* CPA Australia gratefully acknowledges the many authors who have contributed to this module.

Knowledge check Study guide

CONTEMPORARY BUSINESS ISSUES

Question 1.1

What types of activities or roles could a professional accountant provide to improve productivity for an organisation?

Professional accountants can provide several roles in improving productivity, including:

Data capture Both of physical and monetary flows, to enable an accurate view of currentoperations

Analysis Both of financial and non-financial information, to enable identification ofactivity drivers

Performance measurement Includes establishing benchmarks and measuring progress towards goals and targets

Process redesign By applying process improvement tools to identify inefficiencies and bottlenecks, and reconfiguring activities

Resource control Through budgeting and forecasting, as well as designing and implementing internal controls

Question 1.2

For each of the characteristics listed in Table 1.1 (i.e. organisation, strategy, customer/community, financial, governance, work force and information technology processes), list one example of the type of strategic advice that professional accountants may be able to provide.

There is a wide range of business advisory services that professional accountants may be able toprovide, including:

Organisation Legal structure (sole trader, partnership, trust, company). Succession planning.

Strategy Business planning process, including linking budgets to organisational objectives. External environment information and analysis. Specific growth strategies (acquisition, joint venture, partnership). Performance measurement systems design, evaluation and implementation.

Customer/Community Customer profitability and segmentation. Sustainability improvements and reporting.

Financial Capital structures and sources of funding. Wealth maximisation strategies (dividends, buy-backs, reinvestment). Finance function (budgeting, payroll, accounts payable/receivable, inventory,

taxation,reporting). Costing and pricing, and leasing versus purchasing of assets.

Governance Governance structures (board composition, committees). Independent director role. Risk management and internal controls.

Work force Organisational structures (in-house, outsource). Performance measures and links to remuneration.

IT processes Management information systems (reviews, scoping, implementation, testing). Project management services.

Question 1.3

Do you believe professional accountants are well placed to provide strategic advisory services (outside the traditional areas of cost accounting, financial accounting and taxation) to organisations? Justify your position.

Professional accountants, both internal and external to organisations, are well placed to provide strategic advisory services to organisations for a number of reasons, including the following: The professional approach of the accountantsuch as having a service ideal, honesty,

integrity and not acting in their own self-interest. The technical abilities of accountants are based on a systematic body of theory and

knowledge. They have gone through rigorous education and training, which provides a base level of knowledge that leads to competence in delivery of services.

Many technical skills are transferablefor example, the technical requirements of an audit (including setting the scope, determining the approach to sampling, and obtaining and reviewing data) are often similar, despite the reviewed data being of a different nature (i.e.physical measures instead of financial measures).

Accountants are often exposed to the whole of an organisationfinance, sales, marketing, human resources, IT, legal, production, logistics and after-sales services. Thisknowledge is invaluable when assessing the impact of potential decisions across different parts of an organisation, as well as its industry supply chain.

Accountants are often exposed to several industries, and similar problems that arise in different organisations. The ability to transfer their knowledge of how similar problems have been resolved provides a valuable resource to clients who may have never experienced suchproblems.

Question 1.4

The business advisory industry thrives during periods of business change and hardship (IFAC2008, p. 26). Explain why this may be the case.

In periods of change and hardship, many organisations realise that they cannot continue operating as they have done previously. Business models that worked in the good times may not be relevant when times get tougher. Many organisations find that, in difficult times, there are additional pressures from: shareholdersto continue generating sufficient returns; employeesto provide tolerable working conditions and guarantee security of work; suppliersto increase/maintain orders and margins; and customerswho are buying less, and on reduced margins.

In addition, regulatory changes (e.g. new licensing regimes or new taxes) and changes in community expectations (e.g. relating to the environment) can also have a significant impact on organisations.

Organisations may not have sufficient resources or expertise to solve the underlying issues, or make the required changes, and so typically request assistance from external sources. Byobtaining that expertise externally, both the adviser and the organisation should benefit.

Question 1.5

1. Soft skills, especially communication skills, networking and the ability to manage relationships, are extremely important to progress to senior roles in accounting/finance. At the CFO level, how important do you think it is to be technically competent in the finance role, compared to actually managing the finance role? Explain your reasoning.

2. A contemporary business and social issue is maintaining worklife balance. What risks does an accountant providing strategic advice face in this area?

3. In the CFO role, how important do you think it is to:

(a) know the organisation and the products/services it offers?

(b) be passionate about the products/services the organisation offers?

Explain your reasoning.

1. There are two main ways of perceiving the CFO role. One is that it is a management role, which oversees a technical function. The key skills involved would focus on managing a team of people and difficult deadlines, making significant financial decisions and being able to interact with both internal and external stakeholders, including banks, regulators, shareholders, consumers and employees. People and project management skills could be seen as equally important as technical competence. However, the second (and more appropriate) view is that, in most situations, it is likely that the CFO needs to be technically qualified. While the technical specialists within the function would provide the technical skill, there is still a need for the CFO to be knowledgeable and competent. A technical understanding of what is being performed by subordinates is essential to properly managing the function. If you do not know what is expected of your team in terms of technical requirements, time, and regulations, then it will be difficult for you to properly understand and manage the area.

2. Along with the benefits of acting in an advisory role, there are also some potential pitfalls. Hitting tight deadlines for important issues (and possibly across multiple clients) can lead to difficulties in finding time and balance with non-work activities. Such deadlines were traditionally compliance-based and reflected the end-of-month/year processes. Being locked in well in advance, and being somewhat repetitive, these activities could be planned for. However, strategic advisory services can take place at any time through the course of the year, and the volume or extent of the workload may not be as easily planned. Important areas of consideration to maintain worklife balance include: planning and booking leave in advance; planning work schedules and work pipelines into the future; maintaining a time log and reviewing hours worked to monitor fatigue; not overcommitting (either with the number of clients or the number/size of

engagements); and having access to temporary support services and backup personnel as needed.

3. The CFO has a dual role of manager with technical expertise. The purely technical role of ensuring the correct recording, reporting and communicating of results must be combined with the broader manager role. Where the CFO is providing strategic advice as to products, services, prices, organisational structure, business planning and overall strategy, it is important for the CFO to be both knowledgeable about the inner workings of the organisation and also a proud supporter of the product offering. What may be more important than passion for a specific product or service is that the needs of the customer are properly satisfied and the financial position of the organisation is strong and under control.

Question 1.6

Refer back to Table 1.1. Consider the strategic advice that a professional accountant could give an enterprise in relation to its customers. Explain how that advice might differ depending on whether an accountant was advising a small, medium or large enterprise.

Potential opportunities for strategic advice in relation to customers include the following: Customer profitability analysisUsing activity-based analysis to determine the full cost of

each customer (including cost of goods sold, sales time, customer service, delivery, logistics and after-sales service). This can determine the real profit that is generated by each customer, which can allow customers to be segmented into groups according to profitability, and also how demanding they are on organisational resources (e.g. sales personnel and after-sales service). The least profitable customers can then be highlighted and strategies for dealing with them can be created. These may include educating the customer on the costs incurred to service them and charging for the services provided (menu-based pricing).

Customer performance ratings and satisfactionDeveloping reporting systems that capture important measurements (like delivery in full and on-time statistics), which should help influence customer satisfaction levels. Where ratings are not satisfactory, strategies may be implemented to make improvements.

Customer pricing analysisAdvice may be provided based on analysis from tools such as cost-volume-profit analysis and sales mix analysis, which may be used to identify the most suitable pricing structures and profitable mix of sales offering.

Customer needs analysisAdvice on providing products and services that customers actually need or desire. This may involve survey generation, the use of focus groups, orthe use of social media to canvass customer feedback. It also links into other customer-related areas of satisfaction and pricing analysis, such that product/service features can be reviewed and priced appropriately to satisfy customers and generate maximum value for theorganisation.

The advice will probably vary depending on the size of the organisation for several reasons. Table1.1 identified the following stereotypical characteristics of different sized organisations.

Small enterprise Mid-sized enterprise Large enterprise

Customer/community

Few customers account for large part of turnover.

Close to their customers and customers business plans.

Growth of customer base.

Moving away from the direct proximity of their clients.

Large, international customer base.

Success or failure of the enterprise is felt through the whole supply chain, the employee base and the wider community.

A smaller organisation may not have the computer systems, records or personnel to conduct a detailed customer profitability analysis, performance measurement or scenario testing using pricing and sales mix tools. The advice may include support in setting up the systems and putting processes in place to conduct this type of work. Medium to larger-sized organisations are more likely to have accounting staff and systems in place, so efforts may be more focused on fine-tuning systems, advising on current best practice, and providing an independent review and verification of current methods.

Question 1.7

A business cannot achieve sustainability and profitability at the same timeone must always be sacrificed for the other. Do you agree or disagree? Explain your answer.

The underlying suggestions in the question are: being sustainable incurs costs that reduce profitability; or a profit focus prevents attention being given to matters outside cost minimisation and profit

maximisation; or at best by pursuing both goals they will cancel each other out to deliver what is called a

zero-sum game resultno improved profit and no improved sustainability.

But this is not necessarily the case. For example, sustainable actions can grow profits, especially as externalities become internal (e.g. carbon prices and Environment Protection Agency (EPA) controls). Competitive advantage can be gained. Some customers only want to buy from ethical/sustainable organisations and are often prepared to pay more for what they see as a superior or ethical product. Similarly, some suppliers only want to deal with sustainable/ethical purchasers, and some investors only want to invest with organisations they perceive as being more ethical, with the consequent possibility for reducing costs of capital.

If you are interested in reading more about profit and sustainability, please read the story about RayAnderson and his experience with Interface (a carpet manufacturer):http://www.greenbiz.com/blog/2009/10/05/ray-anderson-radical-industrialist).

Or you could access his book entitled Confessions of a radical industrialist:http://us.macmillan.com/confessionsofaradicalindustrialist/raycanderson.

Question 1.8

The IT snag (adapted from Sexton 2010).

In the face of a recent economic downturn, the board has requested that you, as the CFO, together with the chief information officer (CIO), produce a business case for outsourcing the organisations information technology (IT) operations offshore. The CIO sees this as an opportunity to significantly reduce costs within his business unit, which will help him achieve his substantial end-of-year bonus. As the CFO, you acknowledge that there is a possibility to reduce overheads associated with the IT operations and, as a consequence, increase profitability.

What ethical issues need to be considered in this situation?

(Adapted from Sexton 2010).

There are many valid reasons to outsource business activities, including risk mitigation, improved cost efficiency and access to technology and skilled staff not available in your own organisation. Yet while outsourcing information technology (IT) may reduce certain risks, such as continued reliance on legacy systems, there are also risks associated with having a third party provide services. These risks include failure to offer services to an appropriate standard (which could harm the reputation of your business), possible breaches in security or an inability to comply with legal and regulatory requirements. There are also additional risks associated with the loss of control over the information source and its security.

Apart from undertaking due diligence to ensure that any identified risks are addressed, it is also necessary to determine that the outsource provider has the appropriate experience and expertise to handle your IT operations, that it is a viable and financially secure organisation with good governance, and that the outsourcing arrangements are appropriate to your business strategy. It is also important to ensure that you are engaging with an ethical service provider whom you are able to trust with your organisations sensitive and confidential data.

It is essential that the board fully understands the corporations ethical obligations before any decision is made to outsource IT offshore. As well, any decision needs to be in accordance withstated corporate social responsibility policies and obligations.

As CFO and a member of a professional accounting body, you also have personal ethical obligations as outlined in the Code. Although the Code does not specifically address outsourcing, it does contain some fundamental ethical principles relevant to this situation. Foremost is the principle of confidentiality. This requires members to refrain from disclosing outside the organisation confidential information acquired as a result of professional and business relationships without proper and specific authority from the client or employer. This extends to refraining from using confidential information to your personal advantage or to the advantage of third parties.

You need to ensure that the board specifically addresses the confidentiality issues that arise from any outsourcing arrangement and formally documents its consideration of these issues together with the authority for any disclosure of confidential information.

The conceptual framework in the Code can also be applied in this situation:

(a) Identify threats to compliance with the fundamental principles: As the CIO has his annual bonus hinging on this decision, there is an appearance that his objectivity is compromised. This situation would therefore create a self-interest threatthat is, a threat that a financial or other interest will inappropriately influence the members judgment or behaviour (APESB2013b).

(b) Evaluate the significance of the threats identified: The CIO has the potential to earn a substantial end-of-year bonus. Being in a decision-making position for the organisation, andbeing a direct benefactor of the decision to outsource (as an individual employee), suggests that the significance of the threat is high.

(c) Apply safeguards, when necessary, to eliminate the threats or reduce them to an acceptable level: As the CIO has a conflict of interest in the outsourcing decision, it would be prudent to seek external independent advice on the outsourcing option. This advice may require an analysis of the outsourcing arrangement (functionality of IT systems, pricing, support, etc.), as well as any proposals received from other outsourcing providers.

It is important that the ethical dimension of any outsourcing decision is given the same weighting as any financial considerations and is not obscured by perceived increases in profitability.

Question 1.9

Fair dealings (adapted from Sexton 2009).

As CFO you have been asked to develop a business plan to support a major restructure of your organisation. The board is hesitant to approve such a major restructure, so you decide to conceal the key assumptions contained in the business plan as this would only confuse the board in its decision-making. At the next board meeting you intend to present your business plan. You are hoping that no director questions you on the assumptions or limitations of the business plan and that the decision to restructure is approved.

If you proceed with this course of action, which fundamental ethical principle would you most likely breach?

(Adapted from Sexton 2009).

As CFO you have an obligation to act with integrity and therefore be straightforward and honest in professional and business relationships. Integrity also implies fair dealing and truthfulness. Further, paragraph 110.2 of the Code requires that a member of CPA Australia:

shall not knowingly be associated with reports, returns, communications or other information where they believe that the information:

a Contains a materially false or misleading statement;

b Contains statements or information furnished recklessly; or

c Omits or obscures information required to be included where such omission or obscurity would be misleading.

It is therefore important that you fully disclose to the board any key assumptions and how they were assessed, as well as highlighting any limitations in the business plan.

As a member in the business you hold a senior position within your organisation. The more senior the position, the greater will be the ability and opportunity to influence events, practices and attitudes. It is therefore expected that you have a role in encouraging an ethics-based culture in your organisation that emphasises the importance that senior management places on ethical behaviour. Accordingly, you should not proceed with your planned actions and you will need to fully consider your ethical obligations.

It is important for members to always act with integrity and to make sure that any report or communication does not omit or obscure information which could render the report or communication misleading.

Reports presented to the board by management, particularly those which accompany the approval of significant transactions, should clearly state the scope of any expert opinions used to support or reject a board decision, the underlying assumptions and any material risks andlimitations.

Note also that the fundamental principles of professional competence and due care and professional behaviour would likely be breached in this scenario. However, the specific threat tothe principle of integrity is more prevalent.

Question 1.10

Assume you are a senior accountant in a construction organisation that undertakes large-scale projects. In your role to date, you have learnt a lot about the project management staff. Youknow that they are predominantly highly professional engineers, who work quite autonomously, andshow a strong work ethic and dedication to their job role.

Your organisation has recently deployed a knowledge sharing system and telecommunications infrastructure that can effectively support teleworking. The project managers have demonstrated a strong commitment to the knowledge sharing system, and it has become a key part of their collaborative working.

Your organisation is now considering the introduction of teleworking for project management staff. You have been asked to provide advice on the likely costs, risks and benefits of this proposal.

What would be your main considerations?

Your advice should include that for the initiative to be successful, the technology used must cater for the work that the project managers need to do. This will require an understanding of what business systems they need to access to perform their work. As the project managers are using the knowledge sharing system, this is a primary consideration.

You should advise that studies have demonstrated that telework promotes increased productivity and work quality. Also, as the project managers have already demonstrated autonomy and a strong work ethic, there is a low risk of any loss of efficiency with the introduction of teleworking to this group.

With the introduction of teleworking, your organisation will be able to build and retain the trust and confidence of its project managers, improving staff engagement and retention. To ensure delivery of the benefits of this service, management support will be critical. The staff concerned should also be informed about monitoring their worklife balance, so as to avoid any risk of burnout.

The costs of providing the relevant technology will include the provision of internet access and communication tools such as mobile phones and email applications. The cost of the provision of these services in remote locations must be included in the estimations.

Question 1.11

What alternative approaches would complexity theory suggest that may lead to a more effective result in the case of QNH Ltd?

Possible approaches in the case of QNH Ltd include the following.

Approach Commentary

Encourage discussion Develop an environment to encourage more discussion between sales and product staff. Strengthening internal relationships can have a marked effect on business performance, and harnessing these relationships will develop corporate social capital. This could be done by setting up meetings in an informal environment where sales staff can ask direct questions of product management. This may also provide an environment for sales staff to bring customer questions and feedback to the product managers.

Rewards and recognition Modify the remuneration schemes to reward sales staff for spending time learning about products, and communicating customer feedback to product staff, and reward product staff for communicating more effectively to sales. This is one element of building a more innovative business culture.

Engage the product andsales staff

Engage both the product and sales staff in helping to develop solutions to the situation. This will lead to staff who are more engaged. More engaged staff will mean more engaged customers, and this can be assessed using human sigma measuring and monitoring.

Use narrative techniques Narrative techniques can be used to effectively uncover more details of the underlying issues. Sense-making can be used to develop shared understanding and methods to resolve the issues.

Use the most significant change technique

As solutions are developed, a tool such as the most significant change technique could be used to provide feedback on which techniques are being most effective. This can also be used to propagate success stories back through the organisation to augment the successful change.

Reinforce corporate values

The disparity in goals between product and sales may lead to a situation of dysfunctional autonomy. To mitigate this, corporate values need to be reinforced within both teams. It is expected that there will be a corporate goal of earning revenue in order to gain profit and maintain shareholder value. To this end, the product team needs to develop products that sales can sell, and sales also need to sell products that will earn value. Involving both teams in discussions on shared goals and values could improve the shared focus.

Approach Commentary

Try safe to fail experiments

Rather than embarking on a costly major IT development to replace the legacy information system, you could try a number of safe-to-fail experiments for alternative ways of getting new information out to sales. These may include: informal training sessions, facilitated by people with knowledge of both

the sales and technology fields; developing communities across sales and product for staff with similar

interests to promote informal questions and discussions; or using easily developed intranet sites or social media tools such

asblogging.

All these low-cost solutions are quick to develop and to add to if successful, and can easily be closed down without major cost if unsuccessful.

Bring in sales staff Bring in sales staff who have an interest in improving the situation to work with the product team for a fixed time, and to help develop product information in their own style of language. This feedback can be used to develop templates for new product information documents. In the same way, someproduct people may be able to spend time working with sales staff ordirectly with customers, so they can understand the environment better and provide more relevant information.

There may be many more solutions. You might inspire innovative solutions from sales and product staff by using the corporate equivalent of throwing a football or lighting the barbecue (see the video How to organise a childrens party referred to in the study guide). By working together, they may come up with solutions that are unimaginable to more senior staff who are removed from the situation and apply only traditional, ordered-systems thinking.

Question 2.1

What trends can be identified when comparing developed countries with the leading developing countries (Brazil, Russia, India, Chinaoften called BRIC)?

The BRIC countries all show significant growth in consumption over the last decade, with Russia the lowest at 23.7 per cent and China the highest at 86.4 per cent. Brazil and India have had significant growth rates in consumption (both around 50 per cent).

Meanwhile, many developed countries have shown declines over the last decade. The US has reduced daily consumption by 5.7 per cent, with Germany and France reducing consumption by 10.0 and 13.8 per cent respectively. The declines may be a result of lower growth due to slow recovery from the Global Financial Crisis (GFC) as well as the eurozone sovereign debt crisis, butthey also reflect a move away from oil to other fossil fuels, renewable energies and more energy-efficient activities. Australias strong growth in consumption during the period (20.1percent) was against the trend for developed countries, and may be reflective of it remaining out of recession during the GFC.

Another interesting observation is that the US share of global consumption has fallen from 25percent in 2003 to 20 per cent in 2013. At the same time, Chinas share has increased from 7 per cent to 12 per cent. This growth is reflective of both Chinas massive population and its growth in GDP over the corresponding period. It is also reflective of the USs shift towards alternative fuels (e.g. natural gas).

Question 2.2

How might peak oil affect an accountant in business?

In a peak oil environment, an accountant would be expected to analyse the financial, operational and environmental impacts on the business, and proactively work to ensure the sustainable future of the business.

For example, peak oil is of concern to an accountant in preparing forecasts of fuel expenditures for staff cars, raw material input costs, production and manufacturing costs, and for distribution of the organisations products. If the organisations products or services rely on oil, and supplies become limited, this could severely restrict the ability of the organisation to operate. Withlimited supply, the price of oil would be expected to rise, potentially causing the organisation to becomeunprofitable.

In addition to forecasting, the accountants role would be to help prepare and position the organisation to continue as a sustainable operation. This may include analysis and recommendations on new energy-efficient investments, alternative energy sources or even thedevelopment of new product/service lines.

Question 2.3

Do you think a nations agricultural industry should be protected from foreign competitors?

There is no correct answer to this question, but it is important to consider the merits of the alternatives.

The pure economic argument of letting markets determine supply and demand would suggest that if cheap produce can be obtained from more efficient and less costly markets, then this should be permitted, and protection via tariffs, quotas and other trade barriers should not be used. The main benefit is that consumers are provided with greater choice at lower cost. They are then able to buy more goods and services with a certain level of disposable income.

However, this ignores several issues including dumping of products (i.e. selling below cost, or at artificially low prices due to foreign government support). When dumping occurs, localindustry can be permanently harmed as a result of distorted market behaviour at the sourceof production. Another issue that must be carefully considered is food security. This is the need for a nation to have enough infrastructure and farming capability to produce enough food for its population in times of difficulty. Difficulties may include global drought, global price increases that the local population cannot afford, and even disrupted supplies due to war.

Domestic producers are often powerful groups within countries and can use their political power to lobby those in power to protect their incomes by ensuring foreign competitors face greater barriers to entry.

Question 2.4

Do you think it is ethical for countries to outsource food production? In your answer, consider how the property rights of minority interest groups should be dealt with.

From a purely commercial point of view there does not seem to be an ethical dilemma involved in outsourcing food production. Some countries have very little land available for agriculture, ortheir climate does not support efficient production. The ability to outsource food production to low-cost nations that have greater areas of arable land appears sensible.

However, it is important to consider how negotiations are conducted, and who they are conducted between. In many instances, governments negotiate directly with each other. Somegovernments are very powerful and are willing to exert this power to extract deals that are very beneficial to themselves, and can be quite detrimental to the other party. Corruption also creates a significant risk. Governments have been known to sell or lease land that was held by minority groups without any consultation. This may also lead to forced relocation, or forced labour without compensation. Companies that are aware of these issues need to acknowledge the ethical implications of their decisions with regards to the effect on local communities, as well as the commercial side of the decision.

Question 2.5

Water stress refers to situations where there is not enough water to meet demand. What are three things that organisations can do to alleviate water stress?

According to the World Business Council for Sustainable Development (2009), things organisations can do to alleviate water stress include: measure and monitor water use to develop an understanding of consumption; recycle and reuse water to minimise consumption; reduce the pollutants and chemicals that enter the water supply, thereby lowering toxic and

other contaminants; engage with suppliers and customers to adopt best practices; develop new water treatment technologies; and enter into partnerships with local government and the scientific community (WBCSD 2009, p. 13).

Question 2.6

Review Figure 2.6 and consider the following questions:

(a) What are the potential reasons for the small increase in domestic water use between low- and middle-income countries and the high-income countries?

(b) What are the causes of the vast differences in agricultural use?

(a) In Figure 2.6 we find that world domestic water use is 8 per cent, which increases to 11percent for high-income countries. However, it is important to remember that this is just the percentage comparison and does not reflect the total amount of water consumed by each person in the high-income countries. The 11 per cent domestic use still represents a significantly higher level of physical water consumption. However, because of the significant levels of industrial and agricultural usage, the overall percentage has remained low. Inhigh-income countries, the domestic use volume (and percentage) is likely to be higher due to better water infrastructure, higher disposable incomes and less frugal use (e.g.watering gardens).

(b) The industries for low- and middle-income countries are still primarily agriculture-based. Incomes tend to rise as countries move towards greater levels of industrialisation. It follows that agricultural water use falls (as a percentage of total water use), while industrial water userises.

Question 2.7

How is biodiversity relevant to the financial services sector, in particular accounting firms, lawfirms, financial planning firms and insurance firms? Outline the possible impacts.

Historically, the financial services sector has been seen as having a low environmental impact given that it has little direct environmental impactprimarily, energy, water and paper for office workers. As such, understanding the relevance of biodiversity, what it is and how it can affect the sector, is often difficult.

However indirectly, biodiversity is often of real relevance to the transactions or investments that the sector is offering or advising on. Lenders, investment managers, insurers and advisory services must understand biodiversity-related risks that might increase project costs and liabilities as well as affect ability to secure a licence to operate in the future. Over the last decade or so, many of these advisory services have included using scientific specialists as part of the service team, or joint venture arrangements to access the appropriate experts. These experts undertake an evaluation of the transaction/investment and highlight compliance, reputation and environmental risks. They then quantify these impacts financially and include them in the transaction (the figures are generally not entirely accurate, as many impacts can only be estimated).

Since 1996, not-for-profit organisations and civil advocates have also become involved in monitoring the activities of the finance sector and in particular the funding of large projects with adverse social and environmental effects. In 2003 the Equator Principles were established by the International Finance Corporation. The principles are a set of voluntary standards designed to help banks identify and manage the social and environmental risks associated with directly financing large infrastructure projects like dams, mining and pipelines. Eighty financial institutions around the world have adopted the principles, covering over 70 per cent of global project finance debt in emerging markets.

Since then, BankTrack (http://www.banktrack.org), a global network of civil society organisations and individuals, has emerged. It tracks the operations of the private financial sector (commercial banks, investors, insurance companies, pension funds) and publishes reports and campaigns on what they consider unsustainable investments. In 2007, BankTrack listed the Australian Gunns Pulp mill proposal for Tasmania on the grounds that it: resulted in the destruction of old growth forests and their ecosystem; posed possible health impacts to those living in the region; and resulted in a violation of human rights and because of its impacts on Aboriginal culture

andheritage.

BankTrack launched a global campaign against ANZ as the bank considered funding the development. In May 2008 ANZ publicly announced that it would not fund the mill for undisclosed reasons. Since then, the project has failed to secure funding. Although ANZ did not disclose why it chose to not pursue the project, most certainly reputation and biodiversity impacts played a significant role in the reduced financial viability of the transaction. Sincethen, ANZ (n.d.) has publicly disclosed how they consider social and environmental business lendingdecisions.

A more recent development is the Natural Capital Declaration (NCD), which is a finance sector initiative to incorporate natural capital elements into decision-making. This includes applying natural capital risks to the cost of capital of relevant projects and operations (natural capital is discussed further in Module 4).

This analysis reveals the relevance and complexity of biodiversity issues within the financial sectorwhether for a bank directly funding a project, a superannuation fund investing in the company undertaking the project, or a legal firm advising on the transaction. Immediate ecological impacts need to be considered, as well as community perceptions and possible future political and regulatory changes.

Question 2.8

What is the current regulatory position of the government in your country regarding measures for operating in a carbon-constrained economy?

Governments can respond with a carbon tax or emissions trading scheme (also known as cap-and-trade). The following is a summary of the current position of some countries (at the time ofwriting):

Australia. Effective 1 July 2012, the Australian Government introduced a carbon tax for entities emitting over 25 000 tonnes of carbon dioxide equivalent greenhouse gases (although the transport and agriculture industries were exempt). The carbon tax had an initial fixed price of $23 per tonne, rising to $24.15 for the following financial year, and it was then planned to transition into an emissions trading scheme for the 2015 financial year. However, with a change of government in 2013, the carbon pricing scheme was out of favour and the carbon tax legislation was repealed with effect from 1 July 2014.

Canada. At a federal level, a carbon tax was proposed in 2008. This proposal was to be a revenue-neutral measure, with increased taxation on carbon being balanced by tax cuts for individual citizens. The proposal is unlikely to be put to the vote due to a lack of support at the national level. At the province level, British Columbia and Qubec each have a carbon tax. In 2008, Qubec and Ontario agreed to collaborate on an inter-provincial cap-and-trade system, although no such system has currently been launched.

European Union. A proposal in the 1990s to initiate a carbon/energy tax was discarded after strong industrial pressure. However, several countries took the initiative to apply a carbon tax. For example, Denmark, Finland, Norway, Italy, the Netherlands and Slovenia applied a household carbon tax that increases the cost of heating and electricity use. Other countries with a carbon tax include Germany, Ireland, Italy, Switzerland, and the UK, although the various carbon tax schemes are not uniform across all sectors. In 2005, the European Union (EU) Emissions Trading Scheme was launched, providing a binding carbon trading system on EU member states (with Norway, Iceland and Liechtenstein since joining). The scheme sets a cap on the amount of certain greenhouse gases that can be emitted and allows companies to trade allowances (e.g. to offset any emissions over the cap).

New Zealand. Originally, New Zealand proposed a carbon tax, but due to a lack of support the proposal was discarded in 2005. This proposal has since been replaced by the Climate Change Response (Emissions Trading) Amendment Bill, and the Electricity (Renewable Preference) Amendment Bill, which were passed into law on September 2008. The legislation establishes the framework for the New Zealand Emissions Trading Scheme. Further amendments to the legislation were made in 2009 and 2012.

USA. The federal government has a long history of trying to pass laws related to climate change. The first attempt was in 1993, when President Clinton proposed a tax on all fuel sources, except for alternative-energy sources (e.g. wind, solar and geothermal). Some states, such as California, are considering the imposition of carbon taxes. In 2009, the House of Representatives voted to reduce carbon emissions by 17 per cent from 2005 levels in 2020 and 83 per cent in 2050, and to begin a national cap-and-trade scheme. Other measures approved by the house will require power companies to produce 15 per cent of their electricity from wind and solar energy. The White House views these energy reforms as part of a job-creation program. In 2009, the Senate passed the Clean Energy Jobs and American Powers Act. Some cities and counties in the United States have carbon taxes. For example, Boulder, Colorado, passed the first municipal carbon tax in 2006 and renewed it in 2012. Boulder residents can receive deductions on their energy bill for using renewable electricity sources. Marylands Montgomery County and Californias Bay Area also have carbon taxes.

Rest of the world. There are very limited efforts in other regions of the world. India has a carbon tax. There are carbon tax proposals in some Asian countries, most notably Taiwan. There are no carbon taxes proposed or in place in the Middle East, and no likelihood of any movement in that direction in the near future. The only Central or South American country with a carbon tax is Costa Rica, and only for hydrocarbon fuels.

Question 2.9

What would be some of the likely effects on business enterprises transitioning to and operating in a carbon-constrained economy?

Most firms will have an initial transition cost to operate in a carbon constrained business environment. However, costs are often offset by bottom-line savings related to reducing GHG emissions, with the major savings being from a drop in energy consumption. The savings will likely be compounded by rising energy prices. Hence, carbon-constrained-economy measures are likely to lower waste and increase operational efficiency, raising long-term economicgrowth.

Proactive businesses that implement GHG-emissions measures early will gain a competitive advantage through product differentiation, thereby increasing market share, reducing operating costs and increasing profit margins. It is estimated that by 2050, markets for low-carbon technologies could be worth at least USD 500 billion. Hence, a carbon-constrained economic environment may provide an opportunity for innovative firms.

It is important to acknowledge that measures will certainly have a disproportionate effect on certain individuals, firms and industries. For example, a carbon tax imposes a tariff at a fixed rate independent of income. This would mean that low-income earners (firms or individuals) are taxed at the same rate as high-income earners. A carbon tax may also be excessive for some social groups, particularly rural residents and the elderly. Environmental and social campaigners argue that whatever type of method is applied, it must have regard for: equity considerations; individual and household welfare; the transition of labour from high- to low-emissions industries; and the guarantee of energy security.

Substantial government funding is needed to sustain research, growth and the economic exploitation of carbon-reducing technology, plant and equipment.

All firms will be exposed to increased supply chain pressure for low-emissions products and services, which initially could be more costly. There is likely to be a substantial increase in business input costs (e.g. electricity, water, gas, diesel, transport, waste services, packaging). There is also likely to be consumer pressure for low-emission goods and services, resulting in disparity between supply and demand. There will be a need to incorporate carbon accounting into business planning and operational process.

Question 2.10

(a) How can reporting environmental performance be helpful to firms?

(b) Why use environmental KPIs?

(c) What are the three key principles in defining KPIs?

(a) Reporting on environmental performance will aid firms in several key ways. it will provide firms with management information to help them exploit cost savings

thatgood environmental performance typically generates; it gives firms the opportunity to set out what they consider to be significant in their

firmsenvironmental performance; and environmental reporting will help firms prepare for the future as they understand

theircosts.

(b) The KPIs are a measurement tool to help firms communicate and manage the links between environmental and financial performance. Environmental KPIs are based on quantifiable metrics that reflect the environmental performance of a business in the context of reaching its wider goals and objectives. KPIs help firms implement strategies by linking various levels of a firm (e.g. business units, departments and individuals) with clearly defined aims andbenchmarks.

Poor management of energy, natural resources or waste can harm performance. Hence, failure to plan for a future in which environmental factors are likely to be significant may risk the long-term value and potential of a business.

KPIs focus on key measures. They provide the most important data for understanding the factors that drive a business forward. Hence, KPIs lessen the need for lengthy reports on a wide range of measures that may be less relevant.

(c) In addition to the general reporting principles, there are three key KPI principles.

1. KPIs should be measurable to facilitate action. [F]or example, targets can be set to reduce a particular emission if it is expressed in a quantitative term.

2. A KPI must be relevant; that is, it should have a general narrative, explaining its aim and

impact. Each KPI is to explain the process undertaken, the calculation methods and relevant assumptions. Moreover, data linking environmental to financial performance should be discussed.

3. The final KPI-specific principle is comparability. Firms are to report data in a comparable

format, so [that] users of reports can assess the performance of a single company over time and relative to its competitors [KPIs] should be expressed in absolute terms that cover the entire business for each period of reporting, and related to a normalising factor. Typical normalising factors are turnover and production output, but others may be relevantfor instance, companies with offices may normalise to floor space Thisallows stakeholders to know how much environmental impact firms have relative to agiven amount of goods and/or services produced (DEFRA 2006, pp. 1617).

Question 2.11

What challenges does an age-diverse workforce present?

There are many potential problems that an age-diverse workforce may produce. They relate to all age groupsfrom older workers feeling threatened by younger, potentially better educated workers, to younger ones who feel resentment at older workers who take up the positions towhich they aspire.

Age is just one aspect of diversity, and often intersects with others. For example, age and gender are often related issues for women, for whom the childbearing years can be still be associated with a lack of commitment to work (e.g. employers might fear that, having spent years training female employees, they might leave to have children). This perception can restrict access to promotion and opportunities. Hence, despite decades now of initiatives, women continue to earn less than men and continue to be under-represented in senior positions. Flexible conditions to assist with childcare can also create resentment from a variety of sources (e.g. from those who missed out on such support to those who see it as favouring one group).

Question 2.12

Why might some employees have a negative perception about a corporate offshoring plan?

There are many reasons why an employee might have a negative perception about a corporate offshore outsourcing plan. As mentioned in the study guide, CPA Australia members who judged their offshoring to be successful noted that the support from internal employees in the finance and accounting areas is deemed critical. This means addressing issues such as individuals being anxious about a change in their or their fellow employees responsibilities as well as the security of their jobs.

For reasons of security, patriotism, or other, an employee may feel uncomfortable taking an activity that was traditionally performed at home and sending it overseas. An employee may also have negative feelings about offshore outsourcing based on something they read in the media or heard from someone in another organisation. For example, the most recent statistics, from the National Secretary of the Finance Union in Australia, suggest that 6000 finance sector jobs have been lost in Australia (Carter 2012).

There is a flip side to this in that negative perceptions may be held of Australia as a recipient of offshore outsourcing plans. As also noted in the study guide, a number of Australian industry bodies, including Invest Australia and the Australia Financial Centre Forum, have promoted Australia as a location for the offshoring of analytics capabilities. Axiss Australias (2006) report Australia as a Hub for Analytics Offshoring laid out the case for making Australia an analytics hub for activities such as equity research, corporate finance, mergers and acquisitions, corporate credit, structured finance, project finance, retail banking, strategic functions and actuarial services.

Question 2.13

What potential costs are associated with the benefit of labour consolidation?

Labour consolidation is considered a primary benefit of offshore outsourcing, although there are several associated costs of attempting to do the same thing in the same place. These costs include: making individuals redundant (e.g. pay, benefits); transitioning to a new location (e.g. rent, sales, set-up); transferring knowledge to new employees (e.g. through tacit and explicit knowledge

management processes); and creating the change (e.g. establishing and communicating new systems and processes).

Question 2.14

What employment and economic advantages and disadvantages of offshoring might you expect to find for host countries such as India and home countries such as Australia?

Although there is limited research on the impact of offshoring at the national level, there is evidence that for host countries, such as India, there are positive impacts on economic growth. Vibrant offshoring sectors can lead to jobs growth, increased spending, an emerging middle class, a positive current accounts balance, local knowledge enhancement, concentrated urban and regional economic growth, and positive change in institutional structures. The overexposure to a particular industry could be problematic, however.

For home countries, such as Australia, research is again limited, and suggests mixed outcomes. While offshoring certainly results in jobs being moved overseas, research on the US economy suggests that offshoring frees up the home labour force to focus on more value-added activities, especially of a complex, strategic nature. In the United States, research from McKinsey & Company (2003) estimatesthat for every USD 1 spent on offshoring, about USD 1.121.14 is generated. As the global labour force becomes more integrated, there will be a more efficient clearing of supply and demand for jobs, and thus a less varied wage rate.

Question 2.15

What factors might you expect to be critical to the success of offshoring finance and accounting activities?

While there is no single recipe for the success of implementing an offshoring program, there are several key elements concerning the relationship between firms and the activities within each firm. It is essential that the relationship between the firm and its provider is characterised by high levels of communication (about current and future activities), trust, fairness and the control of proprietary information. For the business planning to offshore its activities, it is essential to gain the support of leadership and management throughout the organisation. Often a committed offshoring champion is appointed to drive the initiatives. The business should seek alignment between business objectives and outsourcing objectives, and understand technology and stakeholder requirements. It is also critical to craft a careful risk mitigation strategy and consider all the processes, interfaces and business impacts before offshoring.

Businesses that experience more success with offshoring commit adequate resources, establish a change management, communication and implementation plan, and have a sound offshore vendor selection process. Businesses must develop a complete contract to address pricing, performance and quality, the full scope of costs, staff issues and security. Another good policy is to establish a strong governance system of the offshore provider and to institute demand management to avoid scope creep and to monitor the extended support.

Question 3.1

Review the ACFEs (2014) report (http://www.acfe.com/rttn/docs/2014-report-to-nations.pdf) and make brief notes in relation to the following questions. (Note: See the suggested figures in the report for each question.)

(a) What is the effect on the loss ultimately suffered by the victim organisation of failing to detect fraud early? (Figure 9)

(b) What proportion of detected frauds are detected by the external audit process? (Figure 11)

(c) What are the three most common means of fraud detection in your region? (Figure 16)

(d) What sectors suffered the highest rates of fraud? (Figure 22)

(e) What are the most common fraud types in your sector? (Figure 24)

(f) What initiatives do organisations rely on to prevent fraud? (Figure 26)

(g) How would you describe the typical fraudster? (Figures 40 to 76)

(h) What role does gender play in workplace fraud? (Figures 57 to 62 and 74)

(a) Failing to detect fraud early has a dramatic impact on the total loss for organisations. Thelonger the fraud continues, the greater the loss, as shown in Figure 9. The implication of this is that a perpetrator of workplace fraud will continue to offend until such time as they are caught. For example, (looking at Figure 9) the median fraud loss from incidents picked-up in less than seven months was only $50 000, while the median loss from incidents picked-up in 61months or more was $965 000. It is interesting to note the linear progression of the median loss between those extremes. As the report notes, the longer frauds were able to goundetected,the more costly they become (ACFE 2014, p. 16).

(b) External audit was involved in detecting only 3 per cent of detected fraud cases (i.e. not 3% of cases that actually occur). This compares with 3.3 per cent in 2012 and 4.6 per cent in 2010. This contrasts with the expectation of some people in business that an external audit will be effective in detecting fraud.

(c)

Table SA 3.1: Most common means of fraud detection in a selection of regions

Country/region Means of fraud detection

United States Tip, management review, internal audit

Sub-Saharan Africa Tip, management review, internal audit

AsiaPacific Tip, management review, internal audit

Western Europe Tip, management review, internal audit

Eastern Europe and Western Central Asia Tip, management review, internal audit

Canada Tip, management review, accident/account reconciliation

Latin America and the Caribbean Tip, management review, internal audit

Southern Asia Tip, management review, internal audit

Middle East and North Africa Tip, management review, internal audit

It is interesting to note that consistently across the world, the most commonly reported means by which workplace fraud is detected is via tips.

(d) The sectors with the highest rate of detected internal fraud are Banking and Financial Services (17% of the total number of cases reported) followed by Government and Public Administration (10.3%). It is unsurprising that Banking and Financial Services have a higher rate of internally instigated fraud given the volume and accessibility of funds in that sector relative to other sectors.

(e) You should consider the data applicable to your own industry sector; however, data for a selection of sectors is provided in Table SA 3.2.

Table SA 3.2: Most common types of fraud in a selection of sectors

Sector Two most common types of fraud

Banking and Financial Services Corruption, Cash on Hand

Government and Public Administration Corruption, Billing

Health Care Corruption, Billing

Education Corruption, Billing

Insurance Corruption, Skimming

(f) The report found that organisations rely heavily on an external audit of financial statements to identify fraud, with 81.4 per cent of organisations saying that this is one of their fraud detection strategies. This is in contrast to the very low rate of fraud detection by the external audit process. Other fraud detection strategies include having a code of conduct (77.4%) and having an internal audit department. From Figure 26, it is clear that many organisations have multiple strategies in place aimed at detecting workplace fraud.

(g) The survey does not provide the profile of a typical fraudster but we are able to build our own profile based on the highest frequency of each of the available parameters, which shows: male (66.8%); aged 41 to 45 years (frequency rather than value) (18.1%); employed in the accounting department (17.4%); non-management employee (frequency) (42%); 12 months to detect the fraud (for non-management employee); acting alone (54.9%); involved in corruption of billing (false invoicing) schemes (around 22% each); in role for between 1 and 5 years (40.7%); no prior criminal history (86.6%); and exhibiting signs of living beyond their means (43.3%).

(h) Males are more commonly associated with workplace fraud incidents according to the survey, with 66.8 per cent of offenders being male (this is consistent with the other Report to the Nations surveys published in recent years). Representation of males in fraud cases varies across different regions. Males also are responsible for a higher median value of loss, whichis in part due to a higher proportion of males who commit fraud being in management or owner/executive positions. Males also exhibit different behavioural red flags than females, with fewer males than females committing fraud because of financialdifficulties.

Question 3.2

Please access the Australian Institute of Criminology report, Australian Crime: Facts & Figures: 2013 (AIC 2014), available online at: http://aic.gov.au/publications/current%20series/facts/1-20/2013.html.

Go to the section Fraud and deception-related crime in Chapter 2 (located after Figure 27).

(a) Review Table 5. Has the reported rate of fraud been increasing or decreasing in the last 10years?

(b) What factors do you think might be effecting a change in reporting rates?

(c) What proportion of detected fraud cases are reported to the police?

(a) The table shows a steady decline in the rates of reported fraud over the last 10 years, butfor the first time since 200405, there was an increase in reported rates in 201112. The survey notes that the increase in 20112012 may be due to changes to counting rules rather than an increase in reported offences (AIC 2014, p. 35). This decline over the last 10 years (other than 20112012) is at odds with the recent estimates and surveys that all talk about an increase in fraud not a decrease. It is arguable that the decline in reporting rates is just thata decline inthe rate of fraud reported rather than a decline in the number of cases.

(b) Depending on the jurisdiction, reporting fraud to the police or other law enforcement agencies may not be mandatory. That leaves open the question of whether business is less inclined to report such matters to law enforcement than they once were. Some of the reasons why business crime victims may be inclined not to report business crimes to law enforcement agencies are as follows: a wish to avoid negative publicity; a sense that the organisation has nothing to gain; fears that the investigation will involve the organisation unduly in a protracted legal

proceeding; and fears that criminal action against the perpetrator will adversely affect any civil

proceedings taken by the victim.

(c) The report notes that Fraud is believed to be one of the most under-reported offences, with fewer than 50 percent of incidents being reported to police or other authorities (AIC 2014, p. 34). This is similar to the data set out in Report to the Nations on Occupational Fraud and Abuse (ACFE 2014).

Question 3.3

What do you think the role of the forensic accountant would be in investigating bribery and corruption in cases like the AWB and Siemens?

The forensic accountant investigating a business crime, such as bribery and corruption, is focused on capturing and analysing evidence. This will involve: searching for and capturing relevant evidence; identifying witnesses to interview; interviewing witnesses; analysing bank records (both in terms of potential payer and potential receivers of

bribepayments); reviewing electronic communications; reviewing social media to look for relationships between the various parties; preparing relationship charts; analysing all evidence (including the oral evidence of witnesses); and reporting.

Question 3.4

What controls or other initiatives could a business implement to reduce the risk of its staff or agents becoming involved in corruption?

There are a number of controls and initiatives that organisations can take to counter the risks ofcorruption: develop and implement a corruption control plan; develop and implement a communication program; enhance probity and contracting procedures; install a program of alternative avenues for reporting suspicions of corruption; and opening channels of communication with customers, vendors and other third parties.

In relation to enhanced probity and contracting procedures, organisations should ensure that they have a policy of rotation so that their own personnel do not establish an improper association with a supplier, customer or other business partner through an association that has continued for too long.

Question 3.5

(a) What is the objective of money laundering?

(b) What sources of evidence would you consider in an investigation of money laundering activity?

(a) The objective of money laundering is to enable people with a beneficial interest in the proceeds of criminal activity to enjoy the fruits of their criminal conduct while at the same time satisfactorily accounting for the source of those funds to government investigation and regulatory bodies. Without money laundering, the proceeds of large criminal activity would not be available to the criminals who generated it as they would not be able to demonstrate the legitimacy of the income.

(b) Investigations could include: examining the bank records of the subject of the investigation; examining the bank records of a business entity used as a vehicle to launder criminal

proceeds; considering legitimate sources of income of the subject of the investigation; and preparing an asset betterment statement (see later in this module) aimed at identifying

an increase in assets thatcannot be accounted for by income from legitimate sources.

Question 3.6

You have been engaged by a company to investigate an alleged workplace fraud. The allegation is that a member of staff has been diverting payments from a client to their own personal bank account rather than depositing them into the company bank account.

(a) What documents would you request?

(b) What, if any, other sources of evidence would you seek to obtain?

(a) There would be a chain of records and documents held by the company, and which are the property of the company, that can be sourced for analysis. These would include: accounting records disclosing the services rendered and the subsequent billing history

ofthe company to the client(s); and accounting records of payments received from the client company, including bank

statements of the company.

These internal company records can be analysed to find out, by careful reconciliation, thecorrect level of billing to the client and the correct level of payments receivedallowingfor an accurate calculation of any difference.

Assuming the client company is willing to assist in the investigation, that entity should be able to provide copies of their records showing receipt of bills and their payments. Matchingthese records would disclose funds: yet to be paid; paid and received; and paid and not received by your client.

These records would normally be made available to the investigator on request.

It then may be necessary to seek a court order to obtain the banking records of the employee. This may be possible in a situation where you are able to gather sufficient evidence to present to a court.

(b) Other sources of evidence you may seek could be: information gained through interviews with the staff member and other employees; computer-based data from computers operated by the employee at your client company; computer-based data from the computer of the employee (subject to a court order); and telephone records held by the company for telephones used by the employee.

Question 3.7

Go to: http://www-03.ibm.com/software/products/en/analysts-notebook/ for an online demonstration of the capability of the Analysts Notebook.

How do you think Analysts Notebook would assist in preparing a forensic accountants report in a business crime investigation?

The Analysts Notebook would assist in preparing a forensic accountants report in a business crime investigation by showing: relationships between individuals, corporations and other parties; timelines of events; and movement of funds between various relevant parties.

Question 3.8

Payroll fraud (involving the payment of salary and wages to a fictitious employee) will present adifferent range of accounting anomalies to accounts payable fraud.

List three accounting anomalies that may be associated with payroll fraud.

Payroll fraud presents accounting anomalies such as: casual staff who have not worked for some time, suddenly being included on the payroll; salary and wages for more than one employee being paid into a common account; alterations to time sheets or other payroll records to show more hours worked; alterations to hourly rates; and unusual claims for higher-duties allowances.

Question 3.9

Review the example data in the following table. Using both horizontal and vertical data analysis techniques, identify indicators of possible fraudulent activity for further investigation.

Horizontal analysis In Year 2 there has been an 80 per cent increase in salesthis would seem to be a dramatic

increase in sales volume in one year. At the same time, the cost of goods sold (COGS) has increased by 140 per centit would be

worthwhile making enquiries about why the increase in COGS is out of step with the increase in sales (you would expect them to be similar).

This could indicate: understated sales volume; overstated sales volume; theft of inventory; or false invoicing (payment for inventory not received).

However, it could also be due to other non-integrity related mattersfor example, a price reduction in order to compete in the market or obsolete inventory being written-off.

Vertical analysis Cost of goods as a ratio of sales volume is very high in this business for both Year 1 and

Year2 (50% and 67% respectively relative to an industry average of 42% of sales)this variation would need to be investigated and accounted for.

Selling and administration expenses appear to be quite high relative to the industry average.

Vertical analysis shows unusual variations in COGS which are worthy of further investigation. Thepotential fraud types are the same as for the horizontal analysis. Higher than expected selling and administration expenses as a proportion of sales could indicate manipulation, suchas false invoices for services associated with these functions. But again, there may be otherlegitimate reasons for the apparent anomalies.

Question 3.10

Consider the procurement/accounts payable system of an organisation that you have dealt with. List at least three fraud risks associated with that system.

Accounts payable/procurement fraud (otherwise referred to as false invoicing) is a commonly encountered workplace fraud. It is important to consider the risks in all their variations to ensure that an accurate assessment of the risks confronting the business can be achieved. So, for example, when conducting a fraud risk assessment, the risk would not be limited to a generic accounts payable fraudit would need to include as many of the variations as listed below that apply to the business under review.

False invoicingin collusion with a genuine suppliergenerating an invoice for: inventory not provided; non-inventory goods or services not provided.

False invoicingsomeone masquerading as a genuine suppliergenerating an invoice for: inventory not provided; non-inventory goods or services not provided.

False invoicingbogus suppliergenerating an invoice for: inventory not provided; non-inventory goods or services not provided.

Fraudulent undersupply of ordered inventory by the supplier. Corrupt relationship with suppliers:

inventory; and non-inventory.

Question 4.1

Explain the issues with accounting for state-owned assets on an historical cash basis (which is often done using a cash rather than an accrual system).

Currently, accounting for state-owned asset sees many governments recognising these assets at historical cost. Further, many make do with cash accounting rather than accrual accounting.

Accounting for state-owned assets at historical cost has implications for the decision usefulness of the balance sheet. This is because the historical cost of assets is merely a historical record of the financial sacrifice made to construct it. The historical cost, particularly if incurred long ago, isnot a relevant measure of the future economic benefits expected to be derived from using the asset. In addition, it may not require the recognition of other assets controlled by governments; for example, land under roads or mineral resources.

There may also be implications for the comparability of financial statements that contain such assets because the financial statements may include costs relating to assets acquired at different points in time. Also, ratios would be distorted by the comparison of current income with a historical cost, in light of changes in the purchasing power. In this regard, historical cost has been criticised on the grounds that it aggregates costs incurred at various points in time as though they are equivalent in economic terms. However, allowing for the time value of money, thepresumption is open to criticism.

The impact of cash accounting is that obligations are only accounted for when the bill is received rather than when the obligation is incurred. This helps to disguise weak finances and also has implications for the decision usefulness of the financial statements.

Question 4.2

(a) What are special purpose entities (SPEs)?

(b) How could an unconsolidated SPE be used to hide the fall in value of investments?

(c) How might the application of IFRS 10 Consolidated Financial Statements change how SPEsare accounted for?

Note: You are not required to have or to apply a detailed knowledge of IFRS 10 in answering this question.

(a) Special purpose entities (SPEs) are legal or accounting entities that are treated as separate from the reporting entity. For example, if a company establishes a limited partnership to conduct part of its business and accounts for the partnership separately from the company, then the partnership is an SPE. The business conducted through an SPE usually has a different nature from the business of the main company. It is usually narrow in focus, temporary or specific. For example, a company might use a partnership to own an asset and borrow money against that asset.

(b) If the assets and liabilities of the SPE are not included in the companys consolidated financial statements, it is off-balance sheet. If the assets owned by the SPE fell in value, the decline would not be disclosed in the companys financial statements. This lack of disclosure is one advantage of SPEs for those who do not want others to know about a fall in asset values orthe existence of a liability.

(c) IFRS 10 Consolidated Financial Statements has a revised definition of control. Applying the new definition requires significantly more judgment to determine whether an entity should be consolidated. An entity needs to consider whether control exists, particularly when the ownership interest is less than 50 per cent. Further, it needs to assess whether they have the power to direct activities that significantly affect returns. The assessment under IAS 27 was based on the power to govern the financial and operating policies.

The new requirements create a greater need to consider both the entitys holdings and rights, and the holding and rights of the other shareholders, to determine whether the entity has the necessary control.

Question 4.3

What gives rise to liquidity risk in the banking system?

A mismatch between the duration of deposits and loans gives rise to liquidity risk.

A substantial proportion of customer deposits are at call, which means that depositors may withdraw their funds at any time without penalty. Loans are provided for a much longer duration; for example, a mortgage may be advanced for 25 years or longer.

Liquidity risk is inherent in the banking business model, and managing this risk well is central to the business of banking.

Question 4.4

What are the two main ways that a bank can manage liquidity risk?

There are a number of possible techniques for managing the liquidity risk, but the most important two are: Maintaining the trust that depositors have in the banking system in general and in a

given bank, so as to minimise the probability of a bank run occurring. This requires prudent management.

Maintaining a sufficient base of available liquid funds to meet the daily obligations of the bank. This level will vary, and banks estimate the level of reserve funds required based on their particular circumstances.

Question 4.5

What were the key causes of the 2008 liquidity crisis?

The causes of the liquidity crisis in 2008 were brewing over from the preceding decade, and can be broadly grouped into the following categories:

1. Dramatic loan growth beyond available core deposit funding, making the banking system more vulnerable to shocks, and resulting from the following process: Significant growth in demand for lending products, including amongst the US sub-prime

borrowers. Significant proportion of bank funding sourced via nervous wholesale funding. Banks engaging in the trade of complex structured products, which allowed banks to

further expand their balance sheets and take on higher risks. Perception that bank assets, such as securitised mortgages, were liquid, and high-quality

assets, reinforced by robust credit ratings (which later proved to be overly optimistic).

2. Financial institutions holding insufficient capital and inadequate liquidity buffers: This became apparent with the benefit of hindsight.

3. Inadequate risk management practices: Corporate governance, market transparency and quality of supervision were found to be

lacking, in hindsight. In particular, the focus of risk management had been firm-specific, and there was a lack of

appreciation of how a system-wide shock would play out under stress.

Question 4.6

What were the causes of the eurozone sovereign debt crisis?

The eurozone sovereign debt crisis was caused by significant ongoing budget deficits and a build-up of very high debt levels by a number of governments in the eurozone.

The average level of debt as a percentage of GDP in the eurozone reached 79 per cent in 2009. Even before the Global Financial Crisis, debt levels were already high, with the average level of debt as a percentage of GDP in the eurozone at 68 per cent, 8 per cent higher than the maximum level stipulated by the EU agreement of 60 per cent.

No actions were taken against EU member states which breached agreed debt ceilings, and a number of EU member states took advantage of this to finance their ongoing expenditure with debt which was relatively cheap at the time.

The build-up of high debt levels was caused by consistent budget deficits (the difference between a governments tax receipts and its spending), which meant that should a government lose access to cheap debt, it would need to take drastic measures to cut its expenditure, orincrease taxes, in order to be able to balance its budget.

A number of EU members became very vulnerable to financial shocks. The high debt levels and high budget deficits meant that a sudden increase in interest costs would place significant additional burden on those countries, and loss of access to reasonably priced debt would expose governments to bankruptcy risk (i.e. an inability to meet their payment obligations). This is what happened to Greece and a number of other countries in the eurozone.

Question 4.7

Why did the revision of the Greek budget deficit trigger the sovereign debt crisis?

While there is no one correct answer to this question, the following is a reasonable hypothesis: Greece was the EU country most vulnerable to financial shocks, as it had the highest

level of debt as a percentage of GDP and consistently ran very high current account and budgetdeficits.

When Greece revised its budget deficit estimate for 2009 from 6 per cent to 12.7 per cent, it undermined the credibility of the Greek economic forecasting and reduced investor confidence in the Greek economy. Investors started to question whether Greeces budget deficit was likely to be revised up again later, whether Greeces debt-funding model was sustainable and whether other countries would also be revising their budget deficits, andexperience debt refinancing issues.

Risk premia on Greek and other European government bonds increased, increasing the likelihood of Greece and a number of other EU members defaulting on their debt, and creating a vicious cycle.

Question 4.8

What is contagion in the context of the eurozone sovereign debt crisis?

Contagion in the context of the eurozone sovereign debt crisis refers to the financial shocks which initially affected Greece and then proceeded to affect other economies in one or more of the following ways: Increase in the perceived likelihood of a financial crisis. Correlated increase in asset-price volatility. Correlations in asset-price movements which were not driven by fundamentals, but rather by

perception of risk and changes in risk.

Question 4.9

How could stronger regulations in banking and accounting lead to increased international protectionism?

Regulations relating to banking and accounting could disadvantage less-developed countries because their financial institutions and companies are less able to meet the international standards. For example, less-developed countries could have smaller economies, and a smaller proportion of their economies run by large businesses. Smaller businesses are less likely to issue shares to the public, and thus share markets are smaller and less developed. In addition, less-developed countries are unlikely to have laws that offer as much protection for investors if a company they invested in does not abide by the disclosure rules in accounting standards.

In addition, economies in less-developed countries could be more adversely affected when companies in other countries take action to meet the new regulations (e.g. by selling assets in thepoorer countries, or withdrawing their investments from companies in those countries).

Question 4.10

Islamic finance is claimed to be an ethical alternative to traditional finance practices. Reflect on the nature of this alternative and discuss how it is different from other ethical alternatives.

Ethical finance refers to any financing structure that is based upon non-financial criteria incorporating a social or a religious dimension. Conventional ethical finance mainly focuses on excluding investments in harmful industries (such as tobacco, weapon and environment polluting industries). It also promotes the proactive search for welfare-enhancing investments. See, for example: http://www.australianethical.com.au/what-ethical-investment. As a matter of principle, Islam also bans investment in industries that might harm a society, as discussed in Aban on investing in harmful business activities in the What is Islamic banking? section. Thisis where Islamic finance shares space with other ethical finance. Islamic finance, however, differs from other ethical alternatives in that:(i) Islams universe of banned industries is relatively bigger (it includes industries that might

not be considered harmful by other ethical alternatives, such as the entertainment industry); andthat

(ii) Islams ethical concerns extend to contractual relationships underlying business exchanges, as evident from the prohibition of riba and gharar (as discussed in What is Islamic banking?).

Question 4.11

(a) What are some of the disadvantages of operating leases and how could they be overcome in a sharia-compliant manner?

(b) Conventional accounting practices mostly rely on interest-based financing. Islamic finance shifts the focus to asset-based financing. Do you think Islamic finance products require a different accounting treatment to interest-based products?

(a) The ownership of the asset in an operating lease remains with the lessor (bank) and at the end of the lease period the bank may then lease the asset out to another customer or sell it in a secondary market. It might be difficult to do so when the asset is not in a good shape or when there is not an active secondary market for certain specialised equipment. One way to deal with the problem is to set the lease period equal to economic life of the asset. Theasset in this case is given to the lessee as a gift or sold at a minimal price at maturity, as in the contract of ijara muntahia bitamleek or AITAB. Another sharia-compliant alternative could be to use the diminishing musharaka structure where the lessee gradually purchases units of theassets until she or he completely owns the asset.

(b) Asset-based financing is by nature different from debt-based financing as it underlies a different risk structure. This obviously implies that, from an accounting point of view, assets and liabilities need to be treated differently. Islamic banks, for example, do not guarantee safe return of the principal amount, as holders of these accounts share in the profit or loss. Conventional banks on the other hand guarantee the principal amount along with interest payment. Similarly, conventional home financing is simply an interest-based loan, whereas Islamic home financing on diminishing partnership basis, for example, represents diminishing ownership in the asset, which is subject to price risk. These differences in risk structures therefore require different accounting treatments.

There is agreement among advocates and practitioners of Islamic financial services that it is not appropriate to use accounting standards and guidelines issued by conventional bodies, such as the IASB, for Islamic finance products without appropriate adjustments. Thisis seen as an important step towards adequate comparability and transparency of financial statements, and proper presentation and disclosure to reflect the true nature of how IFIs (Islamic financial institutions) operate. These adjustments are done by AAOIFI (Accounting and Auditing Organisation for Islamic Financial Institutions), which was established in 1991 with a mandate to issue sharia accounting and auditing standards that are voluntarily adopted by IFIs.

Question 4.12

Describe how the disclosures in an integrated report show the flow and transformation of capitals through the organisation.

Disclosures in the integrated report show the flow and transformation of capitals through the organisation. Every organisation requires one or more of the capitals as inputs to its business model. These capitals are then consumed or transformed by activities that produce a range of outputs. Whether these outputs create or destroy value depends upon the outcomes they generate. For instance, manufacturing a product that appeals to customers will create demand and generate revenue; whether that demand is profitable depends on the market price that the product can command and the cost structure in the entire supply chain. In the longer term, factors such as customer satisfacti