Page 1 of 7

Finaquest Professional Training

MOCK 3

Time allowed

Reading and planning: 15 minutes

Writing: 3 hours

This paper is divided into two sections:

Section A – This ONE question is compulsory and MUST be attempted

Section B – TWO questions ONLY to be attempted

Paper P1
Do NOT open this paper until instructed by the supervisor.
During reading and planning time only the question paper may
be annotated. You must NOT write in your answer booklet until
instructed by the supervisor.

This question paper must not be removed from the examination hall.

COMPILED: GBENGA OKUBADEJO

The Association of Chartered Certified Accountants

‘Someday isle, in someday island, with someday discussion, on a someday mood where the chief
discussion is excuses. Some where once in your situatio10/29/2010 2:52:16 AMn yet made it – No excuses’ …………
AMG
 Page 2 of 7

Section A – This ONE question is compulsory and MUST be attempted

1 Chemco is a well-established listed European chemical company involved in research into, and the production of,
a range of chemicals used in industries such as agrochemicals, oil and gas, paint, plastics and building materials.
A strategic priority recognised by the Chemco board some time ago was to increase its international presence as a
means of gaining international market share and servicing its increasingly geographically dispersed customer base.
The Chemco board, which operated as a unitary structure, identified JPX as a possible acquisition target because of
its good product ‘fit’ with Chemco and the fact that its geographical coverage would significantly strengthen
Chemco’s internationalisation strategy. Based outside Europe in a region of growth in the chemical industry, JPX
was seen by analysts as a good opportunity for Chemco, especially as JPX’s recent flotation had provided potential
access to a controlling shareholding through the regional stock market where JPX operated.

When the board of Chemco met to discuss the proposed acquisition of JPX, a number of issues were tabled for
discussion. Bill White, Chemco’s chief executive, had overseen the research process that had identified JPX as a
potential acquisition target. He was driving the process and wanted the Chemco board of directors to approve the
next move, which was to begin the valuation process with a view to making an offer to JPX’s shareholders. Bill said
that the strategic benefits of this acquisition were in increasing overseas market share and gaining economies of
scale.

While Chemco was a public company, JPX had been family owned and operated for most of its thirty-five year
history. Seventy-five percent of the share capital was floated on its own country’s stock exchange two years ago,
but Leena Sharif, Chemco’s company secretary suggested that the corporate governance requirements in JPX’s
country were not as rigorous as in many parts of the world. She also suggested that the family business culture was
still present in JPX and pointed out that it operated a two-tier board with members of the family on the upper tier.
At the last annual general meeting, observers noticed that the JPX board, mainly consisting of family members, had
‘dominated discussions’ and had discouraged the expression of views from the company’s external shareholders.
JPX had no non-executive directors and none of the board committee structure that many listed companies like
Chemco had in place. Bill reported that although JPX’s department heads were all directors, they were not invited
to attend board meetings when strategy and management monitoring issues were being discussed. They were, he
1
said, treated more like middle management by the upper tier of the JPX board and that important views may not
be being heard when devising strategy. Leena suggested that these features made the JPX board’s upper tier less
externally accountable and less likely to take advice when making decisions. She said that board accountability was
fundamental to public trust and that JPX’s board might do well to recognise this, especially if the acquisition were
to go ahead.

Chemco’s finance director, Susan Brown advised caution over the whole acquisition proposal. She saw the
proposal as being very risky. In addition to the uncertainties over exposure to foreign markets, she believed that
Chemco would also have difficulties with integrating JPX into the Chemco culture and structure. While Chemco was
fully compliant with corporate governance best practice, the country in which JPX was based had few corporate
governance requirements.

Manprit Randhawa, Chemco’s operations director, asked Bill if he knew anything about JPX’s risk exposure.
Manprit suggested that the acquisition of JPX might expose Chemco to a number of risks that could not only affect
the success of the proposed acquisition but also, potentially, Chemco itself. Bill replied that he would look at the
risks in more detail if the Chemco board agreed to take the proposal forward to its next stage.
Finance director Susan Brown, had obtained the most recent annual report for JPX and highlighted what she
considered to be an interesting, but unexplained, comment about ‘negative local environmental impact’ in its
accounts. She asked chief executive Bill White if he could find out what the comment meant and whether JPX had
any plans to make provision for any environmental impact. Bill White was able to report, based on his previous
dealings with JPX, that it did not produce any voluntary environmental reporting. The Chemco board broadly

10/29/2010 2:52:16 AM
‘Someday isle, in someday island, with someday discussion, on a someday mood where the chief
discussion is excuses. Some where once in your situatio10/29/2010 2:52:16 AMn yet made it – No excuses’ …………
AMG
 Page 3 of 7

supported the idea of environmental reporting although company secretary Leena Sharif recently told Bill White
that she was unaware of the meaning of the terms ‘environmental footprint’ and ‘environmental reporting’ and so
couldn’t say whether she was supportive or not.

It was agreed, however, that relevant information on JPX’s environmental performance and risk would be
necessary if the acquisition went ahead.

Required:

(a) Evaluate JPX’s current corporate governance arrangements and explain why they are likely to be considered
inadequate by the Chemco board. (10 marks)

(b) Manprit suggested that the acquisition of JPX might expose Chemco to a number of risks. Illustrating from
the case as required, identify the risks that Chemco might incur in acquiring JPX and explain how risk can be
assessed. (15 marks)

(c) Construct the case for JPX adopting a unitary board structure after the proposed acquisition. Your answer
should include an explanation of the advantages of unitary boards and a convincing case FOR the JPX board
changing to a unitary structure. (10 marks)
(Including 2 professional marks)

(d) Explain FOUR roles of non-executive directors (NEDs) and assess the specific contributions that NEDs could
make to improve the governance of the JPX board. (7 marks)

(e) Write a memo to Leena Sharif defining ‘environmental footprint’ and briefly explaining the importance of
environmental reporting for JPX. (8 marks)
(Including 2 professional marks)
(50 marks)

‘Someday isle, in someday island, with someday discussion, on a someday mood where the chief
discussion is excuses. Some where once in your situatio10/29/2010 2:52:16 AMn yet made it – No excuses’ …………
AMG
 Page 4 of 7

Section B – TWO questions ONLY to be attempted

2 Chen Products produces four manufactured products: Products 1, 2, 3 and 4. The company’s risk committee
recently met to discuss how the company might respond to a number of problems that have arisen with Product 2.
After a number of incidents in which Product 2 had failed whilst being used by customers, Chen Products had been
presented with compensation claims from customers injured and inconvenienced by the product failure. It was
decided that the risk committee should meet to discuss the options.

When the discussion of Product 2 began, committee chairman Anne Ricardo reminded her colleagues that, apart
from the compensation claims, Product 2 was a highly profitable product.

Chen’s risk management committee comprised four non-executive directors who each had different backgrounds
and areas of expertise. None of them had direct experience of Chen’s industry or products. It was noted that it was
common for them to disagree among themselves as to how risks should be managed and that in some situations,
each member proposed a quite different strategy to manage a given risk. This was the case when they discussed
which risk management strategy to adopt with regard to Product 2.

Required:

(a) Describe the typical roles of a risk management committee. (6 marks)

(b) Using the TARA framework, construct four possible strategies for managing the risk presented by Product 2.
Your answer should describe each strategy and explain how each might be applied in the case.
(10 marks)

c) Risk committee members can be either executive or non-executive.

Required:
(i) Distinguish between executive and non-executive directors. (2 marks)

(ii) Evaluate the relative advantages and disadvantages of Chen’s risk management committee being non-
executive rather than executive in nature. (7 marks)
(25 marks)

‘Someday isle, in someday island, with someday discussion, on a someday mood where the chief
discussion is excuses. Some where once in your situatio10/29/2010 2:52:16 AMn yet made it – No excuses’ …………
AMG
 Page 5 of 7

3 Susan Paullaos was recently appointed as a non-executive member of the internal audit committee of Gluck and
Goodman, a public listed company producing complex engineering products. Barney Chester, the executive finance
director who chairs the committee, has always viewed the purpose of internal audit as primarily financial in nature
and as long as financial controls are seen to be fully in place, he is less concerned with other aspects of internal
control. When Susan asked about operational controls in the production facility Barney said that these were not
the concern of the internal audit committee. This, he said, was because as long as the accounting systems and
financial controls were fully functional, all other systems may be assumed to be working correctly.

Susan, however, was concerned with the operational and quality controls in the production facility. She spoke to
production director Aaron Hardanger, and asked if he would be prepared to produce regular reports for the
internal audit committee on levels of specification compliance and other control issues. Mr Hardanger said that
the internal audit committee had always trusted him because his reputation as a manager was very good. He said
that he had never been asked to provide compliance evidence to the internal audit committee and saw no reason
as to why he should start doing so now.

At board level, the non-executive chairman, George Allejandra, said that he only instituted the internal audit
committee in the first place in order to be seen to be in compliance with the stock market’s requirement that
Gluck and Goodman should have one. He believed that internal audit committees didn’t add materially to the
company. They were, he believed, one of those ‘outrageous demands’ that regulatory authorities made without
considering the consequences in smaller companies nor the individual needs of different companies. He also
complained about the need to have an internal auditor. He said that Gluck and Goodman used to have a full time
internal auditor but when he left a year ago, he wasn’t replaced. The audit committee didn’t feel it needed an
internal auditor because Barney Chester believed that only financial control information was important and he
could get that information from his management accountant.

Susan asked Mr Allejandra if he recognised that the company was exposing itself to increased market risks by
failing to have an effective audit committee. Mr Allejandra said he didn’t know what a market risk was.

Required:

(a) Internal control and audit are considered to be important parts of sound corporate governance.

(i) Describe FIVE general objectives of internal control. (5 marks)

(ii) Explain the organisational factors that determine the need for internal audit in public listed companies.
(5 marks)
(b) Criticise the internal control and internal audit arrangements at Gluck and Goodman as described in the case
scenario. (10 marks)

(c) Define ‘market risk’ for Mr Allejandra and explain why Gluck and Goodman’s market risk exposure is
increased by failing to have an effective audit committee. (5 marks)
(25 marks)

‘Someday isle, in someday island, with someday discussion, on a someday mood where the chief
discussion is excuses. Some where once in your situatio10/29/2010 2:52:16 AMn yet made it – No excuses’ …………
AMG
 Page 6 of 7

4 ‘Happy and healthy’ is a traditional independent health food business that has been run as a family company for
40 years by Ken and Steffi Potter. As a couple they have always been passionate campaigners for healthy foods and
are more concerned about the quality of the foods they sell than the financial detail of their business. Since the
company started in 1970, it has been audited by Watson Shreeves, a local audit firm. Mr Shreeves has overseen
the Potters’ audit for all of the 40 year history (rotating the engagement partner) and has always taken the
opportunity to meet with Ken and Steffi informally at the end of each audit to sign off the financial statements and
to offer a briefing and some free financial advice in his role as what he calls, ‘auditor and friend’. In these briefings,
Mr Shreeves, who has become a close family friend of the Potters over the years, always points out that the
business is profitable (which the Potters already knew without knowing the actual figures) and how they might
increase their margins. But the Potters have never been too concerned about financial performance as long as they
can provide a good service to their customers, make enough to keep the business going and provide continued
employment for themselves and their son, Ivan. Whilst Ken and Steffi still retain a majority shareholding in ‘Happy
and healthy’ they have gradually increased Ivan’s proportion over the years. They currently own 60% to Ivan’s 40%.
Ivan was appointed a director, alongside Ken and Steffi, in 2008.

Ivan grew up in the business and has helped his parents out since he was a young boy. As he grew up, Ken and
Steffi gave him more and more responsibility in the hope that he would one day take the business over. By the end
of 2009, Ken made sure that Ivan drew more salary than Ken and Steffi combined as they sought to ensure that
Ivan was happy to continue in the business after they retired.

During the audit for the year ended 31 March 2010, a member of Watson Shreeves was performing the audit as
usual when he noticed a dramatic drop in the profitability of the business as a whole. He noticed that whilst food
sales continued to be profitable, a large amount of inventory had been sold below cost to Barong Company with
no further explanation and it was this that had caused the reduction in the company’s operating margin. Each
transaction with Barong Company had, the invoices showed, been authorised by Ivan.

Mr Shreeves was certain Ken and Steffi would not know anything about this and he prepared to tell them about it
as a part of his annual end of audit meeting. Before the meeting, however, he carried out some checks on Barong
Company and found that it was a separate business owned by Ivan and his wife. Mr Shreeves’s conclusion was that
Ivan was effectively stealing from ‘Happy and healthy’ to provide inventory for Barong Company at a highly
discounted cost price. Although Mr Shreeves now had to recommend certain disclosures to the financial
statements in this meeting, his main fear was that Ken and Steffi would be devastated if they found out that Ivan
was stealing and that it would have long-term implications for their family relationships and the future of ‘Happy
and healthy’.

Required:

(a) Explain how a family (or insider-dominated) business differs from a public listed company and, using
evidence from the case, explore the governance issues of a family or insider-dominated business. (10 marks)

(b) Mr Shreeves is a professional accountant and auditor. Explain why he is considered a professional by society
and describe the fundamental principles (or responsibilities) of professionalism that society expects from him
and all other accountants. (7 marks)

(c) Discuss the professional and ethical dilemma facing Mr Shreeves in deciding whether or not to tell Ken and
Steffi about Ivan’s activity. Advise Mr Shreeves of the most appropriate course of action. (8 marks)
(25 marks)

‘Someday isle, in someday island, with someday discussion, on a someday mood where the chief
discussion is excuses. Some where once in your situatio10/29/2010 2:52:16 AMn yet made it – No excuses’ …………
AMG
 Page 7 of 7

End of Question Paper

‘Someday isle, in someday island, with someday discussion, on a someday mood where the chief
discussion is excuses. Some where once in your situatio10/29/2010 2:52:16 AMn yet made it – No excuses’ …………
AMG