Acca p1 Excellent File

7/27/2019 Acca p1 Excellent File

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ACCA P1Professional Accountant

Arno ld Xu

Arno [email protected]

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Principals Agents

Views

-Capitalists

-Expedients

-Proponents ofsocial contract

-Socialecologists

Governance,IC, Audit,

ERM

Law, regulation, professional codes, professional values,personal ethics

Ethical theories, consequentialism, CMD

Stakeholders

-Shareholders

-Staff

-Lenders

-Customers

-Government

-Public

-Futuregenerations

Directors/accountants

National/localgovernment

Health authorities

Professional bodies

Schools/colleges

Duties

-Performance

-Competence

-Conflicts ofinterests

-Confidentiality

-Accountability

Power

Interests

Investments

Objectives

SOX, Combined Code

NED, AC, RC, NC

Risk Committee

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Safeguards

Governance,

IC, Audit,ERM

Risks

-Financial

-Operational

-Reputation

-Legal

Threats

-Self-interest

-Self-review

-Advocacy

-Familiarity

-Intimidation

Identify,Assess ,

Evaluate

ARTA

Integrity

Independence

Objectivity

Confidentiality

Competence

Risk CommitteeNED, AC, RC, NC

Law, regulation, professional codes, professional values,personal ethics

Ethical theories, consequentialism, CMD

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Introduction - Syllabus

A. Governance and respons ibil ity

1. The scope of governance

2. Agency relationships and theories

3. The board of directors

4. Board committees

5. Directors remuneration

6. Different approaches to corporate governance 7. Corporate governance and corporate social responsibility

8. Reporting & disclosure

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Introduction Examinable Models & theories

Corporate Governance

Agency theory (2 Define)

Transaction Costs theory (2 Explain & Analyze)

Stakeholder theory (2 Explain & Analyze)

Ethics

Relativisim & Absolutism ( 2 Explain & distinguish)

Kohlbergs stages of moral development (3 Explain)

Deontological and consequentialist (2 Describe &distinguish)

American Accounting Association model (2 - Apply)

Tuckers 5 question model-PLFRS (2 - Apply)

Gray, Owen and Adams 7 positions (2 Describe &evaluate) 6

Chapter 1

Corporate Governance

Concepts & Scope


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KNOWLEDGE CHECKLIST

Business organizations

Agency Theo ry & Transact ion Cost Theory

Agency theory

Agency relationship

Duties of agent

Accountability

Fiduciary duty

Agency cost

Alignment of interest

Close monitoring

Transaction cost theory

stakeholders

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KNOWLEDGE CHECKLIST

Corporate governance

Definition

Concepts

Fairness

Transparency

Independence

Probity

Responsibility & accountability

Integrity

Stakeholders

Relationship

Direct & control

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Corporate Governance Stakeholders 3

Stakeholder

Definition:

Any entity

Affect or be affected

Bi-directional

Power x interest = influence Source of risks

Debates over stakeholder

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Al l about s takeho lders

Stakeholdertheory

Instrumental Normative

Identification ofstakeholders

Stakeholdermapping

7 Positions CSR

Corporate CitizenSustainability

Reporting

Tuckers 5 Question

Institutional investors

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Chapter 2

Different Approaches

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KNOWLEDGE CHECKLIST Models of Business Ownership 2

Approaches to Corporate Governance Guidance 3

Principle vs. Rules based

Impetus for Corporate Governance Code 3

Investor (equity treatment)

Responsive

Major Corporate Governance Codes

Combined Code UK 2

Sarbanes-Oxley US 2

International 2


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Major Corporate Governance Codes 2

Principle Based:

UK Combined Code

OECD (CG concept)

ICGN (Ethics & stakeholders)

Rules based:

Sarbanes-Oxley Act

Other national codes

South Africa Kings report (CSR)

Singapore Code of Corporate Governance14

Chapter 3

Best Practices

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KNOWLEDGE CHECKLIST

Board composition & roles 3

Board structures 3

Directors Remuneration 3

Board committees 3

Communicating & Reporting

AGM 2

Proxy voting 3

Corporate Governance reporting 2

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Information & Professional Development of the Board 3

UK Combined Code

The board should be supplied in a timely manner withinformation in a form and of a quality appropriate to enable it todischarge its duties.

All directors should receive induction on joining the board andshould regularly update and refresh their skills and knowledge.

Information to th e Board

Responsibility:

Chairman

Management (provider)

Directors ( seek clarification )

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Induction programme

Contents

Company relationship

People

Products or services

Structure

Constitution

Assets, liab.,

Risks

KPI

Regulations

Meet

Visit

Build relationships

Meet auditor

Customer

Supplier

Shareholder18

Professional Development of the Board 3

Who is responsible?

chairman

CPD programme should be concentrate on

Role of the board

Obligations and entitlements of existing directors

Expected behaviour for effective board performance


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Performance of the Board 2

Board performance evaluation:

Key criteria:

L/T development instead of routine management matters

Who will evaluate?

by external 3rd parties ( e.g. auditors)

by NEDs (for evaluating performance of Chairman)

When

Once a year

Whom to report?

Shareholders

1.Formal, rigoro us

2.Board, committees, individual directors

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What are the crit eria?

For the Board

Board composition and meetings

The BOD is collectively responsible for success of thecompany

Measures:

Meetings (scheduled, unscheduled)

Attendance record

Updates of roles and responsibilities

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What are the criteria?

For the Board

Board balance and independence

ED and NED

Chairman Chief Executive Officer

Measures:

Age profile of the directors

Up to date CVs of directors

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For the Board

Mission and strategy

Measures:

BSC: non-financial + financial targets

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For the Board

Board appointment and re-election

Formal, transparent procedure

Submitted for re-election at regular intervals

Measures:

NC, Length of tenure of each directors

Re-election interval (maximum 3 years)

Succession policy

Combined code:

All directors should be subject to election byshareholders at the firstAGM after theirappointment,

and to re-election thereafter at intervals ofnomore than three years.

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For the Board

Directors' remuneration

Measures:

RC, composed by independent NEDs

Performance targets achieved > performance relatedpay

1. Combined Code:

2. Levels of remuneration for directors should be sufficientto attract, retain and motivate directors of the qualityrequired to run the company successfully but shouldnot be more than is necessary for purpose


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For the Board Information and pro fessional development

Info to the Board > timely and appropriate

All directors > induction training and CPD

Measures:

management a/c information > directors

Training courses

No. of new directors? Attendance?

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For the Board

Accountab il it y

Balanced & understandable assessment of position and prospects inthe annual report and other public statements

Maintain a sound system of IC

Measures:

IC assessed ?

IA examines IC ?

AC (composition, meetings)

IC recommendations from EA

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For the Board

Communication

Dialogue with institutional shareholders

Use AGM to communicate with private investors andencourage their participation

Measures: Meet with major shareholders

Other communications?

Shareholders attendance at AGM

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For the chairman

Effective leadership

Relationships and communications with shareholders

Relationships and communications within the board

Board agenda - enable board members to raise issues and

concerns Company secretary - used appropriately and maximum

value

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Performance of the Board 2Individual directors

Chairman & CEO

Separate appraisal carried out by NEDs

All di rec tors on the Board

Criteria:

independence > objective

preparedness > knowledge, relationship

practice > questioning, education

committee work > process, enthusiasm

development of the organization > suggestion, innovation

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Performance of the Board 2Board Meetings

Agenda:

Balance between L/T & S/T issues

Every director > opportunity to propose

Supportive information:

Informative, Risks and alternatives identified

Distributed in good time


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Legal & regulatory issues over the Board 2

Appointment

Removal

Rights

Responsibility

Remuneration

Directors

- Fees and expenses- Emoluments and

compensation forloss of office

Legal duties- Ski ll- Attend board meetings

-Delegation andcommunication

Conflict and disclosureof interests

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Time-limitedappointments

Removed ordisqualified

Not offering

himself forre-election

Resignation

CompanyDissolutionDeath


Departure from office

writtennotice NEDs:

After 2 x 3 period > explain toSH

After 9 > annual re-election

By companys constitutionBy court

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Insider dealing/trading

What is?

A criminal offence by using insider information to buy orsell shares in a stock market

A breach of agents duty

Insider information

Information that is specific and precise, Not yet been made public > if made public > significant

effect on share price

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BOARD STRUCTURE 3

Good board structure

1. Independence

2. Size

3. Committees and functions

4. Diversity

Division of responsibility in BOD

CEO

Chairman

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BOARD STRUCTURE 3

Bad board structure

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BOARD STRUCTURE 3

CHAIRMAN AND CEO

UK Combined Code

There should be a clear division of responsibilities at the headof the company between the running of the board and theexecutive responsibility for the running of the companysbusiness. No one individual should have unfettered powers ofdecision.

A chief executive should not go on to be chairman of the samecompany. If exceptionally a board decides that a chiefexecutive should become chairman, the board should consultmajor shareholders in advance and should set out its reasonsto shareholders at the time of the appointment and in the nextannual report.


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BOARD STRUCTURE 3

CHAIRMAN AND CEO

1.Different roles

Chairman: Head of the BOD

CEO: leading the management team

Pros for separation

Chairman (representative of Shareholders) manager role

No single person can do BOTHjob well

Can Board make CEO truly accountable for management?CEO is the head of board

Removes possibility of self-interest > act in the interest ofshareholders

NEDs report their concern over CEO to Chairman38

BOARD STRUCTURE 3

CHAIRMAN AND CEO

Possible Cons for separation

2 leaders > conflict

Greater power to the CEO

Motivating tools

What if CEO = Chairman ?

Strong independent element

E.g. senior independent NED

Available to shareholders to answer concerns that have notbe resolved through normal channels

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BOARD STRUCTURE 3

CHAIRMAN AND CEO

Role of Chairman

Run the board and set its agenda

Information to board members

Effective communication with shareholders

Manage the board (meeting and NED)

Induction program for new directors

CPD of individual directors

Performance evaluation (directors and committees annually)

Encourage active engagement by all the members of theboard

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Accountabil ity of Board and CEO

Board

Shareholders

Executive

management

Financial marketsRegulatory bodies

Supervision of managementAnd stewardship of the company

Management of the company& stewardship of its operations

Other stakeholdersEmployee etc

Chairman

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BOARD STRUCTURE 3

CHAIRMAN AND CEO

Role of CEO

Senior executive in charge of management team

Answerable Board

Responsibility:

UK Combined Code

Major Responsibilities of CEO

Business strategy and management

Investment and financing

Risk management

Board committees (recommendation)

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BOARD STRUCTURE 3

Role of NED

Who are they?

NEDs have no executive (managerial) responsibilities

non-executive director

Focuses on what they are not rather than what they are

Equivalent terms:

Outside director

Used in the US and elsewhere but NOT in the UK

independent director appears in Higgs Review

ALL NEDs could, or need to, be independent

UK Combined Code

The board should include a balance of ED and

NEDs (and in particular independent NEDs)such that no individual or small group ofindividuals can dominate the boards decisiontaking.


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BOARD STRUCTURE 3

Role of NED

SENIOR INDEPENDENT DIRECTOR

UK Combined Code

The board should appoint one of the independent NED to bethe senior independent director.

Be available to shareholders

When normal channels of chairman, chief executive orfinance director has failed

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BOARD STRUCTURE 3

Role of NED

SENIOR INDEPENDENT DIRECTOR

Debate over Senior Independent Director:

Pros:

Important > relationship b/w major shareholders and the board

Address shareholder concern

Chair meetings b/w NEDs where chairman does not attend

Unless being appointed as chairman > functions as Deputy Chair

Cons:

Unnecessary or divisive > shareholders may make use of own connectionswith NEDs, or contact the chairmen of board committees if they haveconcerns

Construct the case for having an independent Director onthe Board

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BOARD STRUCTURE 3

Role of NEDs

Strategy:

Constructively challenge and contribute to the development of strategy.

Performance (scrutiny)

Scrutinise the performance of management in meeting agreed goals andobjectives and monitor the reporting of performance.

Risk

Satisfy themselves that financial information is accurate and that financialcontrols and systems of risk management are robust and defensible.

People

Responsible for determining appropriate levels of remuneration ofexecutive directors and have a prime role in appointing, and wherenecessary removing, senior management and in succession planning

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BOARD STRUCTURE 3

Requirement & Provisions for NEDs in the Board

Numberof NEDs

UK Combined Code

At least half the board, excluding the chairman > independentNEDs

Smaller company > at least 2 independent NEDs

NYSE: Listed company > MAJORITY of NEDs ( > 50% of the board)

Singapore:

At least 1/3 > independent NEDs

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BOARD STRUCTURE 3

Pros & Cons for NEDs in the Board

Advantages

External experience and knowledge

Provide wider perspective

Comfort factor for 3rd parties (e.g. investors, creditors)

Well-suited roles played by NEDs

Dual nature of NEDs role

Full board members > same knowledge

Strong, independent element on the board

Compliance with relevant CG codes

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BOARD STRUCTURE 3

Pros & Cons for NEDs in the Board

Problems

Lack independence

Prejudice over recruitment of NEDs

High-calibre NEDs tends to work in best-run companies

Difficult to impose views on the board

Corrective roles may be beyond the capabilities of NEDs

Limited time to devote in company affair

May damage companys performance

Weakening board unity

Stifle entrepreneurship

Debate over CSR:

NED was for political reasons > represent others interest> not in best interest of shareholders


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BOARD STRUCTURE 3

Remuneration of NEDs

UK Combined Code

No share options to NEDs

In practice

Bonus scheme for NEDs could be problematic:

Too small > lack of motivation > observe bottom line

Too generous > conflict of interest > not act in the bestinterests of shareholders

Why?

Fear of challenging ED

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BOARD STRUCTURE 3

Remuneration of NEDs

Recommendations: Sufficient to attract high quality and motivated NEDs > shareholders

benefit

Payment:

Cash or shares

No share options

Linked to L/T performance rather than financial performance of currentperiod

Balanced performance measures

Encourage broader view of CG

Shareholders' prior approval of any bonus scheme

NEDs' bonuses > determined by Shareholder, NOT by ED

Incentive for NED to achieve specific objectives or tasks outside normalduties as NED

Paid immediately

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BOARD STRUCTURE 3

Supervisory board only non-executive members

Management board

Executive members only

Board of directorsExecutive &

non-executive members

Two-tier structureUnitary structure

Executive committee

committees committees

Supervisory boardComposition:Workers representativesShareholdersrepresentativesManagement boardComposition:-Appointed by SupervisoryBoard-Entirely of managers

Policy boards- L/T strategic issuesFunctional boards

-Main senior executives withfunctional roleMonocratic boards-Few responsibilities-More symbolic role

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BOARD STRUCTURE 3

Unitary or Multi-tier?

Arguments for & against

Unitary Boards

Advantages:

Equal legal responsibility > NEDs involvement

Same meeting

Decision-making + information

More balanced decision > all directors involved

Presence of NEDs > scrutinizing and challenge > betterdecision-making

Enhance relationship between different types of directors

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BOARD STRUCTURE 3


Arguments for & against

Unitary Boards

Disadvantages:

Overloaded NEDs > manager + monitor

Time pressure for NEDs > meeting and understand

No EE in management board

Division b/w shareholders and directors > AGM only placefor shareholders

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BOARD STRUCTURE 3


Multi-tier Boards

Advantages:

Separation b/w monitors and those being monitored

Supervisory/policy board

Guard & Deterrent (similar to IA)

Stakeholders needs > by supervisory board

Shareholder involvement and EE participation (appointmentand supervision of directors)


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BOARD STRUCTURE 3


Multi-tier Boards

Disadvantages:

Confusion over authority > lack of accountability

Theorypractice

Management board may restrict info passed tosupervisory board

Independence of supervisory board

Representatives of shareholders > interfere

NED?

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BOARD STRUCTURE 3

Trends and futures

UK & US

Increasing criticism over two-tier board structure

Advocates on NEDs role in the board

Germany and Japan

Under pressure of globalisation of capital markets andcross-boarder M& A

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Board representation: Weight and influence ofdifferent stakeholders on the board

ExecutivedirectorsIn

depe

ndent

director

s

Shareholders employees

Executive

Directors

Chairman&CEO

Executive

directorsIn

depe

ndent

Dire

ctors

Nonex

ecutivech

airm

an

Indepe

ndent

director

s

Significant

shareholdersShareholders

employees

employees

United KingdomUS Continental Europe

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DIRECTORS REMUNERATION 3

Purpose & general guideline:

Adequate remuneration to attract individuals with sufficientcalibre

Motivate individuals to achieve performance levels

High-performing directors should be rewarded

> but how much is enough?

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Setting o f Directors remuneration

By remuneration committee

Role

general policy on remuneration of executive directors

specific remuneration packages for each director

Composition

INDEPENDENCE (3 NEDs)

Staffed by NEDs > ED can NOT set on own salaries

3 No

no personal interest

no conflicts of interest

no day-to-day involvement in running the business60


Remuneration Policy

pay scales

proportion of rewards

period for performance related payments become payable

proportion of performance related, balance b/w L/T & S/T

transparency of directors remuneration (pension rights)

Benchmarking with similar companies > applied with caution


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Remuneration Policy

Determine the Performance Measures

Problems:

Wrong measure applied

Myopia (short-term focus)

Remunerated with time delay ( reward for the past)

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Remuneration Policy


Other considerations:

Link variety of strategic goals and targets together

Profit based

EPS

Problem: S/T, manipulation, risk-taken

Market based

TSR

Problem:

Market fluctuation

Individual performance

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TSR

Total Shareholder Return

Capital Gain + Total Dividend over the period

Initial investment (Opening SP)

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Remuneration Policy



Link variety of strategic goals and targets together

Internal based

Measures: financial + non-financial

Problems: Intangible

Benchmark

Compliance

Environmental

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Remuneration Policy



Remuneration for different levels of directors

Loss of management (confidentiality)

Additional and basic

Flexibility

Difficult to distort

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Basicsalary

Performancerelated

Shares

Shareoptions


Remuneration Package

1. UK Combined Code

2. Levels of remuneration should be sufficient to attract,retain and motivate directors of the quality required torun the company successfully, but a company shouldavoid paying more than is necessary for this purpose.

3. A significant proportion of executive directorsremuneration should be structured so as to linkrewards to corporate and individual performance.


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Components

Basic salary

Determined by employment contract (experience, marketrate)

Not related to performance

Performance related bonuses

Cash bonus (may have a cap)

Transaction bonuses

Shares

Award shares and exercise after period of service

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Components

Share options

a) What is

A right to purchase shares at a specified exercise price overa specified time period in the future

At the exercising day, if share price > exercise price, followexercise price

Initiatives and Problems

A mechanism to align interest of management with that of theshareholders

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Share options

Conditional based on achievement of certain conditions

Market based:

Share price

Target share price relative to an index of market prices

Non-market based:

Revenue / Profits

Increase in EPS

Non-financial targets (IPO, number of EEs)

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Share options

Initiatives and Problems

Vesting period

UK Combined Code:

Not less than 3 years

Encourage for longer holding period

Grants > in phase

Performance criteria

A matter of debate

Benchmark to a group of comparable companies

What will the directors do to protect own interests?

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Benefits in kind

Transport, health provisions, life assurance, holidays,expenses, loans

Concerns:

Cost & benefit

Compared with EEs package

Loans

Abuse of loan (WorldCom case)

Loans to directors of listed companies > prohibited(some jurisdiction)

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Pensions

Pension contributions

UK Combined Code

Only basic salary is pensionable

Pension consequences and associated cost need to beconsidered


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Service Contracts & Termination Payments

Length of service contract

Most CG > less than 12 months

Compensation for terminating service contract

Continue to pay

Cease payment when directors finds new job

Paying shares

1.UK Combined Code:

2.The remuneration committee should carefully consider what compensationcommitments (including pension contributions and all other elements) theirdirectors terms of appointment would entail in the event of early termination.The aim should be to avoid rewarding poor performance. They should take arobust line on reducing compensation to reflect departing directorsobligations to mitigate loss.

3.Notice or contract periods should be set at one year or less. If it isnecessary to offer longer notice or contract periods to new directorsrecruited from outside, such periods should reduce to one year or less afterthe initial period.

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Remuneration Disclosures

Annual report:

Remuneration policy

Arrangement for individual directors

Other disclosures

Duration of directors contracts

Notice periods and termination payments

Details of external remuneration consultants employed byRC

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Voting on Remunerations

Shareholders

Approve remuneration policy > voting on remunerationstatement + remuneration packages

However

Legally binding contract b/w Co. & directors

Shareholders can not force a breach of contract

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BOARD COMMITTEES 3

Sub-board committees responsible for supervising specificaspects of governance.

Main board committees

Internal Audit Committee

Remuneration Committee

Nomination Committee

Risk Committee

Operation of committee system does not discharge theresponsibility of board on the specific areas

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COMMUNICATING & REPORTING 2

Board shareholders (institutional)

AGM > forum

Annual Report and Accounts

Shareholder has the right to appoint a agent (proxy) to act ontheir behalf at company meetings

Board should maintain a regular dialogue withshareholders, particularly institutional shareholders

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COMMUNICATING & REPORTING 2

AGM

Guidelines:

Company

Notice > 20 working days before meeting

Business presentation + Q&A session

Chair of key sub-committees > available to answer questions

Shareholders

Vote separately on EACH substantial separate issue (no bounding ofissues)

Propose a resolution at AGM relating to reports and accounts

Institutional investors

Provide details of their vote in the AGM

Eliminate impediments to cross-border voting


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CORPORATE GOVERNANCE REPORTING

Importance of Reporting

Reduce information asymmetry

Helps to address key difficulties of agencyrelationship

Principles vs. Compulsory

Principle based : London Stock Exchange

Compulsory: NYSE

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Whether complied throughoutthe accounting period

Non-compliance > explained

Narrative statement

LSE

Statement of compliance

how applied

explanations on detail

Supplementary Disclosures

balanced and detailed information

based on judgement

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CORPORATE GOVERNANCE REPORTING 2

Reporting Requirements

1. Explain responsibilities for preparing accounts

2. Report on going concern status

3. Information on BOD

4. Brief reports on

i. remuneration

ii. audit

i ii . nomination committees

5. Relations with auditors

6. Statement > reviewed effectiveness of IC, risk management

7. Statement > relations and dialogue with shareholders

8. Statement > company is a going concern

9. Substantiality report

10. Operating and financial review (OFR)82


Voluntary Disclosure 2

Any disclosure above mandated minimum

CEOs report

Social/environmental report

Additional risk or segmental data

General guidelines:

Transparent & planned process > communicated to everyoneresponsible for preparing the information

Consultation within business, shareholders and other key g roups

All relevant information > taken into account

Comprehensive, consistent and subject to review

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Q 1 Remuneration package

(a) As a consequence of the corporate governance codes, there isincreasing disclosure in the accounts of listed companies ofthe procedures for determining the remuneration of directors,and the actual remuneration.

The following statements are quoted from recent accounts:

'The (two) non-executive directors constitute the remunerationcommittee.'

'No member of the committee has a personal financial interest,other than as a shareholder, in the matters to be decided.There are no conflicts of Interest arising from crossdirectorships....'

'The Chairman has a service contract with a notice period ofthree years. This was originally drawn up in 20X2 and wasconsidered at that time to afford protection for the Groupagainst the loss of the services of a key executive. ....theBoard does not intend to seek to var the terms.'

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Answer:

'The (two) non-executive directors constitute the remunerationcommittee.

Membership:

Wholly by NEDs > ED cant decide on own salary

Number of NEDs

Significant number of NEDs (recommended)

At least 3 (Combined Code)

2 for small company

Reliance on NEDs

Overloaded > insufficient attention

Minimum number of NEDs at least 3


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Answer:

'No member of the committee has a personal financial interest,other than as a shareholder, in the matters to be decided.There are no conflicts of Interest arising from crossdirectorships....

Independence

All NEDs should be independent

No share option

No performance-related pay

No pension scheme

Cross-directorship

Agreement on set higher salary for each other

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'The Chairman has a service contract with a notice period of

three years. This was originally drawn up in 20X2 and wasconsidered at that time to afford protection for the Groupagainst the loss of the services of a key executive. ....theBoard does not intend to seek to vary the terms.

Answer:

Lengthy contract

Good: retain key management

Bad:

Financial disincentives to remove > high compensation costs

Shareholders right to remove directors > undermined

Service Contracts

Combined Code: for 1 year only

87


(b) Required:

Analyze and explain the motivational effect on the ChiefExecutive of each elements of the remuneration package, andof the total package. (14 marks)

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(b) Under contractual remuneration arrangements, the ChiefExecutive of X Group received in 20X6, as disclosed in theannual report and accounts:

Salary 516,000

Bonus 50,000

Employee profit-sharing scheme 8,000

Benefits 21,000

He has a three-year rolling contract. The Group contribution tohis pension scheme was 85,000.

The bonus is determined by the remuneration committee, and isnon-pensionable. It is based on the committee's assessment of theannual performance of the company and the individual's contributionthereto. The bonus may not exceed 25% of salary. Participation inthe employee profit-sharing scheme is limited to 8,000. Thebenefits relate to the use of a company car and accommodation.

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In addition to the above, the contract provides that the ChiefExecutive can receive, as part of his remuneration package,the following.

(i) A conditional allocation of ordinary shares, which may beapproved annually by the Remuneration Committee, based ona percentage of salary not exceeding 50%.

Shares are held by trustees during the measurement period ofthree years.

Vesting (formal ownership and possession) of the shares issubject to a performance test at the end of the period. The testinvolves ranking the total shareholder return (TSR) againstthose of other top 100 companies (FT-SE 100).

(1) An upper quartile ranking will produce 100% vesting, alower quartile zero.

(2) The calculation of intermediate points is linear. 90


The shares required are purchased in the market. Conditionalallocations are expected to be at 50% of salary (the maximum).

(ii) Share options may be granted, at the market price at thedate of grant. The maximum share options granted in a three-year period can not exceed four times annual salary.

These can not be exercised for three years, and can beexercised only if the percentage growth of the TSR of thecompany equals or exceeds that of the average of the FT-SE100 companies.


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FTSE 350 Total Shareholder Return*

2. Imperial Tobacco 305.3%

3. Man Group 303.9%

4. Hit Entertainment 268.9%

5. Lonmin 259.2%

6. Grainger Trust 233.0%

7. RPS Group 230.3%

8. Enterprise Inns 230.1%

9. McCarthy & Stone 228.7%

10. Wimpey (George) 226.0%

11. Holiday Break 197.7%

12. PZ Cussons 179.0%

13. Interim Capital Group 178.0%

*Source: Datastream - Total Shareholder Return, period covering 5 years from Jan/98 Jan/03

1. Jardine Lloyd Thompson 376.9%

14. Persimmon 177.6%

15. BHP Billiton 171.9%

16. PZ Cussons A 168.8%

17. Inchcape 165.0%

18. Br iti sh Am eri can To bacco 162.8%

19. Gallaher Group 161.1%

20. Wembley Group 154.9%

21. Alba 154.1%

22. Signet Group 150.6%

23. Schroder Ventures 135.2%

24. Smith & Nephew 132.3%

25. Royal Bank of Scotland 128.5%

92


Answer:

Salary: 516,000 Substantial

Implication:

One of the highly-paid & highly sought-after directors

May increase in line with companys growth

Motivating

93


Answer:

Bonus: 25 % x 516,000 = 129,000

Relate to performance of Co.

Criteria ?

Assessment of Remuneration Committee

Implication:

Company politics > de-motivational ?

Based on annual performance > S/T view?

94


Answer:

Employee profit-sharing scheme 8,000 (Max)

Insignificant

However, average performance will get the bonus

Other benefits, pension contribution 85,000

Substantial

Unlikely linked to performance > limited motivation

95


Answer:

Conditional Allocation of Shares

50% of salary > significant

3 year time scale > related to TSR > not S/T focus

Motivational

However

Penalized by market?

If group perform well, but sector performed bad > CEOpenalized

96


Answer:

Share Option

Not exceeding 4 times of salary > lucrative

Strong motivational

However > based on market > out of control of CEO

Current position of the company?

Average > reasonable target

Low > mission impossible?

Recommendation:

Sliding scale approach instead of all or nothing


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97


Answer:

Total Package

Motivation depend on how CEO controls

Internal

External

Share grant + share option

Very lucrative

Encourage L/T perspective

However

Fixed proportion > substantial already

If CEO ambitious > higher performance

People are usually motivated by success itself

98

Chapter 4

Internal Control

Framework

99

Introduction - Syllabus

B Internal control and review

1. Management control systems in corporate governance

Propose

Assess

2. Internal control, audit and compliance in corporategovernance

Internal audit independence 2 - Assess 3. Internal control and reporting 2

4. Management information in audit and internal control

Communication of info 3

100

COSO- A process,- Effected by BOD, management and other personnel- reasonable assurance . achievement of objectives in thefollowing categories:

Effectiveness and efficiency of operations

Reliability of financial reporting

Compliance with applicable laws and regulations

Purpose of Internal control system 2

101


Importance of Internal Control

Achieve objectives

Underpin investor confidence

Risk awareness and control

Information on internal operations and compliance

Performance (expose and improve underperformed)

Reporting

Information for internal and external reporting

102


Key stages involved in a Control System

1. Identification of system objectives

2. Setting targets for system objectives

3. Measuring achievements/outputs of the system

4. Comparing achievements with targets

5. Identifying what corrective action might benecessary

6. Implementing corrective action


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103

Importance of Internal control system 3

Turnbull Proposal

A company's system of internal control has a key role inthe management of risks that are significant to thefulfilment of its business objectives.

A sound system of internal control contributes tosafeguarding the shareholders' investment and thecompany's assets.

1. Internal controls should include all types of controlsincluding

Operational and compliance

Internal financial controls104


Turnbull Proposal

What is a Sound system of Internal Control

Embedded in operations and form part of its culture;

Capable of responding quickly to evolving risks

Within the company

In business environment

Procedures for reporting immediately to management

Significant control failings or weaknesses identified

+

Corrective action being undertaken

105


Combined Code Requirements on Internal Control

The board should maintain a sound system of internalcontrol to safeguard shareholders' investment and thecompany's assets.

The directors should, at least annually, conduct a reviewof the effectiveness of the group's system of internalcontrol and should report to shareholders that they havedone so.

The review should cover all material controls, includingfinancial, operational and compliance controls and riskmanagement systems.

106


Combined Code Requirements on Internal Control

For listed companies, the BOD should

Assess how the company has applied coderequirement to main a sound system of internalcontrol

Review effectiveness of internal control

Reporting on these matters to shareholders in theannual report and accounts

107


Roles and responsibilities over internal control

Board of Directors

Responsible for the company's system of internal control

Set policies

Seek regular assurance on effective operation

Ensure effectiveness of IC in managing risks

108



Management

Implementing ro le

Identify and evaluate the risks > consideration by the board

Design, operate and monitor IC

CEO- Ultimately responsible & assume "ownership" of the system

- Sets the "tone at the top" > control environment- Provide leadership and direction to senior managers- Review senior managers control over the business


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109



Senior Management

Assign responsibility > responsible personnel

All EEs

Some responsibility > accountability for achieving objectives

Collectively establish, operate and monitor

Produce information & communicate

Defined in everyone's JD

110



Internal Auditors

Evaluating

Monitoring

External parties

EA > NO responsibilities, NOR being part of IC

111

INTERNAL CONTROL FRAMEWORK 3

SOX Requirements on Internal Control

Statutory requirement

Sox 404

Audit and reporting of internal control systems

Management (CEO & CFO)

Understand IC

Evaluate effectiveness (design + operating)

Written assessment at Y/E on effectiveness > included in annual return External Auditor

Opinion on managements assessment

Test & Verify > assessment is correct

Express an opinion on F/S of the company

112


SOX Requirements on Internal Control

Statutory requirement

Sox 404

Audit and reporting of internal control systems

113

Sample Auditors Report - Microsoft In our opinion, such consolidated financial statements present fairly,

in all material respects, the financial position of MicrosoftCorporation and subsidiaries as of June 30, 2007 and 2006, and theresults of their operations and their cash flows for each of the threeyears in the period ended June 30, 2007, in conformity withaccounting principles generally accepted in the United States of

America.

We have also audited, in accordance with the standards of thePublic Company Accounting Oversight Board (United States), theeffectiveness of the Companys internal control over financialreporting as of June 30, 2007, based on the criteria established inInternal Control Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission and ourreport dated August 3, 2007, expressed an unqualified opinion onmanagement's assessment of the effectiveness of the Companysinternal control over financial reporting and an unqualified opinion onthe effectiveness of the Company's internal control over financialreporting.

DELOITTE & TOUCHE LLP 114


Internal Control Framework

Control Environment

ControlProcedures

Culture, infrastructure

+

Attitude of management

Detailed control in place


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115


COSO

1. Effectiveness and efficiency of Operations

2, Reliability of Financial reporting

3. Compliance with applicable laws and regulations

Key Concepts

Internal control is a process. It is a means to an end, not an end in itself.

Internal control is effected by people. Its not merely policy manuals andforms, but people at every level of an organization.

Internal control can be expected to provide only reasonable assurance,not absolute assurance, to an entitys management and board.

Internal control is geared to the achievement ofobjectives in one ormore separate but overlapping categories.

116


COSO

4 Objective Categories

Strategic development

Operations

Reporting

Compliance

5 components of internal control

Control Environment

Risk assessment

Control Activities

Information and Communication

Monitoring

Added

117

COSO ERM Framework

118

COSO

Control Environment

Sets the tone, influencing control consciousness

Foundation > discipline and structure

Control environment factors

Integrity

Ethical values and competence

Philosophy and operating style

Assigns authority and responsibility and organizes anddevelops its people

Attention and direction provided by the BOD

119

COSO

Control Environment

Importance of Control Environment

Strong control environment

Does not, by itself, ensure the effectiveness of theoverall IC system

Major influence only

- Establishment of business objectives

- Structuring of business activit ies

- The way business followed to deal with risks

120

COSO

Risk Assessment

Assessment of external and internal risks pertain to the entity

Identification and analysis of relevant risks to achievementof the objectives

Basis for determining how the risks should be managed

Risk assessment > ongoing


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121

COSO

Control Activities

Control activities occurthroughout the organization, atALL levels and in ALL functions

Typical activities (SOAPMAPS)

Supervision

Organization

Author izat ion

Personnel

Management

Ar ithmetical & Accounting

Physical

Segregation of duties

122

COSO

Information and Communication

Information must be identified, captured and communicated ina form and timeframe that enable people to carry out theirresponsibilities

Information:

IS reports

Operational, financial and compliance-related information

For planning and control of the business

Information sources:

Internally generated data

External events, activities and conditions necessary for informedbusiness decision-making and external reporting

123

Tactical

Strategic

Operational

Information & Communication

Planning

Controlling

124

COSO

Monitoring

A process that assesses the quality of the system'sperformance over time

Ongoing monitoring (in the course of operations)

Separate evaluations

Internal control deficiencies > upstream

Serious matters > top management & the board A combination of the two

125

COSO

Relationships:

All 5 components must be in place to achieve either one of 3objectives.

Advantages:

Focused on a wide concept of IC

Not just limited to financial control

126

COCO

COCO framework

Criteria of control

Canadian Institute of Chartered Accountants

Importance of feedback and continuous improvement incontrol systems learning process

Definition of Internal Control:

Internal Control is those elements of an organization(including its resources, systems, processes, culture,structure and tasks) that, taken together, support people inthe achievement of the objectives.


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127

PurposeA sense of direction.

What are we here for?

CommitmentA sense of identity

and values.

Do we want to doa good job?

CapabilityA sense of competence.

What action do we need totake?

Monitoring and

LearningA sense of evolution.

What Progress?

What Next?

ACTION

COCO

128

COMPONENTS OF INTERNAL CONTROL 3

Major Classifications:

Corporate, management, business process, transaction,

Administrative, accounting

Prevent, detect, correct

Discretionary and non-discretionary

Voluntary and mandated

Manual and automated

Application and general IS controls (Covered in F8)

Financial and non-financial

129

INTERNAL CONTROL AND RISK MANAGEMENT3

Turnbull Proposal

The board must further ensure that the system of internalcontrol is effective in managing those risks in the mannerwhich it has approved.

In determining its policies with regard to internal control, andthereby assessing what constitutes a sound system of internalcontrol in the particular circumstances of the company,

Factors to be considered by the Board

Nature and extent of the risks facing the company;

The extent and categories of risk which it regards asacceptable for the company to bear;

The likelihood of the risks concerned materialising;

The company's ability to reduce the incidence and impact onthe business of risks that do materialise; and

The costs of operating particular controls relative to the benefitthereby obtained in managing the related risks.

Risk management is ONGOING process!

130

Cost & benefits of internal control 2

Benefits & measurements:

Helps to achieve objectives

not ensure achievement (factors out of managementcontrol)

Helps to reduce fraud and errors

cant eliminate ( inherent limitation of internal control)

Helps to improve effectiveness and efficiency how to quantify

The Cost of implementing a specific control should NOTexceed the expected Benefit of the control.

131

Cost & benefits of internal control 2Cost

Tangible costs

salary, additional expenditures

Opportunity costs

management time spend on monitoring and supervision

Intangible co sts

Reduced flexibility, responsiveness, creativity

Does control stifle initiative?

132

Cost & benefits of internal control 2Practical Difficulties for Cost & Benefit analysis:

How to estimate potential monetary loss or gain in the event ofcontrol failure or absence

How to assess effect of control

E.g. how much a control can save?

Many benefits are non-monetary

E.g. improved morale or reputation


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133

Exam Questions on IC

Pilot Paper

- Sound system of internal control (optional Q)

Dec 07 (Q 1)

- Importance of internal control

- Recommendation of control procedures (application)

Jun 08 (Q1)

- IC over subcon (application)

134

Chapter 5

Internal Control - Internal Audit

No prior Exam Question on this area!

135

KNOWLEDGE CHECKLIST

Internal Audit

Need for Internal Audit function 1

Roles of Internal Audit 1

Independence of internal audit 3

Source of internal auditor

Relationship with external auditor

IIAs standards over internal auditor 3 Internal audit reports

Assess the performance of internal audit 3

Audi t Commit tee 2,3

Roles and functionsRelationship with IA & EA 2

Roles in internal control 3136

Need for Internal Audit function

Factors:

Scale, diversity and complexity of companys activities

Number of EE

Cost/benefit considerations

Changes in organizational structures, reporting process orunderlying IS

Changes in key risks Problems with internal control system

An increased number of unexplained or unacceptableevents

Combined Code:

Companies which do not have an internal auditfunction should from time to time review the need forone

137

Definition of internal audit 1

Appraisal or monitoring activity

Within an entity

Service to the entity

Examine & Report to management & directors

Accounting & internal control systems

UK APB

138

Typical Tasks 1

INTERNAL REVIEW

Internalaudit

Externalauditors/consultants

OR

Types of assignment Performed by

Operational

SystemsValue formoney

Financial


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139

Roles of Internal Audi t 1

Review of accounting and internal control system

Review design

Monitoring operation

Risk assessment

Detailed testing

Recommending cost effective improvements

Financial + non-financial controls

Examination of financial and operating information

Review of IS over financial and operation

Detailed testing of transactions, balances and procedures

140


Review of 3Es of the operations

Review of Compliance with

Review controls over safeguarding of assets

Review of implementation of corporate objectives

Review effectiveness of planning

Relevance of standards and policies

CG procedures and operation of particular procedures

141


Risk management Identification of significant risks (F, O) Monitoring overall risk management policy and risk

management strategies

Insuffici ent ERM

Effective ERM

Recommend

Audit & impr ove

142


1. Independent of theactivities they audit

2. Independent reporting line

3. Objectivity (state of mind)

1. Independent mentalattitude

143


Recommended Principles fo r Internal Auditor

Integrity

Objectivity

In gathering, evaluating, and communicating information

Balanced assessment

Impartial, unbiased attitude and avoid conflicts of interest

Confidentiality

Not disclose without appropriate authority > unlesswhistleblowing!

Competency

IA: ethics, public in terest, duty of agent

144


Recommended Principles for Internal Audito r

Management o f IA

CIA

TOR (scope of work)

Planning, supervising, control

CPD


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145

Threats to Independence 3

Involvement in system design

Overfamiliarity

Close professional or personal relationship with managersand staff under audit

Reporting relationships

Independent of line management ( finance director)

Should report to board or AC

146

Threats to Independence 3

Dealing with threats to independence

No audits over previously worked department

No post-implementation audits on new systems ifinvolved in designing and implementation

Defined scope of responsibilities, unrestricted accessto records, assets and personnel

Rotation of staff over different audit areas

147

Independence of internal audit 3Consulting and safeguards

Problems:

Too much efforts onconsultancy projects

Involved in operationalconcerns >independence ?

Unrealistic expectation:

Reliance on IA forsolution

involvement ofoperational staffs

Safeguards

No management responsibility

Clearly defined TOR:

Resources

Prioritize

Additional resources

Include recommendation work on IC asIAs responsibility

Different staff Serious control weaknesses discovered in

consultancy > high risk > regular review

148

Sourcing Internal AuditInternal Auditor

Internal

Outsourced

Fresh perspective, experience

Independence > no operationalproblems

No prejudices and bias

No training cost or ongoing cost

More flexible > provided whenneeded

Problem:

Independence

Cost

Confidentiality

Staff change

149

Internal Audit Report

No formal reporting requirement

Standard Report Format

Executive Summary

Background

Objectives

Major outcomes

Key risks identified

Key action points

Summary of work left to do

Body of the Report

List of Findings

Potential impact of issues

Recommended approaches

Managements response

Agreed actions and deadlines 150

Assess the performance o f internal audi t 3

Assessment Cri ter ia

Professional proficiency Scope of work Performance of audit work Management of internal audit Independence of internal audit Authority of internal audit


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151


Quality control of IA

Internal Audit function should

Establish QC policies and procedures

All audits conducted in accordance with internal standards

Communicate > to IA

Factors affecting the policies

Size and nature of dept.

Geographic dispersion

Organization

Cost-benefit considerations

152


Quality control of IA

Responsibility

Chief audit executive (CAE)

Develop & maintain QA and improvement program

Continuously monitors its effectiveness

Internal External

153


Annual Rev iew o f Inter nal Audi t

By whom:

Board or

AC

Criteria:

Scope of work

Operational IC

Risk assessment and management process

Compliance with laws, regulations and policies

Safeguarding of assets

Reliability of information

Value for money

Organizations objectives and goalsSources of info: internal audit plan 154


Annual Review of In tern al Au dit

Criteria:

Author ity

TOR

IA reports > adequately considered & actions taken

Independence

Adequate safeguards

Reporting line

Removal of head of IA

No operational responsibility

No system design, installation and other operational taskby IA

155


Annual Rev iew of In ternal Audi t

Criteria:

Resources

Sufficient resources available for IA to carry out allnecessary work

Human

Hardware

Knowledge, skill and experience

156

Audi t Commit tee 2, 3

Composition:

Combined Code:

The board should establish an audit committee of at least three,or in the case of smaller companies two, members.

All members

Independent NED

The board should satisfy itself that at least one member ofthe audit committee has recent and relevant financialexperience


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157


Appointm ent

Chairman of BOD member of audit committee

By board

Taking recommendation from NC (where there is one)

In consultation with the AC chairman

Period

Up to 3 years

Extendable by no more than 2 x additional 3 year periods,so long as members continue to be independent.

158


Meetings of AC

Frequency and timing decided by

AC chairman

Company secretary

Frequency depend on role and responsibilities required > not lessthan 3 meetings

Timing:

Key dates within FR and audit cycle

Attendance

Only ACs chairman + members of committee

Non-members > subject to audit committees decision

Audit lead partner + FD

159


Meetings of AC

Meet with EA & IA > at least annually

Chairman of AC should maintain close contact with key peopleinvolved in the companys governance

Board chairman

CEO, FD

EA lead partner Head of IA

160


Resources

Remuneration

Component:

Remuneration paid to all NED

+

Further remuneration for the additional responsibilities

Skills, experience and training

1 x recent and relevant financial experience + professional qualification fromone of the professional accountancy bodies

Other member x experience of corporate financial matters

Induction programme for new member

CPD

Ongoing and timely training

161


Relationship with the board

Board responsible for

Role and extent of work

Reporting line

TOR

Annual review of audit committees effectiveness

Disagreement with board

Allow adequate time for discussion

Unresolved > report to the shareholders in annual report

162


Review annuala/c and IC

Monitor andrevieweffectiveness ofIA function,

App oin t/remov eCAE

Liaise with EA

whistleblowing


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163


Communication with Shareholders

AnnualReport

AGM

Separate section for AC

Workof AC

Summary of role

Names and qualifications of allmembers

Number of meetings

Report on how AC has discharged itsresponsibilities

Non-audit services & safe uards

Chairman should answer

AC activities and

Matters within the scope of auditcommittees responsibilities.

164

Chapter 6

Risk Management

Identification of Risk

165

KNOWLEDGE CHECKLIST

Risk concept 2

Nature of risks

Risk & return

Risk and Corporate Governance 2

Strategic and Operational Risks 2

Business Risks 2

166

RISK CONCEPT

Nature of Risks

Definition:

A condition

in which there exists a possibility of deviation

From

a desired outcome that is expected or hoped for

167

RISK CONCEPTNature of Risks

Risk and Hazard

Risk is Probability

Likelihood that it will actually cause harm or injury

Hazard is Consequences

Something with the potential to cause harm orinjury

Relationship:

Risk is often used as generic term to coverHazard aswell.

168

RISK CONCEPTNature of Risks

Types of Risk

Speculative risks

Consequences >either good or harm

Example?

Business entity

Pure risks

Only consequence isharmful

Usually can be dealt withinsurance

Example?

Negative Risk

- Downside


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169

RISK CONCEPT

Risk & return

Risk management

Minimizing but not eliminate

Residual or remaining risk

Still be in presence > cost and benefit considerations

170

Different Attitudes to Risk

Definition

People have asymmetrical

views on risk

Types

Risk Seeking

Risk Neutral

Risk Averse

171

Different Attitudes to Risk

For a business

Profit is a reward for risk taking

Risk management

Avoid risks ( surprises)

Form integral part of business strategy

Enable business focusing on key value drivers

172

RISK AND CORPORATE GOVERNANCE

Links:

Risk taken shareholder return achieved

Risk taken directors remuneration

Should we link directors remuneration with risks taken?

Corporate Governance requirements :

Directors sh ould

Establish appropriate control mechanism to deals with risksorganization face

Monitor risks by regular review and a wider annual review

Disclose risk management processes in the accounts

173

Business strategy

Risk appetite

Risk attitude Risk capacity

Risk

strategy

Risks

Residual

risk

amount of risk willing to accept

overall approach torisk

risk averse

risk seeking

risk neutral

maximum risk abusiness canaccept

174

STRATEGIC AND OPERATIONAL RISKS

Strategic Risk

Fundamental and keydecisions that directorstake about the future ofthe organization

Business risk

Non-business risk

L/T financing

Operational risk

Risk of loss due to

People, processes,infrastructure ortechnology

operational impact,

Outside environment

Out of control of entity

Long term perspective

Internal environment

Controllable by entity

Day to day basis


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175


Strategic risk

Responsibility

BOD

Vision, info, skill

Risk management

Accept

New product in New mkt

Reduce in long run

Redesign

Avoid

High impact

Slim prospect

Operational risk

Responsibility

BOD>

Risk Committee>

Risk managementfunction>

Line MGR > EE

Risk management

Transfer

H (impact) L (probability)

Reduce

L (impact) H (probability) 176


Operational risk

Staff

Competence, labor

Technology

Fraud

Processes/procedure

Outsourcing

Language/translation

Security

Staff welfare

177

BUSINESS RISKS

Financial Risk

Risk that affect the entitys going concern status

Structure of finance, fraud and misuse of financial resources

Long term risks

Currency risk

Interest rate risk

Short-term risks Credit risk

Liquidity risk

178

BUSINESS RISKS

Financial Risk

Currency Risk

Possibility of loss or gain due to future changes in exchange rates

1. Transaction Risk

Exchange rate movements

2. Translation Risk

B/S values of foreign assets and liabilities > prevailingexchange rate at Y/E

3. Economic Risk

Intl competitiveness (imp & exp)

Hedging strategies

Internal

Domestic currency invoicing

Netting

Leading and lagging

External

Forward market hedges (buying or selling currency forward)

Money market hedge (exporter)

Borrow the foreign currency

Sell the foreign currency in the spot market

Lend the domestic currency

Futures or options

179

BUSINESS RISKS

Financial Risk

Interest Rate Risk

Risk of volatility in interest rate that may affect companys cost ofdebts

How to deal with the risk?

-Forward rate agreement

-Swaps:

- Reduce each partys financial risk

180

BUSINESS RISKS

Financial Risk (short-term)

Credit Risk

The risk that a counterparty may not pay amounts owed whenthey fall due.

How to management (exporter case):

Documentary credits

Bills of exchange

Export credit insurance

Export factoring and forfeiting


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181

BUSINESS RISKS


Liquidity Risk

Risk of loss due to a mismatch between cash inflows and outflows

182

BUSINESS RISKS


Finance providers Risk

Risks to the entity for providing finance for others

Risk of default on debt payment

Risk of low or no return on investment

Dividend

Capital gain

183

BUSINESS RISKS

Legal and Political Risk

Risks

Financial or other penalties

Compliance costs

Loss of reputation

Typical regulations:

Health and safety

Environmental legislation

Trade descriptions

Consumer protection

Data protection

Employment issues184

BUSINESS RISKS

Political Risk

The risk that there will be a change in the political framework ofthe country

Government policies:

Limitations on equity

Restrictions / interference with operations

Discriminatory taxation or tariffs

Non-tariff barrier

Profit repatriation

Wage fluctuations

Fiscal and monetary policies

185

BUSINESS RISKS

Political Risk

How to manage?

Avoidance

Insurance

Negotiate the environment

Structure the investment

R&D

Supplies of key components or materials

Global trademarks

Local stakeholders

186

BUSINESS RISKS

Country risk

Risk that a foreign currency will not be available to allowpayments due to be paid because of a lack of foreign currency orthe government rationing that which is available


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187

Tactical

Strategic

Operational

BUSINESS RISKS - Information

Planning

Controlling

Strategic

Tactical

Operational

188

Tactical

Strategic

Operational

Information Requirement

Planning

Controlling

ESS

DSS

ES

MIS

TPS

KWS

189

BUSINESS RISKS

Technological Risk

Physical damage risks

Fraud risk

Data and system integrity risk

Denial of service attack

Internet risk

190

BUSINESS RISKS

Health & Safety Risk

Environmental Risk

Fraud Risk

191

BUSINESS RISKS - Fraud risks

OpportunitiesWeak Board of DirectorsWeak Internal Controls

Att itudes /Rational izati onsLack of a Code of Conduct

Disregard for FinancialReporting

Incentives/PressuresTight Debt Covenants

Unrealistic AnalystExpectations

192

BUSINESS RISKS

Trading Risk

Risk with trading both internationally and domestically

Physical risk

Trade risk

Liquidity risk

Disruption risk

Cost and resource wastage risk

Product risk


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193

BUSINESS RISKS

Reputation risk

Loss of reputation as a result of the adverse consequences of another riskA genuine emerging issue after a series of accounting scandals

Affected stakeholders > power, interest

Poor customer service

Failure to innovate

Poor ethics

Non-cooperation from suppliers and customers

Inability to recruit high-quality staff

Fall in demand because of consumer boycotts

Increased public relation costs

Increased compliance cost

Loss of market value

194

Chapter 7

Risk Management - Risk Assessment

195

KNOWLEDGE CHECKLIST

Risk Analysis 2

Risk Identification

Risk Assessment

Risk Profiling

Risk Quantification

Risk Consolidation

Risk & Stakeholders 3

Role of the Board i n Risk Management 3

196

Risk Analysis 2

Risk analysis involves identifying , assessing, profili ng,

quantifying and consolidating risks.

Other terms may be used to describ e these stages

Identify

Assess

Profiling

Quantifying Consolidating

197

Control It

Share orTransfer It

Diversify orAvoid It

RiskManagement

ProcessLevel

ActivityLevel

Entity Level

RiskMonitoring

Identification

Measurement

Prioritization

RiskAss essment

Risk Analysis

198

Risk Analysis 2

1. Risk Identification

A continuous process to identify new risks and changes inexisting risks

Involves identifying risk conditions

Method:

Physical inspection

Enquiries (e.g. QC procedures)

Check documents, correspondence

Brainstorming sessions

Checklist

Benchmarking (internal and external)


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199

Risk Analysis 2

2. Risk Assessment

Understand the extent of impact of potential events

Assesses risks from 2 perspectives:

Likelihood

What is the likelihood of an incident occurring?

Impact

If an accident occurs, what would be the magnitude of itsconsequence?

200

Risk Analysis 2

3. Risk Profiling (Prioritisation)

Af ter evaluation o f

Likelihood of occurrence

Impact

Analyzed fur ther int o a pr ior it ized r isk l ist

Which risks need the most urgent attention

201

Low

High

High

I

M

P

A

CT

PROBABILITY

High Risk

Medium Risk

Medium Risk

Low Risk

Risk Analysis 2 Likelihood/consequence matrix

Loss of key customers Failure of computer

system

Loss of senior staff Loss of sales to competitor Loss of sales due to macro-

eco factors

Lost of low level staff Lost of unimportantsupplier

Can we quantify? 202

Risk Management Response to risks

Con t r ol

Sh a r e M it i g a t e & Co n t r o l

Accep t

High Risk

Medium Risk

Medium Risk

Low Risk

Low

High

High

I

M

P

A

CT

PROBABILITY

Strategicissues

203

Risk Analysis 23. Risk Profiling (Prioritisation)

Likelihood/consequence matrix

Qualitative way of assessing impact of risk

High Risks > more urgent attention > Strategic Decisions

Low Risks > less urgent

Attention:

Risk profile vary in different businesses

Risk can evolve due to environmental changes

204

Risk Analysis 23. Risk Profiling (Prioritisation)

CIMA

Factor affecting location of risk in a risk map

Strategic objective affected

Type of risk ( pure risk or speculative risk?)

Direct and indirect impact of risk

Likelihood of risk

Cost of responses

Organizations environment

Constraints within the organization

Organizations ability to respond to events

Analyze and lo cate the r isks in the map andgive reasons


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205

Question 14 Risk Map

Required

Prepare a 2 X 2 risk map, with one risk identified in eachquadrant of the map.

Explain your reasons for assessing the probability and impactof the risk as high or low in each case.

206


BC Freight is a freight-forwarding business. It sends

containers of freight from Heathrow to airports around theworld. It specialises in consolidating the freight of differentshippers into a single container, to obtain the benefit of lowerfreight charges for large shipments. The prices that BCcharges its clients cover a share of the airline flight costs andinsurance, and provide a margin to cover its running costs andallow for profit. To make a satisfactory profit, BC needs to fillits containers to at least 75%, and at the moment is achievingan average' fill' of 78%.

International trade and commerce have been growing in thepast year, although at a slow rate.

BC's management is aware that airline flight costs are likely torise next year due to higher fuel costs, and because severalmajor airlines that have been suffering large losses will behoping to increase their prices.

207


Step 1:

What are the risks?

A. Container not filled to B/E level

B. Increasing airline freight costs

C. Downturn in international trade

D. Some major airline may go out of business

208

Low

High

High

I

M

P

A

CT

Likelihood

High Risk

Medium Risk

Medium Risk

Low Risk

Step 2:Rank the impact and likelihood

Downturn ininternational trade

Container not filledto B/E level

Increasing airlinefreight costs

Major airline may goout of business

209

Risk Analysis 2

4. Risk Quantification

Risk can be further analyzed by quantifying

Consequences

Probability

Expected Value

EV = Probability of Occurrence x Impact

210

Risk Analysis 2


Risk can be further analyzed by quantifying

Consequences

Probability

Fire atoffice

(0.2)

Likelihood ofdamage

(0.8)

No alarm or sprinklersystem

80% of equipment maybe lost

$10,000

0.2 x 0.8 x$10,000

=

$1,600


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211

Risk Analysis 2


Results from quantification

Average or expected result or loss

( $1,600)

Frequency of losses

Predictable by studying available records

Confidence margin improved by including likely effects of changedcircumstances

Non-recurrence events > difficult to predict

Chances of losses

(0.16)

Largest predictable loss

($10,000)

No calculation r equired in EXAM!

212

Risk Analysis 2


Tools and techniques for quantifying risk:

Scenario planning

Sensitivity analysis

Decision trees

Computer simulations

Software packages

Analysis of existing data

213

Risk Analysis 2

5. Risk Consolidation

Divisional or subsidiary level > aggregated at corporate level

Group level risk > Board set up risk management system:

Identify changes in risks

Monitor risks regularly

Wider annual review (IC, ERM)

Categorization also helps to develop and implementcommon control for certain group of risks

Example?

Shared service

214

Examiners Definition of Risk Assessment

5 components in risk assessment stage:

1. Identify nature and extent of the risks facing the company

2. Decide whether risks are acceptable (Cost of control such riskand benefit to the business if risks are to be controlled)

3. Quantify risk by determining the likelihood (probability) of theidentified risks materialising

4. Examine businesss ability to reduce the impact of risks that domaterialise

5. Understanding of the costs of operating particular controls toreview and manage the related risks

Bad debtsControl?

L/C

Cash on delivery

Discount/factoring30% of AR >bad debts

Sufficient workingcapital?

Legal action?Cost:

Charges

Loss potentialcustomers

215

RISK & STAKEHOLDERS 3

Customers

Employees

Managers

Directors

Shareholders

Impact of Business RiskStakeholder

Identify stakeholders

Describe their claims

What are their actions & effects on business risks?

216

RISK & STAKEHOLDERS 3

Wider Community

Banks

Government

Supplier

Impact of Business RiskStakeholder


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217

ROLE OF THE BOARD IN RISK MANAGEMENT 3

Strategic level risk and attitude and approach to risk

Driving risk management and provide resources to managers

Ensure that risk management supports strategic objectives

Determine acceptable level of risk

Communication of risk management strategy throughoutorganisation and embedded in all activities

Reviews, identifies and monitors progress risk managementplans

Determine which risks will be accepted which cannot bemanaged, or which it is not cost effective to manage, i.e.residual risk

218

ROLE OF THE BOARD IN RISK MANAGEMENT 3

Turnbull Guidance

The board is responsible to develop internal control tomanagement risks facing the business

Factors to consider when determining policies on internalcontrol

Nature and extent of risks facing the company

Extent and categories of risk which it regards as acceptablefor the company to bear

The likelihood of the risks materializing

The companys ability to reduce the incidence and impacton the business of risks that do materialize

Cost and benefit consideration for operating particularcontrols

219

Chapter 8

Risk Management

Dealing with Risks

220

KNOWLEDGE CHECKLIST

Risk Management Systems 3

COSO ERM

Reducing Risk 2

Embedding risk awareness

Diversification

Risk Avoidance/retention/transference

Risk Avoidance & retention 2

Risk transference

Risk Attitude and Strategy 3

221

KNOWLEDGE CHECKLIST Risk Management Responsibilities 3

Role of Risk Committee

Risk Management Group

Role of Risk Manager

Risk Auditing

Others involved in Risk Management

Information on Internal Control & Risk 2

Information requirement of directors

Review of Internal Control

Reporting on Internal Control and Risk Management

222

KNOWLEDGE CHECKLIST

Controlling Risk

Targeting risk

Risk Manager

Risk Committee

Risk Audit

Risk Avoidance/Retention/Transfer

Reducing Risk

Embedding Risk

Diversification

Risk Avoidance

Risk Retention

Risk Transfer

Risk Attitude

Reporting on Internal Control & Risk


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223

RISK MANAGEMENT SYSTEMS

a process, effected by an entity's board of directors,

management and other personnel,applied in strategy setting and across the enterprise,

designed to identify potential events that may affect theentity,

and manage risks to be within its risk appetite,

to prov ide reasonable assurance regarding theachievement of entity ob jectives.

Source: COSO Enterpris e Risk Management Integrated Framework. 2004.

224


Benefits/Purpose of ERM

Al ign ing (ri sk appet ite = st rateg y)

Enhancing risk response decisions

Framework for determine risk responses ARTA

Reducing operational surprises and losses

Identifying and managing multiple and cross-enterprise risks

Interrelated impacts > integrated responses

Seizing opportunities

Improving deployment of capital

Risk management helps an entity get to where it wantsto go and avoid pitfalls and surprises along the way.

225


Fundamental concepts

A process > ongoing and flowing through an entity

Effected by people at every level

Applied in strategy setting

Applied across the enterprise > entity-level portfolio view of risk

Designed to identify > manage risk within its risk appetite

Reasonable assurance Geared to achievement of objectives in one or more separate

but overlapping categories

226

Internal Control Vs. ERM


Internal Environment

Objective Setting

Event Identification

Risk Assessment

Risk Response

Control Activities

Information & Communication

Monitoring

Entity-Level

Division

BusinessUnit

Subsidiary


Objective Setting

Risk Response

Event Identification

Strategic

227


Entity objectives can be viewed in thecontext of four categories:

Strategic Operations Reporting Compliance8 components for

- Whole entity

- Each objective

- Individual unit228



Set the tone at the top

Philosophy regarding risk management.

Risk culture

Objective setting

Objectives = risk appetite

Event Identifi

Acca p1 Excellent File

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