ACCA Paper P1 December 2012 Exams

goVernAnce, risK & etHicsPaper

P1

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ACCA QuAlifiCAtionCourse notes

December 2012 examinations

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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

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Paper P1December 2012 Examinations


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.


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


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


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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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



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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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



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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• Eachexternalstakeholderhas:

• aroletoplayininfluencingtheoperationsoftheentity

• theirowninterestsandclaimsintheentity

• considertheseinthecontextoftheexternalinterests:

• auditors

• regulators

• government

• stockexchange

• smallinvestors

• institutionalinvestors

• ReferencetoDavidCampbellStudentAccountantarticles:“Rules,principlesandSarbanes-Oxley”April2008




APProAChes to CorPorAte GovernAnCe

two distinct approaches to corporate governance

• rulesbased,and

• principlesbased

Characteristics of the rules based approach

• prescribedsetofcgrequirements

• quickwayofensuringcompliance

• adoptsachecklistapproach

• cleardistinctionbetweencomplianceandnon–compliance

• easytoseethatentityiscomplying

• reductionofflexibilityonthepartofmanagementandauditors

• difficulttosetrulestocoverallsituations

• possibletomisinterpretrules

• samerulesapplytoall,whatevertheirsize



Chapter 2 Paper P1Approaches to Corporate Governance December 2012 Examinations

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Characteristics of the principles based approach• activitiesofentitiesmustaddressmajorprinciplessetoutincodesofbestpractice

• notsimplyaboxtickingexercise

• moredifficulttoavoidthanarulesbasedapproach

• easytoseethatentityiscomplying

• directorsrequiredtoworkintheentity’sbestinterests

• moreflexible,andthereforebetterabletodealwith“new”situations

• easierjustificationforapparentbreachofprinciples

• butprinciplesmaybeinterpreteddifferently


11Chapter 2 Paper P1Approaches to Corporate Governance December 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



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



summary of ICGn principles

• identifiescorporateobjectiveofprovidingreturnstoshareholdersontheirinvestments

• disclosureandtransparencymatters

• independentaudit

• detailsshareholders’ownership,responsibilities,rightsandremedies

• detailsprovisionsrelatingtoboardsofdirectors

• prescribesboardremunerationpolicies

• providesguidanceoncgimplementation

• prescribessocialawareness

• recommendsentity/stakeholderrelationship

• establishesneedforbusinessethics



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The Board of direCTors

directors

• anyonewhooccupiesthepositionofdirector

• shadowdirectorsare‘anyoneinaccordancewithwhoseinstructionsthedirectorsareaccustomedtoact’

• cgcestablishesrolesandresponsibilities:

• provideleadershipfortheentity

• representtheentityinitsdealings,andtothepublicgenerally

• settheagendasforboardmeetings

• decidethosematterswhicharetobedeterminedbytheboard,andnotthereforetobedelegated

• decideuponastrategyfortheentity

• selectadirectortobeCEO,and…

• …anotheronetobeChair



Chapter 3 Paper P1The Board of Directors December 2012 Examinations

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• directors’rolesandresponsibilitiescontinued

• establishacorporateculture

• ensurethatthosechargedwithtakingoperatingdecisionsaredoingtheirjobproperly

• establishandimplementaneffectivesystemofinternalcontrolscapableofriskassessmentandmanagement

• ensurethataimsandobjectivesoftheentityarerealisticandachievable

• ensurethatallemployeesareawareoftheentity’sresponsibilitiestoitsstakeholders

• holdregularandfrequentboardmeetings

• assessownperformance,andreportannuallytoshareholders

• submitthemselvesforre–electioneverythreeyears(FTSE350entity?re-electALLdirectorseveryyear)

• forlistedentitiesthereare“additionalrequirements”


19Chapter 3 Paper P1The Board of Directors December 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



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



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



structure of the board - two-tier structure

• twotierstructurecharacteristics:

• consistsofasupervisoryboardandamanagementboard

• entitiesinFrance,GermanyandotherpartsofEuropeoftenhaveatwo–tierboard

• managementisresponsibleforthegeneralrunningofthebusiness

• managementboardisledbyCEO

• supervisory board is responsible for the appointment, supervision and removal of members from themanagementboard

• alsoresponsibleforoverseeingtheactivitiesofthemanagementboard,anditscompliancewithlaw,regulationandtheentity’sconstitution

• also,ageneraloverseeingoftheentityanditsbusinessstrategies

• supervisoryboardisledbytheChair



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directors - structure of the board

• thestructureshouldtakeaccountofthefollowingfactors:

• aneffectiveboardisessentialforgoodcorporategovernance

• abalancebetweenexecutiveandnedssothatnosinglegroupcandominate

• theboardshouldnotbedominatedneitherbyanyindividual

• norbyanygroup/section

• thereneedstobeasplitofpowerbetweenCEOandChair

• executivedirectorsshouldeachbeanexpertintheirownfield



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



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



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



directors - induction and education

• TheCGCestablishesprinciplesfortheeducationofanewdirectorintheactivitiesoftheentityItisclearlyimportantthatthenewdirectorshouldbecomeacquaintedwiththeexecutiveboardassoonaspossibleaftertheirappointment,sotheentity’sinductionprocedureshould:

• becomprehensive

• betailoredtotheneedsoftheentityandindividualdirectors

• containwritteninformationpluspresentationsandappropriateactivities(egsitevisits)

• givenewappointeesabalancedoverviewoftheentity

• notoverloadthedirectorwithanexcessofinformation

• attheendoftheinductionprocess,thenewdirectorshouldhave:

- anunderstandingofthenatureoftheentity,itsbusinessandthemarketsinwhichitoperates

- alinkwiththeentity’semployees

- anunderstandingoftheentity’smainrelationshipsincludingtherelationshipwiththeauditors



34

directors – performance evaluation

• TheCGCcontainsaframeworkforassessingtheperformanceofindividualdirectorsaswellasoftheboardasawhole:

• thereshouldbeanannualevaluationoftheperformanceoftheboardasawholeandofeachmemberoftheboard

• theevaluationexerciseshouldbetailoredtosuittheentity’sneeds

• entitiesshouldpublishinthefinancialstatementswhethersuchanevaluationexercisehasbeencarriedout

• theChairisresponsiblefortheselectionofaneffectiveprocess,andfortakingappropriateactiononcompletion

• theuseofanindependentthirdpartywouldbringadditionalobjectivitytotheexercise

• theevaluationexerciseshouldconsistofanumberofquestionsandanswersdesignedtoassessperformanceandidentifyhowperformancecouldbeimproved

• thewholeprocessshouldbeusedconstructivelyasameanstoimproveboardeffectiveness,maximisestrengthsandminimiseweaknesses

• theresultsoftheboardevaluationshouldbesharedwiththewholeboard,but

• theresultsofindividualevaluationsshouldremainconfidentialbetweentheChairandtheindividualdirector



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



Chapter 4 Paper P1Board committees - audit committee December 2012 Examinations

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internal control systems

• foranicsystemtobeeffectiveitneedstominimisesuccessfullythebusinessrisksidentifiedbymanagement:

• playsanimportantrole inmanagingthoseriskswhichmostthreatentheattainmentoftheentity’sbusinessobjectives

• contributes significantly to protecting shareholders’ investment, safeguarding the assets and ensuringcompliancewithlawandregulation

• shouldalsoseektopreventandtodetectfraudInapoorcontrolenvironmentfraudcouldmoreeasilydevelop

• shouldbereviewedcontinuallyandimprovedasappropriate

• thecostsofimplementingacontrolshouldnotexceedthebenefittobegainedfromthereducedrisk

• suitabilityofacontrolwillvaryfromentitytoentity

• shouldbeanintegralpartofanyentity’sriskmanagementstrategy–itshouldnotbeanafter–thought

• effectivefinancialcontrols(includingmaintenanceofproperaccountingrecords)areanimportantelementofasystemofic


37Chapter 4 Paper P1Board committees - audit committee December 2012 Examinations

internal controls -categorisation

• canberememberedbythemnemonicoapspasm

o organisational

A Arithmeticandaccounting

P Personnel

s segregationofduties

P Physical

A Authorisation

s supervision

m management



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



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



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



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



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’



role and function of an audit committee

• createaclimateofdisciplineandcontrolleadingtoareductionofopportunitiesforfraud

• lendanairofcredibilityandobjectivityinthefinancialstatementstherebyincreasingpublicconfidence

• assistCFObyprovidingaforum

• reviewfinancialstatementstoimprovethequalityofreporting

• independentjudgement

• strengthenpositionoftheinternalauditor

• strengthenpositionoftheexternalauditor

• assistintheresolutionofdisputesbetweenexternalauditorandexecutiveboard

• rememberClarissa


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remuneration committee

• importance:

• executivedirectorsshouldnotberesponsiblefordeterminingtheirownremuneration

• remunerationdecisionscanbeseentobetakenbythosewhowillnotbenefitfromthosedecisions

• thereisaneedforformal,transparentproceduresfordevelopingpolicyandforindividualpackages

• role

• the committee determines appropriate packages for the executive directors, and the composition of thosepackages

• composition

• inlistedentitiesthecommitteewilltypicallycompriseneds

• accountability

• reportstothemainboard


45Chapter 4 Paper P1Board committees - remuneration committee December 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


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




CorPorate GovernanCe and CorPorate SoCial reSPonSibility

• entitiesareincreasinglyacceptingthattheyhavesocialandenvironmentalresponsibilities

• whoarethepeoplewhoareaffectedbyanentity’sactions?

• thereare,ofcourse,manyincluding:

- employees

- customers,suppliersandthelocalcommunity

- theenvironmentmaybeaffectedasaresultofourproductionprocesses

• CGvsCSR

• cgisnotthesameascorporatesocialresponsibility(csr)

• csristheprinciplethatanentitywillthinkaboutitsimpactonthewiderenvironmentandwilltakedocumentedstepstominimisethedamageandmaximisethebenefitsofitsactions

• strategyofanorganisationisshapedbymanyfactors,includingthedemandsofstakeholders

• eachdifferentstakeholder,orclassofstakeholder,willtypicallyhavedifferentobjectivesaswellasdifferentlevelsofinfluence

• expression stakeholder is applied to anyonewhohas anything todowith thebusiness,whetherdirectlyorindirectly

• cgframeworkofanentityshouldrecognisetherightsofstakeholdersestablishedbylaworbyseparateagreement

• becausedifferentstakeholdershavedifferentobjectives,itisnecessaryfortheboardtobalancetheseconflictinginterests

• anentity’sstrategyisoftentomanage,ratherthansatisfy,stakeholderobjectives

• inevitably,themoreinfluentialthestakeholder,thegreaterwillbetheattentiondirectedtotheirinterests



Chapter 5 Paper P1Corporate Governance and Corporate Social Responsibility December 2012 Examinations

50

the most important group of stakeholders is ( normally ) the shareholders

• theyarethelegalownersoftheentity,andcontrolitthroughvotescastattheannualgeneralmeeting

• eventhoughtheyowntheentity,theydonotownthepropertyoftheentity–thisreinforcesthelegalconceptofanentitybeingaseparatelegalperson

• shareholdershaveanumberofstatutoryrights:

• therighttotransfertheirshares

• therighttoreceivenoticeofmeetings

• therighttoattend,speakandbeheardatthosemeetings

• therighttoreceiveadividend(whenapprovedbythegeneralmeeting)

• therighttoacopyoftheentity’sfinancialstatements

• oncetheyhavepaidthefullfacevalueofthesharesheldbythem,they(normally)willhavenofurtherobligationtocontributetoashortfallinaninsolventliquidation(butthereareexceptions)

• theydoNOThavetoremainloyaltotheentityandmayselltheirsharesatanytime

• nordotheyhaveanydutytoensurethattheentityoperatesinasociallyresponsibleway


51Chapter 5 Paper P1Corporate Governance and Corporate Social Responsibility December 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



52

CGC disclosure recommendations

• disclosure

• itallowstheentity’sboardtoprovideinformationongovernancematterstoshareholdersandotherstakeholders

• disclosuredemonstratesthatgoodcgprinciplesarebeingappliedbytheentity

• alsoameansofcommunicatingmattersofinterestandvalue

• CGCcontainspoliciesandprovisionswithwhichlistedentitiesareexpectedtocomply

• thesepoliciesandprovisionsrepresent“bestpractice”intermsofdisclosure

• CGCrequirements

• alistedentityisrequiredtostatewithinthefinancialstatements:

- howithasappliedtheprinciplesoftheCGC,and

- whetherithascompliedwiththeCGCthroughouttheaccountingperiod

- andifnot,whynot



CGC – additional disclosures

• astatementbytheboardacknowledgingtheirresponsibilityforthefinancialstatements

• astatementbytheboardtoconfirmtheirviewthattheentityisagoingconcern

• detailsofeachboardmembertogetherwithdetailsoftheirresponsibilitiesandtheirrecordofattendanceatboardmeetings

• theidentityoftheChair,theCEOandwhichdirectorssitonwhichofthesub–committees(audit,socialresponsibility,nominations,remunerationandriskmanagement)aswellastheirattendancerecordsatmeetingsofthosecommittees

• reportsontheactivitiesofthecommittees

• ifthereisnointernalauditfunction,therelevantsectionoftheannualreportshouldexplainwhynot

• astatementthatthedirectorshaveundertakenareviewoftheeffectivenessoftheinternalcontrolsystem

• areportonthemethodsusedtoevaluateperformanceoftheboardanditscommittees

• informationaboutthemeasurestakenbytheboardtoensurethatitunderstandstheviewsofitsmajorshareholders

• informationaboutthestepstakentoensurethecontinuingindependenceoftheexternalauditors

• wheretheboarddoesnotacceptarecommendationfromtheauditcommittee,thereshouldbeastatementbytheauditcommitteeexplainingtheirrecommendationandwhytheboardhastakenadifferentview



54

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



other general meetings and proxy votes

• entitiesmayalsofindthattheyneedtoholdgeneralmeetingswhicharenotAGMsTheseareOtherGeneralMeetings(OGMs)

• somequickpointsaboutOGMs

• heldirregularly,andonlywhensomethingurgentariseswhichneedsshareholderapproval

• separateresolutionsshouldbepassedforeachdifferentmatter

• lengthofnoticeofthemeetingdependsonwhattypeofresolutionistobeproposed

• itistheoreticallypossibleforanentitytogofrombirthtodeathwithoutanyneedtoholdanOGM

• proxyvoting

• ashareholderwhoisunabletoattendageneralmeetingmayappointapersontoattendthemeetingontheirbehalf

• suchapersoniscalleda“proxy”andthedocumentwhichappointsthemisa“proxyform”

• wheretheshareholderisanentity,theywillappointa“representative”andnotaproxy



56

CGC and proxies

• CGCsaysaboutproxies:

• foreachresolutiontobeproposed,theproxyformshallprovidetheshareholderwiththeoptionsofdirectingtheirproxytovoteinfavour,against,orwithholdtheirvote

• avotewhichiswithheldisnotcountedasavote–neitherinfavournoragainst

• theentityshouldensurethatallproxyformsreceivedareproperlyrecordedandcounted

• foreachresolution,afteravotehasbeentaken,theentityshouldpublishonitswebsitethedetailsofthevotesand,inparticular:

- thenumberofsharesinrespectofwhichvalidproxieshavebeenreceived

- thenumberofvotesforeachresolution

- thenumberofvotesagainsttheresolution

- thenumberofsharesinrespectofwhichthevotewaswithheld




CorPorate governanCe – Control systems

• Internalcontrolisakeyprocesswithinanorganisationconcernedwiththemanagementofriskandtheachievementofobjectives

• byinternalcontrolismeantnotonlyinternalcheckandinternalauditbutthewholesystemofcontrols,financialandotherwise,establishedbythemanagementinorderto

• carryonthebusinessoftheentityinanorderlyandefficientmanner

• ensureadherencetomanagementpolicies

• safeguardtheassets

• preventanddetectfraudanderror

• secureasfaraspossiblethecompletenessandaccuracyoftheaccountingrecordsenabling

• thetimelypreparationofreliablefinancialinformation

• Internalcontrolandriskmanagementincg

• bothelementsofinternalcontrolandriskmanagementarefundamentalpartsofsoundcgbecause:

- cghaskeylinkstorisksandtointernalcontrols

- whilstitisnotpossibletopreventcorporatefailures,goodcgcangoalongwaytominimisetherisk,andwell–runentitiestendtoachievetheirobjectivesinalessriskyway

- sowecanseethatcgisakeytoriskreduction

- theCGC requiresentities tooperateappropriatesystemsof internalcontrol,and toensure that thosesystemsareregularlyreviewedandimproved



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turnbull report and internal controls

• requiresthatinternalcontrolsshouldbeestablishedusingarisk–basedapproach

• specificallyanentityshould:

• establishitsbusinessobjectives

• identifytheassociatedkeyrisks

• designcontrolstoaddressthoserisks

• establishasystemtoimplementthecontrols,includingtheprovisionofregularfeedback

• objectivesofinternalcontrolsystems

• managetheriskswhichhavebeenidentifiedwithinanentityincludingtheriskthattheentityfailstoachieveitsobjectives

• internalcontrolsystemsshouldbedesignedsothattheygivereasonableassurancethat:

- operationsarerunningefficientlyandeffectively

- financialreportingisreliable

- applicablelawsandregulationsarebeingadheredto

• iftherewerenointernalcontrolsystem,managementwouldbeunabletomonitortheeffectivenessoftheirriskmanagementstrategy,andwouldcertainlynotbeinanypositiontorespondtonewthreatsastheyarose


59Chapter 6 Paper P1Corporate governance – control systems December 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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Auditors And internAl Controls

Function and importance of internal audit

• internalaudit(ia)isanindependentappraisalactivityestablishedwithinanorganisationasaservicetoit

• itisacontrolwhichfunctionsbyexaminingandevaluatingtheadequacyandeffectivenessofothercontrols

• inalargeorganisationiawillbeaseparatedepartment

• insmallerentities,itcouldbethatanindividualisallocatedtocarryoutspecifictasksofanianature

• itmaybethattheiafunctionisoutsourced

• ifitisanin-housedepartment,itisimportantthatthefunctionisstructuredinanappropriateway

• scopeofinternalaudit

• managementwillprescribethescopeandobjectivesoftheiadepartment,butthesewilltypicallyinclude:

- reviewoftheaccountingandinternalcontrolsystems

- detailedtestingoftransactionsandbalances

- reviewoftheeconomy,efficiencyandeffectivenessofoperations

- reviewoftheimplementationofentitypolicies

- specialinvestigations

- assistingtheexternalauditors



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independence of internal audit

• foranauditfunctiontooperatesuccessfully,itisnecessarythattheauditorisindependent

• appliesequallywelltointernalauditorsastoexternalauditors

• for internal audit to be effective, the reviews which they carry out must be conducted and reported on on anindependentbasis

• theequivalentoftheconfidencewhichisgivenbytheexternalauditorbeingindependent

• Comparisonofinternalandexternalauditors

External Internal

Requiredby statute management

Appointedby shareholders management

Reportsto shareholders,andmanagement management

Reportson financialstatements internalcontrols

Opinionabout truthandfairness,properpresentation adequacyofintconts,valueformoney

Scope asnecessary prescribedbyexecutiveboard


63Chapter 7 Paper P1Auditors and Internal Controls December 2012 Examinations

Potential threats to independence

• inthesyllabusfortheearlierauditingpaper,

• seehowmanyyoucanremember!

• f

• f

• c

• l

• b

• g


Chapter 7 Paper P1Auditors and Internal Controls December 2012 Examinations

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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




The Risk ManageMenT PRoCess

Risk and corporate governance

• goodcginvolveseffectiveriskmanagement,andthateffectiveriskmanagementinturninvolvesasoundsystemofinternalcontrol(TurnbullReport)

• goodcorporategovernancewilleliminateordecreasemanyoftherisksfacinganentity

• fairtreatmentofshareholders

• rightsofshareholders

• theroleofstakeholders

• disclosurerequirementsandtransparencyarrangements

• boardresponsibilities



Chapter 9 Paper P1The Risk Management Process December 2012 Examinations

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First three principles of good corporate governance

• Fairtreatmentofshareholders

• preferentialtreatmentshouldnotbegiventoanyonegroupofshareholders

• othershareholderscouldresentthisanditcouldresultinbadpublicityfortheentity

• Rightsofshareholders

• theentitymaynotallowshareholderstheirrights

• forexample, if theentity fails toallowashareholder to join indiscussionsatanAGM,or if theentity fails tocommunicatethedetailsoftheAGM

• Theroleofstakeholders

• entitiesmayignorestakeholders

• astakeholdergroupcouldbetreatedinappropriately

• forexample,ifanentitytriestomakeanemployeeredundantwithoutfollowingestablishedlegalprocedure


69Chapter 9 Paper P1The Risk Management Process December 2012 Examinations

Final two principles of good corporate governance

• Disclosurerequirementsandtransparencyarrangements

• directorspossiblyfailtoprovideappropriatereports

• directorsfailtoreportthetruefinancialpositionoftheentity

• itisnecessarilythecasethat,forproperdisclosureandtransparency,asoundsystemofinternalcontrolintheentityshouldexist

• Boardresponsibilities

• theboardpossiblydoesnotcontroltheentityadequately

• theboardattemptstoruntheentityfortheirownbenefitratherthanforthebenefitofshareholdersandotherstakeholders



70

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



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



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



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



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



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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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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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…



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!



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



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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EthiCs and soCial REsPonsibility

Chapter sub–divides into three:

• ethicaltheories

• differentapproachestoethicsandtocorporatesocialresponsibility

• theroleoftheaccountantinthecontextofvaluesandethics

Ethical theories

• Withreferencetoethicaltheories,thereisacleardistinctionbetweenthosebasedonabsolutevaluesandthosebasedonrelativevalues

• Absolutevaluetheorists

• theyassumedthattherewasonlyonesetofmoralrules,andtheywerealwaystrue

• but truth in one culturemust be different from the truth in another Consider the different truths behindChristianityandIslam!

• sothe“absoluteschool”nowacceptsthateachseparateculturehasitsowntruths

• but,eventhen,sometruthsareinternational–forexample,murderbyonepersonofanothermustsurelybeabasicunacceptableanti–socialact,whatevertheculture,religion,geographicallocation…



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• Incontrast,relativevaluetheorists:

• acceptthattherearemanymoral/ethicalcodeseachofwhichevolvesovertimeandeachcouldbedifferentfromeveryother

• asaresultofthismoreopenacceptanceofdifferingcodesofethics,therelativetheoristsdonotbelieveinthe“onemoraltruth”

• accepttheneedforevolutionofmoralcodes

• acceptalsotheideaofdifferentraces,religions,sects…havingtheirowncodesofethics

• auditorsinonecountrymaywellacceptasnormalanactivitybyaclientwhichwouldbeseenasabnormalbyauditorsinothercountries

• thesedifferentattitudes,andassociatedmorality,havebeendevelopedintoatheoryexplaininghowmoralsandethicschangeovertime

• LawrenceKohlbergsixstages

• Level1Pre–conventionalMorality

- ObedienceandPunishmentOrientation

- IndividualismandExchange

• LevelIIConventionalMorality

- GoodInterpersonalRelationships

- MaintainingtheSocialOrder

• LevelIIIPost–conventionalMorality

- SocialContractandIndividualRights

- UniversalPrinciples


93Chapter 11 Paper P1Ethics and Social Responsibility December 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


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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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




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


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



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



• 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




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…


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



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



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



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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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


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



• 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



• 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



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.



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



• 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



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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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)



Chapter 16 Paper P1Ethical Characteristics of Professionalism December 2012 Examinations

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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


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


Chapter 16 Paper P1Ethical Characteristics of Professionalism December 2012 Examinations

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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




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


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


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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ACCA Paper P1 December 2012 Exams

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