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goVernAnce, risK & etHicsPaper
P1
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ACCA QuAlifiCAtionCourse notes
December 2013 examinations
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The besT Things in life are free
Free ACCA resourCes By PAPer
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F1 Accountant in Business / FAB Foundations in Accountancy
F2 Management Accounting / FMA Foundations in Accountancy
F3 Financial Accounting / FFA Foundations in Accountancy
F4 Corporate & Business Law (English & Global)
F5 Performance Management
F6 Taxation (UK)
F7 Financial Reporting
F8 Audit and Assurance
F9 Financial Management
P1 Governance, Risk & Ethics
P2 Corporate Reporting
P3 Business Analysis
P4 Advanced Financial Management
P5 Advanced Performance Management
P7 Advanced Audit & Assurance
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a Paper P1
December 2013 Examinations
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Contents
Aims and Objectives i
1 Corporate Governance 1
2 Approaches to Corporate Governance 9
3 The Board of Directors 17
4 Board committees 35
5 Corporate Governance and Corporate Social Responsibility 49
6 Corporate governance – control systems 57
7 Auditors and Internal Controls 61
8 Management Information Systems 65
9 The Risk Management Process 67
10 Controlling Risk 81
11 Ethics and Social Responsibility 91
12 Deontology and Teleology 97
13 Social Responsibility 99
14 Professions and the Public Interest 107
15 Professional Practice and Codes of Ethics 117
16 Ethical Characteristics of Professionalism 133
17 Social and Environmental and Ethical Behaviour 137
Paper P1
i Paper P1
December 2013 Examinations
Paper P1
Aims And Objectives
Aim
• Toapply relevantknowledge,skillsandexerciseprofessional judgement incarryingout the roleof theaccountantrelatingtogovernance,internalcontrol,complianceandthemanagementofriskwithinanorganisation,inthecontextofanoverallethicalframework.
Objectives
• Onsuccessfulcompletionofthispaper,candidatesshouldbeableto:
• Definegovernanceandexplainitsfunctionintheeffectivemanagementandcontroloforganisationsandoftheresourcesforwhichtheyareaccountable
• Evaluatetheprofessionalaccountant’sroleininternalcontrol,reviewandcompliance
• Explaintheroleoftheaccountantinidentifyingandassessingrisk
• Explainandevaluatetheroleoftheaccountantincontrollingandmitigatingrisk
• Demonstratetheapplicationofprofessionalvaluesandjudgementthroughanethicalframeworkthatisinthebestinterestsofsocietyandtheprofession,incompliancewithrelevantprofessionalcodes,lawsandregulations.
Position of the paper in the overall syllabus
• ThesyllabusforPaperP1,Governance,RiskandEthics,actsasthegatewaysyllabusintotheprofessionallevel.ItsetstheotherEssentialsandOptionspapersintoawiderprofessional,organisational,andsocietalcontext.
• The syllabus assumesessential technical skills and knowledgeacquiredat the Fundamentals levelwhere the coretechnicalcapabilitieswillhavebeenacquired,andwhereethics,corporategovernance,internalaudit,control,andriskwillhavebeenintroducedinasubject-specificcontext.
• TheP1syllabusbeginsbyexaminingthewholeareaofgovernancewithinorganisationsinthebroadcontextoftheagencyrelationship.Thisaspectof thesyllabus focusesontherespectiverolesandresponsibilitiesofdirectorsandofficerstoorganisationalstakeholdersandofaccountingandauditingassupportandcontrolfunctions.
• The syllabus thenexplores internal review, control, and feedback to implementand supporteffectivegovernance,includingcomplianceissuesrelatedtorisk,decision-makinganddecision-supportfunctions.Thesyllabusalsoexaminesthewholeareaofidentifying,assessing,andcontrollingriskasakeyaspectofresponsiblemanagement.
• Finally,thesyllabuscoverspersonalandprofessionalethics,ethicalframeworks–andprofessionalvalues–asappliedinthecontextoftheaccountant’sdutiesandasaguidetoappropriateprofessionalbehaviourandconductinavarietyofsituations.
Paper P1December 2013 Examinations
detailed syllabusA Governanceandresponsibility
1. Thescopeofgovernance2. Agencyrelationshipsandtheories3. Theboardofdirectors4. Boardcommittees5. Directors’remuneration6. Differentapproachestocorporategovernance7. Corporategovernanceandcorporatesocialresponsibility8. Governance:reportinganddisclosure
B Internalcontrolandreview1. Managementcontrolsystemsincorporategovernance2. Internalcontrol,auditandcomplianceincorporategovernance3. Internalcontrolandreporting4. Managementinformationinauditandinternalcontrol
C Identifyingandassessingrisk1. Riskandtheriskmanagementprocess2. Categoriesofrisk3. Identification,assessmentandmeasurementofrisk
D Controllingrisk1. Targetingandmonitoringrisk2. Methodsofcontrollingandreducingrisk3. Riskavoidance,retentionandmodelling
E Professionalvaluesandethics1. Ethicaltheories2. Differentapproachestoethicsandsocialresponsibility3. Professionsandthepublicinterest4. Professionalpracticeandcodesofethics5. Conflictsofinterestandtheconsequencesofunethicalbehaviour6. Ethicalcharacteristicsofprofessionalism7. Socialandenvironmentalissuesintheconductofbusinessandofethicalbehaviour
Approach to examining the syllabus
• Thesyllabuswillbeassessedbyathree-hourpaper-basedexamination.Theexaminationpaperwillbestructuredintwosections.SectionAwillbebasedonacasestudystylequestioncomprisingacompulsory50markquestion,withrequirementsbasedonseveralpartswithallpartsrelatingtothesamecaseinformation.Thecasestudywillusuallyassessarangeofsubjectareasacrossthesyllabusandwillrequirethecandidatetodemonstratehighlevelcapabilitiestoevaluate,relateandapplytheinformationinthecasestudytoseveraloftherequirements.
• SectionBcomprisesthreequestionsof25markseach,ofwhichcandidatesmustanswertwo.Thesequestionswillbemorelikelytoassessarangeofdiscretesubjectareasfromthemainsyllabussectionheadings,butmayrequireapplication,evaluationandthesynthesisofinformationcontainedwithinshortscenariosinwhichsomerequirementsmayneedtobecontextualised.
• TheexaminerisDavidCampbell
1 Paper P1December 2013 Examinations
Free lectures available for Paper P1 - click hereChapter 1
CorPorate GovernanCe
• thesystembywhichorganisationsaredirectedandcontrolled(CadburyReport)
• corporategovernance(cg)isasetofrelationshipsbetweenanentity’sdirectors,shareholdersandotherstakeholders
• alsoprovidesthestructurethroughwhichtheobjectivesoftheentityaresetanddeterminesthemeansofachievingthoseobjectivesandmonitoringperformance
• cgisanissueforallentities,whethertheybe
• largequotedentities
• commercialentities
• not–for–profitorganisationsincluding:
- publicsector
- non–governmentalorganisations
Chapter 1 Paper P1Corporate Governance December 2013 Examinations
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Corporate governance - elements
• management,awareness,evaluationandmitigationofrisk
• includestheoperationofanadequateandappropriatesystemofcontrol
• overallperformanceisimprovedbygoodsupervisionandmanagementwithinsetbestpracticeguidelines
• frameworkforanorganisationtopursuestrategyinanethicalandeffectiveway
• offerssafeguardsagainstmisuseofresources–human,financial,physicalandintellectual
• involvesmorethanfollowingexternallyestablishedcodesofgoodpracticeAlsorequiresawillingnesstoapplythespiritaswellastheletterofthelaw
• canattractnewinvestmentintoentities,particularlyindevelopingnations
• accountabilitytoshareholdersandalsootherstakeholders
• underpinscapitalmarketconfidenceinentities,government,regulatorsandtaxauthorities
3Chapter 1 Paper P1Corporate Governance December 2013 Examinations
Corporate governance – concepts
• honesty / probity – not simply telling the truth but also not being guilty of issuingmisleading statements orpresentinginformationinaconfusingordistortedway
• accountability–emphasisofthedirectors’accountabilitytoshareholders,butopensthedoorfordiscussionabouttheextentoftheiraccountabilitytootherstakeholders
• independence–strongemphasisontheappointmentofindependentnon–executivedirectorswhoarefreefromconflictsofinterestandarethusabletomonitoreffectivelytheentity’sandexecutivedirectors’activities,ideallyworkingcloselywiththeexternalauditors
• responsibility–asystemofresponsibilityshouldexistwherebyentitydirectorsacknowledgetheirresponsibilitiestothestakeholders,andwilltakewhatevercorrectiveactionisnecessaryinordertokeeptheentityfocussed
• decisiontaking/judgement–theskillwithwhichmanagementmakedecisionswhichwillimprovethewealth/prosperityoftheorganisation
• reputation–builtbydirectors,oftenasaresultoftheirabilitytocomplywithothercgconcepts
• integrity–straightforwarddealing,honesty,andbalanceForfinancialstatementstohavethecharacteristicofintegrity,thisdependsupontheintegrityofthosepeoplewhopreparethemIntegrityinvolvesapersonwhodemonstrateshighmoralcharacter,isprincipled,professional,honestandtrustworthy
• fairness–takingintoaccounttheinterests,rightsandviewsofeveryonewhohasalegitimateinterestintheentity
• transparency /openness – involves full disclosure ofmaterialmatterswhich could influence thedecisions ofstakeholders This means not simply openness in the reporting of information required by IFRS in the financialstatements It also involvesother information suchas cashandmanagement forecasts, environmental reports andsustainabilityreports
Chapter 1 Paper P1Corporate Governance December 2013 Examinations
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Corporate governance and agency theory
• directorsactasagentsoftheshareholders
• cg tries to ensure that agency responsibilities are fulfilled as agents by requiring disclosure and by suggestingperformance-relatedrewards
• definition:anagencyrelationshipisacontractunderwhichoneormorepersons(theprincipals)engageanotherperson(theagent)toperformsomeserviceontheirbehalfthatinvolvesdelegatingsomedecision–makingauthoritytotheagent
• fiduciarydutiesdefinition:adutyimposeduponcertainpersonsbecauseofthepositionoftrustandconfidenceinwhichtheystand in relationtoanotherTheduty ismoreonerousthangenerallyarisesunderacontractualor tortrelationshipItrequiresfulldisclosureofinformationheldbythefiduciary,astrictdutytoaccountforanyprofitsreceivedasaresultoftherelationship,andadutytoavoidconflictsofinterest
• fiduciarydutiesareowedtotheentity,nottoindividualshareholders
• directorsmustexercisetheirpowersfortheproperpurpose
5Chapter 1 Paper P1Corporate Governance December 2013 Examinations
Duties of directors as agents
• performance–ifpaid,directorshaveacontractualobligationtoperformasagreed(ifunpaid,nosuchobligation)
• obedience–directorsshouldactstrictlyinaccordancewiththeprincipal’sinstructions
• skillandcare–directorsshouldactwithsuchadegreeofskillandcareasmayreasonablybeexpectedfromapersonwithsuchexperienceandqualifications
• personalperformance–directorsshouldonlydelegatetheirassignmentswheretheyhavenoreasontobelievethatthepersontowhomtheworkisdelegatedisnotcapableofproperperformance
• avoidconflictsofinterest–egshouldnotsellhisownpropertytotheentity,eventhoughitmaybeatanindependent,arm’slengthvaluation
• confidence–agentsshouldnotdiscloseconfidentialmattersabouttheprincipal,evenaftertheagencyagreementhasended
• accountingforbenefits–agentsmustaccounttotheprincipalforanyundisclosedbenefitwhichtheyreceiveasaresultoftheirofficeasagent
• becauseownershipofanentityisnecessarilyseparatedfromthemanagement,problemsmayresult
Chapter 1 Paper P1Corporate Governance December 2013 Examinations
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Corporate governance – Potential Problems
• directorsmaychoosetopursuestrategiesmorebeneficialfortheirowninterestratherthantheentity’s
• directorswillalmostcertainlyhaveadifferentattitudetorisk,andriskmanagement,sinceitisnottheirowninvestmentwhichtheyarerisking
• ifmanagementhaveonlyasmallbeneficial interest intheentity(orevennoneatall )thentheymaywellpursueactivitieswhichimproveshorttermresults(thereforeimprovingtheircurrentbonuses)totheexclusionofmorefar–sightedstrategieswhichwouldbeofgreaterbenefittotheentityinthelongerterm
• ultimately,shareholdershavetherighttodecidewhoshall(andwhoshallnot)bedirectorsoftheirentityButthisis,inpracticalterms,verymuchatheoreticalpowerGenerallyshareholdersneitherhavethedynamismnororganisationtoeffectsuchachangeinthecompositionoftheboard
overcoming the problem – alignment of interests ( goal congruence )
• incentivesdesignedtoaligninterestsinclude:
• profitrelatedpay
• shareissueschemes,forinstanceontheoccasionofamanagementbuy–out
• shareoptionschemes
• butforallofthesethereisanaturaltendencyformanagementtoadoptcreativeaccountingtomanipulatetheprofitfigureuponwhichtheseincentivesarebased
7Chapter 1 Paper P1Corporate Governance December 2013 Examinations
Stakeholders
• anyoneoranygroup
• primaryorsecondary
• internalorexternal
• narroworwide
• knownorunknown
• legitimateorillegitimate
• activeorpassive
• voluntaryorinvoluntary
• recognisedorunrecognised
• stakeholdersmaybesub-classified
• anoperationalrolewithintheentity
• aroleincorporategovernance
• anumberofinterestsintheentity,bothinternalandexternal
• considertheseelementsinthecontextoftheinternalinterests:
• directors
• entitysecretary
• secondtiermanagement
• employees
• unions
Chapter 1 Paper P1Corporate Governance December 2013 Examinations
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• Eachexternalstakeholderhas:
• aroletoplayininfluencingtheoperationsoftheentity
• theirowninterestsandclaimsintheentity
• considertheseinthecontextoftheexternalinterests:
• auditors
• regulators
• government
• stockexchange
• smallinvestors
• institutionalinvestors
• ReferencetoDavidCampbellStudentAccountantarticles:“Rules,principlesandSarbanes-Oxley”April2008
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9 Paper P1December 2013 Examinations
Free lectures available for Paper P1 - click hereChapter 2
APProAChes to CorPorAte GovernAnCe
two distinct approaches to corporate governance
• rulesbased,and
• principlesbased
Characteristics of the rules based approach
• prescribedsetofcgrequirements
• quickwayofensuringcompliance
• adoptsachecklistapproach
• cleardistinctionbetweencomplianceandnon–compliance
• easytoseethatentityiscomplying
• reductionofflexibilityonthepartofmanagementandauditors
• difficulttosetrulestocoverallsituations
• possibletomisinterpretrules
• samerulesapplytoall,whatevertheirsize
Chapter 2 Paper P1Approaches to Corporate Governance December 2013 Examinations
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Characteristics of the principles based approach• activitiesofentitiesmustaddressmajorprinciplessetoutincodesofbestpractice
• notsimplyaboxtickingexercise
• moredifficulttoavoidthanarulesbasedapproach
• easytoseethatentityiscomplying
• directorsrequiredtoworkintheentity’sbestinterests
• moreflexible,andthereforebetterabletodealwith“new”situations
• easierjustificationforapparentbreachofprinciples
• butprinciplesmaybeinterpreteddifferently
11Chapter 2 Paper P1Approaches to Corporate Governance December 2013 Examinations
• Arrivalofcorporategovernance
• headlinehittingcorporatefailuresinEurope,USAandUKledtorecognitionoftheneedforsomesortofcontrolinanattempttopreventsimilarfailures
• commonelementsidentifiedas:
• poorentitymanagementbydirectors
• singledominantindividual
• unreliablefinancialreporting
• ineffectiveinternalcontrols
• incompetentdirectors
• lackofcloseinvolvementofinstitutionalshareholders
• directorsinterestedmoreinpersonalpositionratherthaninthewelfareoftheentity
Chapter 2 Paper P1Approaches to Corporate Governance December 2013 Examinations
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Development of the UK Corporate Governance Code 2010 ( CGC )
• 1992,theCadburyReport
• followedbyGreenburyreportondirectors’remuneration
• thenHampelreport–alistofprinciplesof“goodcorporategovernance”
• 1998,thesethreemergedintotheCombinedCodeonCorporateGovernance
• 2003,HiggsReport,effectivenessofnon-executivedirectors(neds)
• 2005,Turnbullreport,guidanceoninternalcontrols
• 2006,newCGCpublished
• 2010,revisedandre-named–TheUKCorporateGovernanceCode(CGC)
• CGCappliestoallUKquotedentitieswhichmuststate:
• howithasappliedCGCprinciples
• whetherornotithascompliedwithCGCthroughouttheaccountingperiod,and…
• …ifnot,whynot
13Chapter 2 Paper P1Approaches to Corporate Governance December 2013 Examinations
rules based approach
• USApassedlegislation-SarbanesOxley(SOX)
• appliestoallUSquotedentities
• butalsotoanyentity,anywhereintheWorld,ifithasanAmericanquotedparententity
• mainprovisionsofSOX
• allquotedentitiesmustprovideacertificatetotheSecuritiesExchangeCommissionconfirmingtheaccuracyoftheirfinancialstatements
• wherefinancialstatementshavetoberestatedfollowingmaterialnon-compliance,CEOandCFOmustrepayanybonusesreceivedintheprevioustwelvemonths
• auditorsrestrictedtoauditwork(andtax)
• seniorauditpartnermustrotateofftheauditafternomorethanfiveyears
• PublicEntityOversightBoard–responsibleforenforcingprofessionalstandardsinaccountingandauditing
• directorsforbiddenfromdealinginentitysharesduring“sensitive”times
Chapter 2 Paper P1Approaches to Corporate Governance December 2013 Examinations
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oeCD and ICGn have both issued principles on corporate governance
• theseprinciplesservemultiplepurposes:
• assistgovernmentsintheireffortstointroducecgprinciples
• provideguidanceandadvicetoregulatorybodiessuchasstockexchanges,investorgroupsandinstitutions
• althoughaimeddirectlyatlistedentities,recognisedthatallentitiescouldbenefitfromadoptionofprinciples
• theprincipleshavenolegalstatus
summary of oeCD principles
• ContentsoftheOECDPrinciples:
• identificationofthebasisforaneffectivecgframework
• fairtreatmentforallshareholders
• identifiestherightsofshareholders
• andtheroleofstakeholders
• detailsdisclosurerequirements
• andtransparencyarrangements
• establisheskeyownershipfunctions
• andboardresponsibilities
15Chapter 2 Paper P1Approaches to Corporate Governance December 2013 Examinations
summary of ICGn principles
• identifiescorporateobjectiveofprovidingreturnstoshareholdersontheirinvestments
• disclosureandtransparencymatters
• independentaudit
• detailsshareholders’ownership,responsibilities,rightsandremedies
• detailsprovisionsrelatingtoboardsofdirectors
• prescribesboardremunerationpolicies
• providesguidanceoncgimplementation
• prescribessocialawareness
• recommendsentity/stakeholderrelationship
• establishesneedforbusinessethics
17 Paper P1December 2013 Examinations
Free lectures available for Paper P1 - click hereChapter 3
The Board of direCTors
directors
• anyonewhooccupiesthepositionofdirector
• shadowdirectorsare‘anyoneinaccordancewithwhoseinstructionsthedirectorsareaccustomedtoact’
• cgcestablishesrolesandresponsibilities:
• provideleadershipfortheentity
• representtheentityinitsdealings,andtothepublicgenerally
• settheagendasforboardmeetings
• decidethosematterswhicharetobedeterminedbytheboard,andnotthereforetobedelegated
• decideuponastrategyfortheentity
• selectadirectortobeCEO,and…
• …anotheronetobeChair
Chapter 3 Paper P1The Board of Directors December 2013 Examinations
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• directors’rolesandresponsibilitiescontinued
• establishacorporateculture
• ensurethatthosechargedwithtakingoperatingdecisionsaredoingtheirjobproperly
• establishandimplementaneffectivesystemofinternalcontrolscapableofriskassessmentandmanagement
• ensurethataimsandobjectivesoftheentityarerealisticandachievable
• ensurethatallemployeesareawareoftheentity’sresponsibilitiestoitsstakeholders
• holdregularandfrequentboardmeetings
• assessownperformance,andreportannuallytoshareholders
• submitthemselvesforre–electioneverythreeyears(FTSE350entity?re-electALLdirectorseveryyear)
• forlistedentitiesthereare“additionalrequirements”
19Chapter 3 Paper P1The Board of Directors December 2013 Examinations
Listed entity requirements and the higgs report contents
• listedentitiesshould:
• appointappropriateandindependentneds
• establishsub-committees
- audit
- remuneration
- risk
- nomination
• Higgsidentifiedfourfactorswhichaffecttheeffectivenessoftheboard:
• timeavailabletodevotetoentitymatters
• personalcompetence
• qualityofinformation
• boardroomculture
• othermajorpointsaddressedbyHiggswere:
• theroleofneds,and
• performancemeasurementfortheboardasawholeandforindividualdirectors
Chapter 3 Paper P1The Board of Directors December 2013 Examinations
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Corporate Governance Code sub-divisions
• CGCbreaksdownneatlyintofoursub-divisions:
• directors
• directors’remuneration
• accountsandaudit
• investorrelations
21Chapter 3 Paper P1The Board of Directors December 2013 Examinations
CGC sub-divisions - directors
• everylistedentityshouldhaveaneffectiveboard
• positionsofChairandCEOshouldbeheldbydifferentindividuals
• boardshouldcomprisebothexecutiveandnon–executivedirectors
• thereshouldbeatleastasmanynedsasexecutivedirectors
• appointmenttotheboardshouldbeformalandtransparent
• informationshouldbeprovidedtotheboard
• thereshouldbeaformalassessmentoftheboard’sperformanceannually
• shouldsubmitthemselvesforre–electiononaregularbasis
• withintervalsnotgreaterthanthreeyears
Chapter 3 Paper P1The Board of Directors December 2013 Examinations
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CGC sub-divisions – directors’ remuneration
• shouldbesufficienttoattract,retainandmotivate
• aproportionshouldbeperformancerelated
• nodirectorshouldbeinvolvedindeterminingtheirownremuneration
• remunerationcommitteeshouldpublishareportoftheiractivitiesintheannualfinancialstatements
CGC sub-divisions – accounts and audit
• boardshouldpresentabalancedassessmentoftheentity’sposition
• theboardshouldmaintainasoundsystemofinternalcontrolinordertosafeguardshareholders’investments
• formalarrangementsshouldbeinplaceforconsideringhowtoapplyfinancialreportingandinternalcontrolprinciples
• theboardshouldmakearrangementsformaintaininganappropriaterelationshipwiththeauditors
• thiswillinvolveestablishinganauditcommittee
23Chapter 3 Paper P1The Board of Directors December 2013 Examinations
CGC sub-divisions – investor relations and potential problems with implementation of CGC
• directorsshouldhaveregulardialoguewithinstitutionalinvestors
• directorsshouldencourageactiveparticipationofallshareholdersattheannualgeneralmeeting
• toadoptalltherecommendationsoftheCGCsoundslikeanexcellentidea,buttherecanbeproblems!
• potentialproblems
• possiblethatexecutiveboardcouldlackskillorexperience
• when daily management team report to executive, their failings could mean that problems are not fullyappreciatedoropportunitiescouldbeoverlooked
• directorsmaymeetinfrequentlyandarenotnecessarilycloseacquaintancesThiscouldmakeitdifficultforthemeffectivelytoquestionthedailymanagementteam
• CEOsareoftenpeoplewithforcefulpersonalitieswhosometimesexerciseadominantinfluenceovertheboard
• CEO’sperformanceis judgedbythesamepeoplewhoappointedhimCouldbeverydifficult forthemtobeunbiasedintheirevaluationofCEO’sperformance
Chapter 3 Paper P1The Board of Directors December 2013 Examinations
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structure of the board - single tier ( unified ) or two-tier?
• singletierstructurecharacteristics:
• bothcontrolandmanagementareinthehandsofasinglegroupofdirectors
• commonintheUSandtheUK
• thecgcrecommendsthatatleasthalftheboardshouldbeneds
• anotherrecommendationconcernsthesplitoftherolesofCEOandChair
• theeffectistosplitthemanagement(CEO)fromcontrol(anon–executiveChair)
• inpractice,thenedsnotonlymonitormanagementbutalsocontributetostrategydevelopment
• inlargerentities,managementisoftendevolvedtosub–committees
• alldirectors,whethermanagementorneds,haveequallegalandexecutivestatusAllarethereforeaccountableandresponsibleforboarddecisions
• nedsmayalsotaketheinitiativeinmanagementdecisionsandarenotrestrictedtopost–decisionapproval
• alldirectorsowethesamefiduciarydutiestotheentity
25Chapter 3 Paper P1The Board of Directors December 2013 Examinations
structure of the board - two-tier structure
• twotierstructurecharacteristics:
• consistsofasupervisoryboardandamanagementboard
• entitiesinFrance,GermanyandotherpartsofEuropeoftenhaveatwo–tierboard
• managementisresponsibleforthegeneralrunningofthebusiness
• managementboardisledbyCEO
• supervisory board is responsible for the appointment, supervision and removal of members from themanagementboard
• alsoresponsibleforoverseeingtheactivitiesofthemanagementboard,anditscompliancewithlaw,regulationandtheentity’sconstitution
• also,ageneraloverseeingoftheentityanditsbusinessstrategies
• supervisoryboardisledbytheChair
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directors - structure of the board
• thestructureshouldtakeaccountofthefollowingfactors:
• aneffectiveboardisessentialforgoodcorporategovernance
• abalancebetweenexecutiveandnedssothatnosinglegroupcandominate
• theboardshouldnotbedominatedneitherbyanyindividual
• norbyanygroup/section
• thereneedstobeasplitofpowerbetweenCEOandChair
• executivedirectorsshouldeachbeanexpertintheirownfield
27Chapter 3 Paper P1The Board of Directors December 2013 Examinations
directors - sub-division of roles
• Executivedirectors
• involvedindaytodaymanagement
• usuallyremuneratedasfull–timeemployees
• dedicatetheirworkinglivestofulfillingtheirdutiesasdirector
• takeresponsibilityforthedaytodayrunningoftheentity
• Non-executivedirectors
• membersoftheboard,butnotinvolvedinthedaytodayrunningoftheentity
• neitherafull–timeemployee,norconnectedinanyotherwaywiththeentity
• serveonthevariousboardsub-committees:
- audit
- remuneration
- risk
- nominations
- socialand
- ethical
Chapter 3 Paper P1The Board of Directors December 2013 Examinations
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functions of neds• constructivelychallengeandcontributetodevelopmentofstrategy
• overseeandevaluatemanagement’sperformanceinmeetingagreedobjectives
• satisfythemselvesthatfinancialinformationisaccurate
• satisfythemselvesthatfinancialcontrolsandsystemsofriskmanagementarestrongandappropriate
• roleonremunerationcommittee
• constantlyseektoestablishandmaintainconfidenceintheconductoftheentity
• beindependentinjudgement,andinquisitive
• trytounderstandtheviewsofthemajorinvestors
• beofferedtheopportunitytoattendmeetingswithmajorshareholders
29Chapter 3 Paper P1The Board of Directors December 2013 Examinations
statutory duties of all directors
• Wehavealreadycomeacrosssomeofthedutiesofdirectors,butthefollowinglistincludessomenewones:
• actingoodfaith,intheinterestsoftheentityasawhole,by:
- treatingallshareholdersequally
- declaringanyconflictsofinterest
- notmakingpersonalprofitsattheentity’sexpense
• ensurethattheentitymaintainsproperaccountingrecords
• produceproperfinancialstatementsanddirectors’report
• filethefinancialstatementswiththeGovernmentdepartment
• obeyotherlawsandregulationssuchashealthandsafetylegislation
• Individually,eachdirectormust:
• discloseanyinterestinanentitycontract
• discloseanyinterestinsharesordebenturesoftheentity
• disclosedetailsofanyoptionswhichareheld
• Inaddition,directorshaveacommonlawdutytodemonstratesuchdegreeofskillandcareasmayreasonablybeexpectedfromapersonofthatage,experienceandqualification.FailuretodosomayresultinthedirectorbeingfoundliablefornegligencewiththeconsequencethataCourtmayholdthedirectorpersonallyliableforanylosswhichtheentityhassufferedasaresultofthatnegligence.
Chapter 3 Paper P1The Board of Directors December 2013 Examinations
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directors - appointment and service contracts
• Appointment
• Therulesfortheappointmentandremovalofdirectorsarefoundintheconstitutionofanentityandtypicallyprovidethefollowing:
- thefirstdirectorsareappointedatthetimeofformationoftheentity
- subsequentdirectorsarenormallyappointedbythedirectorsinthetimebetweengeneralmeetings,butsuchappointeesmustseektobere–electedbytheshareholdersatthenextannualgeneralmeeting
- directorsarerequiredtoretirebyrotation
- directorsshouldstepdownfromofficeatleasteverythreeyears,butmayseekre–election
- iftheentityisanFTSE350entity,alldirectorsmustbere-electedeveryyear
• Directors’servicecontracts
• Thesearelegaldocumentscontainingthetermsofserviceforeachdirectorandwillnormallyinclude:
- keydates
- duties
- remunerationdetails
- terminationprovisions
- constraints
- anyother“normal”employmentprovisions
• Thecontractshouldnotbeforaperiodinexcessofoneyear
31Chapter 3 Paper P1The Board of Directors December 2013 Examinations
directors – removal and disqualification
• Directorsmaybe removed fromofficeat any timeby thevoteof themajorityofmembers ingeneralmeeting Inaddition,theofficeofdirectorshallbevacatedaccordingtotherulessetoutintheentity’sconstitutionTypicallythiswillprovidethatadirectorshallloseofficeif:
• becomesdisqualifiedbylaw
• dies
• isremovedbyshareholders
• becomespersonallybankrupt
• resignsfromofficebynoticeinwriting
• isabsentfromboardmeetingswithoutpermissionforaperiodinexcessofsixmonths
• Disqualificationunderthelawcanhappenwhenadirectorisguiltyof:
• allowingtheentitytocontinuetotradewhilstitisinsolvent
• notkeepingproperaccountingrecords
• failuretopreparefinancialstatements
• threedefaults(withinafiveyearperiod)offailingtofilerelevantdocumentswiththeGovernmentdepartment
• failuretofiletaxreturns(orpaytax)
• takingactionswhicharedeemedbytheCourttobeinappropriateforthemanagementoftheentity
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directors – insider dealing
• Insider – a personwho has a business connectionwith an entity as a result ofwhich theymay acquire relevantinformation
• Dealing–buyingorsellingsharesorsecuritiesinanentity
• Unpublishedprice–sensitiveinformationisinformationabouttheentitywhichisnotinthepublicdomain
• islessthan6monthsold,and…
• is,onpublication,likelytohaveamaterialimpactonthemarketpriceoftheentity’sshares
• Aninsiderinpossessionofunpublishedprice–sensitiveinformationshouldnotdeal
• Anoffenceisalsocommittediftheinsiderencouragesanotherpersontodeal
• Apersondealingasaresultofthatencouragement,andbelievingthesourcetobeaninsider,isalsocommittinganoffence
• Disclosureofinsideinformation,otherthaninthepropercourseofemploymenttoanauthorisedperson,isalsoanoffence
• Somedefencesareavailabletobeclaimed
33Chapter 3 Paper P1The Board of Directors December 2013 Examinations
directors - induction and education
• TheCGCestablishesprinciplesfortheeducationofanewdirectorintheactivitiesoftheentityItisclearlyimportantthatthenewdirectorshouldbecomeacquaintedwiththeexecutiveboardassoonaspossibleaftertheirappointment,sotheentity’sinductionprocedureshould:
• becomprehensive
• betailoredtotheneedsoftheentityandindividualdirectors
• containwritteninformationpluspresentationsandappropriateactivities(egsitevisits)
• givenewappointeesabalancedoverviewoftheentity
• notoverloadthedirectorwithanexcessofinformation
• attheendoftheinductionprocess,thenewdirectorshouldhave:
- anunderstandingofthenatureoftheentity,itsbusinessandthemarketsinwhichitoperates
- alinkwiththeentity’semployees
- anunderstandingoftheentity’smainrelationshipsincludingtherelationshipwiththeauditors
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directors – performance evaluation
• TheCGCcontainsaframeworkforassessingtheperformanceofindividualdirectorsaswellasoftheboardasawhole:
• thereshouldbeanannualevaluationoftheperformanceoftheboardasawholeandofeachmemberoftheboard
• theevaluationexerciseshouldbetailoredtosuittheentity’sneeds
• entitiesshouldpublishinthefinancialstatementswhethersuchanevaluationexercisehasbeencarriedout
• theChairisresponsiblefortheselectionofaneffectiveprocess,andfortakingappropriateactiononcompletion
• theuseofanindependentthirdpartywouldbringadditionalobjectivitytotheexercise
• theevaluationexerciseshouldconsistofanumberofquestionsandanswersdesignedtoassessperformanceandidentifyhowperformancecouldbeimproved
• thewholeprocessshouldbeusedconstructivelyasameanstoimproveboardeffectiveness,maximisestrengthsandminimiseweaknesses
• theresultsoftheboardevaluationshouldbesharedwiththewholeboard,but
• theresultsofindividualevaluationsshouldremainconfidentialbetweentheChairandtheindividualdirector
35 Paper P1December 2013 Examinations
Free lectures available for Paper P1 - click here Chapter 4
Board Committees
audit committee
• auditcommitteeisasub–committeeoftheboardandiscomprisedentirelyofneds
• inalistedentity,thereshouldbeatleastthreenedsontheauditcommittee,oneofwhomhashadrecentrelevantfinancialexperience
• keyrolesfortheauditcommitteeare:
• oversight
• assessment
• reviewoftheotherfunctionsandsystemsintheentity
• mostoftheboard’sobjectivesrelatingtointernalcontrolwillprobablybedelegatedtotheauditcommittee
• theauditcommitteeshould:
• reviewtheentity’sinternalfinancialcontrols
• reviewalltheentity’sicandriskmanagementsystems
• approvethewordinginthefinancialstatementsrelatingtoicandriskmanagementsystems
• receivereportsfrommanagementabouttheeffectivenessofthecontrolsystems
• receivereportsconcerningtheconclusionofanytestscarriedoutonthecontrolsbyeitherinternalorexternalauditors
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internal control systems
• foranicsystemtobeeffectiveitneedstominimisesuccessfullythebusinessrisksidentifiedbymanagement:
• playsanimportantrole inmanagingthoseriskswhichmostthreatentheattainmentoftheentity’sbusinessobjectives
• contributes significantly to protecting shareholders’ investment, safeguarding the assets and ensuringcompliancewithlawandregulation
• shouldalsoseektopreventandtodetectfraudInapoorcontrolenvironmentfraudcouldmoreeasilydevelop
• shouldbereviewedcontinuallyandimprovedasappropriate
• thecostsofimplementingacontrolshouldnotexceedthebenefittobegainedfromthereducedrisk
• suitabilityofacontrolwillvaryfromentitytoentity
• shouldbeanintegralpartofanyentity’sriskmanagementstrategy–itshouldnotbeanafter–thought
• effectivefinancialcontrols(includingmaintenanceofproperaccountingrecords)areanimportantelementofasystemofic
37Chapter 4 Paper P1Board committees - audit committee December 2013 Examinations
internal controls -categorisation
• canberememberedbythemnemonicoapspasm
o organisational
A Arithmeticandaccounting
P Personnel
s segregationofduties
P Physical
A Authorisation
s supervision
m management
Chapter 4 Paper P1Board committees - audit committee December 2013 Examinations
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internal controls - categorisation
• theseeightcontrolscannowbecategorisedintothreeheadings–
Structure Transactions Staff
Organisational•controlovertheorganisationstructureincludingmanagershavingspecificresponsibilitiesanddelegationtasks
Physical•protectionofassetsagainsttheft,unauthorisedaccessoruse
Personnel•controlsthat:-suitablepeoplearerecruited
foreachjob,and-appropriatetrainingispro-
videdforthatjob
Segregationofduties•foreachtransactiondifferentpeople:
-authoriseit-recordit-maintainphysicalcustodyof
anyassets-payforit
Arithmeticandaccounting•checkingaccountingtransac-tionsforaccuracy
•includesuseofcontrolaccountsandreconciliations(egbankreconciliation)
Supervision•oversightofworkofotherindividualstoensuretasksarecarriedoutcorrectly
Authorisationandapproval•controlstoensurethattransac-tionsdonotproceeduntilanappropriateindividualhasgivenapproval(normallyinwriting)
Management•controlactiontakenbyman-agementdependingonthecontentsofreportsreceived
39Chapter 4 Paper P1Board committees - audit committee December 2013 Examinations
audit committee and internal audit ( ia )
• aspartoftheirobligationtoensureadequateandeffectivecontrolsauditcommitteeisresponsiblefortheactivitiesofia
• theauditcommitteeshould:
• monitorandassesstheroleoftheiafunctionwithintheentity’soverallriskmanagementsystem
• checktheefficiencyofia
• approvetheappointment(orremoval)ofthechiefinternalauditor
• ensurethattheiafunctionhasdirectaccesstotheChairandisaccountabletotheauditcommittee
• reviewandassesstheannualiaworkplan
• receivereportsconcerningtheworkoftheiafunction
• reviewandmonitormanagement’sresponsetoiafindings
• ensureia’srecommendationsareimplemented
• helptopreservetheiafunctionfrompressureswhichmightotherwiseimpairtheirobjectivity
• auditcommitteeshouldmeetwithiaatleastonceeachyeartodiscussaudit–relatedmatters
• possiblethatevenalistedentitydoesnothaveaniafunction
• ifnoauditcommittee,shouldreviewthesituationannuallyandmakeanyappropriaterecommendation
• ifthereisnoiadepartment,thisfactmustbedisclosedinthefinancialstatements
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audit committee and the external auditors ( ea )
• auditcommitteeisresponsibleforoverseeingtheentity’srelationshipwiththeea
• responsibilityisgivenbytheCGCwhichalsostatesthattheauditcommitteeshould:
• havetheprimaryresponsibilityforrecommendingeasforappointment,re–appointmentorevenremoval
• overseetheselectionprocesswhenreplacementauditorsarebeingconsidered
• approvetheterms(notnecessarilynegotiate)oftheea’sengagement,andtheirremuneration
• developprocedureswherebytheycanannuallyensuretheea’scontinuingindependenceandobjectivity
• reviewthescopeoftheauditwithea,andsatisfythemselvesthatthescopeissufficient
• ensurethatappropriateplansareinplacefortheauditatthecommencementoftheaudit
• carryoutapostauditreview
41Chapter 4 Paper P1Board committees - audit committee December 2013 Examinations
reporting on internal controls to shareholders
• CGCrequiresthatanentity’sboardshouldmaintainasoundsystemofinternalcontrolstosafeguardtheentity’sassetsandtoprotectshareholders’investments
• issueishowmuchtheentityshouldtellitsshareholdersabouttheinternalcontrolsystem
• asownersof theentity, shareholdersareentitled toknowwhether the internalcontrol system issufficientlystrongtosafeguardtheentity’sassets
• boardshould,atleastonceeachyear,reviewtheeffectivenessoftheinternalcontrolsystem,andreporttotheshareholderstheresultsofthatreview
• reviewshouldcoverallmaterialcontrolsincludingfinancial,operationalandcompliancecontrolsaswellastheriskmanagementsystem
• in addition, the shareholders shouldbe told, through the financial statements, about thework of the auditcommittee
• attheannualgeneralmeetingtheChairoftheauditcommitteeshouldbeavailabletoansweranyshareholderquestions
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internal audit reporting Report section Reason Example
Objectivesofauditwork •Setsthesceneforreportaudiencebydescribingpurposeofreview
•Forapayrollaudit‘checkwhether:-wagesarepaidtothecorrect
individuals-deductionsfromgrosspayare
properlycalculated’
Summaryofprocessunder-takenbyauditor
•Describeshowtheevidencetosupporttheopinionandrecom-mendationswasgathered
•‘Recalculationofdeductionswasperformedforasampleof50monthlyand50weeklywagespayments’
Auditopinion(ifrequired) •Summaryofwhetherthecontrolreviewedisworkingornot
•‘Inouropinion,thecontroliswork-ingasintended’
Recommendations •Highlightareasofcontrolweaknessandsuggestcourseofremedialaction
•‘Werecommendthatnewemploy-eesareonlyaddedtothepayrollsystemonreceiptofanappropri-atelyauthorisedForm1a’
43Chapter 4 Paper P1Board committees - audit committee December 2013 Examinations
role and function of an audit committee
• createaclimateofdisciplineandcontrolleadingtoareductionofopportunitiesforfraud
• lendanairofcredibilityandobjectivityinthefinancialstatementstherebyincreasingpublicconfidence
• assistCFObyprovidingaforum
• reviewfinancialstatementstoimprovethequalityofreporting
• independentjudgement
• strengthenpositionoftheinternalauditor
• strengthenpositionoftheexternalauditor
• assistintheresolutionofdisputesbetweenexternalauditorandexecutiveboard
• rememberClarissa
Chapter 4 Paper P1Board committees - remuneration committee December 2013 Examinations
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remuneration committee
• importance:
• executivedirectorsshouldnotberesponsiblefordeterminingtheirownremuneration
• remunerationdecisionscanbeseentobetakenbythosewhowillnotbenefitfromthosedecisions
• thereisaneedforformal,transparentproceduresfordevelopingpolicyandforindividualpackages
• role
• the committee determines appropriate packages for the executive directors, and the composition of thosepackages
• composition
• inlistedentitiesthecommitteewilltypicallycompriseneds
• accountability
• reportstothemainboard
45Chapter 4 Paper P1Board committees - remuneration committee December 2013 Examinations
strategy of the remuneration committee may consider:
• greaterbenefitsinkindtocompensateforlowerbasicsalaries
• offeringnon–cashmotivationforsome(orall)oftheentity’semployees.Non–cashmotivatorscouldincludethingslikecrèchefacilities,carsandadditionalholidays
• availabilityofentityresources.Forexample,theentitymaynothavesufficientcashresourcetopayanannualbonus,butmayofferashareincentiveschemeinstead
• encouragementoflong–termloyaltybyofferingshare–purchaseschemes
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remuneration committee responsibilities
• determine, and regularly review, the framework, broadpolicy and specific terms for the remuneration, terms andconditionsofemploymentoftheChairandoftheexecutivedirectors
• recommendandmonitorthelevelandstructureoftheremunerationofseniormanagement
• setdetailedremunerationforallexecutivedirectorsandtheChairincludingpensionrightsandcompensationpayments
• ensurethatexecutivedirectorsandseniormanagementarefairlyrewardedfortheir individualcontributionstotheoverallperformanceoftheentity
• demonstratetoshareholdersthattheremunerationofexecutivedirectorsandseniormanagementissetbyindividualswithnopersonalinterestintheoutcomeofthecommittee’sdecisions
• agreecompensationforlossofoffice
• ensurethatprovisionsfordisclosureofremuneration,includingpensions,assetoutinlawandintheCGCarefollowed
47Chapter 4 Paper P1Board committees - nominations committee December 2013 Examinations
Nominations committee
• importance:
• needstobeseentobeunbiasedandimpartial
• needstobeobjectiveinordertoensurethatappointmentsaremadeinlinewithpre–agreedspecifications
• role
• identifyappropriatepeopletobeinvitedtojointheboard
• thecommitteedeterminesappropriatepackagesfortheprospectiveexecutivedirectors,andthecompositionofthosepackages
• composition
• executivedirectorsandneds,butnedsshouldbethemajority
• accountability
• makesrecommendationstothemainboard,but
• finaldecisionsaremadebythemainboardasawhole
• overallresponsibilitiesofthenominationscommitteeareto:
• reviewregularlythestructure,sizeandcompositionoftheboard,andmakerecommendationstotheboardofnewnominees
• givefullconsiderationtosuccessionplanningfordirectors
• regularlyevaluatethebalanceofskills,knowledgeandexperienceoftheboard
• prepareadescriptionoftheroleandcapabilitiesrequiredforanyparticularboardappointment
• identify,andnominateforapproval,candidatestofillboardvacanciesastheyarise
• recommendtotheboardconcerningexistingdirectorsstandingforre–appointment
Chapter 4 Paper P1Board committees - risk management committee December 2013 Examinations
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risk management committee
• boardisresponsibleforriskidentificationandriskmanagement,bothofwhichinvolvetheestablishmentofasoundsystemofinternalcontrol
• importance:
• givesanobjectiveviewontheentity’sriskprofile
• role
• assessesinternalcontrols
• performsriskassessmentsoftheentity’skeyoperations
• oftenoverseestheimplementationandeffectiveoperationofriskstrategy,policiesandprocedures
• composition
• executivedirectorsandneds,butnedsshouldbethemajority
• accountability
• makesrecommendationstothefullboardofinternalcontrolandriskstrategy,or
• totheauditcommittee,buttheyinturnwillreporttothefullboard
• mainresponsibilitiesanddutiesoftheriskmanagementcommitteeareto:
• advisethefullboardonriskmanagementissues,strategyandpolicy
• emphasiseanddemonstratethebenefitsofarisk–basedapproachtointernalcontrols
• setappropriateinternalcontrolpolicies
• regularlyassurethatthesystemisfunctioning
• reviewtheeffectivenessofinternalcontrols
• providerelevantdisclosuresaboutinternalcontrolsinthefinancialstatements
• reviewthesystemofinternalcontrolspayingparticularattentiontothecontrolenvironment,riskassessment,informationsystems,controlproceduresandmonitoring
49 Paper P1December 2013 Examinations
Free lectures available for Paper P1 - click here Chapter 5
CorPorate GovernanCe and CorPorate SoCial reSPonSibility
• entitiesareincreasinglyacceptingthattheyhavesocialandenvironmentalresponsibilities
• whoarethepeoplewhoareaffectedbyanentity’sactions?
• thereare,ofcourse,manyincluding:
- employees
- customers,suppliersandthelocalcommunity
- theenvironmentmaybeaffectedasaresultofourproductionprocesses
• CGvsCSR
• cgisnotthesameascorporatesocialresponsibility(csr)
• csristheprinciplethatanentitywillthinkaboutitsimpactonthewiderenvironmentandwilltakedocumentedstepstominimisethedamageandmaximisethebenefitsofitsactions
• strategyofanorganisationisshapedbymanyfactors,includingthedemandsofstakeholders
• eachdifferentstakeholder,orclassofstakeholder,willtypicallyhavedifferentobjectivesaswellasdifferentlevelsofinfluence
• expression stakeholder is applied to anyonewhohas anything todowith thebusiness,whetherdirectlyorindirectly
• cgframeworkofanentityshouldrecognisetherightsofstakeholdersestablishedbylaworbyseparateagreement
• becausedifferentstakeholdershavedifferentobjectives,itisnecessaryfortheboardtobalancetheseconflictinginterests
• anentity’sstrategyisoftentomanage,ratherthansatisfy,stakeholderobjectives
• inevitably,themoreinfluentialthestakeholder,thegreaterwillbetheattentiondirectedtotheirinterests
Chapter 5 Paper P1Corporate Governance and Corporate Social Responsibility December 2013 Examinations
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the most important group of stakeholders is ( normally ) the shareholders
• theyarethelegalownersoftheentity,andcontrolitthroughvotescastattheannualgeneralmeeting
• eventhoughtheyowntheentity,theydonotownthepropertyoftheentity–thisreinforcesthelegalconceptofanentitybeingaseparatelegalperson
• shareholdershaveanumberofstatutoryrights:
• therighttotransfertheirshares
• therighttoreceivenoticeofmeetings
• therighttoattend,speakandbeheardatthosemeetings
• therighttoreceiveadividend(whenapprovedbythegeneralmeeting)
• therighttoacopyoftheentity’sfinancialstatements
• oncetheyhavepaidthefullfacevalueofthesharesheldbythem,they(normally)willhavenofurtherobligationtocontributetoashortfallinaninsolventliquidation(butthereareexceptions)
• theydoNOThavetoremainloyaltotheentityandmayselltheirsharesatanytime
• nordotheyhaveanydutytoensurethattheentityoperatesinasociallyresponsibleway
51Chapter 5 Paper P1Corporate Governance and Corporate Social Responsibility December 2013 Examinations
Corporate social responsibility and disclosure
• isasuccessfulbusinessalsoagoodcorporatecitizen?
• onlyifitpaysattentiontoitsenvironmentandstakeholders
• forexample:
• aswellasmakingproductsorsupplyingservices, resulting inprofitability, it shouldalso try tomaximise thebenefitsof,andminimisetheharmcausedby,itsoperatingactivities
• it should achieve a balance between its legal responsibilities, its commercial responsibilities and its socialresponsibilities
• itshouldconstantlybereviewingitssocialresponsibilityposition
• asaconsequenceofacknowledgingitssocialresponsibility,andbeingseentobeactinginaresponsibleway,anentitycouldverywellfindthatdemandforitsproductsincreases
• disclosure
• generalprinciples
- becauseshareholdersaretheownersofanentity,theyareentitledtobegivensufficientinformationtoenablethemtomakeinvestmentdecisions
- theAnnualGeneralMeetingisseenasthemostopportunetime(oftentheONLYtime!)fordirectorstobeabletocommunicatedirectlywiththeentity’sshareholders
- inaddition,thefinancialstatementsareoftentheonlyprintedinformationwhichshareholdersreceivefromtheentity
• commonsensewilltellusthat:
• moreregularandconstructivedialoguewithourshareholderswillleadto:
- betterunderstandingofshareholders’interestsandconcerns
- betterunderstandingbytheshareholders’ofwhattheentityistryingtoachieve
- increaseinshareholderinterestthereforeencouragingchecksonthemanagersoftheentity
- potentialbenefitresultingfromthecloserinterestintheentitybythemajorshareholders
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CGC disclosure recommendations
• disclosure
• itallowstheentity’sboardtoprovideinformationongovernancematterstoshareholdersandotherstakeholders
• disclosuredemonstratesthatgoodcgprinciplesarebeingappliedbytheentity
• alsoameansofcommunicatingmattersofinterestandvalue
• CGCcontainspoliciesandprovisionswithwhichlistedentitiesareexpectedtocomply
• thesepoliciesandprovisionsrepresent“bestpractice”intermsofdisclosure
• CGCrequirements
• alistedentityisrequiredtostatewithinthefinancialstatements:
- howithasappliedtheprinciplesoftheCGC,and
- whetherithascompliedwiththeCGCthroughouttheaccountingperiod
- andifnot,whynot
53Chapter 5 Paper P1Corporate Governance and Corporate Social Responsibility December 2013 Examinations
CGC – additional disclosures
• astatementbytheboardacknowledgingtheirresponsibilityforthefinancialstatements
• astatementbytheboardtoconfirmtheirviewthattheentityisagoingconcern
• detailsofeachboardmembertogetherwithdetailsoftheirresponsibilitiesandtheirrecordofattendanceatboardmeetings
• theidentityoftheChair,theCEOandwhichdirectorssitonwhichofthesub–committees(audit,socialresponsibility,nominations,remunerationandriskmanagement)aswellastheirattendancerecordsatmeetingsofthosecommittees
• reportsontheactivitiesofthecommittees
• ifthereisnointernalauditfunction,therelevantsectionoftheannualreportshouldexplainwhynot
• astatementthatthedirectorshaveundertakenareviewoftheeffectivenessoftheinternalcontrolsystem
• areportonthemethodsusedtoevaluateperformanceoftheboardanditscommittees
• informationaboutthemeasurestakenbytheboardtoensurethatitunderstandstheviewsofitsmajorshareholders
• informationaboutthestepstakentoensurethecontinuingindependenceoftheexternalauditors
• wheretheboarddoesnotacceptarecommendationfromtheauditcommittee,thereshouldbeastatementbytheauditcommitteeexplainingtheirrecommendationandwhytheboardhastakenadifferentview
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annual General Meetings
• everyentitymustholdanannualgeneralmeetingonceineverycalendaryear(Thisisnottechnicallycorrect–privateentitiesmaydispensewiththisrequirementbut,forourpurposes,whendealingwithcorporategovernanceofpublicentities,thestatementistrue)
• somequickpointsaboutAGMs
• theyarealegalrequirement
• eachissuemustbeapprovedbyseparateresolution
• themeetingrequiresnotlessthan21days’notice
• thefirstmeetingmustbeheldwithin18monthsoftheentity’sincorporationdate
• eachsuccessivemeetingshallbeheldnolaterthan15monthsafterthepreviousmeeting
• allshareholderswhoareentitledtoattendmustbegivennoticeofthemeeting
• theboardshouldusetheAGMtocommunicatewithshareholders,andshouldencouragetheirparticipation
• thepurposeofthemeetingistoapprovethe“ordinarybusiness”oftheentitytogetherwithanyothermatterswhichrequireshareholderapproval
• “ordinarybusiness”comprises:
- thereceivingoftheannualfinancialstatements
- thereappointmentofdirectorsretiringbyrotation
- thereappointmentoftheauditorsforanotherfullyear
- theformalapprovalofthedividendwhichhasbeenproposedbythedirectors
• theboardshouldarrangefortheChairofthesub–committeestobepresentattheAGMtoansweranyquestionsfromtheshareholders,andforalldirectorstobepresent
55Chapter 5 Paper P1Corporate Governance and Corporate Social Responsibility December 2013 Examinations
other general meetings and proxy votes
• entitiesmayalsofindthattheyneedtoholdgeneralmeetingswhicharenotAGMsTheseareOtherGeneralMeetings(OGMs)
• somequickpointsaboutOGMs
• heldirregularly,andonlywhensomethingurgentariseswhichneedsshareholderapproval
• separateresolutionsshouldbepassedforeachdifferentmatter
• lengthofnoticeofthemeetingdependsonwhattypeofresolutionistobeproposed
• itistheoreticallypossibleforanentitytogofrombirthtodeathwithoutanyneedtoholdanOGM
• proxyvoting
• ashareholderwhoisunabletoattendageneralmeetingmayappointapersontoattendthemeetingontheirbehalf
• suchapersoniscalleda“proxy”andthedocumentwhichappointsthemisa“proxyform”
• wheretheshareholderisanentity,theywillappointa“representative”andnotaproxy
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CGC and proxies
• CGCsaysaboutproxies:
• foreachresolutiontobeproposed,theproxyformshallprovidetheshareholderwiththeoptionsofdirectingtheirproxytovoteinfavour,against,orwithholdtheirvote
• avotewhichiswithheldisnotcountedasavote–neitherinfavournoragainst
• theentityshouldensurethatallproxyformsreceivedareproperlyrecordedandcounted
• foreachresolution,afteravotehasbeentaken,theentityshouldpublishonitswebsitethedetailsofthevotesand,inparticular:
- thenumberofsharesinrespectofwhichvalidproxieshavebeenreceived
- thenumberofvotesforeachresolution
- thenumberofvotesagainsttheresolution
- thenumberofsharesinrespectofwhichthevotewaswithheld
57 Paper P1December 2013 Examinations
Free lectures available for Paper P1 - click hereChapter 6
CorPorate governanCe – Control systems
• Internalcontrolisakeyprocesswithinanorganisationconcernedwiththemanagementofriskandtheachievementofobjectives
• byinternalcontrolismeantnotonlyinternalcheckandinternalauditbutthewholesystemofcontrols,financialandotherwise,establishedbythemanagementinorderto
• carryonthebusinessoftheentityinanorderlyandefficientmanner
• ensureadherencetomanagementpolicies
• safeguardtheassets
• preventanddetectfraudanderror
• secureasfaraspossiblethecompletenessandaccuracyoftheaccountingrecordsenabling
• thetimelypreparationofreliablefinancialinformation
• Internalcontrolandriskmanagementincg
• bothelementsofinternalcontrolandriskmanagementarefundamentalpartsofsoundcgbecause:
- cghaskeylinkstorisksandtointernalcontrols
- whilstitisnotpossibletopreventcorporatefailures,goodcgcangoalongwaytominimisetherisk,andwell–runentitiestendtoachievetheirobjectivesinalessriskyway
- sowecanseethatcgisakeytoriskreduction
- theCGC requiresentities tooperateappropriatesystemsof internalcontrol,and toensure that thosesystemsareregularlyreviewedandimproved
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turnbull report and internal controls
• requiresthatinternalcontrolsshouldbeestablishedusingarisk–basedapproach
• specificallyanentityshould:
• establishitsbusinessobjectives
• identifytheassociatedkeyrisks
• designcontrolstoaddressthoserisks
• establishasystemtoimplementthecontrols,includingtheprovisionofregularfeedback
• objectivesofinternalcontrolsystems
• managetheriskswhichhavebeenidentifiedwithinanentityincludingtheriskthattheentityfailstoachieveitsobjectives
• internalcontrolsystemsshouldbedesignedsothattheygivereasonableassurancethat:
- operationsarerunningefficientlyandeffectively
- financialreportingisreliable
- applicablelawsandregulationsarebeingadheredto
• iftherewerenointernalcontrolsystem,managementwouldbeunabletomonitortheeffectivenessoftheirriskmanagementstrategy,andwouldcertainlynotbeinanypositiontorespondtonewthreatsastheyarose
59Chapter 6 Paper P1Corporate governance – control systems December 2013 Examinations
• Executivemanagementrolesinriskmanagement
• in any entity the board is ultimately responsible for all matters concerning the entity However, it is notunreasonabletoexpecttheboardtodelegatedutiesdowntoindividualexecutivedirectorlevel
• CEO(ultimatelyresponsiblefortheentiresystemandoperationsoftheentity)shouldbeseentobeincontrolofriskmanagement
• CEOistheoneindividualmorethananyotherwhosetsthestandardforethicsandacceptanceofresponsibility
• boardofdirectors,asawhole,isresponsibleforensuringtheadequacyoftheinternalcontrolsystemandtheyshouldthereforeensurethatexecutivedirectorsmonitortheinternalcontrolsystemeffectively
• senior executivemanagement is responsible for setting the internal control policies and formonitoring theadequacyandeffectivenessoftheinternalcontrolsystemTheyalsoreporttothefullboardthatthishasbeendone
• lower levelmanagement ( not executive directors ) will typically find that these responsibilities have beendelegated to them! But executive directors remain the ones responsible for confirming adequacy andeffectiveness
• employeesgenerallyhave the taskof carryingout thedirectors’ orders, andare therefore theoneswhoarechargedwiththeresponsibilityofensuringthecorrectapplicationoftheinternalcontrols
61 Paper P1December 2013 Examinations
Free lectures available for Paper P1 - click hereChapter 7
Auditors And internAl Controls
Function and importance of internal audit
• internalaudit(ia)isanindependentappraisalactivityestablishedwithinanorganisationasaservicetoit
• itisacontrolwhichfunctionsbyexaminingandevaluatingtheadequacyandeffectivenessofothercontrols
• inalargeorganisationiawillbeaseparatedepartment
• insmallerentities,itcouldbethatanindividualisallocatedtocarryoutspecifictasksofanianature
• itmaybethattheiafunctionisoutsourced
• ifitisanin-housedepartment,itisimportantthatthefunctionisstructuredinanappropriateway
• scopeofinternalaudit
• managementwillprescribethescopeandobjectivesoftheiadepartment,butthesewilltypicallyinclude:
- reviewoftheaccountingandinternalcontrolsystems
- detailedtestingoftransactionsandbalances
- reviewoftheeconomy,efficiencyandeffectivenessofoperations
- reviewoftheimplementationofentitypolicies
- specialinvestigations
- assistingtheexternalauditors
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independence of internal audit
• foranauditfunctiontooperatesuccessfully,itisnecessarythattheauditorisindependent
• appliesequallywelltointernalauditorsastoexternalauditors
• for internal audit to be effective, the reviews which they carry out must be conducted and reported on on anindependentbasis
• theequivalentoftheconfidencewhichisgivenbytheexternalauditorbeingindependent
• Comparisonofinternalandexternalauditors
External Internal
Requiredby statute management
Appointedby shareholders management
Reportsto shareholders,andmanagement management
Reportson financialstatements internalcontrols
Opinionabout truthandfairness,properpresentation adequacyofintconts,valueformoney
Scope asnecessary prescribedbyexecutiveboard
63Chapter 7 Paper P1Auditors and Internal Controls December 2013 Examinations
Potential threats to independence
• inthesyllabusfortheearlierauditingpaper,
• seehowmanyyoucanremember!
• f
• f
• c
• l
• b
• g
65 Paper P1December 2013 Examinations
Free lectures available for Paper P1 - click here Chapter 8
ManageMent InforMatIon SySteMS
• informationflowsarevitalifmanagementaretobeabletomanageriskandmonitorinternalcontrols
• threeelementswhichshouldbeapparent:
• bothinternalandexternalinformationisrequiredinorderthatinformeddecisionscanbemade
• theinformationshouldbeprovidedonaregularbasisinorderthatmanagementcanmonitorperformanceofeconomy,efficiencyandeffectiveness
• there needs to be clearly defined, effective channels of communication within the organisation so thatmanagementreceivetheinformationonatimelybasis
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Information characteristics
• a accessible
• a adequate
• c complete
• c concise
• c consistent
• i integrated
• o objective
• p provable
• r relevant
• r reliable
• t timely
• u unbiased
• u understandable
67 Paper P1December 2013 Examinations
Free lectures available for Paper P1 - click hereChapter 9
The Risk ManageMenT PRoCess
Risk and corporate governance
• goodcginvolveseffectiveriskmanagement,andthateffectiveriskmanagementinturninvolvesasoundsystemofinternalcontrol(TurnbullReport)
• goodcorporategovernancewilleliminateordecreasemanyoftherisksfacinganentity
• fairtreatmentofshareholders
• rightsofshareholders
• theroleofstakeholders
• disclosurerequirementsandtransparencyarrangements
• boardresponsibilities
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First three principles of good corporate governance
• Fairtreatmentofshareholders
• preferentialtreatmentshouldnotbegiventoanyonegroupofshareholders
• othershareholderscouldresentthisanditcouldresultinbadpublicityfortheentity
• Rightsofshareholders
• theentitymaynotallowshareholderstheirrights
• forexample, if theentity fails toallowashareholder to join indiscussionsatanAGM,or if theentity fails tocommunicatethedetailsoftheAGM
• Theroleofstakeholders
• entitiesmayignorestakeholders
• astakeholdergroupcouldbetreatedinappropriately
• forexample,ifanentitytriestomakeanemployeeredundantwithoutfollowingestablishedlegalprocedure
69Chapter 9 Paper P1The Risk Management Process December 2013 Examinations
Final two principles of good corporate governance
• Disclosurerequirementsandtransparencyarrangements
• directorspossiblyfailtoprovideappropriatereports
• directorsfailtoreportthetruefinancialpositionoftheentity
• itisnecessarilythecasethat,forproperdisclosureandtransparency,asoundsystemofinternalcontrolintheentityshouldexist
• Boardresponsibilities
• theboardpossiblydoesnotcontroltheentityadequately
• theboardattemptstoruntheentityfortheirownbenefitratherthanforthebenefitofshareholdersandotherstakeholders
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Management’s responsibility for risk management
• Riskisdefinedas“thechanceofexposuretotheadverseconsequencesofuncertainfutureevents”
• Itcanthereforebeseenthat:
• riskcanadverselyaffecttheachievementoftheentity’sobjectives
• byreducingthelikelihoodofanevent,oritspotentialimpact,theriskismanaged
• theresponsibility formanagingtherisk ismanagement’sandtheydosobyestablishingariskmanagementsystem
• Processofriskmanagementsystemestablishment
• identify–preparelistofpotentialrisks
• analyse–prioritisethepotentialrisks
• reporttomanagementabouttherisksidentified
• designriskmanagementsystem–prepareavoidanceandcontingencyplans
• recommenddesignedsystemforimplementation
• implement–putinplacetheacceptedsystem
• evaluate–monitorand,ifnecessary,re-analyse
71Chapter 9 Paper P1The Risk Management Process December 2013 Examinations
Risk management
• necessarytomanagerisk:
• identifynewrisksthatmayaffecttheentitysoanappropriatemanagementstrategycanbedesigned
• identifychangestoexistingorknownriskssoanamendmentmaybemadetoexistingstrategy
• ensurethatbestuseismadeofchangingopportunities
• managingtheupside
• riskappliesequallyto“goodnews”
• thisupsideriskneedstobemanagedjustasmuchasdownsiderisk
• managementoftheupsideriskisviewedinadifferentwaythanthedownsidebecause:
• risksareseenasopportunitiestobeusedtoadvantage
• organisationsareprepared toaccept someuncertainty inorder togaingreaterbenefitsandhigher rewardsassociatedwithhigherrisk
• riskmanagementisusedtoidentifyrisksassociatedwithnewopportunitiesleadingtoanincreaseinprobabilityofprofitabilityandmaximisedreturns
• effectiveriskmanagementisseenasawayofimprovingshareholdervaluebyimprovingperformance
• ALARPattitudetoriskmanagement
• manageriskdowntoalevelaslowasreasonablypossible
• basically,acostbenefitanalysis
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• strategicoroperational?
• strategic risksarethosewhicharisefromthepossibleconsequencesofstrategicdecisionstakenwithintheorganisation
- examplewouldbewhereoneentitypursuesastrategyofgrowthbyacquisitionwhereasanotheraimstogroworganically
- “acquisition”entityisexposedtoagreaterdegreeofrisk,butthepotentialreturnsarelikelytobegreater
• operational risks aretherisksoflossesresultingfrominadequateorfailedinternalprocesses,peopleandsystems,orfromexternalevents
- referstothepotentiallosseswhichmightariseinbusinessoperations
- includesriskoffraudortheftbyemployees
- canbemanagedbyinternalcontrolsystems
73Chapter 9 Paper P1The Risk Management Process December 2013 Examinations
sources and impacts of business risks
• businessesfaceriskfromanumberofdifferentsources:
• market–risksassociatedwiththesectororindustryinwhichtheentityoperates
• credit–relatestothecreditratingofthebusiness,andthereforeitsabilitytoraisefinance
• liquidity–theriskofbeingunabletomeetdebtsastheyfallduebecauseofinsufficientcash
• technological–relatestotherisksassociatedwhereafast–changingtechnologyaffectsthemarketorproducts
• legal–riskassociatedwiththeneedtocomplywithlawandregulation
• healthandsafetyandenvironmentalissues
• reputation–thepossibilityofdamagetotheentity’simagearisingfrompoorperformanceoradversepublicity
• businessprobity–relatestothegovernanceandethicsoftheentity
• derivatives–risksduetotheuseoffinancialinstruments
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examples of risks faced by entities
Risk Sources Impact
Market •Failuretoprovidegoodscustomersrequire
•Marketsectoroveralldeclines.
•Entityceasestotrade.
Credit •Entity’scredit–ratingisdecreased(on,e.g.StandardandPoor’s).
•Therearegoingconcernproblemssosuppliersarepaidlate.
•Entitymaynotobtainmaterialsneededforproduction.
Liquidity •Customersarenotpayingquicklyenough.
•Thereispoorcredit–rating(asabove).•Thereispoorcashmanagement.
•Entitymaynotobtainmaterialsneededforproduction.
•Entitycannotmeetcommitmentswhichmayleadtoentityfailure.
Technological •Thereislackofinvestmentinresearchanddevelopment.
•Competitorsachievetechnologicaladvantage.
•Productsappeartobeoutofdate.•Thereislossofmarketshare.
Legal •Thereisabreachofregulations,e.g.CompaniesAct.
•Entityissuedbythirdpartyforbreachoflegislation.
•Adversepublicity•Finesandpenaltiespayablebyentityand/orofficers.
Health,safetyandenvironmental
•Breachofrelevantlegislation.•Entitytradinginsectorwithadversereputation(e.g.testingonanimals).
•Adversepublicity•Finepayablebyentity•Legaldamagespayable(accidentsatwork).
Reputation •Productionofpoorquality•Productrecalls/adversepublicityagainstentity.
•Lossofmarketshare•Intheextreme–entityclosure.
Businessprobity •Directors/officersreceivehighbonuseswhenentityismakinglosses.
•Entitytradinginsectorwithadversereputation(e.g.armstradewith‘enemy’countries).
•Adversepublicity•Possibleboycottofentityproducts.
Derivatives •Lossesmadeonforwardexchangecontracts.
•Financialstatementsdonotadequatelydiscloseentity’stransactions/exposure
•Financiallosstoentity.•Adversepublicity.•Possibleclosureofbusinessiflosseslarge
75Chapter 9 Paper P1The Risk Management Process December 2013 Examinations
sector specific risks
• businessrisksmaybesimplygeneralrisksfacinganybusiness
• butsomeriskswillbespecifictoaparticularentity,market,orindustry
• genericrisksincludechangesininterestrates,ornon–compliancewithlaw
• inaddition,althoughariskmaybegeneral,itcanaffectdifferentbusinessesindifferentways
• aboveexampleofachangeininterestrateswillclearlyhaveoppositeaffectsforoneentitywithasubstantialdepositaccountatthebankandanotherwithalargeoverdraft!
• sectorspecificrisksrelatetoaparticularsector,andpotentiallynottoanyothersector
• forexample,sectorspecificrisksfacingaprivatehospitalcouldbe:
• inabilitytoemploysufficientnumberofjuniordoctors(orevenseniorconsultants)
• increaseincompetitionfromanotherprivatehospitalopeninginthesamearea
• improvementinstatehealthcaresystemleadingtofalloffindemandforprivatetreatment
• collapseofstatehealthcaresystemthroughlackoffunding(remember,riskcanbe“upside”aswellas“downside”)
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analysis of risk
• onewayofanalysingriskistoacknowledgethattheprobabilityofriskcouldbe“high”or“low”,andthatconsequences(impact)couldalsobe“high”or“low”
• amatrixcanbepreparedshowingthefourpossiblecombinationsof“high”/“high”,“high”/“low”etc
• whenariskisseenas“high”/“high”,itneedsurgentattention/immediateactioninordertomanagetherisk
• if the risk is“high”probability,but“low” impact, then thepositionneeds tobemonitored,and theentityneeds topreparetomeetthechange
• a“low”probability,“high”impactcombinationneedsactiontobeconsideredand,attheveryleast,acontingencyplan
• “low”probabilityand“low”impact–keepaneyeonthesituation,andbepreparedtoadapttoanychange
IMPACT/CONSEQUENCE
HIGH LOW
PROBABILITY
HIGH
LOW
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Role of the board in risk analysis
• boardhasanimportantroletoplayinriskmanagement,becausethey:
• considerriskatthestrategiclevel,andthendefinetheentity’sattitudeandapproachtorisk
• areresponsibleforimplementingtheriskmanagementprocess,andthereforeforensuringthatthosechargedwithadministeringithaveappropriateresources
• arealsoresponsibleforensuringthattheriskmanagementpoliciessupporttheoverallstrategicobjectivesoftheentity
• determinethelevelofriskwhichtheentityispreparedtoacceptinordertomeetitsstrategicobjectives
• communicatetheriskmanagementstrategytotherestoftheentityandwillensurethatitisintegratedwithallotherentityactivities
• reviewtherisks,andthenidentifyandmonitortheprogressoftheriskmanagementpolicies
• determine the riskswhichwillbeaccepted,butwhichcannotbemanaged,orwhere it is tooexpensive tomanage.Thesearecalledresidualrisks
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external reporting
• Shouldreportsbemadetopeopleotherthanmanagementconcerningtheinternalcontrolsandriskmanagement?
• Pointstoconsider:
• reportingmayberequired,ormaybevoluntary
• inanextremesituation,itmaybethatthirdpartieshavetobereportedtowheremanagementisunawareofreportingrequirementsorsimplyrefusestoreportvoluntarily
• manyreportsareintendedforinternaluseonly–forexample,reportstotheauditcommittee–buttherecanbesituationswhereexternalreportingisrequired
• suchexternalreportingwillnormallyonlybedoneasarequirementofcompliancewithlaworregulation,orcompliancewithethicalguidelinesapplicableeithertotheentityitselfortotheexternalregulator
• Reportingmethods
• threeobviouswaysinwhichentityinformationcanbereportedexternally:
- annualfinancialstatements
- auditors
- auditcommittee
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Reporting methods
• annualfinancialstatements-internalcontrols
• disclosureisrequiredbytheprinciplesoutlinedincgregulationsforlistedentities
• detailtobegivenisastatementofthedirectors’assessmentoftheadequacyoftheinternalcontrolsystem,andofhowthedirectorsmaintainthesystem
• annualfinancialstatements–risk
• disclosureshouldbemadeexplaininghowthedirectorshaveaddressedsomeoftherisksfacingtheentity
• disclosurewouldbemade,forinstance,intheCorporateandSocialResponsibilityReport
• auditors–internalcontrols
• wheretheinternalcontrolsystemisweak,thiscouldleadtotheauditorsissuingamodifiedauditreport
• thismodifiedreportmaythereforeincludedetailsoftheparticularareasofthecontrolsystemwhichhavegiventheauditorscauseformajorconcern
• auditors–risk
• theauditorswouldonlyreportonrisksfacingtheentityinthesituationthattheriskhasgivenrisetoamaterialerrorinthefinancialstatements
• auditcommittee–internalcontrols
• inthenormalcourseofevents,theauditcommitteewillreportitsrecommendationsaboutcontrolweaknessestotheboard
• onlyinanextremesituation(forinstance,wheretheboardignorestherecommendationsandthesituationisserious)willtheauditcommitteereportexternally(called“whistleblowing”)
• auditcommittee–risk
• itwouldbeunusualforanauditcommitteetoreportexternallyonmattersconcerningrisk
81 Paper P1December 2013 Examinations
Free lectures available for Paper P1 - click hereChapter 10
Controlling risk
• risk targeting
• riskmanager
• riskmanagementcommittee
• audit(internalandexternal)
• risk reduction
• riskawareness
• embeddingriskinsystems
• embeddingriskinculture
• diversification
• risk avoidance / retention / modelling
• riskavoidanceandretention
• riskattitude
• needforrisk
• attitudetorisk–doessizematter?
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risk targeting – risk manager
• leaderoftheriskmanagementcommittee
• reportsdirectlytotheboard
• roleisprimarilytooverseeimplementationoftheboard’sriskmanagementpolicies
• supportedbyriskmanagementcommittee
• notnormallyinvolvedindeterminingstrategy
• moreofanoperationalrole
• policiestobeimplementedaredecidedbyboardandriskmanagementcommittee
83Chapter 10 Paper P1Controlling Risk December 2013 Examinations
risk targeting – risk management committee and audit
• riskmanagementcommittee
• establishedbytheboard
• reportstotheboard
• ifnocommittee,functionspasstoauditcommittee
• threemainobjectives
- raisingriskawarenesswithintheentity
- ensuringreportingandmonitoringproceduresareinplaceandeffective
- keeping the risk profile up to date, reporting to the board, andmaking recommendations about riskattitude
• audit
• providesindependentreviewofrisksandcontrols
• providesafreshoutlookonthesituation
• Soxrequiressomeauditwork
• auditorwillreportanyrecommendationsarisingfromtheauditwork
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risk reduction – risk awareness
• tobetotallyeffective,riskawarenessneedstobeapparentatstrategic, tactical and operationallevels
• alackofawarenessautomaticallyindicatesthatanentityhasaninappropriateriskmanagementstrategy
• ifanentityisnotawareofrisksatalllevels,itcouldmeanthattherearerisksaffectingtheentitywhichhaveremainedunidentifiedandthatautomaticallymeansthattheriskisnotbeingcontrolled
• evenifthereisawarenessariskcouldoccurbut,becauseofpoormonitoring,theriskisnotcontrolled
• continuousmonitoringisclearlynecessary,andmanagementstrategyshouldbereviewedandupdatedasappropriate
• risksatthestrategiclevelincludenewcompetition,newtechnology…
• risksatthetacticallevelincludelossofkeycustomer,supplier,product,licence,employee…
• risksat theoperational level include failure to recognisechanges inmarket tastes, failure toapplyeffectivequalitycontrolprocedures,repetitivestock–outs…
85Chapter 10 Paper P1Controlling Risk December 2013 Examinations
risk reduction – embedding risk in systems
• itisimportantthatriskmanagementshouldbeincludedwithinanentity’scontrolsystemsandnottreatedasaseparateexercise
• thispointisincludedasaprincipleintheUKCGCandinlawintheUS
• itisessentialthattheboardgivesapprovaltotheprincipleofembeddingriskmanagement
risk reduction – embedding risk in culture
• eventhoughriskmanagementmaybeincludedasintegraltothecontrolsystems,itcanonlybeeffectiveifeveryonewithintheorganisationrecognisesitsimportance
• inthatway,allpersonnelwillviewtheprocessesaspartofthenormal“life”oftheentity
• anumberofmattersneed tobe considered in thedecision to embed riskmanagement into the control systemsincludingthegeneralattitudetointernalcontrols,thecommitmentofallpersonneltoriskmanagement,governance…
• similarly,thereareanumberofwaysofintroducingriskmanagementawarenessintoanentitysuchasperformancetargets,employeerewards,corporatemagazines,website,jobdescriptions,in–housecourses…
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risk reduction – diversification
• onewayofreducingriskistospreadtheentity’sactivitiesoveragreaterrange,whethergeographical,product,targetmarket…
• inthisway,poorperformanceinonesectorcouldwellbecounterbalancedbyagoodperformanceinanother
• tobeeffective,thediversebusinessesshouldnotbecloselyorsimilarlyaffectedbyexternal factors–asthefactoraffectsadverselyonearea,wedon’twishittoaffectadverselythediverseareatoo!
87Chapter 10 Paper P1Controlling Risk December 2013 Examinations
risk avoidance and retention
• theexpression”riskavoidance”meansastrategybywhichanentity,quiteliterally,avoidsarisk,whereas…
• “riskretention”istheriskstrategybywhichanentitychoosestoretaintheriskwithintheentity
• bothexpressionsareindicatorsoftheentity’sriskappetite
• forexample,anentitymaychoosetoaccepttheriskofexchangeratemovementsoftheEuro,believingthemtobeprobablyinsignificant,whereas…
• thesameentitycouldwellavoidtheriskofenteringcontractsquotedintheUzbekistancurrency(thesoum)believingsuchexchangeratemovementscouldwellbesignificant
risk avoidance – risk attitude
• attitudeisdeterminedbyacombinationofstrategy,capacityandappetite
• theoverallstrategydeterminestheoverallapproach
• thecapacityindicateshowmuchrisktheentitycanaccept
• theappetitedeterminesthewayinwhichriskswillbemanaged
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risk avoidance – need for risk
• acceptingriskcangiveanentityacompetitiveadvantage
• equally,anentitywhichisnotpreparedtoacceptriskwillloseacompetitiveadvantagetoanotherwhichis
• thegreatertherisk,thegreatertherewards–returnstendtobehigheronriskierprojects
• andthebenefitsdon’tneedtobefinancial–theycouldalsoinvolvebetterqualityinformation
89Chapter 10 Paper P1Controlling Risk December 2013 Examinations
risk avoidance – attitude to risk – does size matter?
• thematterofanentity’ssizeand itsattitudeto risk isnota relationshipwhich isnecessarilycloselycorrelated It ispossible tomake somegeneralisations, but individual entities in their own situation could verywell disprove thegeneralisation
• for example, asmall entitywouldnormally facehigher risks,managed at board level Itwill not, typically, haveresourcesavailabletocovertheriskofnewproductdevelopment
• itisprobablethatasmallerentitywillhaveasmallerproductrangeIfoneproductfailsthentheimpactontheentitycouldbesubstantial.Thelaunchofanewproductcaninvolveamajorinvestment,andthere’snoguaranteethatitwillbepopular/viable
• but,ifitistosurvive,asmallentitywillneedtocontinuetotakethegamble/accepttherisk
• asageneralisation,itshouldbe“easy”toseethatasmallentitywillneedtoacceptacertaindegreeofrisk
• ontheotherhand,alarge entitywillnormallyfacefewerrisks–thesub–dividedstructureofalargerorganisationallowssuchentities/groupstoenjoymuchgreaterdiversification,thusspreadingtherisk
• amoreextensiveproductrange,adiversificationofmarketsandgeographicalareasofoperationallcontributetoareductioninrisk
• theappetiteforriskwilldependupontheexistingportfolioofinvestments/activities.Adiverseportfoliocouldmeanthattheentitymaybepreparedtoacceptgreaterrisksinnewventures,whereasahigher–riskportfoliomightsuggestanaversiontotakinganymorerisks
• itissometimesthecasethat,becauseofitssizeandestablishedreputation,largerentities/groupswillwishtoprotecttheirimageandreputation,andthenbecomepositivelyriskaverse
• inaddition,theoryalsosuggeststhat,asentitiesgrow,theyincreasinglyfacetheproblemsofmakingincorrectdecisionsatcriticaltimes(Grainger’sModel).Naturally,entitieswillseektominimisethisriskbytakingactionassoonaspossible.Eitherthat,or,byrecognisingtherisk,plantomanageit
91 Paper P1December 2013 Examinations
Free lectures available for Paper P1 - click here Chapter 11
EthiCs and soCial REsPonsibility
Chapter sub–divides into three:
• ethicaltheories
• differentapproachestoethicsandtocorporatesocialresponsibility
• theroleoftheaccountantinthecontextofvaluesandethics
Ethical theories
• Withreferencetoethicaltheories,thereisacleardistinctionbetweenthosebasedonabsolutevaluesandthosebasedonrelativevalues
• Absolutevaluetheorists
• theyassumedthattherewasonlyonesetofmoralrules,andtheywerealwaystrue
• but truth in one culturemust be different from the truth in another Consider the different truths behindChristianityandIslam!
• sothe“absoluteschool”nowacceptsthateachseparateculturehasitsowntruths
• but,eventhen,sometruthsareinternational–forexample,murderbyonepersonofanothermustsurelybeabasicunacceptableanti–socialact,whatevertheculture,religion,geographicallocation…
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• Incontrast,relativevaluetheorists:
• acceptthattherearemanymoral/ethicalcodeseachofwhichevolvesovertimeandeachcouldbedifferentfromeveryother
• asaresultofthismoreopenacceptanceofdifferingcodesofethics,therelativetheoristsdonotbelieveinthe“onemoraltruth”
• accepttheneedforevolutionofmoralcodes
• acceptalsotheideaofdifferentraces,religions,sects…havingtheirowncodesofethics
• auditorsinonecountrymaywellacceptasnormalanactivitybyaclientwhichwouldbeseenasabnormalbyauditorsinothercountries
• thesedifferentattitudes,andassociatedmorality,havebeendevelopedintoatheoryexplaininghowmoralsandethicschangeovertime
• LawrenceKohlbergsixstages
• Level1Pre–conventionalMorality
- ObedienceandPunishmentOrientation
- IndividualismandExchange
• LevelIIConventionalMorality
- GoodInterpersonalRelationships
- MaintainingtheSocialOrder
• LevelIIIPost–conventionalMorality
- SocialContractandIndividualRights
- UniversalPrinciples
93Chapter 11 Paper P1Ethics and Social Responsibility December 2013 Examinations
Kohlberg’s six stages
• Level1stage1pre-conventional
• inanyaction,theindividualthinksonlyofthemselves
• actionsareseenasbeingrightorwrongandconsequencesasbeingtherewardorpunishment
• individualsfocusontheconsequenceswhicharelikelytoarisefromtheiractionsandhowthoseconsequenceswillaffectthempersonally
• themoralityofanactioncanbemeasuredbyconsideringtheconsequences
• thegreaterthepunishment,thegreaterthelackofmorality
• Level1stage2pre-conventional
• atthisstage,individualsthinkoftheaffectoftheiractionsonothers-butonlytoaverylimitedextent
• whilststilllookingatmoralityfromanindividualisticpointofview,individualsatthisstagearemoreconcernedwithhowtheywillbenefitpersonallyfromaparticularcourseofaction
• actionsarethereforetakenfroma“what’sinitforme”thoughtprocess
• “ifyouscratchmyback,I’llscratchyours”
• thinking about the affect of actionsonotherpeople is incidental tohow the action cangeneratepersonalbenefit
• Level2stage3conventional
• stage 3 sees the beginning of the recognition of society beyond the individualistic attitude of the pre-conventionallevel
• actionstakenareseentoaffectsociety,andsocietymayapproveordisapproveofthoseactions
• themoraldecisionisonewheresocietyapproves
• thisleadstotheindividualbeinglikedbysociety
• “Iwanttobelikedandwell-thoughtof;Icanachievethisbynotbeingnaughty”
• butrecognitionofsocietyextendsonlytotheindividual’sdesiretobeliked
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• Level2stage4conventional
• atthispoint,theindividualrecognisestheimportanceofmaintainingastructuredandfunctioningsociety
• thisautomaticallyleadsontotheacceptanceoftheneedforlawsandregulations
• andtotheacceptancethatthoselawsandregulationsshouldbeobeyedifsocietyistobeabletofunction
• ifonepersonbreaksalaw,thiscouldleadtoeveryonealsobreakingthatlaw
• andthatinturnwillleadtoanarchyandthebreak-downofsociety
• stage4(theplacereachedbymostadults)involvestheobeyingoflawspurelybecausetheyarelaws
• andindoingthat,thebestinterestsofsocietyareprotected(butnotalways!)
• Level3stage5post-conventional
• level3isknownastheprincipledlevel
• recognitionthatpeopleareindividualsseparatefromsociety
• themoralityofactionsisviewedfromanindividual’sownperspective
• lawsareseenassocialcontracts
• anylawwhichdoesnotoperatetothegeneralbenefitofsocietyneedstobechanged
• butthatchangeiseffectedbymajoritydecisionand,inevitably,compromise
• “forthegreatergoodofthegreaternumber”
• generally,thedemocraticprocess
95Chapter 11 Paper P1Ethics and Social Responsibility December 2013 Examinations
• Level3stage6post-conventional
• moralreasoningbasedonabstractprinciplesusinguniversalethicalprinciples
• lawsareonlyvalidiftheyaregroundedinjustice
• justasitisimportantthatsocietyshouldobeylaws,itisarguedtobeofequalimportancethat“bad”lawsshouldbebroken
• butalsoacknowledgedbythestage6thinkerthat,inbreakingthe“bad”law,society’sruleshavebeenviolatedandshouldresultinpunishment
• Gandhi,Mandela,MartinLutherKing,Christ
• deontologicalmorality-followaparticularcourseofactionnotbecauseofyourownself-interestbutbecauseit’s“therightthingtodo”
• sosocialcontracts ( lawsandregulations ) shouldbeunnecessary - theyarenotessential fordeonticmoraldecisionsandresultantactions
• decisionmakingisnotsometheoretical,hypothetical,conditionalexercise
• it’scategoricalandabsolute
• JohnRawldescribedthethinkingasusinga“veilofignorance”-imaginingwhatyouwouldwishtohappenifyouviewedthesituationfromthepointofviewofothersaffected
• theresultingconcensusistheactionwhichshouldthenbetaken
• inthisway,anyactionisnotameanstoanend-itisanendinitself
• anactionistaken“becauseit’stherightthingtodo”notbecauseit isexpected,requiredbylaworhasbeenpreviouslyagreed
97 Paper P1December 2013 Examinations
Free lectures available for Paper P1 - click hereChapter 12
Deontology anD teleology
Deontological approach
• “deontic”definedas“ofsuchethicalconceptsasobligationandpermissibility”and“designatingthebranchoflogicthatdealswiththeformalisationoftheseconcepts”
• approachisbasedonthetheoryproposedbyImmanuelKant
• sometimesreferredtoasa“non-consequentialist”approach
• suggeststhatwhetheranactionisrightorwrongisnotdependentupontheoutcomeofthedecision
• instead,whatisimportantisthemotivationorprinciple
• itisthereforeanapproachbasedonethics/morality
• the“rightorwrong”ofanactionisdeterminedbylookingatthemoralattitudebehindthataction
• canonlybemorallycorrectifitsatisfiesthreetests:
• consistency-motivationforanactionshouldbeonewhichwouldbegoodtobeseenappliedthroughouttheWorld(consistency)(eglyingisimmoralbecauseitdestroystheconceptoftruthandleadstothedeteriorationofsociety)
• humandignity–actionstakenshouldbearinmindthewholeofsociety(egtheconceptofslaverycannotbeconsideredacceptable)
• universality–actionsshouldbetakenwhichareofnetbenefittosociety(eghaveyouevertakenanactionwhich,ifpublicised,wouldmakeyoufeeluncomfortable?Ifso,it’sprobablyofdoubtfulmoralstatus)
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Deontology and teleology
• teleologydefinedas“thebeliefthatcertainphenomenaarebestexplainedintermsofpurposeratherthanintermsofcause”
• alsoreferredtoasa“consequentialistapproach”
• motivationfortheactionisnotimportant
• instead,iftheactionresultsinbenefit,thenitmustbegood
• but“benefit”forwho?
• egoistview
• utilitarianview
• egoistasks“isitgoodforme?”
• utilitarianasks“isitgoodforsociety/themajority?”
• theseviewsarenotmutuallyexclusive–considerthepositionofatuitionprovider
• inageneralsense,theutilitarianviewlooksattheconsequencesofaproposedactionandtriestomeasure“good”effectsagainst“bad”effects
• if“good”outweighs“bad”effects,theactionispursued
• butmeasurementoftheseeffectsisimpreciseandsubjective–effectivelyit’sacost/benefitexercise
99 Paper P1December 2013 Examinations
Free lectures available for Paper P1 - click hereChapter 13
SoCial ReSPonSibility
Gray, owen and adams
• bookbyGray, Owen and AdamsonACCA’sreadinglistlookscloselyatthesocialresponsibilityofentities
• proposedthatentitiesshouldacceptsomedegreeofsocialresponsibilityand
• asanextensiontothat,somedegreealsoofsocialaccountability
• alsoacceptthatthismaymeanthattheWorldneedstochangeinthatasitisnowcouldbedifferentthanastheybelieveitshouldbe
• identifiesseven positions on social responsibility
• sevenidentifiedcategories/groupsofpeoplewhoseesocialresponsibilityfromtheirownperspective:
• capitalists
• opportunists
• socialcontractors
• socialecologists
• socialists
• feminists
• committedecologists
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• Capitalists
• theirpositionisthattheybelievethatthewaytheWorldworksnowisagoodapproximationtohowitshouldwork
• inaddition,theyaccepttheprincipleoftheliberaldemocraticeconomy
• by way of explanation, this group accepts that the needs of shareholders are most important, and thatshareholdersthemselvesalsobelievethattobetrue
• itisonlyonesmallsteptounderstandthatthisgrouphaslittleornoconceptofcorporatesocialresponsibility(csr)!
• Opportunists
• theirposition is that theybelieve that forentities tobe successful, theyneed to seizeopportunitiesas theyariseInthatsituation,itcaneasilybeseenthattheconceptofcsrissecondary/minimaltotheinterestoftheopportunisticentity’sobjectives
• butalsorealisethat,inorderforanentitytogrowandbesuccessful,itisnecessaryforittoacceptsomedegreeofcsr
• peoplerealisethatthereshouldbeatleastaminimumacceptanceofcsr,whetheritbeimposeduponthembylegislationorregulation,orwhethertheyhavevoluntarilyrealisedthisintheirownself–interests
• impactonsocietyoftheentity’sactionsisbeginningtoberecognisedasimportant,andentitiesareacceptingthattheiruseofresourcedoesinfacthaveanimpactonsociety
• Socialcontractors
• believethatentitiesexistonlybecausesocietywantsthemtoexistandthereforetheentityshouldoperatetoservetheneedsofsociety
• thepropositionisthattheexistenceofanentityisjustifiedifitservesthepublicinterest
• Socialecologists
• expressconcernthatlargeorganisationshavedamagedtheenvironmentandcausedsocialproblems
• believethatthewaytorepairthisdamageisinthepowerofthosesamelargeorganisations
• believethatentitiesshouldamendtheiroperatingandproductionpractices,and
• becomemoreawareofmatterssuchaspollution,wastedisposalandsustainabilityofresource
• onlyinthiswaycanthequalityofhumanlifebeimproved
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• Socialists
• believethatcapitalisdominantinsocial,economicandpoliticallife
• thisneedstochangeinordertoreducetheextentofthisdominance
• considerstheproductionofgoodsshouldbeasecondaryconsideration,socialresponsibilityshouldbenumberone
• distrustsaccountingsystemsandcsrsystemsbutdoesnotnecessarilyhaveaclearideaofhowtoachievetheirobjectives
• Feminists
• believethatoursocietyismaledominated–socially,economically,politicallyandinbusiness
• thisdominanceisreflectedbythemasculineconceptsofstrength,power,aggression,achievementandconflict
• seethatthebusinessworldislackinginthesofterfemininetraitsofcompassion,co–operation,tendernessandlove
• seethatcsrsystemsareinherentlyflawedinthattheyomitfeminineviewsand
• to follow themaledominatedcharacteristics isnot thebestwayoforganisingagroupofcompassionate (essentially)humanbeings
• Committedecologists
• believethatthehumanracehasnogreaterclaimtotherighttoexistthananyothergroupoflivingorganisms
• feelthatourexistingthinkingistotallyflawed
• weshouldnotbedestroyingnaturalhabitatstobuildroadsornewairportterminals
• inaddition,thefarmingofsuchnaturalresourceasfishortimbershould,attheveryleast,besustainable
• weshouldbetryingtoleavemoreonthisplanetforfuturegenerationsthanweourselvesinherited
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Corporate and personal ethical stances
• referstothepositionsadoptedbyentitiesandindividualstakeholderswithinthoseentities
• needtoconsidertheentity’spositiontogetherwiththepositionoftheseparategroups
• therearefourgroupstoconsider:
• short–termshareholders
• long–termshareholders
• multiplestakeholderorganisations
• shapersofsociety
• short–termshareholders
• fromtheentity’spointofview,itneedstoprovideanadequatereturntothegroup
• fromthegroup’spointofview, the small shareholders requirea suitable returnon their investment ( Largershareholderswilllikelyhaveverylittleshort–terminterestintheentity)
• long–termshareholders
• fromtheentity’spointofview,itisnecessaryfortheentitytoremaininexistence!
• thegroupitselfwillbeconcernedaboutthesecurityoftheirinvestment,andwillrequirecapitalgrowth
• multiplestakeholderorganisations
• theentitywillidentifythemultiplestakeholders–thosewhoholdgreatpowerandinfluenceovertheentity–andwillconsciouslytrytosatisfytheirrequirements
• thegroupitselfexpectstheentitytorecognisetheir interest,andexpectstheentitytorespectthemandactuponthatrecognitionintheinterestofthegroup
• shapersofsociety
• theentitywilltrytochangesociety(hopefullyforthebetter!)byapplyingitspowerThischangewillbefortheentity’sbenefitbutalso,hopefully,forthebenefitofsocietyatlarge
• asanindividual,littlecanbeachievedtochangesocietybut,actingasagroup,theseindividualscanaccumulatepowerandeffectchangeinthewaythattheyexercisethatpower
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Variables determining the cultural context of ethics and csr
• fourvariablesareidentifiedandeachhasadifferentfocus:
• economic focusesonprofitability
• legal focusesoncompliancewithlaw
• ethical focusesonwhatis“right”
• philanthropic focusesonwhatis“desirable”
• differentculturesviewthesemattersindifferentwaysAneasywaytoillustratethatpointistoconsidertheEuropeanattitudeinparallelwiththeattitudeoftheNorthAmericans
• Economic
• Europe - majorfocusontheactionsoftheentityDecisionstakeintoaccountpublicimageandsocialacceptability
• USA - focusalmostentirelyonprofitabilityandinterestsofshareholders
• Legal
• Europe - governmentisseenasanecessity,andlawsasnecessaryforthepurposesofregulationofentities’activities
- governmentseenasalawenforcerandacceptedasbeinginthepositionof“interference”inanentity’sactions
- for example, Health and Safety legislation may mean slower production times, but isneverthelessfollowed(bymost!)
• USA - governmentisseenasaninterference–aninfringementofpersonalliberties
- theroleofGovernmentisthereforeoftenminimal
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• Ethical
• Europe - ethicalresponsibilityisattheforefrontofEuropeanconsciousnessandEuropeanbusinessesarecontinuallyawareoftheethicsandethicalconsequencesoftheiractions
- this even extends to the point of making their ethical attitudes the subject of positiveadvertising – confirming in theminds of the public that their entity is a socially awareorganisation
• USA - asaresultofthegreatertrustbytheAmericanpublicintheethicsoftheUScorporations,itisgenerallyacceptedthatUScorporationswillbeethical,sonogreatissueismadeofthis
• Philanthropic
• Europe - major focus on regulatory systems to provide educational, recreational and culturalopportunities
- forexample,theopeningandsponsorshipofartgalleries,theatresandmuseums
• USA - a great focus on the philanthropic acts of individuals ( the Hearst Collection, the GettyMuseumandBillGates)ratherthanontheregulatoryframework
- insummary,EuropeconcentratesontheethicalandphilanthropicactionswhicharelegallyenforcedwhereastheUSAconcentratesitsattentiononthediscretionaryactsofindividualsandcorporations
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• AmericanAccountingAssociationapproachtoethicalissues
• Facts
• Ethicalissues
- Independence
- Obedience
- Confidentiality
• Norms,principlesandvalues
- Objectives
- Governance
- Independence
- Transparency
• Alternativecoursesofaction
• Bestcourseofaction
• Consequencesofeachaction
• Decision
• Remember-FenABCD
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• Tucker’smodelforethicaldecisionmaking
• Profitable – whatwouldbetheaffecton“profits”ofalternativecoursesofaction
• Legal – whatlegallimitationsarethereonalternativecoursesofaction
• Fair – arestakeholders’claimsfair
• Right – whataretheright/ethicalissuesinvolvedconcerningdifferentstakeholdergroups
• Sustainable – whatevercourseofactionischosen,itshouldbeacoursewhichissustainable
• Remember–Professionallecturersfindresponsiblestudents
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Free lectures available for Paper P1 - click hereChapter 14
Professions and the PubliC interest
the topic sub–divides into:
• thenatureofa“profession”and“professionalism”
• publicinterest
• theinfluenceofaccountingasaprofessioninthecontextofanorganisation
• theroleofaccountancyinsociety
• theroleofaccountancyasavalue–ladenprofessioncapableofinfluencingthedistributionofwealthandpowerinsociety
• issuessurroundingaccountingandactingagainstthepublicinterest
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“Profession” and “professionalism”
• Definition
• “profession”isdefinedas“anoccupationrequiringspecialtrainingintheliberalartsorscience,orthebodyofpeopleinsuchanorganisation”
• easilyextendedtoincludeaccountants(liberalart?orscience?)
• “professionalism”definedas“takingactiontosupportthepublicinterest”
• Grayidentifiedthataprofessionhastwoessentialanddefiningcharacteristics:
- a body of theory
- andknowledge which guides its practice and commitment to the public interest
• istheaccountingprofessionreallyaprofession?
• applyingGray’sthinking,doesaccountancyhave
- abodyoftheoryand
- knowledgewhich…
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• Bodyoftheory?
• ethicalstandards
• auditingstandardsestablishingqualityofauditwork
• examination system toensure thatonlypeoplewithappropriateprofessional skills shouldbeaccepted intomembership
• Knowledgewhich…?
• guidancenotesonhowtoapplyethicalstandards
• experience, accumulated over longer than a century, of the acceptability of accountants’ actions, and theapplicationofethicstospecificsituations
• theneedtoremainasaprofessioninwhichthepubliccansafelyputitstrustandthereforebeseentobeactinginthepublicinterest
• so,yes,theaccountingprofessionseemstosatisfytheGraycriteriaandisrightlyclassedasa“profession”
• doestheprofessiondemonstratetheattributesofprofessionalism?
• remember–professionalismcanbedefinedas“takingactiontosupportthepublicinterest”
• withinanyprofession,themembersofthatbodyarenormallyexpectedtotakeactionswhichcontributetothepublicinterestandthesesamemembersshouldbeseentobeactingprofessionally
• “independenceisanattitudeofmind”
• sotoois“professionalism”
• ACCAsetsouttherulesforustofollowinourdailyprofessionallivesbut,really,itisourownindividualcodeofpersonalconductwhichestablishesusasprofessionalpeople
• historically,theprofessionrespondedtocrisesastheyarose–areactiveresponsetoeachnewsituationneedingtobeaddressed
• morerecently,theprofessionhasbeentakingaproactiverole–seekingtopreventcrisesarisingandtryingtoanticipateproblemsbeforetheybecomeareality
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Public interest aspect of professionalism
• Whatexactlyisthepublicinterest?
• nodefinition!
• butit’ssafetosaythatactsinthepublicinterestshouldbenefitsocietyasawhole
• thisextendstotheprinciplethattheinterestsofsocietyshouldoutweightheinterestsofanyindividualwithinsociety(wherethereisconflictbetweenthetwo)
• notonlyshouldaccountantsactinthepublicinterestgenerally
• butalso,whereacliententityisactingagainstthepublicinterest,theactionsoftheaccountantshouldbedictatedbyloyaltytosocietyandnotloyaltytotheclient
• potentialclashesbetweentheinterestsofthepublicandthebasichumanrightsofanindividual
• whereapersoncommitsacrimeandissenttoprison,thatsurelyisabreachofthatperson’shumanrightoffreedom
• butforthegreatergoodofsociety,thepublicinterestisbestservedbykeepingthatcriminalinprisonandawayfromsociety
• similarly,anentitymay,actingthroughitsmajority,harmtherightsofaminorityshareholderEnglishentitylawincludesprovisionsfortheprotectionofminorityrightsThelawwillintervenewhereitisnecessarytopreventthoseincontroloftheentityfromleadingitintoasituationwhereitisabouttobreachitsownconstitutionbut,otherwise,thegeneralprincipleofmajorityrulewillapply
• Governmentmayalsofinditselfinapositiontoregulatetheaffairsofanentityintheinterestsofthepublic,forexample,wheretheentityisguiltyofcreatingexcessivepollution
• intheUKtheGovernmenthasgivenpowertotheNationalRiversAuthoritytotakeactionagainstentitieswhichareguiltyofcausingpollutiontotheriversystem
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the influence of accounting as a profession in the context of an organisation
• accountancyfirmsarecloselyinvolvedwiththeirclientseitherthroughtheroleasauditorsorintheprovisionof“other”services
• anauditor’sindependencecouldbethreatenedandcouldresultintheauditorexpressinganinappropriateopiniononthetruthandfairnessoftheviewshownbytheclient’sfinancialstatements
• but theauditor/accountant facesotherdilemmas inadditionto theproblemsposedby the traditional threats toindependence
• wheretheclientisinfinancialdifficulties
- inthissituationthedilemmafacingtheauditoriswhethertomodifytheauditreportornot
- amodificationintheformofaqualificationcouldwellhastentheclient’sprogresstoinsolvency–isthebanklikelytowanttocontinuesupportingtheclient?
- equally,nottomodify/qualifycouldwellgivethewrongmessagetostakeholdersand,whensubsequentlytheentitydoesfail,theauditorscouldfaceseverecriticismatbestandlegalactionfornegligenceatworst
- precisewordingofanauditreportisthereforeclearlyamatterforgreatcareandrequiresprofessionalskill,expertiseandexperience,buttheauditorshouldconsidercarefullythe“publicinterest”
• shouldtheauditorprovideotherservices?
- whynot?Theauditfirmalreadyhasawealthofknowledgeabouttheclientand,almostbydefinition,probablyhastheprofessionalskillsnecessary
- however,thereremainsthedangeroftheaudit/accountingfirmbecomingtoodependentontheclientbecauseoftheaggregatefeesreceivedfromtheclientinrespectofthecombinedservicesrendered
- fromsociety’spointofview,itmustbebeneficialfortheauditortoprovidetheseadditionalservices–lessexpensiveandquicker–sotheclientavoidstheunnecessarylargercostsoftheservicewhichtheywouldotherwisehavepassedoninthecostsoftheirproducts
- butsocietymaybebetterservedif theseotherserviceswereprovidedbyasecondaccountancyfirm,therebyprotectingbothaccountancyfirmsagainstthethreatstotheirindependence
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• Clientrelationships
- it is inthe interestsofboththeclientandtheauditorthattheauditfirmshouldnotbechangedonafrequentbasis
- witheachchange,thenewauditormustgothroughaneducationprocess,learningallabouttheclient,thesystems,thehistory,products,risk…
- from the client’s point of view, it automatically restricts the number of people who have detailedknowledgeabouttheentity,andthusconfidentialityisprotected
- however,thereisadangerthattherelationshipbecomestoofamiliarandthattheauditorsaretheninapositionwheretheyseeonlywhattheyexpecttosee
- suchasituationisnotinthepublicinterest!
- intheUSA,Soxrequiresarotationofreportingpartnerfortheclienteveryfiveyears
- theequivalentguidanceintheUKissevenyears
• Shouldthesizeofanaudit/accountancyfirmberestricted?
- itisinthepublicinterestthatanauditfirmshouldbelargeenoughtobeabletoenjoythebenefitsofeconomyofscale,andthelargertheyare,thegreaterthepotentialsavings
- thiswillkeeptheaudit/accountancyfeestoasensiblelevel,andthepublicshouldbenefit
- itisreallyonlyalargefirmthatisinapositiontoundertakemulti–nationalgroupaudits
- butwithgrowthcomesincreasingimpersonality
- inturn,thiscouldleadtoafallinthequalityofservicecausedbythoseincontrollosingsightofthedetail
- so,maybeit isnotinthepublicinterestforauditfirmstobeallowedtogrowwithoutsomelimitationbeingimposed
• Thebig4
- onlyafewyearsago,the“big4”werethe“big6”ThenPriceWaterhouse(2)mergedwithCoopersandLybrand(5)andthe“big6”becamethe“big5”
- at thispoint, theaccountingprofession,underpressure from theMonopoliesCommission inLondon,agreedthatthereshouldbenomoremergersofsuper–largeaccountingfirms,sothe“big5”shouldneverbecomethe“big4”!
- toofewsuper–firmsisclearlynotinthepublicinterestbecauseofthereductioninchoiceavailableforclients
- but the“big 4” are in a highly competitivemarket, they are profit orientated, and they need to keepwinningnewclients
- thiscompetitionmaybeseentobeatemptationtoreducefeestoanartificiallylowlevel
- couldbearguedasathreattothequalityoftheservicesrendered
- butincreasingawarenessinthemindsofclientsofthepossibilityoftakingasuccessfulactionagainsttheauditorsfornegligenceisagooddeterrentfortheauditorthinkingofcuttingcorners
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accountancy in society
• Theroleofaccountancyinsociety
• thereisadoubtinthemindsofthepublicaboutthecompetenciesandintegrityofaccountantswhichisfuelledbyeachsuccessivehigh–profilecorporatefailure…
• …butaccountantsthemselvesbelievethattheyhavearoletoplayinsocietyandasbeingabletoservethepublicinterestTheyclearlyhavetheskillsandknowledgetoperformthetaskswhichareexpectedofthem
• generally, accountants see their role aswell–established, the profession having developed over a period inexcessofonehundredyears
• the profession is, however, slow to changeThere is not normally a lot of time for accountants to considerinnovation,andthoseworkingforothersinanentityareprettymuchrestrictedbytheexpectationsofthosewhoemploythem
• Sohowdoaccountantsbecomeinvolvedin“change”?
• changesinthedesignandmanagementofinformationsystemsoftenrequiretheinvolvementofaccountantsbecausetheyareskilledintheprocessesofcollectingandverifyingdata
• changeinvolvingsomefinancialaspectagainpresentstheaccountantwithanopportunitytousespecialistskills
• Anynewentityinitiativewilllikelybeprofitrelated,andonceagaintheaccountantwillbeheavilyinvolved
• working in the public interest means that accountants need to design rules ( IFRS! ) for dealing with thedoubtfulpracticeswhichentitiesindulgeinExampleswouldinclude“ContingenciesandProvisions”,“FinancialInstruments”and“ShareBasedPaymentSchemes”tonamebutthree
• oneotherareainwhichtheaccountantcouldwellbeinvolvedisinthepreparationorreviewoftheCorporateandSocialResponsibilityReport
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the role of accountancy as a value laden profession capable of influencing the distribution of wealth and power in society
• wesaw,atthestartofthischapter,thesub–heading“Theroleofaccountancy”
• thequestionis“Howcanaccountancy?”
• Thismaybeachievedinanumberofwaysincluding:
• givingadvicetoGovernmentaboutthecontentandwordingofsuccessiveActsofParliamentwhichcouldhaveanaffectontheinterestsofcreditors,employeesandminorities
• advisingtheGovernmentonwaysofmakingmorefairthetaxburdenonindividuals
• ensuringthatclientscomplywithlegislationsuchasthefulldisclosureofdirectors’remunerationInthisway,directorsmaybelessinclinedtopaythemselvesoutrageousbonusesinordertoavoidthecriticismwhichmayotherwisebedirectedatthem
• whistle–blowingontheillegalactionsofentityofficials
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accountancy and acting against the public interest
• itis(almost)inconceivablethatanaccountantwouldknowinglyactagainstthepublicinterest
• buttherearesituationswhere,iftheydidnothing,itwouldbetheequivalentofassistingaclienttooperateagainstthatpublicinterest
• thefollowingsectionprovidessomeexampleswheredisclosure,orlackofdisclosure,ofinformationcouldbeseenasactingagainstthepublicinterest.
Situation Example
Lackofdisclosurewoulddecreaseaccountabilityorlimitdecisionmakingofthepublic.
•Not providing information on illegal actions of entities (e.g.Enron)allowsactionstocontinuetothelong–termdetrimentofstakeholders.
Lackofdisclosurewouldleadtolackofenforcementofappropriatelaws.
•It would be against the public interest not to disclose theinformation.
•Lack of disclosure would mean a criminal could continue acrimesuchasmoneylaunderinginbreachofmoneylaunderingregulations.
Disclosurewouldadverselyaffecttheeconomicinterestsofthejurisdictioninwhichtheaccountantisworking.
•It would be against the public interest to disclose theinformation.
•Disclosingpricesensitiveinformationonanentity’ssharepriceor details of interest rate movements before they had beenauthorised could harm businesses in the jurisdiction or thejurisdictionasawhole(exchangeratemovements).
•Disclosurewouldbeinappropriatebecausethepublicinterestwouldbeharmed.
Lackofdisclosurewouldimpairthehealthandsafetyofpublic.
•Notdisclosinginformationonpotentialcontaminationoflandbyanorganisation.
•Non–disclosureofthisinformationwouldnotbeinthepublicinterestashealthandsafetycouldbecompromised.
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Free lectures available for Paper P1 - click hereChapter 15
Professional PraCtiCe and Codes of ethiCs
Corporate ethics
• thetopicrelatestotheattitudeandbehaviourofanentityinitsapplicationofethicalvalues
• inearlierchapterswehavecomeacrosstheCorporateandSocialResponsibilityReport(csr)Itiswithinthiscsrreportthatwewouldexpecttofinddisclosureoftheentity’sethicalapproachtobusiness
• disclosureextendsbeyondlegalrequirementsand,inthisrespect,couldbeviewedasdiscretionary
• theentityshouldhavedevelopedpoliciesinanumberofareasinanefforttoensurethecontinuedsurvivaloftheentity
• Keyareasofcorporateethicsinclude:
• purposeofthebusiness
• workforce
• customerrelations
• shareholdersandotherprovidersoffinance
• suppliers
• society
• implementation
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• purposeofthebusiness
• thereasonfortheentity’sexistence
• broadoutlineoftheentity’sproductsorservices
• entity’sfinancialobjectives
• roleofthebusinessinsociety,asseenbytheentityitself
• workforce–thereshouldbedisclosureoftheentity’spolicieson:
• workingconditions
• recruitment
• traininganddevelopment
• rewardsandbonuses
• healthandsafetyandsecurity
• equalopportunities
• retirement
• redundancy
• discrimination
• useofentityassetsbyemployees
• customerrelations
• howcantheentitymaintainthequalityofitsproductorserviceand,inthatway,keepitscustomersloyal
• howshouldtheentityarriveatafairpriceforitsproductssothattheentitymakesaprofit,butthecustomerpaysareasonableprice
• howcantheentityimproveitsafter–salesservice
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• shareholdersandotherprovidersoffinance
• becausetheshareholdersprovidemuchofthefinanceforanentity,itisonlyrightthattheyshouldwantareturnontheirinvestment
• inaddition,theyareentitledtoexpectatimelysetoffinancialstatementsandotherfinancialinformation
• toagreaterorlesserextent,undertheprinciplesofgoodcorporategovernance,shareholderswillbeinvolvedinthedecisionmakingprocessoftheentity
• suppliers
• theprovidersofgoodsandservicestotheentityalsoneedtobeconsidered
• theentitycanexpectgoodsandservicesofappropriateandacceptablequalitytobedeliveredonatimelybasis
• inturn,theentityshouldtrytosettletheirdebtstosupplierspromptly
• trytoarrangewithsuppliersforthemoreefficientdeliveryofgoods
• andnotusedoubtfulpracticestosecurecontractswithsuppliers–sonobribesorexcessivehospitality!
• society
• asamemberofsociety,eachentityshouldacceptitsrolewithinthatsocietyandwithinthecommunityatlarge
• thisacceptancecanbecommunicatedthroughthecsrand,inparticular,theentityshouldincludewithinthereportinformationabout:
- howtheentitycomplieswithrelevantlegislation
- thestepstakenbytheentitytoprotectandimprovetheenvironment
- howtheentityisinvolvedwiththelocalcommunity
- theentity’spolicywithreferencetosponsorshipandcharitabledonations
• implementation
• theentityshouldidentifytheCGC,andtheprocessoftheentity’simplementationoftheCGC’sprovisions
• itshouldalsoincludewithinitsprocessesanannualreviewoftheCGC,itsprovisions,andthewaytheentityismakingeffortstocomply
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Professional ethics
• mostprofessionsissuetheirowncodeofethics,andtheaccountancyprofessioningeneral,andACCAinparticular,isnoexception
• mainpurposeofethicsguidesistoensurethatmembersandstudentsoftheprofessionsmaintainproper,acceptable,professionalstandardsofcare
• therehastobe,withineachprofession,amechanismfortheadministeringofdisciplinarymeasuresintheeventthatanymemberorstudentbreakstheethicalguidance
• theprofessioncanbeseentobeactinginthepublicinterestandthereforegivesthepublicabasisfortheplacingofconfidenceintheactivitiesoftheprofessionanditsmembers
• inanycodeofethicsofaprofession,therewillnormallybe:
• introduction–providingabackgroundtothecode, identifyingthosetowhomitshallapply,howit is tobeenforced,andoutliningdisciplinarymeasures
• fundamentalprinciples–keyprinciples,eitherdetailedorinsummary,whichmustbefollowedbyallthosetowhomthecodeapplies
• conceptualframework–explanationofhowtheprinciplesareapplied,andalsoarecognitionthattheframeworkcannotcoverallsituationsandshouldthereforebefollowedinspiritratherthanfollowingtheactualwords
• detailedapplication–examplesoftheapplicationoftheprinciplestospecificsituations
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• IntheACCA’scodeofethics,thefundamentalprinciplesare:
• I integrity
• O objectivity
• C competence
• C confidentiality
• B behaviour
• integrity
• impliesfairdealingandhonesty
• membersshouldnotbecomeinvolvedwithanyreportorcommunicationwheretheinformationiseither:
- materiallyfalse,orknowntocontainmaterialmisstatements
- providedrecklesslyorcarelessly
- incompleteinsuchawaythatthereportbecomesmisleading
• objectivity
• accountantsshouldensurethattheirprofessionaljudgementisnotimpairedbyreasonofanybiasorconflictofinterest
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• competence
• accountantsshouldhavethenecessaryknowledgeandskilltocarryoutworkfortheirclients
• accountantsshouldfollowapplicabletechnicalandprofessionalstandardswhencarryingoutworkforclients
• accountantsshouldnotacceptorcontinueworkwhichliesbeyondtheirprofessionalcompetenceunlesstheybuyinthosecompetencies
• once an accountant has satisfactorily passed all the professional exams ( acquired competence ) it is thennecessarytoensurethatthesecompetenciesaremaintained
• hencetherequirementofcpd
• confidentiality
• informationobtainedinabusinessrelationshipshallnotbedisclosedoutsidethefirmunlessthereisproperandspecificauthoritytodoso,orunlessthereisaprofessionalrightordutytodisclose
• confidentialinformationacquiredinthecourseofemploymentshallnotbeusedforpersonalgain
• themainreasonsfordisclosurearewhen:
- permittedtobylaw,andauthorisedbytheclient
- requiredtobylaw
- thereisaprofessionaldutyorrighttodisclose,forexample,whenreplyingtotheACCAorwhencomplyingwithethicalrequirements
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• ethicalconsiderationsaboutdisclosure
• theaccountantneedstoconsidertheextenttowhichdisclosurewilladverselyaffecttheinterestsofthirdparties
• theextentofdisclosurewillbeaffectedbyanyuncertaintiesinthematterThemoreuncertain,thelessdisclosure
• theaccountantshouldensurethatdisclosureismadeonlytoauthorisedpersons
• professionalbehaviour
• theaccountantmustcomplywithallrelevantlawsandregulations
• shouldnotgetinvolvedinanyactionwhichwouldbringdiscredittotheprofession
• shouldtreatallpeoplewithwhomtheycomeintoprofessionalcontactwithcourtesyandconsideration
• shouldnotindulgeinanymarketingactivitywhichwouldbringtheprofessionintodisrepute
• ethicalthreatsconnectedwithconflictsofinterest
• inthecontextofprofessionalethics,theACCAguideidentifies,withinitsframework,theproblemsassociatedwithconflictsofinterest
• butthepotentialfornumerousdifferentexamplesofconflictsofinterestissogreatthattheproblemscanonlybesolvedonthebasisofageneralisedframeworkusingthefundamentalprinciplesasguidance
• thisapproach–applyinggeneralisedprinciplestoparticularsituationsastheyarise–isseentobepreferabletoarulesorlegalbasedapproachItinvolvestheaccountantinapplyingthespiritoftheethicalguideratherthanstrictlyadheringtoawrittensetofruleswhichmaywellnotcovertheindividualsituationwhichtheaccountantisfacing
• safeguardscanbeadoptedbydifferentinterestgroupsinanattempttoprotecttheaccountantfromthethreatscausedbyconflictsofinterest
• theseinterestgroupsincludetheprofession,theworkenvironmentandtheindividual
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Bribery
• BriberyAct2010targetsbothbriberyandcorruption
• 4offences
• bribinganotherperson
• receivingabribe
• bribingaforeignpublicofficial(FPO)(seenextpage)
• commercialorganisationfailingtopreventbribery(seenext)
• bribing=offeringfinancialorotheradvantagetoperformarelevantfunctionoractivityimproperly
• relevantfunctionoractivity:
• anyfunctionofapublicnature
• anyactivityconnectedwithabusiness
• anyactivityperformedinthecourseofaperson’semployment
• anyactivityperformedby,oronbehalfof,agroupofpersons
• these“relevantfunctionsoractivities”maybeanywhereintheworld
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Bribing an fPo
• offencetooffer,directlyorindirectly,afinancialorotheradvantagetoanFPOintendingtoinfluencethemingainingbusinessoranadvantageinconnectionwithbusiness
• anFPOholdsanadministrative,legislativeorjudicialpositionoutsidetheUK
• commercialorganisationfailing...
• acompanyorpartnershipisliableifanagent,employeeorsubsidiarybribesanotherpersonintendingtogainabusinessadvantage
• Defence-ifacompanycanshowthatithadadequateproceduresinplace,appropriatetothelevelofrisk
• “adequateprocedures”basedonsixguidanceprinciples
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the six principles
• proportionateprocedures
• proportionatetorisksfacedandsizeofcompany
• commitmentbymanagement
• managementshouldassessthenatureandextentofrisksfacedanddevelopappropriateprocedurestomanagethatrisk
• duediligence
• thecompanyshouldapplyduediligenceproceduresinrespectofcompanypersonnelwhoareatgreaterriskofofferingbribes
• communication
• toensureallemployees/connectedpersonsareawareofthecompany’scultureandattitude
• includestrainingandeducationprocedures
• monitoringandreview
• proceduresshouldberegularlyreviewedandimprovedasnecessary
• “adequacyofprocedures”isamatterforacourttodecide
• NB“hospitality”thatisreasonableandproportionateisacceptable,ieisitnotprohibitedbytheAct.
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Penalties
• anindividualwhoisfoundguiltyfacesimprisonmentupto10years
• aguiltycompanyisliabletoanunlimitedfine
• but,inaddition,thereisreputationloss...
• ...andpotentially,civilclaimsagainstthedirectorsforfailingtoimplementadequateprocedures
first conviction
• MunirPatelfoundguiltyofaccepting£500tosuppressadrivingconvictionfromcourtrecords.Servinga3yearprisonsentence
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safeguards from within:
• theprofession
• educationandtraining,includingcpdrequirements
• settingcorporategovernanceregulationsandprofessionalstandards
• monitoringofthequalityofprofessionalwork,grantingauditregistrationcertificatesandapplyingdisciplinaryproceedingswhenappropriate
• theworkenvironment
• internalcontrolsystems
• reviewprocedures
• disciplinaryprocedures
• entity’sowncodeofethics
• separatereviewandreportinginkeyareas
• theindividual
• compliancewithprofessionalstandards
• maintenanceofrecordsofcontentiousissues
• mentoring
• contactingACCAwithprofessionalqueries
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• examplesofthreatsandsafeguards
Ethicalthreat Safeguard
ConflictbetweenrequirementsoftheemployerandthefundamentalprinciplesForexample,actingcontrarytolawsorregulationsoragainstprofessionalortechnicalstandards
• obtaining advice from the employer, professionalorganisationorprofessionaladvisor
• theemployerprovidingaformaldisputeresolutionprocess
• legaladvice
PreparationandreportingoninformationAccountantsneedtoprepare/reportoninformationfairly,objectivelyandhonestlyHowever,theaccountantmaybepressurisedtoprovidemisleadinginformation
• consultationwithsuperiorsintheemployingentity
• consultationwiththosechargedwithgovernance
• consultationwiththerelevantprofessionalbody
HavingsufficientexpertiseAccountantsneedtobehonestinstatingtheirlevelofexpertise–andnotmisleademployersbyimplyingtheyhavemoreexpertisethantheyactuallypossessThreatsthatmayresultinlackofexpertiseincludetimepressuretocarryoutduties,beingprovidedwithinadequateinformationorhavinginsufficientexperience
• obtainingadditionaladvice/training
• negotiatingmoretimeforduties
• obtainingassistancefromsomeonewithrelevantexpertise
FinancialinterestsSituationswhereanaccountantorclosefamilymemberhasfinancialinterestsintheemployingentityExamplesincludetheaccountantbeingpaidabonusbasedonthefinancialstatementresultswhichheispreparing,orholdingshareoptionsintheentity
• remunerationbeingdeterminedbyothermembersofmanagement
• disclosureofrelevantintereststothosechargedwithgovernance
• consultationwithsuperiorsorrelevantprofessionalbody
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Inducements–receivingoffersReferstoincentivesbeingofferedtoencourageunethicalbehaviourInducementsmayincludegifts,hospitality,preferentialtreatmentorinappropriateappealstoloyaltyObjectivityand/orconfidentialitymaybethreatenedbysuchinducements
• Donotaccepttheinducement!
• Informrelevantthirdpartiessuchasseniormanagementandprofessionalassociation(normallyaftertakinglegaladvice)
Inducements–givingoffersReferstoaccountantsbeingpressurisedtoprovideinducementstojuniormembersofstafftoinfluenceadecisionorobtainconfidentialinformation
• Donotoffertheinducement!Ifnecessary,followtheconflictresolutionprocessoutlinedintheprevioussection
ConfidentialinformationAccountantsshouldkeepinformationabouttheiremployingentityconfidentialunlessthereisarightorobligationtodisclose,ortheyhavereceivedauthorisationfromtheclientHowever,theaccountantmaybeunderpressuretodisclosethisinformationasaresultofcompliancewithlegalprocessessuchasanti–moneylaundering/terrorism–inthissituationthereisaconflictbetweenconfidentialityandtheneedfordisclosure
• Discloseinformationincompliancewithrelevantstatutoryrequirements,egmoneylaunderingregulations
Whistle-blowingSituationswheretheaccountantneedstoconsiderdisclosinginformationalthoughthereisnoobligationfromstatuteorregulationDisclosurewouldthereforebeinthepublicinterest
• Followthedisclosureprovisionsoftheemployer,egreporttothoseresponsibleforgovernance
• Otherwisedisclosureshouldbebasedonassessmentof:
- legalobligations
- whethermembersofthepublicwillbeadverselyaffected
- gravityofthematter
- likelihoodofrepetition
- reliabilityoftheinformation
- reasonswhyemployerdoesnotwanttodisclose
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threats to independence
Threattoindependence Possibleaffectonethicalbehaviour
Financialinterests–anaccountantholdssharesinacliententity
ConflictbetweenwantingadividendfromtheshareholdingandreportingthefinancialresultsoftheentitycorrectlyMaywanttohideliabilitiesoroverstateassetstoimprovedividends
Financialinterests–anauditorholdssharesinacliententity
ConflictbetweenwantingadividendfromtheshareholdingandprovidinganhonestauditreportontheentityMaywanttohideerrorsfoundinthefinancialstatementstoavoidqualifyingtheauditreportandpotentiallydecreasingthedividendpayment
Closefamilymemberhasaninterestintheassuranceclient
Self–interestthreatMaydecidenottoqualifytheauditreporttoensurethatthefinancialinterestsofthefamilymemberarenotcompromisedMayalsobeanintimidationthreat–ifanemployee,theassuranceclientmaythreatentosackthefamilymemberifaqualifiedauditreportisproduced
Theassurancepartnerplaysgolfonaregularbasiswiththechairmanoftheboardoftheassuranceclient
Self–interestthreatTheremaybeaconflictbetweenpotentialqualificationoftheentityfinancialstatementsandlosingthefriendship/golfwiththechairman
Feeduefromaclientisoldandtheassurancefirmisconcernedaboutpaymentofthatfee
IntimidationthreatTheclientmaythreatentodefaultonthepaymentunlessmoreworkiscarriedoutbytheassurancefirmTheassurancefirmmayalsobeseentobesupportingtheclientfinancially,implyingthatanyreportwillbebiasedbecausethefirmwantsthe‘loan’toberepaid
Aentityoffersanassurancepartneranexpensivecarataconsiderablediscount
Potentialconflictbecausethepartnermaywantthecar,butalsorecognisestheethicalthreatofappearingtobebribedbytheclientThepartnermayacceptthecarandnotreportthis
Aclosefamilymemberisadirectorofacliententity
PotentialconflictbecauseanassurancepartnerwouldnotwanttoqualifytheauditreportandcreatebadfeelingbetweenthepartnerandthedirectorTheauditreportmaythereforenotbequalifiedwhenitshouldbe
Anassurancepartnerservesasanofficerontheboardofanassuranceclient
Self–interestandself–reviewthreatsThepartnerwouldhaveaconflictbetweenproducinginformationforauditandthenreportingonthatinformationThepartnermayeithermisserrorsorevendecidetoignoreerrorsidentifiedtoavoidhavingtoadmittomistakesbeingmade
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Free lectures available for Paper P1 - click hereChapter 16
EthiCal CharaCtEristiCs of ProfEssionalism
• Ethical decision making isafour–stageprocesswhichisinfluencedbothbytheparticularsituationandbytheindividualmakingthedecision
• Thefourstagesofethicaldecisionmaking:
• recognisingthemoralissue
• makingamoraljudgement
• establishingmoralintent
• behavinginamoralway
• Ahypotheticalexample:
• Acustomerhasaccidentallyoverpaidoneofyourinvoicesby$2,000.Whatistheprocessofthedecisionwhichyoumake?
• Recognisethemoralissue–ifyoukeepquiet,thenyouwillbericherby$2,000
• Makeamoraljudgement–itiswrongtostealfromyourcustomers
• Establishmoralintent–decideuponacourseofhonesty
• Behaveinamoralway–notifythecustomerofhismistake,andrepaythe$2,000
• (Kohlberg’stheoryofsixstages–wecameacrosshiminchapter11–fitscomfortablywiththeethicaldecisionmakingprocess)
• Butthedecisiontakenwilldependupontheindividualmakingthatdecision(age,sex,experienceetc)aswellasonthesituation(financialstabilityoftheindividual,demandsonhisresources,cultureetc)
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• Ethical behaviourofaccountantsisgenerallyexpectedbythepublicHowever,thatbehaviourcanbeshowntobedependentuponthenatureoftheissueandthecontextinwhichtheissuetakesplace
• withreferencetoissue–relatedmatters,weshallseethatthegreatertheintensityofadecision,themorelikelyitisthatanethicaldecisionwillbetakenThus:
• whereadecisionwillaffectalotofpeople,butonlyslightly,thenanunethicaldecisioncouldwellresultwhereasifonlyafewpeoplearelikelytobeaffected,buttoagreatextent,thedecisionwillprobablytendtobeethical
• similarly,iftheidentityoftheaffectedpeopleisunknowntothedecisionmaker,thenanunethicaldecisionismorelikely,butifthedecisionmakerknowsthepeoplewhowillbeaffected,thedecisionwillmorelikelybeethical
• athirddeterminingfactoristhetimeframewithinwhichtheconsequencieswillbecomeapparentIfthetimeframeislong,thedecisioncouldwellbeunethicalIfthetimeframeisshort,thenanethicaldecisionismorelikely
• withreferencetocontext–relatedmattersweshallseethattheactionsofotherscaneasilyaffecttheethicsofdecisionsForexample,wherecolleaguesarerewardedforactionsdemandedbysuperiors,eventhoughthoseactionsmaybeofdoubtfulethics,thena“new”colleagueislikelytowanttherewardtoo
• similarly,ifeveryonewithinanentitycarriesouttheirworkinanunethicalway,thenallindividualsarelikelytoconformwiththatestablishedstandard
• Keycontextualfactors
• rewardsystem
• authority
• bureaucracy
• workroles
• entityculture
• nationalculture
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Factor Effectonethicaldecisionmaking
Rewardsystem Whererewardsarebasedonachievement(egnumberofsalesmade)thenethicaldecisionmakingmaybeaffectedUnethical decision making may also increase where unethical behaviour isunpunishedorevensupportedbytheorganisation
Authority JuniormanagerstendtofollowinstructionsfromseniormanagersWhereseniormanagersmakeunethicaldecisionsthesearelikelytobefollowedbyjuniorsSeniormanagementmayalsoprovokeaclimatewhereunethicaldecisionmakingisaccepted
Bureaucracy Bureaucracies tend tomake employees follow rules rather than think about theethicsofdecisionsbeingmadeMorebureaucracymaythereforemeana lower levelofethicaldecisionmaking–althoughthisdependsonauthority–seeabove
Workroles Managers tend to follow the‘work role’ expected–henceanethical role suchasan accountant will normally findmanagers behaving ethically – because that isexpectedInotherroleswhereethicsarebelievedtobecompromisedregularly,managerswillusuallyalsobehavelessethically
Entityculture Managerstendtosharethenormsofthegrouptheyarein,sowhatmaybedescribedasunethicalbehaviouroverallmaybe‘ethical’forthegroupA groupmay decide that copyingwork–related software at home is‘ethical’ andthereforeallmembersofthegroupparticipateinthisbehaviour
Nationalculture DifferentcountriesorcultureswillhavedifferentethicsWhetheradecisionisethicallycorrectornotmaythereforedependonthespecificculture
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• Ethicaldilemmas:theapproachofaccountantsandotherprofessionstoethicaldilemmasisbasedonacodeofprinciplesasdiscussedearlierinthesenotes.Arules–basedapproachistheobviousalternative
• Eachapproachhasitsowncharacteristics,advantagesanddisadvantages
Rules-basedapproach Principles-basedapproach
1 Establishethicalrulesthatmembersmustfollow 1 Establishfundamentalethicalprinciplesthatmembersmustfollow
2 Ensuremembersareawareoftherules 2 Ensuremembersareawareoftheprinciples
3 Ensurememberscomplywiththoserules 3 Requirememberstoidentifyandaddressthreatstocompliancewiththeprinciplesandmakeanappropriateresponsetomitigateeachthreat
Advantages
• Easytocheckcomplianceasbasedonfact
• Easytoamendrulesetasrequired
• Recognisesthateverythreatcannotsimplybe‘listed’
• Allowsforsubjectivejudgement,sothemembercanapplytheprinciplesinaccordancewiththeirspecificsituationandnatureofthethreat
Disadvantages
• Thelistofrulesmaynotbecomplete
• Thereisnoroomforindividualdecisionmaking
• Insomesituationsitmaybedifficulttoconfirmthatthecomplianceactionwasappropriateastwopeoplemaymakedifferentandvaliddecisionsbasedonthesamethreatandcircumstances
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Free lectures available for Paper P1 - click here Chapter 17
SoCial and EnvironmEntal and EthiCal BEhaviour
Economic activity
• economic activityisonlycapableofbeingsustainedwheretheimpactonsocietyandtheenvironmentcanalsobesustained
• thesocialfootprintlooksatsustainabilityintermsofthreeaspectsofcapital–social,humanandconstructed,andentitiesneedtoensurethattheireconomicactivitiesaresustainableinallthreeareas
• theenvironmentalfootprintistheaspectofensuringthatanentity’suseofscarceresourceisreplenishedThatis,weshouldleavemorenaturalresourcetothenextgenerationthanweourselvesinheritedfromthepreviousgeneration
Sustainability
• sustainabilitycanbemeasuredobjectivelyorsubjectively
• theobjectiveapproachmeasuressustainabilityintermsofactualresourceusedcomparedwiththeamountofresourceavailable
• subjectiveapproachacceptstheinabilitytomeasureresourceandconcentratesinsteadontheintentionsoftheentityintheirattemptstoachievesustainabilitygoals
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Environmental footprint
• environmental footprint – the effect on the environment of today’s society and how it will affect the nextgenerations
• asanexample,considerthesealingoffoodpackagesThetraditionalwayofsealingthesefoodcontainershasbeentousegluetostickthesee–throughcovertothebasiccontainerAUKentityhasrecentlydesignedandpatentedamethodofsealingwhichusesradio–wavestoeffectthatseal
• theoveralleffectofthisismultiple!
• ituseslessglueandthereforefewerwhalesneedtobekilled(fromwhichtheglueismade)
• itismoreefficientintermsoffewerbrokenfoodpackages,solesswastageandthereforefeweranimalskilledbecauseoflesswastage
• theentirepackageisnowbio–degradablewhereaspreviouslyitwasn’t
• theequipmentnecessaryforradio–wavesealingcanbeboughtandusedinalltheseparatefoodpackagingentities,sothereisnoincreaseintheuseoffueltotransportthefoodtothesupermarkets
Social footprint
• social footprintlooksattheuseofcapitalintermsofsocial,humanandconstructedcapital
• social–involvestheuseofservicesprovidedcentrally(health,education,hospitals,pensionsetc)Iftheseservicesarenotmaintained(ifmoneyraisedbycentralGovernmentisnotsufficienttomaintaintheservices)thentaxrateswillneedtoincrease
• human–involvestherequirementthatpeopleshouldbeabletocontinueworkingeffectivelyThisinturninvolvestheentitytakingstepstohelpthesepeoplelookaftertheirpersonalhealth,andimprovetheirknowledgeandskills
• constructed–involvesmaintainingthephysicalstructures(roads,buildingsetc)thatsocietyhasbuilt
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Environmental accounting systems
• relatestotheneedtoestablishandmaintainsystemsforassessingtheimpactoftheentityontheenvironment
• Eco–ManagementandAuditScheme(EMAS)andISO14000werebothdevelopedinthe1990s,andbothrelatetotheestablishmentandmaintenanceofenvironmentalaccountingsystems
• whereastheISOfocusesoninternalsystems,EMASfocusesonthestandardofgoodreportingandauditing
• manyentitiesrefertotheircompliancewithintheircsrreport
• EMAS
• isavoluntaryinitiativedesignedtoimproveentities’environmentalperformance
• aimistorecogniseandrewardthoseentitieswhichconsistentlygobeyondcompliancewithminimumstandardsintheireffortstoimprovetheirenvironmentalperformance
• requiresentitiestoproduceregularreportsabouttheirenvironmentalperformance
• tobecomeamemberoftheEMASparticipators,entitiesmustadoptanEco–ManagementSystem(EMS)whichmeetstherequirementsofISO14001
• participatingentitiesmustshowthattheyunderstandandcanimplementallrelevantlegislation
• theentitiesmustrecogniseandmeettheinformationneedsoftheshareholders
• participatorsarerequiredtoimprovetheirenvironmentalperformanceovertime
• employeesoftheentitiesmustbeinvolvedatalllevels
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• ISO14000
• isaseriesofstandardsdealingwithenvironmentalmanagementtogetherwithasupportingauditprogramme
• itdesignsthespecificationsforanEMS,givesguidanceforitsuseandestablishesthestandardagainstwhichitcanbeaudited
• toberegisteredasISO14000compliantanentitymust
- implement,maintainandimproveanEMS
- assureitselfofitsownconformancewithitsownstatedenvironmentalpolicy
- demonstrateconformance
- ensurecompliancewithenvironmentallawsandregulations
- haveitsEMSexternallycertified
• anentityshouldidentifyelementsofitsoperationswhichhaveanimpactontheenvironment
• produceplansforitsimprovementandamanagementsystemtomonitortheimprovements
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• Advantagesofcompliance
• compliancewitheitherstandardwillreducethecostofwastedisposal
• therewillbesavingsintermsofconsumptionofenergy
• improvedcorporateimage
• theentitywillhaveaframeworktoworktointryingtoimproveitsenvironmentalperformance
• Socialauditing
• processbywhichanentitycanassessanddemonstrateitssocial,economicandenvironmentalbenefits
• italsomeasurestheextenttowhichanentityachievesitsobjectivesassetoutinitsmissionstatement
• inaddition,itestablishestheprocessforenvironmentalauditing
• Environmentalauditing
• aimstoassesstheimpactoftheentityontheenvironment
• itnormallyinvolvestheimplementationofEMASorISO14000
• itprovidesthedatafortheenvironmentalaudit
• Environmentalaccounting
• the development of an environmental accounting system to support the integration of environmentalperformancemeasures
• itprovidesevidenceoftheachievementsofsocialandenvironmentalobjectives
• withoutsocialandenvironmentalauditing,environmentalaccountingwouldnotbepossible