people in power (the agents or stewards) will act for the
benefit of those who have engaged them.
supply chain management The management of flows of goods and services to and throughout an
organisation as a part of its business.
sustainability The ability of an environment to be maintained at a certain level.
teleological Ethical theories that are based on the rightness, goodness or worth of the end results
of decisions.
threats Actions or behaviours that may cause a member to breach the fundamental principles of the
ethical code.
those charged with governance The person(s) or organisation(s) (for example, directors, corporate
trustees) with responsibility for overseeing the strategic direction of the entity and obligations related
to the accountability of the entity.
TPB Tax Practitioners’ Board
trade union An organisation that is formed to represent the interests of workers in one or more
industries on matters related to wage negotiations.
UK FRC Financial Reporting Council in the United Kingdom.
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GLOSSARY 369
unconscionable conduct Conduct that results in people being harmed by unfair or unfairly imposed or
created contracts.
utilitarianism An ethical theory that looks at decision making that places the greatest good for a group
of individuals over the good for an individual.
virtues Behaviour showing high moral standards.
whistleblowing The act of breaching corporate or government confidentially to report misconduct or
malpractice in the public interest.
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370 GLOSSARY
SUGGESTED ANSWERS
MODULE 1
QUESTION 1.1
(a)
Accountability
Competition and Consumer Act (2010) This act seeks to protect people by promoting competition, fair
www.austlii.edu.au/cgi-bin/viewdb/au/ trading practices and regulation in the area of consumer protection.
legis/cth/consol_act/caca2010265
Corporations Act (2001) The Corporations Act is the legislation regulating companies and it
www.austlii.edu.au/cgi-bin/viewdb/au/ also regulates aspects of work done by accounting professionals.
legis/cth/consol_act/ca2001172 This includes the areas of audit, financial report preparation
and lodgement and insolvency. The roles of directors and other
company officers are also covered in this legislation.
Privacy Act (1988) The Privacy Act regulates how the privacy and the handling of
www.austlii.edu.au/cgi-bin/viewdb/au/ personal information.
legis/cth/consol_act/pa1988108
(continued)
Governance
Governance
Ethics
An understanding of the environment within which professional accountants operate should include
the items shown in each section of the diagram as well as how they interact. For example, IFAC
promulgates the education standards around which PAOs such as CPAA, IPA, and CAANZ develop
and assess initial education programmes and accredit university degrees. IFAC is also responsible
for auditing standards while IFRS is responsible for the conceptual framework and the international
accounting standards. In Australia, overseen by the FRC, the AUASB and the AASB develop the
Australian variants of the international standards which are given force at law by the Corporations Act.
In turn the Corporations Act gives rise (albeit indirectly) to the ASIC which monitors accountant’s
application of these standards.
(b) As mentioned above IFAC is a global organisation responsible for promulgating the education and
auditing standards that apply to its member organisations (CPA Australia being one of these). It also
promulgates a code of ethics. Responsibility for this work is vested in several IFAC Boards (IAESB,
IAASB, and IESBA). IFAC’s member organisations then interpret and apply these “international
standards and codes” to their respective jurisdictions. This often results in local variants, for example
Australia’s accounting and auditing standards, Australia’s code of ethics and CPA Australia’s CPA
Program. Responsibility for this work is vested in AUASB, APESB and CPA Australia. Please note
that a similar trickle down approach for accounting standards occurs with IFRS, IASB and AASB.
(c) Your glossary of acronyms should include those contained in the table above. Please add to the glossary
as the course progresses.
QUESTION 1.2
Example 1.2
In this example the accountant believed they had the right to economic benefits because of their expertise.
However, they exceeded the norm for liquidator charges. The consequences were that creditors would
have received lower entitlements and eventually, when they were discovered, the accountant was ordered
to repay the excess. Longer term this may impact their reputation including the ability to secure work or,
at the very least, they could expect their fees for future work to be subject to scrutiny.
Example 1.3
In this example, the accountant acquired economic benefits without exercising her skills and professional
judgment for the benefit of the client. As a consequence the client had a lower amount invested in
superannuation resulting in financial hardship. The accountant was banned from providing financial
services for three years and may have suffered reputational damage as a result.
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QUESTION 1.4
Many authors’ views are described in module 1. The variety of views shows that there is a wide range of
interpretations about the actions of professional accountants in terms of serving the public interest. There
are those whose motives are selfish, and whose overarching desire is to establish a monopoly group that
maintains a position of prestige and power within the community. There are others who believe that many
professionals have a genuine desire to contribute to society, without the need for significant monetary
reward or political power.
In such a large profession, it is likely that there are many individuals who fit into the different categories
that have been described. While we often hear about the disgraceful or harmful actions and outcomes
from corporate collapses and failures, there are many untold examples of selfless efforts and sacrifices that
provide a significant contribution to the community.
QUESTION 1.5
The following examples illustrate many situations where accountants might apply professional judgment,
although this list is not exhaustive. Your answer may have included four of the following.
• Making decisions about workflows and staff recruitment needs.
• Making staff selection decisions and choosing accounting team member roles.
• Advising clients on business decisions.
• Advising managers on accounting information relevant for business decisions.
• Identifying environmental cost parameters and advising management, and devising reporting
mechanisms.
• Planning for all types of professional assignments.
• Interpreting accounting standards and other professional pronouncements.
• Identifying business and audit risks.
• Making assumptions in forecasts and estimates.
• Placing quantitative assessments on future liabilities for clients and others.
• Providing overall opinions on the adequacy of internal control, the reliability of accounting records and
the sufficiency of audit evidence.
• Drawing conclusions on the going concern assumption in relation to a business.
• Evaluating materiality levels for the presentation of financial reports.
• Relying on management representations.
• Exercising judgment about the adequacy of non-financial information to be disclosed.
• Setting and revising budgeting parameters.
• Estimating levels of activities.
• Developing and assessing costing methods.
• Assisting with the strategic directions of clients.
QUESTION 1.6
On the topic of Artificial intelligence, see the CPA Australia podcast: Artificial intelligence and the future
of accounting | 9 March 2018 | Episode 53.
Historically, accountants have been data specialists who collate, organise and analyse data; and those
skills will continue to be in demand. If we consider the role of the machine with respect to AI, the machine’s
role is to identify patterns in data and may not be able to understand what those patterns mean or identify
the causal relationship that may exist and from which critical learnings can be taken. Accountants, as
humans, are able to take the recognition of the pattern and make an interpretation as to why they may be
occurring or how they can be used to take a particular course of action in the future.
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QUESTION 1.7
The ‘force of law standards’ provisions are found within the Corporations Act.
QUESTION 1.8
This situation highlights the importance of implementing an appropriate system of quality control. Policies
and procedures developed by individual firms need not be complex or time-consuming to be effective.
However, APES 320 Quality Control for Firms requires firms to address each of the following elements
of a system of quality control:
• leadership responsibilities for quality within the firm
• ethical requirements
• acceptance and continuance of client relationships and specific engagements
• human resources
• engagement performance
• monitoring.
Although we have not yet studied ethics (see module 2), it is useful to assess your current understanding
of ethics. You may like to review this question and solution after completing module 2 to identify how
your study of that module changes your approach to the question. Ethical requirements are featured in the
compiled APES 110 Code of Ethics for Professional Accountants and, as we shall see in more detail in
module 2, the code addresses the fundamental principles of professional conduct:
• integrity
• objectivity
• professional competence and due care
• confidentiality
• professional behaviour.
Policies and procedures must be in place to identify and evaluate circumstances and relationships that
create threats to compliance with the fundamental principles. Appropriate action must be taken to eliminate
or reduce these threats to such a level that compliance with the fundamental principles is not compromised.
Therefore, professional accountants must identify any actual or perceived conflicts of interest, not only
between their clients but also between their clients and their employees and manage these conflicts in
accordance with any ethical requirements. The firm’s personnel already have an obligation to maintain
the confidentiality of information acquired as a result of professional and business relationships, and not
to disclose such information without authority from the client or employer unless there is a legal duty to
disclose. In this case, it would have been prudent to ensure that the employees providing bookkeeping
services were also free of any conflicts of interest.
Policies and procedures addressing the ethical requirements need to be communicated to all personnel,
reinforced by the firm’s leaders through education and training, monitored and supported by a defined
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process for dealing with non-compliance. It is important that policies and procedures that address ethical
requirements are continually reviewed and take into account changes in circumstances including staff
changes, client acquisitions and structural changes such as mergers.
The trust and confidence of clients is crucial for any ongoing professional relationship, and avoiding
conflicts of interest builds this trust. It is necessary for professional accountants to ensure that there are
appropriate policies and procedures to address their clients’ concerns and to respond to clients’ concerns.
QUESTION 1.9
This question does not require an answer.
QUESTION 1.10
The findings and decisions from CPA Australia’s Disciplinary Tribunals against CPA Australia members
are found on its website: www.cpaaustralia.com.au/about-us/member-conduct-and-discipline/outcome-of-
disciplinary-hearings. Names are not always published if, for example, there are extenuating circumstances.
QUESTION 1.11
Some SMEs seek business advice extensively from external accountants; however it is apparent that many
SMEs are not yet taking this approach. The challenge for the profession is to engage with SMEs so that the
role of external accountants as business advisers (doing far more than traditional bookkeepers, accountants
and tax return agents) is better understood by all SMEs.
IFAC (2010) identified that researchers have found ‘fortress mentality’ SME operators who simply
do not know how accountants could function as their valued business advisers. Other researchers have
identified that business advising is growing in range and quality. SMEs operated by those with a fortress
mentality need to be better informed about the range and quality of external business advice from
accountants.
IFAC also identified that, as a matter of logic, SMEs need external business advice and that change
needs to occur. IFAC demonstrated that change is occurring (for example, in the business advising role of
in-house accountants) and that more change is needed. It is apparent that external accountants must learn
how to better communicate with clients and ensure that SMEs with no in-house accountants do not suffer
by not having access to good business advice. External accountants must learn to depict their role team
players with those who manage SMEs and ensure that their role in value creation is understood.
The following summary explains how IFAC (2010) discussed the issue.
Some owner-managers want to ‘go it alone’ rather than expose their problems to outsiders, depicting
this as a ‘fortress enterprise’ mentality. Owners displaying this attitude wanted to hide their weaknesses
and typically they would justify their approach by saying that outside advice was ‘irrelevant or poor.’ As
they were not using outside advice anyway — how would they know?
Other researchers have pointed out that the ‘range and quality of advice available’ in relation to business
advising from external advisers is growing. This has been a derivative of the work of external advisers
helping SMEs to meet regulatory requirements and can be seen in the increased number of advisers and
the increasing advisory skills in relation to ‘regulatory and day-to-day and strategic challenges’.
It is apparent that SMEs do require external advice because many smaller entities (much smaller than
‘André Rieu’ for example) have no internal accounting staff. Much advice has been in relation to meeting
regulatory requirements but demand is also evident in relation to business monitoring and quality control.
Importantly, IFAC states that ‘this is not merely confined to financial compliance’. While it is clear that a
compliance bias has continued, external advice and support have been sought from accountants as general
business advisers in relation to employment, health and safety, and environmental regulations.
QUESTION 1.12
From careful reading of reading 1.2, it is apparent that:
• Roel van Veggel acts as CFO and has a clear understanding of the business, its key revenue and cost
activities
• the strong accounting team that Roel built is providing assistance
• he takes control of risks, freeing André Rieu to concentrate on his music and related skills to build the
overall business
QUESTION 1.13
The four issues raised are:
• incentives to manipulate or misstate accounting information
• lack of auditor independence
• poor audit quality
• too much flexibility and loopholes in reporting practices.
One overarching reason that the profession may lose credibility from these problems is they can all be
linked to members of the profession acting in a self-interested way that ignores serving the public interest.
Another reason is linked to the interpretation that accountants are not as technically skilled and capable
as they claim. This is especially the case when issues of poor audit quality are raised.
Lack of auditor independence can lead many people to doubt the usefulness or worth of audits. Instead
of being perceived as a public service, audits may be seen as a waste of time and only performed to generate
extra fees for accountants.
Strategies for dealing with these issues may include more restrictive accounting standards and rules to
minimise creative accounting, and greater penalties for inaccurate financial reporting, including fines and
jail terms. Expanded disclosure requirements for accounting estimates and treatments may also be helpful.
One proposed solution for addressing auditor independence is to have auditors appointed to a particular
company by an independent body, rather than by the company itself. This should help avoid the inherent
conflict of interest that exists with the current way auditors are appointed.
QUESTION 1.14
This question does not require an answer.
MODULE 2
QUESTION 2.1
(a) Example 2.2 relates to the issue of presentation of information to avoid deception. This conflicts with
numerous requirements of the Code of Ethics, and further information about these conflicts can be
found in part C of the module. They include the fundamental principle of integrity, in relation to being
knowingly associated with a report that ‘omits or obscures information required to be included where
such omission or obscurity would be misleading’. There is also a conflict with the notion of professional
behaviour. It would be inappropriate for a member of a professional accounting body bound by this
Code of Ethics.
Example 2.3 illustrates conflict of interest. For further discussion of conflict of interest, read and
take notes on the relevant sections in the Code related to conflicts of interest for members in business
and members in practice These sections cover conflicts of interest in detail.
(b) One possible answer is that both are examples of Truth versus Loyalty. In both examples there is a
pre-existing relationship with either the employer or the clients. The accountant should look beyond
the relationship and take actions that results in a truthful outcome.
(c) Gil may consider distancing himself from the report and not having anything to do with it. A further
course of action for Gil is resignation if he believes this conduct will continue and he is convinced he
is incapable of dealing with a toxic environment.
Jane can choose to discuss the issue with her client and alert her client as to her concerns. The other
way in which Jane may deal with this is to distance herself from this behaviour by resigning because
the conduct is unprofessional.
QUESTION 2.2
The candidate is confusing the concept of egoism with utilitarianism. An ethical egoist is one who evaluates
the rightness of a proposed action by choosing a course of action that maximises the net positive benefits
to oneself. A utilitarian act or decision is one that produces the greatest benefit to the greatest number
of people.
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QUESTION 2.3
Jack is thinking about his ethical challenges in the context of egoism, which is an ethical framework that
deals with the self-interest having primacy over the overall good.
Jane takes a view looking at the rights of the parties involved in the relationship dispute and is concerned
that the former husband is taking advantage of a situation in order to lower the amount given in any
settlement to his former partner.
QUESTION 2.4
(a) The Code has been designed to stipulate what the profession across the globe believes is an appropriate
standard of behaviour for the accounting profession.
(b) The Code applies to all members of professional accounting bodies but it has specific sections providing
guidance for members in business and members in practice.
(c) Members in not for profit organisations are covered by the Code of Ethics because all members must
follow the fundamental principles and reviews their activities in accordance with the Code.
(d) R standards for rule and A stands for Application guidance.
(e) ‘Shall’ denotes something that is imperative while the other two words — ‘may’ and ‘might’ — will
reflect something a member could do based on the circumstances.
QUESTION 2.5
TABLE 2.3 Fundamental principles
Professional Competence (i) Attain and maintain professional knowledge and skill at the level required
and Due Care to ensure that a client or employing organisation receives competent
Professional Activities, based on current technical and professional standards
and relevant legislation; and
(ii) Act diligently and in accordance with applicable technical and professional
standards.
Professional Behaviour To comply with relevant laws and regulations and avoid any conduct that the
Member knows or should know might discredit the profession
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
Pdf_Folio:377
Statement Principle
One of five fundamental principles deals with implicit fair dealing and Integrity
truthfulness.
A member is required to ensure they act diligently and in accordance with Professional competence and
professional standards that apply to their work. due care
A member should not associate themselves with documents where the Integrity
member believes the content is materially false
Conduct that a reasonable and informed third party would be likely to Professional behaviour
conclude adversely affects the good reputation of the profession is conduct
that is or may be defined as conduct discrediting the profession.
Members shall avoid conduct that they know may discredit the profession. Professional behaviour
A member shall make clients, or employers aware of any limitations of the Professional competence and
services a member is providing to them. due care
Members should not be involved with the publication of information where Integrity
the presentation of information omits or obscures the true substance of
a situation.
Members shall not mislead clients or potential client with claims that Professional behaviour
misrepresent their actual qualifications or experience.
A member shall take necessary measures to ensure people working under Professional competence and
their authority are properly supervised and trained. due care
dPf_Folio:378
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
QUESTION 2.7
(a) There are a number of stakeholders in this case. Below is a list of the stakeholders and the likely impacts
on them:
– Scott London — embarrassment, public humiliation, loss of stakeholders and reputation, breach of
trust, prison and monetary fine
– KPMG, London’s former employer, who has had a former partner of the firm trading on inside or
non-public information — embarrassment to the firm, employees of the firm and clients, loss of
clientele, potential need to review existing procedures
– Accounting profession in general — ethical conduct of a senior member of the accounting profession
is subject to public scrutiny and undermines the reputation of the accounting profession
– US Securities Exchange Commission and FBI, enforcement agencies — need to devote extra
resources to investigating London’s conduct
– KPMG audit clients — inside information is used by London and clients were named in relation
to London’s trading when they had no knowledge of his conduct, or his violation of trust and
confidentiality
– New York Stock Exchange — negative impact on the integrity of trading on the securities market
generally and of trading in KPMG audit clients specifically
– Bryan Shaw — embarrassment and public humiliation
– London’s family and friends — embarrassment, public humiliation, and breach of trust
– Traders in securities of KPMG audit clients — lack of awareness that London and Shaw were trading
in securities using inside information, thus placing other securities traders at a disadvantage.
(b) Integrity (APESB Code of Ethics subsection 111). London has breached his client’s trust by disclosing
confidential information to his close friend for personal gain. London had an obligation to be honest in
his professional relationships with clients and his involvement in insider trading was dishonest conduct.
Objectivity (APESB Code of Ethics subsection 112). London’s professional judgment was compro-
mised by his conflicts of interest in relation to his securities trading and his dealings with KPMG and
audit clients.
Professional competence and due care (APESB Code of Ethics subsection 113). London may have
been technically competent in the work he performed, but he did not show due care to his clients and
KPMG, as he did not provide his services in accordance with relevant laws and regulations. Being
involved in insider trading showed a lack of due care to his clients.
Confidentiality (APESB Code of Ethics subsection 114. London traded in securities based on non-
public information obtained in his role at KPMG. The confidentiality principle imposes an obligation
on accountants to refrain from using to their personal advantage, or to the advantage of third parties
(in this case, Bryan Shaw), confidential information acquired as a result of professional relationships.
Professional behaviour (APESB Code of Ethics subsection 115). London should have complied with
the relevant laws and regulations so as to avoid any discredit to the accounting profession. His failure
to comply with the securities laws and KPMG’s internal procedures has indeed brought discredit to it.
It can be concluded that London placed his own self-interest ahead of his duties to the audit clients,
KPMG, the securities market and the accounting profession.
QUESTION 2.8
The importance of the selected sections can be summarised as follows.
• The exercise of professional judgment is an important part of the work of an accounting. Paragraphs
R120.5–120.5 A4 deal with how a member should view the exercise of professional judgment.
• Paragraphs R120.9–120.9 A2 alert accountants that new facts and circumstances need to be allowed for
in the context of decision making.
Pdf_Folio:379
QUESTION 2.9
TABLE 2.5 Threat categories
Definition Threat
The threat that a Member will be deterred from acting objectively because of actual or Intimidation
perceived pressures, including attempts to exercise undue influence over the Member.
The threat that a Member will promote a client’s or employing organisation’s position to Advocacy
the point that the Member’s objectivity is compromise.
The threat that a Member will not appropriately evaluate the results of a previous Self-review
judgement made, or an activity performed by the Member, or by another individual
within the Member’s firm or employing organisation, on which the Member will rely when
forming a judgement as part of performing a current activity
The threat that a financial or other interest will inappropriately influence a Member’s Self-interest
judgement or behaviour.
The threat that due to a long or close relationship with a client, or employing organisa- Familiarity
tion, a Member will be too sympathetic to their interests or too accepting of their work.
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
QUESTION 2.10
TABLE 2.6 Examples of threats — accountants in business and accountants in public practice
Self-interest
Intimidation
Self-review
Familiarity
Advocacy
Circumstance
Members in Business
A Member holding a financial interest in, or receiving a loan or guarantee from the ✓
employing organisation.
A Member being responsible for the financial reporting of the employing organi- ✓
sation when an Immediate or close family member employed by the organisation
makes decisions that affect the financial reporting of the organisation.
A Member being offered a gift or special treatment from a supplier of the employing ✓
organisation.
dPf_Folio:380
A Member being threatened with dismissal from a client engagement or the Firm ✓
because of a disagreement about a professional matter.
An audit team member having a long association with the audit client. ✓
A Member quoting a low fee to obtain a new engagement and the fee is so low that ✓
it might be difficult to perform the professional service in accordance with applicable
technical and professional standards for that price.
A Member having prepared the original data used to generate records that are the ✓
subject matter of the assurance engagement.
A Member being informed that a planned promotion will not occur unless the ✓
Member agrees with an inappropriate accounting treatment.
A Member having accepted a significant gift from a client and being threatened that ✓
acceptance of this gift will be made public.
A Member feeling pressured to agree with the judgement of a client because the ✓
client has more expertise on the matter in question.
Source: APESB 2018, APES 110 Code of Ethics for Professional Accountants (including Independence Standards),
www.apesb.org.au/uploads/standards/apesb_standards/23072019020747_APES_110_Restructured_Code_Nov_2018.pdf.
QUESTION 2.11
Toby has a self-interest threat and it would be inappropriate for Toby to provide advice to the client. One
way of dealing with this threat to fundamental principles is for Francis to take on the client engagement.
QUESTION 2.12
The company can consider the fundraising proposal but Celia has a conflict of interest because she is on
the management committee. It is possible that there is a familiarity threat and self-interest threat present in
the situation. The board of the company should consider the fundraising matter without Celia in the room.
Pdf_Folio:381
QUESTION 2.14
Toby must consider whether the hospitality is likely to compromise the work he does and also how his
work is perceived. When in doubt, it is best to not accept hospitality except in circumstances where it
is insignificant.
QUESTION 2.15
The invitations to lunch and dinner pose a familiarity threat irrespective of whether the inducement is
intended or not intended to influence the tendering process. Both independence in appearance and in fact
are needed.
QUESTION 2.16
(a)
TABLE 2.15 Guidance for managing non-compliance
Steps for Audits (paras. R360–360.28 A1) Steps for professional services other than audits
(paras. R360.29–360.40 A1)
3. Determine if further action is needed 3. Communicate with the entity’s external auditor
(b) It requires a member to make a decision as to whether the imminent breach warrants immediate action
in terms of reporting. Paragraph R260.22 provides further guidance on this matter.
QUESTION 2.17
An accountant is required to ‘act in the public interest’ (para. 100.1 A1). This would require Kath to act
in the interest of the client’s employees and report the client’s non-compliance with laws and regulations
in a timely manner.
Kath has been responsible for managing the client’s payroll for three and a half years so should be
aware of the outcome of the regulator’s payroll audit three years ago. Kath has an obligation to provide
professional competence and due care to her clients (subsection 113). DDV Accounting was informed of
the regulator’s findings and provided with information about the legal labour rates and conditions that apply
in the jurisdiction. Kath, an accountant with DDV Accounting, therefore has a duty to provide professional
competence and due care to ensure her client updated their payroll records and were paying their employees
at the correct rates.
Pdf_Folio:382
QUESTION 2.19
The motto of the profession is ‘integrity’ and as such accountants have long been trusted to assure the
community of reliable and accurate financial information. According to this view, integrity underpins and
supports high-quality information for the efficient functioning of capital markets. Consequently, people
who rely on the services provided by accountants expect those accountants to be highly competent and
objective. Therefore, those who work in the field of accounting must not only be well qualified but must
also possess a high degree of integrity.
Promoting integrity within the profession through leadership, policies, information and culture will in
turn produce desirable behavioural attributes in accountants, such as honesty, fairness, a commitment
to others and compliance with relevant laws and regulations. Only then will the profession reduce the
incidence of accounting failures. To this end, integrity is intrinsically linked to trust, which is vitally
important to the reputation of individuals, reporting entities and the profession. Without trust, the work of
accountants would be ignored. Integrity and trust are also linked to the public interest ideal, which obliges
accountants to advance the interests of the public before the interests of others. This duty is mandatory and
applies without exception.
QUESTION 2.20
(a) The Code of Ethics states that, in connection with marketing of professional service, a member in
public practice ‘shall be honest and truthful’. James Chan is not an expert in the assurance of elder
care services and advertising himself as such is false, misleading and deceptive. This is a self-interest
threat to the principles of professional care and due diligence and professional behaviour.
(b) His traditional audit skills will not enable him to provide high-quality elder care assurance services
without proper training in this area. If he wishes to proceed, he should get the requisite expertise or
hire or contract staff with the required expertise.
QUESTION 2.21
(a) The threat concerned is an intimidation threat.
(b) The junior accountant should refuse to pay the invoices and, if required, see another senior manager to
report the conduct concerned.
QUESTION 2.22
The APESB Code of Ethics, including NOCLAR, does not impose a responsibility on accountants in
business to actively look for any non-compliance with laws and regulations. However, accountants need
to respond to any actual or suspected non-compliance when they encounter it or are made aware of it.
Accountants who have management responsibilities or are accountants of the governance team must ensure
that the activities of the employing organisation are carried out in accordance with applicable laws and
regulations (para. 360.10).
The Code does not impose a responsibility on accountants to know laws and regulations that are
not related to their responsibilities or those laws and regulations that are not required to be known to
competently perform their roles. The principle of professional competence and due care (subsection 113)
requires accountants to maintain professional knowledge and skill required so that they perform their
Pdf_Folio:383
QUESTION 2.23
The definition of independence in the Code of Ethics has two parts. The first part relates to independence of
mind. Can the professional conducting the audit say that they only have their professional judgment about
the fact pattern before them in mind? The second part of the definition relates to whether the perception
of independence is compromised by any actions or relationships an auditor may have.
The two fundamental principles that independence ultimately concerns are objectivity and integrity.
QUESTION 2.24
Do you have a direct or indirect material financial interest in a client or its Objectivity
subsidiaries/affiliates?
Do you have any outside business relationship with a client or an officer, Objectivity, confidentiality
director or principal shareholder having the objective of financial gain?
Do you owe any client any amount, except as a normal customer, or in Objectivity
respect of a home loan under normal lending conditions?
Do you have the authority to sign cheques for a client, or make electronic Objectivity
payments on their behalf?
Are any billings delinquent for clients that are your responsibility? Objectivity
Have you received any benefits such as gifts or hospitality from a client, Objectivity, professional behaviour
that are not commensurate with normal courtesies of social life?
QUESTION 2.25
There are circumstances in which non-audit services may threaten the integrity or the objectivity of
an external financial statement audit. Non-audit services may create self-review threats if the output of
the services becomes subject to audit. Other services may also create a self-interest threat because the
additional revenue may be something the firm may be reluctant to lose, Parts 4A and 4B of the Code
identify various threats and how a practice may introduce safeguards in certain situations.
QUESTION 2.26
(a) The culture of an organisation may be formally expressed through written policies and codes of
ethics, or may be informally expressed through the words and actions of significant others such as
the organisation’s leaders. If the culture is strong and supports high ethical standards, it should have a
powerful and positive influence on employees’ behaviour. Generally, the more ethical the culture of
an organisation, the more ethical employee behaviour is likely to be.
The firm had undergone significant change during the 1980s and 1990s. Arthur Andersen became
a business that focused on financial gains at the expense of its third-party obligations. This focus on
self-interest was also evidenced by the firm’s behaviour in relation to the document shredding.
(b) Audit firms such as Arthur Andersen traditionally provided to their audit clients a range of non-audit
services that were consistent with their skills and expertise. The provision of non-audit services (which
include all fees that do not constitute audit services) to assurance clients is an activity that often provides
additional value for an audit client. Consequently, audit clients benefit from the non-audit services
provided by their audit firms, who have a good understanding of the client’s business.
Pdf_Folio:384
QUESTION 2.27
The culture of such wholesale referral, and doing so to a select number of firms, itself represents a potential
violation of the Code of Ethics. Paragraph AUST R330.5.2 states that ‘A Member in Public Practice shall
not receive commissions or other similar benefits in connection with an Assurance Engagement.’ Referral
fees may fall within the intent of this section. If it does there is a possible self-interest threat to compliance
with the principles of objectivity and professional competence and due care.
Also of concern is what could possibly be called an intimidation threat to Jerry. The lack of choice
afforded to Jerry in making these referrals, by the workload and punitive culture, implicates him in the
potential violation. Furthermore, in referring clients to the specialist firms in this complete and wholesale
fashion, Jerry is unable to maintain an ongoing relationship with the client. The pressure placed on
employees such as Jerry through the high workload means insufficient time and knowledge are applied
either to the client or to the referral. This may well lead to Jack being in breach of the fundamental principle
of professional care and due diligence.
QUESTION 2.28
There are many factors that may cause an employee to compromise their personal ethical standards.
Although the ethical culture of the firm is a primary influence, there are many other factors (supporting or
countering the existing culture) that could influence behaviour. The list is not exhaustive. You will find that
a careful examination of your own corporate environment and discussion with colleagues in business will
highlight numerous other factors. The intention here is to highlight some of the major and more obvious
influences on personal behaviour, which include the following.
• Tight or unrealistic targets cause pressure to cut corners and therefore quality.
• Remuneration or reward systems often overemphasise profit-oriented bonuses, causing actions that
focus on profit maximisation — possibly at an ethical cost.
• The ethical culture of an organisation creates an environment that condones questionable acts.
• Top management — through its management style — sets the tone for inappropriate behaviour.
• A lack of explicit rules defining acceptable behaviour (such as a code of conduct) or, alternatively, codes
that are not enforced may result in instances of inappropriate behaviour.
QUESTION 2.29
The notion of trust in the professional–client relationship is fundamental to the concept of professionalism.
Without public trust, the status of the accounting profession would be reduced considerably. Unfortunately,
the actions of a questionable few can affect the reputation of the entire profession. For this reason, it is the
aim of the profession to maintain a proper ethical image. This is possible by informing and reminding
Pdf_Folio:385
QUESTION 2.30
Law generally codifies society’s customs and values, and undoubtedly any changes to law are reflections of
changes in society’s attitudes. But it is wrong to suggest that legal compliance will amount to satisfactory
ethical conduct. Generally, it will be more accurate to claim that legal compliance sets the minimum
standard for ethical conduct, implying that the standard of ethical conduct is higher than that expected
from the law. The real dilemma, for which there is no easy solution, is to what extent is moral conduct
higher than legal conduct? Similarly, breaking the law does not necessarily mean conduct is immoral. The
law in question could be outdated or simply wrong.
QUESTION 2.31
Gifts are a common practice for companies operating internationally. The problem for many companies
and their accountants is that gifts can influence business behaviour, giving rise to possible conflicts. In
some cultures, gift giving and receiving are simply expected. For an ethical relativist, there is no universal
standard of right or wrong but only the standard of a particular society. The problem for many people is that
they may feel constrained to accept such practices while knowing or feeling that they are unacceptable.
The decision to accept or reject the gift is a difficult issue. Refer to the guidelines provided in the Code
to help you make a decision. You have a number of options available to you, such as informing your
superiors or referring to company policy for guidance. In general, it is normally the size of the gift and the
intention of the giver that determines whether it is unethical. In this case, the intention appears honourable;
therefore, it is the size of the gift that will determine whether you should reject the gift. Company policy
will normally provide guidance in this area.
If the gift is deemed to be of considerable value, then it must be returned. A thank you note with an
explanation will ease any potential ill feelings. Nowadays, with the extent of trade internationalisation,
business people worldwide are well informed on the courtesies of gift giving and receiving.
QUESTION 2.32
A solution has not been provided for this question.
QUESTION 2.33
To apply this model we ask four questions:
1. Do the benefits outweigh the harms to oneself?
In this case, the benefits of lower cost production combined with equivalent quality provide benefit,
although potential harm linked to poor reputation must be considered.
2. Do the benefits outweigh the harms to others?
Benefits to others include employment that may not otherwise be available. The harms include poor
working conditions and significant danger from fires, for example, which have had a devastating impact
in Bangladesh.
3. Are the rights of individual stakeholders considered and respected?
Despite compliance with local regulations, it is possible that the rights of Delta Ltd’s employees are not
being fully respected. The pressure to have lower costs and lower prices may have led to compromises in
factory design and to working conditions that fail to respect these rights.
4. Are the benefits and burdens justly distributed?
The main benefits appear to accrue to the managers of Alpha Ltd and also to the managers of Delta Ltd.
The employees of Delta Ltd will also benefit from salary and wages, but the burden they bear may not be
justly distributed. The rightful benefits of some of these employees may be reduced in order to provide
additional benefit to other stakeholders—for example, lower prices for customers.
Pdf_Folio:386
QUESTION 2.34
1. Do the benefits outweigh the harms to oneself?
Considering the question from Jacqueline’s perspective, the benefits of following Paul’s recommendation
would outweigh the harms to herself. If she follows his recommendation she will garner his approval,
and ensuring the viability of the company would aid her chance of tenure, whereas going against his
recommendation would threaten the company’s viability and may draw managerial censure. As she was
involved in no direct or official way in the agreement, there is no formal record of her involvement should
the manipulation be exposed, and so she bears no formal liability.
2. Do the benefits outweigh the harms to others?
The benefits of Jacqueline abiding by Paul’s recommendation would accrue to DIGFX—its management,
employees and shareholders—by ensuring DIGFX’s viability. This would also benefit their suppliers and
their other clients in maintaining contracts of supply, as well as NovaTech.
The chief cost is a loss of tax revenue, affecting government finances and those that draw benefit from
them (the general public).
It could be argued that the direct and considerable benefits to the stakeholders of DIGFX and NovaTech
outweigh the indirect and minimal costs to the general public.
3. Are the rights of individual stakeholders considered and respected?
The rights of investors are not being respected insofar as the recommendation would require falsification
of financial reporting, compromising transparency and hence an investor’s right to transparent and correct
information. This is not, however, to say their interests have not been respected, as they have an interest in
its viability.
The rights of employees have not been clearly violated unless it can be established that they have a right
to know the details of all relevant financial deals made by the company, which it generally cannot unless
the employees have some representation on the board.
The rights of suppliers, clients and competitors can all be said to have been respected, for similar reasons
to those of employees, in the absence of any case to suggest that they had a right to consultation in the
managerial decisions of DIGFX.
The rights of the government, and via them the elective community, have not been respected, as they
have been deceived out of the benefit of the appropriate amount of taxation.
4. Are the benefits and burdens justly distributed?
The benefits and burdens would not be justly distributed, as the potential benefits are accruing to one set of
stakeholders while the costs are accruing to a separate set of stakeholders. Hence one group of stakeholders
(the government and, through them, the community) is being exploited for the benefit of DIGFX’s other
stakeholders.
What would you do if you were Jacqueline?
Jacqueline has a responsibility under Part A of the Code of Ethics to act with integrity, objectivity, and
professional competence and due care. She has demonstrated that she has acted ethically by researching
her concerns and reporting them to her supervisor, the CFO.
Jacqueline also has a duty to act ethically under Part 2 of the Code of Ethics — Members in Business.
This part advises accountants working in business on their responsibilities with preparation and reporting
of information (s. 220), acting with sufficient expertise (s. 230), and responding to non-compliance with
laws and regulations (s. 260).
Non-compliance comprises ‘acts of omission or commission, intentional or unintentional, which are
contrary to prevailing laws or regulations’ (para 360.5 A1). These acts can be committed by:
(a) A client;
(b) Those Charged with Governance of a client;
(c) Management of a client; or
(d) Other individuals working for or under the direction of a client (para. 360.5 A1).
Pdf_Folio:387
QUESTION 2.35
The following points should be noted when applying the AAA model.
1. What are the facts of the case?
Davis has to confront a possible conspiracy by those senior to him in the organisation (aided and abetted
by the external auditors to present an inaccurate picture). Booker was apparently a successful family firm
that was taken over by a larger company. Davis was asked to stay in his position with the subsidiary but
would now have to report to the senior management of Booker and the parent company.
At the time of the takeover, Davis considered that the fixed assets were assigned their fair market value
and that the purchase price included $450 000 for goodwill. The figures seemed reasonable. Later, the end
of financial year consolidated financial statements for 2019 did not show the $450 000 as goodwill; instead
the entry had been used to raise the overall value of fixed assets. The auditors had rendered an opinion
lacking requisite detail.
The parent company stood to gain from ‘cooking the books’ in its negotiations with the unions. Union
claims were based on company profits, which were reduced because the depreciation charges for the assets
exceeded the amortisation charge for the goodwill.
2. What are the ethical issues in the case?
(a) Who are the stakeholders? The ethical issues will most likely arise out of conflicting interests between
and among the stakeholders. The stakeholders can be listed as follows.
– Davis — he has knowledge of the accounting manipulation and feels he has an obligation to act on
this information.
– Shareholders or owners — accounting adjustments can affect the share price, profit and balance
sheet figures, all of which affect shareholder wealth and investment decisions.
– Unions — they use net profit as a basis for negotiating wage levels, so reduced profit from the
accounting adjustment will affect their bargaining position.
– The CEO of the parent company — he or she is ultimately responsible for the fair presentation of
the financial reports; in this case, the CEO will ultimately be held accountable for the manipulation
or may, in fact, be the instigator.
– The external auditors — they have signed off on the accounts that are potentially misleading.
(b) What are the ethical issues? Most of these concern Davis’s integrity, namely:
– his integrity versus his job security
– his integrity versus his loyalty to the firm
– his integrity versus the reputation of the external auditors
– his integrity versus the reputation of the parent company’s CEO
– the company’s financial health versus the unions’ right to information.
An ethical issue or dilemma arises when there are two or more equally compelling courses of action
without clear resolution. The conflict could involve two or more obligations, duties, principles, rules or
loyalties. But irrespective of the nature of the conflict, the two principles, duties and so on, contradict each
other. Similarly, each alternative has negative and positive outcomes, and choosing one alternative will
come at the expense of the other.
In this case, Davis’s integrity is at odds with his self-interest and the interests of the company as well as
with external parties such as the shareholders and the union. In brief, if Davis remains silent, he protects
his self-interest, but this comes at a cost to the unions and shareholders (who act according to diminished
information) and to his own integrity. If Davis acts on this information, he protects his integrity but it
may disadvantage his career. Each alternative Davis faces produces negative and positive outcomes and
supports different principles.
3. What are the norms, principles and values related to the case?
Here we are obviously concerned with integrity. We are also concerned with ethical concepts such as
obligation, rights, justice and harm. The following items appear relevant to our analysis:
• integrity
• fairness in dealing with the unions
• doing no harm and trying to prevent harm being done to the various stakeholders
Pdf_Folio:388
QUESTION 2.36
1. What are the facts of the case?
The projected estimates for future revenues of the Deep Vein mine are probably inaccurate, overstating the
investment’s worth. The inaccuracy is being knowingly maintained in the financial reports of Millennial,
and in this fashion, it is deceiving its investors. In addition to this, the investment is in contradiction to
the principles of investment articulated by Millennial’s CFO. Jenna is being pressured to conceal the
inaccuracy via intimidation, or the implication of intimidation.
2. What are the ethical issues in the case?
(a) Who are the stakeholders? The principal stakeholders are:
– Millennial’s management
– Millennial’s employees
– Millennial’s investors
– Deep Vein’s proposed operators (depending on the investment of funds such as Millennial)
– rival investment funds (less direct stakeholders).
(b) What are the ethical issues? These are:
– the deliberate deception of investors regarding investments by Millennial
– the failure to act in accordance with stated business objectives and managerial decisions
– the intimidation of staff to maintain deception and prevent disclosure.
3. What are the norms, principles and values related to the case?
This case relates to several of the fundamental principles of the APESB Code of Ethics, and to the normative
values expressed in several of the ethical theories discussed in part B.
Fundamental principles of the Code:
• Subsection 111 — Integrity — in particular paragraph R111.2, which specifies that:
A Member shall not knowingly be associated with reports, returns, communications or other information
where they believe that the information:
(a) Contains a materially false or misleading statement;
(b) Contains statements or information furnished recklessly; or
(c) Omits or obscures information required to be included where such omission or obscurity would be
misleading.
• Subsection 113 of the Code — Professional competence and due care — in particular the obligation
of due care requiring that accountants ‘act diligently in accordance with applicable technical and
professional standards’ (para. R113.1 (b)).
• Subsection 115 of the Code — Professional behaviour — in particular the requirement to ‘comply with
relevant laws and regulations and avoid any conduct that the Member knows or should know might
discredit the profession’ (para. R115.1).
Values articulated in the ethical theories:
• Egoism — the emphasis on satisfying self-interest relates to the consequences of Jenna’s decision for
herself.
• Utilitarianism — the emphasis on satisfying the interests of the greatest number affected by the action
relates to the consequences of Jenna’s decision for all relevant stakeholders.
• Ethics of duties (deontology) and ethics of rights both apply, and work reciprocally. Investors and
potential investors have a contractual right to know the state of the company’s finances, and the company
has a contractual duty to provide this information.
4. What are the alternative courses of action?
Jenna could:
(a) prepare the report as recommended incorporating Deep Vein’s estimates
(b) disclose the probable value of the investment (including her revised estimates)
(c) consult with someone in senior management, perhaps notifying the CFO, given the proposed invest-
ment’s conflict with his stated objectives.
Pdf_Folio:390
MODULE 3
QUESTION 3.1
A company is deemed to be a small proprietary company if two of the following three criteria are met.
• The consolidated gross operating revenue for the financial year of the company and any entities it
controls is less than $25 million.
• The consolidated gross assets of the company for the relevant financial year is less than $12.5 million.
• The company has fewer than 50 employees.
A proprietary company would be deemed to be large if:
• the consolidated gross operating revenue for the financial year of the company and any entities it controls
is more than $25 million
• the consolidated gross assets of the company for the relevant financial year is more than $12.5 million
• the company has more than 50 employees.
QUESTION 3.2
No solution is provided. Candidates are to use the ASIC information to self-assess.
QUESTION 3.3
(a) and (b) You should have downloaded the two documents and your answer may include the observations
below. Similarities and differences are shown in the following table.
Excerpts
Box 2.3 from the ASX Corporate
Governance Council Principles and Provision 10 of the Financial Reporting
Recommendations Council Code Comparison
• is, or has been, employed in an • is or has been an employee of the Similar, but the FRC
executive capacity by the entity or any company or group within the last five Code specifies a
of its child entities and there has not years period of 5 years
been a period of at least three years versus the ASX
between ceasing such employment Principles of 3 years.
and serving on the board
• receives performance-based • has received or receives additional Similar, but the FRC
remuneration (including options remuneration from the company apart Code extends criteria
or performance rights) from, or from a director’s fee, participates to include pension
participates in an employee incentive in the company’s share option or a scheme.
scheme of, the entity performance-related pay scheme, or
is a member of the company’s pension
scheme
• is, or has been within the last • has, or has had within the last three Similar, but the FRC
three years, in a material business years, a material business relationship Code extends the
relationship (e.g. as a supplier, with the company, either directly or relationship to include
professional adviser, consultant or as a partner, shareholder, director or cross directorships
customer) with the entity or any of senior employee of a body that has with respect to other
its child entities, or is an officer of, or such a relationship with the company entities.
otherwise associated with, someone • holds cross-directorships or has
with such a relationship significant links with other directors
through involvement in other
companies or bodies
Pdf_Folio:392
• has close personal ties with any person • has close family ties with any of the Similar.
who falls within any of the categories company’s advisers, directors or senior
described above employees
• has been a director of the entity for • has served on the board for more than Similar, but the FRC
such a period that their independence nine years from the date of their first Code specifies a
from management and substantial appointment. Where any of these or time period as a
holders may have been compromised. other relevant circumstances apply, factor which impacts
and the board nonetheless considers independence.
that the non-executive director is
independent, a clear explanation
should be provided.
(c) The ASX Corporate Governance Council recommends that the tenure of board members that have
served more than 10 years be assessed regularly to ensure that they still meet the definition of
independence.
QUESTION 3.4
The Small Business Guide in the Corporations Act 2001 (Cwlth) states that the company secretary
has specific responsibilities under the Corporations Act, including responsibility for ensuring that the
company:
• notifies ASIC about changes to the identities, names and addresses of the company’s directors and
company secretaries
• notifies ASIC about changes to the register of members
• notifies ASIC about changes to any ultimate holding company
• responds, if necessary, to an extract of particulars that it receives and that it responds to any return of
particulars that it receives.
QUESTION 3.5
TABLE 3.4 Shareholder powers
136 By special resolution the power to adopt, modify, or repeal a constitution or parts thereof.
162 By special resolution the power to change the company to a different type.
173(2) The right to inspect or get copies of member, option holders, or debenture holder registers.
234 Power to apply to the Court for orders under s. 233 (which includes winding up of the
company)
246B If the constitution does not exist or doesn’t set out a procedure the power by special
resolution to vary or cancel class rights.
251B Power to request access to minutes of member meetings (they may need to pay for copies)
(continued)
Pdf_Folio:393
314 and 316A The right to a financial report, directors’ report and an auditor’s report.
327B and 329 The right to vote at an AGM on the appointment of an auditor.
QUESTION 3.6
Conflict of interest is a major issue that arises when an agent receives delegated powers. The agent is
required to act in the best interests of the principal. However, the temptation to act for the agent’s own
interest is strong, as agents have significant power and often control the flow of information, and there
may be little chance of getting caught.
QUESTION 3.7
Agency theory recognises that agents may do all they can to show loyalty (and, therefore, agents accept
the costs of bonding). No matter how well bonded an agent may be, it is a fact that the agent is not the
principal and will not act in the same way and will not reach the same outcomes as the principal. Insofar
as the agent does not achieve what would have been achieved by the principal, this is termed ‘residual
loss’. It will possibly arise because of deliberate (self-seeking) actions by the agent or unintentionally, by
mistake or by simply not understanding the principal’s goals. Whatever the final cost, we can describe the
non-congruence of goals between agent and principal as the key to understanding residual loss.
The existence of agency relationships means that there is a need to monitor activity so that residual loss
is identified and then can be further explored to rectify problems arising from lack of goal congruence
between the agent and principal. This means that there will always be monitoring costs. The law, for
example, demands financial audits and full public reporting as part of monitoring. Aside from legally
required monitoring, there are many ways in which monitoring can be carried out and, therefore, a vast
array of ways in which monitoring costs will be incurred.
Residual loss and monitoring costs are both borne by the principal and, as they are paid out of the
company’s resources, will clearly result in a diminution of the company’s value.
QUESTION 3.8
(a) Information asymmetry refers to the differential of knowledge or information that two parties to a
transaction possess. A simple example is the parties involved in buying a second-hand vehicle. In
most cases the sales person will have more knowledge of the vehicles that they are selling than the
buyer does.
Moral hazard describes the situation where one party takes action (often considered risky) knowing
that other party will bear the risk and any associated costs. This is often the result of information
asymmetry.
(b) Where information asymmetry exists, there is potential for:
– poor decisions being made because complete information may not be available to the party making
the decision
– ‘sneaky’ risky actions being taken because the party taking the action knows that they will not be
‘found out’ and, if they are, they will not bear the risk or the consequences.
Within a company, information asymmetry may exist between the following parties:
– boards and members
– management and boards
– employees and management.
QUESTION 3.9
Note that there is not always a clear distinction for each category. For example, budgeting is a useful tool
in achieving improved performance, but it also provides a useful conformance and control mechanism to
ensure resources are effectively managed and monitored.
Pdf_Folio:394
• Taking steps designed to protect the company’s • Determining the company’s vision and mission.
financial position and its ability to meet its debts and
other obligations as they fall due.
• Adopting clearly defined delegations of authority from • Reviewing opportunities and threats to the company
the board to the chief executive officer (CEO) or in the external environment, and strengths and
a statement of matters reserved for decision by weaknesses within the company.
the board.
• Ensuring systems are in place that facilitate the • Considering and assessing strategic options for the
effective monitoring and management of the principal company.
risks to which the company is exposed.
• Determining that the company has instituted • Adopting a strategic plan for the company, including
adequate reporting systems and internal controls general and specific goals, and comparing actual
(both operational and financial) together with results with the plan.
appropriate monitoring of compliance activities.
• Establishing and monitoring policies directed at • Adopting an annual budget for the financial
ensuring that the company complies with the law performance of the company and monitoring results
and conforms to the highest standards of financial on a regular basis.
and ethical behavior.
• Determining that the company accounts conform • Agreeing on performance indicators with
with Australian Accounting Standards and are true management.
and fair.
• Determining that satisfactory arrangements are in • Selecting and, if necessary, replacing the CEO,
place for auditing the company’s financial affairs and setting an appropriate remuneration package For
that the scope of the external audit is adequate. the CEO, ensuring adequate succession plans
are in place for the CEO, and giving guidance on
the appointment and remuneration of other senior
management positions.
• Selecting and recommending auditors to • Adopting formal processes for the selection of
shareholders at general meetings. new directors and recommending them for the
consideration of shareholders at general meetings,
with adequate information to allow shareholders to
make informed decisions.
• Ensuring that the company has in place a policy that • Reviewing the board’s own processes and
enables it to communicate effectively with effectiveness, and the balance of competence on
shareholders, other stakeholders and the public the board.
generally.
Source: Adapted from Bosch, H 1995, Corporate Practices and Conduct, 3rd edn, Pitman, Melbourne, p. 9. Reproduced with
permission.
QUESTION 3.10
Usually, the expected benefits of audit committees include:
• improving the quality of financial disclosures
• acting as a forum for the resolution of disagreements between management, the internal auditor and the
external auditor
• ensuring that an effective whistleblower system is in place.
The Enron audit committee failed to achieve these desired outcomes. Possible reasons why they were
not obtained can be linked to the limitations of audit committees, which include:
• committee members may have been selected because of their association with the CEO or chair, thus
reducing their real independence
• audit committees may have been formed as a means of giving the appearance of good corporate
governance without achieving any useful purpose for the organisation.
Pdf_Folio:395
QUESTION 3.11
Full disclosure is the foundation upon which the integrity of equity markets is built. Without an equal
sharing of available information, investors who are informed will have an advantage over those who are
not. This can lead to exploitation of uninformed shareholders, and the growth of equity markets would be
inhibited by the resulting lack of confidence. As equity markets mature, there is an increasing emphasis
on full and continuous disclosure which modern communication technologies facilitate.
Essentially, markets are built upon trust. Once this trust is damaged, such as when it is revealed that
privileged groups have monopolised information for their own benefit, it is very difficult to rebuild trust.
Therefore, full disclosure and transparency are not only the practical mechanisms by which markets operate
efficiently, they are the central ethical principles of markets.
QUESTION 3.12
Internationally, there is a clear correlation between market failure and corporate collapse with renewed
interest in review commentary and extension to regulations. It is only natural when investors have
lost considerable amounts of money that attention is given to the viability of regulatory systems.
However, as corporate governance is about wealth generation and risk management, these duties require
continuous and simultaneous performance. Avoiding mandatory restrictive over-regulation requires active
market regulation, particularly at times of expansion. The drive to make corporations improve corporate
performance and governance, and enhance corporate accountability needs to continue as an essential part
of building sustainable economies and enduring companies.
QUESTION 3.13
The market-based system of corporate governance has the following strengths:
• dispersed ownership and strong institutional investors
• primacy of shareholder interests in company law
• emphasis on protection of minority shareholder interests in law and regulation
• stringent requirements for disclosure
• fluid capital investment in dynamic economy
• competitive performance.
The weaknesses of a market-based system of corporate governance include:
• overly dominant and overpaid CEOs
• weak boards of directors
• failures in reporting and transparency
• short-term investment
• instability of governance and investment
• cyclical volatility in a dynamic economy.
Pdf_Folio:396
QUESTION 3.15
The benefits of the family-based insider system of corporate governance practised in Asia are as follows.
• Flexibility and dynamism contribute to rapid economic growth.
• Unity of ownership and control eliminates principal/agent problems.
• Investors can support successful management teams and companies.
• Interlocking networks of subsidiaries and sister companies create commercial strength and capability.
• Understanding of customary practices generates a sense of purpose and cohesion.
• It has strength and stability of tradition.
The costs of the family-based insider system of corporate governance are as follows.
• Minority shareholders can be persistently neglected.
• Dominant shareholders, through pyramidal structures, acquire control of operations and/or cash flow
disproportionate to their equity stake in the company.
• The independence and diligence of boards of directors can be called into question.
• Standards of disclosure and transparency are minimal.
• Regulators are unable to act because of poor information and access.
• Weak courts make the enforcement of contracts problematic.
QUESTION 3.16
Sub-principle G states that minority shareholders should be protected from abusive actions by controlling
shareholders. However, sub-principle A4 states that basic shareholder rights include participating and
voting in general shareholder meetings.
There may be times when the majority of the organisation’s shareholders want a particular event to
occur, but this may be perceived to go against a small minority who do not want this to happen. The
minority may view this as an abusive action, while the majority may regard it as a legitimate business
transaction.
An example where this may arise is when a company votes on a significant issue, such as an equity
raising that dilutes current shareholdings, or a sale of a major component of the business, or a significant
change in strategy. In this situation, the intention of the action becomes important — it will generally be
permissible if it is done for the benefit of the company as a whole, with no intention to deliberately hurt
the minority. The law in this case becomes complex.
QUESTION 3.17
These three actions all create issues in relation to the OECD Principles (OECD 2015).
1. There are no independent board members, therefore the composition of the board of directors does not
appear to satisfy Principle VI, Item E1, which states that ‘boards should consider assigning a sufficient
Pdf_Folio:397
QUESTION 3.18
All references below are to the FRC Code (FRC 2018).
(a) The audit committee is responsible for reviewing the company’s internal controls (Provision 25).
(b) A formal evaluation of its own performance should be conducted by the board on an annual basis
(Provision 21).
(c) The same individual should not have the roles of chairman and chief executive at the same time
(Provision 9). One important reason for this is that the chair should be independent, which cannot
be the case if the position is held by the CEO. In addition to this, there needs to be clear separation of
duties and the avoidance of giving a single person too much power.
QUESTION 3.19
The areas in this case scenario that do not comply with the FRC Code include the following.
• The chair is not independent as required, as this director holds a significant shareholding (Provisions 9
and 10).
• At least half the board, excluding the chairman, should be independent (Provision 11). The board
currently has at least five members who are not independent (the four executives and the chair).
• There should be three independent members of the audit committee. The chair and the CFO are not
independent and the chair should not be a member of the audit committee (Provision 24).
• The company does not have a remuneration committee (Provision 32).
QUESTION 3.20
No answer is supplied for this question.
QUESTION 3.21
The challenge of public sector enterprise governance is that it is informed by a broad public service mission,
while private enterprise may focus more on the bottom line profit. That is, while the public sector enterprise
will be required to work within a budget, the definition of its mission is often broad enough to demand
careful assessment of the priorities the enterprise must pursue. Often for public sector enterprises, there is
unlimited demand for services from the public, and therefore the analysis of priorities and the assessment
of performance in meeting those priorities needs to be finally tuned.
In this context, good governance is required to deliver on the three E’s — economy, efficiency and
effectiveness. With such wide and competing economic and social objectives, the boards of public
enterprises need to build good relationships with wider stakeholders to fully understand their needs, while
engaging with government to remain fully accountable. There must be a clear delineation of the roles
and powers of government ministers and boards, and capable directors, while boards need to be given the
opportunity to do their work with responsibility and accountability, and without undue intervention from
government ministers.
MODULE 4
QUESTION 4.1
The two-strikes rule provides a new type of power to shareholders who are dissatisfied with the
remuneration report. This report, as part of the corporation’s annual report, discloses the salaries paid
to senior executives. If shareholders are unhappy, the first strike may occur at the next AGM if at least
25% of the eligible shareholders vote against accepting the remuneration report. Shareholders ineligible
Pdf_Folio:398
QUESTION 4.2
A disqualified person is not permitted to hold an office in a corporation, which includes not being permitted
to act as a director or be a senior manager. To act as an officer while disqualified is an offence and is subject
to criminal punishments.
Automatic disqualification means that the disqualified person is not necessarily informed that they
are disqualified. For example, a person involved in corporate crime, or even a non-corporate crime that
involves dishonesty and is not just a minor wrong, is most likely to be automatically disqualified because
they are criminally open to punishment. Accordingly, officers need to be aware of the possibility of
automatic disqualification if they are ever found guilty of an offence. Five years is usually the period of
automatic disqualification.
Where a court or a regulator such as ASIC orders disqualification, it will be because a legislated wrong
has occurred. This can include civil wrongs where proof is on the balance of probabilities. Periods of
disqualification are commonly up to 20 years (and sometimes more). Note that the disqualified person
is advised when the court or regulator states the outcome as an order to the relevant person. Aside from
disqualification, such orders are often in conjunction with civil or even criminal penalties.
QUESTION 4.3
(a) Ideally, independent directors are not paid any performance bonuses. They should receive only flat
payments, in accordance with an overall payment policy approved by shareholders. As such, they are
not personally influenced by levels of pay. Independent directors should not be on a board too long (as
also discussed in module 3) so that they are able to stay independent and free from external influence.
Independent directors can, therefore, make decisions that are for the good of the company as a
whole (which is a specific legal formula about the relationship between the board and shareholders)
from a more objective stance than directors who are not independent. Non-independent non-executive
(NINE) directors are less able to make unbiased decisions and certainly appear more biased to ordinary
shareholders because they have relationships that deny independence. Executive directors should not
be allowed to make decisions regarding their own remuneration.
(b) This is a difficult question to answer in detail as every corporation is different and the remuneration
committee will look at many complex factors. Below are two possible methods.
– The CEO bonus should be based on achieving a certain return on investment (ROI), or a percentage
linked to achievement above a certain ROI. Care must be taken not to allow the remuneration
incentive to overcome organisational priorities and great care must be taken to ensure that excessive
risk is not accepted in the hope that great remuneration may result.
– The bonus should be paid partly in cash to emphasise an immediate return for current performance,
and partly in share options, with perhaps a two year exercise date, to encourage the CEO to stay in
their current position and continue to build share value. After two years, the options will be worth
more and will be exercisable, giving a good reward after two years.
This approach could also apply to senior managers. The possible concepts and approaches under this
question are numerous and form a key part of the determinations of a good remuneration committee.
Pdf_Folio:399
QUESTION 4.4
A board may do many things to help ensure that the relationship between the corporation and the
external auditor is independent. One important item for which auditors are responsible is a statement
of independence that they must make to the corporation. This audit statement must be a part of the
corporation’s annual report, along with the actual audit report itself.
Apart from including the auditor’s statement of independence in the annual report, the board can consider
other important measures that will help to make independence easier to achieve. We have not looked at
every such measure but they include clearly stated policies and practical procedures which:
• ensure an independent auditor is engaged to perform the audit
• establish a correctly structured audit committee so that this body can be identified easily by the auditor
as comprising those charged with governance
• ensure that the audit committee understands that it is the body through which all audit communications
are normally expected to take place
• define the way management should behave when their activities are the subject of audit activities. This,
importantly, will also include the CEO and the CFO.
In addition, appropriate measures should be in place to ensure that employees’ interactions and dealings
with the auditor are at arm’s length.
QUESTION 4.5
(a) In examples 4.16 and 4.17 the ultimate responsibility for decision making rests with the board, therefore
the boards of both corporations were lax in allowing anti-competitive practices to go on. For example,
Intel, the largest computer chip maker in the world, used its status to stifle its competition and to
unfairly pressure customers into doing business with it. Indeed, it can be argued that the directors
breached their fiduciary duties by allowing such anti-competitive behaviour. In either case it might
be difficult to demonstrate that the board had actual or constructive knowledge of the wrongdoing to
the extent that its failure to respond to the alleged red flags was a breach of its fiduciary duties to
properly monitor corporate compliance; nonetheless, compliance oversight is a key role of the board,
so the directors should have systems in place to prevent or at least warn them of these anti-competitive
practices.
Corporate governance should ensure the constructive use of market power. Effective board oversight
of legal compliance can strengthen the corporation today and into the future, and allow it to avoid
accusations of wrongdoing with respect to domestic or global competition law. The board can be
assisted in doing this by establishing a strong and impartial ‘compliance committee’ that consists of
independent directors and by instituting appropriate compliance policies, procedures and programs.
Directors should ask themselves to what extent they are prepared to bear the negative consequences
of non-compliance. They should also check which early warning systems and processes have been put
in place for ensuring that the corporation’s practices are not anti competitive, since the impact, both in
terms of reputation and bottom line, can be extremely damaging when a corporation fails to live up to
its regulatory compliance duty.
(b) Companies form strategies to make profits, and eliminating competitors or pursuing anti-competitive
action may help achieve those profits. So, from this perspective, competition laws may stifle an
aggressive corporation’s ability to be competitive.
However, in a market driven by competition, there is always an incentive to bring about technological
advances and innovations that provide consumers with new or better-quality products and services.
As such, from the perspective of a corporation that seeks competitive advantage in a market, it can be
harmful to stifle competition in the long run as inertia (lack of change or development) can set in. The
corporation will lose its competitive edge and new entrants to the market will ultimately succeed with
new, innovative products and/or cheaper prices.
Pdf_Folio:400
QUESTION 4.6
(a) The purchasing managers of both Shark and Loose would likely be in breach of laws that prohibit
cartel conduct including this highly-visible price fixing. In addition to the purchasing managers, the
corporations themselves would also be in breach, as the actions of employees are also those of the
corporation. Notwithstanding that the purchasing managers may have been acting contrary to corporate
policy, and not informing the corporations, they are still acting on behalf of their corporation. This will
lead to the corporation also being accountable for its conduct.
(b) Potential penalties include individual jail terms and fines, and fines for the corporations, which could
be as high as USD 10 million or more (e.g. in Australia, the US and the EU). In addition to penalties,
compensation would also be payable to Goods Ltd as the affected party. Compensation may be very
large, depending on the economic damage suffered by Goods Ltd. Note that, if the misconduct is not
established as a crime proven beyond reasonable doubt, it is likely that the matter would be held as a
civil matter. The civil balance of probabilities standard of proof is easier to satisfy. While a civil wrong
does not establish a crime, it can result in a financial pecuniary penalty which may be at exactly the
same level as the criminal fine would have been.
(c) Acting alone, there would be no collusion and therefore no cartel conduct. There is simply no agreement
or understanding between competitors. Here, an individual corporation has decided to deal with a
certain customer in a certain way. This type of unilateral decision making is generally not a problem,
and on the facts stated, Shark and Loose should be safe.
QUESTION 4.7
The conduct is misleading or is likely to mislead. To make a specific statement about an objective matter
is acceptable if it is essentially correct. The problem is that there is an objective matter that has been
ignored and that makes the specific statement objectively invalid. The advice received by the beverage
manufacturer clearly states that the higher carbohydrate content is statistically insignificant with respect
to the drink’s ability to improve endurance. Ignoring this objective fact and using only that which was
favourable to the drink maker constitutes misleading conduct.
Where misleading conduct is found, a range of outcomes apply such as; compensation orders,
injunctions or adverse publicity orders.
QUESTION 4.8
Financial market protection rules apply to everyone who breaches a market protection rule. To break the
rule, you do not need to be a director, an employee or an accountant — merely a person who breaks a
rule that applies to you as a person meddling with the market. If a director is involved, which is common
because they often hold secret market sensitive information, then they also may easily breach other laws
relating to directors’ duties.
It is clear that:
• Paroo has information (knowledge of the takeover bid)
• the information has not been disclosed and is not readily available in the market
• the information will have a material impact on the share price once it is released.
The information about the takeover is therefore inside information. Paroo is not permitted to act upon
this information or disclose it. By purchasing shares, Paroo has engaged in insider trading, deliberately
using knowledge not known to the market in order to acquire shares at a price that would encourage others
to buy those shares had they been privy to the information.
Paroo has also misused her position as a director and has misused information gained as a director. She
has also not acted in good faith in the best interests of the corporation and has not used her powers for
proper purposes.
Pdf_Folio:401
QUESTION 4.10
The Murdoch family holds slightly less than 40% of the shares in News Corp. This is not a majority.
However, as no other voting group holds anything close to this percentage, it means that News Corp
is controlled by the Murdoch family. This can be seen in the fact that family members hold dominant
executive management positions as well as board positions. At the time of the report (2011), the phone-
tapping scandal involving News Corp was at its height, and the CEO and Chairman of the Board were both
the same person — Rupert Murdoch.
Normal small shareholders, whose individual votes provide no real power in many corporations, will be
able to exert even less influence where a single, closely aligned group of shareholders (i.e. the Murdoch-
aligned votes) has dominance of the type described.
We see here that the institutional investor CalPERS is offended by the nature of the board structure,
by reported corporate activities and by the way that the voting system is organised. The voting system
concern, if relating to ‘non-voting’ and ‘partial-voting’ shares, arguably may not be justified. This is
because CalPERS presumably bought shares aware of the voting rights. If it wishes all of its shares to
have voting rights then it is free to sell its non-voting shares and acquire only voting shares. If CalPERS’
concerns relate to the absence of power available to voting shares because of the Murdoch family’s voting
block, then the concerns are more understandable. It is also a concern that cannot be corrected unless
corporations laws change dramatically. A fundamental feature of all corporate governance is that those
who own the shares (including the Murdoch family) have the right to vote those shares. Even so, it
is the duty of all directors to act in the interests of the corporation as a whole. That means decisions
must be made for the benefit of all shareholders — not to the advantage of a few or to deliberately hurt
any shareholders.
CalPERS, as an institutional investor, has about 1% of the voting shares. We also see strong animosity
from CalPERS towards the voting and power structure within News Corp. Accordingly, we might expect
CalPERS to more readily align with other disgruntled shareholders. Indeed, the impact of shareholder
demands for News Corp to be split into 21st Century Fox for the film and television interests and News
Corp for the newspaper interests was eventually heeded by Murdoch, and for several years proved a highly
successful strategy. However, Rupert Murdoch has not listened to shareholders’ complaints regarding the
governance and management structure of both companies and, in 2015, was resolved to continue with
the Murdoch family firmly in control (with his sons James and Lachlan holding the controlling positions
with himself), despite wide concerns among shareholders and other commentators that this might prove
an unstable succession strategy.
Pdf_Folio:402
MODULE 5
QUESTION 5.1
Crescent Wealth (https://crescentwealth.com.au/super/faqs/) calls its approach ‘ultra-ethical’, as it is
compliant with Islamic investment principles. It argues that its ‘investment philosophy is grounded and
bound by Islamic finance principles, which aim to the meet the financial needs of participants with justice,
equity and fairness’.
Islamic investing is done in accordance with rules of Islamic finance, which prohibits investment and
transactions that are inconsistent with the practices of Islam. The kinds of investments that would not be
appropriate in an Islamic investment context are:
• conventional financial services
• weapons or defence orientated companies
• tobacco
• pork and pig products
• alcohol
• gambling
• adult materials
• morally hazardous media.
QUESTION 5.2
This will be a matter of opinion but, arguably, if corporate managers adopt Milton Friedman’s view
(i.e. that as long as organisations operate within the rules or laws, they should act only to maximise
shareholder wealth), then sustainable development is not a realistic goal. Sustainable development requires
current generations not to concentrate on maximising their own wealth, but to consider the needs of all
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QUESTION 5.3
(a) An externality is defined as an impact that an entity has on parties that are external to the organisation
where such external parties did not agree or take part in the actions causing, or the decisions leading
to, the cost or benefit. Depending on the organisation in question, you may have identified a number
of positive and negative externalities.
For many organisations, negative externalities might include:
– emissions into the atmosphere with implications for climate change (this would impact on many
stakeholders, including the environment and future generations)
– waste emitted into waterways with implications for water life and drinking water quality (this would
impact on local communities, the environment and potentially future generations)
– production of goods that create waste that goes to landfill, thereby using land that might potentially
be used for other, more productive purposes (stakeholders affected here would include local
communities, the environment and future generations)
– the retrenchment of staff, thereby causing social costs inclusive of welfare payments paid by
government (stakeholders affected here would include the former employees, their families, local
communities and government).
Positive externalities could include the creation of products or services that have widespread social
benefits. For example, an organisation might breed endangered species and release these to the
environment.
(b) Most externalities would not directly affect an organisation’s profit or loss, although indirectly they
might. From an indirect perspective, poor social and environmental performance could impact on
an organisation’s compliance with its social contract and this in turn might affect the demand for its
products as well as the availability of factors of production — such as labour (i.e. if an organisation has
created a poor reputation for its social or environmental performance, it might have difficulty attracting
employees, capital and so forth).
Increasingly, a number of externalities are being recognised as costs (i.e. internalised). For example,
consider carbon-related taxes (but whether the taxes charged reflect the ‘true cost’ of the damage being
done is another issue).
(c) You will have your own opinion about whether the failure to recognise externalities represents a failure
of current financial reporting systems. This module will expose you to current corporate reporting
systems that have broader reporting mandates and will identify and report on certain externalities in
accordance with their objectives.
(d) Possible ethical implications of business not being held accountable for its externalities are wide
ranging and have both short-term and long-term implications such as the following.
– When businesses chase the lowest cost manufacturing sites around the world and the lowest
employee costs, they typically destabilise the local society and when they move on, it leaves large-
scale unemployment in the neighbouring communities.
– Local governments and local communities typically have to pick up the costs of business externali-
ties such as the clean-up costs associated with abandoned mines, the medical costs of treating people
who suffer from lung cancer as a result of cigarette smoking, and the costs for asbestos sufferers
and sufferers of other workplace-related diseases.
– Consumers can be physically harmed and die prematurely from toxic industrial wastes that are not
adequately disposed of.
– The global commons can be polluted and degraded from over-intensive commercial farming and
arable land turned into dustbowls.
– Developing countries can be deprived of access to water where mining and other companies overuse
local water supplies.
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QUESTION 5.5
Rio Tinto is more closely aligned with an enlightened self-interest approach by arguing that ‘Rio Tinto’s
primary focus is on the delivery of value for our shareholders’. Creating value for stakeholders is only
a secondary concern to Rio Tinto. They are primarily interested in financial returns. If the company did
interact with stakeholders, it would be according to managerial stakeholder theory.
Stockland, on the other hand, seems to adopt a stakeholder perspective. The excerpt shows that
shareholders are seen as only one of a variety of stakeholders that the company is managed for.
Their emphasis on stakeholders for their intrinsic value (rather than their ability to generate profit for
shareholders) is more consistent with normative stakeholder theory.
QUESTION 5.6
A mining firm such as BHP has a large and diverse number of environmental impacts. There are many
direct environmental impacts of their activities — consider the environmental impact of opening a mine,
the operation of the mine (often over a very long period of time) and the remediation required when a
mine closes. There are also more indirect effects of the firm’s activities that may be harder for BHP to
map and potentially measure. This includes the supply chains for the products it uses (such as its trucks
and equipment) or the environmental impact that comes about from the use of all of its products. This is
potentially very large, as BHP’s products are often the input for other production processes.
By comparison, the direct environmental impact of a professional services firm is expected to be
considerably smaller. This does not mean that it should not manage these impacts, which would include
the use of resources in day-to-day activities, energy use and transport. Managing environmental impact
can bring financial benefits and enhance a firm’s reputation in the eyes of potential clients and employees.
QUESTION 5.7
Marks & Spencer uses a five stage progress key to illustrate where it is at in terms of meeting its objectives
under its Plan A plan. These progress points or milestones are:
1. Not started
2. Not achieved
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QUESTION 5.8
The quote shows how important climate change is to the business. HSBC has recognised it as a business risk
and an important part of its strategy. This could also be seen as an attempt to secure a licence to operate
in the face of a legitimation crisis facing banks (i.e. public trust in banks has been very low, especially
since the global financial crisis). It also clearly demonstrates how important the development of the CDSB
framework has been, not only as a contributor, but also because the information produced has improved
their internal decision making.
QUESTION 5.9
The reporting frameworks that are contained in the ‘Guidelines and non-mandatory reporting’ section of
this module include the following.
• GRI Standards: the most widely accepted CSR or sustainability reporting guidance. The standards
provide a framework for the production of a comprehensive CSR report.
• <IR> framework: a corporate reporting framework that combines both financial and non-financial infor-
mation into a concise communication about how an organisation’s strategy, governance, performance
and prospects, in the context of its external environment, lead to the creation of value in the short,
medium and long term.
• Climate Disclosure Standards Board (CDSB): has developed a climate change reporting framework
that is intended for use by companies making climate change disclosures in their mainstream financial
reports.
• Equator Principles: provide a framework for assessing and managing social and environmental risk in
project financing.
• Greenhouse Gas Protocol (GHG Protocol): one of the most widely used international accounting
frameworks for quantifying greenhouse gas emissions.
• Sustainability Accounting Standards Board (SASB): a not-for-profit organisation that has issued
industry-specific standards for disclosure of financially material, decision-useful information on envi-
ronmental, social and governance issues.
The benefits of the frameworks are that they provide the criteria against which to report. As such they
give us the basis and measurement of the subject matter, and aid comparability of information across
organisations.
QUESTION 5.10
(a) A social audit can be seen as the process that an organisation undertakes to investigate whether it
is perceived by particular stakeholder groups to be complying with the social contract negotiated
between the organisation and the respective stakeholder groups. The reason why an organisation might
undertake a social audit can be explained in conjunction with a consideration of legitimacy theory. A
breach of the social contract can create significant costs for an organisation and, therefore, organisations
often undertake social audits to examine whether their operations appear to be conforming with the
expectations of particular societies or particular stakeholders.
(b) The results of a social audit often form an important component of an entity’s CSR/sustainability report.
The module provides the example of The Body Shop Australia, which has a report that is centred on
its social audit.
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INDEX 407
Australian Securities and Investments output restrictions 254 Conceptual Framework for Financial
Commission (ASIC) 7, 226–8, price-fixing 254–5 Reporting
331 cash flows, discounting 295–6 discounting future cash flows 295–6
Australian Securities and Investments caveat emptor 259 elements of 294–5
Commission Act 2001 (Cwlth) 10 CDP see Carbon Disclosure Project entity assumption 297
Australian Securities Exchange 160 (CDP) relevance and faithful representation
Australian Shareholders’ Association CDSB see Climate Disclosure 296
(ASA) 142 Standards Board (CDSB) scope of 294
Australian Small Business and Family Centro case 125 short-term performance reporting
Enterprise Ombudsman (ASBFEO) CEO powers 131–2 296–7
195 chain of command 110 confidentiality 65
AWA Ltd v. Daniels (1992) 10 ACLC 933 charities and not-for-profit sector, conflicts of interest 74–6
130 governance issues in 232–8 conformance 138, 193
Chartered Accountants Australia and consumer protection 258
‘Basic Religious Charities’ 188 New Zealand (CAANZ) 14, 18 caveat emptor to 259
B-Corporation 324 chief executive officer (CEO) 21 misleading conduct and
Bank Australia 304 child labour 321 representations 260–1
Banking Act 1959 285 churning 271 regulation and 259
best practice, examples of 353–4 civil liability 238 unconscionable conduct 261–6
best-in-class investment 303 civil outcomes and penalties 239–40 consumers 155, 238
beyond reasonable doubt 239 civil penalty 239 and customers 258–66
bid-rigging 254 Clean Energy Act 2011 (CE Act) 334 corporate accountability 308–9
Big Four accounting firms 306 climate change reporting Corporate Accounting and Reporting
biodiversity, environmental sustainability accounting techniques 356–7 Standard 345
320 corporate governance and 359–5 corporate culture 101, 208
BlackRock 303 emissions, accounting for levels of corporate failure, common causes of
board 357–9 208–11
chair 144–5 environmental sustainability issues poor risk management 210–11
committees 146–9 320
remuneration 210
functions 145 international response 355–6
wilful blindness 210
powers 130–1 Climate Disclosure Standards Board
corporate governance 207
responsibilities 145 (CDSB) 337, 358
accountants 140–1
structure, roles and responsibilities Climate Solutions Fund 334
agents 138
164 co-regulation 10
ASX Listing Rules 178
board appointments, financial failure and Code of Corporate Governance 332
auditors 150
211–17 code of ethics 15–16
Australian Securities Exchange
appointment of directors 211 Code of Ethics for Professional
160–1
directors departures 212–13 Accountants see APES 110 Code
disqualification 215–17 board 144–50
of Ethics for Professional
election of directors 211–12 Accountants CLERP Act 2004 161–2
evaluation of board performance 212 codes of conduct 246, 259, 282 and climate change 359–6
removal of director 213–15 coercive isomorphism 317 concept 138
board of directors’ responsibility collusive behaviour 253 conformance 138
323–4 Commercial Bank of Australia Ltd v. continued evolution of 231
bonding costs 133 Amadio (1983) 262 and CSR reporting 330
brands 300–1 commissions 78 disclosures 332
bribery and corruption 273–5 common law 239 diversity 216–29
international experience of 274–5 Commonsense Principles of Corporate events and responses 159
Brundtland Report see Our Common Governance 279 family-owned businesses 187–8
Future communication 87 framework 141–57
Building Better Governance 193 community service 14 and fraud 234
business consumers 258 Companies Act 2006 176 improving 229–31
business ethics 246 company law 164 international approaches 161–70
business judgment rule (s. 180(2)) 122 company, improving general perception management 155–60
business leadership capabilities 37 302–3 non-corporate sector 195–206
Business Roundtable 306 compensation 223 not-for-profit organisations 188–91
Competition and Consumer Act 2010 OECD 139
CAANZ see Chartered Accountants 237, 241 OECD principles see OECD
Australia and New Zealand competition and stakeholders 248–9 principles
California Public Employees’ Retirement competition law 258 performance 138, 140
System (CalPERS) 158, 163 competition policy 247 principals 138
cap-and-trade systems 356, 357 competitive advantage 248 private benefit, conflict of interest
Carbon Disclosure Project (CDP) 337, competitors, agreements between 234
342 253–4 public sector enterprises 191–5
cartel conduct 253–4 compliance program 241–3 Ramsay report 160
allocating customers, suppliers or conceptual framework approach 68–74 regulators 150–1
territories 254 documentation and advice 74 responsibilities and accountability
bid-rigging 254
Pdf_Folio:408
identifying threats see threats 305–8
408 INDEX
risk of financial failure see financial criminal penalties 238–9 efficiency 194
failure criminal sanctions 239 egoism 53–4
shareholders 141–4 CSR reporting see corporate social Emerging Integrated Reporting Database
SME 187–8 responsibility (CSR) reporting 353
social and environmental performance CSR theory see corporate social emissions
349–50 responsibility theory accounting for levels of 357–9
stakeholders 152–5 cultural diversity 104 trading/reporting schemes 358
theories of 131–7 cultural relativism 105 Emissions Reduction Fund 334
UK FRC Corporate Governance Code culture 104–6 employees 154, 164
176–8 custody of client assets 88 satisfaction 328
corporate governance codes 217 customer owned bank 304 employment model 305
Corporate Governance Principles and customer satisfaction 328 Energy Supply Association of Australia
Recommendations 307 340
Corporate Law Economic Reform de-professionalisation 6 enlightened self-interest 3, 6, 53, 308,
Program (CLERP) Act 2004 149, decision making 3, 99 313–14
161–2 decisions 43, 44 Enron’s audit committee 149
corporate powers deontological theories (duty based) 52, entity assumption 297
board 130–1 56–8 entrepreneurship 6
CEO 131–2 justice 57–8 environment 344
shareholder 129–30 motive 56 environmental behaviours 311
corporate social responsibility (CSR) rights 56–7 environmental disasters 319
308–9, 324 direct costs 301 environmental laws 174
climate change reporting 355 directors environmental management accounting
corporate governance and 330 appointment of 211 350–1
emergence of 319 election of 211–12 environmental performance 312
financial reporting and limitations removal of 213 corporate governance mechanisms
294 resignation 212 improving 349–50
reporting landscape, changing 298 disclosures Environmental Protection Acts 327
surveys of current reporting practice for Australian mandatory reporting environmental reporting 327–8
352 requirements 335–6 environmental responsibility 311
theories 136–40, 313 corporate governance 332 environmental sustainability 319–20,
corporate stakeholders 152 and remuneration 222 322
Corporate Value Chain Accounting and discounting future cash flows 295–6 Equal Opportunity for Women in the
Reporting Standard 345 disqualification 215–17 Workplace Act 1999 (Cwlth) 216
corporations ethics of 216–17 equality 57
Centro case 125 distinctive ethos or culture 16 Equator Principles 344–5
company secretaries and their duties diversity 216–29 Equator Principles Financial Institutions
128–9 adopting 218 (EPFIs) 344, 345
compliance requirements 118 audit quality and audit regulation equity, financial reporting 295
corporate governance see corporate 227–9 ethical courage 100
governance auditing the financial statements ethical decision making 99
corporate powers see corporate 225–7 American Accounting Association
powers compliance with the Corporations Act model 108–13
corporate structures 119 225 factors influencing 100–5
Corporations Act 116 executive remuneration and individual factors 100–1
director independence 127–8 performance 218–24 organisational factors 101–3
directors and their duties 119–24 documentation and advice 74 philosophical model of 107–8
governance theories see governance Dodd-Frank Act (US) 222 professional factors 103–4
theories Dodd-Frank Wall Street Reform and societal factors 104
James Hardie case 126 Consumer Protection Act 2010 ethical decisions, impact of 43–4
officers or agents 127 151 ethical egoism 53
proprietary companies 117 domestic consumers 258 vs. utilitarianism 55
proprietary vs. public companies 117 Dow Jones Sustainability World Index ethical failures by accountants 95–9
public companies 117 347 ethical obligations 246–8
shareholders 116 due care 64–5 failure in relation to employees
types of 116 246–7
Corporations Act 2001 8, 10, 18, 116, economic reporting 328–31 trade and labour unions 247–8
131, 208, 225, 237, 284, 307, 331–2 economic stability 321 ethical relativism 104
Corporations and Markets Advisory economic sustainability 321–2 ethical standards 10
Committee (CAMAC) 223, 306 economic system, stability of 322 ethical theories 51, 52
cost of capital 302 economy, and legal system 238–41 deontological theories 56–8
cost-benefit analysis 54 laws leading to criminal penalties normative theories 51–2
creative accounting 34–5 238–9 teleological (consequential) theories
Crimes Act 1958 120 laws with civil outcomes and penalties 52–5
criminal 238 239–40 virtue ethics 58–60
criminal intent 239 proof, penalties and redress 238 ethical trading 321
criminal liability 238 redress compared with penalties ethics 3, 43, 282–3
criminal offence 238
Pdf_Folio:409
240–1 accounting work environment 48–51
INDEX 409
ethical challenges within accounting fraud 234 Greenhouse Gas Reporting Program
profession 46–8 FRC see Financial Reporting Council 357
overview 44–6 FRC Code see Financial Reporting
professional ethics 43 Council Code Hayne Royal Commission 12
ethics of character see virtue ethics free debate 268 health and safety laws 174
ethics of conduct 52–3 free good 309 heuristics 105
deontological theories (duty based) FSB see Financial Stability Board Hong Kong competition law 253
see deontological theories (duty Hornsby Building Information Centre
fundamental principles of Code of
based) Pty Ltd v. Sydney Building
Ethics 63
teleological (consequential) theories Information Centre Ltd (1978)
confidentiality 65
see teleological (consequential) 260
integrity 63–4
theories human rights 57, 326, 344
EU Transparency Directive 122 objectivity 64
professional behaviour 65–7 humanistic perspective 319
European Union Emissions Trading
Scheme (EU ETS) 336–9, 356, professional competence and due care
357, 359 64–5 IAS 16 Property, Plant and Equipment
exclusive dealing 255–6 fundraising documents, misuse of 332
expenses, financial reporting 295 272–3 IAS 37 Provisions, Contingent Liabilities
external auditors 230 and Contingent Assets 332
externalities 309–12 IESBA see International Ethics
gender balance of boards 217
Standards Board for Accountants
gender diversity, in Australian
IFAC see International Federation of
fair pay and working conditions 244–5 boardrooms 216
Accountants
faithful representation, financial German Corporate Governance Code
IFRS see International Financial
accounting 296 165
Reporting Standards
family and leave entitlements 245–6 GFC see Global Financial Crisis impact investment 304
family-controlled companies and GHG Protocol for Community-Scale inadequate governance 298
business networks 168–71 Greenhouse Gas Emission incentives 77–8, 299–302
family-owned businesses 187–8 Inventories 346 income, financial reporting 294
FASEA see Financial Adviser GHG Protocol Mitigation Goal Standard independence 88–91
Standards and Ethics Authority 346 chair of board 230–1
FCA see Federal Court of Australia GHG Protocol Policy and Action
Federal Court of Australia (FCA) 125 Independent Pricing and Regulatory
Standard 346 Tribunal Act 1992 335
fees 77–8 give ‘back’ model 305
‘fictional entities’ 116 indirect costs 301
global financial crisis (GFC) 123, 208, individual factors, decision making
financial accounting distortions 35–6
223, 298–9 100–1
Financial Accounting Standards Board
Global Reporting Initiative (GRI) 319, individual shareholders 142
337
322, 337, 339 inducements 79–81
financial advice environment 30–1
Global Sustainable Investment Alliance information and the media 266–8
Financial Adviser Standards and Ethics
(GSIA) 299 information asymmetry 143–4
Authority (FASEA) 31
financial failure 208–16 ‘goal congruence’ 132 innovation model 305, 328
board appointments 211–17 golden handshakes 223 innovative reporting, examples of
corporate failure 208–11 good faith requirement 307 353–4
financial markets 265 Good Trade 305 insider system 164
protecting 268–77 goods and services market, protecting insider trading 268–70
role of information and the media 247–65 Institute of Public Accountants (IPA)
266–8 competition and stakeholders 14
role of market regulators 266 248–9 institutional investors, representational
role of ratings agencies 268 consumers and customers 258–66 role of 279–82
financial reporting regulating anti-competitive behaviour institutional shareholder power 142
discounting future cash flows 295–6 250–8 Institutional Shareholders’ Committee
elements of 294–5 workable competition 248 (ISC) 279
entity assumption 297 institutional theory 316–18
governance 3
and limitations 294 integrated reporting 325, 340–1
governance issues
relevance and faithful representation integrated thinking 325–6
in charities and not-for-profit sector
296 integrity 63–4, 85, 194
232–8
scope of 294 intergenerational argument 319
in government bodies 231–2
short-term performance reporting Intergovernmental Panel on Climate
governance theories Change’s (IPCC) Fifth Assessment
296–7
Financial Reporting Council (FRC) 9 CSR theory 136–40 Report 355
Financial Reporting Council (FRC) Code stakeholder theory 135 internal auditors 226
128, 176–8, 197 transaction cost theory 135–6 internal control, and risk management
Financial Stability Board (FSB) 223 government bodies, governance issues in 229–30
Task Force on Climate-related 231–2 International Accounting Standards
Financial Disclosures report 301, government intervention 309–12 Board (IASB) 337
360 greenhouse gas (GHG) emissions 301 international auditing standards 226
financial statements, auditing 225–7 Greenhouse Gas Protocol (GHG international competition legislation and
forecasts, analysts’ 302
Pdf_Folio:410
Protocol) 345–6 regulators 249
410 INDEX
International Ethics Standards Board for liquidity, uncontrolled 298 natural capital accounting 325
Accountants (IESBA) 60 long-term viability of businesses 321 Natural Capital Coalition 310, 337
International Federation of Accountants loss-leader 257 Natural Capital Protocol 310, 341
(IFAC) 12, 27–30, 46, 140, 229, naturalistic argument 319
350 Mainzeal case 124 NBN see National Broadband Network
International Financial Reporting managerial stakeholder theory 315 Neville’s Bus Service Pty Ltd (NBS) 6
Standards (IFRS) 225 mandatory reporting 330–6 New York Stock Exchange (NYSE)
International Integrated Reporting accounting standards 331–2 163
Council (IIRC) 325, 337 Australian mandatory reporting NOCLAR see non-compliance with
International Organisation of Supreme requirements 335–6 laws and regulations
Audit Institutions (IntOSAI) 191 Climate Solutions Fund 334 nomination committee 147
International Organization for Corporations Act 331–2 nominee directors 121
Standardization (ISO) 337 CSR-related corporate governance non-compliance with laws and
International Standards on Auditing disclosures 332 regulations (NOCLAR) 60, 81–4
(ISAs) 225 Emissions Reduction Fund 334 for members in public practice 83–4
international stock exchanges 265 European Union (EU) emissions non-corporate sector 195–206
intimidation 86 trading system 336–9 non-executive directors, payment for
intimidation threat 69 Modern Slavery Act 2018 334–5 220–1
IntOSAI see International Organisation National Greenhouse and Energy non-mandatory reporting 312
of Supreme Audit Institutions Reporting Act 2007 333–4 guidelines and 336–47
investigating case manager (ICM) 21 National Pollutant Inventory 335 normative isomorphism 317
investment community 300 market disruption penalties 255 normative stakeholder theory 314
ISAs see International Standards on market dominance 252 normative theories 51–2
Auditing market efficiency 269 not-for-profit organisations 188–91
ISC see Institutional Shareholders’ market manipulation 267–79 Note Printing Australia (NPA) 232
Committee bribery and corruption 273–5 NPA see Note Printing Australia
ISO 14001 Environmental Management phoenix companies 276–9 NSW Energy Savings Scheme 335
Systems-Requirements with Ponzi schemes 276 NYSE see New York Stock Exchange
Guidance for Use 349 principles relating to 271 NZ ETS 359
ISO 26000 Guidance on Social rogue trading 275–6
Responsibility 349 types 271–3 objectivity 64
isomorphism 317 market regulators 266 obligations to employees 242–7
market sensitive 265 ethical obligations 246–8
James Hardie case 126 market share 328 fair pay and working conditions
justice 57–8 market sharing 253, 254 244–5
market-based systems 162–3 family and leave entitlements 245–6
Marks & Spencer 328 occupational health and safety
KETS 359
McKinsey & Company 306 243–4
key management personnel (KMP) 214 measurement, sustainability issues
key performance indicators (KPIs) 221 occupational health and safety 243–4
325–9 OECD see Organisation for Economic
KMP see key management personnel mergers and acquisitions 252–3
KPIs see key performance indicators Co-operation and Development
mid-sized enterprises (MEs) 29 OECD Guidelines for Multinational
KPMG 323, 352 mimetic isomorphism 317
Kyoto Protocol 345, 355, 356 Enterprises (OECD 2011) 341–2
misleading conduct and representations OECD principles
260–1 corporate governance framework
L J HL Bolton Engineering Co. Ltd v. TJ Modern Slavery Act 2018 307, 334–5 171–2
Graham & Sons Ltd 1957 1 QB 159 monetisation 326 disclosure and transparency 174–5
at 179 144 monitoring costs 133 equitable treatment of shareholders
labour 344 monopolist corporation 247 172–3
labour laws 174 moral agency 58–62 institutional investors, stock markets,
labour practices 326 moral courage 64 and intermediaries 173–4
labour union see trade union motive 56 market-orientated economies 171
lack of auditor independence 35 responsibilities of the board 175–9
laws and regulations 104 NAB see National Australia Bank role of stakeholders in corporate
laws of contract 174 narrative reporting 326 governance 174
leadership 194 National Australia Bank (NAB) 218, One Person Tribunal (OPT) 21
LeapFrog Investments 304 285 openness 194
legal and contractual rights 56–7 National Broadband Network (NBN) operating and financial review (OFR)
legal compliance and governance 248 reporting 331
241–3 National Employment Law Project Organisation for Economic Co-operation
legal system 237–42 (NELP) 300 and Development (OECD) 209,
economy and 238–41 National Greenhouse and Energy 229, 231
legal compliance and governance Reporting (NGER) Scheme 358 organisation wealth 299–302
241–3 National Greenhouse and Energy organisational factors, decision making
legitimacy theory 315–16 Reporting Act 2007 (NGER Act) 101–3
lenders 154–5 323, 327, 333–4 organisational initiatives
leverage, high 298 National Pollutant Inventory (NPI) 335 board of directors’ responsibility for
liabilities, financial reporting 295
Pdf_Folio:411
natural capital 325 323–4
INDEX 411
organisational legitimacy 315–16 professional judgment, application of risk and GFC 223
Origin Energy 316 16–17 tightening rules regarding 222–3
Our Common Future report 293 professional scepticism 119 remuneration committee 147
Outboard Marine Australia Pty Ltd v. professions 1, 8–10, 22 representation 277
Hecar Investments No. 6 Pty Ltd credibility of 34–7 expanding ethics 282–3
(1982) 248 credibility under challenge 34 institutional investors, representational
output restrictions 254 key issues causing reduced credibility role of 279–82
34–6 whistleblower protection 283–91
professional discipline 20–2 reputation 300–1
PAIB see professional Accountants in
quality assurance process 19–20 resale price maintenance 250, 256–7
Business
regulatory process 18–22 Reserve Bank Act 1959 193
Panasonic 300
self-regulation 9–10 Reserve Bank of Australia (RBA) 193
parental leave legal action 246
self-regulation to co-regulation residual loss 133–5
pecuniary penalty 239
10–12 responsible decision making 3–9
performance 130, 134, 138, 140, 193
social contract between society responsible investment 299–303
performance-based remuneration
and 9 Responsible Investment Association of
221–2
trust and 11–12 Australia (RIAA) report 299
personal social responsibility (PSR) Project Protocol 345 restricted egoism 54
356 proof, penalties and redress 238 rights 56–7
philosophical model, of ethical decision Property Council of Australia 340 human rights 57
making 107–8 proprietary companies 117 legal and contractual rights 56–7
philosophy 51 proprietary vs. public companies 117 risk control systems 230
phoenix companies 276–9 prospectus 272 risk management 229–30
pollution, environmental sustainability provision of non-assurance services, to internal control and 229–30
320 audit client 93 risk management committee 150
Ponzi schemes 276 public commentary 268 risk management incentives 301
pools 272 public companies 117 rogue trader 275
poor audit quality 35 public disclosure 268 rogue trading 275–6, 285
poor corporate governance 208 public interest 3–6, 61–2 rule-based codes 68
poor ethical cultures 102 public practice environment, accountants runs 272
poor ethics 282 25–7
poor risk management 210–11 roles 26
safeguards 73
predatory pricing 250 sub-types 25
Samsung 300
preparation and presentation of public sector 193
Sarbanes-Oxley Act (2002) 122, 147,
information 84–5 public sector enterprises 191–5
148, 183, 221, 230, 284
price-fixing 251–5 public sector environment 30
Satyam Computer Services 168
PricewaterhouseCoopers (PwC) puffery 261
second opinions 87
227–32 Puma 328
Securities and Exchange Commission
principles-based vs. rules-based (SEC) 222
regulation 151 quality assurance process 19–20 self-interest 11
Product Life Cycle Accounting and quality rankings 328 self-interest, accountants 3–6
Reporting Standard 346 quantification 326 self-managed superannuation funds
product responsibilities 326 (SMSF) 7
professional 10 self-regulation, professions 9–10
Ramsay report 160
professional accountants 3, 39 Rana plaza building collapse 300, 320 senior members in business 82–3
business leadership capabilities 37 ratings agencies 268 shadow banking 298
career perspectives 38 rational decision making 100 shareholder primacy
soft skills, knowledge and experience RBA see Reserve Bank of Australia approach 308
38 redress compared with penalties vs. social contract 307
technical skills, knowledge and 240–1 shareholder spills, reaction to 215
experience 37–8 referrals 87 shareholder threat 281
professional accountants in business regulation of member conduct 20–1 shareholder wealth 299–302
(PAIB) 27, 150, 229 relationship-based systems shareholders 116, 141–4, 164
activities of professional accountant Asian approaches 166–71 activism 158
29 European approaches 163–5 Anglo-American legal approaches
employed in large businesses 27–8 relativism 104 174
IFAC research 28–30 relevance, financial accounting 296 equitable treatment of 172–3
in small and medium enterprises 28 relevant market 248 market-based systems 169
professional appointments 86–7 remuneration 77–8, 129–30, 177, 203, power 129–30
professional behaviour 65–7 210, 214, 218–24 representation 277
professional competence 64–5 disclosure, transparency and 222 rights and participation mechanics
professional conduct officer (PCO) 21 executive directors and other senior 164
professional discipline 15, 20–2 executives 221 short-term performance reporting
penalties and appeals 21–2 international debates 219–20 296–7
regulation of member conduct 20–1 non-executive directors 220–1 Singapore Stock Exchange Sustainability
professional ethics 43 payments for past and future Reporting Guide 332
professional factors, decision making performance 220–4 small- and medium-size enterprises
103–4
Pdf_Folio:412
performance-based 221–2 (SMEs) 28
412 INDEX
SMSF see self-managed environmental, economic and social UN 17 Sustainable Development Goals
superannuation funds 322 (UNSDG) 293
Social Accountability 8000 International reporting 325 UN Principles for Responsible
Standard (SAI 2014) 348 Sustainability Accounting Standards Investment (UNPRI) 302
social audits 347–8 Board (SASB) 337, 346–7 unconscionable conduct 261–6
social behaviours 311 sustainable distribution 48 UNCTAD see United Nations
social contract 9, 298, 315–16 sustainable investment 303–4 Conference on Trade and
shareholder primacy vs. 307 Sustainable Practice Framework 340 Development
social enterprises 304–14 Swiss ETS 359 unethical decisions, impact of 43–4
social impact of accounting 32–4 Unilever 301
higher levels of depreciation 32–3 United Nations Conference on Trade and
Task Force on Climate-related Financial Development (UNCTAD) 122
lower levels of depreciation 33–4
Disclosures (TCFD) 301, 337 United Nations Framework Convention
social justice rationale 217
Tax Practitioners Board (TPB) 10 on Climate Change (UNFCCC)
social performance 312
Taxation Administration Act 1953 355
corporate governance mechanisms
285 United Nations Global Compact
improving 349–50
social reporting 326–7 teleological (consequential) theories (UNGC) 337, 343–4
social responsibility 311 52–5 United Press International (UPI) 268
social return on investment (SROI) 327 egoism 53–4 United States False Claims Act 284
social sustainability 320–2 utilitarianism 54–6 unsupportive management 101
socially responsible investment (SRI) teleology 56 US EPA GHG Reporting Program 359
302–5 The Body Shop 348 utilitarianism 54–6
societal factors, decision making 104 The UK Corporate Governance Code vs. ethical egoism 55
society 326 128
soft-dollar benefits 78 thematic investment 304 Victorian Public Sector Commission
special purpose financial statements third-line forcing 256, 257 (VPSC) 194
89–90 threats 69 virtue ethics 58–60
stakeholder theory 314–15 addressing 73–4 moral agency 58–62
managerial 315 categories 69 virtues 58
normative 314 evaluating 71–3 Visa 301
stakeholders 164, 314 examples of 70–1 Vision 2050 299
concept 152 identifying 69–74 voluntary disclosure theory 302
consumers (customers) 155 Tokyo CapandTrade Program 359 VPSC see Victorian Public Sector
corporate governance 174 top-tier management 101 Commission
description 152 TPB see Tax Practitioners Board
employees 154 trade union 247 waste, environmental sustainability
issues 164 transaction cost theory 135–6 320
map 152–4 transparency 194, 322 weaknesses, in internal control 230
relationships 153 and remuneration 222 whistleblowers’ protection legislation
suppliers and lenders 154–5 Treasury Laws Amendment (Enhancing 284–91
theory 135 Whistleblower Protections) Act whistleblowing 100–284
workforce 176 2019 285 wilful blindness 210
stewardship 194 Woodside Petroleum Limited 353
Tricker model 145
stewardship theory 132 workable competition 248
trust and professions 11–12
suppliers 154–5 workplace 326
turnover rates 328
supply chain management 321 Workplace Gender Equality Act 180
two-strikes rule 214, 215
surveys, of current reporting practice workplace injuries 243
352 World Business Council for Sustainable
sustainability 325 UK Bribery Act 2010 274 Development (WBCSD) 299, 337
board of directors’ responsibility for UK Companies Act 2006 307
323–4 UK FRC Corporate Governance Code
bond 304 176–8, 197
Pdf_Folio:413
INDEX 413