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June 2015 exams

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a Paper P1 June 2015 Examinations

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CONTENTS

1 Corporate Governance 1

2 Approaches to Corporate Governance 9

3 The Board of Directors 17

4 Board committees 35

5 Corporate Governance and Corporate Social Responsibility 49

6 Corporate governance control systems 57

7 Auditors and Internal Controls 61

8 Management Information Systems 65

9 The Risk Management Process 67

10 Controlling Risk 81

11 Ethics and Social Responsibility 91

12 Deontology and Teleology 97

13 Social Responsibility 99

14 Professions and the Public Interest 107

15 Professional Practice and Codes of Ethics 117

16 Ethical Characteristics of Professionalism 133

17 Social and Environmental and Ethical Behaviour 137

18 Internal Management Systems such as Emas and ISO 14000 143

19 Integrated reporting 151

Paper P1

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1 Paper P1June 2015 Examinations

Free lectures available for Paper P1 - click hereChapter 1

CORPORATE GOVERNANCE

thesystembywhichorganisationsaredirectedandcontrolled(CadburyReport)

corporategovernance(cg)isasetofrelationshipsbetweenanentitysdirectors,shareholdersandotherstakeholders

alsoprovidesthestructurethroughwhichtheobjectivesoftheentityaresetanddeterminesthemeansofachievingthoseobjectivesandmonitoringperformance

cgisanissueforallentities,whethertheybe

largequotedentities

commercialentities

notforprofitorganisationsincluding:

- publicsector

- nongovernmentalorganisations


Chapter 1 Paper P1Corporate Governance June 2015 Examinations

2

Corporate governance - elements

management,awareness,evaluationandmitigationofrisk

includestheoperationofanadequateandappropriatesystemofcontrol

overallperformanceisimprovedbygoodsupervisionandmanagementwithinsetbestpracticeguidelines

frameworkforanorganisationtopursuestrategyinanethicalandeffectiveway

offerssafeguardsagainstmisuseofresourceshuman,financial,physicalandintellectual

involvesmorethanfollowingexternallyestablishedcodesofgoodpracticeAlsorequiresawillingnesstoapplythespiritaswellastheletterofthelaw

canattractnewinvestmentintoentities,particularlyindevelopingnations

accountabilitytoshareholdersandalsootherstakeholders

underpinscapitalmarketconfidenceinentities,government,regulatorsandtaxauthorities


3Chapter 1 Paper P1Corporate Governance June 2015 Examinations

Corporate governance concepts

honesty / probity not simply telling the truth but also not being guilty of issuingmisleading statements orpresentinginformationinaconfusingordistortedway

accountabilityemphasisofthedirectorsaccountabilitytoshareholders,butopensthedoorfordiscussionabouttheextentoftheiraccountabilitytootherstakeholders

independencestrongemphasisontheappointmentofindependentnonexecutivedirectorswhoarefreefromconflictsofinterestandarethusabletomonitoreffectivelytheentitysandexecutivedirectorsactivities,ideallyworkingcloselywiththeexternalauditors

responsibilityasystemofresponsibilityshouldexistwherebyentitydirectorsacknowledgetheirresponsibilitiestothestakeholders,andwilltakewhatevercorrectiveactionisnecessaryinordertokeeptheentityfocussed

decisiontaking/judgementtheskillwithwhichmanagementmakedecisionswhichwillimprovethewealth/prosperityoftheorganisation

reputationbuiltbydirectors,oftenasaresultoftheirabilitytocomplywithothercgconcepts

integritystraightforwarddealing,honesty,andbalanceForfinancialstatementstohavethecharacteristicofintegrity,thisdependsupontheintegrityofthosepeoplewhopreparethemIntegrityinvolvesapersonwhodemonstrateshighmoralcharacter,isprincipled,professional,honestandtrustworthy

fairnesstakingintoaccounttheinterests,rightsandviewsofeveryonewhohasalegitimateinterestintheentity

transparency /openness involves full disclosure ofmaterialmatterswhich could influence thedecisions ofstakeholders This means not simply openness in the reporting of information required by IFRS in the financialstatements It also involvesother information suchas cashandmanagement forecasts, environmental reports andsustainabilityreports

innovationtherequirementthatentitiesshouldcontinueintheireffortstobeinnovative.Ifnot,andtheystagnate,theirlong-termfutureisundermajorthreat

scepticismtheneedforentitiesalwaystobesceptical intheirestimationoftheprobabilitythatgoodtimesliearoundthenextcorner.Theneedthereforetoadoptanattitudeofprudenceandcaution



4

Corporate governance and agency theory

directorsactasagentsoftheshareholders

cg tries to ensure that agency responsibilities are fulfilled as agents by requiring disclosure and by suggestingperformance-relatedrewards

definition:anagencyrelationshipisacontractunderwhichoneormorepersons(theprincipals)engageanotherperson(theagent)toperformsomeserviceontheirbehalfthatinvolvesdelegatingsomedecisionmakingauthoritytotheagent

fiduciarydutiesdefinition:adutyimposeduponcertainpersonsbecauseofthepositionoftrustandconfidenceinwhichtheystand in relationtoanotherTheduty ismoreonerousthangenerallyarisesunderacontractualor tortrelationshipItrequiresfulldisclosureofinformationheldbythefiduciary,astrictdutytoaccountforanyprofitsreceivedasaresultoftherelationship,andadutytoavoidconflictsofinterest

fiduciarydutiesareowedtotheentity,nottoindividualshareholders

directorsmustexercisetheirpowersfortheproperpurpose



Duties of directors as agents

performanceifpaid,directorshaveacontractualobligationtoperformasagreed(ifunpaid,nosuchobligation)

obediencedirectorsshouldactstrictlyinaccordancewiththeprincipalsinstructions

skillandcaredirectorsshouldactwithsuchadegreeofskillandcareasmayreasonablybeexpectedfromapersonwithsuchexperienceandqualifications

personalperformancedirectorsshouldonlydelegatetheirassignmentswheretheyhavenoreasontobelievethatthepersontowhomtheworkisdelegatedisnotcapableofproperperformance

avoidconflictsofinterestegshouldnotsellhisownpropertytotheentity,eventhoughitmaybeatanindependent,armslengthvaluation

confidenceagentsshouldnotdiscloseconfidentialmattersabouttheprincipal,evenaftertheagencyagreementhasended

accountingforbenefitsagentsmustaccounttotheprincipalforanyundisclosedbenefitwhichtheyreceiveasaresultoftheirofficeasagent

becauseownershipofanentityisnecessarilyseparatedfromthemanagement,problemsmayresult



6

Corporate governance Potential Problems

directorsmaychoosetopursuestrategiesmorebeneficialfortheirowninterestratherthantheentitys

directorswillalmostcertainlyhaveadifferentattitudetorisk,andriskmanagement,sinceitisnottheirowninvestmentwhichtheyarerisking

ifmanagementhaveonlyasmallbeneficial interest intheentity(orevennoneatall )thentheymaywellpursueactivitieswhichimproveshorttermresults(thereforeimprovingtheircurrentbonuses)totheexclusionofmorefarsightedstrategieswhichwouldbeofgreaterbenefittotheentityinthelongerterm

ultimately,shareholdershavetherighttodecidewhoshall(andwhoshallnot)bedirectorsoftheirentityButthisis,inpracticalterms,verymuchatheoreticalpowerGenerallyshareholdersneitherhavethedynamismnororganisationtoeffectsuchachangeinthecompositionoftheboard

Overcoming the problem Alignment of interests ( goal congruence )

incentivesdesignedtoaligninterestsinclude:

profitrelatedpay

shareissueschemes,forinstanceontheoccasionofamanagementbuyout

shareoptionschemes

butforallofthesethereisanaturaltendencyformanagementtoadoptcreativeaccountingtomanipulatetheprofitfigureuponwhichtheseincentivesarebased



Stakeholders

anyoneoranygroup

primaryorsecondary

internalorexternal

narroworwide

knownorunknown

legitimateorillegitimate

activeorpassive

voluntaryorinvoluntary

recognisedorunrecognised

stakeholdersmaybesub-classified

anoperationalrolewithintheentity

aroleincorporategovernance

anumberofinterestsintheentity,bothinternalandexternal

considertheseelementsinthecontextoftheinternalinterests:

directors

entitysecretary

secondtiermanagement

employees

unions



8

Eachexternalstakeholderhas:

aroletoplayininfluencingtheoperationsoftheentity

theirowninterestsandclaimsintheentity

considertheseinthecontextoftheexternalinterests:

auditors

regulators

government

stockexchange

smallinvestors

institutionalinvestors

ReferencetoDavidCampbellStudentAccountantarticles:Rules,principlesandSarbanes-OxleyApril2008




APPROACHES TO CORPORATE GOVERNANCE

Two distinct approaches to corporate governance

rulesbased,and

principlesbased

Characteristics of the rules based approach

prescribedsetofcgrequirements

quickwayofensuringcompliance

adoptsachecklistapproach

cleardistinctionbetweencomplianceandnoncompliance

easytoseethatentityiscomplying

reductionofflexibilityonthepartofmanagementandauditors

difficulttosetrulestocoverallsituations

possibletomisinterpretrules

samerulesapplytoall,whatevertheirsize


Chapter 2 Paper P1Approaches to Corporate Governance June 2015 Examinations

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Characteristics of the principles based approach activitiesofentitiesmustaddressmajorprinciplessetoutincodesofbestpractice

notsimplyaboxtickingexercise

moredifficulttoavoidthanarulesbasedapproach

easytoseethatentityiscomplying

directorsrequiredtoworkintheentitysbestinterests

moreflexible,andthereforebetterabletodealwithnewsituations

easierjustificationforapparentbreachofprinciples

butprinciplesmaybeinterpreteddifferently


11Chapter 2 Paper P1Approaches to Corporate Governance June 2015 Examinations

Arrivalofcorporategovernance

headlinehittingcorporatefailuresinEurope,USAandUKledtorecognitionoftheneedforsomesortofcontrolinanattempttopreventsimilarfailures

commonelementsidentifiedas:

poorentitymanagementbydirectors

singledominantindividual

unreliablefinancialreporting

ineffectiveinternalcontrols

incompetentdirectors

lackofcloseinvolvementofinstitutionalshareholders

directorsinterestedmoreinpersonalpositionratherthaninthewelfareoftheentity



12

Development of the UK Corporate Governance Code 2010 ( CGC )

1992,theCadburyReport

followedbyGreenburyreportondirectorsremuneration

thenHampelreportalistofprinciplesofgoodcorporategovernance

1998,thesethreemergedintotheCombinedCodeonCorporateGovernance

2003,HiggsReport,effectivenessofnon-executivedirectors(neds)

2005,Turnbullreport,guidanceoninternalcontrols

2006,newCGCpublished

2010,revisedandre-namedTheUKCorporateGovernanceCode(CGC)

CGCappliestoallUKquotedentitieswhichmuststate:

howithasappliedCGCprinciples

whetherornotithascompliedwithCGCthroughouttheaccountingperiod,and

ifnot,whynot



Rules based approach

USApassedlegislation-SarbanesOxley(SOX)

appliestoallUSquotedentities

butalsotoanyentity,anywhereintheWorld,ifithasanAmericanquotedparententity

mainprovisionsofSOX

allquotedentitiesmustprovideacertificatetotheSecuritiesExchangeCommissionconfirmingtheaccuracyoftheirfinancialstatements

wherefinancialstatementshavetoberestatedfollowingmaterialnon-compliance,CEOandCFOmustrepayanybonusesreceivedintheprevioustwelvemonths

auditorsrestrictedtoauditwork(andtax)

seniorauditpartnermustrotateofftheauditafternomorethanfiveyears

PublicEntityOversightBoardresponsibleforenforcingprofessionalstandardsinaccountingandauditing

directorsforbiddenfromdealinginentitysharesduringsensitivetimes



14

OECD and ICGN have both issued principles on corporate governance

theseprinciplesservemultiplepurposes:

assistgovernmentsintheireffortstointroducecgprinciples

provideguidanceandadvicetoregulatorybodiessuchasstockexchanges,investorgroupsandinstitutions

althoughaimeddirectlyatlistedentities,recognisedthatallentitiescouldbenefitfromadoptionofprinciples

theprincipleshavenolegalstatus

Summary of OECD principles

ContentsoftheOECDPrinciples:

identificationofthebasisforaneffectivecgframework

fairtreatmentforallshareholders

identifiestherightsofshareholders

andtheroleofstakeholders

detailsdisclosurerequirements

andtransparencyarrangements

establisheskeyownershipfunctions

andboardresponsibilities



Summary of ICGN principles

identifiescorporateobjectiveofprovidingreturnstoshareholdersontheirinvestments

disclosureandtransparencymatters

independentaudit

detailsshareholdersownership,responsibilities,rightsandremedies

detailsprovisionsrelatingtoboardsofdirectors

prescribesboardremunerationpolicies

providesguidanceoncgimplementation

prescribessocialawareness

recommendsentity/stakeholderrelationship

establishesneedforbusinessethics



16




THE BOARD OF DIRECTORS

Directors

anyonewhooccupiesthepositionofdirector

shadowdirectorsareanyoneinaccordancewithwhoseinstructionsthedirectorsareaccustomedtoact

cgcestablishesrolesandresponsibilities:

provideleadershipfortheentity

representtheentityinitsdealings,andtothepublicgenerally

settheagendasforboardmeetings

decidethosematterswhicharetobedeterminedbytheboard,andnotthereforetobedelegated

decideuponastrategyfortheentity

selectadirectortobeCEO,and

anotheronetobeChair


Chapter 3 Paper P1The Board of Directors June 2015 Examinations

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directorsrolesandresponsibilitiescontinued

establishacorporateculture

ensurethatthosechargedwithtakingoperatingdecisionsaredoingtheirjobproperly

establishandimplementaneffectivesystemofinternalcontrolscapableofriskassessmentandmanagement

ensurethataimsandobjectivesoftheentityarerealisticandachievable

ensurethatallemployeesareawareoftheentitysresponsibilitiestoitsstakeholders

holdregularandfrequentboardmeetings

assessownperformance,andreportannuallytoshareholders

submitthemselvesforreelectioneverythreeyears(FTSE350entity?re-electALLdirectorseveryyear)

forlistedentitiesthereareadditionalrequirements


19Chapter 3 Paper P1The Board of Directors June 2015 Examinations

Listed entity requirements and the Higgs report contents

listedentitiesshould:

appointappropriateandindependentneds

establishsub-committees

- audit

- remuneration

- risk

- nomination

Higgsidentifiedfourfactorswhichaffecttheeffectivenessoftheboard:

timeavailabletodevotetoentitymatters

personalcompetence

qualityofinformation

boardroomculture

othermajorpointsaddressedbyHiggswere:

theroleofneds,and

performancemeasurementfortheboardasawholeandforindividualdirectors



20

Corporate Governance Code sub-divisions

CGCbreaksdownneatlyintofoursub-divisions:

directors

directorsremuneration

accountsandaudit

investorrelations



CGC sub-divisions - directors

everylistedentityshouldhaveaneffectiveboard

positionsofChairandCEOshouldbeheldbydifferentindividuals

boardshouldcomprisebothexecutiveandnonexecutivedirectors

thereshouldbeatleastasmanynedsasexecutivedirectors

appointmenttotheboardshouldbeformalandtransparent

informationshouldbeprovidedtotheboard

thereshouldbeaformalassessmentoftheboardsperformanceannually

shouldsubmitthemselvesforreelectiononaregularbasis

withintervalsnotgreaterthanthreeyears



22

CGC sub-divisions directors remuneration

shouldbesufficienttoattract,retainandmotivate

aproportionshouldbeperformancerelated

nodirectorshouldbeinvolvedindeterminingtheirownremuneration

remunerationcommitteeshouldpublishareportoftheiractivitiesintheannualfinancialstatements

CGC sub-divisions accounts and audit

boardshouldpresentabalancedassessmentoftheentitysposition

theboardshouldmaintainasoundsystemofinternalcontrolinordertosafeguardshareholdersinvestments

formalarrangementsshouldbeinplaceforconsideringhowtoapplyfinancialreportingandinternalcontrolprinciples

theboardshouldmakearrangementsformaintaininganappropriaterelationshipwiththeauditors

thiswillinvolveestablishinganauditcommittee



CGC sub-divisions investor relations and potential problems with implementation of CGC

directorsshouldhaveregulardialoguewithinstitutionalinvestors

directorsshouldencourageactiveparticipationofallshareholdersattheannualgeneralmeeting

toadoptalltherecommendationsoftheCGCsoundslikeanexcellentidea,buttherecanbeproblems!

potentialproblems

possiblethatexecutiveboardcouldlackskillorexperience

when daily management team report to executive, their failings could mean that problems are not fullyappreciatedoropportunitiescouldbeoverlooked

directorsmaymeetinfrequentlyandarenotnecessarilycloseacquaintancesThiscouldmakeitdifficultforthemeffectivelytoquestionthedailymanagementteam

CEOsareoftenpeoplewithforcefulpersonalitieswhosometimesexerciseadominantinfluenceovertheboard

CEOsperformanceis judgedbythesamepeoplewhoappointedhimCouldbeverydifficult forthemtobeunbiasedintheirevaluationofCEOsperformance



24

Structure of the board - single tier ( unified ) or two-tier?

singletierstructurecharacteristics:

bothcontrolandmanagementareinthehandsofasinglegroupofdirectors

commonintheUSandtheUK

thecgcrecommendsthatatleasthalftheboardshouldbeneds

anotherrecommendationconcernsthesplitoftherolesofCEOandChair

theeffectistosplitthemanagement(CEO)fromcontrol(anonexecutiveChair)

inpractice,thenedsnotonlymonitormanagementbutalsocontributetostrategydevelopment

inlargerentities,managementisoftendevolvedtosubcommittees

alldirectors,whethermanagementorneds,haveequallegalandexecutivestatusAllarethereforeaccountableandresponsibleforboarddecisions

nedsmayalsotaketheinitiativeinmanagementdecisionsandarenotrestrictedtopostdecisionapproval

alldirectorsowethesamefiduciarydutiestotheentity



Structure of the board - two-tier structure

twotierstructurecharacteristics:

consistsofasupervisoryboardandamanagementboard

entitiesinFrance,GermanyandotherpartsofEuropeoftenhaveatwotierboard

managementisresponsibleforthegeneralrunningofthebusiness

managementboardisledbyCEO

supervisory board is responsible for the appointment, supervision and removal of members from themanagementboard

alsoresponsibleforoverseeingtheactivitiesofthemanagementboard,anditscompliancewithlaw,regulationandtheentitysconstitution

also,ageneraloverseeingoftheentityanditsbusinessstrategies

supervisoryboardisledbytheChair



26

Directors - structure of the board

thestructureshouldtakeaccountofthefollowingfactors:

aneffectiveboardisessentialforgoodcorporategovernance

abalancebetweenexecutiveandnedssothatnosinglegroupcandominate

theboardshouldnotbedominatedneitherbyanyindividual

norbyanygroup/section

thereneedstobeasplitofpowerbetweenCEOandChair

executivedirectorsshouldeachbeanexpertintheirownfield



Directors - sub-division of roles

Executivedirectors

involvedindaytodaymanagement

usuallyremuneratedasfulltimeemployees

dedicatetheirworkinglivestofulfillingtheirdutiesasdirector

takeresponsibilityforthedaytodayrunningoftheentity

Non-executivedirectors

membersoftheboard,butnotinvolvedinthedaytodayrunningoftheentity

neitherafulltimeemployee,norconnectedinanyotherwaywiththeentity

serveonthevariousboardsub-committees:

- audit

- remuneration

- risk

- nominations

- socialand

- ethical



28

Functions of neds constructivelychallengeandcontributetodevelopmentofstrategy

overseeandevaluatemanagementsperformanceinmeetingagreedobjectives

satisfythemselvesthatfinancialinformationisaccurate

satisfythemselvesthatfinancialcontrolsandsystemsofriskmanagementarestrongandappropriate

roleonremunerationcommittee

constantlyseektoestablishandmaintainconfidenceintheconductoftheentity

beindependentinjudgement,andinquisitive

trytounderstandtheviewsofthemajorinvestors

beofferedtheopportunitytoattendmeetingswithmajorshareholders



Statutory duties of all directors

Wehavealreadycomeacrosssomeofthedutiesofdirectors,butthefollowinglistincludessomenewones:

actingoodfaith,intheinterestsoftheentityasawhole,by:

- treatingallshareholdersequally

- declaringanyconflictsofinterest

- notmakingpersonalprofitsattheentitysexpense

ensurethattheentitymaintainsproperaccountingrecords

produceproperfinancialstatementsanddirectorsreport

filethefinancialstatementswiththeGovernmentdepartment

obeyotherlawsandregulationssuchashealthandsafetylegislation

Individually,eachdirectormust:

discloseanyinterestinanentitycontract

discloseanyinterestinsharesordebenturesoftheentity

disclosedetailsofanyoptionswhichareheld

Inaddition,directorshaveacommonlawdutytodemonstratesuchdegreeofskillandcareasmayreasonablybeexpectedfromapersonofthatage,experienceandqualification.FailuretodosomayresultinthedirectorbeingfoundliablefornegligencewiththeconsequencethataCourtmayholdthedirectorpersonallyliableforanylosswhichtheentityhassufferedasaresultofthatnegligence.



30

Directors - appointment and service contracts

Appointment

Therulesfortheappointmentandremovalofdirectorsarefoundintheconstitutionofanentityandtypicallyprovidethefollowing:

- thefirstdirectorsareappointedatthetimeofformationoftheentity

- subsequentdirectorsarenormallyappointedbythedirectorsinthetimebetweengeneralmeetings,butsuchappointeesmustseektobereelectedbytheshareholdersatthenextannualgeneralmeeting

- directorsarerequiredtoretirebyrotation

- directorsshouldstepdownfromofficeatleasteverythreeyears,butmayseekreelection

- iftheentityisanFTSE350entity,alldirectorsmustbere-electedeveryyear

Directorsservicecontracts

Thesearelegaldocumentscontainingthetermsofserviceforeachdirectorandwillnormallyinclude:

- keydates

- duties

- remunerationdetails

- terminationprovisions

- constraints

- anyothernormalemploymentprovisions

Thecontractshouldnotbeforaperiodinexcessofoneyear



Directors removal and disqualification

Directorsmaybe removed fromofficeat any timeby thevoteof themajorityofmembers ingeneralmeeting Inaddition,theofficeofdirectorshallbevacatedaccordingtotherulessetoutintheentitysconstitutionTypicallythiswillprovidethatadirectorshallloseofficeif:

becomesdisqualifiedbylaw

dies

isremovedbyshareholders

becomespersonallybankrupt

resignsfromofficebynoticeinwriting

isabsentfromboardmeetingswithoutpermissionforaperiodinexcessofsixmonths

Disqualificationunderthelawcanhappenwhenadirectorisguiltyof:

allowingtheentitytocontinuetotradewhilstitisinsolvent

notkeepingproperaccountingrecords

failuretopreparefinancialstatements

threedefaults(withinafiveyearperiod)offailingtofilerelevantdocumentswiththeGovernmentdepartment

failuretofiletaxreturns(orpaytax)

takingactionswhicharedeemedbytheCourttobeinappropriateforthemanagementoftheentity



32

Directors Insider dealing

Insider a personwho has a business connectionwith an entity as a result ofwhich theymay acquire relevantinformation

Dealingbuyingorsellingsharesorsecuritiesinanentity

Unpublishedpricesensitiveinformationisinformationabouttheentitywhichisnotinthepublicdomain

islessthan6monthsold,and

is,onpublication,likelytohaveamaterialimpactonthemarketpriceoftheentitysshares

Aninsiderinpossessionofunpublishedpricesensitiveinformationshouldnotdeal

Anoffenceisalsocommittediftheinsiderencouragesanotherpersontodeal

Apersondealingasaresultofthatencouragement,andbelievingthesourcetobeaninsider,isalsocommittinganoffence

Disclosureofinsideinformation,otherthaninthepropercourseofemploymenttoanauthorisedperson,isalsoanoffence

Somedefencesareavailabletobeclaimed



Directors - induction and education

TheCGCestablishesprinciplesfortheeducationofanewdirectorintheactivitiesoftheentityItisclearlyimportantthatthenewdirectorshouldbecomeacquaintedwiththeexecutiveboardassoonaspossibleaftertheirappointment,sotheentitysinductionprocedureshould:

becomprehensive

betailoredtotheneedsoftheentityandindividualdirectors

containwritteninformationpluspresentationsandappropriateactivities(egsitevisits)

givenewappointeesabalancedoverviewoftheentity

notoverloadthedirectorwithanexcessofinformation

attheendoftheinductionprocess,thenewdirectorshouldhave:

- anunderstandingofthenatureoftheentity,itsbusinessandthemarketsinwhichitoperates

- alinkwiththeentitysemployees

- anunderstandingoftheentitysmainrelationshipsincludingtherelationshipwiththeauditors



34

Directors performance evaluation

TheCGCcontainsaframeworkforassessingtheperformanceofindividualdirectorsaswellasoftheboardasawhole:

thereshouldbeanannualevaluationoftheperformanceoftheboardasawholeandofeachmemberoftheboard

theevaluationexerciseshouldbetailoredtosuittheentitysneeds

entitiesshouldpublishinthefinancialstatementswhethersuchanevaluationexercisehasbeencarriedout

theChairisresponsiblefortheselectionofaneffectiveprocess,andfortakingappropriateactiononcompletion

theuseofanindependentthirdpartywouldbringadditionalobjectivitytotheexercise

theevaluationexerciseshouldconsistofanumberofquestionsandanswersdesignedtoassessperformanceandidentifyhowperformancecouldbeimproved

thewholeprocessshouldbeusedconstructivelyasameanstoimproveboardeffectiveness,maximisestrengthsandminimiseweaknesses

theresultsoftheboardevaluationshouldbesharedwiththewholeboard,but

theresultsofindividualevaluationsshouldremainconfidentialbetweentheChairandtheindividualdirector



Free lectures available for Paper P1 - click here Chapter 4

BOARD COMMITTEES

Audit committee

auditcommitteeisasubcommitteeoftheboardandiscomprisedentirelyofneds

inalistedentity,thereshouldbeatleastthreenedsontheauditcommittee,oneofwhomhashadrecentrelevantfinancialexperience

keyrolesfortheauditcommitteeare:

oversight

assessment

reviewoftheotherfunctionsandsystemsintheentity

mostoftheboardsobjectivesrelatingtointernalcontrolwillprobablybedelegatedtotheauditcommittee

theauditcommitteeshould:

reviewtheentitysinternalfinancialcontrols

reviewalltheentitysicandriskmanagementsystems

approvethewordinginthefinancialstatementsrelatingtoicandriskmanagementsystems

receivereportsfrommanagementabouttheeffectivenessofthecontrolsystems

receivereportsconcerningtheconclusionofanytestscarriedoutonthecontrolsbyeitherinternalorexternalauditors


Chapter 4 Paper P1Board committees - audit committee June 2015 Examinations

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Internal control systems

foranicsystemtobeeffectiveitneedstominimisesuccessfullythebusinessrisksidentifiedbymanagement:

playsanimportantrole inmanagingthoseriskswhichmostthreatentheattainmentoftheentitysbusinessobjectives

contributes significantly to protecting shareholders investment, safeguarding the assets and ensuringcompliancewithlawandregulation

shouldalsoseektopreventandtodetectfraudInapoorcontrolenvironmentfraudcouldmoreeasilydevelop

shouldbereviewedcontinuallyandimprovedasappropriate

thecostsofimplementingacontrolshouldnotexceedthebenefittobegainedfromthereducedrisk

suitabilityofacontrolwillvaryfromentitytoentity

shouldbeanintegralpartofanyentitysriskmanagementstrategyitshouldnotbeanafterthought

effectivefinancialcontrols(includingmaintenanceofproperaccountingrecords)areanimportantelementofasystemofic


37Chapter 4 Paper P1Board committees - audit committee June 2015 Examinations

Internal controls -categorisation

canberememberedbythemnemonicoapspasm

O Organisational

A Arithmeticandaccounting

P Personnel

S Segregationofduties

P Physical

A Authorisation

S Supervision

M Management



38

Internal controls - categorisation

theseeightcontrolscannowbecategorisedintothreeheadings

Structure Transactions Staff

Organisationalcontrolovertheorganisationstructureincludingmanagershavingspecificresponsibilitiesanddelegationtasks

Physicalprotectionofassetsagainsttheft,unauthorisedaccessoruse

Personnelcontrolsthat:-suitablepeoplearerecruited

foreachjob,and-appropriatetrainingispro-

videdforthatjob

Segregationofdutiesforeachtransactiondifferentpeople:

-authoriseit-recordit-maintainphysicalcustodyof

anyassets-payforit

Arithmeticandaccountingcheckingaccountingtransac-tionsforaccuracy

includesuseofcontrolaccountsandreconciliations(egbankreconciliation)

Supervisionoversightofworkofotherindividualstoensuretasksarecarriedoutcorrectly

Authorisationandapprovalcontrolstoensurethattransac-tionsdonotproceeduntilanappropriateindividualhasgivenapproval(normallyinwriting)

Managementcontrolactiontakenbyman-agementdependingonthecontentsofreportsreceived



Audit committee and internal audit ( ia )

aspartoftheirobligationtoensureadequateandeffectivecontrolsauditcommitteeisresponsiblefortheactivitiesofia

theauditcommitteeshould:

monitorandassesstheroleoftheiafunctionwithintheentitysoverallriskmanagementsystem

checktheefficiencyofia

approvetheappointment(orremoval)ofthechiefinternalauditor

ensurethattheiafunctionhasdirectaccesstotheChairandisaccountabletotheauditcommittee

reviewandassesstheannualiaworkplan

receivereportsconcerningtheworkoftheiafunction

reviewandmonitormanagementsresponsetoiafindings

ensureiasrecommendationsareimplemented

helptopreservetheiafunctionfrompressureswhichmightotherwiseimpairtheirobjectivity

auditcommitteeshouldmeetwithiaatleastonceeachyeartodiscussauditrelatedmatters

possiblethatevenalistedentitydoesnothaveaniafunction

ifnoauditcommittee,shouldreviewthesituationannuallyandmakeanyappropriaterecommendation

ifthereisnoiadepartment,thisfactmustbedisclosedinthefinancialstatements



40

Audit committee and the external auditors ( ea )

auditcommitteeisresponsibleforoverseeingtheentitysrelationshipwiththeea

responsibilityisgivenbytheCGCwhichalsostatesthattheauditcommitteeshould:

havetheprimaryresponsibilityforrecommendingeasforappointment,reappointmentorevenremoval

overseetheselectionprocesswhenreplacementauditorsarebeingconsidered

approvetheterms(notnecessarilynegotiate)oftheeasengagement,andtheirremuneration

developprocedureswherebytheycanannuallyensuretheeascontinuingindependenceandobjectivity

reviewthescopeoftheauditwithea,andsatisfythemselvesthatthescopeissufficient

ensurethatappropriateplansareinplacefortheauditatthecommencementoftheaudit

carryoutapostauditreview



Reporting on internal controls to shareholders

CGCrequiresthatanentitysboardshouldmaintainasoundsystemofinternalcontrolstosafeguardtheentitysassetsandtoprotectshareholdersinvestments

issueishowmuchtheentityshouldtellitsshareholdersabouttheinternalcontrolsystem

asownersof theentity, shareholdersareentitled toknowwhether the internalcontrol system issufficientlystrongtosafeguardtheentitysassets

boardshould,atleastonceeachyear,reviewtheeffectivenessoftheinternalcontrolsystem,andreporttotheshareholderstheresultsofthatreview

reviewshouldcoverallmaterialcontrolsincludingfinancial,operationalandcompliancecontrolsaswellastheriskmanagementsystem

in addition, the shareholders shouldbe told, through the financial statements, about thework of the auditcommittee

attheannualgeneralmeetingtheChairoftheauditcommitteeshouldbeavailabletoansweranyshareholderquestions



42

Internal audit reporting Report section Reason Example

Objectivesofauditwork Setsthesceneforreportaudiencebydescribingpurposeofreview

Forapayrollauditcheckwhether:-wagesarepaidtothecorrect

individuals-deductionsfromgrosspayare

properlycalculated

Summaryofprocessunder-takenbyauditor

Describeshowtheevidencetosupporttheopinionandrecom-mendationswasgathered

Recalculationofdeductionswasperformedforasampleof50monthlyand50weeklywagespayments

Auditopinion(ifrequired) Summaryofwhetherthecontrolreviewedisworkingornot

Inouropinion,thecontroliswork-ingasintended

Recommendations Highlightareasofcontrolweaknessandsuggestcourseofremedialaction

Werecommendthatnewemploy-eesareonlyaddedtothepayrollsystemonreceiptofanappropri-atelyauthorisedForm1a



Role and function of an audit committee

createaclimateofdisciplineandcontrolleadingtoareductionofopportunitiesforfraud

lendanairofcredibilityandobjectivityinthefinancialstatementstherebyincreasingpublicconfidence

assistCFObyprovidingaforum

reviewfinancialstatementstoimprovethequalityofreporting

independentjudgement

strengthenpositionoftheinternalauditor

strengthenpositionoftheexternalauditor

assistintheresolutionofdisputesbetweenexternalauditorandexecutiveboard

rememberClarissa


Chapter 4 Paper P1Board committees - remuneration committee June 2015 Examinations

44

Remuneration committee

importance:

executivedirectorsshouldnotberesponsiblefordeterminingtheirownremuneration

remunerationdecisionscanbeseentobetakenbythosewhowillnotbenefitfromthosedecisions

thereisaneedforformal,transparentproceduresfordevelopingpolicyandforindividualpackages

role

the committee determines appropriate packages for the executive directors, and the composition of thosepackages

composition

inlistedentitiesthecommitteewilltypicallycompriseneds

accountability

reportstothemainboard


45Chapter 4 Paper P1Board committees - remuneration committee June 2015 Examinations

Strategy of the remuneration committee may consider:

greaterbenefitsinkindtocompensateforlowerbasicsalaries

offeringnoncashmotivationforsome(orall)oftheentitysemployees.Noncashmotivatorscouldincludethingslikecrchefacilities,carsandadditionalholidays

availabilityofentityresources.Forexample,theentitymaynothavesufficientcashresourcetopayanannualbonus,butmayofferashareincentiveschemeinstead

encouragementoflongtermloyaltybyofferingsharepurchaseschemes


Chapter 4 Paper P1Board committees - remuneration committee June 2015 Examinations

46

Remuneration committee responsibilities

determine, and regularly review, the framework, broadpolicy and specific terms for the remuneration, terms andconditionsofemploymentoftheChairandoftheexecutivedirectors

recommendandmonitorthelevelandstructureoftheremunerationofseniormanagement

setdetailedremunerationforallexecutivedirectorsandtheChairincludingpensionrightsandcompensationpayments

ensurethatexecutivedirectorsandseniormanagementarefairlyrewardedfortheir individualcontributionstotheoverallperformanceoftheentity

demonstratetoshareholdersthattheremunerationofexecutivedirectorsandseniormanagementissetbyindividualswithnopersonalinterestintheoutcomeofthecommitteesdecisions

agreecompensationforlossofoffice

ensurethatprovisionsfordisclosureofremuneration,includingpensions,assetoutinlawandintheCGCarefollowed


47Chapter 4 Paper P1Board committees - nominations committee June 2015 Examinations

Nominations committee

importance:

needstobeseentobeunbiasedandimpartial

needstobeobjectiveinordertoensurethatappointmentsaremadeinlinewithpreagreedspecifications

role

identifyappropriatepeopletobeinvitedtojointheboard

thecommitteedeterminesappropriatepackagesfortheprospectiveexecutivedirectors,andthecompositionofthosepackages

composition

executivedirectorsandneds,butnedsshouldbethemajority

accountability

makesrecommendationstothemainboard,but

finaldecisionsaremadebythemainboardasawhole

overallresponsibilitiesofthenominationscommitteeareto:

reviewregularlythestructure,sizeandcompositionoftheboard,andmakerecommendationstotheboardofnewnominees

givefullconsiderationtosuccessionplanningfordirectors

regularlyevaluatethebalanceofskills,knowledgeandexperienceoftheboard

prepareadescriptionoftheroleandcapabilitiesrequiredforanyparticularboardappointment

identify,andnominateforapproval,candidatestofillboardvacanciesastheyarise

recommendtotheboardconcerningexistingdirectorsstandingforreappointment


Chapter 4 Paper P1Board committees - risk management committee June 2015 Examinations

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Risk management committee

boardisresponsibleforriskidentificationandriskmanagement,bothofwhichinvolvetheestablishmentofasoundsystemofinternalcontrol

importance:

givesanobjectiveviewontheentitysriskprofile

role

assessesinternalcontrols

performsriskassessmentsoftheentityskeyoperations

oftenoverseestheimplementationandeffectiveoperationofriskstrategy,policiesandprocedures

composition

executivedirectorsandneds,butnedsshouldbethemajority

accountability

makesrecommendationstothefullboardofinternalcontrolandriskstrategy,or

totheauditcommittee,buttheyinturnwillreporttothefullboard

mainresponsibilitiesanddutiesoftheriskmanagementcommitteeareto:

advisethefullboardonriskmanagementissues,strategyandpolicy

emphasiseanddemonstratethebenefitsofariskbasedapproachtointernalcontrols

setappropriateinternalcontrolpolicies

regularlyassurethatthesystemisfunctioning

reviewtheeffectivenessofinternalcontrols

providerelevantdisclosuresaboutinternalcontrolsinthefinancialstatements

reviewthesystemofinternalcontrolspayingparticularattentiontothecontrolenvironment,riskassessment,informationsystems,controlproceduresandmonitoring




CORPORATE GOVERNANCE AND CORPORATE SOCIAL RESPONSIBILITY

entitiesareincreasinglyacceptingthattheyhavesocialandenvironmentalresponsibilities

whoarethepeoplewhoareaffectedbyanentitysactions?

thereare,ofcourse,manyincluding:

- employees

- customers,suppliersandthelocalcommunity

- theenvironmentmaybeaffectedasaresultofourproductionprocesses

CGvsCSR

cgisnotthesameascorporatesocialresponsibility(csr)

csristheprinciplethatanentitywillthinkaboutitsimpactonthewiderenvironmentandwilltakedocumentedstepstominimisethedamageandmaximisethebenefitsofitsactions

strategyofanorganisationisshapedbymanyfactors,includingthedemandsofstakeholders

eachdifferentstakeholder,orclassofstakeholder,willtypicallyhavedifferentobjectivesaswellasdifferentlevelsofinfluence

expression stakeholder is applied to anyonewhohas anything todowith thebusiness,whetherdirectlyorindirectly

cgframeworkofanentityshouldrecognisetherightsofstakeholdersestablishedbylaworbyseparateagreement

becausedifferentstakeholdershavedifferentobjectives,itisnecessaryfortheboardtobalancetheseconflictinginterests

anentitysstrategyisoftentomanage,ratherthansatisfy,stakeholderobjectives

inevitably,themoreinfluentialthestakeholder,thegreaterwillbetheattentiondirectedtotheirinterests


Chapter 5 Paper P1Corporate Governance and Corporate Social Responsibility June 2015 Examinations

50

The most important group of stakeholders is ( normally ) the shareholders

theyarethelegalownersoftheentity,andcontrolitthroughvotescastattheannualgeneralmeeting

eventhoughtheyowntheentity,theydonotownthepropertyoftheentitythisreinforcesthelegalconceptofanentitybeingaseparatelegalperson

shareholdershaveanumberofstatutoryrights:

therighttotransfertheirshares

therighttoreceivenoticeofmeetings

therighttoattend,speakandbeheardatthosemeetings

therighttoreceiveadividend(whenapprovedbythegeneralmeeting)

therighttoacopyoftheentitysfinancialstatements

oncetheyhavepaidthefullfacevalueofthesharesheldbythem,they(normally)willhavenofurtherobligationtocontributetoashortfallinaninsolventliquidation(butthereareexceptions)

theydoNOThavetoremainloyaltotheentityandmayselltheirsharesatanytime

nordotheyhaveanydutytoensurethattheentityoperatesinasociallyresponsibleway


51Chapter 5 Paper P1Corporate Governance and Corporate Social Responsibility June 2015 Examinations

Corporate social responsibility and disclosure

isasuccessfulbusinessalsoagoodcorporatecitizen?

onlyifitpaysattentiontoitsenvironmentandstakeholders

forexample:

aswellasmakingproductsorsupplyingservices, resulting inprofitability, it shouldalso try tomaximise thebenefitsof,andminimisetheharmcausedby,itsoperatingactivities

it should achieve a balance between its legal responsibilities, its commercial responsibilities and its socialresponsibilities

itshouldconstantlybereviewingitssocialresponsibilityposition

asaconsequenceofacknowledgingitssocialresponsibility,andbeingseentobeactinginaresponsibleway,anentitycouldverywellfindthatdemandforitsproductsincreases

disclosure

generalprinciples

- becauseshareholdersaretheownersofanentity,theyareentitledtobegivensufficientinformationtoenablethemtomakeinvestmentdecisions

- theAnnualGeneralMeetingisseenasthemostopportunetime(oftentheONLYtime!)fordirectorstobeabletocommunicatedirectlywiththeentitysshareholders

- inaddition,thefinancialstatementsareoftentheonlyprintedinformationwhichshareholdersreceivefromtheentity

commonsensewilltellusthat:

moreregularandconstructivedialoguewithourshareholderswillleadto:

- betterunderstandingofshareholdersinterestsandconcerns

- betterunderstandingbytheshareholdersofwhattheentityistryingtoachieve

- increaseinshareholderinterestthereforeencouragingchecksonthemanagersoftheentity

- potentialbenefitresultingfromthecloserinterestintheentitybythemajorshareholders



52

CGC disclosure recommendations

disclosure

itallowstheentitysboardtoprovideinformationongovernancematterstoshareholdersandotherstakeholders

disclosuredemonstratesthatgoodcgprinciplesarebeingappliedbytheentity

alsoameansofcommunicatingmattersofinterestandvalue

CGCcontainspoliciesandprovisionswithwhichlistedentitiesareexpectedtocomply

thesepoliciesandprovisionsrepresentbestpracticeintermsofdisclosure

CGCrequirements

alistedentityisrequiredtostatewithinthefinancialstatements:

- howithasappliedtheprinciplesoftheCGC,and

- whetherithascompliedwiththeCGCthroughouttheaccountingperiod

- andifnot,whynot



CGC additional disclosures

astatementbytheboardacknowledgingtheirresponsibilityforthefinancialstatements

astatementbytheboardtoconfirmtheirviewthattheentityisagoingconcern

detailsofeachboardmembertogetherwithdetailsoftheirresponsibilitiesandtheirrecordofattendanceatboardmeetings

theidentityoftheChair,theCEOandwhichdirectorssitonwhichofthesubcommittees(audit,socialresponsibility,nominations,remunerationandriskmanagement)aswellastheirattendancerecordsatmeetingsofthosecommittees

reportsontheactivitiesofthecommittees

ifthereisnointernalauditfunction,therelevantsectionoftheannualreportshouldexplainwhynot

astatementthatthedirectorshaveundertakenareviewoftheeffectivenessoftheinternalcontrolsystem

areportonthemethodsusedtoevaluateperformanceoftheboardanditscommittees

informationaboutthemeasurestakenbytheboardtoensurethatitunderstandstheviewsofitsmajorshareholders

informationaboutthestepstakentoensurethecontinuingindependenceoftheexternalauditors

wheretheboarddoesnotacceptarecommendationfromtheauditcommittee,thereshouldbeastatementbytheauditcommitteeexplainingtheirrecommendationandwhytheboardhastakenadifferentview



54

Annual General Meetings

everyentitymustholdanannualgeneralmeetingonceineverycalendaryear(Thisisnottechnicallycorrectprivateentitiesmaydispensewiththisrequirementbut,forourpurposes,whendealingwithcorporategovernanceofpublicentities,thestatementistrue)

somequickpointsaboutAGMs

theyarealegalrequirement

eachissuemustbeapprovedbyseparateresolution

themeetingrequiresnotlessthan21daysnotice

thefirstmeetingmustbeheldwithin18monthsoftheentitysincorporationdate

eachsuccessivemeetingshallbeheldnolaterthan15monthsafterthepreviousmeeting

allshareholderswhoareentitledtoattendmustbegivennoticeofthemeeting

theboardshouldusetheAGMtocommunicatewithshareholders,andshouldencouragetheirparticipation

thepurposeofthemeetingistoapprovetheordinarybusinessoftheentitytogetherwithanyothermatterswhichrequireshareholderapproval

ordinarybusinesscomprises:

- thereceivingoftheannualfinancialstatements

- thereappointmentofdirectorsretiringbyrotation

- thereappointmentoftheauditorsforanotherfullyear

- theformalapprovalofthedividendwhichhasbeenproposedbythedirectors

theboardshouldarrangefortheChairofthesubcommitteestobepresentattheAGMtoansweranyquestionsfromtheshareholders,andforalldirectorstobepresent



Other general meetings and proxy votes

entitiesmayalsofindthattheyneedtoholdgeneralmeetingswhicharenotAGMsTheseareOtherGeneralMeetings(OGMs)

somequickpointsaboutOGMs

heldirregularly,andonlywhensomethingurgentariseswhichneedsshareholderapproval

separateresolutionsshouldbepassedforeachdifferentmatter

lengthofnoticeofthemeetingdependsonwhattypeofresolutionistobeproposed

itistheoreticallypossibleforanentitytogofrombirthtodeathwithoutanyneedtoholdanOGM

proxyvoting

ashareholderwhoisunabletoattendageneralmeetingmayappointapersontoattendthemeetingontheirbehalf

suchapersoniscalledaproxyandthedocumentwhichappointsthemisaproxyform

wheretheshareholderisanentity,theywillappointarepresentativeandnotaproxy



56

CGC and proxies

CGCsaysaboutproxies:

foreachresolutiontobeproposed,theproxyformshallprovidetheshareholderwiththeoptionsofdirectingtheirproxytovoteinfavour,against,orwithholdtheirvote

avotewhichiswithheldisnotcountedasavoteneitherinfavournoragainst

theentityshouldensurethatallproxyformsreceivedareproperlyrecordedandcounted

foreachresolution,afteravotehasbeentaken,theentityshouldpublishonitswebsitethedetailsofthevotesand,inparticular:

- thenumberofsharesinrespectofwhichvalidproxieshavebeenreceived

- thenumberofvotesforeachresolution

- thenumberofvotesagainsttheresolution

- thenumberofsharesinrespectofwhichthevotewaswithheld




CORPORATE GOVERNANCE CONTROL SYSTEMS

Internalcontrolisakeyprocesswithinanorganisationconcernedwiththemanagementofriskandtheachievementofobjectives

byinternalcontrolismeantnotonlyinternalcheckandinternalauditbutthewholesystemofcontrols,financialandotherwise,establishedbythemanagementinorderto

carryonthebusinessoftheentityinanorderlyandefficientmanner

ensureadherencetomanagementpolicies

safeguardtheassets

preventanddetectfraudanderror

secureasfaraspossiblethecompletenessandaccuracyoftheaccountingrecordsenabling

thetimelypreparationofreliablefinancialinformation

Internalcontrolandriskmanagementincg

bothelementsofinternalcontrolandriskmanagementarefundamentalpartsofsoundcgbecause:

- cghaskeylinkstorisksandtointernalcontrols

- whilstitisnotpossibletopreventcorporatefailures,goodcgcangoalongwaytominimisetherisk,andwellrunentitiestendtoachievetheirobjectivesinalessriskyway

- sowecanseethatcgisakeytoriskreduction

- theCGC requiresentities tooperateappropriatesystemsof internalcontrol,and toensure that thosesystemsareregularlyreviewedandimproved


Chapter 6 Paper P1Corporate governance control systems June 2015 Examinations

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Turnbull Report and internal controls

requiresthatinternalcontrolsshouldbeestablishedusingariskbasedapproach

specificallyanentityshould:

establishitsbusinessobjectives

identifytheassociatedkeyrisks

designcontrolstoaddressthoserisks

establishasystemtoimplementthecontrols,includingtheprovisionofregularfeedback

objectivesofinternalcontrolsystems

managetheriskswhichhavebeenidentifiedwithinanentityincludingtheriskthattheentityfailstoachieveitsobjectives

internalcontrolsystemsshouldbedesignedsothattheygivereasonableassurancethat:

- operationsarerunningefficientlyandeffectively

- financialreportingisreliable

- applicablelawsandregulationsarebeingadheredto

iftherewerenointernalcontrolsystem,managementwouldbeunabletomonitortheeffectivenessoftheirriskmanagementstrategy,andwouldcertainlynotbeinanypositiontorespondtonewthreatsastheyarose


59Chapter 6 Paper P1Corporate governance control systems June 2015 Examinations

Executivemanagementrolesinriskmanagement

in any entity the board is ultimately responsible for all matters concerning the entity However, it is notunreasonabletoexpecttheboardtodelegatedutiesdowntoindividualexecutivedirectorlevel

CEO(ultimatelyresponsiblefortheentiresystemandoperationsoftheentity)shouldbeseentobeincontrolofriskmanagement

CEOistheoneindividualmorethananyotherwhosetsthestandardforethicsandacceptanceofresponsibility

boardofdirectors,asawhole,isresponsibleforensuringtheadequacyoftheinternalcontrolsystemandtheyshouldthereforeensurethatexecutivedirectorsmonitortheinternalcontrolsystemeffectively

senior executivemanagement is responsible for setting the internal control policies and formonitoring theadequacyandeffectivenessoftheinternalcontrolsystemTheyalsoreporttothefullboardthatthishasbeendone

lower levelmanagement ( not executive directors ) will typically find that these responsibilities have beendelegated to them! But executive directors remain the ones responsible for confirming adequacy andeffectiveness

employeesgenerallyhave the taskof carryingout thedirectors orders, andare therefore theoneswhoarechargedwiththeresponsibilityofensuringthecorrectapplicationoftheinternalcontrols


Chapter 6 Paper P1Corporate governance control systems June 2015 Examinations

60




AUDITORS AND INTERNAL CONTROLS

Function and importance of internal audit

internalaudit(ia)isanindependentappraisalactivityestablishedwithinanorganisationasaservicetoit

itisacontrolwhichfunctionsbyexaminingandevaluatingtheadequacyandeffectivenessofothercontrols

inalargeorganisationiawillbeaseparatedepartment

insmallerentities,itcouldbethatanindividualisallocatedtocarryoutspecifictasksofanianature

itmaybethattheiafunctionisoutsourced

ifitisanin-housedepartment,itisimportantthatthefunctionisstructuredinanappropriateway

scopeofinternalaudit

managementwillprescribethescopeandobjectivesoftheiadepartment,butthesewilltypicallyinclude:

- reviewoftheaccountingandinternalcontrolsystems

- detailedtestingoftransactionsandbalances

- reviewoftheeconomy,efficiencyandeffectivenessofoperations

- reviewoftheimplementationofentitypolicies

- specialinvestigations

- assistingtheexternalauditors


Chapter 7 Paper P1Auditors and Internal Controls June 2015 Examinations

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Independence of internal audit

foranauditfunctiontooperatesuccessfully,itisnecessarythattheauditorisindependent

appliesequallywelltointernalauditorsastoexternalauditors

for internal audit to be effective, the reviews which they carry out must be conducted and reported on on anindependentbasis

theequivalentoftheconfidencewhichisgivenbytheexternalauditorbeingindependent

Comparisonofinternalandexternalauditors

External Internal

Requiredby statute management

Appointedby shareholders management

Reportsto shareholders,andmanagement management

Reportson financialstatements internalcontrols

Opinionabout truthandfairness,properpresentation adequacyofintconts,valueformoney

Scope asnecessary prescribedbyexecutiveboard


63Chapter 7 Paper P1Auditors and Internal Controls June 2015 Examinations

Potential threats to independence

inthesyllabusfortheearlierauditingpaper,

seehowmanyyoucanremember!

f

f

c

l

b

g


Chapter 7 Paper P1Auditors and Internal Controls June 2015 Examinations

64




MANAGEMENT INFORMATION SYSTEMS

informationflowsarevitalifmanagementaretobeabletomanageriskandmonitorinternalcontrols

threeelementswhichshouldbeapparent:

bothinternalandexternalinformationisrequiredinorderthatinformeddecisionscanbemade

theinformationshouldbeprovidedonaregularbasisinorderthatmanagementcanmonitorperformanceofeconomy,efficiencyandeffectiveness

there needs to be clearly defined, effective channels of communication within the organisation so thatmanagementreceivetheinformationonatimelybasis


Chapter 8 Paper P1Management Information Systems June 2015 Examinations

66

Information characteristics

a accessible

a adequate

c complete

c concise

c consistent

i integrated

o objective

p provable

r relevant

r reliable

t timely

u unbiased

u understandable




THE RISK MANAGEMENT PROCESS

Risk and corporate governance

goodcginvolveseffectiveriskmanagement,andthateffectiveriskmanagementinturninvolvesasoundsystemofinternalcontrol(TurnbullReport)

goodcorporategovernancewilleliminateordecreasemanyoftherisksfacinganentity

fairtreatmentofshareholders

rightsofshareholders

theroleofstakeholders

disclosurerequirementsandtransparencyarrangements

boardresponsibilities


Chapter 9 Paper P1The Risk Management Process June 2015 Examinations

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First three principles of good corporate governance

Fairtreatmentofshareholders

preferentialtreatmentshouldnotbegiventoanyonegroupofshareholders

othershareholderscouldresentthisanditcouldresultinbadpublicityfortheentity

Rightsofshareholders

theentitymaynotallowshareholderstheirrights

forexample, if theentity fails toallowashareholder to join indiscussionsatanAGM,or if theentity fails tocommunicatethedetailsoftheAGM

Theroleofstakeholders

entitiesmayignorestakeholders

astakeholdergroupcouldbetreatedinappropriately

forexample,ifanentitytriestomakeanemployeeredundantwithoutfollowingestablishedlegalprocedure


69Chapter 9 Paper P1The Risk Management Process June 2015 Examinations

Final two principles of good corporate governance

Disclosurerequirementsandtransparencyarrangements

directorspossiblyfailtoprovideappropriatereports

directorsfailtoreportthetruefinancialpositionoftheentity

itisnecessarilythecasethat,forproperdisclosureandtransparency,asoundsystemofinternalcontrolintheentityshouldexist

Boardresponsibilities

theboardpossiblydoesnotcontroltheentityadequately

theboardattemptstoruntheentityfortheirownbenefitratherthanforthebenefitofshareholdersandotherstakeholders



70

Managements responsibility for risk management

Riskisdefinedasthechanceofexposuretotheadverseconsequencesofuncertainfutureevents

Itcanthereforebeseenthat:

riskcanadverselyaffecttheachievementoftheentitysobjectives

byreducingthelikelihoodofanevent,oritspotentialimpact,theriskismanaged

theresponsibility formanagingtherisk ismanagementsandtheydosobyestablishingariskmanagementsystem

Processofriskmanagementsystemestablishment

identifypreparelistofpotentialrisks

analyseprioritisethepotentialrisks

reporttomanagementabouttherisksidentified

designriskmanagementsystemprepareavoidanceandcontingencyplans

recommenddesignedsystemforimplementation

implementputinplacetheacceptedsystem

evaluatemonitorand,ifnecessary,re-analyse



Risk management

necessarytomanagerisk:

identifynewrisksthatmayaffecttheentitysoanappropriatemanagementstrategycanbedesigned

identifychangestoexistingorknownriskssoanamendmentmaybemadetoexistingstrategy

ensurethatbestuseismadeofchangingopportunities

managingtheupside

riskappliesequallytogoodnews

thisupsideriskneedstobemanagedjustasmuchasdownsiderisk

managementoftheupsideriskisviewedinadifferentwaythanthedownsidebecause:

risksareseenasopportunitiestobeusedtoadvantage

organisationsareprepared toaccept someuncertainty inorder togaingreaterbenefitsandhigher rewardsassociatedwithhigherrisk

riskmanagementisusedtoidentifyrisksassociatedwithnewopportunitiesleadingtoanincreaseinprobabilityofprofitabilityandmaximisedreturns

effectiveriskmanagementisseenasawayofimprovingshareholdervaluebyimprovingperformance

ALARPattitudetoriskmanagement

manageriskdowntoalevelaslowasreasonablypossible

basically,acostbenefitanalysis



72

strategicoroperational?

Strategic risksarethosewhicharisefromthepossibleconsequencesofstrategicdecisionstakenwithintheorganisation

- examplewouldbewhereoneentitypursuesastrategyofgrowthbyacquisitionwhereasanotheraimstogroworganically

- acquisitionentityisexposedtoagreaterdegreeofrisk,butthepotentialreturnsarelikelytobegreater

Operational risks aretherisksoflossesresultingfrominadequateorfailedinternalprocesses,peopleandsystems,orfromexternalevents

- referstothepotentiallosseswhichmightariseinbusinessoperations

- includesriskoffraudortheftbyemployees

- canbemanagedbyinternalcontrolsystems



Sources and impacts of business risks

businessesfaceriskfromanumberofdifferentsources:

marketrisksassociatedwiththesectororindustryinwhichtheentityoperates

creditrelatestothecreditratingofthebusiness,andthereforeitsabilitytoraisefinance

liquiditytheriskofbeingunabletomeetdebtsastheyfallduebecauseofinsufficientcash

technologicalrelatestotherisksassociatedwhereafastchangingtechnologyaffectsthemarketorproducts

legalriskassociatedwiththeneedtocomplywithlawandregulation

healthandsafetyandenvironmentalissues

reputationthepossibilityofdamagetotheentitysimagearisingfrompoorperformanceoradversepublicity

businessprobityrelatestothegovernanceandethicsoftheentity

derivativesrisksduetotheuseoffinancialinstruments



74

Examples of risks faced by entities

Risk Sources Impact

Market Failuretoprovidegoodscustomersrequire

Marketsectoroveralldeclines.

Entityceasestotrade.

Credit Entityscreditratingisdecreased(on,e.g.StandardandPoors).

Therearegoingconcernproblemssosuppliersarepaidlate.

Entitymaynotobtainmaterialsneededforproduction.

Liquidity Customersarenotpayingquicklyenough.

Thereispoorcreditrating(asabove).Thereispoorcashmanagement.

Entitymaynotobtainmaterialsneededforproduction.

Entitycannotmeetcommitmentswhichmayleadtoentityfailure.

Technological Thereislackofinvestmentinresearchanddevelopment.Competitorsachievetechnologicaladvantage.

Productsappeartobeoutofdate.Thereislossofmarketshare.

Legal Thereisabreachofregulations,e.g.CompaniesAct.Entityissuedbythirdpartyforbreachoflegislation.

AdversepublicityFinesandpenaltiespayablebyentityand/orofficers.

Health,safetyandenvironmental

Breachofrelevantlegislation.Entitytradinginsectorwithadversereputation(e.g.testingonanimals).

AdversepublicityFinepayablebyentityLegaldamagespayable(accidentsatwork).

Reputation ProductionofpoorqualityProductrecalls/adversepublicityagainstentity.

LossofmarketshareIntheextremeentityclosure.

Businessprobity Directors/officersreceivehighbonuseswhenentityismakinglosses.

Entitytradinginsectorwithadversereputation(e.g.armstradewithenemycountries).

AdversepublicityPossibleboycottofentityproducts.

Derivatives Lossesmadeonforwardexchangecontracts.

Financialstatementsdonotadequatelydiscloseentitystransactions/exposure

Financiallosstoentity.Adversepublicity.Possibleclosureofbusinessiflosseslarge



Sector specific risks

businessrisksmaybesimplygeneralrisksfacinganybusiness

butsomeriskswillbespecifictoaparticularentity,market,orindustry

genericrisksincludechangesininterestrates,ornoncompliancewithlaw

inaddition,althoughariskmaybegeneral,itcanaffectdifferentbusinessesindifferentways

aboveexampleofachangeininterestrateswillclearlyhaveoppositeaffectsforoneentitywithasubstantialdepositaccountatthebankandanotherwithalargeoverdraft!

sectorspecificrisksrelatetoaparticularsector,andpotentiallynottoanyothersector

forexample,sectorspecificrisksfacingaprivatehospitalcouldbe:

inabilitytoemploysufficientnumberofjuniordoctors(orevenseniorconsultants)

increaseincompetitionfromanotherprivatehospitalopeninginthesamearea

improvementinstatehealthcaresystemleadingtofalloffindemandforprivatetreatment

collapseofstatehealthcaresystemthroughlackoffunding(remember,riskcanbeupsideaswellasdownside)



76

Analysis of risk

onewayofanalysingriskistoacknowledgethattheprobabilityofriskcouldbehighorlow,andthatconsequences(impact)couldalsobehighorlow

amatrixcanbepreparedshowingthefourpossiblecombinationsofhigh/high,high/lowetc

whenariskisseenashigh/high,itneedsurgentattention/immediateactioninordertomanagetherisk

if the risk ishighprobability,butlow impact, then thepositionneeds tobemonitored,and theentityneeds topreparetomeetthechange

alowprobability,highimpactcombinationneedsactiontobeconsideredand,attheveryleast,acontingencyplan

lowprobabilityandlowimpactkeepaneyeonthesituation,andbepreparedtoadapttoanychange

IMPACT/CONSEQUENCE

HIGH LOW

PROBABILITY

HIGH

LOW



Role of the board in risk analysis

boardhasanimportantroletoplayinriskmanagement,becausethey:

considerriskatthestrategiclevel,andthendefinetheentitysattitudeandapproachtorisk

areresponsibleforimplementingtheriskmanagementprocess,andthereforeforensuringthatthosechargedwithadministeringithaveappropriateresources

arealsoresponsibleforensuringthattheriskmanagementpoliciessupporttheoverallstrategicobjectivesoftheentity

determinethelevelofriskwhichtheentityispreparedtoacceptinordertomeetitsstrategicobjectives

communicatetheriskmanagementstrategytotherestoftheentityandwillensurethatitisintegratedwithallotherentityactivities

reviewtherisks,andthenidentifyandmonitortheprogressoftheriskmanagementpolicies

determine the riskswhichwillbeaccepted,butwhichcannotbemanaged,orwhere it is tooexpensive tomanage.Thesearecalledresidualrisks



78

External reporting

Shouldreportsbemadetopeopleotherthanmanagementconcerningtheinternalcontrolsandriskmanagement?

Pointstoconsider:

reportingmayberequired,ormaybevoluntary

inanextremesituation,itmaybethatthirdpartieshavetobereportedtowheremanagementisunawareofreportingrequirementsorsimplyrefusestoreportvoluntarily

manyreportsareintendedforinternaluseonlyforexample,reportstotheauditcommitteebuttherecanbesituationswhereexternalreportingisrequired

suchexternalreportingwillnormallyonlybedoneasarequirementofcompliancewithlaworregulation,orcompliancewithethicalguidelinesapplicableeithertotheentityitselfortotheexternalregulator

Reportingmethods

threeobviouswaysinwhichentityinformationcanbereportedexternally:

- annualfinancialstatements

- auditors

- auditcommittee



Reporting methods

annualfinancialstatements-internalcontrols

disclosureisrequiredbytheprinciplesoutlinedincgregulationsforlistedentities

detailtobegivenisastatementofthedirectorsassessmentoftheadequacyoftheinternalcontrolsystem,andofhowthedirectorsmaintainthesystem

annualfinancialstatementsrisk

disclosureshouldbemadeexplaininghowthedirectorshaveaddressedsomeoftherisksfacingtheentity

disclosurewouldbemade,forinstance,intheCorporateandSocialResponsibilityReport

auditorsinternalcontrols

wheretheinternalcontrolsystemisweak,thiscouldleadtotheauditorsissuingamodifiedauditreport

thismodifiedreportmaythereforeincludedetailsoftheparticularareasofthecontrolsystemwhichhavegiventheauditorscauseformajorconcern

auditorsrisk

theauditorswouldonlyreportonrisksfacingtheentityinthesituationthattheriskhasgivenrisetoamaterialerrorinthefinancialstatements

auditcommitteeinternalcontrols

inthenormalcourseofevents,theauditcommitteewillreportitsrecommendationsaboutcontrolweaknessestotheboard

onlyinanextremesituation(forinstance,wheretheboardignorestherecommendationsandthesituationisserious)willtheauditcommitteereportexternally(calledwhistleblowing)

auditcommitteerisk

itwouldbeunusualforanauditcommitteetoreportexternallyonmattersconcerningrisk



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CONTROLLING RISK

risk targeting

riskmanager

riskmanagementcommittee

audit(internalandexternal)

risk reduction

riskawareness

embeddingriskinsystems

embeddingriskinculture

diversification

risk avoidance / retention / modelling

riskavoidanceandretention

riskattitude

needforrisk

attitudetoriskdoessizematter?


Chapter 10 Paper P1Controlling Risk June 2015 Examinations

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Risk targeting risk manager

leaderoftheriskmanagementcommittee

reportsdirectlytotheboard

roleisprimarilytooverseeimplementationoftheboardsriskmanagementpolicies

supportedbyriskmanagementcommittee

notnormallyinvolvedindeterminingstrategy

moreofanoperationalrole

policiestobeimplementedaredecidedbyboardandriskmanagementcommittee


83Chapter 10 Paper P1Controlling Risk June 2015 Examinations

Risk targeting risk management committee and audit

riskmanagementcommittee

establishedbytheboard

reportstotheboard

ifnocommittee,functionspasstoauditcommittee

threemainobjectives

- raisingriskawarenesswithintheentity

- ensuringreportingandmonitoringproceduresareinplaceandeffective

- keeping the risk profile up to date, reporting to the board, andmaking recommendations about riskattitude

audit

providesindependentreviewofrisksandcontrols

providesafreshoutlookonthesituation

Soxrequiressomeauditwork

auditorwillreportanyrecommendationsarisingfromtheauditwork



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Risk reduction risk awareness

tobetotallyeffective,riskawarenessneedstobeapparentatstrategic, tactical and operationallevels

alackofawarenessautomaticallyindicatesthatanentityhasaninappropriateriskmanagementstrategy

ifanentityisnotawareofrisksatalllevels,itcouldmeanthattherearerisksaffectingtheentitywhichhaveremainedunidentifiedandthatautomaticallymeansthattheriskisnotbeingcontrolled

evenifthereisawarenessariskcouldoccurbut,becauseofpoormonitoring,theriskisnotcontrolled

continuousmonitoringisclearlynecessary,andmanagementstrategyshouldbereviewedandupdatedasappropriate

risksatthestrategiclevelincludenewcompetition,newtechnology

risksatthetacticallevelincludelossofkeycustomer,supplier,product,licence,employee

risksat theoperational level include failure to recognisechanges inmarket tastes, failure toapplyeffectivequalitycontrolprocedures,repetitivestockouts



Risk reduction embedding risk in systems

itisimportantthatriskmanagementshouldbeincludedwithinanentityscontrolsystemsandnottreatedasaseparateexercise

thispointisincludedasaprincipleintheUKCGCandinlawintheUS

itisessentialthattheboardgivesapprovaltotheprincipleofembeddingriskmanagement

Risk reduction embedding risk in culture

eventhoughriskmanagementmaybeincludedasintegraltothecontrolsystems,itcanonlybeeffectiveifeveryonewithintheorganisationrecognisesitsimportance

inthatway,allpersonnelwillviewtheprocessesaspartofthenormallifeoftheentity

anumberofmattersneed tobe considered in thedecision to embed riskmanagement into the control systemsincludingthegeneralattitudetointernalcontrols,thecommitmentofallpersonneltoriskmanagement,governance

similarly,thereareanumberofwaysofintroducingriskmanagementawarenessintoanentitysuchasperformancetargets,employeerewards,corporatemagazines,website,jobdescriptions,inhousecourses



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Risk reduction diversification

onewayofreducingriskistospreadtheentitysactivitiesoveragreaterrange,whethergeographical,product,targetmarket

inthisway,poorperformanceinonesectorcouldwellbecounterbalancedbyagoodperformanceinanother

tobeeffective,thediversebusinessesshouldnotbecloselyorsimilarlyaffectedbyexternal factorsasthefactoraffectsadverselyonearea,wedontwishittoaffectadverselythediverseareatoo!



Risk avoidance and retention

theexpressionriskavoidancemeansastrategybywhichanentity,quiteliterally,avoidsarisk,whereas

riskretentionistheriskstrategybywhichanentitychoosestoretaintheriskwithintheentity

bothexpressionsareindicatorsoftheentitysriskappetite

forexample,anentitymaychoosetoaccepttheriskofexchangeratemovementsoftheEuro,believingthemtobeprobablyinsignificant,whereas

thesameentitycouldwellavoidtheriskofenteringcontractsquotedintheUzbekistancurrency(thesoum)believingsuchexchangeratemovementscouldwellbesignificant

Risk avoidance risk attitude

attitudeisdeterminedbyacombinationofstrategy,capacityandappetite

theoverallstrategydeterminestheoverallapproach

thecapacityindicateshowmuchrisktheentitycanaccept

theappetitedeterminesthewayinwhichriskswillbemanaged



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Risk avoidance need for risk

acceptingriskcangiveanentityacompetitiveadvantage

equally,anentitywhichisnotpreparedtoacceptriskwillloseacompetitiveadvantagetoanotherwhichis

thegreatertherisk,thegreatertherewardsreturnstendtobehigheronriskierprojects

andthebenefitsdontneedtobefinancialtheycouldalsoinvolvebetterqualityinformation



Risk avoidance attitude to risk does size matter?

thematterofanentityssizeand itsattitudeto risk isnota relationshipwhich isnecessarilycloselycorrelated It ispossible tomake somegeneralisations, but individual entities in their own situation could verywell disprove thegeneralisation

for example, asmall entitywouldnor

Documents

ACCA_P1_notes_J15.pdf