Professional Accountant

In this supplementary Section B pilot paper there are three 25-mark questions, with answers and marking schemes.

Note that to answer each 25-mark question would require 45 minutes of standard writing time plus three minutes of standard reading and planning time.

Professional Pilot Paper – Essentials module

Pape

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The Association of Chartered Certified Accountants

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Supplementary Section B – TWO questions ONLY to be attempted

1 TheboardofJHGraphics,adesignandartworkcompany,wasdebatinganagendaitemonthepossibleadoptionofacorporatecodeofethics.JennyHarris,thechiefexecutiveandmajorityshareholder,wasaleadingsupporteroftheidea.ShesaidthatmanyofthelargecompaniesintheindustryhadadoptedcodesofethicsandthatshethoughtitwouldsignaltheimportancethatJHGraphicsplacedonethics.Shealsosaidthatshewaspersonallydrivenbyhighethicalvaluesandthatshewantedtoexpressthesethroughherworkandthroughthecompany’sactivitiesandpolicies.

AlanLeroy,thecreativedirector,explainedthathewouldsupporttheadoptionofthecodeofethicsaslongasithelpedtosupportthecompany’slong-termstrategicobjectives.Hesaidthathecouldseenootherreasonasthecompanywas‘notacharity’andhadtomaximiseshareholdervalueaboveallotherobjectives.Inparticular,hewaskeen,asashareholderhimself,toknowwhatthecodewouldcosttodrawupandhowmuchitwouldcosttocomplywithitoverandaboveexistingcosts.

Jennyargued thathavingacodewouldhelp to resolve someethical issues,oneofwhich, shesuggested,wasaproblemthecompanywashavingoveraparticularimageithadrecentlyproducedforanewspaperadvertisement.Theimagewasproducedforanadvertisingclientandalthoughtheclientwaspleased,ithadoffendedaparticularreligiousgroupbecauseofitscontentanddesign.

Whenitwasdiscoveredwhohadproducedthe ‘offending’ image,somereligiousleaderscriticisedJHGraphicsforbeinginsensitiveandoffensivetotheirreligion.Forabrieftime,theeventswereamajornewsstory.Aspoliticians,journalistsandothersdebatedtheissuesinthemedia,theboardofJHGraphicswasinvolvedinintensediscussionsandfacedwithadilemmaastowhetherornottoissueapublicapologyfortheoffencecausedbytheimageandtoasktheclienttowithdrawit.

Alanarguedthathavingacodeofethicswouldnothavehelpedinthatsituation,astheissuewassocomplicated.Hisviewwasthatthecompanyshouldnotapologisefortheimageandthathedidn’tcareverymuchthattheimageoffendedpeople.Hesaiditwasbringingthecompanyfreepublicityandthatwasgoodforthebusiness.Jennysaidthatshehadsympathyfortheviewpointoftheoffendedreligiousleaders.Althoughshedisagreedwiththem,sheunderstoodtheimportancetosomepeopleoffirmly-heldbeliefs.Theboardagreedthatasthereseemedtobeargumentsbothways,thedecisiononhowthecompanyshoulddealwiththeimageshouldbeJenny’saschiefexecutive.

Required:

(a) Analyse Jenny’s and Alan’s motivations for adopting the code of ethics using the normative-instrumental forms of stakeholder theory. (8marks)

(b) Assess Jenny’s decision on the possible apology for the ‘offending’ image from conventional and pre-conventional moral development perspectives. (4marks)

(c) Explain and assess the factors that the board of JH Graphics might consider in deciding how to respond to the controversy over the offending image. (10marks)

(d) Comment on the legitimacy of the religious group’s claims on JH Graphics’s activities. (3marks)

(25 marks)

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2 TheboardofFranks&Fisher,alargemanufacturingcompany,decidedtosetupaninternalcontrolandauditfunction.Theproposalwastoappointaninternalauditoratmid-managementlevelandalsotoestablishaboardlevelinternalauditcommitteemadeupmainlyofnon-executivedirectors.

Theinitiativetodosowasdrivenbyarecentperiodofrapidgrowth.Thecompanyhadtakenonmanymoreactivitiesasaresultofgrowthinitsproductrange.Theboarddecidedthattheincreasedsizeandcomplexityofitsoperationscreatedtheneedforgreatercontroloverinternalactivitiesandthataninternalauditfunctionwasagoodwayforward.The need was highlighted by a recent event where internal quality standards were not enforced, resulting in thestoppageofaproduction line forseveralhours.Theproductiondirectorangrilydescribed thestoppageas ‘entirelyavoidable’andthefinancedirector,JasonKumas,saidthatthestoppagehadbeenverycostly.

MrKumassaidthattherewereproblemswithinternalcontrolinanumberofareasofthecompany’soperationsandthat therewasagreatneed for internalaudit.Hesaid thatas theheadof thecompany’saccountingand financefunction,thenewinternalauditorshouldreporttohim.Thereasonsforthis,hesaid,werebecauseasanaccountant,hewasalreadyfamiliarwithauditingprocedureandthefactthathealreadyhadinformationonbudgetsandother‘control’informationthattheinternalauditorwouldneed.

Itwasdecidedthatthenewinternalauditorneededtobeapersonofsomeexperienceandwithenoughpersonalitynottobeintimidatednordivertedbyotherdepartmentheadswhomightfindtheinternalauditsaninconvenience.Onedebatetheboardhadwaswhetheritwouldbebettertorecruittothepositionfrominsideoroutsidethecompany.Asecondargumentwasoverthelimitsofauthoritythattheinternalauditormightbegiven.Itwaspointedoutthatwhiletheboardconsideredtheroleofinternalaudittobeveryimportant,itdidn’twantittointerferewiththeactivitiesofotherdepartmentstothepointwheretheiroperationaleffectivenesswasreduced.

Required:

(a) Explain, with reference to the case, the factors that are typically considered when deciding to establish internal audit in an organisation. (10marks)

(b) Construct the argument in favour of appointing the new internal auditor from outside the company rather than promoting internally. (6marks).

(c) Critically evaluate Mr Kumas’s belief that the internal auditor should report to him as finance director. (4marks)

(d) Define ‘objectivity’ and describe characteristics that might demonstrate an internal auditor’s professional objectivity. (5marks)

(25 marks)

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3 SoniaTan,afundmanageratinstitutionalinvestorSentosaHouse,wasreviewingtheannualreportofoneofthemajorcompaniesinherportfolio.Thecompany,EasternProducts,hadrecentlyundergoneanumberofboardchangesasaresultofalackofconfidenceinitsmanagementfromitsmajorinstitutionalinvestorsofwhichSentosaHousewasone.TheproblemsstartedtwoyearsagowhenanewchairmanatEasternProducts(ThomasHoo)startedtopursuewhattheinstitutionalinvestorsregardedasveryriskystrategieswhilstatthesametimefailingtocomplywithastockmarketrequirementonthenumberofnon-executivedirectorsontheboard.

SoniarangEastern’s investor relationsdepartment toaskwhy itstillwasnot incompliancewith therequirementsrelatingtonon-executivedirectors.ShewastoldthatbecauseEasternwaslistedinaprinciples-basedjurisdiction,therequirementwasnotcompulsory. ItwassimplythatEasternchosenot tocomplywiththatparticularrequirement.WhenSoniaaskedhowitsboardcommitteescouldbemadeupwithaninsufficientnumberofnon-executivedirectors,theinvestorrelationsmanagersaidhedidn’tknowandthatSoniashouldcontactthechairmandirectly.Shewasalsotoldthattherewasnolongerariskcommitteebecausethechairmansawnoneedforone.

SoniatelephonedThomasHoo,thechairmanofEasternProducts.ShebeganbyremindinghimthatSentosaHousewasoneofEastern’smainshareholdersandcurrentlyowned13%ofthecompany.ShewentontoexplainthatshehadconcernsoverthegovernanceofEasternProductsandthatshewouldlikeThomastoexplainhisnon-compliancewithsomeofthestockmarket’srequirementsandalsowhyhewaspursuingstrategiesviewedbymanyinvestorsasveryrisky.ThomasremindedSoniathatEasternhadoutperformeditssectorintermsofearningspershareinbothyearssincehehadbecomechairmanandthatratherthanquestionhim,sheshouldtrusthimtorunthecompanyashesawfit.HethankedSentosaHouseforitssupportandhungupthephone.

Required:

(a) Explain what an ‘agency cost’ is and discuss the problems that might increase agency costs for Sentosa House in the case of Eastern Products. (7marks)

(b) Describe, with reference to the case, the conditions under which it might be appropriate for an institutional investor to intervene in a company whose shares it holds. (10marks)

(c) Evaluate the contribution that a risk committee made up of non-executive directors could make to Sonia’s confidence in the management of Eastern Products. (4marks)

(d) Assess the opinion given to Sonia that because Eastern Products was listed in a principles-based jurisdiction, compliance with the stock market’s rules was ‘not compulsory’. (4marks)

(25 marks)

End of Question Paper

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Answers

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Supplementary Section B AnswersProfessional Accountant

1 (a) Thenormative-instrumentaldistinctiondescribestwodifferentapproachesorunderlyingethicalmotivations.Oftenappliedtothewaysinwhichorganisationsbehavetowardsstakeholders,itcanbeappliedtoanysituationinwhichethicalmotivationsarerelevant.

Inthecase,JennyHarrisisdemonstratinganormativeapproachtoadoptionofthecorporatecodeofethics.Itisevidentfromwhatshesaysthatsheisinternallymotivated.Shedescribedherselfaspersonallydrivenbyhighethicalvaluesandappearstoseeethicalbehaviourasanendinitself.Shetendsnottotakethebusinessimplicationsoftheproposedcodeintoaccountandtherebytendstowardsthealtruisticratherthanthestrategic.Herattitudeisinformedprimarilybyinternalmotivationratherthenthepursuitofexternalreward.

Alan,bycontrast,demonstratesinstrumentalcharacteristics.Heappearstobeprimarilymotivatedbybusinessperformanceandseestheethicalcodeasameanstofurtherotherobjectives(notasanendinitself).Hisattitudetothecodeofethicsisunderpinnedbyquestionsaboutwhatcanbegained,forthebusiness,ofthecode’sadoption.Accordingly,heisstrategicratherthanaltruisticinhimmotivation.

(b) ThisquestiondrawsupontwoofKohlberg’sthreelevelsofmoraldevelopment. Inparticular, itaskshowthedecisiononpossible apology for andwithdrawal of the imagewould vary depending onwhether Jenny, as the chief executive of JHGraphics,makesconventionalandpre-conventionalethicalassumptions.

Theconventionalethicallevelviewsthemoral‘right’accordingtowhetheritiscompliantwiththeexistinglegalandregulatoryframeworksand/ornormsofthesocietyorcultureinwhichthedecisionistakingplace.Iftheimagewasgenerallyacceptableandoffensiveonlytothereligiousgroupinquestion,itcanprobablybeassumedthatitwasotherwiseculturallyinoffensive.Itwascertainlynotillegalasnolawswerebroken.Fromtheconventionallevel,therefore,thereisnocaseforwithdrawingtheimage.

Thepreconventional moraldevelopment level views themoral rightas thatwhichattracts the leastpunishmentand themostreward.Whereasinthecaseofpersonalmorality,suchrewardsandpunishmentsarelikelytobemadeatthepersonallevel,theissuesinvolvedaremorecomplexfororganisations.Preconventionalmoralitymightask,forexample,whetherthecompanyislikelytoberewardedorpunishedbykeepingorwithdrawingtheimage.Inthiscontext,rewardsorpunishmentsarelikelytobeviewedineconomictermsorintermsofboycottsorincreasedbusinessarisingfromthepublicity.

(c) ThisisacomplicatedethicalsituationandtheboardofJHGraphicswillbeconsideringseveralfactorsinattemptingtocometoadecisionoverwhattodowiththeoffendingimage.

Onefactorlikelytobeconsideredisthepossibleeffectsofthedisputeonthereputationofcompany.Itisnotatallcertainthattherowwillbedamaging.Insomeindustries,possiblyincludinggraphicdesign,tobeseentobecapableofproducingprovocativeandchallengingimagerycouldbeadvantageouswhereasinothersituationsitmaybeadverse.

Thecompanywillalsobelikelytotakeintoaccountthelevelanddirectionofpublic/politicalopinionandsupport.Thecasementionsthatthecontroversywasamajornewsstoryanditwouldbenecessarytofindoutwhethertheindependentcoverageof the issuewasgenerallycriticalorgenerally favourableofJHGraphics. If themajorityofpublicopinionwasagainstJHGraphicsand supportiveof the religious critics, thatmaybe influential in JHGraphics considering thewithdrawal of theimage.

Considerationshouldalsobegiventotheeconomicimportanceoftheadvertisement/clienttoJHGraphics.Thecasesaysthattheclientishappywiththeimage(andpresumablyuntroubledbythereligiouscontroversy)butfromJHGraphics’spointofview,thequestionconcernshowmuchtheycouldpossiblyloseiftheyunilaterallywithdrewtherightstousetheimageandtherebyupsettheclient.

Theboardwouldalsobe likely toconsider thepossibledirect influenceofoffendedreligiousgroupsonJHGraphics.TheMendelowmap,whichmeasures the influenceof a stakeholderby considering itspowerand interest,maybehelpful indetermininghowinfluentialthereligiousgroupislikelytobeonthewellbeingofJHGraphics.Isit,forexample,largeandpotentiallyinfluential(e.g.intermsofmobilisingopinion)orsmallandunlikelytohaveaneffect?

ThedirectorsshouldalsoassessthevalueofalltheunexpectedpublicitytoJHGraphics?MrLeroyisclearlyoftheviewthatis“wasbringingthecompanyfreepublicityandthatwasgoodforthebusiness”.WhilstsuchaprofileraisingcontroversymightbedamagingtoJHGraphics,itmightalsobeadvantageous,especiallyifbeingseenasbeingwillingto‘pushtheboundaries’oftasteanddecencyisapotentialsourceofcompetitiveadvantage.ThepublicityreceivedisobviouslyfarmorethanthecompanycouldaffordintermsofbuyingpublicitybutthisneedstobeweighedagainstwhetherthepublicityisgoodforJHoradverse.

Thenationalcultureinwhichthedecisionistakingplacecouldhaveaninfluenceontheoutcome.Theintensityofthedebateovertheimportanceofnotcausingoffencewillvarydependinguponthenationalculture,whichcan,inturn,influencedandunderpinnedbyhistoricalandreligiousculture.

(e) Thisquestiontouchesonthedebateoverstakeholderrecognitionandthelimitsofcorporateaccountabilityandresponsibility.Itisinthenatureofanystakeholderthattheymakea‘claim’upontheactivitiesoftheorganisation.Thedebateisoverwhetherthatclaimisrecognisedandwhether,accordingly,thenatureoftheclaimistakenintoaccountindecision-making.

Inthisinstance,itisrelativelyuncontroversialtorecognisethereligiousgroupasastakeholder(Freeman’sdefinitiondefinesastakeholderasanentitythatcan‘affectorbeaffectedby…’).Theperceivedlegitimacyoftheclaimdependsonwherethelimit

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ofaccountabilityisdrawnandthereasonablenessoftheclaim.Thereisacontinuumoflegitimacywith,perhaps,shareholdersbeing‘entirelylegitimate’inmakingaclaimatoneextremeandterroristsas‘entirelyillegitimate’attheother.Thelegitimacyofthereligiousgroup’sclaim(theyareunlikelytohaveadirecteconomicrelationshipwithJHGraphics)dependsuponwherethatlineisdrawn.Itmightalsobepointedoutthatoffencetakenbyastakeholderdoesn’tnecessarilyimplyaresponsibilitytowardsthestakeholder.

2 (a) Thereisanobviouscostinvolvedinsettingupinternalauditinanorganisationandsoitistypicaltoaskwhatfactorssignifytheneedforinternalauditbeforeoneisestablished.Severalfactorsinfluencetheneedforinternalaudit:

Thescale,diversityandcomplexityofthecompany’sactivities.Thelarger,themorediverseandthemorecomplexarangeofactivitiesis,themorethereistomonitor(andthemoreopportunitythereisforcertainthingstogowrong).

Thenumberofemployees.Asaproxyforsize,thenumberofemployeessignifiesthatlargerorganisationsaremorelikelytoneedinternalaudittounderpininvestorconfidencethansmallerconcerns.

Cost-benefitconsiderations.Managementmustbecertainofthebenefitsthatwillresultfromestablishinginternalauditanditmustobviouslybeenseentooutweighthecostsofdoingso.

Changes in theorganisational structures, reportingprocessesorunderlying informationsystems.Any internal (orexternal)changeiscapableofchangingthecomplexityofoperationsand,accordingly,therisk.

Changesinkeyriskscouldbeinternalorexternal innature.Theintroductionofanewproduct,enteringanewmarket,achangeinanyofthePEST/PESTELfactorsorchangesintheindustrymighttriggertheneedforinternalaudit.

Problemswithexistinginternalcontrolsystems.Anyproblemswithexistingsystemsclearlysignifytheneedforatighteningofsystemsandincreasedmonitoring.

Anincreasednumberofunexplainedorunacceptableevents.Systemfailuresorsimilareventsareacleardemonstrationofinternalcontrolweakness.

The case on Franks& Fisher highlights three factors thatwould underpin its need to establish internal audit. There hasbeengrowthinnumberofproducts,activitiesand(presumably)processesinrecenttimes,therebycomplicatingtheinternalenvironmentand introducingmoreopportunity for internalcontrol failure.Therehavebeenproblemswith internalcontrolsystems(thelinestoppageandMrKumas’scommentthat,“problemswithinternalcontrolinanumberofareas”).Finally,therewasanunacceptableevent(thelinestoppage)thatwasattributedtopoorinternalcontrol.MrKumasconfirmedthiswithhisopinionabouta‘greatneed’forinternalaudit.

(b) Inpractice,adecisionsuchas thisonewilldependonanumberof factors including thesupplyof requiredskills in theinternalandexternaljobmarkets.Inconstructingthecaseforanexternalappointment,however,thefollowingpointscanbemade.Primarily,anexternalappointmentwouldbringdetachmentandindependencethatwouldbelesslikelywithaninternalone.Firstly,then,anexternalappointmentwouldhelpwithindependenceandobjectivity(avoidingthepossibilityofauditorcapture).Heorshewouldowenopersonalloyaltiesnor‘favours’frompreviouspositions.Similarly,heorshewouldhavenopersonalgrievancesnorconflictswithotherpeoplefrompastdisputesorarguments.Somebenefitwouldbeexpectedfromthe‘newbroom’effectinthattheappointmentwouldseethecompanythroughfresheyes.Heorshewouldbeunawareofvestedinterests.Heorshewouldbelikelytocomeinwithnewideasandexpertisegainedfromothersituations.Finally,aswithanyexternalappointment,thepossibilityexistsforthetransferofbestpracticeinfromoutside–anetgaininknowledgeforFranks&Fisher.

(c) ThefirstthingtosayisthatMrKumas’sbeliefisinappropriateanditwouldbeanunacceptablefortheinternalauditortoreporttoadivisionaldirectorwhomightbethesubjectofaninternalaudit.Thereasonsputforwardinfavourofhisrequestarespurious.AllofMrKumas’sinformationandexpertisewouldbeavailabletotheinternalauditorinanyevent,withorwithouthisoversightofthefunction.ReportingtoMrKumaswouldbeaclearthreattotheindependenceoftheinternalauditorashe/shewouldnotbeobjectiveinauditingtheaccountingandfinancedepartment.TheadvicefromrelevantcodesandguidelineswouldalsostronglycounselagainstMyKumas’sproposal.TheCadburycodeistypicalwhere,point(g)underthe‘roleoftheinternalauditcommittee’emphasisedtheindependenceoftheinternalauditfunctionfrommanagement.MrKumas’srequestshouldberefused.

(d) Objectivity is a state or quality that implies detachment, lack of bias, not influenced by personal feelings, prejudices oremotions.Itisaveryimportantqualityincorporategovernancegenerallyandespeciallyimportantinallauditsituationswhere,regardlessofpersonalfeeling,theauditormustcarryouthisorhertaskobjectivelyandwiththepurposeoftheaudituppermostinmind.TheIFACCodeofEthicsexplainsobjectivityinthefollowingterms(Introduction,clause16):“…fairandshouldnotallowprejudiceorbias,conflictofinterestorinfluenceofotherstooverrideobjectivity.”

Itthusfollowsthatcharacteristicsthatmightdemonstrateaninternalauditor’sprofessionalobjectivitywillincludefairnessandeven-handedness,freedomfrombiasorprejudiceandtheavoidanceofconflictsofinterest(e.g.byacceptinggifts,threatstoindependence,etc.).Theinternalauditorshouldrememberatalltimesthatthepurposeistodeliverareportonthesystemsbeingauditedtohisorherprincipal.Inanexternalauditsituation,theprincipalisultimatelytheshareholderandininternalauditsituations,itistheinternalauditcommittee(andthenultimately,shareholders).

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3 (a) Anagencycostisacostincurredbytheshareholderinmonitoringtheactivitiesofcompanyagents(i.e.directors).Agencycostsarenormallyconsideredas‘overandabove’existinganalysiscostsandarethecoststhatarisebecauseofcompromisedtrustinagents(directors).Inthiscase,theincreasedagencycoststhatarisearetheincreasedmonitoringand‘policing’coststhatSentosaHouse(Sonia)willincurbecauseoftheirregularbehaviourdescribedinthecase.

ThefirstproblemidentifiedisEastern’snon-compliancewithrelevantcodes/requirementsinrespectofnon-executivedirectorsand committee structure. There are an insufficient number ofNEDs to form the normal committee structure for a publiccompanywhichmeansthatSentosamayconsideritselftohavetomonitorsomeoftheriskstoEasternthatotherwisetheriskcommitteewouldundertake.Theinvestorrelationsdepartmentshowsevidenceofbeingunhelpfulanduninformed–anunfortunatecombinationoffailings.Thechairmanappearstobearrogantandpotentiallyuntrustworthy(hesawnoneedforriskcommitteeanddealtveryabruptlywithSoniawhenshecalled).Finally,thecompanyispursuingriskystrategieswithnoobviousexplanationastowhysuchstrategiesarenecessary.

Inthissituation,then,SentosaHousehasthechoiceofsellingitsholdinginEasternorincurringincreasedmonitoringcoststoensurethatitsowninvestors’interests,inturn,areadequatelyrepresented.

(b) Interventionbyaninstitutionalinvestorinacompanywhosestockitholdsisusuallyconsideredtoberadicalstepandnormallyrepresents a step change in agency costs for the investor. This caveat notwithstanding, it is an important ‘last resort’ forinstitutionalinvestorstohaveavailabletothemastheyseektoadequatelyrepresenttheinterestsoftheirowninvestors.

Thereareanumberofconditionsunderwhichitwouldbeappropriateforinstitutionalinvestorstointerveneinacompanywhosesharesitisholding.

Thefirstconditionisconcernsaboutstrategyintermsofproductssold,marketsserviced,expansionspursuedoranyotheraspectofthecompany’soverallstrategicpositioning.

Itsoperationalperformancemaygiverise,especiallyifthereareoneormoresegmentsthathaveconsistentlyunderperformedwithoutadequateexplanation.

Thethirdconditioniswhennon-executivedirectorsdonotholdexecutivemanagementtoaccount.Theremay,forexample,beevidenceofunaccountable ‘kitchencabinets’orcuriousexecutivedecisionsthatarenotadequatelychallengedbynon-executivedirectors.

Fourth,consistentorseriousfailureininternalcontrolswouldjustifyintervention,althoughthis,inturn,maybecomeevidentthroughoperationalunderperformance.Ongoingorunaddressedfailuresin,forexample,qualityassurance,healthandsafety,environmentalemissions,budgetarycontrolorinformationsystemsmightjustifyintervention.

Fifth,failingtocomplywiththerelevantcode,lawsorstockmarketrulesisthenextsituation.Ifthecompanyislistedinarules-basedjurisdiction,itisamatteroflawbutinaprinciples-basedcountry,complianceisonly‘optional’underthestockmarket’s‘complyorexplain’rules.Consistentorunexplainednon-complianceisliketobepenalisedbythemarket

Sixth, inappropriate remunerationpolicies, ifextremeorobviouslyself-serving,mightattract intervention.Suchasituationwouldnormallyalsosignifyafailureoftheremunerationscommitteewhichwouldmakeitadoublecauseforconcern.

Finally,apoorapproachtosocialresponsibilityisaconditionforpossibleintervention,especiallyifthereispublicly-availableevidencethatmightadverselyaffectthereputationofthecompany.

Withreferencetothecase,EasternProductsfailonseveralcountsthatmightencourageinstitutionalshareholderintervention.Firstly,itsfailuretocomplywithrelevantcode(particularlyonnumberofnon-executivedirectorsandlackofriskcommittee).Second,thenon-executivedirectorsarenotholdingexecutivestoaccountbecausethereisaninsufficientnumberofthem.Third,thereareconcernsaboutstrategy(whichisconsideredtobeveryrisky).

(c) Riskcommitteesareconsideredbestpracticebymostcorporategovernanceregimesaroundtheworldforanumberofreasons.Soniahas,forgoodreason,doubtsoverthecompetenceandgoodfaithofthemanagementofEasternProductsandariskcommitteemadeupofnon-executivedirectorscouldhelpherconfidenceinanumberofways.

Inthefirstinstance,theinformationsystemsputinplacetoprovideinformationfortheriskcommittee.Thiswouldgenerateawarenessofandfacilitatereviewofallrelevantrisksfordiscussionbytheriskcommittee,includingthosearisingfromthe‘veryrisky’strategy.

Itwouldreviewandassesstheeffectivenessofinternalcontrolsonrisk.Acommitteemadeupofindependent,non-executivedirectorswouldbringscrutinytoThomasontwofronts.ThereisevidencethatThomasmayberelativelyinexperienced,havingbeeninpostforonlytwoyears,andthewaythathedealtwithSonia’sentirelylegitimateenquiryshowssomeevidenceofimmaturityand/orimpatience.Nonexecutivepresencewouldbeabletochallengeandactasacounterweighttothisfailing.Non-executivedirectorswouldalsobringscrutinyofThomas’sleadershipoverstrategy,especially(inthecontextoftheriskcommittee)thewisdomofhis‘veryrisky’strategies.

(d) Theopinionshowsconfusionoverthemeaningoftheterm‘compulsory’.Whilstinaprinciples-basedjurisdiction,complianceisnotlegallycompulsory,itisrequiredforthestockmarketlisting.Accordingly,complianceiseffectivelycompulsoryifthecompanywishes to enjoy thebenefits of its listing.Companies in principles-based jurisdictions are subject to ‘comply orexplain’inthatnon-complianceneedstobeexplainedintermsofspecificareasofnon-complianceandthereasonfornon-compliance.ComplianceisalsonecessaryformarketconfidenceintheEasternProductsstockinthatthemarketwouldbelikelytodevalueastockthatwasaconsistentnon-complier.Finally,shareholdersandstockmarketsareentitledtochallengetheexplanationfornon-complianceiftheyaren’tsatisfiedwiththeexplanationgivenintheannualreport.

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Supplementry Section B Marking SchemeProfessional Accountant

1 (a) 1pointforeachrelevantpointmadeonnormativeuptoamaximumof4 1pointforeachrelevantpointmadeoninstrumentaluptoamaximumof4 (Maximumof8marks)

(b) 1markforevidenceofunderstandingthetermsuptoamaximumof2 1markforapplicationofeachtocaseuptomaximumof2 (Maximumof4marks)

(c) 2marksforeachrelevantpointmade (Maximumof10marks)

(d) 1marksforeachrelevantpointmade. (Maximumof3marks) (25 marks)

2 (a) 1markforeachfactoridentifiedandbrieflydiscusseduptoamaximumof7. 1markforeachfactorapplicabletoFranks&Fisheruptoamaximumof3. (Maximumof10marks)

(b) 1markforeachrelevantpointidentifiedandbrieflydescribed.. (Maximumof6marks)

(c) 1marksforeachrelevantpointmade (Maximumof4marks)

(d) 2marksfordefinitionofobjectivity 1markperrelevantcharacteristicidentifiedandbrieflydescribeduptoamaximumof3marks (Maximumof5marks) (25 marks)

3 (a) 2marksfordefinitionofagencycosts 1markforeachproblemidentifiedandbrieflydiscusseduptoamaximumof5 (Maximumof7marks)

(b) 1markforeachrelevantpointidentifiedandbrieflydescribedonconditionsforinterventionuptoamaximumof7. 1markforeachrelevantpointmadeonEasternHouseuptoamaximumof3. (Maximumof10marks)

(c) 1markforeachrelevantpointmade (Maximumof4marks)

(d) 1markforeachrelevantpointmade (Maximumof4marks) (25 marks)