ACCA P1 GOVERNANCE, RISK AND ETHICS

Tuition Note

For exams in June2015

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Content
CHAPTER1 CORPORATE GOVERNANCE ................................................................... 8
Corporate governance definition: .......................................................................................................................... 9
Purpose and objectives of governance................................................................................................................. 10
Fundamental concepts behind corporate governance: ........................................................................................ 11
Corporate governance specific theories: .............................................................................................................. 15
REGULATIONS: UK CORPORATE GOVERNANCE CODE OVERVIEW: .........................17
REGULATIONS: UK CORPORATE GOVERNANCE CODE DETAILS: .............................19
SECTION A LEADERSHIP OF THE BOARD ...............................................................19
A1: Unitary v two tier boards ............................................................................................................................... 20
A2: CEO/Chairman role split ................................................................................................................................ 23
A3: Chairman Role ............................................................................................................................................... 23
A4: NEDs .............................................................................................................................................................. 26
SECTION B: EFFECTIVENESS OF THE BOARD .........................................................30
Effectives of board ............................................................................................................................................... 31
SECTION C: ACCOUNTABILITY ..............................................................................35
What is internal control system? General issues .................................................................................................. 36
C1: Disclosure about internal controls ................................................................................................................. 38
C2: Best practise: [COSO framework or Turnbull report] ..................................................................................... 39
Turnbull Report(3 sessions) ................................................................................................................................. 41
C3: Audit committee ............................................................................................................................................ 43
SECTION D: DIRECTORS REMUNERATION .............................................................44

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Purpose/principles of remuneration .................................................................................................................... 45

Objectives: ........................................................................................................................................................... 46
Components: ....................................................................................................................................................... 47
SECTION E: RELATIONS WITH SHAREHOLDERS ....................................................48
Content of disclosure ........................................................................................................................................... 49
Mandatory v voluntary disclosure ....................................................................................................................... 50
Shareholders dialogue ......................................................................................................................................... 51
GLOBAL VARIETY ..................................................................................................53
Principles and rule based approach ..................................................................................................................... 54
SARBANES OXLEY ACT 2002 Key features: ........................................................................................................... 55
Family structure: [Normally in Asia]..................................................................................................................... 56
Insider structure:(2 tier board structure, usually in Europe) ................................................................................ 58
Public Sector Governance .................................................................................................................................... 59
CHAPTER2 RISK MANAGEMENT .............................................................................65
Management of risks: .......................................................................................................................................... 66
Role of risk manager: ........................................................................................................................................... 67
1. Identify risks: ................................................................................................................................................... 69
2. Risk assessment: .............................................................................................................................................. 74
3. Risk strategy: ................................................................................................................................................... 76
4. Implementation and monitoring risks: ............................................................................................................. 78
Governance standards on risks: ........................................................................................................................... 79
CHAPTER3 ETHICS ................................................................................................81

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STAKEHOLDER THEORY .........................................................................................82

Stakeholders identification: ................................................................................................................................. 82
Should company be responsible for the stakeholders? ........................................................................................ 85
Should company be accountable for the stakeholders? ....................................................................................... 86
ETHICS: .................................................................................................................91
WHAT IS ETHICS? .................................................................................................91
Absolutism VS Relativism .................................................................................................................................... 92
Deontology VS Teleology ..................................................................................................................................... 93
Relativism ............................................................................................................................................................ 94
Ethical stages: ...................................................................................................................................................... 95
Kohlberg model ................................................................................................................................................... 95
Grey, Owen & Adams .......................................................................................................................................... 97
HOW CAN YOU MAKE AN ETHICAL DECISION? ......................................................98
Follow hierarchy .................................................................................................................................................. 98
IFACs code of ethics ............................................................................................................................................ 99
Threats to objectivity: ........................................................................................................................................ 100
Ameriacan Accounting Association (AAA)7 steps ............................................................................................... 101
Tuckers 5 questions .......................................................................................................................................... 102
INTEGRATED REPORTING ...................................................................................103
Capitals .............................................................................................................................................................. 104
Elements in integrated reporting ....................................................................................................................... 105
Benefits of integrated reporting ........................................................................................................................ 106

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Challenges to integrated reporting .................................................................................................................... 107

BASIC REVISION SESSION: .................................................................................108
CORPORATE GOVERNANCE: .................................................................................108
Pilot paper Q4:................................................................................................................................................... 109
Answer to pilot paper Q4:.................................................................................................................................. 110
New Pilot paper Q3: .......................................................................................................................................... 113
Answer to pilot paper Q3:.................................................................................................................................. 114
June2008 Q4 ...................................................................................................................................................... 116
Answer to June2008 Q4: .................................................................................................................................... 118
DEC2010 Q3: ...................................................................................................................................................... 120
Answer to DEC2010 Q3: ..................................................................................................................................... 122
June2010 Q2: ..................................................................................................................................................... 124
Answer to June2010 Q2: .................................................................................................................................... 126
RISK MANAGEMENT QUESTIONS .........................................................................129
DEC2008 Q2 ....................................................................................................................................................... 130
Answer to DEC2008 Q2: ..................................................................................................................................... 131
Extra Risk Question: ........................................................................................................................................... 134
Answer to extra risk question: ........................................................................................................................... 135
ETHICS QUESTIONS ............................................................................................137
DEC2008 Q1 (a) .................................................................................................................................................. 138
Answer to DEC2008 Q1 (a) ................................................................................................................................. 140
DEC2008 Q4 ....................................................................................................................................................... 141

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Answer to DEC2008 Q4: ..................................................................................................................................... 142

June2009 Q2 ...................................................................................................................................................... 144
Answer to June2009 Q2: .................................................................................................................................... 146
June2012 Q1(b) .................................................................................................................................................. 148
Answer to June2012 Q1(b) ................................................................................................................................. 151

How to pass this paper?

The style of study note of this paper is very different from other papers.

Structure of the study note is divided into 3 chapters and for each chapter there
would be firstly, slides that tutors have used in class and secondly, detailed notes.

You need to watch those tuition as well as revision lectures and read the detailed
study note to reinforce your understanding of this subject.

Then you have to do the recommended past exam questions to ensure you can
pass your exam.

Good luck.

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Chapter1 Corporate governance

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Corporate governance definition:

corporte governance is a set of rules to ensure directors work in the best interest of
company.

Because directors are employed by shareholders and shareholders would not trust
directors unless some mesures are in place.

These measures include:

Give them benefit(salary, bonus, cars etc)

Monitor them(corporate governance)

Audit their fianncial statements(audit fees)

Because shareholders employ directors to work for them and hence directors are
called agents.

Those measures put in place would cost money and these are agency costs.
Directors are the primary agent of the shareholders whileas auditors are secondary
agent of shareholders.

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Purpose and objectives of governance

Board of Directors
To identify the rules of the game within which the company should operate to
sustain listing on the exchange.
To provide advice or guidance regarding best practice methods of managing
the enterprise.
To attract investment.

Shareholders
To create a safe environment within which they can invest.
To improve global investment opportunities.
To improve accountability and responsibility.

Governments
To provide a legal framework within which accountability can be exacted.
To create conditions for growth and employment.
To attract global investment and support the economy and society.

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Fundamental concepts behind corporate governance:

Without these fundamental concepts existence or if their existence is called into
question it is likely to affect the willingness of shareholders to invest and may lead
to governmental action to force the corporation to move in line with the types of
behaviour expected from it by society.

Integrity
People:
An individual can demonstrate integrity through operating to a high moral
code of ethics.
They would be honesty, fair-dealing, presenting information without any
attempt to bias opinion, ie, stick to the rules.

Systems:
This means system/financial reporting should be consistent and reliable.

Fairness
People should be treated equally.
What is defined as being fair is intangible however it relates to a societal
perception of what are expected norms of behaviour and a sense of fairness
between differing groups such as the fairness of directors pay in relation to
that received by employees.
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Judgment
Directors must ensure they have all the necessary information and
understanding in order to be able to make sensible business decisions that
improve companys performance.

Probity / honesty
This is not just telling the truth but it also means finding out and
investigating the truth, not ignoring it.

Independence
People who are checking others should be different from those people being
checked, ie, you cant check yourself.

Also it means when doing the work, you will only focus on standards rather
than other issues, ie, when preparing financial statements, you only focus on
international financial reporting standards(IFRS) only.

Transparency/Openness
This means all information should be made to stakeholders.
Transparency can relate to the communication of financial position and the
identification of investment or corporate risk. Transparency is assisted
through disclosure of decision rationale and the use of regular meetings with
shareholders.

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Accountability
Hold accountable to result, ie, achieve 100% in sales growth, and you can
delegate responsibility to different staff below.

So responsibilities can be delegated down through the management structure,

accountability comes with the job and cannot be passed to others.

Responsibility
This means to accept consequence to action.

Innovation
The concept of innovation in the approach to corporate governance
recognises the fact that the needs of businesses and stakeholders can
change over time.

Scepticism
The UK Corporate Governance Code, under the heading of 'Leadership',
encourages non-executive directors (NEDs) to adopt an air of scepticism so
that they can effectively challenge management decisions in their role of
scrutiny. Applying professional scepticism is also an important part of the
role of auditors and audit committees. ISA 200 defines professional
scepticism as: 'An attitude that includes a questioning mind, being alert to
conditions which may indicate possible misstatement due to error or fraud,
and a critical assessment of audit evidence.' This does not mean that all
management decisions and evidence have to be approached with suspicion or
mistrust; but that an open and enquiring mind must always be employed. A
healthy corporate culture and environment is one that encourages and
enables such scepticism to thrive.

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Reputation
Reputation is determined by how others view a person, organisation or
profession. Reputation includes a reputation for competence, supplying good
quality goods and services in a timely fashion, and also being managed in an
orderly way. However a poor ethical reputation can be as serious for an
organisation as a poor reputation for competence. The consequences of a
poor reputation for an organisation can include:

Suppliers and customers unwillingness to deal with the organisation for fear of being victims of
sharp practice
Inability to recruit high-quality staff
Fall in demand because of consumer boycotts
Increased public relations costs because of adverse stories in the media
Increased compliance cost because of close attentions from regulatory bodies or external
auditors
Loss of market value because of a fall in investor confidence

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Corporate governance specific theories:

Agency theory:
This is the separation of ownership and control. Because of agency theory(situation)
which leads to agency problem and hence incur agency costs.

Transaction cost theory:

Transaction cost relates to transaction internally or externally.
Internal: employing directors;
External: integration with supplier.

Types of transaction cost:

Envrionmental uncertainty:
Every company would face outside environmental uncertainty and hence when
signing a contract with each other, the contract should be as detailed as possible
and certainly this costs money, ie, costs relating to research, dress formally etc.
Oppertunisism
Some companies would charge you a higher fee because they think its an
opportunity that you can afford that and hence they will earn more out of this.
As transaction cost decreases, ie, reduction in uncertainty, reduction in
oppertunisism and this would make the company less risky but at the same time it
may imply that company would make less profit.
And hence shareholders would step in because they want the company to make
more profit and hence agency cost increases.
Transaction cost theory tries to explain why companies exist, and why companies
expand or source out activities to the external environment.

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When making a decision, company will decide whether the transaction costs
associated with the decision(outcoursing) will be higher than the costs if you are
going to run your business(employ staff etc) and then you are going to choose a
lower cost option.

Stakeholder Theory:
This means company should take care of other stakeholders as well rather
than just shareholders.
Sample stakeholders:
Shareholders
Employees
Customers
Suppliers
Governments
Communities

For example, tripple bottom line report is the report provided to different
stakeholders. And whether company should do this?
Well, we can discuss this issue from ethicals perspective and businesss perspective.
But from modern worlds perspective, if the disclosure doesnt add value to the
company at all and hence company would not make sure disclosures as well as
responsibilities to stakeholders.

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