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goVernAnce, risK & etHicsPaper
P1
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ACCA QuAlifiCAtionCourse notes
December 2012 examinations
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The besT Things in life are free
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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
P6 Advanced Taxation (UK)
P7 Advanced Audit & Assurance
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a Paper P1
December 2012 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
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Paper P1December 2012 Examinations
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i Paper P1
December 2012 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.
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Paper P1December 2012 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
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1 Paper P1December 2012 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
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Chapter 1 Paper P1Corporate Governance December 2012 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
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3Chapter 1 Paper P1Corporate Governance December 2012 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
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Chapter 1 Paper P1Corporate Governance December 2012 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
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5Chapter 1 Paper P1Corporate Governance December 2012 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
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Chapter 1 Paper P1Corporate Governance December 2012 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
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7Chapter 1 Paper P1Corporate Governance December 2012 Examinations
Stakeholders
• anyoneoranygroup
• primaryorsecondary
• internalorexternal
• narroworwide
• knownorunknown
• legitimateorillegitimate
• activeorpassive
• voluntaryorinvoluntary
• recognisedorunrecognised
• stakeholdersmaybesub-classified
• anoperationalrolewithintheentity
• aroleincorporategovernance
• anumberofinterestsintheentity,bothinternalandexternal
• considertheseelementsinthecontextoftheinternalinterests:
• directors
• entitysecretary
• secondtiermanagement
• employees
• unions
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Chapter 1 Paper P1Corporate Governance December 2012 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 2012 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
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Chapter 2 Paper P1Approaches to Corporate Governance December 2012 Examinations
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Characteristics of the principles based approach• activitiesofentitiesmustaddressmajorprinciplessetoutincodesofbestpractice
• notsimplyaboxtickingexercise
• moredifficulttoavoidthanarulesbasedapproach
• easytoseethatentityiscomplying
• directorsrequiredtoworkintheentity’sbestinterests
• moreflexible,andthereforebetterabletodealwith“new”situations
• easierjustificationforapparentbreachofprinciples
• butprinciplesmaybeinterpreteddifferently
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11Chapter 2 Paper P1Approaches to Corporate Governance December 2012 Examinations
• Arrivalofcorporategovernance
• headlinehittingcorporatefailuresinEurope,USAandUKledtorecognitionoftheneedforsomesortofcontrolinanattempttopreventsimilarfailures
• commonelementsidentifiedas:
• poorentitymanagementbydirectors
• singledominantindividual
• unreliablefinancialreporting
• ineffectiveinternalcontrols
• incompetentdirectors
• lackofcloseinvolvementofinstitutionalshareholders
• directorsinterestedmoreinpersonalpositionratherthaninthewelfareoftheentity
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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
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13Chapter 2 Paper P1Approaches to Corporate Governance December 2012 Examinations
rules based approach
• USApassedlegislation-SarbanesOxley(SOX)
• appliestoallUSquotedentities
• butalsotoanyentity,anywhereintheWorld,ifithasanAmericanquotedparententity
• mainprovisionsofSOX
• allquotedentitiesmustprovideacertificatetotheSecuritiesExchangeCommissionconfirmingtheaccuracyoftheirfinancialstatements
• wherefinancialstatementshavetoberestatedfollowingmaterialnon-compliance,CEOandCFOmustrepayanybonusesreceivedintheprevioustwelvemonths
• auditorsrestrictedtoauditwork(andtax)
• seniorauditpartnermustrotateofftheauditafternomorethanfiveyears
• PublicEntityOversightBoard–responsibleforenforcingprofessionalstandardsinaccountingandauditing
• directorsforbiddenfromdealinginentitysharesduring“sensitive”times
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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
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15Chapter 2 Paper P1Approaches to Corporate Governance December 2012 Examinations
summary of ICGn principles
• identifiescorporateobjectiveofprovidingreturnstoshareholdersontheirinvestments
• disclosureandtransparencymatters
• independentaudit
• detailsshareholders’ownership,responsibilities,rightsandremedies
• detailsprovisionsrelatingtoboardsofdirectors
• prescribesboardremunerationpolicies
• providesguidanceoncgimplementation
• prescribessocialawareness
• recommendsentity/stakeholderrelationship
• establishesneedforbusinessethics
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17 Paper P1December 2012 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
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Chapter 3 Paper P1The Board of Directors December 2012 Examinations
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• directors’rolesandresponsibilitiescontinued
• establishacorporateculture
• ensurethatthosechargedwithtakingoperatingdecisionsaredoingtheirjobproperly
• establishandimplementaneffectivesystemofinternalcontrolscapableofriskassessmentandmanagement
• ensurethataimsandobjectivesoftheentityarerealisticandachievable
• ensurethatallemployeesareawareoftheentity’sresponsibilitiestoitsstakeholders
• holdregularandfrequentboardmeetings
• assessownperformance,andreportannuallytoshareholders
• submitthemselvesforre–electioneverythreeyears(FTSE350entity?re-electALLdirectorseveryyear)
• forlistedentitiesthereare“additionalrequirements”
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19Chapter 3 Paper P1The Board of Directors December 2012 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
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Corporate Governance Code sub-divisions
• CGCbreaksdownneatlyintofoursub-divisions:
• directors
• directors’remuneration
• accountsandaudit
• investorrelations
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21Chapter 3 Paper P1The Board of Directors December 2012 Examinations
CGC sub-divisions - directors
• everylistedentityshouldhaveaneffectiveboard
• positionsofChairandCEOshouldbeheldbydifferentindividuals
• boardshouldcomprisebothexecutiveandnon–executivedirectors
• thereshouldbeatleastasmanynedsasexecutivedirectors
• appointmenttotheboardshouldbeformalandtransparent
• informationshouldbeprovidedtotheboard
• thereshouldbeaformalassessmentoftheboard’sperformanceannually
• shouldsubmitthemselvesforre–electiononaregularbasis
• withintervalsnotgreaterthanthreeyears
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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
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23Chapter 3 Paper P1The Board of Directors December 2012 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
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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
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25Chapter 3 Paper P1The Board of Directors December 2012 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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Chapter 3 Paper P1The Board of Directors December 2012 Examinations
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directors - structure of the board
• thestructureshouldtakeaccountofthefollowingfactors:
• aneffectiveboardisessentialforgoodcorporategovernance
• abalancebetweenexecutiveandnedssothatnosinglegroupcandominate
• theboardshouldnotbedominatedneitherbyanyindividual
• norbyanygroup/section
• thereneedstobeasplitofpowerbetweenCEOandChair
• executivedirectorsshouldeachbeanexpertintheirownfield
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27Chapter 3 Paper P1The Board of Directors December 2012 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
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functions of neds• constructivelychallengeandcontributetodevelopmentofstrategy
• overseeandevaluatemanagement’sperformanceinmeetingagreedobjectives
• satisfythemselvesthatfinancialinformationisaccurate
• satisfythemselvesthatfinancialcontrolsandsystemsofriskmanagementarestrongandappropriate
• roleonremunerationcommittee
• constantlyseektoestablishandmaintainconfidenceintheconductoftheentity
• beindependentinjudgement,andinquisitive
• trytounderstandtheviewsofthemajorinvestors
• beofferedtheopportunitytoattendmeetingswithmajorshareholders
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29Chapter 3 Paper P1The Board of Directors December 2012 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.
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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
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31Chapter 3 Paper P1The Board of Directors December 2012 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
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33Chapter 3 Paper P1The Board of Directors December 2012 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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34
directors – performance evaluation
• TheCGCcontainsaframeworkforassessingtheperformanceofindividualdirectorsaswellasoftheboardasawhole:
• thereshouldbeanannualevaluationoftheperformanceoftheboardasawholeandofeachmemberoftheboard
• theevaluationexerciseshouldbetailoredtosuittheentity’sneeds
• entitiesshouldpublishinthefinancialstatementswhethersuchanevaluationexercisehasbeencarriedout
• theChairisresponsiblefortheselectionofaneffectiveprocess,andfortakingappropriateactiononcompletion
• theuseofanindependentthirdpartywouldbringadditionalobjectivitytotheexercise
• theevaluationexerciseshouldconsistofanumberofquestionsandanswersdesignedtoassessperformanceandidentifyhowperformancecouldbeimproved
• thewholeprocessshouldbeusedconstructivelyasameanstoimproveboardeffectiveness,maximisestrengthsandminimiseweaknesses
• theresultsoftheboardevaluationshouldbesharedwiththewholeboard,but
• theresultsofindividualevaluationsshouldremainconfidentialbetweentheChairandtheindividualdirector
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35 Paper P1December 2012 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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36
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
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37Chapter 4 Paper P1Board committees - audit committee December 2012 Examinations
internal controls -categorisation
• canberememberedbythemnemonicoapspasm
o organisational
A Arithmeticandaccounting
P Personnel
s segregationofduties
P Physical
A Authorisation
s supervision
m management
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Chapter 4 Paper P1Board committees - audit committee December 2012 Examinations
38
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
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39Chapter 4 Paper P1Board committees - audit committee December 2012 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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40
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
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41Chapter 4 Paper P1Board committees - audit committee December 2012 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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42
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’
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43Chapter 4 Paper P1Board committees - audit committee December 2012 Examinations
role and function of an audit committee
• createaclimateofdisciplineandcontrolleadingtoareductionofopportunitiesforfraud
• lendanairofcredibilityandobjectivityinthefinancialstatementstherebyincreasingpublicconfidence
• assistCFObyprovidingaforum
• reviewfinancialstatementstoimprovethequalityofreporting
• independentjudgement
• strengthenpositionoftheinternalauditor
• strengthenpositionoftheexternalauditor
• assistintheresolutionofdisputesbetweenexternalauditorandexecutiveboard
• rememberClarissa
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Chapter 4 Paper P1Board committees - remuneration committee December 2012 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
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45Chapter 4 Paper P1Board committees - remuneration committee December 2012 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
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47Chapter 4 Paper P1Board committees - nominations committee December 2012 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
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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
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49 Paper P1December 2012 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
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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
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51Chapter 5 Paper P1Corporate Governance and Corporate Social Responsibility December 2012 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
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53Chapter 5 Paper P1Corporate Governance and Corporate Social Responsibility December 2012 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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Chapter 5 Paper P1Corporate Governance and Corporate Social Responsibility December 2012 Examinations
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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
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55Chapter 5 Paper P1Corporate Governance and Corporate Social Responsibility December 2012 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
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57 Paper P1December 2012 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
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59Chapter 6 Paper P1Corporate governance – control systems December 2012 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
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61 Paper P1December 2012 Examinations
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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
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63Chapter 7 Paper P1Auditors and Internal Controls December 2012 Examinations
Potential threats to independence
• inthesyllabusfortheearlierauditingpaper,
• seehowmanyyoucanremember!
• f
• f
• c
• l
• b
• g
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65 Paper P1December 2012 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
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67 Paper P1December 2012 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
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69Chapter 9 Paper P1The Risk Management Process December 2012 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
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71Chapter 9 Paper P1The Risk Management Process December 2012 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
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73Chapter 9 Paper P1The Risk Management Process December 2012 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
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75Chapter 9 Paper P1The Risk Management Process December 2012 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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77Chapter 9 Paper P1The Risk Management Process December 2012 Examinations
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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79Chapter 9 Paper P1The Risk Management Process December 2012 Examinations
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
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81 Paper P1December 2012 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
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83Chapter 10 Paper P1Controlling Risk December 2012 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…
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85Chapter 10 Paper P1Controlling Risk December 2012 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!
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87Chapter 10 Paper P1Controlling Risk December 2012 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
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89Chapter 10 Paper P1Controlling Risk December 2012 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
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91 Paper P1December 2012 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
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93Chapter 11 Paper P1Ethics and Social Responsibility December 2012 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
• Level2stage4conventional
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• 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
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95Chapter 11 Paper P1Ethics and Social Responsibility December 2012 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
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97 Paper P1December 2012 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
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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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101Chapter 13 Paper P1Social Responsibility December 2012 Examinations
• 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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103Chapter 13 Paper P1Social Responsibility December 2012 Examinations
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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105Chapter 13 Paper P1Social Responsibility December 2012 Examinations
• 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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107 Paper P1December 2012 Examinations
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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109Chapter 14 Paper P1Professions and the Public Interest December 2012 Examinations
• 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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111Chapter 14 Paper P1Professions and the Public Interest December 2012 Examinations
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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113Chapter 14 Paper P1Professions and the Public Interest December 2012 Examinations
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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115Chapter 14 Paper P1Professions and the Public Interest December 2012 Examinations
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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117 Paper P1December 2012 Examinations
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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119Chapter 15 Paper P1Professional Practice and Codes of Ethics December 2012 Examinations
• 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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121Chapter 15 Paper P1Professional Practice and Codes of Ethics December 2012 Examinations
• 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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123Chapter 15 Paper P1Professional Practice and Codes of Ethics December 2012 Examinations
• 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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125Chapter 15 Paper P1Professional Practice and Codes of Ethics December 2012 Examinations
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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127Chapter 15 Paper P1Professional Practice and Codes of Ethics December 2012 Examinations
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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129Chapter 15 Paper P1Professional Practice and Codes of Ethics December 2012 Examinations
• 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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131Chapter 15 Paper P1Professional Practice and Codes of Ethics December 2012 Examinations
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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133 Paper P1December 2012 Examinations
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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135Chapter 16 Paper P1Ethical Characteristics of Professionalism December 2012 Examinations
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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137 Paper P1December 2012 Examinations
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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139Chapter 17 Paper P1Social and Environmental and Ethical Behaviour December 2012 Examinations
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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141Chapter 17 Paper P1Social and Environmental and Ethical Behaviour December 2012 Examinations
• 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
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