P1GRE Study Text Selected Sessions

ACCA
GOVERNANCE, RISK AND ETHICS P1

STUDY SYSTEM
September 2015June 2016 Edition
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Paper
P1
Contents
Page
Introduction ...............................................................................................v
About This Study System ............................................................................v
Syllabus.....................................................................................................vi
ACCA Study Guide ......................................................................................ix
Examination Approach ............................................................................. xvi
Examination Technique .......................................................................... xvii
Sessions
1 Scope of Governance ............................................................ 1-1
2 Agency Relationships and Stakeholder Theory ...................... 2-1
3 The Board of Directors .......................................................... 3-1
4 Board Committees ................................................................ 4-1
5 Directors' Remuneration ....................................................... 5-1
6 Approaches to Corporate Governance ................................... 6-1
7 Corporate Social Responsibility ............................................ 7-1
8 Governance: Reporting and Disclosure ................................. 8-1
9 Management Control Systems .............................................. 9-1
10 Internal Audit and Compliance ............................................10-1
11 Reporting on Internal Control ..............................................11-1
12 Identifying Risk ...................................................................12-1
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Contents
Sessions Page
13 Assessing Risk .....................................................................13-1
14 Controlling Risk ...................................................................14-1
15 Ethical Theories ...................................................................15-1
16 Ethics and Social Responsibility ...........................................16-1
17 Professions and the Public Interest .....................................17-1
18 Professional Practice and Codes of Ethics ............................18-1
19 Conicts of interest and unethical behaviour ......................19-1
20 Integrated Reporting and Sustainability ..............................20-1
21 Index ..................................................................................21-1
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Introduction
about thiS Study SyStem

This Study System has been specifically written for the Association of Chartered Certified
Accountants Professional Paper P1 Governance, Risk and Ethics (GRE).
It provides comprehensive coverage of the core syllabus areas and is designed to be used
both as a reference text and as an integral part of your studies to provide you with the
knowledge, skill and confidence to succeed in your ACCA studies.
About the author: Keith Rye is ATC International's lead tutor in this subject area of
governance, risk and ethics, and has more than 10 years' experience in delivering ACCA
exam-based training.
How to Use This Study System

You should start by reading through the syllabus, study guide and approach to examining
the syllabus provided in this introduction to familiarise yourself with the content of this
paper.
The sessions which follow include the following features:
These are the learning outcomes relevant to the session,

Focus
as published in the ACCA Study Guide.
Session Guidance Tutor advice and strategies for approaching each session.
A diagram of the concepts and the relationships addressed

Visual Overview
in each session.
Terms are defined as they are introduced and larger groupings of terms will
Definitions
be set forth in a Terminology section.
These are to be read as part of the text. Any solutions to numerical

Illustrations
Illustrations are provided.
These extracts of external content are presented to reinforce concepts and

Exhibits
should be read as part of the text.
These should be attempted using the pro forma solution provided (where
Examples
applicable).
Attention is drawn to fundamental rules, underlying concepts and

Key Points
principles.
Exam Advice These tutor comments relate the content to relevance in the examination.
Commentaries These provide additional information to reinforce content.
Session Summary A summary of the main points of each session.
These quick questions are designed to test your knowledge of the technical
Session Quiz
content. A reference to the answer is provided.
A link to recommended practice questions contained in the Study Question

Study Question Bank. At a minimum, you should work through the priority questions
Bank after studying each session. For additional practice, you can attempt the
remaining questions (where provided).
Example Solutions Answers to the Examples are presented at the end of each session.
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Syllabus P1 Governance, Risk and Ethics
Syllabus
Aim
To apply relevant knowledge, skills and exercise professional judgement in carrying out
the role of the accountant relating to governance, internal control, compliance and the
management of risk within an organisation, in the context of an overall ethical framework.
Rationale
The syllabus for Paper P1 Governance, Risk and Ethics acts as the gateway syllabus into the
professional level. It sets the other Essentials and Options papers into a wider professional,
organisational, and societal context.
The syllabus assumes essential technical skills and knowledge acquired at the Fundamentals
level where the core technical capabilities will have been acquired, and where ethics,
corporate governance, internal audit, control, and risk will have been introduced in a
subject-specific context.
The GRE syllabus begins by examining the whole area of governance within organisations
in the broad context of the agency relationship. This aspect of the syllabus focuses on the
respective roles and responsibilities of directors and officers to organisational stakeholders
and of accounting and auditing as support and control functions.
The syllabus then explores internal review, control and feedback to implement and support
effective governance, including compliance issues related to decision-making and decision-
support functions. The syllabus also examines the whole area of identifying, assessing and
controlling risk as a key aspect of responsible management.
Finally, the syllabus covers personal and professional ethics, ethical frameworksand
professional valuesas applied in the context of the accountant's duties and as a guide to
appropriate professional behaviour and conduct in a variety of situations.
Main Capabilities
On successful completion of this paper, candidates should be able to:
A. Define governance and explain its function in the effective management and control of
organisations and of the resources for which they are accountable
B. Evaluate the Governance, Risk and Ethics' role in internal control, review and
compliance
C. Explain the role of the accountant in identifying and assessing risk
D. Explain and evaluate the role of the accountant in controlling and mitigating risk
E. Demonstrate the application of professional values and judgement through an ethical
framework that is in the best interests of society and the profession, in compliance with
relevant professional codes, laws and regulations.
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P1 Governance, Risk and Ethics Syllabus
Relational Diagram of Main Capabilities
Governance and responsibility (A)
Internal control and review Identifying, assessing and

(B) controlling risk (C and D)
Professional values, ethics and social responsibility (E)
Position Within the Syllabus
GRE Professional
Papers
Professional
Module
AA (F8)
AB (F1)
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Syllabus P1 Governance, Risk and Ethics
Detailed Syllabus
A. Governance and Responsibility C. Identifying and Assessing Risk
1. The scope of governance 1. Risk and the risk management process

2. Agency relationships and theories 2. Categories of risk
3. The board of directors 3. Identification, assessment and
4. Board committees measurement of risk
5. Directors' remuneration
D. Controlling Risk
6. Different approaches to corporate
governance 1. Targeting and monitoring risk
7. Corporate governance and corporate 2. Methods of controlling and reducing risk
social responsibility
3. Risk avoidance, retention and modelling
8. Governance: reporting and disclosure
9. Public sector governance E. Professional Values, Ethics and Social
Responsibility
B. Internal Control and Review
1. Ethical theories
1. Management control systems in 2. Different approaches to ethics and
corporate governance social responsibility
2. Internal control, audit and compliance 3. Professions and the public interest
in corporate governance
4. Professional practice and codes of ethics
3. Internal control and reporting
5. Conflicts of interest and the
4. Management information in audit and consequences of unethical behaviour
internal control
6. Ethical characteristics of professionalism
7. Social and environmental issues in
the conduct of business and of ethical
behaviour
ACCA Support
For examiner's reports, guidance and technical articles relevant to this paper see:
www.accaglobal.com/en/student/acca-qual-student-journey/qual-resource/
acca-qualification/p1.html.
The ACCA's Study Guide which follows is referenced to the Sessions in this Study System.
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P1 Governance, Risk and Ethics ACCA Study Guide
ACCA Study Guide
A. Governance and Responsibility Ref.
1. The scope of governance

a) Define and explain the meaning of corporate governance. 1
b) Explain, and analyse the issues raised by the development of the joint stock
company as the dominant form of business organisation and the separation of
ownership and control over business activity.
c) Analyse the purposes and objectives of corporate governance in the public and
private sectors.
d) Explain, and apply in context of corporate governance, the key underpinning
concepts of:
i) fairness
ii) openness/transparency
iii) innovation
iv) scepticism
v) independence
vi) probity/honesty
vii) responsibility
viii) accountability
ix) reputation
x) judgment
xi) integrity
e) Explain and assess the major areas of organisational life affected by issues in
corporate governance.
i) duties of directors and functions of the board (including setting a responsible
'tone' from the top and being accountable for the performance and impacts of
the organisation)
ii) the composition and balance of the board (and board committees)
iii) relevance and reliability of corporate reporting and external auditing
iv) directors' remuneration and rewards
v) responsibility of the board for risk management systems and internal control
vi) the rights and responsibilities of shareholders, including institutional investors
vii) corporate social responsibility and business ethics.
f) Compare, and distinguish between public, private and non-governmental
organisations (NGO) sectors with regard to the issues raised by, and scope of,
governance.
g) Explain and evaluate the roles, interests and claims of, the internal parties involved
2
in corporate governance.
i) Directors
ii) Company secretaries
iii) Sub-board management
iv) Employee representatives (e.g. trade unions)
h) Explain and evaluate the roles, interests and claims of, the external parties involved
i) Shareholders (including shareholders' rights and responsibilities)
ii) Auditors
iii) Regulators
iv) Government
v) Stock exchanges
vi) Small investors (and minority rights)
vii) Institutional investors (see also next point)
i) Analyse and discuss the role and influence of institutional investors in corporate
governance systems and structures, for example the roles and influences of
pension funds, insurance companies and mutual funds.
(continued on next page)
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ACCA Study Guide P1 Governance, Risk and Ethics
Ref.
2. Agency relationships and theories 2
a) Define and explore agency theory.
b) Define and explain the key concepts in agency theory.
i) Agents
ii) Principals
iii) Agency
iv) Agency costs
v) Accountability
vi) Fiduciary responsibilities
vii) Stakeholders
c) Explain and explore the nature of the principal-agent relationship in the context of
d) Analyse and critically evaluate the nature of agency accountability in agency
relationships.
e) Explain and analyse the following other theories used to explain aspects of the
agency relationship.
i) Transaction costs theory
ii) Stakeholder theory
3. The board of directors 3
a) Explain and evaluate the roles and responsibilities of boards of directors.
b) Describe, distinguish between and evaluate the cases for and against, unitary and
two-tier board structures.
c) Describe the characteristics, board composition and types of, directors (including
defining executive and non-executive directors (NED).
d) Describe and assess the purposes, roles and responsibilities of NEDs.
e) Describe and analyse the general principles of legal and regulatory frameworks
within which directors operate on corporate boards:
i) legal rights and responsibilities,
ii) time-limited appointments
iii) retirement by rotation,
iv) service contracts,
v) removal,
vi) disqualification
vii) conflict and disclosure of interests
viii) insider dealing/trading
f) Define, explore and compare the roles of the chief executive officer and company
chairman.
g) Describe and assess the importance and execution of, induction and continuing
professional development of directors on boards of directors.
h) Explain and analyse the frameworks for assessing the performance of boards and
individual directors (including NEDs) on boards.
i) Explain the meanings of "diversity" and critically evaluate issues of diversity on
boards of directors.
4. Board committees
a) Explain and assess the importance, roles and accountabilities of, board committees
4
b) Explain and evaluate the role and purpose of the following committees in effective
corporate governance:
i) Remuneration committees 4
ii) Nominations committees 4
iii) Risk committees. 6
iv) Audit committees 10
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Ref.
5. Directors' remuneration 5
a) Describe and assess the general principles of remuneration.
i) purposes
ii) components
iii) links to strategy
iv) links to labour market conditions.
b) Explain and assess the effect of various components of remuneration packages on
directors' behaviour.
i) basic salary
ii) performance related
iii) shares and share options
iv) loyalty bonuses
v) benefits in kind
vi) pension benefits
c) Explain and analyse the legal, ethical, competitive and regulatory issues associated
with directors' remuneration.
6. Different approaches to corporate governance 6
a) Describe and compare the essentials of 'rules' and 'principles' based approaches to
corporate governance. Includes discussion of 'comply or explain'.
b) Describe and analyse the different models of business ownership that influence
different governance regimes (e.g. family firms versus joint stock company-based
models).
c) Describe and critically evaluate the reasons behind the development and use of
codes of practice in corporate governance (acknowledging national differences and
convergence).
d) Explain and briefly explore the development of corporate governance codes in
principles-based jurisdictions.
i) impetus and background
ii) major corporate governance codes
iii) effects of
e) Explain and explore the Sarbanes-Oxley Act (2002) as an example of a rules-based
approach to corporate governance.
i) impetus and background
ii) main provisions/contents
iii) effects of
f) Describe and explore the objectives, content and limitations of, corporate
governance codes intended to apply to multiple national jurisdictions.
i) Organisation for economic cooperation and development (OECD) Report
(2004)
ii) International corporate governance network (ICGN) Report (2005)
7. Corporate governance and corporate social responsibility 7
a) Explain and explore social responsibility in the context of corporate governance.
b) Discuss and critically assess the concept of stakeholder power and interest using
2
the Mendelow model and how this can affect strategy and corporate governance.
c) Analyse and evaluate issues of 'ownership,' 'property' and the responsibilities of
2
ownership in the context of shareholding.
d) Explain the concept of the organisation as a corporate citizen of society with rights
7
and responsibilities.
8. Governance: reporting and disclosure 8
a) Explain and assess the general principles of disclosure and communication with
shareholders.
b) Explain and analyse 'best practice' corporate governance disclosure requirements.
c) Define and distinguish between mandatory and voluntary disclosure of corporate
information in the normal reporting cycle.
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Ref.
d) Explain and explore the nature of, and reasons and motivations for, voluntary
disclosure in a principles-based reporting environment (compared to, for example,
the reporting regime in the USA).
e) Explain and analyse the purposes of the annual general meeting and extraordinary
general meetings for information exchange between board and shareholders.
f) Describe and assess the role of proxy voting in corporate governance.
9. Public sector governance
a) Describe, compare and contrast public sector, private sector, charitable status
and non-governmental (NGO and quasi-NGOs) forms of organisation, including 1
purposes, ownership and stakeholders (including lobby groups).
b) Describe, compare and contrast the different types of public sector organisations at 1
subnational, national and supranational level.
c) Assess and evaluate the strategic objectives and governance arrangements specific 4
to public sector organisations as contrasted with private sector.
d) Discuss and assess the nature of democratic control, political influence and policy
implementation in public sector organisations including the contestable nature of 1
public sector policy.
e) Discuss obligations of the public sector organisations to meet the economy,
effectiveness, efficiency (3 Es) criteria and promote public value.
B. Internal Control and Review Ref.
1. Management control systems in corporate governance 9

a) Define and explain internal management control.
b) Explain and explore the importance of internal control and risk management in
c) Describe the objectives of internal control systems and how they can help prevent
fraud and error.
d) Identify, explain and evaluate the corporate governance and executive management
roles in risk management (in particular the separation between responsibility for
ensuring that adequate risk management systems are in place and the application
of risk management systems and practices in the organisation).
e) Identify and assess the importance of the elements or components of internal
control systems.
2. Internal control, audit and compliance in corporate governance 10
a) Describe the function and importance of internal audit.
b) Explain, and discuss the importance of, auditor independence in all client-auditor
situations (including internal audit).
c) Explain, and assess the nature and sources of risks to, auditor independence.
Assess the hazard of auditor capture.
d) Explain and evaluate the importance of compliance and the role of the internal
audit function in internal control.
e) Explore and evaluate the effectiveness of internal control systems. 9
f) Describe and analyse the work of the internal audit committee in overseeing the
10
internal audit function.
g) Explain and explore the importance and characteristics of, the audit committee's
relationship with external auditors.
3. Internal control and reporting 11
a) Describe and assess the need to report on internal controls to shareholders.
b) Describe the content of a report on internal control and audit. 11
c) Explain and assess how internal controls underpin and provide information for
9, 11
accurate financial reporting.
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Ref.
4. Management information in audit and internal control 9
a) Explain and assess the need for adequate information flows to management for the
purposes of the management of internal control and risk.
b) Evaluate the qualities and characteristics of information required in internal control
and risk management and monitoring.
C. Identifying and Assessing Risk Ref.
1. Risk and the risk management process

a) Define and explain risk in the context of corporate governance. 12
b) Define and describe management responsibilities in risk management. 13, 14
c) Explain the dynamic nature of risk assessment. 14
d) Explain the importance and nature of management responses to changing risk
14
assessments.
e) Explain risk appetite and how this affects risk policy. 14
2. Categories of risk 12
a) Define and compare (distinguish between) strategic and operational risks.
b) Define and explain the sources and impacts of common business risks.
i) market
ii) credit
iii) liquidity
iv) technological
v) legal
vi) health, safety and environmental
vii) reputation
viii) business probity
ix) derivatives
c) Describe and evaluate the nature and importance of business and financial risks.
d) Recognise and analyse the sector or industry specific nature of many business
risks.
3. Identification, assessment and measurement of risk
a) Identify, and assess the impact upon, the stakeholders involved in business risk. 13
b) Explain and analyse the concepts of assessing the severity and probability of risk
13
events.
c) Describe and evaluate a framework for board level consideration of risk. 13
d) Describe the process of and importance of, externally reporting on internal control
11, 12
and risk.
e) Explain the sources, and assess the importance of, accurate information for risk
11
management.
f) Explain and assess the ALARP (as low as reasonably practicable) principle in risk
14
assessment and how this relates to severity and probability.
g) Evaluate the difficulties of risk perception including the concepts of objective and
14
subjective risk perception.
h) Explain and evaluate the concepts of related and correlated risk factors. 13
D. Controlling and Managing Risk Ref.
1. Targeting and monitoring of risk 14

a) Explain and assess the role of a risk manager in identifying and monitoring risk.
b) Explain and evaluate the role of the risk committee in identifying and monitoring
risk.
c) Describe and assess the role of internal or external risk auditing in monitoring risk.
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Ref.
2. Methods of controlling and reducing risk 14
a) Explain the importance of risk awareness at all levels in an organisation.
b) Describe and analyse the concept of embedding risk in an organisation's systems
and procedures.
c) Describe and evaluate the concept of embedding risk in an organisation's culture
and values.
d) Explain and analyse the concepts of spreading and diversifying risk and when this
would be appropriate.
e) Identify and assess how business organisations use policies and techniques to
mitigate various types of business and financial risks.
3. Risk avoidance, retention and modelling 14
a) Explain, and assess the importance of, risk transference, avoidance, reduction and
acceptance.
b) Explain and evaluate the different attitudes to risk and how these can affect
strategy.
c) Explain and assess the necessity of incurring risk as part of competitively managing
a business organisation.
d) Explain and assess attitudes towards risk and the ways in which risk varies in
relation to the size, structure and development of an organisation
E. Professional Values, Ethics and Social Responsibility Ref.
1. Ethical theories 15
a) Explain and distinguish between the ethical theories of relativism and absolutism.
b) Explain, in an accounting and governance context, Kohlberg's stages of human
moral development.
c) Describe and distinguish between deontological and teleological/consequentialist
approaches to ethics.
d) Apply commonly used ethical decision-making models in accounting and
professional contexts
i) American Accounting Association model
ii) Tucker's 5-question model
2. Different approaches to ethics and social responsibility 16
a) Describe and evaluate Gray, Owen & Adams (1996) seven positions on social
responsibility.
b) Describe and evaluate other constructions of corporate and personal ethical stance:
i) short-term shareholder interests
ii) long-term shareholder interests
iii) multiple stakeholder obligations
iv) shaper of society
c) Describe and analyse the variables determining the cultural context of ethics and
corporate social responsibility (CSR).
d) Explain and evaluate the concepts of "CSR strategy" and "strategic CSR". 7
3. Professions and the public interest 17
a) Explain and explore the nature of a 'profession' and 'professionalism'.
b) Describe and assess what is meant by 'the public interest'.
c) Describe the role of, and assess the widespread influence of, accounting as a
profession in the organisational context.
d) Analyse the role of accounting as a profession in society.
e) Recognise accounting's role as a value-laden profession capable of influencing the
distribution of power and wealth in society.
f) Describe and critically evaluate issues surrounding accounting and acting against
the public interest.
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Ref.
4. Professional practice and codes of ethics 18
a) Describe and explore the areas of behaviour covered by corporate codes of ethics.
b) Describe and assess the content of, and principles behind, professional codes of
ethics.
c) Describe and assess the codes of ethics relevant to accounting professionals such
as the IESBA (IFAC) or professional body codes.
5. Conflicts of interest and the consequences of unethical behaviour 19
a) Describe and evaluate issues associated with conflicts of interest and ethical conflict
resolution.
b) Explain and evaluate the nature and impacts of ethical threats and safeguards.
c) Explain and explore how threats to independence can affect ethical behaviour.
d) Explain and explore "bribery" and "corruption" in the context of corporate
governance, and assess how these can undermine confidence and trust.
e) Describe and assess best practice measures for reducing and combating bribery
and corruption, and the barriers to implementing such measures.
a) Explain and analyse the content and nature of ethical decision-making using
15, 19
content from Kohlberg's framework as appropriate.
b) Explain and analyse issues related to the application of ethical behaviour in a
19
professional context.
c) Describe and discuss "rules based" and "principles based" approaches to resolving
19
ethical dilemmas encountered in professional accounting.
7. Integrated reporting and sustainability issues in the conduct of business 20
a) Explain and assess the concept of integrated reporting and evaluate the issues
concerning accounting for sustainability (including the alternative definitions
ofcapital):
i) Financial
ii) Manufactured
iii) Intellectual
iv) Human
v) Social and relationship
vi) Natural
b) Describe and assess the social and environmental impacts that economic activity
can have (in terms of social and environmental "footprints" and environmental
reporting).
c) Describe the main features of internal management systems for underpinning
environmental and sustainability accounting such as EMAS and ISO 14000.
d) Explain and assess the typical contents and guiding principles of an integrated
report, and discuss the usefulness of this information to stakeholders.
e) Explain the nature of social and environmental audit and evaluate the contribution
it can make to the assurance of integrated reports.
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Examination Approach P1 Governance, Risk and Ethics
examination approach
The syllabus will be assessed by a three-hour paper-based examination. The examination
paper will be structured in two sections.
Time allowed: 3 hours
Number of marks
Section A: One compulsory question 50
Section B: Choice of two out of three 25-mark questions 50
100
Section A
Section A will be based on a case study style question, with requirements based on several
parts with all parts relating to the same case information. The case study will usually
assess a range of subject areas across the syllabus and will require the candidate to
demonstrate high level capabilities to evaluate, relate and apply the information in the case
study to several of the requirements.
Section B
Section B comprises three questions of 25 marks each, of which the candidate must
answer two. These questions will be more likely to assess a range of discrete subject areas
from the main syllabus section headings, but may require application, evaluation and the
synthesis of information contained within short scenarios in which some requirements may
need to be contextualised.
Additional Information
The examiner has stated that some simple arithmetical calculations may be required when
dealing with risk. This will enable some aspects of risk to be examined that cannot be
examined in a solely narrative based examination.
The study guide offers more detailed guidance on the depth and level at which the
examinable documents will be examined.
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P1 Governance, Risk and Ethics Examination Technique
Examination technique
Aim of Paper P1
"To apply relevant knowledge, skills and exercise professional judgement in carrying out
the role of the accountant relating to governance, internal control, compliance and the
management of risk within an organisation, in the context of an overall ethical framework."
It is widely recognised that there is more to passing exams than recalling facts, terms,
definitions, etc. You must practise your examination technique to convey the skills other
than knowledge (i.e. comprehension, application and analysis) which the examiners and
their markers will be looking for when assessing the quality (rather than the quantity) of
your answers.
The examiner has made it clear that he expects you to read around and research the topic
and be aware of current issues related to the syllabus.
This will mean reviewing appropriate websites and key documents referred to in this Study
System (e.g. the UK Corporate Governance Code and the UK Stewardship Code) and major
listed companies' websites (e.g. business reviews, corporate governance statements,
sustainability reports, risk reports, investors' pages) and generally keeping up to date on
current corporate governance issues (e.g. research the Examples and Illustrations given in
this Study System).
(1) Understand the Requirements

Before attempting any question, and in order to impress the markers, you need to
understand the examiner's requirements.
Understanding the Context
With a long scenario (i.e. Question 1) it is often best to obtain a general idea of the context
of the scenario. This should be done by briefly reading through the first paragraph, no
more. For example, am I dealing with a company or an NGO? What industry is involved
chemical, civil engineering, extraction, service, retailing? Single entity or group? National
or international? Developing country?
DO NOT read through the whole question at this stagedo so ONLY after having understood
the requirements.
Read the Requirements
With the context in mind, read the requirements (at the end of the question). Always
do this before reading the whole question. The longer the question, the more vital it is
that you observe this guidance! It is a waste of time to start by reading a question from
beginning to end because you will not appreciate the relevance of the "scenario" until you
know what the examiner is asking you for. A further advantage of this recommended
approach is that it reduces the risk of answering the question you wanted to see rather than
the question set by the examiner. This risk is greatest when the scenario, if it is read first,
suggests an examinable topic which is not central to the examiner's requirement.
Highlight "Instruction" and "Content"
All requirements (and parts thereof) should have an "instruction" (e.g. "describe") and
"content" (e.g. "procedures"). The instructions tell you how your answer should be written;
the content tells you what you should be writing about.
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Examination Technique P1 Governance, Risk and Ethics
Instructions
< "Construct" (i.e. build up from basics) an argument. Lay the foundation and then
strengthen your argument. If the requirement is to "Construct an argument for X rather
than Y" then concentrate on the positive aspects of X plus the negative aspects of Y.
< "Describe" (i.e. "set out the characteristics of"). Use brief sentences but give more
depth than if the instruction was "state" (see below).
< "Explain" (i.e. make plain, clarify, elucidate). For example, defining a term does not
explain it, but providing an illustration may do so.
< "State" (i.e. express in words). Use one short sentence (bullet point) to make each
answer point.
< "Discuss" or "Constructively criticise" (i.e. give balanced views on and conclude, where
appropriate).
< "List" (i.e. make a list of like things).
< "Justify" (i.e. give reasoning or provide a strong argument for).
< "Identify" (i.e. from the scenario). This requirement is often implied rather than
expressly stated. For example, "Describe the risks ." requires that the risks be
identified before they can be described.
< "Comment" (i.e. make observations, debate, appraise and/or examine (critically),
express a reaction).
< "Suggest" (i.e. propose or put forward).
< "Evaluate/assess" (i.e. weigh up and make a judgement). Consider, for example,
advantages/disadvantages, benefits/costs and/or pros/cons.
< With Q1, look for a particular "thread" running through and linking the requirements.
(2) Read the Scenario
From the requirements you will have a good idea of what to look out for as you read
through the scenario.
It is important to establish the underlying themes in the scenario (e.g. corporate
governance issues, risks of merging with an overseas company, culture and ethics, role and
structure of the board, sustainability).
Points to Look Out For
< Ethical positions of the company and its directorsoften one director will have a
conflicting ethical view to that of another. How can they be reconciled and how can
the ethical conflict be resolved? Identify from the scenario the ethical drivers and the
factors that determine the ethical position. Most situations can easily have an ethical
element.
< Corporate governancethe scenario is likely to present weaknesses that must be
identified and then resolved through recommendations. These may be based at a
national level or they may be based around cultural differences. Best practice has to be
identified.
< Agency and stakeholdersthe scenario will give plenty of detail of the environment
that the entity operates in. If directors are mentioned (as they probably will be) then
consider potential agency problems and costs. Not all of the stakeholders may be
specifically mentionedpractical experience and extrapolation may be necessary.
< As with Paper F8 Audit and Assurance control systems usually implies design,
application, weaknesses and impact on risks. Whenever something has gone wrong,
then consider the control implications (i.e. a control failed or was missing).
< With risks, look out for the most significant risksthese may relate to strategy,
operations and change. Having identified them, you will probably need to assess their
impact and how to respond to thempractical and cost effective solutions are expected.
< Look for clues indicating the use of a particular modelif the requirement does not
mention any by name, the scenario will give good clues if the examiner expects you to
use them.
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< Be aware of the underlying moral and ethical frameworksjust as you may think about
them in real life, do the same when answering questions. For example, is it acceptable
to favour one stakeholder over another?
< "Underpinning confidence"the examiner's "pet" phrases include "sound application
of corporate governance principles underpins market confidence in an entity";
"good controls that are relevant to the information needs of management, underpin
management's confidence in the information received"; "a good control environment
underpins regulatory confidence in the entity". Be alert to opportunities to "underpin".
(3) Plan Your Answer

The importance of adequate planning cannot be over-emphasised. Adequate planning leads
to an organised logical structure to your answer, incorporating all the points you can come
up with and highlighting your powers of analysis and communication.
A lack of planning leads to a disorganised illogical jumble of scraps of thoughts and ideas,
causing you to omit key elements of the question and repeat answer points already made.
How much planning is needed on each question depends, in the main, on just two factors:
(i) How much the requirement and scenario are broken down into partsthe more this
is already done for you, the less you need to do.
(ii) The mark allocation. In general, the more marks available, the more planning will be
required for that section.
When you are practiced in exam technique, planning 25-mark questions should take only
five minutes. Obviously, Q1 will take a little longerbut remember you do have 15 minutes
reading and planning time ("RAPT"). Use this time mostly on Q1 to maximise marks.
Ensure that you read the question thoroughly, as discussed in (2) above. Highlight key
points or note them down to ensure that you incorporate them in your answer.
Plan your answer in whatever way you prefer: some people like to use "mind maps" or
"spider-grams" and put everything on the page and then assemble it into order; others
prefer to put down key headings and then allocate points to them as they work through the
question.
Write any answer plans you do after the RAPT in your answer booklet so you can submit it.
Clearly head up the page "answer plan" or "workings".
WARNING: Never write " sentences"there is no time for them in answer planning and
no place for them in writing out your answer.
(4) Professional MarksQ1

These will not only be awarded for the style of your answer (e.g. a report, press release,
briefing notes or a letter) but also for the logic and structure of your answer, your
argument, the way you construct your case.
Failing to get all of the professional marks can be the difference between passing and
failing49 is the loneliest number in the world (not 1) at the time of your results. So plan
your answer accordingly. If a press release is required, do not do a letter. No marks will be
awarded.
Make sure you know what a press release looks like and the differences between it and,
for example, a briefing note or a statement to shareholders. Look at press releases on the
internet.
Lastly look at past Q1s. Note the way in which the subject matter is introduced and
concludedthe opening and closing paragraphs.
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Examination Technique P1 Governance, Risk and Ethics
(5) Write the Answer

If you have adequately read, thought and planned, this should be the easiest part of the
whole exercise. Points to remember:
< Use underlined HEADINGS and subheadings (generated by the requirement and any
breakdown of the scenario into parts) to produce a logical and structured answer. This
is particularly important if you have been asked to present your answer in the form of a
report, for example.
< The examiner positively discourages rewording of requirements into introductory
sentences as recommended by some (former) examiners because, not only is it time-
consuming, it does not earn marks and candidates fail to identify the key words and so
fail to focus on the question set.
< Maintain a sentence structure and keep sentences and paragraphs short and succinct.
Look to suggested solutions of past examinations for appropriate style.
Explain and define where necessary (e.g. if asked to be writing to a layman, explain phrases
such as "business risk" briefly: "business risk, that is the risk that the business will not
achieve its objectives ..."). This is particularly important, if for example you are asked to
prepare a briefing note for the CEO to explain a position to shareholders. If being explained
to institutional investors, then an explanation would not be necessary.
< Try to achieve a good standard of English. Although you will not lose marks for spelling
mistakes and poor grammar, you may lose marks if your answer points cannot be
understood by the marker.
< Allow plenty of space to present your answer and, if your writing is difficult to read,
write on
every
other
linein CAPITALS if necessary.
WARNING: Restrict the use of underlining to headings and sub-headings (and use a
ruler). Do not waste time underlining what you consider to be the "key" wordsit is quite
unnecessary and may interfere with the marking process.
< Candidates often ask, "How much should I write". The examiner is not interested in
volume, he does not weigh scripts and marking is an arduous task. So do yourselves
(and your markers) a favouranswer the Q set and think about the relevance of what
you are writing. Look back to the answer plan (above).
Summary
When attempting an exam style and standard question, always practise exam technique so
that it is second nature to you by the time of the real exam.
< Spend time thoroughly reviewing your answer against the "model" answer and make
a note of the points you missed. (Do not be despondent if some of the answers you
encounter do not follow this guidancehistorically "model" answers are written solely to
convey technical content rather than exam technique.)
< Study the examiner's comments on candidates' performance in previous exams, areas of
weakness and suggestions for improvements.
< Practice "effective writing" throughout your studiesit is not unique to answering
auditing questions!
Remember the key elements to examination technique:
Read: This provides the facts to trigger your knowledge.
Think: Without this planning process you will not be able to convey the skills of
comprehension, application and analysis which are expected of you.
Write: Concentrate on your style of writing to address the examiners' requirements as
directly as possible.
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NOTES
DeVry/Becker Educational Development Corp. All rights reserved. xxi

Session 1
Scope of Governance
FOCUS
This session covers the following content from the ACCA Study Guide.
A. Governance and Responsibility

1. The scope of governance
a) Define and explain the meaning of corporate governance.
b) Explain and analyse the issues raised by the development of the joint
stock company as the dominant form of business organisation and the
separation of ownership and control over business activity.
c) Analyse the purposes and objectives of corporate governance in the public
and private sectors.
d) Explain, and apply in context of corporate governance, the key
underpinning concepts.
e) Explain and assess the major areas of organisational life affected by issues
f) Compare, and distinguish between, public, private and non-governmental
organisations (NGO) sectors with regard to the issues raised by, and scope
of, governance.
9. Public sector governance
a) Describe, compare and contrast public sector, private sector, charitable
status and non-governmental (NGO and quasi-NGOs) forms of
organisation, including purposes, ownership and stakeholders (including
lobby groups).
b) Describe, compare and contrast the different types of public sector
organisations at subnational, national and supranational level.
d) Discuss and assess the nature of democratic control, political influence
and policy implementation in public sector organisations including the
contestable nature of public sector policy.
(see ACCA Study Guide for expanded learning objectives)
Session 1 Guidance
Read the Introduction (s.1) and Organisational Impact (s.3).
Understand the various meanings of corporate governance (s.2.1) and the key concepts (s.2.3) as
all are highly examinable. The King Report (s.2.4) provides a link to corporate social responsibility
(Session 7).

P1 Governance, Risk and Ethics Becker Professional Education | ACCA Study System
VISUAL OVERVIEW
Objective: To provide a basic understanding of the scope of corporate governance.
CORPORATE DEVELOPMENT
Introduction
A Brief History
MEANING OF ORGANISATIONS
CORPORATE
GOVERNANCE Listed Companies
Private Companies
Terminology
(Non-listed)
Best-Practice Elements
Public Sector
Key Underpinning
Non-governmental
Concepts
Organisations
King Report
Quangos
Lobby Groups
Public Sector Debate
Session 1 Guidance
Understand how concepts of governance apply to public sector organisations (e.g. Q1 June 2010)
and charities (see Q1 June 2011).
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Session 1 Scope of Governance P1 Governance, Risk and Ethics
1 Corporate Development
1.1 Introduction
There is no single, accepted definition of corporate
governance. Corporate governance as a specific discipline
is relatively new, although the concept has been around for
centuries. As beauty "lies in the eyes of the beholder", so
does the answer to the question, "What exactly is corporate
governance?"
There is a range of definitions, from a narrow view that it
is restricted to the relationship between a company and its
shareholders (agency theory) to the much wider view that
corporate governance is a complex web of direct, indirect
and ever-changing relationships between the entity and its *See section 2.1
stakeholders (stakeholder theory).* for definitions
and descriptions
The study of corporate governance is in essence the same as
of Corporate
the study of the mechanics of the capitalist system. It can be
Governance.
argued that every country in the world has its own variation
of the "capitalist system" and management of that system
(corporate governance) based on the law, corporate ownership
structure, culture, history, traditions, politics and economics
of that country. As the capitalist system has evolved, so has
While the United States (US) and United Kingdom (UK) are
just two of the many forms of capitalist systems, history
shows that they tend to be the most active and, therefore,
the most researched. Also, because of the UK's colonial past,
many countries have law and corporate systems (originally)
based on that of the UK.
The principal corporate structure of the 21st century allows
companies to be listed on stock exchanges and shareholders
to freely trade their shares. The so-called Anglo-Saxon (or
Anglo-American) model of corporate governance is one that is
held up as a benchmark for other systems.
1.2 A Brief History

Trade between individuals, settlements and countries has
existed since the first civilisation. Although initiated by sole-
traders and merchant guilds (effectively groupings of specialist
traders and craftsmen in a locality), the financing required to
expand trade and develop new markets outgrew the capacity
of the guilds. They began to seek finance through investment
by wealthy individuals, not connected with the guild, into
"joint stock". This eventually led to the formation of regulated
companies whose members could trade their shares in that
company. In theory, such members controlled the guild.
Also, governments issued charters to organisations to allow
them to raise public funding for particular risky ventures. An
early example of this was the East India Company formed by
Royal Charter in 1600 for the Merchant Guild of London to
develop trade into the East Indies.
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P1 Governance, Risk and Ethics Session 1 Scope of Governance
The growth of incorporation and raising of funds through the

public issue of unlimited liability "shares" continued until, in
1720, the collapse of the Company of Merchants of Great
Britain Trading to the South Seas caused a public outcry and
the banning of companies raising public funds without the
government's approval.
The South Sea Bubble, as the collapse was called, was the
first stock market overvaluation and subsequent demise of a
corporation. At one stage of trading, the value placed on the
shares of the corporation reached 500m ($1,000m), twice
that of the value of all of the land in England.
It was not until the mid-1800s that laws were passed in the
UK to allow limited liability companies to issue shares to fund
the industrial revolution and in particular, the building of a
national railway network. Greater emphasis was placed on
the rights and protection of shareholders, as they employed
managers to run the business for them.
In 1865, the 14th Amendment to the US Constitution gave
corporations the same rights as an individual and in the
UK, Solomon v Solomon, enshrined the same concept into
case lawthat corporations were separate legal bodies to
their managers and owners. Thus commenced the so-called
"divorce" of control and ownership.
Throughout the early and mid-1900s in the UK, various
Companies Acts were passed incorporating some governance
elements on regulating the requirement of companies to
produce audited financial statements, the duties of directors
and the rights of shareholders. In addition, the London Stock
Exchange placed further governance requirements on listed
companies through their listing rules.
Since the 1970s there has been a substantial growth in
the number of corporations, their size, global trading and
power. Many government-controlled utilities were privatised
(especially in the UK), which created millions of additional
shareholders and further widened the gulf between ownership
and management.
Initially this did not seem to be of concern to shareholders
(many writers commented then on the apparent malaise of *The UK Corporate
Governance Code was,
shareholders which allowed directors to gain greater control
prior to 2010, called
over companies) but a series of UK corporate scandals in
the UK Combined
the early 1990s (e.g. Polly Peck, BCCI, Maxwell, British Gas Code. The current
and Barings Bank) spurred the government into requiring edition of "the Code"
a detailed corporate governance code (the UK Corporate was published in
Governance Code).* In the US, Enron and WorldCom had a September 2012
similar effect, leading to the Sarbanes-Oxley Act of 2002, and and applies to all
a review/update of the UK Corporate Governance Code.* companies with a
Premium listing
of equity shares
regardless of whether
they are incorporated
in the UK or elsewhere.
*Although rules and regulations may deter financial fraud, they do
not change the criminal mindset. Financial fraud may still happen
(e.g. Tyco, Shell, Conrad Black, Madoff, Sanlu Group, Satyam, etc).

In addition, the last 10 years have seen a substantial increase

in the scrutiny of the roles and actions taken by corporations
as "good corporate citizens" (e.g. ethical behaviour, social
responsibility and sustainability). This is having a significant
effect on how corporations are being governed in a "CNN
world" and the necessary widening of the directors' vision to
consider all who are affected by the company and those who
can affect the company.*
*"CNN world" refers to the ease with which corporations are being
held to account by the public airing of their actions/inactions by
global media (e.g. use of child labour, the poor treatment of workers
in developing nations).
It may take 20 years to build a good reputation, but only 20 seconds
for bad publicity through the global media to destroy it. Reputation
risk is now taken very seriously.
2 Meaning of Corporate Governance
2.1 Terminology
A specific definition for corporate governance is difficult to
determine because there are many different legal jurisdictions,
corporate structures, cultures, moral beliefs and conditions under
which organisations operate throughout the world.*
*Participants include
The Organisation for Economic Co-operation and Development
the board, managers,
(OECD) explains corporate governance as: shareholders and
"The system by which business corporations are directed and other stakeholders
controlled. The corporate governance structure specifies (e.g. employees,
the distribution of rights and responsibilities among different suppliers, customers,
government, local
participants* in the corporation and spells out the rules
communities)hence
and procedures for making decisions on corporate affairs. By
"society" in the
doing this, it also provides the structure through which the broader definition.
company objectives are set, and the means of attaining those
objectives and monitoring performance."
Other explanations include:
"The system of checks and balances, both internal and
external to companies, which ensures that companies
discharge their accountability to all stakeholders and act in a
socially responsible way in all areas of their business activity."
Jill Solomon, 2004
"Corporate governance is concerned with holding the balance
between economic and social goals and between individual
and communal goals the aim is to align as nearly as possible
the interests of individuals, corporations and society."
Cadbury, World Bank report, 1999
"It is the relationship among various participants in
determining the direction and performance of corporations."
Monks and Minow, 1995

"Corporate governance is the system by which companies are

directed and managed. It influences how the objectives of
the company are set and achieved, how risk is monitored and
assessed, and how performance is optimised. Good corporate
governance structures encourage companies to create value
(through entrepreneurism, innovation, development and
exploration) and provide accountability and control systems
commensurate with the risks involved."
Australian Securities Exchange, 2010
"The ethical corporate behaviour by directors or others
charged with governance in the creation of wealth for all
stakeholders. It is the way of promoting corporate fairness,
transparency, independence, integrity and accountability."
2.2 "Best-Practice" Elements of Corporate

Governance
From these definitions, earlier studies on corporate governance
(e.g. papers F1 and F8) and the study of P1, it is clear that
there are a number of critical elements that reflect corporate
governance best practice:*
A framework through which strategic, tactical and operational *These sum up the
objectives are set (taking into account both internal and way in which an entity
external influences) and performance is optimised. sets a responsible
Strong internal control and risk management procedures. "tone from the top"
(actions of senior
Corporate strategies set and executed in an ethical and executive managers
effective way. and the board) to
Fairness, transparency, independence, integrity and provide sustainable
accountability are essential to ensure market confidence and "wealth" for all its
attract appropriate investment. stakeholders.
Application of substance over form.
Governance is top-down driven (set by the "tone from the
top") and pervasive throughout the organisation.
No longer inward looking and no longer purely about money.
Sustainable development and sustainability reporting had
been evolving parallel to governance during the 1990s and
all are now intrinsically linked through Integrated Reporting
(Session 20).

2.3 Key Underpinning Concepts

Fairness
Openness and
Reputation Transparency
Innovation
Integrity
CORPORATE GOVERNANCE
Judgement KEY UNDERPINNING Scepticism
CONCEPTS
Accountability Independence
Responsibility Probity and Honesty
2.3.1 Fairness
The systems and values in the company must be balanced
in taking into account all those that have an interest in the
company and its future.
There should be equality and even-handedness in directors'
deliberations with the ability to reach an equitable judgement
in any given ethical situation.
The rights of various groups (stakeholders) have to be
acknowledged and respected. For example, minority
shareowner interests must receive equal consideration to
those of the dominant shareowner(s).
2.3.2 Openness/Transparency
The ease with which stakeholders are able to make meaningful
analysis of a company's actions, its economic fundamentals
and the non-financial aspects pertinent to that business.*
A measure of how good management is at making necessary *Stakeholders also
information available in a candid, accurate and timely include board members
mannernot only the statutory and listing disclosures (executives and NEDs)
required in financial statements, but also general reports and management who
(e.g. to financial institutions), press releases, sustainability implement the board's
reports, general corporate social responsibility (CSR) reporting decisions. Board
and other voluntary information (e.g. through integrated meetings and actions
reporting). should be open and
transparent within the
Includes management developing the appropriate culture in confines of the board.
the company at all levels, strategic and operational.
Reflects whether investors and other stakeholders obtain a
true picture of what is happening inside the company.
Strong controls and systems have to be in place to be able
to capture, analyse and present reliable information on a
timely basis to facilitate the appropriate level of openness
and transparency.

2.3.3 Innovation
Innovation"the process through which economic and social

value is extracted from knowledge through the generation,
development, and implementation of ideas to produce new
or improved strategies, capabilities, products, services, or
processes."
The Conference Board of Canada
Entities operate in open and dynamic environments. To

remain competitive and increase stakeholders' wealth (see
Session 2) and be of increasing benefit to society as a whole,
they must "innovate and adapt their corporate governance
practices so that they can meet new demands and grasp new
opportunities." (OECD)
This implies that entities should be innovative in the way they
apply good corporate governance practices. Not just a case
of "following the rules" or "doing the same as last year" but
applying substance over form to ensure that stakeholders
and society as a whole have increased understanding of, and
benefit from, governance procedures (e.g. greater openness
and transparency in reporting to stakeholders and society
through innovative Web-based applications and integrated
reports).
In addition, as noted above, "good corporate governance
structures encourage companies to create value through
entrepreneurism, innovation, development and exploration"
(Australian Securities Exchange).*
*Innovation implies taking risks which require appropriate risk

management. A key element of good corporate governance is the
appropriate management of risks and explanations to stakeholders
on what those risks are and how they are being managed.
2.3.4 Scepticism
Professional scepticism was covered in Paper F8 Audit and
Assurance. In audit terms, it is an attitude that includes a
questioning mind, being alert to conditions which may indicate
possible misstatement due to error or fraud and a critical
assessment of audit evidence.
In corporate governance, and in many other applications,
scepticism requires a questioning mind, being alert for
possible errors and a critical assessment of facts and evidence.

One key element of good corporate governance is the

oversight role applied by non-executive directors and
shareholders (especially institutional shareholders). For
example, under the Code, non-executive directors should
constructively challenge and help develop proposals on
strategy. To do so requires appropriate levels of scepticism.*
*This does not, of course, mean challenging every single document

or discussion held during board meetings. No board could function
under such conditions. Nor does it mean, as in the banking crisis,
that boards, NEDs and shareholders totally fail to challenge chief
executives (and just accept what the CEO is doing because "the bank
is making good profits") until it is too late.
As an underpinning concept, scepticism is, perhaps, unique

in that it can also play a role in other underpinning concepts.
For example, application of healthy scepticism may assist
the development of fairness, openness and transparency,
independence, probity and honesty, integrity and judgement
within the entity (e.g. challenging any system within the
entity that may not appear to be fair to diversity or could
result in a reduction of transparency relating to a particular
transaction).*
*Note that reputation is effectively the cumulative result of all

of the underpinning conceptsalways remember that all of the
underpinning concepts are closely intertwined.
2.3.5 Independence
The extent to which mechanisms have been put in place to
minimise, or avoid, potential conflicts of interest that may
exist. Examples:
separation of the roles of chief executive and chairman of
the board;
independent non-executive directors (NEDs) to represent
the interest of the shareholders and other stakeholders;
independent NEDs balance on appointment and
remuneration committees to counter potential abuse by
executive directors;
use of internal and external auditors reporting to audit
committees; and
audit committees and limitation of non-audit work.
The decisions made and internal processes established should
be objective and not allow for undue influences or overt
personal motivation to prevail. That is, the company should
be run for the benefit of all stakeholders (shareholders being
a primary grouping).

2.3.6 Probity and Honesty

This is fundamental to corporate governance systems
(regardless of their origin) involving integrity, honour, virtue
and fair dealing.
It implies not misleading stakeholders (e.g. shareholders, the
market, employees). At a higher level, the chief executive
provides all appropriate information to fellow executive
directors and NEDs.
2.3.7 Responsibility
Responsibility pertains to behaviour that allows for corrective
action and for penalising mismanagement. It is a willingness
by management to accept liability for the outcome of
governance decisions.*
Responsible management would, when necessary, put in *"The buck stops
here" was a phrase
place what it would take to set the company on the right path
popularised by US
no matter how painful (e.g. dismissing an underperforming President Harry S
chief executive) or against its own interests (e.g. the chief Truman that refers to
executive realising that it is time to step down). "passing the buck" (i.e.
While the board is ultimately accountable to the company's handing responsibility
shareholders, recent corporate governance development to someone else)
means that the board must act responsively to, and with and the fact that as
responsibility toward, all stakeholders of the company. president he had to
make decisions and
With regard to shareholders, it is argued that they have accept the ultimate
responsibilities as owners. That is, to use the available responsibility for
mechanisms (e.g. annual general meetings and voting) those decisions and
to query and assess the actions of management.* the decisions of his
subordinates. As
president, he was
ultimately responsible
to the people who
elected him.
*In the past, institutional investors (e.g. pension funds) were
notorious for not exercising their ownership responsibilities. They
were often happy to sit back and take no interest in how the
managers ran a company (other than to pass to management their
proxy voting rights) so long as dividends and share value increased.
Increased activity by small shareholders, pressure groups (e.g.
Greenpeace), social responsibility and sustainability have resulted in
institutional investors becoming centre stage for shareholder activity
in holding managers accountable for their actions.

2.3.8 Accountability
Individuals or groups in a company who make decisions and
take actions on specific issues need to be accountable for their
decisions and actions.*
*The duties of directors and functions of the board include

being held accountable for the performance and impacts of the
organisation, the relevance and reliability of corporate reports and
the integrity of the integrated report (if producedsee Session 20).
Mechanisms must exist and be effective to allow for

accountability (e.g. annual general meetings). These provide
investors with the means to query and assess the actions of
the board and its committees.
But accountability is a two-way processdirectors must
provide the necessary information (e.g. through annual
financial statements) and opportunities to shareholders
(e.g. annual general meeting or specific meetings with
institutional investors) to be able to hold the directors
accountable for their actions. As discussed above,
shareholders have responsibilities as owners.
Current developments in corporate governance imply that
management is not just accountable to shareholders but to all
stakeholders. This is reflected in the development of CSR (see
Session 7) and integrated reporting (see Session 20) showing
that additional costs (e.g. social and environmental costs)
other than pure economic production costs should be
accounted for and explained.
2.3.9 Judgement
Entities operate in a complex and diverse range of events,
activities and environments. Achieving objectives requires
a series of decisions to be made based on a solid and sound
judgement of the relevant information and environments in
which the entity operates.*
An entity's management must be able to consider numerous
issues and inter-relationships, give each due consideration,
reach meaningful conclusions (that will enhance the prosperity
of the entity) and communicate/enact such conclusions.
This implies that managers have a thorough understanding
of the entity, its operations, business environment and risks/
opportunities as well as the necessary and appropriate skills
to maximise benefits and minimise risks.
*Sound and appropriate judgement is essential to strong corporate

governance as "Corporate governance is concerned with holding the
balance between economic and social goals and between individual
and communal goals the aim being to align as nearly as possible
the interests of individuals, corporations and society."
Cadbury, World Bank report, 1999

2.3.10 Integrity
Example 1 Integrity
Describe the concept of integrity and its context in corporate governance.
Solution
2.3.11 Reputation
Although reputation has both a personal and entity aspect,
an entity's reputation depends heavily on the reputation of its
managers and employeesan entity's reputation is effectively
the cumulative result of all of the other underpinning concepts
of good corporate governance.
Reputation risk is a business risk that many entities now
consider to be the greatest risk to their market standing.
Evidence suggests that reputation carries an appropriate
market capitalisation premium (good reputation) or discount
(bad or declining reputation) for listed companies.
Any of the key concepts can be explicitly examined (e.g. "define

transparency" or "construct the case for greater transparency").
However, as the concepts underpin strong corporate governance,
any one (or more) can easily, and relevantly, be referred to in exam
answers (e.g. transparency and judgement in relation to an ethical
dilemma faced by an entity's CFO and the impact on the entity's
reputation).

2.4 King Report

The South African King Report on Corporate Governance (2002)
considered the characteristics of corporate governance. As well
as transparency, independence, accountability, responsibility and
fairness, the report also noted discipline and social responsibility
as characteristics.* *The latest version
of the King Report
2.4.1 Discipline (King Report III)
was published in
Corporate discipline is a commitment by a company's senior 2009. In this report,
management to adhere to behaviour that is universally the concepts of
recognised and accepted to be correct and proper. This discipline and social
encompasses a company's awareness of, and commitment to, responsibility were
the underlying principles of good governance, particularly at incorporated into the
need for the board to
the senior management level.
embed a strong ethical
2.4.2 Social Responsibility corporate culture
(see Session 16)
A well-managed company will be aware of, and respond to, and ensure that the
social issues, placing a high priority on ethical standards. entity is a responsible
A good corporate citizen is increasingly seen as one that is corporate citizen
non-discriminatory, non-exploitative and is responsible with with the recognition
regard to environmental and human rights issues. A company of sustainability as a
is likely to experience indirect economic benefits (e.g. business opportunity.
improved productivity and corporate reputation) by taking
account of such factors.
3 Organisations
Many commentators on business matters consider that there
are three "sectors" in the business environment. Private sector
(i.e. listed and non-listed companies) and public sector (i.e.
governmental) organisations are the first and second sectors.
The third sector encompasses organisations that do not exist
primarily to make a profit nor to deliver a service on behalf of the
state. Rather, they exist primarily to provide a set of benefits that
cannot easily be provided by either profit-making businesses nor
the public sector. *Also see Session 6
for the contents of
3.1 Listed Companies the OECD and ICGN
principles on corporate
In most jurisdictions, the rights and duties of directors are governance.
enshrined in statutory and case law and, for listed companies,
in listing rules. Corporate governance codes aim to build
flexible requirements on a solid legal base so they can be
updated easily to reflect current best practice.
The contents page of the UK Corporate Governance Code
("the Code") provides an insight into those areas that are
considered to be key issues in corporate governance.* *Integrated reporting
<IR> requires
Leadershipeffective board, clear division of responsibilities
those charged with
between running the board and executive functions, no one governance to
individual should have unfettered powers of decision-making, acknowledge their
chairman leads the board, role of non-executive directors.* responsibilities to
Effectivenessbalance and skills of the board and stakeholders in order
committees; director appointments, re-election, induction, to ensure the integrity
of information provided
training and appraisal; information.
in the report (see
Session 20).

Accountabilitybalanced and understandable assessment

of the company's position and prospects; risks, risk
management and internal controls; relationship with the
external auditor.*
Remunerationappropriate to attract, retain and motivate *Corporate reporting
must be relevant and
directors (without paying more than is necessary) with
reliable.
strong links to company and individual performance; formal
and transparent procedures with no director involved in
deciding own remuneration.
Relations with shareholderssatisfactory dialogue,
communication of shareholder views to the board,
constructive use of the annual general meeting (AGM).
Directorsduties, functions, appointment, induction,
continuing professional education and performance appraisal.
In addition, with CSR and the application of business ethics
having a significant effect on corporate reputation, both
areas should now be considered as well within the scope
of corporate governance.
3.2 Private Companies (Non-listed)

While the concept of corporate governance has evolved
because of the actions of listed companies, it can just as
equally apply to private companies and, in particular, the
larger companies (which will have greater value than smaller
listed companies).* *The South African
King III Report is
Corporate governance may not be of high significance to specifically aimed at
private companies, but that will depend on their size and all companies; its
activities. Specific differences for private companies that requirements are
would have an effect on the level of governance compared compulsory for listed
to listed companies include: companies.
Limited number of shareholders (e.g. family members).
Directors are usually the only or major shareholders.
Lower need for different sources of finance (e.g. usually
just a bank loan).
Less regulation (e.g. standard legal requirements, no
listing rules).
Less complex systems (e.g. no need for internal audit).
Financial statement disclosure exemptions and audit
exemption for small companies.
However, all private companies should consider the principles
of good corporate governance and consider implementing the
most relevant ones (e.g. risk management).

3.3 Public Sector Organisations

3.3.1 Structure and Governance
A range of organisations exist in a "mixed economy" (i.e.
an economy in which some industries and businesses are
government-owned and others are privately owned): *Not to be confused
Business organisations that exist to make a profit. with "public
companies" (which
Organisations that exist for charitable or benevolent purposes. describes the
Public sector organisations that are, in some way, connected public availability of
to, or deliver, public goods and services that cannot (or should shares).
not) be provided by "for-profit" businesses.*
In most cases, public sector organisations are operated, at least
in part, by the state (i.e. a self-governing, autonomous region,
often comprising a population with a common recent or ancient
history).* A state has four essential "organs" without which it
cannot fully operate: *A state is not to
1. The executive (e.g. monarch or other head of state) or be confused with a
government (e.g. prime minister). government.
2. The legislature (formulates and passes statute law)in a
democracy, this is largely elected.
3. The judiciary (the system of courts) that interprets statute
and enforces non-statute laws ("common law")in a
democracy, this is independent.*
4. The secretariat (or administration) is responsible for carrying *So it can bring a
out government policy and administering a large number of legal case against
state functions. It is the largest of the four "organs" and its the government
roles depend on the Constitution but typically include: or its members if
education and health; necessary.
local authority provision and central government;
defence and foreign affairs;
state pensions;
tax collection; and
interior issues (e.g. immigration, policing and prisons).
Public sector organisations do not have shareholders, are mostly
funded by revenues from the state (mainly taxes together with
state borrowing) and they exist to deliver public services that
cannot (or, in the opinion of the government, should not) be
provided by the private sector (i.e. businesses funded by private
capital).*
*The public sector is very large in most developed countries

(e.g. more than 40% of the country's domestic product) and in
many developing countries, too. It accounts for many different
organisations delivering important services and employing thousands
or even millions of people (e.g. in the UK, it accounts for about a
quarter of all jobs).

Depending on their structure and constitution,* they may

be governed by a board of appointed directors, trustees or
governors (e.g. health service, schools), publicly elected officials
(e.g. local city hall mayor) or directly by a government minister.
*Public sector
Ultimately all public sector organisations are accountable organisations may
to the public, directly or indirectly. National and local be at the national,
governments are accountable to the general public, which may sub-national or supra-
pass judgement through voting.* national level (see
Similar to companies, public sector organisations need an s.3.3.23.3.4 below).
executive to show leadership and managementnot only
representative of the services provided, but also from diverse
backgrounds to broaden the "gene pool" and represent the
community. They also need to balance the need for stability
against the need to "keep up with the times".
Although it is not common in the public sector, public sector *Public sector agency
organisations which have a direct link to the public (e.g. local and stakeholder issues
councils) often produce independently audit statements of are discussed in
Session 2.
income and expenditure, but in less detail than required for listed
companies.
Many larger public sector organisations (e.g. local councils)
have internal audit departments carrying out similar roles
to those of listed companies. They do not generally report
to an audit committee, however, as it is rare for corporate
governance style committees to exist in public services.
In the UK (and in other countries), government expenditure
is closely scrutinised through various committees of members
of Parliament and a full-time "internal audit" department, the
Audit Commission. Ministers may be called upon to explain to
Parliament expenditure in their departments. A similar system
operates at the local administration level.
Also, many public sector organisations have established
independent procedures whereby employees and members
of the public may make official complaints about the
organisation's activities and procedures (similar to whistle-
blowing procedures).
3.3.2 National Public Sector Bodies

Typically a national government is divided into various
departments (e.g. treasury, interior ministry, foreign office,
defence ministry, health service, education and social services).
In many cases, these departments are led by a political minister *This process is
from the governing political party, supported by a staff of career an example of the
civil servants. application of a "social
contract" between
In terms of governance, the political minister issues instructions the people and the
on how the department should formulate and implement policy government (i.e. the
to help achieve the government's overall strategic objectives. state only exists to
The civil servants advise the minister and help him or her to serve the will of the
implement policy in the relevant department. people and the people
are the source of all
This structure is important in democratic countries as the policies political power enjoyed
adopted by the various departments affect the entire population by the state). The
of the country (as well as, perhaps, populations of other countries people can choose to
(e.g. through trading and foreign aid) and it is critical that they give or withhold this
are subject to political change when the electorate changes a power.
government at an election.*

In addition, national government policy is configured and

coordinated centrally to ensure that strategic policies are pursued
and that departments work together to achieve this. The head of
government (e.g. the UK prime minister), not to be confused with
the head of state (e.g. in the UK, the Queen), is responsible for
national government policy and in a democracy he or she can be
re-elected or defeated based on his or her performance as head of
the government.
3.3.3 Sub-national Public Sector Bodies

Some countries are organised or subdivided at a "below" (i.e.
"sub-") national level, into regional authorities, variously called
regional assemblies, federal states, cantons, departments,
municipalities, local authorities or similar.
Some selected powers are devolved down to these sub-national
bodies by national government in the belief that these selected
powers are either best handled by local people (to meet specific
local needs) or that service delivery to the regions will be more
efficient or cost effective.
Typical powers devolved down to the sub-national level include:
planning (e.g. roads and new housing permissions);
utilities (e.g. energy and water); and
policing, local schools, housing, support of vulnerable
communities, rubbish collection, etc.
Illustration 1 Healthcare
In many countries general healthcare is one of the tasks devolved to

local authorities, as they are usually in possession of the particular
statistics and needs analyses that are necessary for effective
planning of local health services. If a large housing project is
planned, or if there has been a significant influx of people because
of employment opportunities, the local authority can ensure that
appropriate health services are added or expanded to serve the
increase in the local population. Similarly, local demographic trends
and particular health service needs may be better understood by
sub-national authorities than by national government. In such
cases, individual health centres and general hospitals must report
to the local authority on selected metrics, which might include
budgetary compliance, patient statistics, bed occupancy rates, and
operation statistics. This would also mean that specialist medical
needs (e.g. heart surgery) or very expensive equipment (e.g. brain/
body scanners) could be centralised in each local authority (or a
group of local authorities) to ensure value for money application.
In many cases, sub-national public sector organisations are led

by elected representatives in a way that is similar to national
governments. These are supported by permanent officials in a
similar manner to civil servants in national governments.

3.3.4 Supranational Public Sector Bodies

Supranational bodies are formed by a grouping of national
governments ("locally" or worldwide) for a shared purpose.
They are often subject to significant pressures as the larger the
grouping of governments, the greater the potential for conflicts
and disagreements (e.g. pressure from each country's own people
to prefer one outcome to another).
Typical examples include:
The European Union, with offices in Strasbourg and Brussels.
Similar bodies for trading and/or political reasons exist
elsewhere in the world.
The United Nations (UN), based in New York, expresses the
collective opinion of many countries on a range of international
issues (in 2014, 192 nation states were members). The UN
employs many thousands of people, at its headquarters in
New York as well as around the world through its various
agencies (e.g. the World Health Organisation, refugee agency,
environmental programme, etc).
The World Trade Organisation (WTO, formerly the General
Agreement on Tariffs and Trade), the International Monetary
Fund (IMF), World Bank and the International Court of Justice
at The Hague.
3.3.5 The Seven Principles of Public Life*
*While ownership, control, objectives and risks of public sector

organisations may be different from listed companies, many of the
governance principles are equally applicable (e.g. composition,
ability and succession of the governing body, accountability, risk
management, transparency, effectiveness). It is not uncommon
for national governments (e.g. the UK) to take private-sector
methodologies and apply or adapt them to public sector
organisations in an attempt to make such organisations more
effective, market oriented and accountable.

Taken from the UK Government's Committee on Standards

in Public Life (originally the Nolan Committee on Standards
established in 1995), holders of public office should adhere to the
following principles:
Selflessness Acting solely in terms of the public interest. Not

acting to gain financial or other material benefits for
themselves, family or friends.
Integrity Not placing themselves under any financial or other

obligation to outside individuals or organisations that
might seek to influence them in performing their
official duties.
Objectivity Making choices on merit in carrying out public

business, including making public appointments,
awarding contracts or recommending individuals for
rewards and benefits.
Accountability Public accountability for decisions and actions.

Includes submitting themselves to whatever scrutiny
is appropriate to their office.
Openness Being as open as possible about decisions and actions.

Giving reasons for decisions and restricting information
only when the wider public interest clearly demands it.
Honesty Having a duty to declare any private interests

relating to their public duties and taking steps to
resolve any conflicts arising in a way that protects
the public interest.
Leadership Promoting and supporting these principles by

leadership and example.
3.3.6 The Independent Commission for Good Governance

in Public Services
The Independent Commission for Good Governance in Public
Services (Office for Public Management, or OPM, and the
Chartered Institute of Public Finance and Accountancy, or CIPFA)
identified six principles of good governance in the public service.*
*Because of the significant range and objectives of public services,

taking one set of basic rules and applying them to all situations
is neither practical nor possible. Several organisations publish
guidelines and principles to be applied by public sector organisations.

1. Focusing on the organisation's purpose and on outcomes

for citizens and service users.
Being
clear about the organisation's purpose and its
intended outcomes for citizens and service users.
Ensuring that users receive a high-quality service.
Ensuring that taxpayers receive value for their money.
2. Performing effectively in clearly defined functions and
roles. Being clear about:
the
functions of the governing body;
the
responsibilities of NEDs and the executives and ensuring
that they are carried out; and
the relationships between governors and the public.
3. Promoting values for the whole organisation and
demonstrating the values of good governance through behaviour.
Putting
organisational values into practice.
Individual
governors uphold and exemplify effective
governance.
4. Taking informed transparent decisions and managing
risk through:
being
rigorous and transparent about how decisions are taken;
havingand using good-quality information, advice and
support;
ensuring that an effective risk management system is in
operation.
5. Developing the capacity and capability of the governing
body to be effective by:
ensuring that appointed and elected governors have the
skills, knowledge and experience they need to perform well;
developing the capability of people with governance
responsibilities and evaluating their performance, as
individuals and as a group; and
striking a balance, in the membership of the governing
body, between continuity and renewal.
6. Engaging stakeholders and making accountability real
through:
understanding formal and informal accountability
relationships;
taking an active and planned approach to dialogue with
accountability to the public;
taking an active and planned approach to responsibility to
staff; and
engaging effectively with institutional stakeholders.

3.4 Non-governmental Organisations (NGOs)

These organisations usually consider financial objectives as
constraints under which they have to operate. Examples
include:
Charities and Foundations (collect money and effectively
Non-governmental
distribute according to the charity's aims). organisation"An
Pressure groups (who raise money to be able to follow a independent voluntary
given agenda). association of people
Clubs and mutual societies (e.g. trade unions which acting together on a
raise money directly from members to be able to provide continuous basis, for
common services to them). some common purpose
other than achieving
Such organisations raise money from public sources (e.g. government office,
benevolent individuals) to fund their activities. Larger making money or
organisations take governance seriously as they need to illegal activities."
demonstrate to existing and potential fund providers that
money is being spent appropriately in accordance with the
entity's objectives, statute or charter.*
Also, many may be subject to specific regulatory requirements
(e.g. the UK Charities Act has accounting requirements very
similar to the Companies Act). *Medicins sans
Using charities as an illustration, the principal comparisons to Frontiers ("Doctors
listed companies are: Without Borders") is a
Although unlikely to have shareholders they may have huge, well-structured
organisation, that
members and be supervised by a specific regulatory body
delivers emergency
(e.g. Charities Commission in the UK). medical aid to
Key stakeholders usually will include fund providers, grant people affected by
providers, donors, donation recipients and the general conflict, epidemics,
public. In particular, providers and donors will take a close disasters, etc.
interest in what happens to the funds they provide.
Although often run along the lines of a company (e.g.
with a board of directors, the majority of whom will be
independent) which may be overseen by a board of trustees
(all will be independent). Except for the larger, international
organisations, most directors and trustees may not be
remunerated.
Trustees have an oversight role similar to the combined
roles of audit, nominations and remuneration committees.*
Codes of governance contain similar provisions to codes for
listed companies regarding the board, roles of CEO, chairman
of the board, trustees chairman, committees, appointment, *A key role of the
remuneration, independence, reporting and auditing. Trustees is to ensure
that the charity (or
NGO) operates in line
with its stated purpose
or terms of reference.

3.4.1 Principles for Good Governance and Ethical Practice

(Panelon the Non-profit Sector)
The Panel on the Non-profit Sector (2007) has been dedicated
to finding ways to strengthen governance, transparency and
ethical standards in the US charitable community since its
creation in October 2004.
33 principles are detailed in the guidelines, grouped into 4areas:
1.Legal Responsibilities and practices (e.g.

compliance implementing conflicts of interest and whistle-
and public blower policies) to assist charities in complying
disclosure with their legal obligations and providing
information to the public (similar to the UK
Code).
2.Effective Policies and procedures a board of directors

governance should implement to fulfil its oversight and
governance responsibilities effectively (similar
to the UK Code).
3.Strong Policies and procedures to ensure wise

financial stewardship of charitable resources
oversight (appropriate variations from the UKCode).
4.Responsible Policies and procedures for soliciting funds

fundraising from the public to build donor support and
confidence (appropriate variations from the UK
Code).
3.4.2 Principles of the Code of Governance for the Voluntary

and Community Sector
Board Every organisation should be led and

leadership controlled by an effective board of
trustees to ensure delivery ofits objects,
set its strategic direction and uphold its
values.
The board in The trustees are responsible and accountable

control for ensuring and monitoring that the
organisation is performing well, is solvent and
complies with all its obligations.
The high The board should have clear responsibilities

performance and functions and compose and organise itself
board to discharge them effectively.
Board review The board should periodically review its own

and renewal and the organisation's effectiveness and take
any necessary steps to ensure that both
continue to work well.
Board The board should set out the functions of sub-

delegation committees, officers, the chief executive, other
staff and agents in clear delegated authorities
and monitor their performance.
Board and The board and individual trustees should

trustee integrity act according to high ethical standards and
ensure that conflicts of interest are dealt with
properly.
Board openness The board should be open, responsive and

accountable to its users, beneficiaries,
members, partners and interested others.

3.5 Quasi-Autonomous NGOs (Quangos)

An NGO may be funded by a government but remain semi-
independent of the government in its activities. For example,
a government may want to provide an important service (e.g.
regional support of businesses) but ensure that its delivery is
free from (and seen to be free from) political interference. To
avoid accusations that a business-support decision was based
on political advantage, the governing party may give a publicly
funded organisation effective autonomy in its decision-making,
even though it is helping to implement government policy.
There are two main problems with quangos:
They may be accused of being unaccountable for their
decisions because they only weakly report to the government
(and the taxpayers) who fund their decisions.*
They can be politically awkward and, accordingly, their use in *But that is partly the
the public sector changes over time. point of a quango:
it accounts to many
3.6 Lobbying and Lobby Groups principals, including
In a democratic society (i.e. one in which political priorities are local stakeholders,
central government
publicly debated and governments change with the collective will
and national
of voters), varied external interests seek to influence public policy. taxpayers.
In some cases, external interests unite on a certain opinion,
and it may seem appropriate to campaign to influence
government policy in favour of a particular vested interest.
When organised specifically to try to influence government
policy or new legislation, such interests may "lobby" politicians
for their support (i.e. vote in their favour).
"Lobby groups" may attempt to influence in favour or against
a wide range of issues and include:*
British Medical Association
Campaign for Nuclear Disarmament *Also called pressure
Energy Lobby groups, campaign
Greenpeace groups, special interest
groups, etc.
National Rifle Association
Oxfam
Royal Society for the Protection of Birds.
Although their activities are legal, some argue that they may
not be helpful because the best-funded are most likely to be
heard. This can be against the public interest and in favour
of sectional interests (which is not always helpful to the
democratic process).

3.7 Public Sector Debate

Public sector organisations (regardless of their form) are directly
responsible for delivering part of a government's policy and are,
in most countries, under the control of the government. This
means that they are under "political control" in that people in
government with a political agenda partly control their objectives
and activities.
In many countries, politics divides along a "left-right" split; in
others, political divisions are more concerned with ethnicity,
culture or religion. In some countries, universities may be funded
mainly by governments; in others, they may be mainly private
institutions. Healthcare and schools provide other examples;
these may be under central government control and funding or be
privately funded (citizens must pay for services directly or through
insurance).
There is occasional debate about how public sector organisations
should be operated and whether they should exist. Because, in
many democratic countries, public policy is debated in the public
arena, there is a public debate about how the state sector should
be constituted. This includes debates about the size of the state
and the role of its institutions.
In a democracy, political parties argue about the nature of
public policy and they do so from a particular set of underlying
assumptions. Some of these underlying assumptions influence
the way they argue for particular outcomes and the way in which
they guide a government when they achieve political power (e.g.
left-leaning governments tend to prefer a larger state sector, with
more state spending and more public sector employment, while
right-leaning governments prefer that more be achieved in the
private sector and less by government).
In addition, changing policy objectives mean that some public
sector organisations are required to change over time, both in
size and in what they are asked to do. As governments change,
some public sector organisations grow in size and become more
important, and others become small, less important or even
disappear.
The debate is often intense and enduring. In the case of
education, some believe that it should always be entirely within
the public sector and entirely funded by the taxpayer. This means
that, for the service user (the student), everything is free at
the point of use. Others strongly believe that this is a misuse
of public funds and that people should pay for their education in
other ways, such as through loans or a subscription scheme. With
tertiary, university education, some believe that it should be paid
for by the state (i.e. no fees) and others believe that students
should pay (although some believe that a form of "means testing"
should applyif a student's parents can afford to contribute, they
should do so).
In each case, debates are complicated. If there were easy and
convincing answers, there would be less debate. But public
opinion is split on most areas of public debate and this fuels
political debate and, in turn, how public sector organisations are
configured in line with particular political influences.

One of the ways in which some countries have restructured their

economies in recent years is through the process of privatisation.
This means taking a service that was previously delivered through
public sector organisations and then allowing it to be provided by
private sector organisations.
In some cases, the previous public sector monopoly supplier of a
service is transferred into the private sector by making it into a
public, listed company so people can buy shares in it. Those in
favour of privatisation tend to argue that services can be delivered
more efficiently in the private sector where management have a
profit motive and competition. This, in turn, delivers better value
to the customer.
This process is not without its critics, however. Opponents of
privatisation sometimes argue that some strategic services, such
as utilities, water, etc, are too important to be subject to the
market forces of private enterprise. Others believe, perhaps from
a position of personal ideology, that the state should control much
more of the economy rather than less. So, for example, transport
(especially buses and trains) should also be under state control.
Questions are regularly set that cover the governance issues of public
sector and non-corporate organisations. Such questions require an
understanding of the stakeholders involved and their issues/claims,
a realisation that the organisation is not controlled by shareholders,
agency relationships (see Session 2), the various governing bodies
and how they are overseen. In addition, a question could cover the
impact of moving from a public body (controlled by government)
to a listed private enterprise (accountable to shareholders) through
privatisation. Not only would governance procedures change but
there would also be significant changes in risks and culture.

Session 1
Summary
Corporate governance is the system by which firms are directed and controlled within a
distribution of rights and responsibilities among directors, managers and stakeholders.
Corporate governance provides the structure for determining strategy and setting, monitoring
and achieving corporate objectives.
Corporate governance principles are also applicable to private firms and public entities.
The fundamental underpinning concepts of corporate governance are fairness, openness
and transparency, innovation, scepticism, independence, probity and honesty, responsibility,
accountability, judgement, integrity and reputation.
The UK Corporate Governance Code recognises the key issues of corporate governance to be
leadership, effectiveness, accountability, remuneration, relations with shareholders and the
functions and duties of directors.
Corporate governance may also be applied to public sector organisations. The Committee
on Standards in Public Life adds selflessness (i.e. acting in the public interest rather than to
receive personal financial gain).
Session 1 Quiz
Estimated time: 15 minutes
1. Define corporate governance. (2.1)
2. List the ELEVEN key underpinning concepts of corporate governance. (2.3)
3. Explain why "accountability" is a two-way process. (2.3.8)
4. List FIVE key issues in corporate governance. (3.1)
5. List the SEVEN principles of public life. (3.3.5)
Study Question Bank

Priority Estimated Time Completed
Q1 Corporate Governance 50 minutes

Additional
Q2 Public Service

EXAMPLE SOLUTION
Solution 1Integrity
Under the ACCA Code of Ethics and Conduct, integrity requires that
"in all professional, business, personal and financial relationships,
members should be straightforward and honest. This implies
honesty, fair dealing and truthfulness. Members should not be
associated with (e.g. sign off) reports, returns, communications or
other information where they believe that the information:
contains materially false or misleading statements;
contains statements or information furnished recklessly; or
omits or obscures information required to be included where such
omission or obscurity would be misleading."
This understanding of the concept of integrity is fundamental for
strong corporate governance. The perceived integrity of the entity
(e.g. as a corporate body), the integrity of the actions taken by the
management and employees of the entity, the integrity of its external
and internal reports and information cannot be greater than the
integrity of those involved.
Individual integrity describes a person of high moral valuean
individual who observes a steadfast adherence to a strict moral
code or ethical code notwithstanding other pressures on them to act
otherwise. The virtue of the individual rather than the ethics
of the action is emphasisedintegrity provides the necessary ethical
framework.
As in many situations in life, in corporate governance trust is vital.
Integrity underpins this.

NOTES

Session 3
The Board of Directors
FOCUS
A. Governance and Responsibility

3. The board of directors
a) Explain and evaluate the roles and responsibilities of boards of directors.
b) Describe, distinguish between and evaluate the cases for and against,
unitary and two-tier board structures.
c) Describe the characteristics, board composition and types of directors
(including defining executive and non-executive directors (NED) ).
d) Describe and assess the purposes, roles and responsibilities of NEDs.
e) Describe and analyse the general principles of legal and regulatory
frameworks within which directors operate on corporate boards:
i) legal rights and responsibilities
ii) time-limited appointments
iii) retirement by rotation
iv) service contracts
v) removal
vi) disqualification
vii) conflict and disclosure of interests
viii) insider dealing/trading
f) Define, explore and compare the roles of the chief executive officer and
company chairman.
g) Describe and assess the importance and execution of, induction and
continuing professional development of directors on boards of directors.
h) Explain and analyse the frameworks for assessing the performance of
boards and individual directors (including NEDs) on boards.
i) Explain the meanings of "diversity" and critically evaluate issues of
diversity on boards of directors.
Session 3 Guidance
Understand the role of bank boards and NEDs during the banking crisis. This content is highly
examinable and very topical.
Download for reference the UK Corporate Governance Code and the London Stock Exchange (LSE)
publication Corporate Governance: A Practical Guide.
(Continued on next page)

VISUAL OVERVIEW
Objective: To examine the role, structure and composition of boards of directors following
good corporate governance principles.
THE BOARD
Role
Governance
Legal Framework
Composition
CEO and Chairman
Separation of Roles
BOARD NON-EXECUTIVE DIRECTORS INDUCTION,

STRUCTURES (NEDs) CPD AND
PERFORMANCE
Forms Role
Induction
Unitary Boards Skills
Education
Tiered Boards Independence
Performance
Advantages and Disadvantages
Appraisal
Session 3 Guidance
Research the Walker review into the governance of UK banks, www.hm-treasury.gov.uk/
walker_review_information.htm. Although relating to banks, the subject material and
recommendations are highly topical for all companies. Browse the Web to find summaries/quick
reads as the full report is 140 pages.

Session 3 The Board of Directors P1 Governance, Risk and Ethics
1 The Board
1.1 Role
"Every company should be headed by an effective board
which is collectively responsible for the success of the
company.
"The board's role is to provide entrepreneurial leadership of
the company within a framework of prudent and effective
controls which enables risk to be assessed and managed."
UK Corporate Governance Code, 2012
" to define the purpose of the company and the values
by which the company will perform its daily existence and
to identify the stakeholders relevant to the business of the
company. The board must then develop a strategy combining
all three factors and ensure management implements this
strategy." King Report, South Africa
1.2 Governance
The Code provides guidance on the responsibilities and duties of
the board.* For example, the board is required to:
provide entrepreneurial and ethical leadership of the company;
set the company's strategic aims and objectives and provide
direction for management; *The typical Anglo-
create a performance culture that drives value creation Saxon board has 8 to
without exposing the company to excessive risk of value 16 directors. Larger
companies (e.g. FTSE
destruction;
100) tend to have
ensure that the necessary financial and human resources are more directors than
in place to achieve objectives; smaller companies.
take well-informed and high-quality decisions objectively in The board size relates
the interest of the company; to the complexity of
the business and the
monitor progress in achieving strategic objectives by reviewing potential influence of
performance of the company (including that of the CEO and stakeholders.
managers) and its own performance as a board;
set the company's values and standards (this includes ethical
leadership and promoting throughout the firm behaviour
consistent with the culture and values of the entity);
ensure that obligations (and accountability) to shareholders
and other stakeholders who provide the entity's capital and
finance are understood and met;
ensure that a satisfactory dialogue with stakeholders takes
place and that contact with stakeholder opinion is maintained;
establish various committees (e.g. for audit, remuneration,
appointments) and ensure that they have sufficient resources
to undertake their roles;
appoint a CEO with appropriate leadership qualities;
maintain a sound system of risk management and internal
control;
determine the nature and extent of the significant risks the
board is prepared to take in achieving its strategic objectives;
conduct, at least annually, a review of the effectiveness of the
risk management and internal control systems;

P1 Governance, Risk and Ethics Session 3 The Board of Directors
present to shareholders and others (as required by statute,

regulators and listing rules) a balanced and understandable
assessment of the company's position and prospects;*
use the annual general meeting (AGM) to communicate with
*Communication to
investors and to encourage their participation; shareholders includes
ensure that directors have access to independent professional an explanation in the
advice; annual report of how
undertake a formal and rigorous annual evaluation of its own the company generates
performance, board committees and individual directors; or preserves value
over the longer term
meet frequently and insist on receiving relevant financial and (the business model)
non-financial information to assess the qualitative measures and the strategy for
that are important to broader stakeholder interests; and delivering the objectives
ensure that all board members are able to allocate sufficient of the company.
time to the company to discharge their responsibilities
effectively.
Exhibit 1 EFFECTIVE BOARD *

CHARACTERISTICS
Excerpts from Corporate Governance: A Practical Guide, a publication
of the London Stock Exchange (www.londonstockexchange.com) and
Robson Rhodes, list the following characteristics for an effective board.
The Effective Board *An effective

board may not be
Clear strategy aligned to capabilities;
a "comfortable
Vigorous implementation of strategy; place". Challenge
Key performance drivers monitored; of the executive and
Effective risk management; teamwork are essential
Sharp focus on views of key stakeholders; and features.
Regular evaluation of board performance.
1.3 Legal Framework

As well as governance responsibilities, boards of directors are
subject to extensive legal and regulatory requirements. The
majority of these relate to the individual directors, but may be
extended to the board as being composed of directors.
The following matters relate to the general principles of legal and
regulatory frameworks (with reference to UK law) within which
Note that you will not
directors operate on corporate boards.
be expected to have
specific knowledge
1.3.1 Legal Rights and Responsibilities
of the law of any
As discussed in the previous session, directors have a general particular jurisdiction.
fiduciary duty to the company. Therefore, by extension, so You should, however,
does the board. be aware of the
matters concerning
Essentially, directors are responsible for making sure that the directors that are
company fulfils its statutory duties. likely to be regulated
Beyond their general fiduciary duties, their main statutory (e.g. the concept of
responsibility is the preparation of the financial statements, retirement by rotation
the various elements of the annual report and ensuring that has been examined).
the company maintains "proper accounting records".
Directors have a legal right to fees and expenses according to
the company's constitution, emoluments and compensation
for loss of office in line with their service contracts. Any other
rights are determined by their service contracts.

Example 1 Board Directors' Fiduciary Duty

Directors (and therefore the board) must act in good faith in a way that they
consider would be most likely to promote the success (i.e. long-term increase in
value) of the company for the benefit of its members as a whole.
Required:
Describe the factors that result in this fiduciary duty and include a focus of
"enlightened shareholder value".
Solution

1.3.2 Time-Limited Appointments

Employees and managers of companies usually have open-
length employment contracts. Managers appointed as
directors, however, are usually appointed under a specific
service contract relating to their role as a director.
A director's period of service will usually be specified in the
company's constitution (i.e. a fixed period of time with a fixed
retirement age).
UK law requires that a director's service contract longer than
two years must be approved by the shareholders.
The Code recommends that notice or contract periods should
be set at one year or less (i.e. for listed companies).
For non-executive directors (NEDs) the Code requires that any
term beyond six years should be subject to a rigorous review
and take into account the need for progressive refreshing of the
board. The maximum term served should not exceed nine years.
1.3.3 Retirement by Rotation

Retirement by rotation is a requirement, specified (e.g. by
law, a company's constitution or a director's service contract)
for directors to "retire" after serving a specified period (e.g.
three years) and to offer themselves for re-election (to serve
another term).
Alternatively, one-third of directors may retire each year. For
a stable board this effectively means each director serves
three years before retiring by rotation.
New directors appointed during a year will retire at the end of
that year, offer themselves for re-election (so the appointment
is "ratified" by the shareholders) and then retire by rotation
after having served the rotation period. This procedure applies
to new companies when the entire board retires for re-election
at the first AGM.
In some cases, a chief executive or other named executive

director may be exempt from this procedure. However,
corporate governance often requires all directors to submit
to regular re-election.*
*The Code requires
Advantages of retirement by rotation: all directors of FT
Allows shareholders to remove a particular director as well 350 companies to be
as to bring "fresh blood" into the board while maintaining subject to annual re-
medium-term stability of membership. election, regardless
of position and
Encourages directors to perform, as they know shareholders contractual terms.
can remove them without the need to follow specific
procedures (see later discussions).
Reduces the cost of contract termination for underperforming
directors as they are simply not re-elected and have to retire
from the board.
1.3.4 Service Contracts
As with any contract of employment, a director's service
agreement sets out the basis for the director's employment
and regulates separate activities as a director. Given the
importance of a director to a business, the agreement is long
and detailed and will be drafted to give as much protection to
the company as possible.
Typical contents cover:
appointment and duration, duties, place of work, hours
of work;
salary, expenses, bonus, pension, insurance (health,
medical, life);
holiday, car/car allowance, use of company property;
sickness leave entitlements;
confidential information, intellectual property, conflicts
of interest;
termination of employment and post-termination restrictions
(e.g. non-solicitation);
retirement;
discipline and grievance;
data protection; and
collective agreements.
The terms and conditions of directors' employment have
always been controversial (e.g. salaries, bonuses, use of
rolling contracts, pension payments and other post-retirement
benefits, being rewarded for failure). Many of these areas
are now dealt with (for listed companies) through corporate
governance procedures (e.g. remunerations committee).
In most jurisdictions, it is a legal requirement for directors'
service contracts to be made available for inspection by the
shareholders.

1.3.5 Removal and Disqualification

As discussed above, a director may be removed from office by
the vote of shareholders when the director retires by rotation.
Other means of removal* include: *Director removal also
The director resigning or not seeking re-election. occurs with company
dissolution or the
By special resolution of the shareholders in accordance with
director's death.
the company's constitution or company law.
By resolution of the board.
By breach of specific requirements as set out in the service
agreement of the director (e.g. breach of fiduciary duty,
which in the UK is also enshrined in company law).
Disqualification implies that specific events or actions (usually
dictated by law or the company's constitution) have occurred
resulting in the director being unable or unfit to carry out the
duties of a director. Examples:
Personal bankruptcy;
Mental disorder;
Criminal activity;
Allowing the company to trade while insolvent;
Failing to file statutory returns, tax returns and financial
statements;
Failing to keep proper books and records.
1.3.6 Conflict and Disclosure of Interests

Key elements of a director's fiduciary duty include:
not to fetter discretion (e.g. voting under influence from
others);
to avoid conflicts of interest and conflicting duties; and
not to make a secret profit.
Many examples of conflicts of interest include different types
of fraud against the company and other stakeholders (e.g. a
director forming a parallel company and diverting contracts to
that company).
In executing the company's business (e.g. awarding contracts)
any interest in that business by a director must be declared to
the board.
Ideally, all directors' interests in a company (e.g.
compensation, securities, loans, transactions, connected
parties) should be disclosed to the shareholders. If material,
this is usually required by law and GAAP (e.g. IAS 24 Related
Party Disclosures).
Lawful conflicts of interest may be ratified by a resolution
passed during the AGM. However, an unlawful act cannot be
ratified by the company, directors or its members.

1.3.7 Insider Dealing
Insider dealing"The illegal use of insider information by an

individual to secure a profit or reduce a loss resulting from dealing in
investments. This illegality is extended to any person who knowingly
uses insider information passed by this first person to secure a
similar result."
Insider information"is non-public information of a precise nature
relating to one or more issuers of financial instruments or to one
or more financial instruments, which, if it were made public, would
be likely to have a significant effect on the price of those financial
instruments or on the price of related derivative financial instruments."
Directive 2003/6/EC of the European Parliament
Directors are well placed to benefit from insider (or "inside")

information. As well as being a criminal offence, it is an
abuse of directors' roles as agents.
Although it is legal for directors to buy or sell shares in their
company, they must not use, or appear to use, any inside
information in deciding to do so. In some jurisdictions,
a "closed period" (e.g. two months before results are
announced) is legally enforced during which directors cannot
trade their company's shares.
Dealers track directors' dealings as a means for identifying
shares with substantial potential (i.e. directors buy if they
think the shares are undervalued; they sell if they think they
are overvalued). Such dealings may be an indication of inside
information.
Most stock exchanges use sophisticated intelligent monitoring
systems to identify unusual trades that may indicate insider
trading.
1.4 Composition
1.4.1 Effective Board Characteristics
As stated earlier, "every company should be headed by an
effective board, which is collectively responsible for the success
of the company".
To be effective implies having:
a sufficient number of directors appropriate to the size and
complexity of the company's operations, but not of such a
size as to be unwieldy;
the necessary depth, breadth of skills, experience and life
qualities to understand, manage and grow the company; and
an appropriate diversity (e.g. gender, age, ethnicity) to
ensure that all appropriate views and stakeholder interests
can be considered and that the board reflects the diversity
of its employees and customers.

A key corporate governance principle is that the board should

include a balance of executive directors and non-executive
directors such that no individual or small group of individuals
can dominate the board's decision-making.
Under the Code, at least half the board, excluding the
chairman, should be independent NEDs. Other codes require
fewer (e.g. at least one-third, Singapore Code) while others
require that the NEDs must be in the majority (e.g. US
Sarbanes-Oxley Act).
Executive directorappointed or elected member of the board of

directors of a firm who, with other directors, has the responsibility for
determining and implementing the firm's strategy as well as working *Under the Code,
as a full-time senior manager in the firm. a description of the
Non-executive director (NED)a director of a firm who is neither board's policy on
an executive director nor employed by the company and, therefore, diversity, including
does not participate in the day-to-day management of the company. gender, any
measurable objectives
set for implementing
1.4.2 Board Diversity the policy, and
Diversity in the context of board composition extends beyond the progress on achieving
the objectives, must
typical classifications of gender, age and ethnicity. It includes
be disclosed within an
personality types, functional expertise and industry experience. entity's annual report.
Diversity in board composition is an important driver of the
board's effectiveness.*
A board with limited diversity runs the risk of "groupthink."
Groups whose cohesiveness stems from member similarities
may be too homogeneous in their thinking, resulting in an
insufficiently challenging environment for decision-making.
A variety of personalities will promote active discussions of *It is part of a
company's social
business activities and courses of action, and create a breadth
contract, that it
of perspective. A balance of supportive and challenging
should "reflect
independent directors will encourage innovation and mitigate back" to society its
the emergence of unproductive "factions". own demographic
Functional expertise such as marketing, finance and human diversity (e.g. a board
resources, and industry specific experience reinforce a board's comprising 100%
ability to appropriately rank and address strategic priorities as white, male directors
well as short-term tactical issues. with a minimum age
of 50 is unlikely to
Members of under-represented groups are a gateway to the
understand the needs
needs and wants of customers, shareholders and employees. of mixed gender,
The cultural and societal experiences of these members may mixed race, teenage
help to engage the commitment of the workforce and improve customers).
communication with shareholders.*

1.5 CEO, Chairman and the Senior

Independent Director
The chief executive officer (CEO) and the chairman of the board
(company chairman) are the two key roles in companies. The
chairman heads the board of directors and the CEO leads the
management team at and below board level in implementing and
managing the entity's strategy.
1.5.1 CEO
The managing director/CEO is responsible for the performance *The Chief Financial
Officer (CFO) provides
of the company, as dictated by the board's overall strategy.
necessary financial
The UK's Institute of Directors suggests that the CEOs' information to the
responsibilities include: board and commentary
reporting to the chairman or board of directors; on financial issues
formulating and successfully implementing company policy; facing the company.
directing strategy towards the profitable growth and *The CEO leads
operation of the company; the executive team
developing strategic operating plans that reflect the board's and ensures that
the team's views on
longer-term objectives and priorities;
relevant issues are
maintaining a strong, key relationship with the chairman; communicated to
putting in place adequate operational planning and financial the board. Where
control systems; members of the
closely monitoring the operating and financial results executive are also
against plans and budgets;* board directors, a
clear distinction must
taking remedial action where necessary and informing the
be made between
board of significant changes; their responsibilities
maintaining the operational performance of the company; as directors and
assuming full accountability to the board for all company their day-to-day
operations; responsibilities as
managers reporting to
building and maintaining an effective executive team.*
the CEO.
1.5.2 Chairman
The Financial Reporting Council's publication Guidance on Board
Effectiveness (March 2011) provides practical explanations on the
role of the board and directors. The chairman's role includes:*
demonstrating ethical leadership; *The chairman of
developing productive working relationships with all executive each board committee
directors, and the CEO in particular, providing support and should apply a
advice while respecting executive responsibility; similar leadership
role, particularly in
setting a board agenda which is primarily focused on strategy, creating conditions
performance, value creation and accountability, and ensuring for overall committee
that issues relevant to these areas are reserved for board and individual director
decision; effectiveness.
ensuring a timely flow of high-quality supporting information
so that NEDs have sufficient time to deliberate critical issues
and are not faced with unrealistic deadlines for decision-
making;
making certain that the board determines the nature and
extent of the significant risks that the company is willing to
embrace in implementing its strategy, and that there are no
"no go" areas which prevent directors from operating effective
oversight in this area;

regularly considering succession planning and the composition

of the board;*
making certain that the board has effective decision-making
processes and applies sufficient challenge to major proposals;
*This is especially
ensuring that the board's committees are properly structured important in relation to
with appropriate terms of reference; a new CEO and to the
encouraging all board members to engage in board and diversity of the board.
committee meetings by drawing on their skills, experience,
knowledge, diversity and, where appropriate, independence;
fostering relationships founded on mutual respect and open
communication (both in and outside the boardroom) between
the NEDs and the executive team;
consulting the senior independent director on board matters
where appropriate (see below);
ensuring his own and other directors' development, including
induction programmes for new directors and regular reviews
with all directors;
acting on the results of board evaluation; and
ensuring effective communication with stakeholders and, in
particular, that all directors are made aware of the views of
those who provide the company's capital.
1.5.3 The Senior Independent Director

The senior independent director usually:
acts as a sounding board for the chairman;
provides support for the chairman in the delivery of his
objectives; and
leads the evaluation of the chairman on behalf of the other
directors.
He should work with the chairman and other directors (and/
or shareholders) to resolve significant issues where, for
example:*
there is a dispute between the chairman and the CEO;
*Boards should ensure
shareholders or NEDs have expressed concerns that are not that they have a clear
being addressed by the chairman or the CEO; understanding of when
the strategy being followed by the chairman and the CEO is the senior independent
not supported by the entire board; director might intervene
in order to maintain
the relationship between the chairman and the CEO is
board and company
particularly close, and decisions are being made without the stability.
approval of the full board; or
succession planning is being ignored.

1.6 Separating the Roles of the CEO

and Chairman
The reason that many corporate codes (e.g. the Code)
recommend separating the roles of CEO and chairman is to avoid *Unfettered power
a situation in which one individual has unfettered (uncontrolled) should be avoided
power. There should be a balance of power between board so that it cannot be
members such that no one individual will gain unlimited, abused as in the case
unchecked, power.* of Maxwell.
In a number of governance codes, this is enhanced by requiring

the chairman to be an independent NED.*
1.6.1 Benefits of Separating the Roles

The CEO is able to concentrate on the management of the
*It used to be
company without having to report to shareholders or become
common practice
distracted from executive responsibilities. The chairman is for a retiring CEO to
expected to represent shareholders' interests and act as the become the Chairman.
point of contact for shareholders.* Clearly, this could
Having two people at the head of a large company removes the easily lead to conflicts
risks of "unfettered powers" being concentrated in the hands of over strategy between
one individual. This is an important "check and balance" for the new CEO and the
Chairman (ex-CEO).
investors (as well as other board members) concerned about a
potential lack of transparency and accountability.
Separate roles reduce the risk of a conflict of interest in one
person being responsible for company performance while also
reporting on that performance to markets.
The chairman can be an important "sounding board" for
the concerns of NEDs who, in turn, provide independent *Some governance
representation of external concerns on boards of directors. codes also require the
chairman to represent
1.6.2 Arguments Against Separating the Roles* the interests of other
stakeholders, such as
Even with separate roles a CEO's influence may be so strong employees.
that he dominates the board.*
There is no academic evidence to suggest that it is a good thing.
In family-run companies, the CEO and the chairman may not
be independent of each other.
High-calibre managers may not agree to have the role split
(as is usual in the US).
There are insufficient excellent managers/leaders to source
the two roles.
*Interestingly, in most of the corporate scandals of the last 20

years, a key element has been the dominant CEO who also acted as
chairman. In the few scandals in which there was separation of the
roles (e.g. Enron and RBS) the chairman (and the board as a whole)
was dominated by the CEO. In both cases, the CEO had or was
allowed, unchecked, unfettered power.

Illustration 1 Marks & Spencer (M&S)
In the early 2000s, M&S had lost its way as a leading UK retailer, with serious
splits and battles in the boardroom over strategy. In 2004, the board appointed an
outsider retail specialist, Sir Stuart Rose, to the role of CEO to defend the company
against takeover bids and to turn the business around. Sir Stuart had indicated he
would only stay for five years.
Within two years, all the executive directors had been replaced, a new non-
executive chairman appointed (Lord Burns) and the company was well on the way
to recovery with impressive results. Sir Stuart was doing the job he had been
employed to do.
In 2007, when Lord Burns started to consider the succession of Sir Stuart, it
became clear that there was nobody in the organisation who had the necessary
experience and "whose face fitted". To add to his concern, UK trading conditions
were showing a turn down and by the beginning of 2008 showed no sign of
reversingin fact they were getting worse. To have changed the CEO at this
time would have been potentially disastrous and therefore the board requested
Sir Stuart to stay for a further two years to allow a successor to be found and
embedded in the company.
Sir Stuart agreed, but only on condition that he would also become chairman to
allow him to have total control over the direction and strategy of the business.
Lord Burns agreed to step down as chairman to allow this to happen and the board
therefore agreed to appoint Sir Stuart in the joint role of CEO/chairman.
A letter to shareholders from Lord Burns essentially announced this as a done
deal. There was an immediate uproar from institutional shareholders (65% of total
shareholders) as many considered that too much power was being given to Sir
Stuart and that the combined role was against governance requirements.
Following a bitter two-week row between M&S and its institutional investors, the
M&S board agreed to put in place a series of measures to calm investors' fears of
too much power being concentrated in one pair of hands, including:
Putting Sir Stuart up for re-election at the July 2008 AGM and then every year
(rather than every three years as is normal for all directors);
Roles to be split on Sir Stuart's retirement in 2011;
Providing additional powers to the non-executive vice chairman as a check on
Sir Stuart (i.e. they will work together on chairman issues);
Appointing two additional NEDs to the board;
No additional compensation to be given to Sir Stuart.
While these measures were reluctantly accepted at the July 2008 AGM, on the
basis that keeping Sir Stuart until 2011 was in the company's best interests, many
shareholders stated that they would be closely monitoring what they perceived to
be an unprecedented bid (at least in the UK) for company and boardroom power.
Because Sir Stuart felt hindered by the close monitoring of his dual roles, he stepped
down as CEO in May 2010 and as executive chairman in July 2010 (one year earlier
than expected) but continued as a non-executive chairman until January 2011.

2 Board Structures
2.1 Forms
There are generally two models of board structure:*
unitary; and
tier (usually two tiers, but there may be three).
Which structure is used generally comes down to historical, *A jurisdiction's
legal and cultural factors. corporate governance
requirements often
2.2 Unitary Boards will be based on these
criteria.
This is the most common board structure in the Anglo-Saxon
world and in a number of EU countries.
A unitary board includes both executive directors and NEDs
who take decisions as a unified group and are held legally and
executively responsible (as a group and as individuals) for
their individual actions and the success of the company.*
All members are not equal in terms of the organisational *All listed companies
in the UK operate
hierarchy, but they all are legally responsible and equally
a unitary board,
accountable for board decisions. although any UK
company could operate
2.2.1 Advantages
a tiered board if they
Broadly, that the board acts as one with equal status, considered it to be
responsibilities and decision-making. more appropriate
(e.g. a subsidiary of
All members of the board have the same legal responsibility for
a foreign company
the performance of a company. Therefore, NEDs are empowered that operates a tiered
within the board, being accorded equal status to executive board).
directors rather than just acting in a supervisory capacity.
The presence of NEDS on the board might provide executive
directors with different expertise, experience and perspectives
that may be of invaluable help in devising strategy and the
assessment of risk.
NEDs bring independent scrutiny to the board, challenging the
CEO and executive directors before strategies are devised and
implemented.
Board accountability is enhanced by providing a greater
protection against fraud and malpractice and by holding all
directors equally accountable under a "cabinet government"
arrangement.
Unitary board arrangements reduce the likelihood of abuse of
(self-serving) power by a small number of senior directors.
Closer relationships and better information flow as all directors
are on the same single board. Promotes easier co-operation
between the board members.

2.2.2 Disadvantages
The success of the NED role depends on the robustness,
tenacity and expertise of the NED.
No specific provision is made for employees, external
shareholders or union representatives to be on the board.
Such stakeholders depend on the role of the NEDs to be able
to put forward their point of view.
The role of NEDs may be strenuous in terms of time and
expertise. Not only do they perform a director's role, they
also are expected to monitor executive directors as a whole.
NEDs are dependent on the information provided to them by
the CEO. The higher the quality, the better they will be able
to perform their role. This may, however, lead to "reluctance"
on the part of the CEO to provide information that will then be
used to challenge the CEO's decisions.* *It is critical that
directors ensure they
Managers may be less inclined to share information with a board
receive all relevant
as its monitoring intensity increases. With less information, even
information needed
an independent board cannot monitor effectively. This implies to carry out their
that recent regulation aimed at increasing board independence functionsone of the
may decrease shareholder value if there is a unitary board, even key functions of the
though shareholders may benefit if increases in independence board chairman.
improve disclosure practices.
2.3 Tiered Boards

Predominantly associated with Austria, Germany and the
Netherlands (two tiers) and Japan (three tiers), these also
are found in other countries which have been influenced by
Germany and the Netherlands (particularly in Asia).
Two-tiered boards usually consist of:
a management board; and
a supervisory board.
2.3.1 Management Board

Made up of executive directors, headed by the CEO. Focus is
on operational issues and the running of the business.
Responsibilities broadly include:
Running the business.
Entrepreneurship.
Compliance with statutory requirements.
Regular reporting to the supervisory board on strategy,
accounts and performance.

2.3.2 Supervisory Board

Broadly responsible for safeguarding stakeholders' interests
and overseeing the management board.*
Made up of NEDs (headed by the company chairman) drawn
from employees, shareholders and (often) banks.
Shareholders elect their representatives for the supervisory
board, and employee representatives are elected by the
workers of the corporation or appointed by the trade unions
for a term of four to five years.
The size of the supervisory board often depends on the size
of the company, with up to half of the board consisting of
employee representatives.
Responsibilities include:
Approval and evaluation of strategy and policies.
Monitoring company performance and accounts.
Safeguarding shareholder interests.
Calling shareholders meetings.
Appointment or dismissal of the management board.
Monitoring the management board's performance.
Representing the company in its dealings with members of
the management board.
Examining the annual financial statements.
Providing a written report on the result of the audit for the
shareholders meeting.
*When matters go wrong, it is usually the supervisory board that "takes

the flack".
"It is easier to grab a pig at its soapy tail than to hold the manager of a
German corporation liable."
Hermann Abs, former CEO of Deutsche Bank AG
The focus of the supervisory board has begun to shift more towards
advising and counselling the management board. The rationale of
monitoring a company's management is no longer perceived to be
a question of detecting past mistakes but rather of preventing them
from being made in the first place. From this follows the importance
of controlling and supervising the management in time in order to
prevent worse consequences.

2.3.3 Advantages of the Two-Tier Board

Clear and formal separation between management (those
monitored) and the monitors.
Stakeholders (e.g. investors and employees) can sit on the
supervisory board, therefore ensuring that their interests will
be heard.
Explicit representation of stakeholder interests other
than of shareholders. No major strategic decisions can
be made without the cooperation of employees and their
representatives.
Direct power over management through the right to appoint
and dismiss.
Encourages transparency between management and shop floor.
2.3.4 Disadvantages of the Two-Tier Board

Potential for confusion over authority and therefore lack of
accountability. The more tiers there are in a system the greater
this disadvantage, often resulting in over-secretive procedures.
The nomination of members of the supervisory committee may
not be as independent as intended. Some of the employee
and shareholder representatives may have connections with *In German companies
43% of supervisory
the company management.*
boards include a
Because the management board generates most of the former member of
information required and used by the supervisory board, the management
there is a risk that information may be withheld or not fully board. It is common
disclosed (agency problem). By manipulating information to practice for the
the supervisory board, executive management will be able to retiring CEO to move
influence the agenda of the supervisory board. to the supervisory
board and become its
The number of supervisory board members is not limited. chairman. It seems
Where the number is high (e.g. greater than 1015) research questionable how
has shown that efficient work and orderly discussion becomes this chairman could
far more difficult. Trade unions and employees often block become sufficiently
any attempt to reduce the size of the board relating it to "an independent of his
attack on co-determination". former "environment".
On the other hand,
Employee representatives may delay or block decisions being
his experience could
made that are in the best interest of the company but not of the be valuable for the
employees (e.g. restructuring, rationalisation, redundancies). supervisory board.

3 Non-executive Directors (NEDs)
3.1 Role NEDs are expected to

monitor and challenge
As defined earlier in this session, NEDs are directors who have no the performance
executive or managerial responsibilities. of the executive
The UK Higgs Report (incorporated into the Code) identifies four directors and the
areas of key involvement for NEDs: management, and to
take a determined
1 Strategy stand in the interests
of the firm and its
2. Performance (Scrutiny)
stakeholders.
3. Risk
4. People
3.1.1 Strategy
As part of their role as members of a unitary board, NEDs
should constructively challenge and help develop proposals
on strategy.
The strategy role recognises that NEDs are full members
of the board and thus have the right and responsibility to
contribute to the strategic success of the organisation for the
benefit of shareholders.
The enterprise must have a clear strategic direction and NEDs
should be able to bring considerable experience from their
lives and business experience to bear on ensuring that chosen
strategies are sound.
In this role NEDs may challenge any aspect of strategy and
offer advice or input to help to develop successful strategy.
3.1.2 Performance (Scrutiny)

NEDs should scrutinise the performance of management
in meeting agreed goals and objectives and monitor the
reporting of performance.
NEDs are required to hold executive colleagues to account for
decisions taken and company performance. In this respect
they are required to represent the shareholders' interests
against the possibility that agency issues arise to reduce
shareholder value.
3.1.3 Risk
NEDs should satisfy themselves on the integrity of financial
information and that financial controls and systems of risk
management are robust and defensible.
This includes monitoring the veracity and adequacy of the
financial and other company information provided to investors
and other stakeholders and monitoring the company's legal
and ethical performance.

3.1.4 People
The "people" role involves NEDs overseeing a range of
responsibilities with regard to the management of the
executive members of the board.
They are responsible for determining appropriate levels
of remuneration of executive directors and have a prime
role in appointing and removing executive directors (where
necessary) and in succession planning.
Boards should assign a sufficient number of NEDS capable
of exercising independent judgement to tasks where there
is potential for conflict of interest (e.g. financial reporting,
nomination, executive and board remuneration).
3.2 Skills
The "Tyson Report on the Recruitment and Development of
Non-executive Directors" identified four personal attributes
required by NEDs in order to carry out the responsibilities of
their role:
1. Integrity and high ethical standards.
2. Sound judgement.
3. Ability and willingness to challenge and probe.
4. Strong interpersonal skills.
Integrity and high standards should be taken for granted, as
with all directors and professionals.
The exercise of sound judgement must be based on knowledge
about the company and the environment in which it functions.
NEDs must be able to recognise problematic actions or a
flawed decision-making process. They must be able to identify
issues of risk and judge how and when to raise them with the
CEO or other executive directors.
NEDs must be able and willing to challenge and probe the
information presented to them by company management.*
To be able to challenge and probe, strong interpersonal skills
are essential. Without such skills, an individual NED will
not be able to participate fully on a board of highly talented *The willingness to
individuals or to question the recommendations of powerful confront management
and raise difficult
executives.
issues with executive
NEDs also need high levels of engagement and management is
independence.* often cited as one of
the most important
characteristics of an
effective NED.
"Effectiveness requires high levels of engagement It is not

sufficient just to turn up at board meetings. Instead individuals
need to build their knowledge of the business through all sorts of
informal contact with executives, as well as their work on board sub-
committees. Only with this sort of engagement and understanding
of a company can individuals make a credible contribution to board
discussions."
McNulty, Roberts, Stiles, 2003

The Higgs Report considers that the effective NED:

upholds the highest ethical standards of integrity and
probity;
supports the leadership role of executives, while monitoring
their conduct;
questions intelligently, debates constructively, challenges
rigorously and decides dispassionately;
listens sensitively to the views of others, inside and outside
of the board;
gains the trust and respect of other board members; and
promotes the highest standards of corporate governance
and compliance with the Code.
3.3 Independence*
Under the Code, " the board should identify in the annual
report each NED it considers to be independent. The board
should determine whether the director is independent in *Given their role and
character and judgment and whether there are relationships the skills required of
or circumstances which are likely to affect, or could appear to them, independence
affect, the director's judgment." is clearly a necessary
pre-requisite
Threats to independence include:* for the effective
Being a former employee of the company within the last accountability of NEDs
five years. to shareholders.
Material business relationships with the company in the past

three years.
Remuneration paid (apart from the director's fee) by the
company.
Participation in the company's share option scheme or a
performance-related pay scheme, or being a member of the *Historically, former
company's pension scheme. CEOs have been asked
to stay on the board
Close ties with the company's advisors, directors or senior either as chairman or
employees. in another important
Having been a member of the board for more than nine years. non-executive role
Being, or representing, a major shareholder. so their expertise
and knowledge of the
Holding too many non-executive directorships in various business would not be
companies. lost. This would now
Not being able to devote enough time to the tasks in hand. be a direct threat to
independence.
3.4 Advantages and Disadvantages of NEDs
3.4.1 Advantages
Independent monitoring.
External expertise and knowledge, yet with insider knowledge
of the business.
Wider perspective.
Perception and comfort factor for third parties (e.g. investors,
regulators).
Wider "gene pool" (e.g. gender, culture, ethnicity, age)
representative of major stakeholders.

3.4.2 Disadvantages
Lack of appropriate numbers of suitably qualified individuals.
Low rewards, but high liability (e.g. basic salary, but equal
share of blame).
Conflict with executives when trying to get their views heard.
Resentment from executive directors leading to board disunity.
Recruited for governance political correctness (e.g. female or
ethnicity).
Illustration 2 Royal Bank

of Scotland*
A report (December 2011) by the UK's Financial Services Authority
into the near collapse of RBS (Royal Bank of Scotland) during the
(ongoing) banking crisis noted that:
Underlying deficiencies in RBS management, governance, risk
controls and culture made it prone to make poor decisions.
The CEO tended to take an optimistic view of what was likely to
happen as he had often, in the past, been proved right.
With 17 directors, the board was too big for effective discussion
and challenge and seems to have been badly infected by
groupthink.
A forceful CEO in a complex business and with the wrong
incentives is unlikely to be constrained by an over-large board of
directors drawn from the same establishment pool.
The NEDs were also mostly establishment figures and therefore
failed to be sufficiently challenging of the Chief Executive (i.e.
they let him do what he wanted).
Most on the board did not fully understand the bank's products
and the risks they posed. All they seemed to understand was
that whilst other banks were doing the same, they (RBS) needed
to be the leader in being quicker and doing more. This resulted
in a "Titanic effect" of full steam ahead regardless of the warning
signs (that were not recognised or accepted until it was too late).
This view permeated the whole business and was reinforced by
incentives that made it rational for the CEO and his colleagues to
concentrate on increasing revenue, profits, assets and leverage
rather than on capital, liquidity and asset quality (basically they
weakened what were once very strong foundations).
*The RBS CEO's blind belief in himself, his arrogance and the failure
of the board to rein him in resulted in RBS in 2008 running up the
UK's largest-ever corporate loss of $35 billion, mainly due to the write-
down of its investments. Without government assistance the bank
(and with it the UK's banking system) would have collapsed. The UK
government currently owns over 80% of the share capital of RBS.

4 Induction, CPD and Performance

As part of a wide-ranging review of UK corporate governance
post-Enron, the role of NEDs was closely scrutinised. This
resulted in two reports, the Higgs Report and the Tyson Report
recommendations were incorporated in the Code.*
Although these reports were aimed at NEDs, it was recommended
that their principles be applied to all directors, executive and non-
executive, wherever possible.
*Prior to the Higgs and Tyson reports, it was not unusual for new
directors to "learn the ropes" by doing the job. Only a few of the
larger, listed companies had any form of induction for new directors,
training for all directors and performance reviews.
New directors could be relatively ineffective in their roles for some
time and unwittingly exposed to breaching laws and regulations.
Other directors could easily become out of date and fail to keep up
with emerging issues and the best way to deal with them. There
also was the risk that new directors would be "house trained" by an
aggressive CEO and not protected by a weak chairman.
4.1 Induction
Every company should develop its own comprehensive, formal
induction programme that is tailored to the needs of the
company and individual directors.*
The aim of the programme is to effectively and efficiently
engage new directors with the company, the board and *For NEDs, there
must be emphasis on
stakeholders, and their roles and responsibilities on a timely
independence (rather
basis.* than indoctrination).
The company and its shareholders will benefit through the new For executives,
directors' added value (e.g. through innovative ideas). emphasis will be on
their responsibilities as
For a new NED or an externally appointed executive director,
directors as compared
a combination of selected written information together with
to their roles as
presentations and activities such as meetings, site visits and managers.
shadowing an executive director will help give a balanced and
real-life overview of the company. *To sustain their
added value, all
A new director should not be overloaded with information. A directors must remain
list of all induction information available should be provided so at an effective and
the new director can call up items as required. efficient level of
For individuals who have not previously held directorship operational and
innovative ability
roles, it is important that they fully understand their legal and
through continuing
fiduciary duties.
professional
The induction process should: development (CPD).
communicate vision and culture;
communicate practical procedural duties;
reduce the time for a new director to become productive;
make the new director feel welcomed and a useful member
of the team; and
ensure retention of individuals.

4.1.1 Understanding the Nature of the Company, Its Business

and Its Markets*
Brief history of the company including when it was
incorporated and any significant events during its history. *Obviously, where
Company organisational chart and management succession the director has been
plans. appointed internally,
much of this detail
Current strategic/business plan, market analysis and budgets
may already be known.
for the year with revised forecast and three-/five-year plan.
Latest annual report and accounts (and interim financial
statements as appropriate) plus explanation of key
performance indicators.
Copy of all management accounts prepared since the
company's last audited accounts.
The corporate brochure, mission statement, environmental
reports, etc with a summary of the main events (e.g. mergers,
divestments, introductions of new products, diversification into
new areas, restructuring, etc) over the last few years.
Listing Rules and corporate governance guidelines which the
company seeks to follow.
The company's main products or services.
Group structure/subsidiaries/joint ventures.
Summary details of the company's principal assets, liabilities,
significant contracts and major competitors.
Major risks, risk management strategy and relevant disaster
recovery plans.
Key performance indicators.
Regulatory constraints.
4.1.2 Board Issues

Brief outline of the role of a director and a summary of his
responsibilities and ongoing obligations under legislation,
regulation, best practice and the culture of the organisation.
Up-to-date copy of the company's constitution, with a
summary of the most important provisions.
Minutes of the last three to six board meetings.
Schedule of dates of future board meetings and board
subcommittees if appropriate.
Description of the board structure and procedures (e.g. when
papers are sent out, the normal location of meetings, how
long meetings last and routine business transacted).
Brief biographical and contact details of all directors, the
company secretary and other key executives. This should
include executive responsibilities, dates of appointment and
membership of board committees.
Details of board committees and their terms of reference.
Also, if the director will be joining a committee, copies of the
minutes of meetings for the last 12 months.
Policies as regards health and safety, environmental, ethics
and whistle-blowing, and charitable and political donations.

4.1.3 Link With the Company's People*

Internal company telephone directory (including any
international contact numbers and names).
Meetings with senior management. *It is important, not
Visits to company sites other than the headquarters, to learn only for the board to
get to know the new
about production or services and meet employees in an
NED, but also for the
informal setting.
NED to build a profile
Participating in board strategy development. with employees below
board level.
4.1.4 Understanding the Company's Main Relationships
Auditors;
Major customers;
Major suppliers;
Major shareholders and capital investors;
Shareholder relations policy;
Meeting with shareholders.
4.1.5 Information Provided by the Company Secretary

Protocol, procedures and dress code for board meetings,
general meetings, formal dinners, office, staff social events,
site visits, etc, including the involvement of partners
(husband, wife, etc) where appropriate.
Procedures for accounts sign off, results announcements,
items requiring approval outside of board meetings.
Expenses policy and method of reimbursement.
4.2 Continuing Profession Development (CPD)

As with any profession, continuing education is essential for an
individual to reach and maintain an effective and efficient level
of operation.
To run an effective board, companies need to provide
resources for developing and refreshing the knowledge and
skills of their directors, including NEDs.
The chairman should address the development needs of the
board as a whole with a view to enhancing its effectiveness as
a team.
The chairman should also lead in identifying the development
needs of individual directors, with the company secretary
playing a key role in facilitating provision.
NEDs should be prepared to devote time to keeping their skills
up to date.
Any of the board directors who are members of a professional
body (e.g. accountants, lawyers) will also need to meet their
professional body's annual continuing profession development
(CPD) requirements.

Example 2 CPD*
Suggest the CPD requirements.
Solution
a general board
director of a listed
bank;
an NED on the
audit committee;
and
a director on
the nominations
committee.
*When a director serves on one of the corporate governance

committees (i.e. audit, remuneration, nominations, risk) not only
will they require CPD but they should follow a specific induction
programme to ensure they have the appropriate skills and
understand their role and requirements of being on the committee.

4.3 Performance Appraisal

The key elements are aimed at improving effectiveness,
maximising strengths and tackling weaknesses of individual
directors and of the board as a whole. The system should
provide essential feedback to individuals and the groups in
which they operate.
Under the Code:
The board should undertake a formal and rigorous
annual evaluation of its own performance and that of its
committees and individual directors.*
Evaluation of the board should consider the balance of skills,
experience, independence and knowledge of the company *For major listed
on the board, its diversity, including gender and how the companies (FT
board works together as a unit. 350), an externally-
The chairman should regularly review and agree with each
facilitated review
should be carried
director on their training and development needs.
out at least every
Individual evaluation should aim to show whether each
three years.
director continues to contribute effectively and to demonstrate
commitment to the role (including commitment of time for
board and committee meetings and any other duties).
The chairman should act on the results of the performance
evaluation by recognising the strengths and addressing the
weaknesses of the board and, when appropriate, proposing
new members be appointed to the board or seeking the
resignation of directors.
The board should state in the annual review how performance
evaluation of the board, its committees and individual directors
has been conducted. NEDs led by the senior independent
director, should review the performance of the chairman,
taking into account the views of executive directors.
The use of trusted external consultants, while not a
consideration of the Code, does provide an independent factor
and counselling element into the process.

4.3.1 Evaluation of the Board

How well has the board performed against any performance
objectives that have been set?
Has the board shown clarity of, and given leadership to, the *The questions
purpose, direction and values of the company? phrased for the
What has been the board's contribution to the testing and assessment of NEDs
are also relevant for
development of strategy?
appraising executive
What has been the board's contribution to ensuring robust and directors.
effective risk management?
Is the composition of the board and its committees
appropriate, with the right mix of knowledge and skills to
maximise performance in light of the future strategy? Are
relationships inside and outside the board working effectively?
How has the board responded to any problems or crises that
have emerged and could or should these have been foreseen?
Are the matters specifically reserved for the board the
right ones?
How well does the board communicate with the management
team, company employees and others?
How effectively does it use mechanisms such as the AGM and
the annual report?
Is the board as a whole up to date with latest developments in
the regulatory environment and the market?
How effective are the board's committees?
Is appropriate, timely information of the right length and
quality provided to the board and is management responsive
to requests for clarification or amplification?
Does the board provide helpful feedback to management on
its requirements?
Are sufficient board and committee meetings of appropriate
length held to enable proper consideration of issues? Is time
used effectively?
Are board procedures conducive to effective performance and
flexible enough to deal with all eventualities?
4.3.2 Relationship of the Chairman and the Board

Is the chairman demonstrating effective leadership of
the board?
Are relationships and communications with shareholders well
managed?
Are relationships and communications within the board
constructive?
Are the processes for setting the agenda working? Do they
enable board members to raise issues and concerns?
Is the company secretary being used appropriately and to
maximum value?

4.3.3 NEDs*
How well prepared and informed are NEDs for board meetings
and is their meeting attendance satisfactory?
Do they demonstrate a willingness to devote time and effort
to understand the company and its business and a readiness
to participate in events outside the boardroom, such as site
visits?
What has been the quality and value of their contributions at
board meetings?
What has been their contribution to development of strategy
and to risk management?
How successfully have they brought their knowledge and
experience to bear in the consideration of strategy?
How effectively have they probed to test information and
assumptions? Where necessary, how resolute are they in
maintaining their own views and resisting pressure from
others?
How effectively and proactively have they followed up their
areas of concern?
How effective and successful are their relationships with
fellow board members, the company secretary and senior
management?
Does their performance and behaviour engender mutual trust
and respect within the board?
How actively and successfully do they refresh their knowledge
and skills and are they up to date with:
the latest developments in areas such as corporate
governance framework and financial reporting?
the industry and market conditions?
How well do they communicate with fellow board members,
senior management and others (e.g. shareholders)? Are they
able to present their views convincingly yet diplomatically and
do they listen and take on board the views of others?
*The key aspect of board appraisal is to have evaluation procedures

in place and use them effectively at least once a year. If they
are not in place, the question is, "Why not?" How can a company
set performance-related pay for its directors if there are no such
procedures?
The individual evaluation of directors is useful because it provides
individual directors with the opportunity to discuss important issues
with the chairman on a one-to-one basis to find out about possible
problem areas (e.g. lack of communication, information) and/or better
contribution opportunities.

Summary
Every company should have an effective board which is collectively responsible for the
company's success.
The board's role is to provide entrepreneurial leadership of the company within a framework
of prudent and effective controls which enables risk to be assessed and managed.
There should be a clear division of responsibilities at the head of the company between
the running of the board (chairman) and the executive responsibility for the running of the
company's business (CEO). No one individual should have unfettered powers of decision.
At least half the board, excluding the chairman, should be independent NEDs.
As part of their roles as members of a unitary board, NEDs should constructively challenge
and help develop proposals on strategy.
The board and its committees should have the appropriate balance of skills, experience,
independence and knowledge of the company to enable them to discharge their respective
duties and responsibilities effectively.
There should be a formal, rigorous and transparent procedure for the appointment of new
directors to the board.
All directors should be able to allocate sufcient time to the company to discharge their
responsibilities effectively.
All directors should receive induction on joining the board and should regularly update and
refresh their skills and knowledge.
The board should be supplied in a timely manner with information in a form and of a quality
appropriate to enable it to discharge its duties.
The board should undertake a formal and rigorous annual evaluation of its own performance
and that of its committees and individual directors.
All directors should be submitted for re-election at regular intervals, subject to continued
satisfactory performance.

Session 3
Session 3 Quiz
1. List 10 responsibilities and duties of the board. (1.2)
2. Explain how directors may be removed from the board. (1.3.5)
3. Briefly explain the roles of the CEO and the chairman. (1.5)
4. List the areas that a typical director's induction should cover. (4.1)
5. Explain how external consultants can be used to assist in the appraisal of the board. (4.3)
Study Question Bank

Q5 Alliya Yongvanich 50 minutes
Additional
Q6 TQ Company

EXAMPLE SOLUTIONS
Solution 1Board Directors' Fiduciary Duty
The likely consequence of any decision in the long term.
The interests of the company's employees.
The need to foster the company's business relationships with suppliers, customers
and others.
The effect of the company's operations on the community and the environment.
The desirability of the company maintaining a reputation for high standards of
business conduct.
The need to act fairly as between the members of the company.

Solution 2CPD
General Director of a Bank*
All directors need to maintain a full understanding of the general
environment in which their business operates. They will require
regular briefings and more specific training on:
General political, economic, social and technological ("PEST")
factors that will affect their work environment.
Audit and remuneration issues.
Legal issues with a direct effect on their role as directors.
Management of human resources.
Risk management.
Interpersonal and management skills (e.g. communication,
negotiation, presentation, persuasion, time management, body
language, team development).
Technical issues directly affecting the business.
*With specific reference to the bank, it is becoming clear from

the various investigations into the sub-prime and credit crisis that
many of the banks' managers and directors did not understand the
complexity of the instruments they were dealing in. In a number
of cases, the boards had been warned by their risk managers of the
dangers they faced, but chose to ignore the advice given. In one
such case the former CEO of a major mortgage bank admitted to a
friend in 2005 that he did not fully understand the instruments used
and how the bank was making its money, but it was making a lot
of money. If he had taken the advice of his risk manager (to slow
down the bank's expansion and exposure to such instruments), he
felt, he would have been sacked by his board. "Everybody else was
doing it, and for us not to would have been suicide for me." Instead
he sacked the risk manager and replaced him with an individual who
had less experiencea good example of "shooting the messenger".
NED on Audit Committee

While the Code requires at least one member of the audit committee
to have had recent relevant experience, all of the committee
members should ideally have relevant knowledge of audit and
financial statements. For example, a general understanding of the
roles of internal and external auditors, an understanding of control
procedures and an up-to-date understanding of GAAP (e.g. IFRS).
Therefore, in addition to the general training noted above, audit
committee members should also have specific financial reporting
skills training.
Nominations Committee*
Members of the nominations committee will be specifically involved in
executive search and selection. Therefore sound interviewing skills
will be a high priority, as well as other interpersonal skills (e.g. body
*Nominations
language, questioning). They should also be kept up to date with
Committee is detailed
benchmark comparisons of directors' compensation packages in the
in Session 4.
financial services industry, both nationally and internationally.

Session 15
Ethical Theories
FOCUS
E. Professional Values and Ethics

1. Ethical theories
a) Explain and distinguish between the ethical theories of relativism and
absolutism.
b) Explain, in an accounting and governance context, Kohlberg's stages of
human moral development.
c) Describe and distinguish between deontological and teleological/
consequentialist approaches to ethics.
d) Apply commonly used ethical decision-making models in accounting and
professional contexts.
i) American Accounting Association model
ii) Tucker's 5-question model
a) Explain and analyse the content and nature of ethical decision-making
using content from Kohlberg's framework as appropriate.
Session 15 Guidance
Understand the relationship of values, morality and ethics (s.1).
Differentiate between absolutism and relativism (s.2), including the implications of each
(s.2.1, s.2.2).
Learn Kohlberg's six stages of moral development in relation to an action in a business setting (s.3).

VISUAL OVERVIEW
Objective: To explain and distinguish between ethical theories.
ETHICAL THEORY
ABSOLUTISM AND RELATIVISM

Absolutism
Relativism
Ethical Pluralism
KOHLBERG'S APPROACHES TO ETHICAL DECISION-

STAGES OF MORAL ETHICS MAKING MODELS
DEVELOPMENT (EDMM)
"Kantianism"
Method Issues Addressed
Deontological
Six Stages Approach AAA Model
Level I: Teleological Tucker's 5-Question
Pre-conventional Approach Model
Level II: Other Models
Conventional
Level III:
Post-conventional
Summary
Session 15 Guidance
Differentiate among various approaches to ethics, including Kantianism (s.4.1), the deontological
approach (s.4.2) and the teleological approach (s.4.3).
Learn the ethical decision-making models and be able to apply them to an exam scenario (s.5).

Session 15 Ethical Theories P1 Governance, Risk and Ethics
1 Ethical Theory
Whereas morality concerns "good" v "bad" for an individual
or a community based on that group's values, ethics concerns
development of rules and principles (i.e. "ethical theories") which,
if followed, will likely lead to a morally acceptable outcome in a
given situation.*
*Kaler (1999) suggests that morality is foremost a social

phenomenon (as humans constantly need to establish the rules and
arrangements for living together) and that it is all about harm and
benefit (right and wrong are primarily about avoiding harm and
providing benefits).
2 Absolutism and Relativism

Absolutism and relativism are the two extreme positions of ethical
theory. The middle ground between these extremes is called
pluralism.
2.1 Absolutism
2.1.1 Concept *That is, absolute
standards against
which moral questions
can be judged. There
are "eternal" rules
that should guide
Absolutismbelief that an action is always right or wrong, regardless all ethical and moral
of the consequences or intention behind it.* decision-making in all
situations."
Actions are right (moral) or wrong (immoral).
Right and wrong are objective qualities that can be rationally
determined and do not change regardless of the person,
culture or environment.*
Morals are inherent in some fundamental source, such as:
*Slavery, war,
the "divine right of kings"; dictatorship, the death
the laws of the universe; penalty, abortion
the nature of humanity (this is developed in modern human or childhood abuse
may be judged to
rights theory);
be absolutely and
the will or character of God.
inarguably immoral
At its extreme, actions are judged as moral or immoral regardless of the
regardless of the circumstances in which they occur.* beliefs and goals of a
culture which permits
these practices.
*Lying would always be immoral, even if done for a greater good

(e.g. to save a life). This rare view of moral absolutism might be
contrasted with moral consequentialism (i.e. that the morality of an
action depends on its consequences).

P1 Governance, Risk and Ethics Session 15 Ethical Theories
Absolutism can be expressed in:

deontological theories, where actions are in and of
themselves good or bad; and
absolute principles as well as intrinsic actions.* *Utilitarianism ("the
Absolutism as an ethical theory is contrasted with moral greatest happiness of
relativism. the greatest number"
should be the criterion
2.1.2 Implications of the virtue ("good")
of an action) can
Our truth is the truth (a dogmatic approach to morality, to be be said to have an
accepted without discussion or debate). absolute principle at its
Certain things are intolerable. heart. Kantian ethics
has both absolutist
We cannot learn from others.
principles and
consequent actions
2.2 Relativism inferred by those
principles.
2.2.1 Concept
Relativismbelief that moral truths are relative to social, cultural,

historical or personal references, and to situational ethics, which holds
that the morality of an act depends on the context of the act.
Relativism describes a group of distinct theories arguing that

there is no objective, neutral moral truth.
Moral relativism takes several forms:
Descriptive ethical relativismdifferent cultures and
societies have different moral values derived from universal
principles and, thus, different ethical principles. This view is
supported by the work of cultural anthropologists.
Normative ethical relativismeach culture establishes
the values on which it determines morality and that
there are no universal values to which society must
adhere. This view is not supported by the work of cultural
anthropologists.* *Some relativists
believe that although
Relative assumptions are "situational" in nature. A relativist
moral absolutes
tends to adopt a pragmatic approach and decides, in the may exist they are
particular situation, what is the best outcome. unknowable (because
Modern relativists observe that individual people, rather than no one knows absolute
groups within cultures, have different value setsthey follow truth).
different moral codes.
2.2.2 Implications of Relativism

The need for tolerance and understanding.
The fact of moral diversity.
We should not judge ethical practices in cultures that we do
not understand.
Reasonable people may differ in their view on what is morally
acceptable.

2.2.3 Criticisms of Relativism

It is self-defensive ("if I cannot judge others then neither can
they judge me").
Allowing every culture to live as it sees fit is only feasible
when cultures do not have to interact with each other.
2.3 Ethical Pluralism

Ethical pluralism recognises three categories of actions:
Moral
disagreements
Prohibited: important Prohibited
to absolutism;
Tolerated: important Area of

to relativism; legitimate
disagreement
Ideal: a moral vision; Ideal

society
Respect
Tolerance
No Tolerance
3 Kohlberg's Stages of Moral Development

3.1 Kohlberg's Method
Lawrence Kohlberg (19271987) was a well-known theorist
in the field of cognitive moral development (CMD). He posed
moral dilemmas (e.g. the Heinz Dilemma, Illustration 1) to
his subjects, then asked questions to determine their reasons
for recommending a specific course of action. Kohlberg was
more concerned with the reasoning of the action (that becomes
motivation) than the action itself.
Illustration 1 The Heinz

Dilemma
A woman was near death as the result of a unique cancer.
Only one drug might save her. It had been developed by
a local pharmacist, who sold it for $2,000 a treatment, 10
times more than it cost him to make. The woman's husband,
Heinz, could only borrow $1,000 from everyone he knew. He
asked the pharmacist for a discount or to let him pay later.
The pharmacist refused, saying he had discovered the drug
and wanted to make money from it. Heinz got desperate and
broke into the pharmacy to steal the drug.

3.2 Kohlberg's Six Stages
Kohlberg's Theory of Moral Development
Stage 1: Punishment-Obedience Orientation

Level I:
Pre-conventional Morality
Stage 2: Instrumental Relativist Orientation
Stage 3: Good Boy-Nice Girl Orientation

Level II:
Conventional Morality
Stage 4: Law and Order Orientation
Stage 5: Social Contract Orientation

Level III:
Post-conventional Morality
Stage 6: Universal Ethical Principle Orientation
Kohlberg's theory is a "stage" theory (i.e. everyone goes

through the stages sequentially without omitting any stage).
Movement through these stages is not natural (i.e. people do
not automatically move from one stage to the next as they
mature by some genetic blueprint). Nor are the stages the
product of socialisation. The stages emerge from individual
thinking about moral problems.
In stage development, movement is effected when cognitive
dissonance occurs (i.e. when the inadequacies in a present
way of coping with a moral dilemma are recognised). Social
experiences promote development by stimulating mental
processes. It is through discussions and debates with others *According to stage
that views are questioned and challenged.* theory, people cannot
understand moral
3.3 Level I: Pre-conventional Morality reasoning more than
one stage ahead of
3.3.1 Stage 1: Punishment-Obedience Orientation their own (e.g. a
person in Stage 3
Level 1 thinking is called "pre-conventional" because children cannot understand
do not yet speak as members of society. Morality is seen as beyond Stage 4
something imposed by grown-ups. reasoning).
It often is seen in terms of reward and punishment.
Punishment "proves" that disobedience is wrong so to obey
is to avoid punishment. "Will I be punished, if I am caught?"
"Will I be rewarded, if I obey?"
"Goodness" or "badness" is therefore determined by physical
consequences. The concern is for self.
"Heinz should not steal the drug because he might be
caught and sent to prison."
"Heinz can steal it because he asked first and it's not like he
stole something big; he won't get punished."

3.3.2 Stage 2: Instrumental Relativist Orientation

This stage recognises different sides to any issue. Because
everything is relative, each person is free to pursue his
individual interests. Also called "Individualism and Exchange",
responses might be:
"It is right for Heinz to steal the drug because it can cure his
wife and then she can look after the children."
"The pharmacist had spent lots of money developing the
drug so it's not fair to him if Heinz stole it."
"Heinz was right to steal the drug because the pharmacist
was trying to rip him off."
"Right" meets the needs of the individual (i.e. "What's in it
for me?", an instrumental approach). Aspects of fairness,
reciprocity and equality are interpreted in physical or practical
terms rather than in terms of loyalty, gratitude or justice (e.g.
"you scratch my back and I will scratch yours"). Punishment *Reasoning is still
is a risk to be avoided.* "pre-conventional"
because responses
3.4 Level II: Conventional Morality are those of isolated
individuals "exchanging
3.4.1 Stage 3: Good Interpersonal Relationships ("Good Boy- favours". There is no
Nice Girl" Orientation) identification of family
or community values.
"Good" behaviour is that which pleases, impresses or helps
others and is approved by them (i.e. "What will people think
of me?"). Behaviour is judged by intention. Self-sacrifice is
rewarded by the approval of others.
A form of peer pressure, in that the action taken would
conform to what would be expected from peers or what is
normal among peers ("they do it; so will I"). "Bad" behaviour
is unfair, selfish, greedy, letting the team down, etc.
"Yes, he should steal the drug. He probably will go to jail
but his friends will think he is a good husband."
"The judge should not punish Heinz because he was well-
meaning."
"It was the pharmacist's fault trying to overcharge and
letting someone die."*
3.4.2 Stage 4: Maintaining the Social Order (Law and Order
Orientation)
*This "conventional"
"Right" behaviour is about doing one's duty, showing respect morality assumes a
for authority and maintaining the given social order, regardless collective response (i.e.
of peer pressure. There is concern for society as a whole and "anyone" would be right
"civilised" behaviour. Society is seen as a system of fixed rule, to do what Heinz did.
law and authority. Obligation to the law overrides any loyalty It is what his peers
would have done).
(i.e. no one is above the law).
"Heinz has a duty to save his wife's life so he should steal
the drug. But it's wrong to steal, so he should be prepared
to accept the penalty for breaking the law."
"The judge should sentence Heinz to jail. Stealing is against
the law! He should not make any exceptions. If Heinz is
not punished others may think it is right to steal and there
will be chaos in the society."

3.5 Level III: Post-conventional Morality

3.5.1 Stage 5: Social Contract and Individual Rights
"Right" is defined in terms of protecting individual rights
according to standards which have been agreed on "in the
public interest". The law (a "social contract") should be
upheld until it is changed by democratic means. Although
different social groups will have different values they would all
agree that they would want:
Certain basic rights (e.g. liberty and life) to be protected.
Some democratic procedures for changing unfair law and for
improving society.
"Heinz should steal the drug because everyone has the
right to life. If Heinz is caught and prosecuted then the
law (against stealing) needs to be reinterpreted because a
person's life was at stake."
"It is a husband's duty to save his wife."
"The pharmacist's decision is despicable but his right to
fair compensation (for his discovery) must be maintained.
Therefore, Heinz should not have stolen the drug."*
3.5.2 Stage 6: Universal Ethical Principles *Because democratic
"Right" is defined by conscience according to self-chosen ethical processes alone do
principles appealing to logical comprehensiveness, universality not always result in
outcomes that seem
and consistency. These principles are not concrete moral
"just", Kohlberg
rules (like the Ten Commandments) but universal principles of
believed that there
justice, equality of human rights and respect for individuals. must be a higher
At Stage 6, a commitment to justice increases the argument stage which defines
for civil disobedience. the principles by which
"Heinz should steal the drug to save his wife because justice is achieved.
preserving human life is a higher moral obligation than
preserving property."*
*Martin Luther King Jr. argued that laws are only valid insofar as
they are grounded in justice and that a commitment to justice carries
with it an obligation to disobey unjust laws.

Example 1 Kohlberg's Stages

Relate each of the following business examples to Kohlberg's stages:
Solution
(a) Mihail uses his company BlackBerry mobile for all his personal "intertalk" and Web surfing.
He believes that it is an established practice that company mobiles are used for private
communications.
(b) XYZ Co has had its best year of trading since it was incorporated 15 years ago. The chief
executive offers share options to all suppliers and employees who have contributed to the
company's success.
(c) Elena, an ACCA student, is caught using a "crib sheet" during an ACCA Exam. She is fully
aware of ACCA's Exam misconduct rules. However, when ACCA determined that Elena
violated its rules her firm pleaded "mitigating circumstances" and supported her in an
appeal as a result of which she was not "struck off" ACCA's student register.
(d) Boris, a full-time employee of Defi Co, has charged 60 days to his timesheet developing
a new service but claims that he cannot deliver it as a Defi product because it is too
demanding of him. He asks Defi for part-time employment because delivering the new
product under the terms of his full-time contract is too stressful. As a part-time employee
he is now offering the same services that he refused to supply to Defi to a "personal"
client portfolio on a consultancy basis.
(e) Two employees have, for the first time, violated a corporate policy. The offence calls for
a written reprimand. One employee has an excellent job record and his line manager
verbally counsels him, but does not put a record on his file. The other employee's work
is generally regarded as substandard. The line manager also gives him only a verbal
warning because equity demands that they both receive the same treatment.
(f) Alexei, an accounting trainee attending an introductory course for ACCA Paper P1, signs
the attendance register for an absent colleague. His firm tries to enforce strict policies
to ensure attendance that contributes to their "proper preparedness". He knows that his
firm does not provide any financial support for students who have to re-sit if they did not
fully attend courses provided for their first attempt. Alexei believes that his colleague
will reciprocate the favour.

3.6 Summary
The social perspective and view of a person at each stage may be
summarised as follows:*
Social Perspective Stage View of Person
Mutual respect as a universal Sees how human fallibility and frailty

6 principle are affected by communication.
Contractual perspective Recognises that contracts will allow

5 persons to increase welfare of both.
Social systems perspective Able to see abstract normative

4 systems.
Social relationships perspective Recognises good and bad intentions.

3
Instrumental egoism Sees that

a) others have goals and preferences,
2 b) either conform to or deviate from
norms.
Blind egoism No view of person; only self and norm

1 are recognised.
*Professionals (of all descriptions, not just accountants) would be

expected to be at least at Stage 2 in Kohlberg's stages of moral
development. They are regulated by professional rules incorporating
ethics and would be subject to peer pressure to act as others in the
profession would do so to be in the public interest.
They also would be expected to apply an approach of absolutism,
rather than a relativism, as the ethical standards (principles- or
rules-based) of their profession would effectively be absolute
standards against which moral questions can be judged.

4 Approaches to Ethics
4.1 "Kantianism"
Immanuel Kant, "the grandfather" of modern ethical thought,
argued that it is not possible to create a basic framework
for ethics because religious texts often supply conflicting
responses. Using the philosophy of logic, he created a new
form of ethical thought.
Kant believed in a sense of "duty" which one should follow on
all occasions. To find out what these duties were and provide
rational reasons why they must be obeyed he split reason into:
"theoretical reason" (covered by math and logic); and
a superior "practical reason".* *Duty is grounded in
a sense of "ought",
Kant held that nothing is good except "a good will" (i.e.
which implies can.
one that wills to act in accord with the moral law and out of
There is no sense of
respect for that law, not out of natural inclinations).
"ought" about things
He saw the moral law as a "categorical imperative" (i.e. that cannot (or
an unconditional command) and based his principles on should not) be done.
rationality rather than God's law.
Reason begins with
The primary criticism of Kant's argument is that not all duties the principle: "Act
can be derived from his purely formal principle.* only on that maxim
whereby thou canst
at the same time will
that it should become
a universal law."
*There are numerous prima facie duties (e.g. keeping promises,
reparation, gratitude and justice) rather than one single formal
principle. Such duties are distinguishable from actual duties
because the many aspects of "right" or "wrong" need to be weighed
before forming a judgement and creating an obligation in the given
circumstances.
Categorical
imperativean end in
Three major post-Kant philosophies in modern studied ethics itself and the basis for
are: all action.
1. Deontology; Hypothetical
imperativesa
2. Utilitarianism; and means to an end (e.g.
3. Virtue ethics (a belief in virtuous traits such as servility and "if you pass your
exams you will get a
bravery).
salary increase").

4.2 Deontological Approach

4.2.1 Description
This concerns the application of universal ethical principles to
arrive at rules of conduct. It originates from the Greek word
deon, meaning "duty or obligation" (logos, "science").
It is based on the concept of duty. Duty theories base
morality on specific, foundational principles of obligation (e.g.
an obligation to tell the truth, not to harm others, to improve
ourselves, to improve the life of others).
It lays down the criteria by which actions can be judged in
advance.
An action is considered morally good because of some
characteristic of the action itself, not because the product of
the action (consequence) is good.
Often referred to as non-consequentialist ethical theories, they
are obligatory irrespective of the consequences that will follow.
An action can only be considered right or wrong when the
morals for taking that action are known.*
It is encapsulated in expressions such as: *Some acts are
"Duty for duty's sake";
morally obligatory
regardless of their
"Virtue is its own reward"; and
consequences for
"Let justice be done though the heavens will fall." human welfare.
It is termed "formalistic" because the central principle lies in That is, an action
the conformity of an action to some rule or law. is right (or wrong)
independent of the
4.2.2 Three Maxims consequences (the
Kant put forward three maxims that could be used to end does not justify
determine an ethical act: the means).
1. Consistencyall acts must be treated as if they are
laws of nature. An action can only be right if it would be
acceptable and applied by everyone. Basically, do unto
others as you would have done unto yourself.
2. Human dignityall of humanity must be treated as an
end, not as a means to an end. Humans should not just be
considered as tools to be used. All humans have needs and
expectations that should be considered.
3. Universalityyou are ethical as long as you create laws
within the maxims and follow your own laws.*
*Universality maybe
described as the "New
York Times test" (i.e.
"Would others take
your view if your
actions were publicised
in the press?").

Example 2 Deontological Theory

Explain, using deontological theory, whether advertising standards should allow the marketing of
"alcopop" drinks to underage consumers.
Solution
4.3 Teleological ("Consequentialist") Approach

This derives from the Greek word teos, meaning "end", since
the end result of the action is the sole determining factor of its
morality.
It is a consequentialist approach in that whether a decision
is right or wrong depends on its consequences or outcome.
As long as the consequences of the action taken are more
favourable than unfavourable, then the action can be
considered as morally right.
Duty or moral obligation is derived from what is good or
desirable as an end to be achieved (i.e. the value of what an
action brings into being).
"The end justifies the means."
The teleological theory comprises two approaches:
1. Egoist
2. Utilitarian
4.3.1 Egoism
Individuals ought to do what is in their self-interest (what's
in it for me?), according to egoism. An action is morally right
if the consequences of that action are more favourable (than
unfavourable) only to the person taking that action.
Argument foreach person should pursue their own aims
rather than please others.
Argument againstit ignores blatant wrongdoing.

4.3.2 Utilitarianism
The moral worth of an action, according to utilitarianism,
is judged solely by its contribution to overall utility (i.e. by
how much happiness it creates or by how much it reduces
suffering). An action is morally right if the consequences
of that action are more favourable than unfavourable to
everyone.
Argument forbenefits everyone regardless of the route
chosen to accomplish a goal.
Argument againstit ignores the rights of the individual.
4.3.3 Altruism
A third approach, altruism, is sometimes considered. An action
is morally right if the consequences of that action are more
favourable than unfavourable to everyone other than the person
taking that action.
Illustration 2 Altruism
The decision of a company not to make a donation to a charity could

be based on prejudice or self-interest. This is not then a moral
decision.
Alternatively, it could be based on an ethical position that supporting
the charity may help the plight of those who are disadvantaged and/
or prevent others suffering similarly.
Whether a donation is made does not give insight into the motive. A
donor may give without much thought through embarrassment or a
belief that it is wrong to rebut a call for help. The decision could be
motivated by a considered ethical stance or by self-interest or some
other non-ethical position.

5 Ethical Decision-Making Models (EDMM)
5.1 Issues Addressed

The two basic issues in ethics are determining:
1. the right motive; and
2. the right action.
Ethics may be approached from different perspectives to
resolve these two issues (e.g. Kantian, social contract, egoism,
deontology, teleology).
EDMMs have been developed from conceptual approaches,
to provide a method of practically applying a framework to
resolve ethical dilemmas.
The role of EDMMs is to provide a more systematic analysis
enabling comprehensible judgement, clearer reasons and
a justifiable and more defensible action than would have
otherwise been the case.*
*Although only two
5.2 American Accounting Association (AAA)* models are specified
by the examiner, the
The AAA model frames the ethical decision as a series of AAA and Tucker's,
answers to questions and requires the user to explicitly outline there are many such
their norms, principles and values. The model is appropriate for models.
use when considering professional or individual ethical conflicts.
The questions to be answered are:
1. What are the facts of the case?
2. What are the ethical issues in the case?
3. What are the norms, principles and values related to
the case?
4. What are the alternative courses of action?
5. What is the best course of action that is consistent with
the norms, principles and values identified in No. 3 above?
6. What are the consequences of each possible course of action?
7. What is the decision?
*The AAA model was formerly known as the "American Accounting Association and Arthur
Andersen method of ethics instruction".
Establishing the facts of the case eliminates ambiguity about what is under consideration.
Norms, principles and values are generally standards, rules and beliefs that guide acceptable and
morally "good" conduct (e.g. profit motive, least harm, integrity, respect for individuals, etc). The
model places the decision into its social, ethical and professional behaviour context.
When considering what the alternative courses of action are, all should be listed no matter how
appropriate or inappropriate they may seem.
Note that when deciding the best course of action, a principle or value may be so persuasive that
a resolution is obvious. For example, protecting the environment to avoid permanent damage and
respect the rights of those whose livelihoods depend on the environment.
With each consequence, consider the long- and short-term perspectives and all positive and
negative effects. It is important to ensure that the implications of each outcome are unambiguous
so that the final decision is made with full knowledge.

Example 3 AAA Model

You are the chief executive of a company which depends heavily on government
contracts. You have been approached by the fundraiser for a political party candidate.
He asks you for a large contribution, strongly implying that if this candidate wins the
election it will increase your ability to win government contracts. You do not prefer the
candidate, either personally or from a business perspective.
Required:
Use the AAA model to determine whether the contribution should be made.
Solution
1. What are the facts of the case?
2. What are the ethical issues in the case?
3. What are the norms, principles and values related to the case?
4. What are the alternative courses of action?
5. What is the best course of action that is consistent with the norms, principles
and values identified in No. 3. above?
6. What are the consequences of each possible course of action?
7. What is the decision?

5.3 Tucker's 5-Question Model

Five questions about a business decision must be answered in
the affirmative to confirm that it is ethical. Is the decision:
1. Profitable (but compared to what)?
2. Legal (what framework was used)?
3. Fair (from whose perspective? Consider stakeholders.)?
4. Right (based on what ethical position)? and
5. Sustainable (or environmentally sound)?
Example 4 Tucker's Model

Your company owns a number of large properties in various major cities. The real estate
assessor in one city offers, for a fee, to underestimate the value of your building and
so you will save substantial annual taxes assessed on property value. This is common
practice in the region.
Required:
Use Tucker's model to determine whether you ought to pay the fee.
Solution
Tucker's model actually creates more questions than it asks.

It encourages debate about conflicting ethical approaches, the
stakeholders involved and sustainability, and is therefore more
appropriate to use when considering organisational problems
rather than professional or individual situations.

5.4 Other Models

5.4.1 Laura Nash Model (1981)
This model uses 12 practical steps or questions, some
of which focus more on ethical decision-making in a
business environment. This model is noteworthy because
it acknowledges alternative problem definitions, promotes
comparing intentions against likely consequences, and
considers the role of symbolism in interpreting outcomes.
Only the AAA and Tucker models are examinable, but you should be
aware that other ethical models do exist as described here.
Example 5 Laura Nash Model
You are the president of a firm which manufactures mattresses for cots. You have the option
of using either of two foams for the filling: a less expensive one which meets what you feel to
be a too-lenient government safety requirement regarding inflammability (a requirement which
you are quite sure was established as a result of pressure from your industry) and one which is
considered safer but more expensive. Assume that the market will not pay a higher price for the
more expensive material.
Required:
Use the following Laura Nash model to decide whether you should use the more
expensive filling.

Example 5 Laura Nash Model (continued)
Solution
1. Have you defined the problem accurately?
2. How would you define the problem if you stood on the "other side of the fence"?
3. How did this situation arise in the first place?
4. To whom (and what) do you give your loyalties? (Consider this as a person and as a member
of the corporation.)
5. What is your intention (in making this decision)?
6. How does this intention compare with the likely results?
7. Whom could your decision or action injure?
8. Can you discuss the problem with the affected parties before making your decision?
9. Are you confident that your current stance will be as valid over a long period of time?
10. Could you disclose without qualm your decision or action to your CEO, the board of directors,
your family, or society as a whole?
11. What is the symbolic potential of your action if it is understood? If it is misunderstood?
12. Under what conditions would you allow exceptions to your stance?

5.4.2 ACCA Ethical Conflict Resolution

Under ACCA's Code of Ethics and Conduct, professional
accountants should consider:*
the relevant facts; *Although this is not
the ethical issues involved; specifically examinable
related fundamental principles;
it is clearly relevant
to the professional
established procedures of the firm; careers of ACCA
the action which can be followed and the probable outcome; affiliates and student
alternative courses of action and their consequences; members.
internal and external sources of consultation available (e.g.
ethics partner; audit committee).
If a significant conflict cannot be resolved, consulting
legal advisors and/or ACCA should be considered. Such
consultation can be taken without breaching confidentiality.
If, after exhausting all possibilities, the ethical conflict remains
unresolved, members should, where possible, refuse to remain
associated with the matter creating the conflict.
5.4.3 Institute of Business Ethics (IBE)

The IBE, a UK charity registered in 1986, promotes three
simple ethical tests for a business decision:
1. Transparencydo I mind others knowing what I have
decided?
2. Effectwho does my decision affect or hurt?
3. Fairnesswould my decision be considered fair by those
affected?

Summary
Morality concerns "good" or "bad" outcomes based on values; ethics concerns the
development of rules or principles designed to produce good outcomes.
Absolutism ignores the intentions or consequences of an action in favour of universal
principles of right or wrong. Relativism considers the intentions or consequences of an
action in the context of social, cultural, historical or personal references.
Kohlberg's Theory of Moral Development relies on three levels, each with two stages,
progressing from a self-centered orientation to an other-centered orientation. According to the
theory, everyone passes through each stage as the result of thinking about moral problems.
Kant viewed moral law as categorical imperatives based on rational principles rather than on
religious views, which he found contradictory. However, not all duties could be found from a
rational perspective. His thinking gave rise to additional schools:
Deontological approachapplication of universal ethical principles, based on a concept of
duty, not outcome dependent.
Teleological approachexamination of the end result of actions to determine their morality.
"The end justies the means."
Ethical decision-making models provide clearer reasoning and more defensible actions
than do general ethical decision-making frameworks, and explore ethical principles and
acceptability of outcomes.
Session 15 Quiz
1. Explain the differences between absolutism and relativism. (2)

2. List the SIX stages of Kohlberg's Theory of Moral Development. (3)
3. Describe the deontological approach. (4.2)
4. Compare the AAA decision-making model to Tucker's model. (5)
Study Question Bank

Q20 Ethical theories 30 minutes
Additional
Q21 Ethical Management

Session 15
EXAMPLE SOLUTIONS
Solution 1Kohlberg's Stages
(a) Stage 3: Conformity
Mihail probably believes it to be an established policy because he
is aware that all other employees use their phones for the same
purpose. Even if he knew that it was not company policy to allow
private use of company assets, the fact that his peers (his immediate
group) do so puts him under pressure to do the same.
(b) Stage 4: Maintaining the Social Order
In the context of offering share options to employees, this can be
considered to be one of a number of standard practices in rewarding
employees (e.g. bonuses based on salaries). Therefore the employer
applies what may be considered as a social accord because other
firms do likewise.
Offering share options to suppliers (as a form or reward, rather than
payment for services) may be considered to be unusual in that not
many entities do so. This action may therefore be thought of as
post-conventional (e.g. Stage 5).
(c) Stage 1: Obedience and Punishment
Initially, Elena would have been concerned with the question, "Will
I be punished if I am caught, or can I get away with it and pass the
exam?" Having been caught once and, because of the support from
her firm, escaped being "struck off" from ACCA she took the view
that if caught again, no punishment would be applied. Thus she
continued her practice of examination misconduct.
(d) Stage 2: Individualism
Basically, "what's in it for me?" Boris has decided that he will be
better off by leaving Defi and becoming a freelance consultant,
thereby ignoring any loyalty or gratitude to Defi for his employment,
training and development. It is clear that he would be working just as
many hours, if not more, but would probably be earning more money.
(e) Stage 6: Consistency
The line-manager is applying wider universal ethical principles (e.g.
equity, equality, justice). Having used his judgement to give the
"excellent" employee only a verbal reprimand (although the offence
requires a higher sanction, a written warning) he considers it only fair
and right to do the same for the other employee.
(f) Stage 2: Exchange
Basically, Alexei believes that his absent colleague owes him a
favour. As he has "rewarded" his colleague, so he expects to be
given a similar "reward" at a later stage. It is in both students'
interests to be able to claim full attendance at the courses in order to
meet the "proper preparedness" criteria.

Solution 2Deontological Theory
1. Consistency
Would you allow your children to buy/have alcohol if underage (the
same would apply to smoking, sex, solvents, drugs, etc)? Would
you be happy if a particular product/advert was directly or indirectly
aimed to encourage your children to break the law or be encouraged
to inflict self-damage?
2. Human dignity
Children are easily persuaded by advertising and may not be able
to tell the difference between right and wrong. In many cases,
they may wish to act like adults (e.g. drinking and smoking). Thus,
they have the right to be protected from the consequences, in this
scenario, of underage drinking.
3. Universality
The entity producing the drink and commissioning the advertising
would not be happy should there be negative publicity in the press
(papers, TV, etc). Such publicity would probably damage the
company's reputation.*
*In many countries it
Solution 3AAA Model is illegal to advertise
"adult" products in a
1. Factsin exchange for a significant payment you may secure predominantly child-
government contracts in the future. oriented environment
2. Ethical issuesshould you provide a contribution in what, in the best (e.g. TV adverts before
case, would be an inducement and, in the worst case, be considered 21.00) as the audience
a bribe. As the CEO, you may be in breach of your fiduciary will probably consist of
duties and probably in breach of campaign contribution laws. As a significant number
a professional accountant you would be in breach of your ethical of children, or at the
codes. However, not to do so may mean that there will be a lack of cinemas when the
government orders should the candidate win the election. certificates are, for
3. Norms, principles and valuesgovernment contracts should not example, "15" or less.
be awarded on the basis of favours, inducements or bribesvalue
for money (VFM) would be an expected driver. CEOs, as leaders of
their companies, are expected to set the moral and ethical tone of
the organisation. Professional accountants are expected to have
integrity and objectivity.
4. Alternative courses of action(i) make the contribution; (ii) make a
lower contribution; or (iii) make no contribution.
5. Best course of actiondecline to make a contribution and report the
incident to an appropriate elections committee.
6. Consequences of each possible course of action:
(i) Making the payment will incur cash flow now for which there
may be future awards of contracts if the candidate wins. The
political contribution would need to be disclosed in the financial
statements and the candidate also would need to disclose it,
as it is material. If the candidate wins and additional contracts
are awarded, there may be possible media speculation why the
company appears to be winning more contracts than normal,
which may lead to an investigation and negative consequences
for the firm and its directors.
(ii) If the payment is not made (or is lower than requested) and the
candidate wins, the result may be that future contracts are not
awarded. This would have a detrimental effect on the business
with possible going-concern consequences.
(iii) The broad assumptions are that the candidate will win and have
control over the tendering process (i.e. awards are not made by
a separate committee).
7. Decisionthe ethical approach would be to decline making the
requested contribution.

Solution 4Tucker's Model
This is a case of bribery. Because all five questions in this model must be
answered in the affirmative, the payment is not defensible as the evasion
of tax is illegal.
It is not fair to the wider society that the burden of evaded tax should be
borne by others in order to provide the services and facilities for which
the tax is raised. Nor can it be right (just) that others should suffer a
deterioration in, or lack of, services as a result of under-funding. That it
is considered common practice does not make it acceptable.
It is not sustainable in that a "vicious circle" is created of increasing
levies which are increasingly evaded. The environment may be harmed.
For example, vital services such as the provision of clean water may be
compromised. If charges then have to be made for services such as waste
disposal (because there are no taxes to fund the service), environmentally
damaging practices such as illegal dumping are likely to increase.
Solution 5Laura Nash Model

1. Problemthe safer material will cost the company more/reduce profit.
2. Problem from other side of the fencea safer foam is better.
3. How the situation arosethe opportunity to use an inferior material
exists.
4. Loyalty tothe consumers, without whom there is no profit for
shareholders.
5. Intentionuse the safer foam.
6. Comparison to resultsthe same.
7. Who could be injured (by intention in No. 5.)no one.
8. Discuss with other parties firstyes.
9. Confident about position over a long periodyes.
10. Could discuss decision with familyyes.
11. Symbolic potentialthat profits are based on sound ethical action.
12. Exception conditionsif the less expensive foam met appropriate
safety standards.
The use of the safer material may be considered a sound business

decision, rather than an ethical one, because it would maintain
reputation and be a marketable feature. Or, even if profits are
reduced, this is an acceptable price for the reduction of risk.
(Consider, for example, that even though the foam meets safety
standards, the company's reputation could suffer hugely if accidents
involving infants were publicised in the media. This would result in
future costs/loss of revenues, even if the company had no liability
to the customers.) Because the law in this case does not set an
acceptable ethical safety level, "obedience" to the law is not an issue
no laws are being broken if the safety standard is being exceeded.

Session 16
Ethics and Social

Responsibility
FOCUS

2. Different approaches to ethics and social responsibility
a) Describe and evaluate Gray, Owen & Adams (1996) seven positions
on social responsibility.
b) Describe and evaluate other constructions of corporate and personal
ethical stance:
i) short-term shareholder interests
ii) long-term shareholder interests
iii) multiple stakeholder obligations
iv) shaper of society
c) Describe and analyse the variables determining the cultural context
of ethics and corporate social responsibility (CSR).
Session 16 Guidance
Notethis session moves the ethical theories from Session 15 into the business, social and
cultural arenas.
UnderstandGray, Owens and Adams (s.1.2) and Johnson and Scholes business ethical stances
(s.2.1, s.2.2).

VISUAL OVERVIEW
Objective: To describe some of the key theories underlying views on social responsibility
and ethics in the workplace.
ETHICS AND SOCIAL

RESPONSIBILITY
SOCIAL RESPONSIBILITY ETHICAL STANCE

Environmental Johnson and Scholes
Philosophy Business Stances
Seven Positions on CSR Personal Stances
CULTURAL CONTEXT
INDIVIDUALS ENTITIES
Individual Characteristics Cultural Frames
Situational Influences Pyramid of CSR
Strategic Postures
Corporate Culture
Session 16 Guidance
Read the remaining areas to "soak up" the variables that determine the cultural context of ethics.

Session 16 Ethics and Social Responsibility P1 Governance, Risk and Ethics
1 Social Responsibility
1.1 Overview of Environmental Philosophy

< Traditional philosophy is divided between:
= consequential (or teleological) theories (e.g. utilitarianism);
and
*Consideration of
= non-consequential (or deontological) theories (e.g. rights-
the environment in
based philosophies). decision-making may
< Environmental philosophies can be classified as: involve actions such as
= anthropocentric (human-centred); and pollution abatement,
resource conservation
= eco-centric (earth-centred).*
and restoration
activities. Nature, other
1.2 Seven Positions on Corporate Social species and ecosystems
Responsibility are recognised as
having values beyond
Gray et al. (1996) offer a seven-level classification framework to human usage.
explain "a few general ways in which different groups in society
might envisage the organisation-society relationship."
1. Pristine capitalists Rights Anthropocentric

(human-centred)
Functionalist 2. Expedients
(individualist)
philosophies 3. Social contract
4. Social ecologists
Green
(communitarian) 5. Socialists
accounting
philosophies 6. Radical feminists
Eco-centric
7. Deep ecologists Responsibilities (earth-centred)
1.2.1 Pristine Capitalists
Example 1 Pristine Capitalist
A Pristine capitalist view is that organisations have:

the right to pursue legal business activities, consume resources and maximise returns to
shareholders; and
responsibilities to shareholders, but not society as a whole.
Required:
Describe the role and actions of "pristine capitalists".
Solution

P1 Governance, Risk and Ethics Session 16 Ethics and Social Responsibility
1.2.2 Expedients
< Basically share the same underlying position as the pristine
capitalist (i.e. maximising shareholder wealth). However, they
take a long-term view that economic welfare, stability and
maximising shareholders' wealth can only be achieved by the
acceptance of certain (minimum) social responsibilities.
< Social responsibilities are only accepted to benefit the
organisation (i.e. through enlightened self-interest).
< So begins the recognition that business cannot just use
resources without consideration of the effect on society.
1.2.3 Proponents of the Social Contract

< An attitude that companies and other organisations only exist
at society's will and are expected to respect and respond to
that society.
< Responsibility is reciprocal. In the business-stakeholder
relationship, stakeholders accept the organisation's activities
as long as it acts in their interests. When the business breaks
accepted norms (e.g. by acting unethically) the agreement of
society may be withdrawn and the business will collapse.* *Organisations exist
and thrive only with
< As part of the social contract, the organisation must respect a societal "licence"
the rights of all human beings. This may often take the form to operate. Conflict
of allowing employees to be represented by a trade union. between organisational
and societal values
1.2.4 Social Ecologists can result in the
withdrawal of support
< Those who are concerned for the social environment and
by society. Therefore,
think that because large organisations have been influential
organisations seek
in creating social and environmental problems (i.e. have to align themselves
large social and environmental footprints) they should also be with social norms and
influential in helping to eradicate or minimise these problems. expectations (which
< As economic processes are leading to resource exhaustion, will change over time)
waste and pollution, such processes must be modified. to maximise their
Businesses must adopt socially responsible positions, not social legitimacy.
because they have to meet the norms of society (social
contract) but because they feel a moral responsibility to do so.
< There is a high moral stance on the predatory behaviour of
corporations.
1.2.5 Socialists
< Those who think that there should be a significant
readjustment in the ownership of assets and the structuring of
society away from capitalists ("power to the people").
< All forms of domination (e.g. nation states and multinational
conglomerates) are criticised. There is a call for corporations
to have their charters revoked by communities claiming social
and ecological exploitation.
< Agency theories of accounting (where managers or board
members represent the interests of firm and ecology) are
highly criticised. The inadequacies of voluntary compliance
demand more regulation.
< Business should be conducted in a different way which
recognises and redresses the imbalances in society and
provides benefits to stakeholders more widely.

1.2.6 Radical Feminists

< Those who think that there is something essentially wrong
with the aggressive masculine constructs which guide social
systems (e.g. aggression, power, hierarchy, domination and
competitiveness).
< There is a need for more feminine values (e.g. equality,
dialogue, compassion, fairness, cooperation and mercy).*
*The problem is not really human-centredness, but androcentrism

(taking a masculine "power over" point of view).
Note that radical feminists in this context does not refer to female
militants but more of a school of philosophy. Hofstede (Paper F1)
also considered a female/male cultural dimension.
< "Boys with their toys" (i.e. the masculine approach) have not
only got society and business into its current "mess", but is a
prime factor for just about every "mess".
< A radical rethink of values and social culture is required to
move business towards feminine values. Until this happens,
accounting and corporate social reporting (CSR) systems
are flawed.
1.2.7 Deep Ecologists ("Deep Greens")

< Those who hold that humans have no greater right to
existence or resources than any other form of life. Life and
life forms have intrinsic value and humans have no right to
reduce this richness and diversity except to satisfy vital needs.
< Just because humans can control and subjugate social and
environmental systems does not mean that they should. It is
immoral for businesses to destroy other life forms and create
imbalance within ecosystems just for the purpose of human
economic growth.
< The current economic and accounting systems (including CSR,
3BL, PPP, etc) are fundamentally flawed and should be replaced.
The environment cannot be trusted in the hands of business.*
*At the deep ecologist end of the spectrum, companies may

have legal rights but moral rights take precedent. Companies'
responsibilities to society and the environment must be the primary
business drivers.

2 Ethical Stance Constructions

2.1 Johnson and Scholes
< Johnson and Scholes claim that an organisation's corporate
governance actions determine its minimum obligations to its Ethical stance"the
different stakeholders. extent to which an
< A key strategic issue for many companies is what level of CSR organisation will
to adhere to. This affects the extent to which a company will exceed its minimum
exceed its minimum obligations to stakeholders. obligation to
stakeholders."
< "Ethical stance" helps the organisation to determine how it:
Johnson and Scholes
= tries to reach its goals; and
= relates to its various stakeholders.
< Companies have different basic values of CSR, based on
the ideological beliefs and moral and ethical values of the
organisation. It is important, therefore, that managers and
employees understand and influence the moral standpoints
taken by the company.
2.2 Business Ethical Stances

< Business ethics exist at three levels:
1. Macroconcerns issues about the roles of businesses
and other organisations in the national and international
organisations of society;
2. CSRconcerned with the specific ethical issues facing
corporate entities; and
3. Individualconcerns the behaviour and actions of
individuals in the organisation.
< The differences between these levels is illustrated by four
stereotyped levels of ethical stance (as devised by Johnson
and Scholes) which rank businesses moral objectives:
Short-term shareholder Longer-term

interest shareholder interest
Ethical stances
Multiple stakeholder
Shaper of society
obligations
< The key position is the extent to which an organisation will

exceed its minimum obligations to stakeholders and society
at large.

2.2.1 Short-Term Shareholder Interests

< Applies to entities which:
= aim just to maximise short-term shareholder profits; and
= only meet the minimum obligation required by law.
< Interest is in short-term dividends rather than long-term
capital growth. There will be conflicts between short-term and
long-term strategies and decisions.
< CSR and ethical considerations do not provide short-term
benefit as they may reduce profits (and ability to pay
dividends).
< If a government wants entities to broaden their ethical stance
it should legislate through law or regulate through corporate
governance.
2.2.2 Long-Term Shareholder Interests

< Although an entity wishes to maximise shareholder wealth
over the longer term (e.g. increasing dividends, capital
growth), it needs to maintain its existence and grow.
< An entity will take a wider stance on ethical issues as part
of its strategy, for example, to minimise reputation risk (i.e.
attracting investment because of its ethical approach).
< Taking a proactive approach to actual and expected ethical
issues may also reduce the risk of government legislation
being introduced (which is usually more onerous than applying
requirements voluntarily).
< Stakeholder relationships are managed proactively and
carefully due to long-term self-interest.
Illustration 1 Benefits of Social

Responsibility
The UK Cooperative Bank has a strict code on only doing business
with ethically and socially responsible companies. It views this
approach as giving it a competitive edge. Research has shown
that because of this policy, it has gained more revenue and profits
through attracting similar-minded businesses as customers than
it would have earned from those companies who were declined
because they did not meet the bank's ethical criteria.
2.2.3 Multiple Stakeholders' Obligations

< Stakeholders' interests and expectations are increasingly
incorporated in the organisation's purposes and strategies.
The company will go beyond its minimum financial
obligations and explicitly consider an expanded definition
of stakeholders.*
*Avoiding manufacturing or selling an anti-social product, retaining

a business unit with low profit margins in order to preserve jobs and
accepting reduced profits for the social good are examples of "going
beyond the minimum".

< Each stakeholder group expects its interests to be understood

and generally acted upon. This leads to stakeholder conflict
when it is not possible to meet opposing stakeholders' claims.
Mendelow is therefore important to identify stakeholder claims
and conflicts and assess the moral and ethical levels.
< Stakeholder relationships must be managed proactively and
carefully to sustain long-term self-interest.
< Although there are many jurisdictions in which the rights of
stakeholder groups are protected by law (e.g. employees,
customers, local community), ethics and CSR go beyond
minimum legal requirements.
2.2.4 Shaper of Society

< This is the ideological level at which the organisation has the
ability to change (shape) society for the better. Society may not
be at the national level, but could relate to the local community.*
*Several towns in the UK (e.g. Bourneville (now part of Birmingham)

and Fleetwood) were developed because of philanthropic "shaper
of society" companies (Cadbury in Bourneville and Lofthouse of
Fleetwood). In both cases, members of the Cadbury and Lofthouse
families also played active parts in changing the national society
through their actions in local and national government.
The Body Shop is another example of a "shaper of society" in the
way it deals with local communities where it sources raw materials.
< The organisation is concerned with trying to "make a

difference" to contribute to a better world. Financial
considerations are often of a secondary importance. It can be
easier for a private, family owned business to operate at this
level, because it is not accountable to external shareholders.
< "Shapers of society" are more likely to occur:
= when social justice is prominent in the socio-cultural norms
and political agenda;
= in the more economically developed nations;
= in industries or sectors in the public eye;
= where the degree of competitive rivalry is high; and
= in younger industries.
2.3 Personal Ethical Stances

< An ethical stance is concerned with the ways in which an
organisation exceeds the minimum obligations to stakeholders
specified through regulation and corporate governance.
< The role of individuals includes:
= "whistle-blowing"individual reporting of non-ethical
strategies; and
= integrityuse of powerful positions by individuals.

3 Cultural ContextIndividuals
Ethical decision-making by individuals can be analysed under two
elements:
1. the specific individual characteristics of the person making the
decision; and
2. the context within which the individual will make the decision.
3.1 Individual Characteristics

Various studies (e.g. Crane, Matten, Kohlberg) have researched
general criteria which formulate individual stances on ethics.
3.1.1 Age and Gender

< Although Gray and Adams' radical feminist classification and
research by Hofstede imply that men and women react to ethical
situations differently, there is currently insufficient empirical
evidence to suggest that, for example, men are less ethical.
< Similarly, there is insufficient evidence of the effect of age on
ethical behaviour.
3.1.2 National Cultural

< It is widely accepted that national and cultural beliefs have a
significant influence on an individual's ethical development.
< Following Hofstede's work in this area, an individual may:
= tackle an ethical problem alone (individualism) or by group
consultation (collectivism);
= challenge what they consider to be an unethical command
from a superior or accept it (power distance);
= follow the rules regardless of outcome or circumstance
(uncertainty avoidance).
3.1.3 Education and Employment
< These appear to have an effect on ethical development in the
national and cultural context. A solid base of education and
employment experience possibly enhances ethical decision-
making in most individuals.
< With ethical scandals rocking the business world in increasing
frequency and magnitude, the academic community is under
pressure to improve the ethical reasoning skills and behaviour
of their graduates. Since the Enron scandal (2000/01)
in particular, ethical studies have become an increasingly
integrated component in US business school syllabuses.
Business students tend to be more driven by self-centred
values and display the highest cheating rate relative to
students of engineering, science and humanities (Meade,
1992). Once secondary in importance, ethical studies are
now typically a standard requirement.

3.1.4 Locus of Control

< Individuals with a high internal locus of control believe that
they can significantly determine their destiny and, perhaps,
that of others.
< Those with high external locus believe that their destiny is out
of their hands (controlled by events, circumstance or luck
"pinball syndrome").
3.1.5 Moral Imagination*
*During the Enron trial, Andrew Fastow, the CFO, told the jury, "I
was extremely greedy and I lost my moral compass." Just about all
of the key players would have had a very high internal locus, but no
moral compass. Many argue that greed was a qualification for a job
at Enron, and you left your moral compass with security when you
joined, only to be returned should you leave. This was a company
which displayed its share price in the lifts, and where clever schemes
for getting that share price up became more important than running
a real business.
The concept of a "moral compass" is an interesting one. Adam
Smith in his books "The Wealth of Nations" (1776) and "The Theory
of Moral Sentiments" (1759) implied that all humans, while acting in
their economic self-interest, did so with a "moral sense", effectively
a "moral compass", used to guide individuals in the morally correct
direction. Just as magnetic metal sources will deflect the needle
from pointing to the magnetic North, other metals (e.g. gold) may
well deflect an individual's moral compass from its true direction.
< Moral imagination refers to a sense of the variety of

possibilities and moral consequences of decisions; the ability
to imagine a wide range of possible issues, consequences and
solutions. (Werhane)
< It is the ability to think "outside of the box" and formulate
different solutions to moral and ethical challenges.
3.1.6 Cognitive Moral Development

< Based on the work of Kohlberg (Session 15).

3.2 Situational Influences

< There are two main forms of situational influences:
1. Issue-related (e.g. the nature and perception of an
issue). Some issues may be considered irrelevant (i.e. low
ethical consideration) and others may be considered critical
(i.e. high ethical consideration).
2. Context-related (e.g. group norms, expectations,
demands, roles, work climate, rewards and punishments).
< Although individual characteristics are identified as playing
an important role in ethical and moral stances, research has
shown that the situation the decision-maker finds themselves
in has an equal, if not a greater, effect on the stance taken by
an individual.
< It is possible for an individual to have multiple ethical stances
(Trevino and Nelson) depending on the situation. Thus the
same ethical situation may result in different decisions being
made in different contexts.
< Influences include:
= moral intensity (issue) and moral framing (issue);
= systems of reward (context);
= authority (context);
= bureaucracy (context); and
= work roles (context).
3.2.1 Moral Intensity

The relative importance of the issue (e.g. irrelevant or critical)
affects the ethical decision process. Thomas Jones (1991)
suggests six factors to consider:
Factor Effects on Decision Process
1. Magnitude of consequencesthe harms The greater the harm, the greater the
or benefits caused by the action (or lack of). intensity.
2.Social consensusthe degree to which Disagreement increases the moral intensity.

individuals are in agreement over the
ethics of the problem or the action.
3.Probability of effectignore, negligible, The higher the likelihood, the greater the
likely, possible, probable, certain. intensity.
4.Temporal immediacyhow quickly will The greater the time between action and
the consequences of the decision strike? consequences, the lower the intensity.
5.Proximityhow "near" is the decision- Closeness implies greater moral intensity.

maker to those affected? Proximity
may be social, cultural, psychological or
physical.
6.Concentration of effecthow many Need to consider qualitative and quantitative

people will suffer and by how much? aspects (e.g. stealing $1,000 from a company
Heavily on a few or lightly on many? may be immaterial to the company, but could
be material if stolen from an individual).

3.2.2 Moral Framing

< Issues described using words such as integrity, honesty,
fairness, social responsibility, propriety, lying, cheating or
stealing will probably be considered as moral or ethical issues.
< Some managers may deliberately avoid using such terms (or
reframe them in terms of practicality, organisational interests,
economic sense and rational corporate self-interest) in order
not to be seen taking a moral line. Using moral terms may
cause disharmony, inefficiency and project an image of low
power and ineffectiveness. This has been referred to as
"moral muteness" (Bird and Waters).
3.2.3 Systems of Reward

There is considerable evidence to suggest that employees' ethical
decision-making is influenced by the systems of reward they
work under.
< Basing rewards on set criteria and benchmarks (e.g. sales made,
share price, contracts won) runs the risk that managers and
employees will engage in unethical (and often illegal) practices
to meet or exceed expectations. This is compounded if unethical
practice is accepted (and not punished) by senior management *A common thread
so that it becomes accepted practice in the organisation.* throughout the various
investigations into the
< If ethical behaviour by employees goes unnoticed or collapse of financial
unrewarded, it decreases the chance that employees will institutions following
continue such behaviour. This is compounded if ethical the subprime and
behaviour is punished (e.g. discriminatory action taken against credit crunch has been
employees who report unethical behaviour of superiors). the "greed of bankers
in devising ever more
3.2.4 Authority morally dubious
practices and unethical
< A strict authority hierarchy often means employees will products in order to
be expected to follow the requests of superiors without increase their profits
questioning reason or practice. and thus bonuses" (US
< In other cases, employees will only be able to meet the Congressional report).
requests of managers by taking shortcuts, which may often
mean unethical behaviour.
< Those in authority can also influence unethical decision-
making and actions by employees simply by "turning a blind
eye" and allowing such actions to continue.*
*During the banking crisis, as long as the traders were making

good profits, many "blind eyes were turned" and an unwritten
"no questions asked" policy existed. The controls were effectively
ignored or bypassed.

3.2.5 Bureaucracy
Bureaucracy, through underpinning the system of reward,
punishment and authority, has a number of effects on ethical
decision-making:
< Suppression of moral autonomybureaucracy lays down
the rules and procedures to follow, thus overriding any
individual ethical beliefs.
< Instrumental moralitythe bureaucratic rules are
instrumental in achieving the end result. Hence morality only
has a meaning in conformity to following the rulesethical
decision-making will thus focus on the correct application of
each rule rather than the outcome as a whole.
< Distancingeach employee in the bureaucracy will have a
role. They will not be concerned with the morality of actions
taken beyond that role nor the final outcome.
< Denial of moral statusbureaucracy removes the human
element from employees. They just become a resource to
be used for carrying out the organisation's will rather than
autonomous moral beings.
3.2.6 Work Roles

This refers to patterns of behaviour expected by others from an
individual occupying a certain position in an organisation (role
theory). Roles can thus encapsulate a whole set of expectations
about what to value, how to relate to others and how to behave.
The moral and ethical expectations embedded in the roles will
often override individual moral traits.
4 Cultural ContextEntities
4.1 Cultural Frames

The cultural context is influenced by different cultural frames:
< National and regional culturesthis influences the
expectations of stakeholders directly. It is important to
understand these because:
= values of society change and adjust over time, therefore
strategies which once were acceptable may not be now;
= organisations which work internationally have to cope
with different cultures, hence different expectations of the
*A "recipe" in this
stakeholders in those cultures. cultural context is
< Organisational fielda community of organisations which a set of commonly
partake of a common meaning system and whose participants held assumptions
interact more frequently with another than those outside the about organisational
field. This will mean that organisations in that field have the purposes and a "shared
same "recipe".* wisdom" on how to
manage organisations.
< Organisational culture, consisting of: This means that
= valuesinform the organisation's ethical stances and serve organisations will tend
as the basis for mission statements, objectives or strategies to the same kind of
(may be easy to identify but can be vague); strategy over time,
= beliefswhich are more specific (e.g. belief that the especially during
uncertainty.
company should not trade with particular countries);

= behavioursthe ways in which people in the organisation

and the organisation itself operate, including work routines
and symbolic gestures; and
= assumptions (paradigm)taken for granted as being the
core of an organisation's culture. These aspects may be
difficult to identify and explain.
< Functional and divisional culturesubcultures in
organisations can give rise to problems (especially after
acquisitions or mergers).*
4.2 Pyramid of Corporate Social Responsibility *A common reason for

a failed merger is the
Four variables are identified in Carroll's pyramid of corporate culture clash between
social responsibility: the entities.
PHILANTHROPIC
Be a Good Corporate Citizen
Contribute resources to the
community. Improve quality of life.
ETHICAL
Be Ethical
Obligation to do what is right,
just and fairavoid harm.
LEGAL
Obey the Law
Law is societys codification of right and wrong.
Play by the rules.
ECONOMIC
Be Profitable
The foundation upon which all others rest.
4.2.1 Economic Responsibilities*

< To perform in a manner consistent with maximising earnings
per share.
< To be committed to being as profitable as possible. *A successful firm is
< To maintain a strong competitive position. therefore one that is
consistently profitable.
< To maintain a high level of operational efficiency.
4.2.2 Legal Responsibilities*

< To perform in a manner consistent with expectations of
government and the law.
< To comply with various national and supra-national laws and *A successful firm
regulations. is therefore one
< To be a law-abiding corporate citizen. that fulfills its legal
< To provide goods and services that at least meet the minimal obligations.
legal requirements.

4.2.3 Ethical Responsibilities*

< To perform in a manner consistent with expectations of society
morals and ethical norms.
< To recognise and respect new or evolving ethical/moral norms *Good corporate
adopted by society. citizenship is doing
< To prevent ethical norms from being compromised in order to what is expected
morally or ethically.
achieve corporate goals.
< To recognise that corporate integrity and ethical behaviour go
beyond mere compliance with laws and regulations.
Illustration 2 Cafdirect
Cafdirect is the UK's largest fair trade hot drinks company and
owns the country's sixth-largest coffee brand.
The company pays its 250,000 coffee, tea and cocoa producers
in the developing world guaranteed fair prices, above the current
market rates. The company also makes long-term investment in its
producer partners' organisations.
Since starting in business, Cafdirect has reinvested over 50% of its
profits into grower businesses and local communities (e.g. through
training programs to provide market information and management
skills to its producers). www.cafedirect.co.uk
4.2.4 Philanthropic Responsibilities*

< To perform in a manner consistent with the charitable
expectations of society.
< To assist the fine and performing arts. *Managers and
< To provide assistance to public and private educational employees participate
institutions. in voluntary and
charitable activities
< To assist voluntarily those projects that enhance a in their local
community's "quality of life". communities.
Illustration 3 Tate & Lyle
In 2006, Tate & Lyle made history when it was recognised by

the Guinness Book of World Records as having the world's oldest
branding and packaging.
This global food-related company's long history of supporting the
communities in which it operates (now in Europe, the Americas and
Southeast Asia) began with the philanthropic approach of its co-
foundersHenry Tate was instrumental in founding the Tate Gallery
in London.
The company's charitable spend allocations (usually in excess of
500,000 each year) encompass education, the environment, health
and the arts.
Every year more than 3,000 primary school children visited the
Thames Refinery for its annual child safety awareness programme
run by the Metropolitan Police.
Each year the two London factories also take in 40 work experience
students between them. They also work closely with schoolchildren
on the UK's National Curriculum. www.tateandlyle.com

4.3 Strategic Postures on Social Responsibility

Different organisations clearly respond to social and
environmental concerns in different ways. The degree of
response may be classified as socially:
< obstructiveresisting pressures to modify behaviour which
may flaunt minimum legal standards;
< obligativemeeting legal minimum;
< responsivedoing more to address concerns when lobbied by
pressure groups; and
< contributivewilling to help protect the environment and
promote ethical business practices.
4.4 Corporate Culture
Corporate culturethe blend of beliefs, expectations and values shared

by an organisation's members and transferred from one generation of
employees to the next. "The way we do things around here."
4.4.1 Importance
< Corporate culture, though intangible, provides a framework
which guides individual and organisational behaviour in "grey
areas" (e.g. when there are gaps between the rules or when
issues are not "black or white").*
*Corporate culture
< It not only affects behaviour, but can be the difference establishes the
between organisational success and failure. The long-term acceptable behaviour
economic impact of a failed corporate culture includes: of an organisation's
= the cost of fines and penalties; employees.
= the inability to hire and retain employees; and
= the cost of reputation damage (which is often irreparable).
< It can influence:
= motivation, morale and "goodwill" of employees (and hence
employee turnover, productivity/efficiency/quality of work);
= employee-industrial relations; and
= innovation/creativity.
Example 2 Contaminated Product

In 1982, a subsidiary of Johnson & Johnson (J&J) faced a crisis when seven people died in the US
as a result of capsules of an extra-strength, over-the-counter analgesic, Tylenol, being laced with
cyanide. News of this caused a nationwide panic.
Required:
Set out the best course of action for J&J to have taken.
(Hint: Look at Illustration 5, the J&J Credo, at the end of this session.)
Solution

4.4.2 Assessing Corporate Culture

< A formal assessment of a company's culture often requires
the assistance of experienced outside consultants. Tools may
include: These models are
= an anonymous employee survey; not examinable.
= analyses of employee turnover; and However, as
knowledge of this
= consultation with vendors, customers and other
can be assumed
external parties. (F1 Accountant
< Models that might be used include: in Business) they
1. Johnson and Scholes "cultural web"; and provide useful
illustrations relevant
2. Schein's framework. to corporate culture.
1. Cultural Web
Symbols
Organisational structures Power

structures
Rituals & The

routines Paradigm
Control
Stories Systems
The way an organisation looks at the world is important in

determining how it will respond to an ethical dilemma. The web
contains six interrelated elements (influences).
When an organisation faces an ethical dilemma, taking
appropriate action with those involved is only part of the
process. It is important, for the longer term, to publicly discuss
the issue and ensure that employees know how it was resolved.
This establishes a "template" for handling such situations and
employees will know what is expected of them.

Example 3 Misconduct by Employee

You are the manager responsible for training ACCA students in a firm. You
have been given irrefutable evidence of exam misconduct by a trainee.
Required:
Give THREE arguments for and THREE arguments against
dismissing the trainee.
Solution
Arguments for
Arguments against

2. Schein's Framework
Schein developed a set of logical categories for studying basic
assumptions and analysing cultural paradigms.
Artefacts and Visual organisational

structures and processes
Creations
(hard to decipher)
Espoused Values Strategies, goals, philosophies

(espoused justifications)
Unconscious, taken for granted beliefs,

perceptions, thoughts and feelings
Basic Assumptions (ultimate source of values and action)
Illustration 4 Basic Assumptions
A basic assumption held by tutors and staff of an accountancy training

company may be that students want to pass ACCA Examinations. It is
inconceivable that a student would attend tuition with no intention of
being successful in examinations.
Students may hold a basic assumption that there is a relationship
between the amount of time that they spend on answering a question and
the mark that they are awarded for it.

Exhibit 1 JOHNSON & JOHNSON

The following "Credo" as published by Johnson & Johnson illustrates a
statement of a company's values and beliefs.

Summary
< CSR reflects how the firm sees itself in the context of society and its environment.
< Gray et al.'s framework explains how an organisation interacts with society and identifies
seven classifications ranging from a highly individualistic (human-centred) philosophy
focused on maximising shareholder wealth to a communitarian (Earth-centred) philosophy
focused on green, ecological priorities.
< Ethical stance is the extent to which an organisation exceeds its minimum obligations to
stakeholders. JS&W rank business moral objectives into four levels:
1. short-term shareholder interests;
2. long-term shareholder interests;
3. multiple stakeholder obligations; and
4. the firm being a shaper of society.
< General criteria for individual ethical stances (Crane et al.) include age and gender, national
culture, education and employment, locus of control, moral imagination, and cognitive moral
development.
< Situation influences on ethical stance include:
the nature and perception of the issue; and
the expectations, rewards and punishments associated with outcomes from the
issue (context).
< Organisational culture consists of values, beliefs, behaviours and assumptions.
< Carroll's pyramid of corporate social responsibility proposes that the firm must first
be profitable (economic), play by the rules (legal), avoid harm (ethical), and then can
contribute resources to the community (philanthropic).
< Corporate responses to social and environmental pressures take place along a continuum
from obstructive, to obligative, to response and finally to contributive.
< Corporate culture concerns the way in which individuals behave within an organisation and
are influenced by:
stories exchanged and told to new employees;
corporate symbols;
the power structure;
the organisational structure; and
control systems.
< Corporate culture establishes a template for dealing with customers, other companies, the
public, government and the environment.
< Schein's framework establishes artefacts, espoused values and basic underlying
assumptions as the basis for corporate culture.

Session 16
Session 16 Quiz
1. Explain the difference between a social ecologist and a pristine capitalist. (1.2)
2. State the FOUR levels of ethical stance according to Johnson and Scholes. (2.2)
3. Explain the concept of "moral intensity". (3.2.1)
4. Define corporate culture. (4.4)
Study Question Bank

Q23 Ethical Dilemmas 20 minutes
Additional
Q22 Responsibility
to be Ethical
Q24 Prominent Football Club

EXAMPLE SOLUTIONS
Solution 1Pristine Capitalists

The dominant view in accounting, finance and economic performance
in which the only responsibility of the corporation is to make money
for shareholders. Thus:
Economic performance is the only legitimate goal.
Individual self-interest takes precedence over benefits to society.
Shareholders can expect maximum returns.
Market economy is a good.
There are no real future environmental problems since humans and
technology are infinitely adaptable and solutions will be found in the
market economy.
Any claim upon the organisation which would threaten the optimal
profitability of the organisation is viewed as morally unacceptable as it
would be an effective theft of shareholder wealth.
May be described as "the business of business is business"
(Milton Friedman).
Solution 2Contaminated Product

In tackling this situation, J&J:
immediately launched a public relations program;
alerted consumers nationwide, via the media, not to consume any
Tylenol product;
stopped production and advertising of Tylenol;
recalled all Tylenol capsules from the market (estimated retail
value $100m);
established relations with the police, the FBI and other agencies to
participate in finding the perpetrator;
offered a $100,000 reward; and
researched and developed tamper-proof packaging.
Not only did Tylenol regain its market position when it was
reintroduced, but J&J became the market leader in such packaging.
Perhaps this was not surprising given J&J's "Credo" (Exhibit 1), which
was written in 1943 (many years before the concept of stakeholder
was first developed) and stated that its primary responsibilities were
to its customers, employees, communities and then shareholders, in
that order.*
*J&J's top management put customer safety first, which was unusual
for a large corporation. In similar cases companies which put their
profits first did more damage to their reputations than if they had
immediately assumed responsibility for the crisis. For example, when
traces of benzene were found in Source Perrier bottled water, the
company claimed an isolated incident and announced a limited recall
in North America. When benzene was then found in bottles in Europe,
a world-wide recall was necessary. The company suffered harsh
media criticism for its lack of integrity and disregard for public safety.

Solution 3Misconduct by Employee*
Arguments for
Failure to dismiss the trainee may condone misconduct (which is
clearly unacceptable). Unethical conduct must be discouraged.
With dismissal established as the "template", trainees should have no
doubts regarding the organisation's ethical stance or that they would
be similarly treated.
It would be damaging to the organisation's reputation if its
customers/clients were to become aware of a lack of integrity in
its staff.
The story may be better remembered if action is swift and decisive.
Even if, in the shorter term, there are staffing problems, it will be
better for the longer-term to have instances of misconduct eradicated.
Arguments against
The trainee may be "punished" or "made an example of" in some
other way. For example, the trainee may have his attempts at *Note that the
examinations deferred pending legal and disciplinary procedures organisation does
(a process which may take years). not have to be an
The trainee may be "reformed" and the organisation appears accountancy practice
compassionate for having retained the employee.* but could be any
The continuing presence of the employee will be a constant reminder company with ACCA
to others. trainees.

Session 17
Professions and
the Public Interest
FOCUS

3. Professions and the public interest
a) Explain and explore the nature of a "profession" and "professionalism".
b) Describe and assess what is meant by "the public interest".
c) Describe the role of, and assess the widespread influence of, accounting as
a profession in the organisational context.
d) Analyse the role of accounting as a profession in society.
e) Recognise accounting's role as a value-laden profession capable of
influencing the distribution of power and wealth in society.
f) Describe and critically evaluate issues surrounding accounting and acting
against the public interest.
Session 17 Guidance
Understand the requirements and privileges of a profession (s.1) and the attributes of professionalism
(s.1.3).
Recognise the importance of serving the public interest (s.2), based on the accounting profession's
importance to society (s.3).

VISUAL OVERVIEW
Objective: To explain professions, professionalism, accounting as a profession and an
accountant's role in society.
"PROFESSION" V "PROFESSIONALISM"
Profession
Characteristics
Professionalism
PUBLIC INTEREST ROLE AND INFLUENCE

IFAC Mission Within Society
Oversight Boards Within Organisations
Professional Accountant Value-Laden Profession
PUBLIC INTEREST ISSUES

Bottom Line
Social and Political Impact
Profits Before Ethics?
Public Interest Conflict
of Interest?
Sub-prime Crisis
Session 17 Guidance
Know why accounting may be considered a "value-laden" discipline (s.3.3) and the importance of
that as it relates to public interest.
Understand the public interest issues inherent in accounting scandals (s.4.2) and their impact on
the profession.

Session 17 Professions and the Public Interest P1 Governance, Risk and Ethics
1 "Profession" v "Professionalism"
1.1 Profession
Profession *Inherent in the

The body of people in a learned occupation. last definition is the
concept that social
An occupation, vocation or career requiring specialised knowledge
responsibilities should
and extensive training that usually has a professional association,
take precedence over
ethical code and process of certification or licensing.
other considerations.
A disciplined group of individuals who adhere to high ethical
standards and uphold themselves to, and are accepted by, the
public as possessing special knowledge and skills in a widely
recognised, organised body of learning derived from a high-level
education and training, and who are prepared to exercise this
knowledge and these skills in the interest of others.*
The oldest recorded use of the word "profession", meaning

"avowal or expression of purpose", implied religious and moral
motives to dedicate oneself to good end.
By the 16th century, "profession" had been extended from its
original religious connection and was used for all three of the
high-status, university-educated occupations of divinity, law
and medicine.
All three professions were concerned with the well-being of
individuals who were obliged to put their trust in members of
these occupations if they wished to consult with them. The
requirement of trust led to the development of ethical standards
and a commitment to provide a service for the public good.
The industrial revolution created new skilled occupations
(e.g. actuary and engineer). Thus the modern concept of
"a profession" began to evolve.
Examples of modern professions include:
Health relateddoctors, dentists, physiotherapists,
psychiatrists, pharmacists.
Non-health relatedarchitects, engineers, veterinarians,
surveyors, lawyers, accountants and teachers.
1.2 Characteristics
There have been many attempts to define a profession
through its characteristics of:
expertiseincluding specialised knowledge and skill;
responsibilityto perform a service that is essential to
society; and
corporatenessa collective sense of unity that originates
from the lengthy discipline and training necessary for
professional competence, the common bond of work and
the sharing of a social responsibility. This sets professional
members apart from laymen.

P1 Governance, Risk and Ethics Session 17 Professions and the Public Interest
Another model specifies six characteristics:

an intellectual technique;
an application of that technique;
a long period of training;
an association of members;
enforced standards and a statement of ethics; and
a body of intellectual theory.
Although more than 20 elements have been defined, two

characteristics are essential:
1. Prolonged specialist training in a body of abstract knowledge.
2. Service orientation.
In the accounting profession the body of theory includes:
accounting standards (e.g. International Financial Reporting
Standards);
auditing standards (e.g. International Standards on
Auditing); and
ethical standards (e.g. IFAC Code of Ethics).
The International Federation of Accountants (IFAC)
distinguishes a profession by characteristics including:
mastery of a particular intellectual skill, acquired by initial
training and then lifelong continuous education;
adherence by its members to a common code of values and
conduct established by its administrating body, including
maintaining an outlook which is essentially objective; and
acceptance of a duty to society as a whole (usually in
return for restrictions in use of a title or in the granting of
a qualification).*
*In the UK, the professional bodies of accountants (e.g. ACCA, ICAEW,
ICAS, ICAI, CIMA) have been lobbying the government for many
years to reserve the word "accountant" for use only by professionally
qualified accountants. At present, anyone can set themselves up in
business and use the word "accountant" (e.g. a turf accountant is a
bookmaker, traditionally taking bets on horses raced on turf). Only
members of professional bodies which have received their designation
may refer to themselves as being "chartered accountants". (The "C"
in the initials of the bodies above stands for "chartered".)
1.3 Professionalism
According to the IFAC Code of Ethics for Professional
Accountants (see Session 18), the objectives of the
accountancy profession are:
to work to the highest standards of professionalism;
to attain the highest levels of performance; and
generally to meet the public interest requirement.

These objectives require the accountancy profession to meet

four basic needs:
1. Credibilitysociety needs credibility in information and
information systems.
2. Professionalismindividuals need to be clearly
identifiable by clients, employers and other interested
parties as professional persons in the accountancy field.
3. Quality of Servicesthere is a need for assurance that
all services obtained from a professional accountant are
carried out to the highest standards of performance.
4. Confidenceusers of the services of professional
accountants should be able to have confidence that the
accountant is governed by a framework of professional
ethics.
The key underpinning concepts of corporate governance
(Session 1), together with competence, could be considered
key underpinning concepts of professionalism:
Fairness
Openness and
Reputation Transparency
Innovation
Integrity
CORPORATE GOVERNANCE
Judgement KEY UNDERPINNING Scepticism
CONCEPTS
Accountability Independence
Responsibility Probity and Honesty
2 Public Interest
Public interest"The collective well-being of the community of

people and institutions the professional accountant serves."
IFAC (2003)
2.1 IFAC Mission

A distinguishing characteristic of a profession is acceptance of
its responsibility to the public. The accountancy profession's
"public" consists of:
clients;
governments;
employers and employees;
investors and lenders;
the business and financial community; and

others who rely on professional accountants to maintain the

orderly functioning of commerce.
The difficulty in defining "public interest" is that there is no
one objective or legal definition. It is subjective and can mean
different things to different groups of people.
It has often been used as an excuse to cross the boundary
between private matters and public interest (e.g. publishing
photographs of famous people in private situations on the
basis that they have no right to a private life because they
always seek publicity and therefore everything they do is
"in the public eye" and of public interest).
Politicians and governments are significant users of the phrase
"in the public interest", but many would cynically suggest that
this really means "in our own interests".
Exhibit 1 IFAC CONSTITUTION

(2010) *The term "public
The following extract taken from IFAC's mission demonstrates its interest" is no longer
mission to serve the public interest by:* defined in IFAC's Code
of Ethics (2010),
although it specifically
Contributing to the development, adoption and implementation
addresses "Public
of high-quality international standards and guidance;
Interest Entities".
Contributing to the development of strong professional
accountancy organizations and accounting firms;
Promoting high-quality practices by professional accountants
worldwide; and
Speaking out on public interest issues where the accountancy
profession's expertise is most relevant.
Illustration 1 British Broadcasting

CorporationEditorial
Guidelines
The following language is from the BBC's editorial guidelines. Note
that even here, the meaning of "people" and "public importance"
can be questioned:
There is no single definition of public interest, it includes but is not
confined to:
exposing or detecting crime;
exposing significantly anti-social behaviour;
exposing corruption or injustice;
disclosing significant incompetence or negligence;
protecting people's health and safety;
preventing people from being misled by some statement or
action of an individual or organisation;
disclosing information that allows people to make a significantly
more informed decision about matters of public importance.
There is also a public interest in freedom of expression itself.
When considering what is in the public interest we also need to
take account of information already in the public domain or about
to become available .

Illustration 2 Bernard Madoff
Madoff Scandal, 2008

Bernard Madoff ran an investment company that was effectively a
pyramid (Ponzi) scheme. At the time of its collapse in December
2008, it was estimated that some $50 billion had been lost, making
it the world's largest fraud (so far).
Investigators have noted that a number of European banks
had refused to invest with Madoff, after carrying out their own
due diligence, as they were unable to "reverse engineer" his
investments (i.e. understand how he was able to pay out the high
returns he was making and claiming). They did not, however,
consider reporting their concerns to the authorities as they were
not required to do so and considered it a private matter concerning
their individual clients and therefore not a "public interest" matter.
Ironically, the US Securities and Exchange Commission, which
regulated Madoff, failed to follow through on a number of
complaints from Madoff investors. The earliest recorded complaint
found by investigators (so far) was made in 1999.
2.2 Public Interest Oversight Boards

2.2.1 IFAC
Following the various financial scandals of the 1990s, capped
by Enron, and the ensuing perceived loss of public confidence
in financial reporting, IFAC established an independent Public
Interest Oversight Board in 2005 (www.ipiob.org).
The PIOB was the result of a collaborative effort by the
international financial regulatory community, working with
IFAC, to ensure that auditing and assurance, ethics and
educational standards for the accounting profession were set
in a transparent manner that reflects the public interest.
To achieve this, the PIOB oversees IFAC's auditing and
assurance, ethics and education standard-setting activities as
well as its Member Body Compliance Program.
It was mutually recognised that high-quality, transparent
standard-setting processes with public and regulatory input,
together with regulatory monitoring and public interest
oversight, were necessary to enhance the quality of external
audits of entities.
The PIOB believes that it is in the "public interest":
To produce international standards that will cover all aspects
of the audit process and the education and conduct of those
engaged in preparing and auditing financial statements.
Thus, it must be recognised that not only the audit process
but the qualification and the behaviour of those who
conduct it are paramount in determining the quality of the
final outcome.
To produce standards of high quality, high clarity and usability.
That those who set the standards be committed to the
public interest, act independently of special or personal
interests and be agile and responsive to emerging needs of
standard users.

To promote compliance with IFAC standards by the member

bodies of IFAC around the world.
That the process of developing international standards is
open, transparent and responsive to the views and needs
of all who will use or will be subject to the standards.
The process must involve standard setters who are
knowledgeable, experienced and diverse.
As with the IASB, the due process and running of all
IFAC committees are now fully open to public input and
participation (e.g. by direct attendance at meetings, the
issue of discussion documents and exposure drafts for public
comment, access to all comments received and the basis of
conclusions).
2.2.2 Public Company Accounting Oversight Board (US)

The Public Company Accounting Oversight Board (PCAOB) is a
private, non-profit corporation created by the Sarbanes-Oxley
Act (2002), also known as SOX, to oversee the auditors of
public companies in the US.
PCAOB was created to protect investors and the public interest
by promoting informative, fair and independent audit reports.
It operates through four stages:
1. Registration of auditing firms, requiring set standards to
be met.
2. Standard-setting relating to US auditing standards.
3. Inspection of registered audit firms, their procedures and
audit files.
4. Enforcement of SOX and the rules of the Board.
2.2.3 Audit Regulations (UK)

Following a number of financial scandals in the 1980s (Barlow
Clowes, Polly Peck and Maxwell), a full review of the statutory
audit process was undertaken by the government and the main
chartered accountancy bodies resulting in the issue of Audit
Regulations in the UK in 1991 (updated in 1995 and 2008).
Areas covered by the Regulations include:
Eligibility and application to become a registered auditor
Qualifications (entry requirements, training, post
qualification experience)
Conduct of audit work (application of auditing standards)
Compliance and monitoring (application of the Regulations
and reviews)
Regulatory action
Disciplinary procedures.*
*Many of the
professional
One of the key objectives of the review and of the Regulations accountancy firms
was to "maintain and enhance the reputation of registered complained that a
auditors with the public". heavy regulatory
The original Regulations allowed the various accountancy burden was being
placed on them"after
bodies to be both "judge and jury" (i.e. the process was
all, we are professional
self-regulating). Many commentators claimed that such an and should be trusted".
arrangement could not be in the "public interest" and that
there were far too many conflicts of interest.

2.2.4 Financial Reporting Council (FRC)

Originally established in 1990 as the issuing body for UK
auditing and accounting standards (previously undertaken by
the various accounting bodies).
In 2004, the UK government took the decision to strengthen
the regulatory system in the UK following the major corporate
collapses in the US.
This led to the FRC's role being extended to become the
single independent regulator of the accounting and auditing
profession"an effective, accountable and independent
regulator, operating in the public interest and actively helping
to shape UK, and to influence EU and global approaches to
corporate reporting and governance".
Responsibilities include:
The Professional Oversight Board (established in 2004)
provides statutory oversight of the regulation of the auditing
profession by the recognised supervisory and qualifying *Such that clients
bodies (e.g. the ACCA) and monitors the quality of the and employers
auditing function in relation to economically significant of professionally
(i.e. public interest) entities.* qualified accountants
and actuaries and
The Audit Quality Review Teamprovides compliance and
of accountancy and
monitoring reviews of all auditing firms that audit public actuarial firms can
interest (e.g. listed) entities. rely on them to act
The Accountancy and Actuarial Discipline Board (2004) with integrity and
provides independent investigative and disciplinary action in competence, having
cases involving public interest entities. regard to the public
interest.
The publication of the UK Corporate Governance Code and
the Turnbull guidance.
The publication of UK auditing standards and accounting
standards as well as the ethical standards for auditors.*
2.3 Professional Accountant

*UK auditing
Clearly a professional accountant's responsibility is not standards and ethical
exclusively to satisfy the needs of an individual client or standards for auditors
employer. The standards of the professional accountant are are basically the full
heavily determined by public interest, for example: IAASB standards
independent auditors help to maintain the integrity and with additional
efficiency of the financial statements presented to financial requirements added
for UK consumption.
institutions in support of loans and to stockholders for
raising capital;
financial executives serve in various financial management
capacities in organisations and contribute to the efficient
and effective use of resources;
internal auditors provide assurance about a sound internal
control system which enhances the reliability of the external
financial information of the employer;
tax experts help to establish confidence and efficiency in,
and the fair application of, the tax system; and
management consultants have a responsibility to advocate
sound management decision-making.
The accountancy profession's public relies on professional
accountants for sound financial accounting and reporting,
effective financial management and competent advice on a
variety of business and taxation matters.

The attitude and behaviour of professional accountants in

providing such services affect the economic well-being of their
community and country.
Illustration 3 Economic Importance
Research carried out by Abdolmohammadi and Tucker has shown that many factors may be
associated with economic growth in a given country or region. Their recent studies have shown
four elements to be of particular importance:
the legal system;
the banking system;
an active stock market; and
the development of strong accounting standards.
Countries with larger per capita numbers of accountants and auditors have greater wealth per
capita than those with smaller per capita numbers of accountants and auditors.
The research emphasizes the importance placed by society in such countries on the role of
professional accountants as well as the ability of professional accountants to influence and
generate economic growth for that country.*
*Research also has shown that in most financial crises, the banking
system appears to have played a major role in enhancing that crisis.
This is particularly true for the sub-prime and credit crunch ongoing
since 2007.
The global accountancy profession occupies an important

position in world tradeproviding the universal "language of
business" (the language of "triple bottom lines", "gearing" and
"payback") and at the same time acting as an independent
referee as to the truth and fairness of published financial
statements and the impartiality of public offer documents.
Professional accountants can remain in this advantageous
position only by continuing to provide the public with these
unique services at a level which demonstrates that the public
confidence is firmly founded.
It is in the best interest of the worldwide accountancy
profession to make known to users of the services provided
by professional accountants that they are executed at the
highest level of performance and in accordance with ethical
requirements.*
*With the various scandals of the 1980s (in the UK and the US) and
the 1990s (in the US) peaking with Enron, the accounting profession
worked extremely hard to regain the trust of society (e.g. UK
Corporate Governance Code, SOX, IFAC, FRC)only to be asked in
2008, "Where were the auditors?" in relation to the sub-prime crisis
and the credit crunch.

3 Role and Influence
Example 1 Roles
List the roles and positions held by professional accountants in industry, commerce and society.
Solution
3.1 Within Society

Central to the implicit bargain between the professions and
society is the exchange of privileges (e.g. self-regulation,
the control of training and membership and an effective
monopoly) in return for the trustworthy fulfilment of a role
that society recognises as valuable.
Society grants professions considerable autonomy. Because
professionals have specialised knowledge, they are judged
fit to set appropriate standards of conduct and control their
own behaviour. This unwritten "social contract" (between
society and the profession) imposes special responsibilities
on professions.
3.1.1 Examples of Responsibilities on a Profession

To keep the public's interest foremost in their priorities.
To avoid conflicts of interest.
To enforce its work and ethical standards in meeting the
expectations of society.
To act responsibly in the public interest and proactively
address problems in its area of professional expertise.
To thoroughly and fairly investigate all complaints about the
behaviour of its members.
To take whatever corrective actions are needed (or recommend
corrective actions) for situations that are outside its control.
3.1.2 Specific Roles Within Society

External to their roles in private businesses and organisations,
many professional accountants use their integrity, objectivity
and ethical stances to "pay back" society for the opportunities
that society has given them (e.g. university education,
professional training, monopoly occupation and a good
standard of living, if not high wealth).

External to their business interests, professional accountants

(as well as other professionals) can be found in various NGO
and not-for-profit organisations, providing their business,
auditing, taxation, analytical, managerial and leadership skills
for no fee.
Illustration 4 Giving Back
Founded in 1917, Lions Clubs International has provided millions

of people with the opportunity to give something back to their
communities.
"Lions are an international network of 1.3 million men and women in
205 countries and geographic areas who work together to answer the
needs that challenge communities around the world," according to the
organisation's website, www.lionsclubs.org.
Lions organises a huge variety of fundraising activities to support
projects which are important to their communities (e.g. conducting
vision and health screenings, building children's play parks,
supporting eye and cancer hospitals and orphanages, awarding
education scholarships, assisting youth programs and providing help
in time of disaster).
3.1.3 Public Sector Within Society

Many professional accountants work in the public sector and
therefore have a direct connection to serving the public interest.
In the UK, although many professional accountants (e.g.
ACCA) work in the public sector, the Chartered Institute of
Public Finance and Accounting (CIPFA) is the only professional
body that specialises in the public sector.
CIPFA has responsibility for setting accounting and auditing
standards for a significant part of the economy, namely local
and national government, and therefore has a direct public
interest. Such standards will be followed by all professional
accountants working in the public sector, regardless of
qualification, to ensure the appropriate raising, management,
use, security and accounting of public money.
As with the private sector in the UK, internal auditors play
a key public interest role throughout local and national
government, as does the National Audit Office (NAO).
Exhibit 2 NATIONAL AUDIT OFFICE

The following excerpt is from the National Audit Office website, www.nao.org.uk:
The NAO audits the accounts of all central government departments and agencies,
as well as a wide range of other public bodies, and reports to Parliament on the
economy, efficiency and effectiveness with which they have used public money.
Our work saves the taxpayer millions of pounds every year.
We hold government to account for the way it uses public money.
We support, by helping public service managers improve performance.
We safeguard the interests of citizens who as taxpayers are responsible for
paying for public services.
We champion the interests of citizens as users of public services.

3.1.4 Cultural Impact and Society

The concept of a "profession" is strongly embedded in an English
(Anglo-Saxon) context. In its most traditional form it is strongly
English (e.g. "the English gentleman's word is his bond") and
trust was the foundation of the professional's relationship with
society. With this background, professions in the UK (and its
former colonies such as Australia) have historically regulated
themselves with little government interference.
In Europe, professions have been much more subject to, and
have accepted, state regulation. Education, examination,
compliance, monitoring and discipline are also more directly
controlled through the state (society).
The US is rather a mixture. Individual states have historically
retained control with few nationally organised bodies reflecting
the state and federal systems (e.g. a CPA qualifying in New
York will have difficulty practising in California until satisfying
the California CPA requirements).
3.1.5 Impact From the Modernisation of Society

Initially, professions were based on traditional forms of
knowledge built around formal educational institutions.
Today's society places much more emphasis on a profession's
technical expertise and the ability to access huge resources of
knowledge through technical means (e.g. databases, Internet
and intranet).
The claim by professions that only they have the basis of
knowledge in which to operate is increasingly called into doubt
as such knowledge is, in theory, becoming open to all in the
"Internet society".*
*It is becoming increasingly common for individuals to challenge

their doctors about illnesses and necessary prescriptions because
they look up their symptoms on medical websites. Similarly,
individuals are able to prepare financial statements and cash flows
and prepare their own tax returns online without the help of a
professional.
If professional knowledge is based on technical, objective

detail, then expert systems can be used to codify it and make
it available to society. The professional effectively becomes
a technician. If the skill is 100% subjective judgement (e.g.
art critics and social workers) then professional rigour and the
claim to be called a profession are lost.
As societies have "modernised", a professional's ability to use
his judgement to achieve a better solution in non-standard
situations has become more critical.
Brint (1994) argues that there has been a shift from "trustee
professionalism", where the professional claims to serve an
objective public good, to "expert professionalism", where
the professional sells expertise to serve the client's ends,
regardless of the effect on society.

Illustration 5 Tax Avoidance or

Tax Evasion?
Many professional firms in the UK and the US have devised and

sold tax saving schemes to their clients which were later deemed,
by tax authorities, to be unlawful. In one case, regarding the
banking crisis, the scheme was described as "one of the most
blatantly abusive avoidance scams of recent years" [Professor
Prem Sikka in written evidence to the UK House of Commons
Treasury Committee on the Banking Crisis (2009)].
The difference between tax avoidance (legal) and tax evasion
(illegal) has, over recent years, become blurred by many of the
schemes devised by tax professionals. The view of the UK tax
authorities is that it is in the public interest that every member
of society should be expected to pay their fair share of taxation.
In not doing so, they deprive society of essential funding. They
have declared that tax avoidance schemes with no relation to
commercial reality will be challenged in a court of law.
3.2 Within Organisations and Businesses

A key element in protecting the public interest is ensuring that
accurate and consistent financial information is made available
to an organisation's internal and external stakeholders.
For example:
Managers need relevant and reliable information on which to
make decisions (strategic and operational) and to assess the
value of the assets and liabilities held by the organisation.
Shareholders need such information for investment
decisions (to hold, sell or for new investments) and to judge
the performance of the managers.
Governments need relevant information to assess taxation
liabilities, and to prepare and forecast economic data.
Providers of finance (e.g. banks, trade creditors) need to be
able to rely on the historic, current and projected financial
information produced by organisations to support their
decisions on the terms and conditions of the loans made.
Users of information (or assertions made about information)
from any source may need assurance that they can (within
certain limits) rely on it (e.g. electronic commerce, the
security of a website, systems reliability, due diligence,
performance measures, lottery draws, ensuring that the
names of the Oscar winners are not made public before the
envelope is opened).
In organisations and businesses, professional accountants
will typically be found in the following functions (with the
functional heads often as board directors):
management and cost accounting;
financial accounting;
internal auditors; or
taxation.

There are three common themes linking these functions

(although internal auditors do more):
producing numbers;
using professional skills to interpret and add value to the
numbers; and
using professional judgement and standards to formalise
the numbers.
The "footprint" of professional accountants in organisations
and businesses is therefore significant.
3.3 Value-Laden Profession

Value-laden statements make reference to something being
good or bad in some way, or are biased by someone's
judgement of what is good or bad. A value-laden fact or
datum has a special significance, importance or meaning
beyond its immediate value or information.* *The term "value-
laden" is not normally
Accountants, as a value-laden profession, are thus able to used outside of
take numbers and place special significance, importance and academic circles.
meaning beyond their immediate value as just numbers.
The way that the figures are used and presented by
accountants (e.g. in management accounts, financial
statements, prospectuses, proposals, budgets, cash flows,
variance analysis, asset valuations) often means that "the
whole is greater than the sum".
Based on accountants' reports and recommendations,
businesses can expand, contract, invest or disinvest with all
the positive or negative effects on stakeholders.
The availability and cost of capital committed to an economy
influence its development. In turn, capital relationships affect
the availability and costs of goods and services available and
accessible to fulfil human needs in an economy.
Accounting provides information that influences the behaviour
of people who:
Make decisions about capital. Capital availability and costs
are sensitive to perceived risks and alternative opportunities
for the employment of capital. Consequently, accounting
affects the social realisations in an economy.*
*Accounting information must be reliable if it is to assist investors

in assessing risk/return opportunities and allocating capital.
If information is too optimistic, too pessimistic or potentially
fraudulent, providers of capital will require a higher return as
compensation for greater perceived risk. Thus poor information
increases the cost of capital.

Use information in a company to make decisions about

product development, investment in assets, the operations
of assets and other decisions related to the supply of
products and services that fulfil customer need.*
*The use of a "full-cost model" (e.g. for inventory) includes arbitrary

allocations that may mislead decision-makers. For example, deciding
to cease production of products which make a positive contribution
or submitting unattractive tenders. Thus management accounting
pays more attention to information that influences internal decision-
making processes.
Accountants therefore have a significant ability to influence the
distribution of power and wealth in society.
In making value-laden statements about accountants, some

considered this ability of accountants to be a good thing, and
others consider it to be bad.
The pristine-capitalist approach takes the view that in
producing and interpreting the numbers, accountants aim to
assist management in maximising shareholders' wealth.
Social ecologists, socialists and greens believe that traditional
accounting systems are significantly flawed and that economic,
social and political power and wealth should be redistributed.
4 Public Interest Issues
4.1 Bottom Line

Current accounting methodologies are based on pure
economic costs (e.g. raw materials, labour, overheads,
financing). The bottom line is thus an economic profit or loss.
With the development of corporate social reporting (CSR),
triple bottom line (3BL) reporting and the concept of people,
planet and profit (PPP), accountants are being required to
devise ways of providing assurance on the measures and
performance indicators used by entities in reporting social and
environmental issues.
The difficulty in doing so is that many of the metrics being
used are not easily measurable in quantifiable terms which
*The use of these
could be added to or subtracted from the economic bottom line
social accounting
to arrive at a final bottom line (the concept required by 3BL). measurements and
Also, in many cases, there is no one defined measurement disclosures (e.g. CSR,
criteria, so the comparability concept becomes far more 3BL, PPP) is discussed
subjective. This could lead to a decline in the public in later sessions.
confidence of such information.*

4.2 Social and Political Impact

Decision-making based on pure financial cost structures may
result in social and political consequences which, although not
initially measurable, result in a total cost far exceeding the
original costs.
It is not unknown for accountants to be used by governments
to prove a point or to justify an action.
Illustration 6 National Coal

Board
During the early 1980s, the UK's National Coal Board (NCB) carried
out a review into the profitability and viability of all coal mines in the
UK. As part of that review, Professor Edward Stamp (a senior figure
in the accounting profession) lead a working party of accountants
that had been asked by the NCB to review the accounting and
costing procedures used to determine the viability of pits.
The working party largely endorsed the principles used based on
"best accounting practice". Critiques of the report argued that
as an accountant, Stamp took no consideration of the social and
environmental consequences of the NCB closing down "unprofitable"
pits. He was only concerned with the figures and not with the
people. It was also argued that there was more than one political
choice that could have been justified from the NCB's data.
Others also claimed that the government had already decided that
pits were to close and had used the working party to provide a
cover of professional respectability for doing so.
4.3 Profits Before Ethics?

It has already been discussed that in the accountancy
profession, the professional accountant sells their expertise
to serve the client's ends, regardless of the effect on society.
Examples:
Numerous tax saving schemes devised by the major firms
have been effectively declared illegal by the US and UK tax
authorities.
Various violations of auditor independence rules in the US,
most relating to the holding of shares by partners in audit
clients. Many of the firms initially fined were found to have
continued breaching the independence rules and were
subsequently censored and fined again.
In 2000, Italian authorities fined a number of firms for
operating a cartel.
As well as the demise of Arthur Andersen (AA) following the
Enron scandal, the tax advisers to Enron were censored for
crafting various tax avoidance schemes used by Enron.
Despite AA's demise following the shredding of
documentation after an SEC order not to do so, a partner
in an international firm of accountants was jailed in 2005
because "he knowingly altered, destroyed and falsified
records with the intent to impede and obstruct an
investigation by the SEC".

In 2005, a global firm paid $42m in a settlement with US

authorities "to resolve allegations that it defrauded numerous
federal government agencies over a 13-year period".
Fines totalling $50m were made in 2005 against one firm
for improper professional conduct in the audit of a US client.
In September 2005, Japanese regulators arrested four
partners of the local associate of an international firm for
allegedly helping executives at an audit client to falsify
company accounts over a five-year period.
Two international firms settled claims in 2006 with US
authorities for falsifying travel reimbursements while
working on government assignments.
Exhibit 3 AUDITORS
The following excerpt is from Professor Prem Sikka, written evidence to the UK House
of Commons Treasury Committee on the Banking Crisis (2009):
Auditing firms are commercial enterprises and cannot afford to alienate their
paymasters. The basic auditing model requires one set of business entrepreneurs
(auditing firms) to regulate another (company directors). Neither party owes a
"duty of care" to any individual shareholder, creditor, employee, bank depositor or
borrower. Their success is measured by profits rather than anything they might do
for society, regulators or the state.
4.4 Public Interest Conflict of Interest?

During the 1980s and 1990s, the five largest accountancy
firms in the UK profited from the industry which grew out
of the private finance initiative (PFI) and public private
partnerships (PPPs).
The firms acted as auditors to both private and public
sectors but increasingly developed management consultancy,
which provided half of their profits. This raised concerns of
independence and potential conflicts of interest.
Much of the consultancy work was advising on privatisation
issues. At the same time, the Big Five had been at the heart
of government policy development on privatisation acting as
secondees to government departments; developing the value
for money ("VFM") tests used for PFI projects; and producing
reports for the government on the benefits of PFI and PPPs.*
*UNISON (the UK's largest public sector union) examined PFI

schemes where the Big Five acted as financial advisers. In 45 cases,
the adviser to the public sector was also the auditor to at least one of
the consortium members or bidders on the project.

4.5 Sub-prime Crisis
Illustration 7 New Century Financial Corporation
The insolvency examiner of NCFC, America's second largest sub-prime mortgage lender and the
first bank to crash under the sub-prime crisis, stated:
"The auditors bear responsibility, at a minimum, for suggesting accounting changes in the second
and third quarters of 2006 that were inconsistent with GAAP and for failing to detect the material
understatements The audit team acquiesced in NCFC's departures from prescribed accounting
methodologies and often resisted or ignored valid recommendations from specialists in their own
firm. At times, the engagement team acted more as advocates for NCFC, even when practices
were questioned by their firm specialists who had greater knowledge of relevant accounting
guidelines and industry practice. When one specialist persisted in objecting to a particular
accounting practice on the eve of NCFC's 2005 Form 10-K filingan objection that was well
founded and later led to a change in NCFC's practicethe lead engagement partner told him in
an e-mail: 'I am very disappointed we are still discussing this. As far as I am concerned we are
done. The client thinks we are done. All we are going to do is "piss everybody off." ' "*
US Bankruptcy Court, District of Delaware, 2008 report extract.
*Further press commentary has suggested that a key factor in the

partner's (lack of) action was his fear that if he forced NCFC to
revalue the sub-prime assets, or otherwise qualify the audit report,
the client and the fees would be lost.
Although this paints "a black picture", the remaining 99% of
the accounting profession's work (which is sound) does not
get mentioned as it was not newsworthyonly bad news sells
newspapers. However, it was enough to cast doubt among the public
about the trust they place on the profession.

Session 17
Summary
A profession requires specialised knowledge, extensive training and continuing education,
and is usually governed under the ethical code of a professional association that may also
grant certification to use an appropriate designation.
Professionalism concerns a practitioner's level of intellectual technique and its application
to the situation in the broader context of serving the public interest. The characteristics of
professionalism parallel those key underpinnings of corporate governance.
Public interest concerns the collective well-being of the community of people and institutions
served by professional accountants.
Accounting has an importance to society beyond simply satisfying the needs of an individual
client or employer, for example, to:
validate the distribution of invested capital;
contribute to efcient and effective use of capital;
ensure the reliability of external nancial information; and
establish the efciency and fair application of and condence in the tax system.
Accounting pronouncements may have a "value-laden" aspect which can:
affect the allocation of capital based on perceived risks and alternative opportunities;
cease non-economic production that has a positive societal contribution; and
be corrupted by politicians for their own ends.
The accounting profession has many examples in which accountants failed to address
the public interest, choosing instead to maintain engagements that created a conflict
of interests, falsifying results, and ignoring their clients' financial misrepresentations to
maintain audit business.

Session 17 Quiz
1. Define "profession" and state the characteristics of being a professional. (1)
2. Explain the concept of "corporateness". (1.2)
3. State the FOUR basic needs the accountancy profession is required to meet according to the
IFAC Code of Ethics. (1.3)
4. Explain the concept of "public interest". (2)
5. Describe the FOUR stages through which the PCAOB operates. (2.2.2)
6. List THREE stakeholders in an organisation and describe the way in which they use financial
information. (3.2)
7. Give TWO examples of "profits before ethics". (4.3)
Study Question Bank

Q25 Boleyn & Co. 40 minutes

EXAMPLE SOLUTION
Solution 1Roles
Entrepreneurs, CFO, CEO, NED, internal auditor, management accountant, cost accountant,
tax accountant, bursar (schools and universities).
Auditor, regulator, financial adviser, taxation adviser, forensic accountant/auditor, corporate

insolvency, business reconstruction, consultant.
Managers and agents (of the rich and (in)famous), project manager, risk manager, analyst,
programmer, trustee (e.g. health service, charities, pension schemes).
Private education (e.g. ATC tutors), public education (e.g. university).
Industry, commerce, banking, private sector, public sector, local government, national
government (including elected officials) armed forces, NGOs, not-for-profit sector.
Some that are (perhaps) odd-ball: professional footballers, cricketers, golfers, authors,
songwriters, rock and roll artists, DJs, actors, comedians, inventors, sports promoters,
mercenaries ("dogs of war").

Session 20
Integrated Reporting
and Sustainability
FOCUS
E. Professional Values, Ethics and Social

Responsibility
7. Integrated reporting and sustainability issues in the conduct
of business
a) Explain and assess the concept of integrated reporting and evaluate the
issues concerning accounting for sustainability (including the alternative
definitions of capital):
(i) Financial
(ii) Manufactured
(iii) Intellectual
(iv) Human
(v) Social and relationship
(vi) Natural
b) Describe and assess the social and environmental impacts that economic
activity can have (in terms of social and environmental "footprints" and
environmental reporting).
c) Describe the main features of internal management systems for
underpinning environmental and sustainability accounting such as EMAS
and ISO 14000.
d) Explain and assess the typical content elements and guiding principles
of an integrated report and discuss the usefulness of this information to
stakeholders.
e) Explain the nature of social and environmental audit and evaluate the
contribution it can make to the assurance of integrated reports.
Session 20 Guidance
Understand the "environmental footprint" (s.1.3) and "social footprint" (s.1.4) and how they
are measured.
Read the criteria for sustainability (s.2.2).
Comprehend the nature of and requirements for the Global Reporting Initiative (s.2.4).
Understand the purpose of the integrated reporting framework (s.3.2) and the different definitions of
capital (s.3.3).
Learn the guiding principles (s.3.5) and content elements (s.3.6) for an integrated report.
VISUAL OVERVIEW
Objective: To identify and explain the impact of integrated reporting and sustainability
issues in the context of business.
SOCIAL AND ENVIRONMENTAL

EFFECTS
Introduction
Economic Activity
Environmental Footprint
Social Impact Assessment
SUSTAINABILITY
Concept
Criteria for Sustainable
Development
Accounting for Sustainability
Global Reporting Initiative (GRI)
INTEGRATED REPORTING INTERNAL MANAGEMENT

SYSTEMS
IIRC
Management Systems
Integrated Framework
Standards
Definitions of Capital
ISO 14001
Integrated Report
Guiding Principles EMAS
Content Elements
Usefulness to Stakeholders
SOCIAL AND ENVIRONMENTAL

AUDIT
Report Format
Audit Approach
Impact on Integrated Reporting
Session 20 Guidance
Learn the main differences between ISO 14001 and EMAS (s.4.3 and s.4.4) on social and
environmental auditing (read the technical article Environmental Accounting and Reporting).
Search company websites (e.g. BP, BT, IKEA, Vodafone and The Body Shop) and review
sustainability, social and environmental reports. Pay particular attention to the form of assurance
reports. The best way to understand is to immerse yourself in the real thing (not Coca-Cola
interesting ethical issues there).

Session 20 Integrated Reporting and Sustainability P1 Governance, Risk and Ethics
1 Social and Environmental Effects
1.1 Introduction
< The social and environmental effects of economic activity
have risen towards the top of companies' board agendas
(e.g. when setting strategic and operational objectives,
corporate governance and risk management procedures)
as well as concentrating the minds of many stakeholders
(e.g. local communities, pressure groups).
< Measuring economic activity in pure economic terms has
always been the prime role of accountants. However, being a
"good corporate citizen" and accepting CSR require different
metrics, benchmarks and disclosures from those used in
traditional accounting.
< Key elements in managing and reporting social and
environmental issues include:
= environmental footprints;
= social footprints; and
= sustainability.
1.2 Economic Activity*
Economic activitythe production and distribution of goods *Economic activity

and services. has an important
influence on security
prices because of its
< In the production and distribution of goods and services, a interrelationship with
significant range of resources will be consumed (e.g. raw corporate profits,
materials, power, fuel, water, labour) with resultant outputs inflation, interest rates,
(e.g. products, waste, packaging, pollution). etc. At the national
< Some of these resources may be renewable (e.g. timber, solar level, one frequently
energy, wheat); others will not be renewable (e.g. oil, gas used measure of
economic activity is
and iron ore). Even if renewable, if a resource is over-used
gross domestic product
then its replacement will not match its use and the stocks will (GDP).
decline (e.g. fish).
Observable forms
< The products of economic activity may be consumed (e.g. food, of economic activity
fuel, electricity) or used and then "thrown away" (e.g. white include money,
goods, electronics, motor vehicles, ACCA materials). consumption,
< Although most products may be recyclable (e.g. 98% of the preferences, buying,
metal used in modern vehicles is recyclable), the amount of selling and prices.
recycling is heavily dependent on the economics of recovering
and on legal requirements in individual countries (e.g. by
2015, 95% of vehicles that reach the end of their life in the EU
must be reused or recovered).

P1 Governance, Risk and Ethics Session 20 Integrated Reporting and Sustainability
1.3 Environmental Footprint (EF)*
Environmental footprint"The impact of an organisation in *The environmental

environmental terms (resource use, waste generation, physical footprint is also
environmental changes, etc)." referred to as the
A measure of human demand against earth's supply of resources. "ecological footprint".
< For an industrial setting, the company's environmental

impact is determined by the amount of depletable raw
materials and non-renewable resources it consumes to
make its products and the quantity of wastes and emissions
generated in the process.
< Traditionally, for a company to grow, the environmental
footprint ("EF") usually had to get larger. The development
of new technologies and the use of sustainable and recycled
materials, however, has resulted in many companies being
able to contain or reduce their EF as they grow.
< As economies grow, populations increase and lifestyles
mature, and demand for products and services increases.
For mature companies, if the incremental increase in demand
outweighs the unit reduction to their EF, the net EF will grow.
The EF of new companies, however, adds directly to the total
EF of the industry and country in which they operate.
1.3.1 Environmental Impact Issues*

< Air pollution and qualityairborne pollutant emissions and
nuisance from odours.
< Water qualityavailability of water supply, its rational supply
and use, and pollutant emissions to water. *In broad terms
these can be classified
< Soil protectionsoil erosion, pollution and contamination, between consumption
"land take" (i.e. the total area of land needed for a building issues (i.e. taking
or development). from the environment)
< Climate change: or emission issues
(i.e. producing and
= emissions and concentrations of greenhouse gas ("GhG");
discharging into the
= ozone depletion; environment).
= effects of climate change.
< Noisenoise emissions, noise nuisance and damage from noise.

< Land and resource usedepletion of non-renewable resources
and rational use of natural resources.
< Biodiversityprotection of endangered species and ecologically
sensitive areas.
< Natural/cultural heritageprotection and conservation of
natural/cultural assets.
< Waste managementwaste production/disposal and nuisances
from waste.
< Environmental risksprobability and magnitude.
< Human safety and health.

Illustration 1 A Decision on a
Transport Project
As well as considering the need for fast, safe and efficient
transportation, decision-makers in the current business and
economic environment must take account of the costs of eliminating
or minimising adverse effects such as:
air, noise and water pollution;
destruction or disruption of man-made and natural resources;
community cohesion and the availability of public facilities
and services;
adverse employment effects;
losses to property values;
injurious displacement of people, businesses and farms; and
disruption of desirable community and regional growth.
1.3.2 Measuring EF
< EF may be summarised by the equivalent area of land needed
to assimilate the impact. The normalised measure of land is
called "global hectares" (gha).
< The EF therefore measures the extent to which nature's
resources are being used, and can be used to calculate how EF is not a complete
sustainability
much faster resources are used than they can regenerate.
measure.
*Although EF reflects an ecological outcome it does not, for example,

include any measure of social well-being. Comparing the footprint
of a particular measurement segment against that segment's bio-
productive capacity allows determination of whether the group is a
net user or provider of resources.
Illustration 2 Environmental
Footprint
Carbon dioxide emissions in the United Arab Emirates account for
almost 8 of the 9.5 gha per person the country uses. (A sustainable
"earthshare" is estimated to be 1.7 gha.)

< A country's EF is determined by:*

= its population;
= the amount consumed by its average resident; and
= the resource intensity used in providing the goods and
services consumed.
< For organisations, categories of operational impact include:
= paper usage;
= energy usage (e.g. electricity and gas);
= transportation (e.g. commuter travel, fleet operations
(diesel), air travel);
= buildings; and
= water.
*The World Wildlife Fund (WWF) has developed an Ecological

Footprint (see http://footprint.wwf.org.uk/) which, through a series
of questions, allows individuals to broadly calculate their own
ecological and carbon footprints.
The 2012 WWF Living Planet report estimated that the Ecological
Footprint (the amount of biologically productive land and water
required to meet the demand for food, timber and shelter and absorb
pollution from economic activity) was 50% more than the actual
bio-capacity available in the world (compared with 30% excess
estimated in 2008).
Further footprint calculators can be found online (e.g. carbon
footprint questionnaire at www.carbonfootprint.com).

Example 1 Mitigating Strategies
Consider the following activities and environmental impacts of a banking operation.

Required:
For each activity suggest TWO strategies to mitigate impacts.
Paper usage: Office/copy paper; bank statements; direct mail; marketing; forms;
financial paper; ATM envelopes and receipts.
Solution
1.
2.
Energy usage: Building heating and air conditioning; lighting; powering

computers, servers, monitors.
1.
2.
Transportation: Employee commuter travel; business travel (air and ground);

couriering (including armoured transport).
1.
2.
Buildings: Building construction; procurement of materials; carpet, furniture

and office equipment (manufacturing/distribution).
1.
2.
Water usage: Water usage and sewer usage.

1.
2.

1.4 Social Impact Assessment
Social impact assessment"Social impact assessment includes

the processes of analyzing, monitoring and managing the intended
and unintended social consequences ... of planned interventions
(policies, programs, plans, projects) and any social change
processes invoked by those interventions. Its primary purpose is
to bring about a more sustainable and equitable biophysical and
human environment."
International Association for Impact Assessment
"The Social Footprint Method (SFM) is an approach to measurement
and reporting that quantifies the social sustainability performance of
an organisation."
Center for Sustainable Organisations
< Although SIA is often conducted as a compliance process for

government approvals many resource developers voluntarily
undertake SIA to understand better their Social Footprint (SF)
and respond to societal expectations.
< Unlike the EF, which measures an entity's use of, and impact
on, natural capital, the SF deals with impacts on people and
communities, measured through the concept of using "anthro
capital" (capital created by people).
< Unlike the EF, the SF can be increased; a greater investment
can be made in each area of the SF to increase the capital
available.*
< Anthro capital, which underlines the well-being of people,
comprises three elements: *Increasing the
school leaving age
= Human capital (e.g. personal health, knowledge, skills,
and providing greater
experience, human rights, ethical entitlements); skills training (SF
= Social capital (e.g. social networks, cohesion, shared investment) helps to
interests, mutually held knowledge, democratic activities, ensure that a well-
goodwill, social intercourse); and educated workforce is
available for economic
= Constructed capital (e.g. physical infrastructures, roads,
development (capital
utilities built by people). increase).
< As with CSR, there is a broad spectrum of views on the
concept of SF and who holds what responsibilities. At one
end, the view is that governments are responsible for society
and should thus ensure appropriate levels of anthro capital
are available.
< However, at some stage along the spectrum, organisational
demands on anthro capital may be such that governments
will not or cannot sustain the needs of organisations. At that
stage, the organisation may become a net benefactor to the
anthro capital of society.* *In most developing
nations, the SF of an
< Also, an organisation's CSR philosophy may include a post-
organisation can be
conventional, normative approach to its effect on employees, substantial because
the community and society, regardless of the government's of lax governmental
support of anthro capital. regulations and
involvement.

1.4.1 Social Impact Issues
< Human rights = Equality of opportunity and entitlement;

= Compatibility with the fundamental
rights.
< Social cohesion = Social exclusion and risks of poverty.
< Economic = Disparitiesbetween incomes, groups of
cohesion consumers, citizens, workers, etc.
< Employment = Opportunities (job creation, enterprise
creation) and quality of employment
and of the working environment.
< Human capital = Educational achievements in the
formation population;
= Training and lifelong learning
opportunities;
= Skills and learning capability.
< Public health = Health of the population;

and safety = Safety risks;
= Nutrition, food quality and safety.
< Social protection = Accessibility to health services and

and social their long-term sustainability.
services
< Liveable = Quality of housing, infrastructures,
communities services and the living environment.
< Culture = Preserving cultural diversity and
heritage, increasing integration.
< Consumer = Improving consumer information and
interests choice and reducing consumers' risks.
< Security = Crime prevention and protection
against terrorism;
= Protection of networks and
infrastructures; and
= Integration of systems and services.
< Governance = Participation and social capital

formation (through increased
accountability, democracy, citizens and
stakeholders' empowerment, etc).

1.4.2 Interactions
< Although social and environmental impact issues have been
separately identified previously, it can be argued that they
should not be analysed separately because of the multiple
interactions between them because:
= economic impacts increasingly include the monetary value
of social and environmental costs and benefits;
= reaping environmental benefits is often conditional upon the
achievement of social changes; and
= socio-economic conditions influence environmental
awareness and the subsequent level of diffusion of
environmentally friendly technologies.
Example 2 Traffic Reduction Measures

Suggest measures to reduce traffic in a capital city.
Solution
Illustration 3 Linking ES and SF
The Center for Sustainable Innovation www.sustainableorganizations.org

is carrying out research on how an organisation's EF and SF can be linked
in the area of climate change. The aim is to devise a metric that yields
"quantitative measures of the social sustainability of behaviorscollective
organisational behaviors, in particular".
In other words, the social footprint should look not only at whether an
organisation's efforts to reduce its greenhouse gas emissions (currently
measured in terms of weight produced per year) are merely worthy or
exemplary, but whether they are sufficient to solve the problem (e.g.
measured in terms of amount per employee, per person within a
measurable area and compared with a sustainable benchmark per person).

2 Sustainability
2.1 The Concept*
Sustainable development:
< " not a fixed state of harmony, but rather a process of change in
which the exploitation of resources, the direction of investments,
the orientation of technological development and institutional
change are made consistent with future as well as present needs.
"Development that meets the needs of the present without
compromising the ability of future generations to meet their
own needs."
Bruntland report to the World Commission
on Environment and Development, 1987
< "Improving the quality of human life while living within the
carrying capacity of supporting ecosystems."
World Wildlife Fund, 1991
*The "needs of the present" include the provision of economic,

social and environmental benefits. New development should be
judged against criteria (e.g. public transport, affordable housing and
avoidance of long commutes). Unsustainable development includes
environmentally destructive features (e.g. traffic pollution) or uses of
non-replaceable energy (e.g. oil).
< The concept of sustainability can be considered from several

viewpoints. For example:
= Sustainable for whom and what: humans, animals, natural
resources, developed nations, developing nations?
= Sustainable in what way: ecological focus or social focus,
needs or wants, current status quo or change?
= Sustainable for how long: definite, indefinite, infinite?
= Sustainable at what cost: economic, generation,
preservation, substitution?
2.2 Criteria for Sustainable Development

< Using or adapting existing facilities, rather than building
"from scratch".
< Financial viability.
< Environmentally friendly, in building and design.
< Minimisation of adverse effects on nearby residents.
< Protection of native vegetation (e.g. forests, wetlands, fauna).
< Constructed on "brownfield sites" (i.e. those previously
used as industrial/commercial sites)leaving "greenfield"
(i.e. undeveloped) land untouched.
< Inclusion of effective public transport system for accessibility.
< Minimisation of waste with recycling encouraged.

< Minimisation of energy use (e.g. using solar power) and

avoiding high energy usage systems (e.g. air conditioning).
< Minimisation of water use (e.g. recycling of storm water and
sewage for irrigation).
< Inclusive benefit (i.e. across all communities including
minorities, disabled groups, etc). Allowing low-income groups
to benefit. Affordable housing for all.
< Minimisation of pollution (or cleaning up if it exists).
2.3 Accounting for Sustainability*

Examples of frameworks for sustainability reporting, include:
< Triple Bottom Line reporting; and
< Balanced Scorecard methodologies.
*The most recent
2.3.1 Triple Bottom Line Reporting ("TBL" or "3BL")
development in this
< The phrase was coined by John Elkington, co-founder of area is integrated
the business consultancy SustainAbility. It is an expanded reporting (see s.3).
baseline for measuring performance.
< Triple Bottom Line accounting attempts to measure and
report corporate performance against economic, social and
environmental benchmarks in order to show improvement or
to make more in-depth evaluation.*
< It can be viewed as:
= a reporting device (e.g. information presented in annual
reports); and/or *Adding governance
= an approach to improving decision-making and the to the bottom line
activities of organisations (e.g. by providing tools and gives rise to the
frameworks for considering the economic, environmental "Quadruple Bottom
and social implications of decisions, products, operations Line" approach.
and future plans).
Advantages Disadvantages
Makes transparent the organisation's There are currently few standards for
decisions that explicitly consider effects measuring these effects.
on the environment and people, as well Usefulness and comparability, as there
as on financial capital. is a significant range of disclosure
More informed decision-making as (content and quality).
decision-makers can quantify trade- The difference between the economic
offs between different aspects of bottom line and the financial bottom line
sustainability. is often blurred.
Improved relationships with key Increase in annual reporting costs
stakeholders and improved risk- with disproportionate costs for smaller
management through consultation. entities.
Specific commercial advantages (e.g. Potential exposure to risk and liability
competitive advantage with customers relating to the reliability of the report's
suppliers and providers of finance). content (unless audit is mandatory).
Enhancement of reputation and brand. Potential bias in voluntary presentation
May result in attracting and retaining (e.g. including only favourable
employees with sustainable values. information).

INDICATORS OF IMPACT
ECONOMIC SOCIAL ENVIRONMENTAL

Gross operating Health and safety Ecological or carbon
surplus records footprint
Dependence on Tax contributions Emissions to soil,
imports Employment water and air
Stimulus to domestic Water and energy
economy (local use
purchasing)
< Such indicators can distil complex information into a form

that is accessible to stakeholders. (Organisations report on
indicators that reflect their objectives and are relevant to
stakeholders.)
< One difficulty in identifying and using indicators is consistency
in an organisation, over time and between organisations at
any point in time (important for benchmarking).
2.3.2 Balanced Scorecard Methodologies

< The balanced scorecard was developed by Kaplan and Norton
(1996/97) to improve established performance measurement
systems, which are focused mainly on financial performance
and conventional physical and tangible assets.*
< As a broader approach, it also takes into account customers,
processes and organisational learning. It incorporates the value
of intangible and intellectual assets (e.g. high-quality products,
motivated employees, and satisfied and loyal customers).
< It complements financial measures of past performance
with measures of the drivers of future performance. The
objectives and measures of the scorecard are derived from
the organisation's vision and strategy.
*The term "balanced" refers to a balance between external measures

(for shareholders and customers) and internal measures (of critical
business processes, innovation and learning and growth). The
measures are balanced between the outcome measures (the results
from past efforts) and the measures that drive future performance.
The scorecard is balanced between objective, easily quantified
outcome measures and subjective, somewhat judgemental,
performance drivers of the outcome measures.

< There are four key perspectives:
FINANCIAL CUSTOMER
PERSPECTIVE PERSPECTIVE
Measures the ultimate results Focuses on customer needs and
provided to shareholders satisfaction as well as market share
INTERNAL ORGANISATION
PERSPECTIVE LEARNING
Focuses attention on the Directs attention to the basis of all
performance of the key internal future successthe organisation's
processes that drive the business people and infrastructure
< The balanced scorecard can incorporate sustainability issues in

different ways:
= restructuring the existing perspectives (i.e. incorporating
all sustainability issues in the market to which it relates
financial, customer, supplier or labour);
= adding a new key perspective (e.g. a "non-market"
perspective) to incorporate the sustainability-oriented
objectives and indicators not covered by the conventional
perspectives (e.g. social pressure of subcontractors using
child labour).
Illustration 4 Timber
A Scottish timber-growing company sells logs to a mill for onward

sale (e.g. to a paper manufacturer). The company incurs costs of
labour, equipment, repairs, transport, etc. In addition to pesticide
and fertiliser costs, it also incurs replanting and compliance costs
(e.g. maintaining public access, health and safety, habitat protection)
in compliance with legislation/forestry commission standards. These
costs must all be absorbed by increasing the price of timber. Thus
the price of paper already reflects a significant hidden social and
environmental cost.
Issue 1: An Asian company is felling forests using cheaper labour,
with far less rigorous health and safety requirements. Despite higher
transportation costs it competes, effectively, in the European market.
Issues 2: In moving to more sustainable development the Scottish
grower needs to find alternative methods for felling trees and for
transporting them. This will further increase the timber price.
Discussion points:
Who should bear the "burden" of social and environmental
responsibility? (Consider, for example, the seller, consumers,
government, taxpayers.)
Can the risk of price-based competition be overcome?
How can rules of international trade (as overseen by the World
Trade Organisation) contribute to sustainability? (Consider, for
example, "eco-labelling" of products, product taxes, subsidies,
import/export licencing and restrictions, tariffs, trade bans and
prohibited goods.)
Is the Scottish grower's development sustainable?
Should timber/timber products become luxury goods only available
to wealthy society?

2.4 Reporting Frameworks

< Several frameworks of public disclosure and accountability
have been developed to produce corporate "stand-alone"
reports. These include, though are not limited to:
= the Global Reporting Initiative (GRI);
= the IFAC Sustainability Framework (see Illustration 5); and
= the International Integrated Reporting Framework (see s.3).
Illustration 5 IFAC Sustainability

Framework
"A web-based tool (published in January 2009) that targets professional
accountants working in commerce, industry, the public sector, education and
the not-for-profit sector who can influence the way organizations integrate
sustainability into their objectives, strategies, management and definitions
of success, now has a resources section related to climate change policy
developments. Carbon disclosures, cap-and-trade, and green legislative
initiatives are among the issues addressed by these new links."
The model highlights issues organisations must address to make
sustainability an integral part of their business model.
Designed from four different perspectivesbusiness strategy, internal
management, financial investors and other stakeholdersthe new
Sustainability Framework illustrates how a commitment to sustainability
can help to further improve an organisation's products or services,
motivate its people, lower its costs and enhance its reputation.
It challenges conventional ways of thinking on economic, social and
environmental achievements and promotes the injection of sustainability
leadership into the full management cycle, from making and executing
strategic decisions to reporting on performance to all stakeholders.
Source: www.ifac.org/news-events/paib-enews-6
2.5 Global Reporting Initiative ("GRI")

GRI arose from the need to address the failure of the then-
current governance structures and to respond to changes in the
global economy.*
*The following websites provide useful reports to understand the

concept of GRI and to see examples of sustainability reporting:
www.globalreporting.org
www.shell.com/sustainabilityreport
www.vaisala.com/en/sustainability/Pages/default.aspx

2.5.1 Mission
< GRI is a long-term, multi-stakeholder, international
undertaking whose mission is:
"To develop and disseminate globally applicable sustainable
reporting guidelines ('guidelines') for voluntary use by
organisations reporting on the economic, environmental and
social dimensions of their activities, products and services."
< GRI has envisioned a generally accepted framework for
reporting on an organisation's economic, environmental and
social performance.
2.5.2 Reporting Guidelines

< In June 2000, GRI published the first set of voluntary
sustainability reporting guidelines.*
Sustainability
reporting"... the
practice of measuring,
*Reports published after 31 December 2015 should be prepared in
disclosing and
accordance with "G4 Guidelines".
being accountable
to internal and
< GRI's guidelines promote disclosure of an organisation's external stakeholders
positive and negative contributions to sustainability. for organisational
performance towards
< The guidelines address: the goal of sustainable
= What to reportStandard disclosures and sector supplements. development."
= How to reportPrinciples and guidance, as well as more GRI Sustainability
specific protocols. Reporting Guidelines
< The GRI guidelines include:
= Reporting principles;
= Standard disclosures.
Principles for Defining Content

Application of these principles determines the topics and
indicators the report should cover:
< Stakeholder inclusiveness: Identify stakeholders and
explain in the report how the organisation has responded to
their reasonable expectations and interests.
< Sustainability context: Present the organisation's performance
in the wider context of sustainability. How does or will the
organisation contribute to the improvement or deterioration of
economic, environmental and social conditions?*
< Materiality: The information in a report should cover topics *The firm must
and indicators (both internal and external) that reflect the report negative
organisation's significant economic, environmental and social sustainability aspects
impacts or that would substantively influence the assessments and its relationship
to the organisation's
and decisions of stakeholders.
sustainability and
< Completeness: Coverage should be sufficient to reflect business strategies.
significant economic, environmental and social impacts and
enable stakeholders to assess the organisation's performance.

Principles for Reporting Quality

These principles address the quality of the reported information:
< Balance: The report should reflect positive and negative
aspects of the organisation's performance to enable a
reasoned assessment of overall performance.
< Comparability: Issues and information should be selected,
compiled and reported consistently. Reported information
should be presented in a manner that enables stakeholders to
analyse changes in the organisation's performance over time
and could support analysis relative to other organisations.* *Consistency is
< Accuracy: The reported information (quantitative and a critical element
of comparability.
qualitative) should be sufficiently precise and detailed
Maintaining consistency
for stakeholders to assess the reporting organisation's with the methods used
performance. The accuracy of qualitative information is to calculate data, with
largely determined by the degree of clarity, detail and balance the layout of the report
in presentation. The accuracy of quantitative information may and with explaining
depend on the specific methods used to gather, compile and the methods and
analyse the data. assumptions used to
< Timeliness: Reporting occurs on a regular schedule and prepare information,
facilitates comparability
information must be available in time (not too early and not
over time.
too late) for stakeholders to make informed decisions. The
organisation should balance the need to provide information
in a timely manner with the importance of ensuring the
information is reliable.
< Clarity: Information should be made available in a manner
that is understandable and accessible to stakeholders using
the report (e.g. use of graphics and consolidated data tables).
It should be comprehensible to stakeholders who have a
reasonable understanding of the organisation and its activities.
< Reliability: Information and processes used in the
preparation of a report should be gathered, recorded,
compiled, analysed and disclosed in a way which could be
subject to examination and which establishes the quality and
materiality of the information.
2.5.3 Standard Disclosures

< Three sets of disclosures should appear in a GRI sustainability
report:
1. Strategy and profileset the overall context for
understanding performance (e.g. strategy, analysis, report
parameters, governance).
2. Management approachhow the organisation addresses
a given set of topics to provide context for understanding
performance in a specific area.
3. Performance indicatorselicit comparable information
on the economic, environmental and social performance of
the organisation.
< Feeding into these sets will be the "results"economic,
environmental, labour practices, human rights, society and
product responsibility.

2.5.4 Performance Indicators

GRI based reports should cover the following areas, as a minimum:
< Economic: economic performance, market presence and
indirect economic impacts.
< Environmental: materials, energy, water, biodiversity,
emissions, effluents and waste, products and services,
compliance with laws and regulations, transport of products
and employees.
< Social:
= Labour practices: employment, labour/management
relationships, occupational health and safety, training and
education, diversity and equal opportunity.
= Human rights: investment and procurement practices
(e.g. human rights screening of partners, suppliers,
agents, contractors, etc) non-discrimination, freedom of
association and collective bargaining, child labour, forced
and compulsory labour, security practices, indigenous rights.
= Society: community, corruption, public policy, anti-
competitive behaviour, compliance (e.g. monetary value of
material fines).
= Product responsibility: customer health and safety,
product and service labelling, marketing communications,
customer privacy, compliance.
Illustration 6 Sustainability Report
The following are examples of the GRI performance indicators for

environment: emissions, effluent and waste.
Total direct and indirect greenhouse gas emissions by weight
Other relevant indirect greenhouse gas emissions by weight
Initiatives to reduce greenhouse gas emissions and reductions achieved
Emissions of ozone-depleted substances by weight
NOx, SOx and other significant air emissions by type and weight
Total water discharge by quality and destination
Total weight of waste by type and disposal method
Total number and volume of significant spills
Weight of transported, imported, exported or treated waste deemed
as hazardous
Identity, size, protected status and biodiversity value of water bodies
and related habitats significantly affected by discharges of water and
runoff.
Review the latest Shell sustainability report for the way these performance
indicators (and others) have been incorporated into a typical sustainability
report.

Example 3 Indicators of SocietyCorruption

Suggest THREE performance indicators relating to corruption (society).
Solution
1.
2.
3.

3 Integrated Reporting
3.1 International Integrated Reporting

Council (IIRC)
< Integrated reporting reflects "integrated thinking".
Integrated thinkingan application of the collective mind of those

charged with governance and the ability of management to monitor,
manage and communicate the full complexity of the value-creation
process and how this contributes to the success of the organisation
over time.
< The International Integrated Reporting Council (IIRC) is a

global coalition of regulators, investors, companies, standard
setters, the accounting profession and non-government
organisations. It has a vision of a business environment in
which integrated thinking is ingrained in mainstream business
practice, in both public and private sectors. This would be
facilitated by integrated reporting.
< The IIRC launched a new international framework for
integrated reporting in December 2013. The document can be
downloaded from the IIRC's website, www.theiirc.org.*
< A primary motivation behind the progress towards integrated
reporting is that financial information alone is insufficient as *The framework is
an indicator of the long-term sustainability of a business. often referred to as
the International
< Integrated reporting combines financial and non-financial <IR> Framework and
information in one report with the goal of maximising the integrated reporting as
value of information provided to stakeholders with a variety of <IR>.
interests in an organisation.
< Accounting for the sustainability of an organisation is
important for the organisation and for those who provide
financial capital to an organisation, as:
= An organisation needs a reporting environment that is
conducive to comprehending and articulating its strategy
to provide focus and drive internally and attract financial
capital for investment.
= Investors need to understand how the strategy being
pursued creates value over time.

< The goals of integrated reporting are:

= to improve the quality of information available to providers
of financial capital;
= to promote a more cohesive and efficient approach to
corporate reporting that better reflects all of the factors
that materially affect the ability of an organisation to create
value over time;
= to enhance accountability and stewardship for all forms of
capital (see s.3.3);
= to promote the understanding of the interdependencies
among the various capitals; and
= to support integrated thinking in decision-making and
actions which create value over the short, medium, and
long term.
Illustration 7 "What It Isand Is Not"
In an interview with Dr. Carol Adams, director of Integrated Horizons, the CEO
of the IIRC described integrated reporting as not being:
1. Another reportbut instead an evolution in corporate reporting.
2. Sustainability reporting. It does not create sustainability indicators.
3. A reporting process that emphasises multi-stakeholders but a reporting
process emphasising integrated thinking.
C. Adams (2013, Oct 15). Integrated reportingWhat it isand is not: An interview with
Paul Druckman. Source: http://drcaroladams.net/integrated-reporting-what-it-is-and-is-
not-an-interview-with-paul-druckman/
3.2 The International <IR> Framework

< The purpose of the framework is to provide principles and
content elements that help:
= to shape the information provided; and
= to explain why the inclusion of the information provided is
important.
< Although the framework is written to be specifically applicable
to for-profit companies of any size in the private sector, it can
be adapted by not-for-profit and public sector organisations.
< Any communication which claims to be an integrated report
written in conjunction with the international framework should
apply the guiding principles (see s.3.5), unless:
= reliable information is not available; or
= specific legal requirements prohibit inclusion of information; or
= disclosure of information would cause significant
competitive harm.
< An integrated report should include eight content elements.
The content elements are provided in the form of questions
which can be categorised (see s.3.6).

3.3 Alternative Definitions of Capital

Integrated reporting results in a more expansive coverage of
information than does traditional financial reporting. Integrated
reporting more clearly demonstrates an organisation's use of and
dependence on different resources and relationships or "capitals"
and the organisation's access to and effect on them.
< Financial: The pool of funds that is:
= available for use in the production of goods or provision of
services; or
= obtained through financing.
< Manufactured: Manufactured physical objects that are
distinct from natural physical objects (e.g. buildings,
equipment and infrastructure).
< Intellectual: Organisational, knowledge-based intangibles.
< Human: People's competencies, capabilities and experience
and their motivations to innovate.
< Social and Relationship: The institutions and the
relationship within and between communities, groups of
stakeholders and other networks, and the ability to share
information to enhance individual and collective well-being.
< Natural: All renewable and non-renewable environmental
resources and processes that provide goods or services
that support the past, current or future prosperity of an
organisation.
3.4 The Integrated Report
Integrated reporta concise communication about how an

organisation's strategy, governance, performance and prospects, in
the context of its external environment, lead to the creation of value
over the short, medium and long term.
< An integrated report is prepared in accordance with the

International <IR> Framework. It may be prepared in
response to existing compliance requirements.
< It is a specific and identifiable communication that may be
either:
= a standalone report; or
= included as a distinguishable, prominent and accessible part
of another report or communication (e.g. in the financial
statements).
< It should be more than a summary of information available
in other communications but should provide insight into the
connectivity of the information and how value is created over
time in an organisation.

Illustration 8 Transnet
In 2013, Transnet, a company based in South Africa,* issued

an integrated report that is included in the Emerging Integrated *The Johannesburg
Reporting database, which can be found at http://examples.theiirc. Stock Exchange from
org/home. In this report, Transnet highlighted the company's 1 March 2010 has
mandate, business model, strategy, governance, performance required all listed
review and future outlook. Furthermore, it aims to demonstrate companies to adopt
how Transnet responds to its context, stakeholders, risks and <IR> on an "apply or
opportunities in order to create sustainable value for the economy, explain" basis.
society and the environment. Transnet's annual financial statements
and sustainability report are in publications separate from the
integrated report.
3.5 Guiding Principles

The guiding principles provide the foundation for how an
organisation should consider information to be included in the
report and how information should be presented. These principles
are:
A. Strategic focus and future orientation: The report should
provide insight into the organisation's strategy and how it
relates to:
< the organisation's ability to create value over time; and
< its use and effect on the identified capitals.
B. Connectivity of information: The report should demonstrate
connectivity between the factors that affect the organisation's
ability to create value over time.
C. Stakeholder relationships: The report should provide insight
into the nature and quality of the organisation's relationships
with its key stakeholders.
D. Materiality: The report should disclose information about
items which significantly affect the organisation's ability to
create value over time.
E. Conciseness: The report should be focused and avoid
superfluous information that would not be relevant to
stakeholders.
F. Reliability and completeness: The report should reflect
all material items (both positive and negative) affecting the
organisation and be free from material error.
G. Consistency and comparability: Information contained in an
integrated report should be consistent over time and presented
in a way which can be compared to other organisations.

3.6 Content Elements

< The content elements are fundamentally linked to each other
and not mutually exclusive.
< The goal of the integrated report is not to necessarily address
each content element (as a "checklist") but to ensure that the
content elements are addressed in a way that demonstrates
that the connections between them are logical when
considering the circumstances of the organisation.
< The content element categories and the question to be
addressed in the integrated report when considering each
category are as follows:
A. Organisational overview and external environment:
What does the organisation do and what are the
circumstances under which it operates?*
B. Governance: How does the organisation's governance or
leadership structure support its ability to create value over *The International
<IR> Framework
time?
gives greater detail
C. Business model: What is the organisation's business on each content
model? element and question
(e.g. organisational
D. Risks and opportunities: What are the specific risks and overview means
opportunities that affect the organisation's ability to create culture, ethics, values,
value over time, and how is the organisation dealing with ownership, operating
these risks and opportunities? structure, competitive
landscape, etc).
E. Strategy and resource allocation: Where does the
organisation want to go, and how does it intend to get
there?
F. Performance: To what extent has the organisation
achieved its strategic objectives for the period, and what
are its outcomes in terms of effects on the capitals?
G. Outlook: What challenges and uncertainties is the
organisation likely to encounter in pursuing its strategy,
and what are the potential implications for its business
model and future performance?
H. Basis of preparation and presentation: How does
the organisation determine the issues to include in the
integrated report, and how are such issues quantified or
evaluated?
The best way to understand the concept of integrated reporting is

to review a typical report (e.g. Transnet) and analyse it according to
the framework.

3.7 Usefulness to Stakeholders
The primary purpose of an integrated report is to explain to providers

of financial capital how an organisation creates value over time.
< According to the framework, the creation of value is influenced

by the external environment, facilitated through relationships
with stakeholders and dependent on various resources.
< These external aspects to the organisation change over time
and will vary in priority for different stakeholders. Therefore,
focusing on just one capital while disregarding the others is
unlikely to maximise value of the organisation in the long term.
< Although the report is to benefit all stakeholders interested
in an organisation's ability to create value over time, the
intention of the report is not to provide all information that all
interested stakeholders may want.*
*This is impossible
because different
stakeholders have
different information
needs.

4 Internal Management Systems
4.1 Management Systems
Management is "the organisation and controlling of the affairs of a

business or a particular sector of a business".
ENCARTA World English Dictionary, 1999
A [management] system is "the interconnection of components to
achieve a given objective. These components include the organisation,
resources and processes".
Institute of Quality Assurance, 2003
A management system is a goal oriented, systematic way of running
a business, by building an organisational structure and assigning
responsibilities "that everyone is clear about who is responsible for
doing what, when, how, why and where".
International Organization for Standardization (2003)
The four basic steps in management systems are: planning,

implementing, monitoring and reviewing (the "plan-do-check-
review/act cycle").
Plan
Review/Act Do
Check
Specialised management systems are an organisational tool for

reaching specific goals. For example:
< An Occupational Health and Safety (OHS) Management
System aims to improve the health and safety of employees
by assessing the working environment and minimising
accidents and work-related illness.
< A Quality Management System (QMS) aims to meet customer
requirements.
< An Environmental Management System (EMS) aims to
minimise harmful effects on the environment caused by the
organisation's activities.

In contrast to specialised management systems, Integrated

Management Systems (IMS) follow a holistic approach (i.e. considers
several issues at the same time and balances different objectives).
Whereas internal management systems are the way a business is

organised, formalised management systems follow defined standards.
4.2 Standards
Standardsaccepted specifications or codes of practice or procedure

which set out materials, methods, processes and practices which,
when effectively implemented, ensure that products, services or
systems provide acceptable levels of quality, performance, safety
and reliability.
< ISO, the International Standard Organisation, is a private

organisation which develops various international standards by
coordinating national standardisation working groups all over
the world.*
*Standards can be agreed on at many levels (e.g. regional, state,

national, international or sector specific).
< Management system standards are process standards (i.e.

they specify management processes and procedures). They
are not product standards or performance standards.
< The 14000 family of International Process Standards for
environmental management were first developed in 1992 to
provide a practical toolbox to assist in the implementation of
actions supportive to sustainable development. They include
the following standards, which were first issued in 1996:
= ISO 14001 (2004): EMSRequirements with guidance
for use
= ISO 14004 (2004): EMSGeneral guidelines on principles,
systems and support techniques.

4.3 ISO 14001

4.3.1 Requirement
< ISO 14001 requires an organisation to:*
= measure the environmental performance of all activities,
products and services; and
= continually improve this performance through monitoring.
*ISO 14001 requires
< Contents cover: an EMS audit.
= General requirements;
= Environmental policy;
= Planning implementation and operation;
= Checking and corrective action; and
= Management review.
4.3.2 Benefits Associated With a Certified ISO 14001

Management System
Compliancewith legislative and other requirements by
providing a systematic approach for meeting current and
identifying future legislation.
Conformancewith and fulfilment of policy commitments
and making continual improvement against specific targets to
meet overall objectives.
Competitive edgeover non-certified businesses when
invited to tender (may increase access to new customers and
business partners).
Improved managementof environmental risk.
Increased credibilitywhich comes from independent
assessment.
Continual improvementhelps drive more efficient use
of raw materials and enhanced performance leading to cost
reductions.
Integrationof quality, environmental and occupational
health and safety management systems from shared common
management system principles.
Reduces public liability insurance costs.
Enhanced reputationthrough leveraging all of the above.
4.4 Eco-Management and Audit Scheme (EMAS)

4.4.1 Objective
< A similar process-orientated European standard for
environmental management is the Eco-Management and
Audit Scheme (EMAS). EMAS regulation is a voluntary EU
initiative designed to improve environmental performance.
EMAS acknowledges organisations which improve their
environmental performance on a continuous basis.

4.4.2 Summary of Main Features
COMPANY/SITE
Environmental
Environmental review
Environmental
programme
Environmental
objectives EMS
Environmental audit
Environmental statement Environmental verifier
Registration Registration body
Statement of participation
The Public
(consumers, public authorities etc.)

4.4.3 Requirements
< To achieve EMAS, organisations must:
= be legally compliant;
= run an EMS; and
= report on their environmental performance through the
publication of an independently verified (by a third party)
environmental statement.*
< Applies to manufacturing industry and energy.
< Site-based (all companies operating one or more industrial *Certification (or
validation in the
sites are invited to sign up to the standard).
EMAS system) is the
< Promotes continuous improvement of environmental successful result of a
performance by requiring the setting of objectives and a procedure whereby
programme for continuous improvement. a third party gives
< Voluntary but requires compliance with the provisions of written assurance that
compliance against a
the Regulation as a minimum requirement for registration
clearly defined standard
under EMAS.
has been achieved.
< Initial review is a requirement.
< Requires registers of significant environmental effects and
relevant legislation.
< Refers to EVABAT (Economically Viable Application of Best
Available Technology).
< Compulsory audit against set objectives.
< Publication of an environmental statement.
4.4.4 Differences Between ISO 14001 and EMAS
The main difference is that EMAS requires a greater degree of public

disclosure and verification of compliance with environmental law.
< Generally EMAS is assigned more credibility because the system:

= Requires verifiers (the auditors in the ISO-system) to check
compliance with the relevant environmental legislation and
have to refuse validation (certification in the ISO-system) in
the case of non-compliance. (Although ISO 14001 requires
identification and access to relevant regulations and legal
requirements, the auditors are not required to check the
performance regarding legal compliance.)
= Requires an Environmental Statement (including all relevant
environmental aspects of the organisation and its EMS) to
be validated and published.
= Is based on European legislation and all organisations
validated against EMAS are registered. (ISO 14001
organisations are not centrally registered.)
= Requires an Initial Environmental Review as a first step
(i.e. the identification of significant environmental impacts
and the valuation of these impacts) which is not prescribed
in ISO 14001 (although it is the logical starting point of the
implementation of an EMS).

5 Social and Environmental Audit
Social auditing has been defined as:

"A process which enables organisations to assess and demonstrate
their social, community and environmental benefits and limitations.
It is a way to measure the extent to which an organisation lives up to
the shared values and objectives it has committed itself to promote."
Northern Ireland Co-operative Development Agency
"The process whereby an organisation can account for its social
performance, report on and improve that performance. It assesses
the social impact and ethical behaviour of an organisation in relation
to its aims and those of its stakeholders."
New Economics Foundation
"A method for organisations to plan, manage and measure non-
financial activities and to monitor both the internal and external
consequences of the organisation's social and commercial operations."
Social Enterprise Partnership
< Whereas financial audits measure financial performance but

make no comment about the achievement of other objectives,
a social audit provides a tool for measuring an organisation's
impact through the systematic monitoring of performance and
collection of stakeholder views.
< A social audit provides a flexible yet credible way to
demonstrate accountability to stakeholders and the impact and
effectiveness of activities. Accountability is improved through
the inclusion and involvement of stakeholders (a central
feature). They can be involved in measuring performance,
defining indicators and setting targets.
< The process used should be inclusive and transparent and
the findings published, so that they can be seen by anyone
who is interested. Public disclosure of results helps to
increase accountability.

5.1 Report Format
Illustration 9 Traidcraft
Established in 1979, Traidcraft combines a trading company and a

development charity. Its mission is "to fight poverty through trade,
practising and promoting approaches to trade that help poor people
in developing countries transform their lives".
Traidcraft's social accounts attempt to show both what it is
achieving and what its various stakeholders think about the way it
works with them.
Every year as part of its commitment to stakeholder engagement,
Traidcraft gathers the views of stakeholders about its performance
through surveys, interviews and focus groups.
Its stakeholders include employees, producers, donors (institutional
and public), fair traders, beneficiaries, campaigners, shareholders,
suppliers, mail-order customers, retail customers and wholesalers.
2011 Goals
Full details of the organisation's goals, together with its social
report, can be found at www.traidcraft.co.uk
ASSURANCE STATEMENT
Traidcraft[1] commissioned justassurance[2] to undertake independent
assurance of its 2010/11 Social Accounts ('the Report'). justassurance
was paid 16,800 for this work. justassurance has no other
relationships with Traidcraft that might compromise its independence.
The assurance process was conducted in accordance with AA1000AS
(2008). We were engaged to provide Type 2 moderate[3] assurance,
covering:
evaluation of adherence to the AA1000APS (2008) principles of
inclusivity, materiality and responsiveness (the Principles)
the reliability of key performance claims.
We were engaged to provide high level assurance on Developing
World Purchases performance information.
We used the Global Reporting Initiative (GRI) Quality of Information
Principles as Criteria for evaluating performance information and
relied on audited financial information.
Responsibilities of the directors of Traidcraft and of the
assurance providers
The directors of Traidcraft have sole responsibility for the preparation
of the Report. Our statement represents our independent opinion
and is intended to inform all of Traidcraft stakeholders including
management. We adopt a balanced approach towards all Traidcraft
stakeholders.
We were not involved in the preparation of any part of the Report.
We have no other contract with Traidcraft and this is the fourth year
that we have provided assurance.
Our team comprised Mark Line, Adrian Henriques and Sini Forssell[4].
Basis of our opinion
Our work was designed to gather evidence with the objective of
providing assurance as defined in AA1000AS (2008).
To prepare this statement, we reviewed the scope of the Social
Accounts, assessed areas of risk, interviewed managers, scrutinised
the Social Accounts, the underlying data and documents and
considered the efficacy of the management systems. We provided
some feedback to Traidcraft on aspects of drafts of the Social
Accounts and where necessary, changes were made.

Illustration 9 Traidcraft (continued)
We are satisfied that we have been allowed unhindered access to the

financial accounts, documentation and reports covering its activities
and stakeholder engagements and to managers and staff.
Findings
On the basis of the work undertaken, nothing came to our attention
to suggest that the Report does not properly describe Traidcraft's
adherence to the Principles or its performance. The description of
Developing World Purchases performance is fairly stated.
Overall, Traidcraft's Social Accounts provide an excellent level of
transparency and disclosure. This is particularly remarkable in the
current trading and funding context. While the financial performance
of both Traidcraft plc and Traidcraft Exchange has been challenging,
its social performance has improved in a number of areas.
Observations
Without affecting our assurance opinion we also provide the following
observations.
Inclusivity concerns the participation of stakeholders in developing
and achieving an accountable and strategic response to
sustainability.
The past year has seen a significant increase in stakeholder
engagement by Traidcraft compared to previous years. In part this
has been in order to inform the development of the Strategic Plan
(20112020) for which staff input was sought. Traidcraft has also
sought to understand the views of the Christian community through
surveys conducted in the year.
Producer stakeholders of Traidcraft plc have again provided feedback
about Traidcraft's treatment of them. This revealed very positive
relationships. Traidcraft's policy work has also included input from
southern stakeholder groups in its campaigning.
Material issues are those which are necessary for stakeholders to
make informed judgments concerning Traidcraft and its impacts.
Traidcraft's mission is built on a concern to improve the position
of vulnerable producer groups in the South, as is reflected in its
Foundation Principles and in the Charter of Fair Trade Principles.
This Report clearly reflects that central concern and addresses the
great majority of Traidcraft's material issues. However there is no
formal materiality process connected with the Report. In part this
may be addressed by the Strategic Plan and its reflection in future
reports.
In the past year Traidcraft has begun to explore new approaches
to measuring its impact on producers. In particular an additional
measure of Developing World Purchases, based on the weight of
products purchased, has been evaluated and has shown important
results that a measure based on prices alone can mask. This has
resulted in a much fuller account of the groceries trading impacts
that can be found in the Supporting Information.
While the reporting of environmental issues has not advanced
significantly in the past year, it is welcome to note the reduction
in the use of air freight. The Strategic Plan has led to a much
clearer focus on environmental issues, including the development of
environmentally related criteria for project proposals and attention to
the provenance of raw materials for products, including commodities.
Local conditions will need to determine the priorities for any given
producer. Environmental issues could also be related to the producer
categorisation approach.

Illustration 9 Traidcraft (continued)
It would be helpful to describe Traidcraft's overseas presence more

fully in future reports.
Responsiveness concerns the extent to which an organisation
responds to stakeholder issues.
Following a commercially difficult year in 2009/10 which led to
redundancies, the relationship with staff has improved. This is
reflected in positive results from the staff survey.
The prioritisation of producers has led to attention and assistance
being focussed accordingly and this supports the positive producer
survey responses received. The new measure for Developing World
Purchases could be given a higher profile in the report.
We welcome the planned development of new, more nuanced
monitoring and evaluation measures for Traidcraft Exchange
projects and Traidcraft plc producers as a way of guiding resources
even more effectively.
Performance Information
The actual performance achieved in many areas has been good.
This includes customer complaints, health and safety as well as
in relation to staff. Data for Traidcraft Exchange projects has
been collated for the Social Accounts in a systematic manner and
data protocols outlining the assumptions and estimations used in
calculating beneficiary numbers added. An ongoing challenge is
to ensure project data is being systematically recorded by project
managers and we understand that work is underway to develop a
clear and accessible system for this.
The methodology for Developing World Purchases is appropriate
and the results appear reliable. However for groceries in particular,
the underlying calculations rely on a deep knowledge of industry
practices that is not documented or widely shared. It is important
that this knowledge is documented and the calculation of Developing
World Purchases given IT support where possible.
Traidcraft has continued to demonstrate exemplary transparency
across all areas of its activities. The past year has also seen a
significant improvement in its performance in many areas.
Mark Line AA1000
Adrian Henriques Licensed Assurance Provider
Sini Forssell 000-2
Just Assurance Network Ltd

London, June 20th 2011
[1]
'Traidcraft' here refers to both Traidcraft plc and Traidcraft Exchange.
'justassurance' here refers to Just Assurance Network Ltd, trading
[2]
as justassurance. Two Tomorrows Group Ltd provides assurance

services to justassurance. Two Tomorrows is a licensed AA1000AS
assurance provider and oversees justassurance's assurance work
using AA1000AS (2008).
[3]
There are two levels of assurance: Highwhere sufficient evidence
has been obtained to support a statement that the risk of our
conclusion being in error is 'very low but not zero'; Moderatewhere
sufficient evidence has been obtained to support a statement that
the risk of our conclusion being in error is reduced, but not reduced
to 'very low'.
Further information about competencies of team members can be
[4]
found at www.twotomorrows.com

5.2 Audit Approach
Notice the similarities between a standard audit report (from Paper

F8 Audit and Assurance) and the social assurance report shown in
Illustration 7. Knowledge from F8 will be sufficient to answer any
questions on the audit approach to a social, sustainability, CSR or
integrated report.
5.2.1 Assurance Engagement Overview (From Paper F8)
RESPONSIBLE Directors are responsible

PARTY for the report
Relevant criteria used,

Prepares
e.g. GRI 3.1
CSR sustainability SUBJECT MATTER Evaluates subject

report matter using
appropriate standards
and methodologies,
e.g. ISAE when issuing
an assurance report
INTENDED
PRACTITIONER
USER
Assures by issuing
appropriate report
Stakeholders External provider of
assurance

5.2.2 Audit Approach Overview (From Paper F8)

< In three wordsplan, do, report.
< Adapting the standard audit approach as discussed in Paper F8
(see diagram below):
= Agree to the terms of reference to determine management's
and the practitioner's responsibilities, the scope of the work
to be carried out, the principles and guidelines used, the
subject matter content, quality and boundaries, establish
the metrics, basis of measurement and estimation for the
performance indicators to be used.
= Importantly the practitioner must establish to whom the
report will be addressed, how the findings will be reported
(especially where deviations and errors are found) how it
will be issued, who will have access to it and how will they
rely upon it.
= The practitioner will also need to ensure that it is ethically
able to accept the work (e.g. integrity, objectivity,
capability) and determine the level of assurance (reasonable
or low) that it will be able to provide.
= Although (as with any audit) the planning stage is similar,
the information being dealt with is more likely to be
qualitative than quantitative with greater subjectivity than
financial information. Risks and materiality have different
impacts compared to financial audits.
= The range of controls to be assessed will be wider than for
financial audits. But as with any audit, the controls must
be assessed to ensure that the information produced is
relevant and reliable.
= Substantiating the content of the subject matter will require
a thorough understanding of the entity, its stakeholders and
integrity of management. The practitioner's professional
judgement and scepticism will be called into greater use
than on financial audits, purely because of the subjective
nature of the work.
= The remainder of the assurance approach is broadly similar
to that for a financial statement audit.*
*Remember that a
financial statement
auditor must review
other information
sent with the financial
statements. This
will include the
environmental report,
so providing assurance
on such reports will
include reconciling
relevant information
to/from the financial
statements and
other reports (e.g.
chairman's statement,
operational reports).

Agree to terms
of engagement
Form opinion Understand the

(Assurance entity and its
report) environment
Documentation
Obtain
Plan
management
representations
Assess risk and

Review internal control
Substantiate
Reliance on control
principles, management
effectiveness
approach, parameters,
performance indicators,
assumptions and other
disclosures
5.3 Contribution to Integrated Reports

< Because social and environmental factors must be considered
in the integrated thinking process, the issues examined as part
of the social and environmental audit will be important in the
integrated reporting process.
< Whereas organisations in the past may have thought about
sustainability issues strictly in terms of environmental
preservation and awareness and separated their reporting on
these factors from financial reporting, integrated reporting
encourages organisations to reconsider the definition of
sustainability in broader terms and how these factors
contribute over time to the value in the organisation.
< The social and environmental audit can help organisations to
better connect the areas examined in this type of audit to their
overall strategy and creation of value.*
*Under <IR> there is currently no mandatory requirement

for an independent assurance report. There is, however,
a requirement for those charged with governance to
acknowledge their responsibilities to ensure the integrity of
the integrated report and give an opinion on whether it is
presented in accordance with the International <IR> Framework.

Session 20
Summary
< EF concerns the equivalent land in global hectares that can produce renewable resources
used by the company during a reporting period.
< EF is determined as a function of population, average consumption and resource intensity
of production.
< SF deals with the impact of processes on people and communities measured through capital
created by people (anthro capital). Anthro capital encompasses human capital, social
capital and constructed capital.
< Sustainability means meeting the needs of the present without compromising the ability of
future generations to meet their own needs.
< Integrated reporting <IR>, as required by the International <IR> Framework, reflects
integrated thinking. It aims to improve the quality of information available to the providers
of capital.
The Framework provides principles and content elements that shape the information pro-
vided and explain why that information is important.
An integrated report is a concise communication on how strategy, governance, perfor-
mance and prospects lead to the creation of value.
< Methods of reporting CSR issues include:
GRIguidelines to promote reporting consistency; GRI-based reports should cover
economic, environmental, labour practice, human rights, society, and product
responsibility areas.
ISO 14001requires organisations to measure environmental performance of all
activities, products and services and continually improve performance through
monitoring. This is intended to improve management of potential environmental risks
as well as improve management and help develop a competitive edge.
EMASsimilar to ISO 14001 except that it requires a greater degree of public disclosure
and verication of compliance with environmental law.
< Social and environmental auditfocuses more on how the organisation communicates with
stakeholder groups and meets their needs.
< Standard audit approachplan, do, report. The approach will usually follow the
requirements of ISAE 3000 Assurance Engagements Other Than Audits or Reviews of
Historical Financial Information or AccountAbility's AA 1000 series of standards.

Session 20 Quiz
1. Define environmental footprint, social footprint and carbon footprint. (1)

2. List the THREE elements which comprise anthro capital. (1.4)
3. Explain the concept of sustainable development. (2.1)
4. True or False? In addition to the costs of running a business, full cost accounting also
considers environmental and social costs. (2.3.4)
5. List the GRI reporting principles for defining content. (2.5.1)
6. List FOUR goals of integrated reporting. (3.1)
7. Define natural capital. (3.3)
8. List the guiding principles of an integrated report. (3.5)
9. List the EIGHT content elements of an integrated report. (3.6)
10. Explain the key differences between ISO 14001 and EMAS. (4)
11. Describe social auditing. (5)
Study Question Bank

Q29 PAIB 50 minutes
Additional
Q30 Unsustainable Behaviour

Session 20
EXAMPLE SOLUTIONS
Solution 1Mitigating Strategies
Paper usage < Company-wide paper recycling policy.
< Increased recycled content of purchased paper.
< Only non-chemical bleached paper used.
< Printing and copying defaults set to duplex (two-sided) printing.
< Increased use of electronic reports, customer statements (that are
not then printed off by recipients), Internet banking, etc.
< Shareholder information (annual reports, voting) communicated
through the Internet (e-mails, websites).
Energy usage < Energy-efficiency enhancements in buildings (e.g. insulation).
< Green building techniques in new construction, materials and
renovations.
< Lighting retrofits (e.g. replacing standard light bulbs with low energy
bulbs, adding reflectors and removing unnecessary lamps).
< Energy-efficient equipment purchasing policies (e.g. requesting
environmental footprint information as part of tenders).
< Automatic shut-off of computers and other electrical equipment.
< Movement sensors to turn on lights when required.
< Green power purchasing. A green power resource (e.g. solar power)
produces electricity with zero anthropogenic (i.e. human-caused)
emissions.
Transportation < Employee carpooling (sharing).
< Alternative fuel fleet vehicle purchasing.
< Increased use of video/teleconference meetings in lieu of travel.
< Employee working-from-home strategies.
Buildings < High-performance/green building.
< Materials recycling programs, including electronic waste.
< Procurement policies favouring energy-efficient and/or
environmentally preferable equipment.
Water usage < Installation of water-saving fixtures (e.g. movement-activated water
taps and flushers).
< Employee conservation awareness programs (would apply to all
aspects, not just water usage).

Solution 2Traffic Reduction Measures
< "Congestion charging", that is, charging a fee for some motorists
travelling in a specified area (e.g. in London this is designated as
the Congestion Charge Zone, or CCZ). The main objectives of this
charge are to reduce congestion (pollution) and to raise funds for
investment in the transport system.
< Traffic bans (e.g. on certain days of the week, between specified times).
< Designating "pedestrian only" areas.
< Relocating industry away from city centre.
< Restricting the number of new vehicle registrations in a specified period.
< Creating "low emission zones" (LEZ) which ban vehicles that do not
meet emission criteria. The aim is to improve air quality by deterring
the most polluting vehicles from driving in the area. (Although
London introduced an LEZ in 2008, such schemes have been in place
in Sweden since 1996.)
Solution 3Indicators of SocietyCorruption

1. Percentage and total number of business units analysed for risks
relating to corruption.
2. Percentage of employees (split between management and non-
management) trained in the organisation's ant-corruption policies
and procedures (in total and during year).
3. Actions taken in response to incidents of corruption (to include
number of incidents in which employees were dismissed or disciplined
and total number of incidents where contracts with business partners
were not renewed because of violations related to corruption.

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ACCA

GOVERNANCE, RISK AND ETHICS P1

Copyright 2015 DeVry/Becker Educational Development Corp. All rights reserved.

Exclusion of Damages: UNDER NO CIRCUMSTANCES AND UNDER NO LEGAL THEORY, TORT,

About This Study System ............................................................................v

ACCA Study Guide ......................................................................................ix

Examination Approach ............................................................................. xvi

Examination Technique .......................................................................... xvii

1 Scope of Governance ............................................................ 1-1

2 Agency Relationships and Stakeholder Theory ...................... 2-1

3 The Board of Directors .......................................................... 3-1

4 Board Committees ................................................................ 4-1

5 Directors' Remuneration ....................................................... 5-1

6 Approaches to Corporate Governance ................................... 6-1

7 Corporate Social Responsibility ............................................ 7-1

8 Governance: Reporting and Disclosure ................................. 8-1

9 Management Control Systems .............................................. 9-1

10 Internal Audit and Compliance ............................................10-1

11 Reporting on Internal Control ..............................................11-1

12 Identifying Risk ...................................................................12-1

DeVry/Becker Educational Development Corp. All rights reserved. iii

13 Assessing Risk .....................................................................13-1

14 Controlling Risk ...................................................................14-1

15 Ethical Theories ...................................................................15-1

16 Ethics and Social Responsibility ...........................................16-1

17 Professions and the Public Interest .....................................17-1

18 Professional Practice and Codes of Ethics ............................18-1

19 Conicts of interest and unethical behaviour ......................19-1

20 Integrated Reporting and Sustainability ..............................20-1

iv DeVry/Becker Educational Development Corp. All rights reserved.

about thiS Study SyStem

How to Use This Study System

These are the learning outcomes relevant to the session,

A diagram of the concepts and the relationships addressed

These are to be read as part of the text. Any solutions to numerical

These extracts of external content are presented to reinforce concepts and

Attention is drawn to fundamental rules, underlying concepts and

Commentaries These provide additional information to reinforce content.

Session Summary A summary of the main points of each session.

A link to recommended practice questions contained in the Study Question

DeVry/Becker Educational Development Corp. All rights reserved. v

vi DeVry/Becker Educational Development Corp. All rights reserved.

Relational Diagram of Main Capabilities

Governance and responsibility (A)

Internal control and review Identifying, assessing and

Professional values, ethics and social responsibility (E)

Position Within the Syllabus

DeVry/Becker Educational Development Corp. All rights reserved. vii

1. The scope of governance 1. Risk and the risk management process

viii DeVry/Becker Educational Development Corp. All rights reserved.

ACCA Study Guide

A. Governance and Responsibility Ref.

1. The scope of governance

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x DeVry/Becker Educational Development Corp. All rights reserved.

DeVry/Becker Educational Development Corp. All rights reserved. xi

B. Internal Control and Review Ref.

1. Management control systems in corporate governance 9

xii DeVry/Becker Educational Development Corp. All rights reserved.

C. Identifying and Assessing Risk Ref.

1. Risk and the risk management process

D. Controlling and Managing Risk Ref.

1. Targeting and monitoring of risk 14

DeVry/Becker Educational Development Corp. All rights reserved. xiii