Acca P1 Passcards PDF

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ACCA Passcards
Paper P1
Governance, Risk and Ethics
Passcards for exams
up to June 2015
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Professional Paper P1
Governance, Risk and Ethics
5/28/2014
12:38 AM
First edition 2007, Eighth edition June 2014

ISBN 9781 4727 1129 8
e ISBN 9781 4727 1185 4
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the
British Library
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BPP Learning Media Ltd,
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Your learning materials, published by BPP Learning
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sustainable sources.
Page ii
All rights reserved. No part of this publication may be

reproduced, stored in a retrieval system or transmitted, in
any form or by any means, electronic, mechanical,
photocopying, recording or otherwise, without the prior
written permission of BPP Learning Media.
BPP Learning Media Ltd

2014
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Preface
Contents
Welcome to BPP Learning Medias ACCA Passcards for Professional Paper P1 Governance, Risk and Ethics.
They focus on your exam and save you time.
They incorporate diagrams to kick start your memory.
They follow the overall structure of the BPP Learning Media Study Texts, but BPP Learning Medias ACCA
Passcards are not just a condensed book. Each card has been separately designed for clear presentation.
Topics are self contained and can be grasped visually.
ACCA Passcards are just the right size for pockets, briefcases and bags.
Run through the Passcards as often as you can during your final revision period. The day before the exam, try to
go through the Passcards again! You will then be well on your way to passing your exams.
Good luck!
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Preface
1
2
3
4
5
6
7
8
9
10
Scope of corporate governance

Approaches to corporate governance
Corporate governance practice and reporting
Internal control systems
Risk attitudes and internal environment
Risks
Risk assessment and response
Information, communication and monitoring
Personal ethics
Professional ethics
11
Corporate social responsibility
Contents
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1
11
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1: Scope of corporate governance
Topic List
Definition
Concepts
Agency
Stakeholders
Main issues
This chapter sets out the foundations of good corporate

governance, defining what corporate governance is, the
key concepts, and the stakeholders whom good
corporate governance serves.You may need to consider
the conflicting interests of stakeholders and how
stakeholders can control managers/directors. We also
summarise major issues in corporate governance.
Definition
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Concepts
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Agency
Stakeholders
Main issues
Corporate governance is the system by which organisations are directed and controlled. It is a set of
relationships between directors, shareholders and other stakeholders.
Risk management
and reduction
Appropriate control
systems
Framework to
pursue strategy
Corporate governance
Guards against
misuse of resources
Spirit of codes
Accountability to
stakeholders
Definition
Fairness
Transparency
Independence
Innovation
Scepticism
Probity
Responsibility
Accountability
Reputation
Judgement
Integrity
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Concepts
Page 3
Agency
Stakeholders
Main issues
Take into account all stakeholders with legitimate interests

Openness, disclosure in financial statements, press releases, websites
Being free from constraints or influences that would prevent a correct course of
action being taken
Recognise that the needs of businesses and stakeholders can change over time
NEDs, auditors and audit committees should adopt an air of scepticism and an
enquiring mind
Truth-telling/not misleading
Management responsible for organisation, means of corrective action and
penalising mismanagement
Directors and companies answerable for consequences of actions to shareholders,
professionals to values, public sector to stakeholders
Jeopardised by poor risk management/corporate governance ethical behaviour,
may impact commercially
Taking decisions that enhance organisations prosperity
Straightforward dealing, honesty and completeness, basis of trust
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Definition
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Concepts
Page 4
Agency
Stakeholders
Main issues
Agency
Agency in corporate governance
Agency is acting on behalf of another (principal) in

dealing with others.
Directors (agents) run company on behalf of

shareholders (principals).
Agency costs are the monies and resources

expended by principal in monitoring agent.
Agency problem how to prevent directors excessively

rewarding themselves/
underperforming.
Agents responsibilities

Accountability
Fiduciary duty (trust and care)
Personal performance
Obedience
Skill
No conflict of interest
Confidentiality
Handing over benefits
Main solution is to link reward with company

performance:
Profit related pay
Shares
Share option plans
Transaction costs theory

Companies seek to keep business dealings in-house,
managers act opportunistically in their own interests.
Definition
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Concepts
Stakeholders
Level of interest
Low
Stakeholder theory
Power
A broad range of stakeholders have claims on an

organisation. Stockholder/Shareholder view that
company just responsible to shareholders is
wrong as modern corporations are very large and
social/political/legal impact is therefore great.
A:
B:
C:
D:
Normative view ethical/philanthropic

responsibilities as well as economic/legal
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Main issues
Stakeholder power mapping
Stakeholders are groups or individuals whose

interests can affect or are directly affected by the
activities of a firm or organisation.
Instrumental view mainly economic

responsibilities with aim of maximising profits
Stakeholders
Agency
Low
High
High
A
minimal effort
keep informed, as can influence more powerful stakeholders
keep satisfied
strategy must be acceptable
Results of mapping

Corporate governance accommodates views

Repositioning of stakeholders
Identify change blockers/facilitators
Assess legitimacy/urgency
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Definition
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Concepts
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Agency
Stakeholders
Main issues
Proximity to organisation
Primary and secondary stakeholders
Internal employees/management
Primary need participation to continue as going

concern (customers, suppliers, government)
Connected shareholders, customers, suppliers,

lenders, trade unions, competitors
External government, local government, public,
pressure groups, opinion leaders
Narrow and wide stakeholders
Secondary their ceasing to participate wont affect

continued existence (government, managers)
Active and passive stakeholders
Narrow most affected by organisations strategy

(shareholders, employees, suppliers, major customers)
Active seek to participate in organisation's

activities (managers, shareholders, regulators,
pressure groups)
Wide less affected by organisations strategy

(government, less significant customers, community)
Passive dont seek to participate in policy-making

(shareholders, local communities, government)
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Voluntary and involuntary stakeholders
Legitimacy of stakeholders
Voluntary those who of their own choice have

involvement with the organisation employees,
customers, suppliers, shareholders
Legitimate valid claims
Involuntary engage with the organisation without

choosing to do so neighbours, wider public
Who decides legitimacy? Basis?
Illegitimate invalid claims
Knowledge of stakeholders
Known Existence known to organisation
Recognition of stakeholders
Recognised Managers consider interests and views
when deciding strategy
Unrecognised Managers don't consider claims when
deciding strategy
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Unknown Existence unknown to organisation

(wildlife, communities affected by suppliers)
Direct stakeholders know effect/how affected by
Indirect unaware of claims or cannot express them
directly
Definition
Directors
Secretary
Sub-board management
Employees
Trade unions
Suppliers
Customers
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Concepts
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Agency
Stakeholders
Main issues
Executive full-time managers, non-executive monitoring

Arranges board meetings, plans agenda, deals with documents and registers, general
administration, reports to chairman
Concerned with impact of board upon position, supervise and co-ordinate
implementation of business strategy and risk management, provide data for board
Commitment, interest in pay and conditions, need to implement control systems, adopt
culture and provide feedback
Pay and working conditions, concerned with poor board communication, lax risk and
control environment, can be used to harness employee support
Co-operation needed for just-in-time supply, poor payment record leads to credit
restriction and poor service
Increased expectations, power to shop elsewhere, ability to make views known, ethical
requirements
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External auditors
Highlight governance and reporting issues, independence required to supply

confidence in information, need for audit committee to reinforce position
Regulators
Establish rules and standards, carry out inspections. May be enforcement costs or
regulatory capture, domination of regulator by regulated
Government
Establish overall climate, encourage private shareholdings, provide subsidies,

nationalise poorly performing industries, run public sector organisations
Stock exchanges
Companies raise money, investors transfer shares, supply data about company
value and provide regulatory framework for governance
Institutional investors
Can influence prices, avoid speculative shares, want short-term profits, can influence
companies through meetings and voting, able to take direct action if dissatisfied
Small investors
Hold small numbers of shares in companies, trusts and funds. Likely to be

undiversified and concerned with information asymmetry
Recipients
Donors
Services from public sector, aid from charities
Page 9
Provide funds to charities, want them well-spent

Definition
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Concepts
Page 10
Agency
Stakeholders
Main issues
Duties of directors
Directors' remuneration
Corporate governance guidelines reinforce legal and

fiduciary duties to act in companys best interests,
use powers for proper purpose, avoid conflicts of
interest and exercise duty of care.
Directors being paid undeserved and excessive

remuneration and bonuses. Allegations that directors
have been rewarded for making losses.
Board composition
Board supervision
Need to avoid domination by single individual/small

group of executive directors.
Need for board to meet regularly to consider effectively

organisations activities, risks and control systems.
Accounting and auditing
Greater transparency and reliability of accounts,

decreasing investor risks. Tougher auditing standards
and requirements for auditors to avoid conflicts of
interest.
Builds on stakeholders' debate, what responsibilities

should organisation and board fulfil.
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2: Approaches to corporate governance
Topic List
Development of guidance
Basis of guidance
Major governance codes
Sarbanes-Oxley
Public sector governance
In this chapter we summarise the factors that have

influenced the ways corporate governance has
developed, including the important rules v principles
debate.You may be asked about these in part (a) of a
question before you consider specific corporate
governance arrangements later in the question. We also
give details of the major worldwide codes, particularly
those that have international impact.
Corporate social responsibility is a major topic in this
exam, and the themes we cover here and in Chapter 11
will occur in many questions.
Development of
guidance
Internationalisation
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Basis of
guidance
12:39 AM
Major
governance codes
Investor treatment
Page 12
Sarbanes-Oxley
Financial reporting
weaknesses
Corporate social
responsibility
Individual country
characteristics
Public sector
governance
Corporate scandals
Governance development
Openness
Integrity
Accountability
Development of
guidance
5/28/2014
Basis of
guidance
12:39 AM
Major
governance codes
Page 13
Sarbanes-Oxley
Principles-based approach
Most corporate governance codes use a principlesbased approach with broad guidelines supplemented by
limited specific requirements. Encourage companies to
comply or explain.
Rules-based approach
Rules-based approach focuses on regulations and
targets that must be met without any leeway. It should be
easy to ascertain compliance, but in practice there may
be questionable situations which are not fully covered by
the rules.
Corporate social
responsibility
Public sector
governance
Key Principles

Fulfil strategic objectives

Reinforce governance regulation
Minimise risk
Promote ethical behaviour
Underpin investor confidence
Fulfil stakeholder responsibilities
Establish management accountability
Maintain NED/auditor independence
Provide accurate reporting
Encourage owner involvement

Direct behaviour
Page 13
Development of
guidance
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Basis of
guidance
12:39 AM
Major
governance codes
Page 14
Sarbanes-Oxley
Advantages of principles

Avoids inflexible rules

Less burdensome
Allows scope for development
Comply or explain
Emphasis on investor judgement
Corporate social
responsibility
Public sector
governance
Problems with principles

Principles too broad

Lack of consistency
Confusion over what is compulsory
Companies treat as non-binding
Markets don't understand disclosures
Insider systems
Outsider systems
Most companies listed on stock exchange are controlled

by a few individuals, for example family companies.
Shareholdings are widely dispersed, manager/owner

separation.
Outsider
Advantages/Disadvantages
Robust governance regime
Strong owner-manager links
Hostile takeover threat constrains management
Longer-term view
Agency problem
Discrimination v minority
Short-term priorities
Lack of monitoring/governance
Insider
Development of
guidance
5/28/2014
Basis of
guidance
12:39 AM
Major
governance codes
Page 15
Sarbanes-Oxley
Corporate social
responsibility
Public sector
governance
UK Corporate Governance Code
OECD principles
Code derived originally from Cadbury, Greenbury and

Hampel reports, supplemented by:
Organisation for Economic Co-operation and

Development produced non-binding principles to
address the interests of global investors. Companies
should work towards achieving principles, and
principles are guidelines for individual countries to
develop own codes.
Turnbull report risk and internal control

Smith report audit committees
Higgs report non-executive directors
Principles
ICGN report
International Corporate Governance Network has
provided practical guidance for boards to operate
efficiently and compete for scarce capital.
Page 15

Shareholder/stakeholder rights
Equitable treatment of all shareholders
Stakeholders rights protected
Timely/accurate disclosure of material matters
Board responsible for strategy and monitoring
Development of
guidance
5/28/2014
Basis of
guidance
12:39 AM
Major
governance codes
Page 16
Sarbanes-Oxley
Sarbanes-Oxley
The Sarbanes-Oxley Act was a response to the
collapse of Enron, one of America's biggest companies.
The Act is more prescriptive than codes in other
jurisdictions, impacting on review of controls,
disclosures, audits, ethics and directors share trading.
Auditing requirements
The non-audit services auditors can provide are
significantly restricted and auditors are subject to
various other rules:
Compulsory partner rotation
Retention of audit papers
Quality control standards
Review internal control systems
Corporate social
responsibility
Public sector
governance
Weaknesses at Enron

Lack of transparency in accounts

Non-executive directors weak
Lack of external audit scrutiny
Directors use of inside information
Dishonesty and law-breaking
Corporate responsibility
Chief executive/chief finance officer certify:
Appropriateness of accounts
Accounts fairly reflect operations and financial
condition
If accounts have to be restated, they forfeit their
bonuses.
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Audit committees
Internal control reports (s404)
Every listed company should have an audit

committee consisting of independent directors, with
member(s) with financial expertise. Audit committee
should be responsible for:
Annual accounts must contain internal control reports

that:
Appointment, compensation and oversight of

auditors
Discussing key accounting policies with auditors
Setting up complaints mechanisms
State management responsibility for control

structure/financial reporting procedures
Assess effectiveness of control structure/financial
reporting procedures (with audit report)
State whether code of conduct for senior financial
officers has been adopted
Whistleblowing
Off-balance sheet transactions
Employees/auditors will be granted whistleblowing

protection if they disclose private employer
information to parties involved in a fraud claim.
There should be appropriate disclosure of material offbalance sheet transactions.
Page 17
Development of
guidance
5/28/2014
Basis of
guidance
12:39 AM
Major
governance codes
Page 18
Sarbanes-Oxley
Corporate social
responsibility
Public sector
governance
Significance of responsibility
CSR and stakeholders
Large businesses in particular face expectations that

they will act in a socially responsible fashion.
Businesses benefit from goodwill and other aspects

of society and therefore owe those particularly
affected by their activities certain duties in return.
Carroll's model
Four levels of responsibilities:

Economic shareholders/employees/customers
Legal comply with laws
Ethical act in fair and just way
Philanthropic generosity to employees/
community
Problems with stakeholder view

Collaboration time-consuming and expensive
Culture clashes with certain stakeholders
Collaboration on some issues, conflict on
others
Lack of consensus between different
stakeholders
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Ownership responsibilities
By buying shares, shareholders buy a responsibility to
ensure that company is managed efficiently and in ways
consistent with public welfare. Responsibilities of institutional shareholders have been stressed, institutional
shareholders' large % shareholdings meaning they
should be actively involved and pressure managers.
Ownership view problems
Shareholders with small % holdings arent
influential
Shareholders can easily dispose of shares and
this loosens feelings of obligation
Page 19
Impact of CSR
Objectives
Mission statements
Ethical codes
Governance codes
Stakeholder board representation
Corporate social reporting
Development of
guidance
5/28/2014
Basis of
guidance
12:39 AM
Major
governance codes
Public sector
Purposes and objectives Public service
Page 20
Sarbanes-Oxley
Private sector
Profit
Corporate social
responsibility
Charitable status
Public sector
governance
NGOs/quasi NGOs
Relief of poverty,
research, etc
As defined by owners
Performance
Central regulation Financial reporting

standards
SORP
Set outcomes
Ownership
Government
Donors
Government
Stakeholders
(including lobby groups)
The public, central Shareholders,

Service users
government,
regulators, taxation
service users
authorities
Partners/
shareholders
Government,
lobbying groups
5/28/2014
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3: Corporate governance practice

and reporting
Topic List
Role of board
Board membership
Non-executive directors
Directors' remuneration
Stakeholder relationships
Reporting
Corporate governance practice is a key area in this

syllabus, and you can expect to be asked whether an
organisation is following good practice. The role and
activities of the board will be significant elements in
many questions. How corporate governance practice
serves the interests of stakeholders will also be
important.
Role of board
5/28/2014
Board
membership
12:40 AM
Page 22
Directors'
remuneration
Non-executive
directors
Scope of board's role

The board should have a formal schedule of matters
reserved to it for decisions. Board is also responsible
for overseeing strategy, monitoring risk, control
systems and management, and ensuring effective
communication.
Stakeholder
relationships
Reporting
Advantages of diversity

Maximise talent pool

Broader range of knowledge
Access stakeholder constituencies
Greater independence
Corporate citizen
Nomination of directors
Nomination committee should oversee appointments
and make recommendations to the board. Needs to
consider:
Executives/non-executives
Gaps in current board's skills
Expanding board diversity (age, gender, race,
ethnicity, education, background)
Continuity and succession planning
Legal and regulatory frameworks

Legal responsibilities
Avoidance of conflict of interest
Time limits on appointments
Limits on service contracts
Retirement by rotation
Insider dealing
5/28/2014
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CPD and appraisals

All board members should have training covering
strategy, management, legal responsibilities and
company related issues.
There should be annual appraisals of the performance
of the whole board and of individual directors.
Multi-tier boards
Companies in some countries are run by two or more
boards, often with supervisory/management role split.
Board appraisal

Performance against objectives

Contribution to strategy/environment
Response to problems
Considering right matters
Communication
Effectiveness of board committees
Quality of feedback
Adequacy of decision-making
Advantages of multi-tier boards
Disadvantages of multi-tier boards

Supervisors/supervised separation
Deters management fraud
Better links with stakeholders
Better use of non-executive time
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Lack of accountability
Don't receive information from managers
Supervisory board decision-making restricted
Less effective at questioning managers
3: Corporate governance practice and reporting
Role of board
5/28/2014
Board
membership
12:40 AM
Non-executive
directors
Page 24
Directors'
remuneration
Stakeholder
relationships
Reporting
Board membership
Division of responsibilities
Companies need to consider optimum

size, balance of executive and nonexecutive directors, and diversity of
membership.
No one individual should have unfettered control. Ideally chairman and

chief executive should be different people; if not there should be a strong
independent element on the board with a recognised senior member.
Responsibilities of CEO
Responsibilities of chairman
Board committees
Board committees supervise specific
areas, doesn't absolve main board
from overall responsibilities. Key
committees:
Running board
Accurate board information
Shareholder communication
(Chairman's Statement)

Nomination
Audit
Remuneration
Risk management
(this chapter)
(Chapter 8)
(this chapter)
(Chapter 5)
New director induction

Board appraisal
Board development
Signing off accounts

Strategic development
Investment analysis
Risk management
Recommendations to
board committees
Control systems
enforcement
Role of board
5/28/2014
Board
membership
12:40 AM
Page 25
Directors'
remuneration
Non-executive
directors
Stakeholder
relationships
Reporting
Non-executive directors (NEDs)
Number of NEDs
NEDs have no executive (managerial) responsibilities.

They should provide balance and help to reduce
conflict between executive directors and shareholders.
Majority of NEDs should be independent.
USA/UK Independent NEDs at least half of board,

others sufficient for views to carry weight.
Independence of NEDs
Role:
Strategy
Scrutiny

Risk management
Board personnel
No business/financial/other connection
No share options/pensions
Appointment for specified term
Ability to take independent advice
Advantages of NEDs
Disadvantages of NEDs
External experience and knowledge

Wider perspective
Comfort for investors
Confidant/enabler
Board members but objective

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Independence?
Restricted recruitment
Difficult to impose views
Cant prevent problems
Limited time
Role of board
5/28/2014
Board
membership
12:40 AM
Page 26
Non-executive
directors
Principles
Directors' remuneration set by independent board
members
Bonuses related to measurable performance/enhanced
long-term shareholder value
Full transparency in annual accounts
Remuneration committee
Remuneration policy
Specific remuneration packages
Stakeholder
relationships
Reporting
Remuneration statement
UK's Greenbury committee suggests:
Committee of independent NEDs determining:
Directors'
remuneration
Consider and disclose:

Remuneration policy
Arrangements for individual directors
Consider allowing members to vote on
remuneration statement in accounts.
Service contracts
If service contracts are too long, premature termination
may mean significant payments. Service contracts
shouldn't be >12 months normally.
5/28/2014
12:40 AM
Elements of remuneration package

Basic salary in contract of employment
Performance-related bonuses limited possibly
to maximum % of pay, shouldn't be given for
transactions, or if excessive risks taken?
Shares granted on condition can't be sold
Share options purchased at specified exercise
price, encouragement to improve company's
performance and hence share prices, options
(and shares) to be held for certain length of time
Benefits-in-kind is cost excessive and how
comparable are they with what employees are
given?
Pensions best practice to make only basic
salary pensionable
Page 27
Page 27
Factors affecting remuneration levels

Need to attract and retain directors

Interests of stakeholders
Weighting and phasing of different parts of package
Director/manager differentials
Impact of director/manager resigning
Performance measures
Performance measures

Variety of financial/non-financial measures

Focus on current not historic performance
Avoid short-termism
Reward individual effort
Role of board
5/28/2014
Board
membership
12:40 AM
Page 28
Directors'
remuneration
Non-executive
directors
Stakeholder
relationships
Relationships with shareholders
Relationships with stakeholders
Directors should be required to submit to regular

re-election (every year/every three years). Boards should
consider relationships with all shareholders, particularly
institutional shareholders. Annual general meetings normal part of calendar, other general meetings discuss
issues of immediate/serious concern.
OECD stresses role of:
Proxy voting
Myners report recommends:
Clear agreements between beneficial owners
and investment managers
Stock lending shouldn't happen
Electronic voting
Poll (including proxies) for all resolutions

Reporting
Employees
Creditors
Suppliers
Investors
Government
Position of stakeholders should be:

Protected by law
Enhanced by participation (eg employees share
ownership, profit-sharing arrangements, seat on
board)
5/28/2014
Notice > 20 days

before
12:40 AM
Page 29
Business
presentation
Question and
answer sessions
Annual general meetings
Shareholders vote on
substantially
separate issues
Page 29
Shareholders vote on
report and accounts
Role of board
5/28/2014
Board
membership
12:40 AM
Page 30
Directors'
remuneration
Non-executive
directors
Reporting
Reporting
Major disclosures
London Stock Exchange requires:

Narrative statement of how principles in UK
Corporate Governance Code have been applied
Statement of compliance/details of reasons for
non-compliance
Voluntary disclosures
Disclosures above statutory/best practice minimum.
Disclosures should follow certain principles:

Stakeholder
relationships
Planned process
Transparency in disclosures made
Consultation with users
All relevant information considered
Disclosures subject to review
Board composition, directors, NEDs, evaluation

of board performance
Committee reports
Relations with auditors and shareholders
Review of internal controls
Going concern
Sustainability reporting
Business review
Benefits

Wider information provision

Different forms of information
Greater assurance about management
Reflect investor interests
5/28/2014
12:42 AM
Page 31
4: Internal control systems
Topic List
Control systems
Nature of risks
Control framework
Control limitations
Enterprise risk management
Assessment of systems
In this chapter we look at the key elements of sound

control systems. The overall environment and ethos of
organisation is as important as the specific procedures.
The risks organisations face should have a significant
impact upon the control frameworks they adopt.You may
need to assess the effectiveness of control systems and
the difficulties of implementing sound systems.
Control
systems
5/28/2014
Nature of
risks
12:42 AM
Control
framework
Internal management control

Management planning, organising and directing so
that organisational objectives are achieved.
Turnbull report listed key aims:
Facilitate effective and efficient operation
Ensure quality of reporting
Ensure compliance with laws and regulations
Cybernetic control system

Process of control within system.
Identification of system objectives
Setting targets for system objectives
Measuring system achievements/outputs
Comparing achievements with targets
Identifying corrective action
Implementing corrective action
Page 32
Control
limitations
Enterprise risk
management
Assessment of
systems
Features of control systems

Ease of target
achievement
Qualitative/
quantitative
measures
Short/long-term
measures
Consistency of
measures
Management
intervention
Automatic control
mechanisms
Reliance on social
relationships
Characteristics of control systems

Embedded in operations
Form part of culture
Capable of quick response
Control
systems
Nature of
risks
5/28/2014
12:42 AM
Control
framework
Page 33
Control
limitations
Risk classification
Risks can be classified in various ways:
Fundamental affects society in general
Particular individual in control
Speculative good or bad consequences
Pure only outcomes harmful
Risk and uncertainty

Uncertainty means possible outcomes and/or chances
of each occurring are unknown.
Risk and return

Businesses have to take some risks to trade
(entrepreneurship). Businesses may tolerate higher
risk levels provided they receive higher returns.
Page 33
Enterprise risk
management
Assessment of
systems
Benefits of risk management

Predictability of cash flows

Limitation of effects of bad events
Increased shareholder confidence
Weigh costs
Risk and corporate governance

Corporate governance reports aim to address
shareholder concerns that directors are not
achieving adequate returns for risks incurred and
provide mechanisms for controlling directors who
are taking excessive risks. Directors' responsibility
for monitoring and disclosing risk management is
stressed.
Control
systems
5/28/2014
Nature of
risks
12:42 AM
Control
framework
Page 34
Control
limitations
Enterprise risk
management
Assessment of
systems
CONTROL FRAMEWORK
Control environment
Purposes

Orderly conduct of business

Adherence to internal policies and laws
Safeguarding assets
Prevention/detection of fraud
Accuracy/completeness of accounting records
Quality of information and reporting
Control activities
Control systems and risks
Objectives
Nature/extent of
risks
Acceptable risks
Likelihood risks
materialise
Ability to reduce
risks
Costs/benefits of
controls
Changes in risk
conditions
Control
systems
Nature of
risks
Costs > benefits
5/28/2014
12:42 AM
Control
framework
Page 35
Control
limitations
Human error/Fraud
Enterprise risk
management
Assessment of
systems
Employee collusion
LIMITATIONS OF CONTROLS
Management
bypass
Page 35
Designed for routine

transactions
Depend on method
of data processing
Control
systems
Nature of
risks
5/28/2014
12:42 AM
Control
framework
Page 36
Control
limitations
Enterprise risk management (ERM)

ERM is framework suggested by COSO for dealing
with risk. It is a fundamental process, operated at
organisation level, that helps staff understand risks,
responsibilities and authority levels. ERM should:

Apply in strategy setting

Apply in all areas and over whole organisation
Identify events affecting entity
Manage risk according to risk appetite
Provide reasonable assurance
Support organisational objectives
Enterprise risk
management
Assessment of
systems
ERM benefits

Align risk appetite and strategy

Link growth, risk and return
Choose best risk response
Minimise surprises and losses
Manage risks over whole organisation
Allows organisation to seize opportunities
5/28/2014
12:42 AM
Page 37
COSO's Enterprise Risk Management framework
SUBSIDIARY
BUSINESS UNIT
DIVISION
ENTITY LEVEL
E
S
ING
GIC TION
NC
T
E
A
I
R
T
L
A
O
RA
ER
MP
EP
P
ST
O
R
O
C
Internal Environment
Objective Setting
Event Identification
Risk Assessment
Risk Response
Control Activities
Information & Communication
Monitoring
Page 37
Control
systems
Objectives
Nature of
risks
5/28/2014
12:42 AM
Control
framework
Risk links
Page 38
Control
limitations
Compatibility
Enterprise risk
management
Control mix
Assessment of
systems
Human
resources
ASSESSMENT
Framework
Review
Information
Feedback
Costs/benefits
5/28/2014
12:43 AM
Page 39
5: Risk attitudes and internal environment
Topic List
Risk attributes
Stakeholders and risk
Internal environment
Risk management responsibilities
Objective setting
This chapter covers the underlying factors that help

determine how organisations respond to the risks they
face. These factors include attitudes to risk, the
environment and culture, and the organisational structure
including responsibilities for dealing with risks.
5/28/2014
Risk attributes
12:43 AM
Stakeholders
and risk
Page 40
Internal
environment
Risk management
responsibilities

Emotional satisfaction
Risk-averse or riskseeking
Personal views
Objective
setting
Size
Structure
Development
Past experience
Focus on avoiding
risk
Organisational influences
Risk attributes
National influences
Shareholder requirements
Government protection
Risk/return
5/28/2014
Risk attributes
Shareholders
Debt providers
Employees
Suppliers
Customers
Wider community
Page 41
12:43 AM
Page 41
Internal
environment
Stakeholders
and risk
R
I
S
K
C
O
N
C
E
R
N
S

Risk management
responsibilities
Objective
setting
Dividend impact
Capital gain impact
Dependent on their risk appetite/diversification
Threat to repayment
Security imposed
Threat of other debts
Job threats
Health and safety worries
Ability to take action
Losses on sales
Unwilling credit suppliers
Disruption of relationships
Delivery failures
Lack of value
Poor quality
Poor employment policies
Adverse impact on the environment
5/28/2014
Risk attributes
12:43 AM
Stakeholders
and risk
Page 42
Internal
environment
Internal/control environment
The control environment is the attitude, awareness and
actions of management in relation to internal controls,
providing the background for the operation of other
controls.
Risk management
responsibilities
Elements of internal environment

Management's philosophy and operating style

Control culture
Organisational structure
Methods of imposing control
Integrity, ethical values and competence
Strong internal environment

Risk environment

Clear risk management strategies

Culture/code of conduct/HRM/reward systems support
objectives and risk limitation
Senior management commitment to competence,
integrity and trust
Clear authority and responsibility
Communication procedures
Staff have knowledge, skills and tools
Objective
setting

Risk management philosophy

Risk appetite
Integrity
Ethics
Organisational environment
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Page 43
Embedding risk awareness
Risk register
Risk assessment should evolve into a consistent activity

embedded across all processes, focus on:
Formal collection of risk and response information.

Register lists and prioritises risks, and specifies
responsible individuals and action taken.
Threats to shareholders/stakeholders (future growth

opportunities/core business)
Consistent action-orientated risk assessment
Changing risk culture

Internal communications programme

Training
Involvement in risk identification
Incentives
Key personnel persuasion
Infrastructure support
Page 43
Risk policy statement

Definitions and objectives

Regulatory requirements
Links to strategic decision-making
Key areas
Risk classification
Risk responsibilities
Important controls
Assurance reporting
Training
5/28/2014
Risk attributes
12:43 AM
Stakeholders
and risk
Page 44
Internal
environment
Risk management
responsibilities
Objective
setting
Board
Determines risk management strategy and monitors overall risks, sets

and reviews internal control
Senior managers
Build on overall framework, specifying risk management methods and

co-ordinate responses, may staff risk management group
Internal audit
Audit risk management process/key risk area controls
External audit
Audit risk areas that impact materially on financial statements
Line managers
Identify and evaluate risks in their areas, use performance

indicators for monitoring, implement responses
Staff
Follow risk management procedures, have good understanding,

report dangers
5/28/2014
12:43 AM
Page 45
Risk committee
Risk management personnel
Committee of directors, separate from audit

committee, responsible for monitoring and
supervising risk identification and management.
Risk specialist consultant called in to advise on particular

aspects of risk management
Risk manager employee with specific responsibility for
dealing appropriately with risks
Risk management function employees in larger
organisations
Can be staffed by executive directors

Allows audit committee to concentrate on
financial risks
Role of RM function
Role of RM committee
Determine risk management
strategy/policy
Review reports on risk
Monitor overall exposure
Monitor changes in circumstances
Assess effectiveness of RM systems
Review statement on internal control
Page 45

Helping determine risk management strategies

Champions of risk management
Building risk awareness culture
Establishing risk policy and structures
Developing and reviewing risk management processes
Co-ordinating functional responses
Preparing report for board/shareholders
5/28/2014
Risk attributes
12:43 AM
Internal
environment
Stakeholders
and risk
Mission
A general objective, visionary, often unwritten and
very open-ended, without any time limit for
achievement.
Objective setting and risk

Strategic objectives and mission will influence risk
management.
However businesses should also determine risk
appetite (willingness to take risks) and risk
strategy.
These in turn should influence business objectives.
Businesses should take a portfolio view of risks,
looking at relevant risks over the whole organisation.
Page 46
Risk management
responsibilities
Objective
setting
COSO model

Strategic high level goals, support mission

Operational effectiveness and efficiency
Reporting reliability
Compliance with applicable laws
Corporate objectives

Profitability
Market share
Growth
Cash flow
Customer satisfaction
Quality
Added value
5/28/2014
12:43 AM
Page 47
6: Risks
Topic List
Strategic and operational risks
Types of risks
Risk identification
In this chapter we look at the risks that organisations

face. We draw various important distinctions between
different kinds of risk, and emphasise the link between
risk and return. We also look at examples of the key risks
that organisations have to counter.
5/28/2014
12:43 AM
Page 48
Strategic and
operational risks
Types of risks
Risk identification
Strategic risks
Operational risks
Fundamental risks to organisation's profits/existence

arising from the sector its in and the nature of what it
does. Strategic risks arise out of decisions about
resources, products, acquisitions and investments.
Risks of loss from failures in internal business and

control processes.
Factors affecting strategic risks

Stakeholders
State of economy
Nature of industries/markets
Level of competition
Availability/price of resources
Flexibility of production
Ability to innovate/R&D
Stage of product life cycle
Examples

IT failures
Human error
Loss of key staff
Fraud
Business interruptions
Internal audit weaknesses
5/28/2014
12:43 AM
Page 49
Strategic and
operational risks
Types of risks
Risk identification
Entrepreneurial risks
Product risks
Risks from carrying out business activities.

Entrepreneurial risks must be taken if business is to
make profits.
Risks of financial loss due to producing a poor

quality product. They include need to compensate
dissatisfied customers, possible loss of sales and
need for expenditure on quality control procedures.
Financial risks
Threats to organisations continued existence
through lack of available funds or taking on
excessive or unsuitable commitments. Risks also
include credit risk from non-paying debtors and
currency/interest rate risks.
Market risks
Risks arising from markets within which a company
operates, risks arising from movements in market
value of asset.
Page 49
Legal risks
Risks of fines or threats of closedown, or incurring
costs to fight legal actions.
Political risks
Political risk is the risk that political action will affect
organisation. Examples include quotas, tariffs,
exchange controls and nationalisation.
6: Risks
5/28/2014
12:43 AM
Page 50
Strategic and
operational risks
Types of risks
Risk identification
Technological risks
Fraud risks
Risks of loss through the inadequacies/disruption of

IT systems and resources, risks arising from
information strategy pursued.
Risks of loss through fraudulent activities of employees

or managers. Fraud risks are often increased by poor
corporate governance procedures, allowing senior staff
to commit fraud because mechanisms to challenge
their behaviour are ineffective.
Health and safety risks

Risks include loss of employees' time and having to
pay compensation or legal costs. Risks arise
because of lack of policy, poor culture, lack of
emergency procedures.
Environmental risks
Risk arising out of environmental effects of
operations. Organisations can suffer fines, bad
publicity, non-co-operation.
Knowledge management risks

Risks of losses due to failure to secure knowledge
resources adequately. Risks include abuse of
intellectual property, power failures leading to loss of
information, loss of key staff.
Property risks
Risks from damage, destruction or theft of property.
Dangers include fire, wind, water leakage and
vandalism.
5/28/2014
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Page 51
Trading risks
Organisational risks
Risks of disruption in the course of trade.
Risks that members/employees of an organisation

will behave in ways detrimental to the organisation,
eg failure to adapt to change.
Physical goods/documentation lost/stolen

Trade customer refuses goods/cancels order
Liquidity inability to finance activities
Disruption risks
Risk of disruption to operations caused by IT
failures, employee problems, supplier loss, legal
action.
Resource wastage risks

Risks include incurring excessive costs or waste of
employees' time and resources.
Page 51
Reputation risks
Risk of loss of reputation arising from adverse
consequences of another risk.
Poor reputation

Crystallisation of risks
Poor customer service
Failure to innovate
Poor ethics
6: Risks
5/28/2014
12:43 AM
Page 52
Strategic and
operational risks
Types of risks
Risk
identification
Risk identification
Need to know whether likely perils are present and be aware of possibility of unlikely risks. Identification can
focus on targeting unacceptable risks or risk levels.
Risk condition identification
Event identification
Physical inspection
External events eg economic conditions
Enquiries
Internal events eg human errors
Brainstorming
Conditions resulting in risks
Checklists
Trends and root causes
Benchmarking
Event interdependencies
5/28/2014
12:43 AM
Page 53
7: Risk assessment and response
Topic List
Risk assessment
Risk responses
Control activities
In this very important chapter, we deal with how risks are

managed, in particular how risks are reduced by control
activities.
5/28/2014
12:43 AM
Page 54
Risk
assessment
Risk management
effectiveness
Control
activities
Risk
responses
Stakeholder
pressures
Risk management
costs
Risk assessment
Comprehensive
coverage
Accurate analysis
Responsive to
changing risks
5/28/2014
12:43 AM
Page 55
Likelihood/Consequences matrix
Risk quantification
Use Likelihood/Consequences matrix as basis for

setting priorities for risk management.
Need an idea of possible results or losses, together

with distributions and confidence limits.
Consequences
Low
Low
L
i
k
e
l
i
h
o
o
d
Loss of suppliers
Loss of lower-level
staff
High
Page 55
Key calculations
High
Loss of key customers

Failure of computer systems
Loss of senior or specialist

staff
Loss of sales to competitor
Loss of sales due to
macroeconomic factors

Average or expected result or loss

Frequency of losses
Chances of losses
Largest predictable loss
Sensitivity analysis
Examine impact of key variable changes, such as
sales price + volume, initial + operating costs, cost of
capital.
5/28/2014
12:43 AM
Page 56
Risk
assessment
Control
activities
Objective/subjective risks
Accounting ratios
Objective risks can be assessed with high accuracy.
Ratios can demonstrate risks to companies and

shareholders, particularly liquidity or solvency risks.
Key ratios

Risk
responses
Debt ratio
Gearing
Interest cover
Cash flow ratio
Current ratio
Quick ratio
Subjective risks cannot be quantified easily,

assessment depends on knowledge and skills of
assessor.
Related risks
Risks may be related/correlated because their
causes are the same, or one risk links to another.
Consolidation of risk
Need to aggregate at organisation levels risks
identified and quantified at operational level.
Need also to consider impact of correlated risks,
where two or more different risks vary together.
5/28/2014
12:43 AM
Page 57
Risk
assessment
Risk
responses
Control
activities
Likelihood/Consequences matrix
Consequences
L
i
k
e
l
i
h
o
o
d
Low
High
Low
High
Accept
Transfer
Cost of action/benefits
Insurance/contingency planning
Reduce
Avoid
Controls to limit risk

occurrence/impact
Immediate action required,

possible abandonment of activities
Stop/Drop Not taking profitable opportunity on grounds of excessive risk

Go Going ahead with activity and incurring losses
ALARP Reducing risks to as low as reasonably practicable levels
Page 57
5/28/2014
12:43 AM
Page 58
Risk
assessment
Risk
responses
Control
activities
Natural hedging
Debt/equity mix
Internal netting
International
Working capital management
Diversification
Internal strategies
Financial risk management
Risk transfer
Risk sharing
Forwards
Joint ventures
Options
Futures
Swaps
Insurance
Securitisation
5/28/2014
12:43 AM
Page 59
Risk
assessment
Classification of controls
Corporate are general policy, culture, values, overall
monitoring
Management include planning, performance monitoring,
risk evaluation
Administrative include organisation structure, authority
and reporting lines, communication channels
Accounting are recording of transactions and
safeguarding records, transactions and assets
Prevent stop errors happening including checks of
documentation before payment/deliveries made
Detect pick up errors
Correct minimise or negate errors eg back-up
Non-discretionary can't be bypassed
General relate to environment
Page 59
Risk
responses
Control
activities
Types of control procedure

Approval and control of documents
Controls over computerised applications and IT
environment
Checking arithmetical accuracy
Control accounts
Trial balances
Reconciliations
Physical counts
Comparing internal and external data
Limiting direct physical access
5/28/2014
12:43 AM
Page 60
Risk
responses
Risk
assessment
Control
activities
Assurance from internal controls
Benefits of controls
Internal controls can only provide

reasonable assurance that management
objectives will be achieved, because of their
limitations.
Benefits may be financial

(less costs)
Benefits may be non-financial
(efficiency and effectiveness improvements, less internal
audit resource required)
Costs of controls
Costs include direct costs (salary), opportunity
costs (time) and perhaps reduced flexibility,
responsiveness and creativity.
Benefits v costs
Difficult to estimate risk exposure
Difficult to estimate impact of controls
Comparison of financial costs v non-financial benefits
5/28/2014
12:44 AM
Page 61
8: Information, communication and monitoring
Topic List
Internal communication
Monitoring
Internal audit
Audit committee
Board review and reporting
This chapter emphasises the importance of information

flows and communication between managers and staff.
The principles of good communication also apply to
formal reports in the accounts on risk and internal
control. We also cover the monitoring activities required
to ensure control systems remain effective.
Internal
communication
5/28/2014
12:44 AM
Monitoring
Page 62
Internal audit
Audit committee
Board review
and reporting
Directors' information requirements
Communication of policies
Directors need information about risks linked to

achievement of organisation's objectives and
control mechanisms that should respond to
changes in business environment.
Directors should:
Turnbull report recommends policies are communicated in

following areas:
Customer relations
Service levels
Health, safety and environment
Asset security and business continuity
Expenditure
Accounting, financial and other reporting
Compare different sources of data

Consider adequacy of communication
channels
Provide feedback
Review management/information systems
Communication methods

Guidance from chief executive

Circulation of risk policies
Staff involvement in policy development
Workshops and training
Whistleblowing procedures
Internal
communication
5/28/2014
12:44 AM
Monitoring
Page 63
Internal audit
Audit committee
Board review
and reporting
Monitoring ensures that internal controls continue to operate effectively. This process involves
assessment by appropriate personnel of the design and operation of controls on a timely basis and
taking necessary actions.
Elements of monitoring
Ongoing monitoring includes routine, day-to-day
reviews.
Separate evaluation includes annual review of
controls plus internal audit evaluations.
Effective/efficient monitoring
Strong control environment
Prioritisation
Communication structure/reporting
Page 63
Monitoring procedures

Audit committee liaison with auditors

Internal audit work on control
Monitoring programs in information systems
Reports of potential failures
Supervisory controls
Management self-assessment
Quality control on internal audit
Internal
communication
5/28/2014
12:44 AM
Monitoring
Page 64
Internal audit
Audit committee
Board review
and reporting
Internal audit
Internal audit is an independent appraisal activity established within an organisation which examines and
evaluates the adequacy and effectiveness of other controls.
Need for internal audit

Need depends on complexity of activities, employee
numbers, cost-benefit considerations. Necessary when:

Changes in organisational structure

Changes in key risks
Problems with internal control systems
Increased number of unexplained or unacceptable
events
Objectives depend on information and recommendations
required by organisation, also state of organisation's risk
management.
Internal audit areas

Accounting and internal control systems

Financial and operating information
Economy, efficiency and effectiveness
Compliance with laws and regulations
Safeguarding of assets
Implementation of organisation's objectives
Risk auditing
Special investigations
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12:44 AM
Independence
IA should be independent of activities and
management being audited.
Page 65
Objectivity
Impartiality
Threats to independence
Threats include involvement in systems design and
consultancy, familiarity with other staff and reporting
to finance director whose activities are being audited.
Unbiased views
Valid opinion
Dealing with threats

IA staff don't audit their previous departments

IA staff don't audit systems they designed
Unrestricted access to records, staff, personnel
Report to audit committee
Rotation of IA staff
Page 65
Access to all areas

Relevant skills
Audit senior managers
I
n
d
e
p
e
n
d
e
n
c
e
Internal
communication
5/28/2014
12:44 AM
Monitoring
Role of audit committee

The audit committee's work should improve public
confidence in corporate governance, by helping to
create a climate of control and improving the quality of
financial reporting. The committee should also:
Enable NEDs to play positive role
Help finance director
Strengthen position and independence of external
auditors
Audit committee membership

Audit committee should consist of independent nonexecutive directors and should include member(s)
with significant and recent financial experience.
Page 66
Internal audit
Audit committee
Board review
and reporting
Duties of audit committee

Review of financial statements including changes
in policies, judgemental areas, compliance
Relationship with external auditors including
appointment/removal, independence, scope, liaison
Review of internal audit including standards,
independence, scope, resources, reporting, work
plans, liaison with external auditors, results
Review of internal control including systems
adequacy, legal compliance, fraud risk, auditors'
reports, disclosures
Review of risk management
Investigations
5/28/2014
Internal
communication

Monitoring
Strategic
Identifying,
Consequences/likelihoods evaluating and
Risks
12:44 AM
Page 67
Audit committee
Internal audit
Control system
effectiveness
Board review
and reporting
Actions to
reduce risk
Need for more

monitoring
managing risks
Regular review
Risk assessment

Control
environment/activities
Clear objectives
Assessment of significant
risks

Acceptable risks

understood

Page 67
Risk management policy

Effective culture
Senior management
commitment
Clear authority lines
Communication
Information and
communication

Quality of reports
Changing information needs
Balanced reporting?
Whistleblowing channels
Monitoring

Effective processes
Flexibility
Follow-up
Significant event
reporting
5/28/2014
Internal
communication
12:44 AM
Monitoring
Page 68
Internal audit
Audit committee
Board review
and reporting
Annual review of controls
External reporting on risk management
Review should be wider-ranging than normal review:

Changes in risks faced
Changes in organisation's ability to respond to risks
Scope and quality of managements monitoring
Work of/need for internal audit
Extent and frequency of reports to board
Significant controls, failings and weaknesses
Board should disclose existence of process for

managing risks, how the board reviewed the
effectiveness of the process and whether the
process accords with the Turnbull guidance.

Needs to be comprehensive and carried out systematically
and regularly. Most serious risks may need to be reported
daily. Reports should show:

Risk levels before controls implemented

Actual risks vs predicted risks

Feedback on action taken
Level of residual risks
Internal risk reporting
Contents of report
Responsibility for internal control
Responsibility for review of effectiveness
System manages, not eliminates, risk
System provides reasonable assurance v
loss
Summary of review
Process for dealing with problems
Weaknesses resulting in material losses
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Page 69
9: Personal ethics
Topic List
Ethical theories
Individual influences
Situational influences
Approaching ethical problems
Dont think of this chapter as too theoretical.You may see

questions where you have to determine what would
influence an individual's ethical decision-making, or use
Tucker or the AAA model to assist the decision-making
process.
5/28/2014
12:46 AM
Ethical theories
Page 70
Individual
influences
Situational
influences
Approaching
ethical problems
Lack of objective standards
Objective standards
Non-cognitivism no possibility of acquiring objective

knowledge of moral principles.
Moral relativism right and wrong are culturally
determined.
Cognitivism objective, universal principles exist and

can be known, ethics can be regarded as absolute.
Deontological ethics
Teleological Consequentalist ethics
Kant stated that acts can be judged in advance by

moral criteria:
Moral judgements based on outcomes or

consequences. Utilitarianism means acting for the
greatest good to the greatest number.
Do what others should be doing

Treat people as autonomous beings and not as
means to an end
Act as if acting in accordance with universal laws
Egoism
Act is ethically justified if decision-makers pursue
short-term desires or long-term interests (justification
for free market).
Pluralism
Different views may exist but it should be possible to
reach a consensus; morality is a social phenomenon.
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12:46 AM
Ethical theories
Page 71
Individual
influences
Situational
influences
Approaching
ethical problems
National and cultural beliefs
Psychological factors
Differences lie in four main areas.

Role of individual v collective good
Acceptance of power distribution
Desire to avoid uncertainty
Masculinity v femininity (money/possessions v
people/relationships)
Focus is on how people think and how they decide

what is morally right and wrong.
Education and employment
Locus of control
Influence individuals believe they have over their own
lives.
Internal individuals have significant influence
External lives shaped by luck/circumstances
People's education/work background seems to be more

significant with globalisation.
Moral development
Morality
Kohlberg's three levels ethics determined by:

1 Rewards/punishments (Pre-conventional)
Actions are influenced not only by people's own

integrity but also how much awareness they have of
their actions' moral consequences.
Page 71
Others' expectations/law (Conventional)
Individual's own decisions (Post-conventional)

9: Personal ethics
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Page 72
Ethical theories
Individual
influences
Situational
influences
Approaching
ethical problems
Moral intensity
Moral framing
Can be used to decide how ethically significant an

issue is.
How issues are perceived in organisations. Use of

language can be important (fairness/honesty), but also
significant is the degree to which managers are willing
to frame issues in moral terms.
Criteria

Magnitude of consequences
Society's view of problem
Probability of effect
Speed consequences will occur
Nearness of those affected
Level of suffering of those affected
National/cultural context
Ethical decision may be shaped by nation in which it
happens.
Organisational culture
Basic assumptions that define organisation's view of
itself and its environment.
Components of organisational culture

Values
Beliefs
Behaviours
Taken for granted assumptions
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Page 73
Systems of reward
Bureaucracy
Ethical positions can be affected for better or worse by

remuneration.
Basis of reward may encourage undesirable practices
Failing to reward/punishing ethical behaviour may
deter it
A system including detailed rules and procedures,

that underpins reward and authority systems.
Authority
Managers can encourage good or bad behaviour by the
example they set, whether they set targets that encourage
poor behaviour, or fail to stop unethical behaviour.
Work roles
The work role individuals have will determine what they
believe to be ethical.
Page 73
Bureaucracy characteristics

Rules override individual beliefs

Morality in terms of following procedures
Distancing individuals from consequences
Denial of individuals moral status
Organisational field
Organisations share a common business
environment, and hence common norms and
values.
9: Personal ethics
5/28/2014
12:46 AM
Ethical theories
How to gain marks

Marks will be awarded for:
Analysis of the situation
Recognition of ethical issues
Explanations of relevant ethical guidance
Making clear, logical and appropriate
recommendations
Justifying recommendations in practical business
and ethical terms
Page 74
Individual
influences
Situational
influences
Approaching
ethical problems
Tucker's model of decision-making

Profitable
Legal
Fair
Right
Sustainable
American Accounting Association

Facts
Ethical issues
Norms/principles/
values
Alternative courses
of action
Best course of
action
Consequences
Decision
5/28/2014
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10: Professional ethics
Topic List
Company codes
Professional codes
Ethical threats and safeguards
Accountants in business
Public interest
In this chapter we focus on professional and business

ethics. Knowledge of the ethical threats is as important
as it was in earlier auditing papers, and you need to
adopt a logical approach to solving ethical dilemmas.
However, in this paper its also important to understand
why codes take the form they do and how much impact
they have. Independence will be a key issue in many
questions.
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Company codes
12:48 AM
Professional
codes
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Ethical threats and

safeguards
Code of conduct
Public interest
Contents of codes
Code seeks to establish organisation's values, promote

business objectives, emphasise responsibilities to
stakeholders, control individuals' behaviour.
However, issuing a code isn't enough, a code needs to
be backed by:
Commitment of senior management
Staff understanding of importance of ethics
Staff commitment to ethics
Other measures

Accountants
in business
Detailed guidance
Recruitment/Selection/Induction
Training
Reward schemes
Whistle-blowing procedures
Ethical departments/audits

Ethical principles
Commitment required from employees
Compliance with law
Treatment of customers
Treatment of suppliers
Commitment to fair competition
Commitment to environment
Commitment to community
Corporate citizenship
Problems with codes

Codes may be seen as inflexible and unfair sets of
rules, that are not relevant to the ethical situations
employees encounter.
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Company codes
12:48 AM
Professional
codes
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Ethical threats and

safeguards
Accountants
in business
Public interest
Professional codes
Fundamental principles
Professional codes stress the

importance of the public interest.
Most then set out:
Fundamental principles
Conceptual framework
Threats to compliance
Safeguards
Professional competence/due care maintain knowledge/comply with

standards
Integrity straightforwardness/honesty
Professional behaviour avoid actions discrediting profession
Confidentiality don't disclose to third parties unless legal/professional
duty
Objectivity avoid influence by bias/conflicts of interest/undue influence
Advantages
Professional codes
Disadvantages
Emphasise public interest/confidence

Onus on active thought
International application
Can include detailed guidance/prohibitions
Prescribe minimum behaviour
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Lack of focus
Permit box-ticking
Don't capture regional variations
Not legally enforceable
Examples interpreted as rules
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Company codes
T
H
R
E
A
T
S
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Professional
codes
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Ethical threats
and safeguards
Self-interest
Self-review
Advocacy
Familiarity
Intimidation
Public interest
Professional safeguards

Importance of independence
Independence promotes:
Reliability of financial information
Credibility of financial information
Value for money of audit
Credibility of profession
Accountants
in business
Entry requirements
Training requirements
CPD requirements
Professional standards
Professional monitoring
Disciplinary procedures
External review
Safeguards in practice

Peer review
Independent consultation
Partner/staff rotation
Discussion/disclosure to audit committee
Reperformance by another firm
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Employment with assurance client

Close business
relationships
Partner on client board
Financial
interests
Family and personal relationships
Recruitment
SELF-INTEREST THREAT
Gifts and hospitality
Loans and guarantees

Lowballing
High %
of fees
Recent service
with assurance
client
% or contingent
fees
Overdue fees
General other
services
Preparing accounting records

and financial statements
SELF- REVIEW THREAT
Other services
Corporate
finance
Page 79
Internal audit
services
Valuation services
Tax services
Company codes
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12:48 AM
Professional
codes
Page 80
Ethical threats
and safeguards
Accountants
in business
Public interest
Familiarity threat
Advocacy threat
Where accountants take client's part, act as their
advocate or will only earn fees from client if
successful outcome is achieved (contingent fees).
Examples include provision of legal service and
corporate finance advice.

Intimidation threat
Conflicts of interest
These can arise from accountants acting for clients
with whom they are in dispute, eg over quality of
work. It can also arise through disputes between two
clients for whom accountants are acting.
Family relationships between client and firm

Personal relationships between client and firm
Long association with client
Recent service with client
Future employment with client

Close business relationships

Family relationships
Personal relationships
Staff employed by client
Litigation
Company codes
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12:48 AM
Professional
codes
Page 81
Ethical threats and

safeguards
Accountants
in business
Public interest
Preparation and reporting of information
Bribery and corruption
Information should describe clearly nature of

business transactions, classify and record information
in timely and proper manner, and represent facts
accurately.
Bribery is giving value in return for influence,

corruption also includes systems abuse, bid giving
and cartels.
Problems with bribery
Acting with expertise

Competent performance by accountant may be
threatened by lack of time, lack of information,
insufficient training, inadequate resources.
Financial interests
Share ownership, share options and profit-related
bonuses provide incentives to manipulate
information. Accountants may be offered
inducements to act illegally.
Page 81

Lack of honesty/good faith

Conflicts of interest
Misallocation of resources
Poor international risk management
Loss of reputation
Measures to combat bribery include code of conduct,

risk assessment, conduct of business rules and
whistleblowing questionable transactions.
Company codes
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12:48 AM
Professional
codes
Page 82
Ethical threats and

safeguards
Accountants
in business
Public interest
Public interest
Professionalism
The collective well-being of the community of people

and institutions the accountant serves. But lack of
statutory definition can make it difficult to enforce.
Critics have claimed profession acts against public
interest in a number of ways.
Compliance with relevant laws and regulations, and

avoidance of actions that may bring discredit on
profession.
Influence of profession
Against public interest
Accounting standards allow excessive leeway
Ineffective auditing standards
Emphasise confidentiality over public interest
Critics have accused the profession of:

Getting the numbers wrong
Failing to realise the assumptions used in
preparing accounts support a capitalistauthoritarian view of society
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11: Corporate social responsibility
Topic List
Ethical stances
Social responsibility
Social and environmental impacts
Environmental audits
In this chapter we examine organisations' impact upon

the natural and human environment. This has been
highlighted as an important topic and it illustrates how
various aspects of control systems (management
systems, internal audit and external reporting) are
applied.
5/28/2014
Corporate
citizenship
Ethical
stances
12:49 AM
Page 84
Social
responsibility
Social and
environmental impacts
Environmental
audits
Core principles
The business strategy shaping the values underpinning mission and choices made as the
corporation engages with society. Corporate
social responsibility discussions are often in
terms of corporate citizenship, focusing on rights
(carrying on business lawfully) as well as
responsibilities.
Minimising harm
Maximising benefit
Accountability and responsiveness to stakeholders
Limited view
Voluntary philanthropy, corporate citizen engages with local communities and

employees, mainly for self-interest.
Equivalent view
Focus on a broad range of stakeholders and response to demands of society and

legal requirements.
Extended view
Active social and political citizenship, promotion of social, civil and political rights,
filling void caused by lack of government action.
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Corporate
citizenship
Ethical
stances
12:49 AM
Page 85
Social
responsibility
Social and
Environmental
audits
Wider view of ethical responses

Better for reputation
Prevents more legal regulation
Minimum compliance
Government imposes wider constraints
Short-term shareholder
interest
Long-term shareholder
interest
Ethical stance
Multiple stakeholder
Building relationships
Which stakeholders?
Which obligations?
Page 85
Shaper of society
Constitution requirements
Accountability
Financial viability
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Corporate
citizenship
Ethical
stances
12:49 AM
Page 86
Social
responsibility
Social and
Environmental
audits
Pristine capitalists
Private property rights paramount, companies exist to make profits

and achieve economic efficiency
Expedients
Acknowledgement of business excesses, acceptance of limited social

and moral responsibilities
Social contract proponents
Survival depends on delivery of benefits to society/groups that

determine its power, behaviour adheres to society norms
Social ecologists
Modification needed of economic processes, resulting in resource

exhaustion, waste, pollution
Socialists
Society's framework should promote equality, not requirements of

capitalism
Radical feminists
Need for emphasis on feminine values such as co-operation and

reflection, fundamental readjustment of society required
Deep ecologists
Human rights to existence don't exceed other species' rights.

Economic systems should not trade species survival v economic
imperatives
Corporate
citizenship
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Ethical
stances
12:49 AM
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Social
responsibility
Social and
Depletion of
natural resources
Adverse visual and

aural impacts
Indirect impacts
through supply
chain
How organisations affect

the environment
Waste
disposal
Page 87
Positive/negative
health impacts
Environmental
audits
Air and water

emissions
Contribution to
climate change
Raising/lowering
local quality of life
Corporate
citizenship
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12:49 AM
Social
responsibility
Ethical
stances
Environmental costs
Waste management
Remediation
Compliance activities
Permit fees
Environmental training
R&D
Maintenance
Legal costs
Environmental assurance bonds
Environmental certification
Natural resource inputs
Record keeping and reporting
Page 88
Social and
Environmental
audits
Contingencies
X
X
X
X
X
X
X
X
X
X
X
X
__
X
__
__

Remediation/compensation
Future regulatory impacts
Essential product improvements
Employee health and safety
Environmental knowledge acquisition
Non-sustainable inputs
Impaired assets
Stakeholders and reputation risk

Increasingly stakeholders are aware of environmental
impacts and require businesses to do more to deal
with them. Being known as a poor corporate citizen
can pose a serious reputation risk.
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12:49 AM
Sustainability
Sustainability is ensuring that economic
development meets the needs of the present
without compromising the future.
Sustainability for organisations means
developing strategies by which an organisation only uses resources at rate that can be
replenished, and emissions of waste don't
exceed environments ability to absorb them.
For whom?
Other species
% of current population
In what way?
Natural/social/economic
How long?
Availability of raw materials
Dependent on climate change
At what cost?
Presentation
Substitution/compensation possible
Weak sustainability
Strong sustainability

Fundamental change in perceptions required

Harmony with natural world
Sustain all species
Continue to pursue economic growth?
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Page 89

Catastrophe prevention
Sustaining humanity
Regulate resource usage
Maintenance of existing system
Corporate
citizenship
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12:49 AM
Ethical
stances
Page 90
Social
responsibility
Social and
Environmental
audits
The Global Reporting Initiative aims to develop Sustainability Reporting Guidelines for organisations to use
when reporting on economic, environmental and social dimensions of their activities, products and services.
Full cost accounting
GRI indicators
Full cost accounting ultimately allows the incorporation of all costs/benefits into accounting equation,
including environmental and social externalities.

Sustainability report

Vision and strategy

Profile
Governance structure and management
systems
GRI content index
Performance indicators

Direct economic impact on key stakeholders

Environmental use of natural resources, emissions,
transport usage, compliance with standards
Labour practices employment practices, health and
safety, training, diversity
Human rights strategy, non-discrimination, workers
rights, low-paid labour
Society community contribution, political activities,
competitive attitudes
Products customer health and safety, advertising,
privacy
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12:49 AM
Advantages of external reporting

Enhances transparency and accountability

Promotes improvement in control systems
Addresses investor worries about risk
Enhances reputation
Limits damage if incidents occur
EMAS
Emphasis on verified improvement and disclosure.
Requirements include:
Environmental policy statement
On-site environmental review
Environmental management system
Environmental audits and actions
Public environmental statement
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Integrated reporting
Integrated reporting links reporting on sustainability
issues with reporting on financial results and operations.
It emphasises reporting on goals and strategies as well
as issues and impacts. Businesses should show their
relationships with capitals used (financial, manufactured,
human, intellectual, natural, social).
Environmental control systems

Control systems should cover relevant functions and
activities:
Policy development and objectives
Life-cycle assessment
Compliance
Waste and pollution minimisation
R&D
Performance reporting
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Corporate
citizenship
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Ethical
stances
Page 92
Social
responsibility
Social and
Environmental
audits
Environmental audit
Audit review
Assesses how organisation is safeguarding the

environment. It should enhance management control
of environmental practice and compliance with
internal policies and external reputation.
Auditors will concentrate on a number of aspects that

affect environmental impact:
Types of audit
Environmental impact assessment of major
projects
Surveys of organisation's impact on targets
SWOT analysis
Quality management programme
Eco-audit
BS7750 compliance
Supplier audits

Board knowledge
Compliance procedures
Environmental information systems
Performance targets and review
Implementation of previous recommendations
True and fair reporting
Audit work
Establish metrics
Compare planned/desirable and actual
performance
Report results

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First edition 2007, Eighth edition June 2014

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BPP Learning Media Ltd

Scope of corporate governance

Corporate social responsibility

1: Scope of corporate governance

This chapter sets out the foundations of good corporate

Take into account all stakeholders with legitimate interests

Agency in corporate governance

Agency is acting on behalf of another (principal) in

Directors (agents) run company on behalf of

Agency costs are the monies and resources

Agency problem how to prevent directors excessively

Main solution is to link reward with company

Transaction costs theory

A broad range of stakeholders have claims on an

Normative view ethical/philanthropic

Stakeholder power mapping

Stakeholders are groups or individuals whose

Instrumental view mainly economic

Corporate governance accommodates views

Primary and secondary stakeholders

Primary need participation to continue as going

Connected shareholders, customers, suppliers,

Narrow and wide stakeholders

Secondary their ceasing to participate wont affect

Active and passive stakeholders

Narrow most affected by organisations strategy

Active seek to participate in organisation's

Wide less affected by organisations strategy

Passive dont seek to participate in policy-making

Voluntary and involuntary stakeholders

Voluntary those who of their own choice have

Legitimate valid claims

Involuntary engage with the organisation without

Who decides legitimacy? Basis?

Illegitimate invalid claims

Unknown Existence unknown to organisation

1: Scope of corporate governance

Executive full-time managers, non-executive monitoring

Highlight governance and reporting issues, independence required to supply

Establish overall climate, encourage private shareholdings, provide subsidies,

Hold small numbers of shares in companies, trusts and funds. Likely to be

Services from public sector, aid from charities

Provide funds to charities, want them well-spent

Corporate governance guidelines reinforce legal and

Directors being paid undeserved and excessive

Need to avoid domination by single individual/small

Need for board to meet regularly to consider effectively

Accounting and auditing

Corporate social responsibility

Greater transparency and reliability of accounts,

Builds on stakeholders' debate, what responsibilities

2: Approaches to corporate governance

In this chapter we summarise the factors that have

Fulfil strategic objectives

Encourage owner involvement

2: Approaches to corporate governance

Avoids inflexible rules

Problems with principles

Principles too broad

External experience and knowledge