ACCA Paper P1 Governance, Risk & Ethics Final Mock Examination

Question Paper Time allowed Reading and planning Writing This paper is divided into two sections Section A Section B One compulsory question MUST be attempted TWO questions ONLY to be attempted 15 minutes 3 hours

Instructions:
Take a few moments to review the notes on the inside of this page titled, Get into good exam habits now! before attempting this exam.

DO NOT OPEN THIS PAPER UNTIL YOU ARE READY TO START UNDER EXAMINATION CONDITIONS

ACP1GRE12(D) EFM The examination has been prepared for the December 2012 sitting

Get into good exam habits now!

Take a moment to focus on the right approach for this exam.

Effective time management

Watch the clock, allow 1.8 minutes per mark. Work out how long you can spend on each question and do not exceed that time. Take a few moments to think what the requirements are asking for and how you are going to answer them.

Effective planning
This paper is in exactly the same format as the real exam. You should read through the paper and plan the order in which you will tackle the questions. Always start with the one you feel most confident about and take time to choose the questions you will answer in sections with choice. Read the requirements carefully: focus on mark allocation, question words (see below) and potential overlap between requirements. Identify and make sure you pick up the easy marks available in each question.

2 ACP1GRE12(D) EFM The examination has been prepared for the December 2012 sitting

SECTION A ONE compulsory question

Question One
The board of directors of WER has pursued an ambitious growth strategy in the past six years. Under the leadership of its chairman and chief executive officer (CEO) Thomas Yip, the company has become a major listed company on its countrys stock exchange. The company has mostly complied with the governance code for listed companies on the stock exchange, although the nomination of new directors is considered by the whole board and not a separate nomination committee. The growth strategy of the company has not been without its problems. WER made a successful takeover bid for a large rival company, Tred, about two years ago, but at a high price that favoured the Tred shareholders. Since the takeover, new transport and storage regulations in Treds industry have reduced Treds profitability. At WERs last annual general meeting some shareholders questioned why the board did not appear to take the impact of these regulations into account when assessing the future profitability of Tred and hence the price that should have been paid to acquire it. The outcome from the takeover of Tred has been a substantially enlarged business, but with profits only marginally higher than before the takeover. In spite of this, the remuneration of the executive directors of WER has increased substantially in each of the past two years. The directors remuneration is determined by a remuneration committee that consists of the senior partner of WERs solicitors and the Chief Executive of a wellknown charity, who has spent his entire career in the charitable sector. The remuneration committee justified the increases by stating that the executive directors now had much greater responsibilities than in the past, and there were incentive rewards for achieving a high rate of sales growth. A few months after the last annual general meeting, the Tred subsidiary suffered another setback. New transport regulations meant that the company would be required to invest more heavily in environment-friendly transport vehicles, at a high cost. At the next meeting of WERs board of directors, Thomas Yip initiated a discussion on the performance of the board and in particular whether the board had failed to carry out sufficiently well its responsibilities for risk assessment. Thomas Yip also reported to the board that the accounting department had developed plans for a system of environmental management accounting reports, which would provide management and the board with better information about environmental costs. In his view, environmental concerns were growing in importance for the companys business, and this initiative was coming at a good time. He added that it was also the intention of the executive management to apply for certification under the ISO14000 standard. The companys financial year end followed soon after this meeting. The board was disappointed to find that profits had increased by only a very small percentage amount compared with the previous year, in spite of a ten per cent increase in sales revenue. The stock market was disappointed by the news and the companys share price fell. At the annual general meeting following the publication of the annual results, shareholders expressed their frustration at the companys performance. The board was accused of rewarding itself excessively whilst the shareholders obtained no benefit. Some of the non-executive directors were criticised for a poor attendance record at full board and board committee meetings. The failure of the board to address the risks that the company faced was a particular source of shareholder anger. Per Nilsson, the chairman of the audit committee, was standing for re-election to the board at the meeting, and a large number of shareholders voted against his re-election. He succeeded in remaining on the board with only 55 per cent of shareholder votes cast in his favour. This near-failure to obtain re-election was sufficient to make him think more deeply about the failures of corporate governance in the company, the agency problem and the failures of the non-executive directors.

ACP1GRE12(D) EFM 3 The examination has been prepared for the December 2012 sitting

Per Nilsson arranged a meeting with Thomas Yip and suggested that there was an urgent need for improvements in several areas of governance. He welcomed the recent initiative to develop a system of environmental management accounting and the proposal to apply for ISO14000 certification, but he wanted to see further initiatives in environmental risk management. He also argued that a programme should be developed for making the non-executive directors more effective in their roles. As a starting point he wanted to ask his two colleagues on the audit committee to resign, and be replaced with individuals who had a better understanding of finance and accounting matters, as well as greater risk awareness. WER operates in a country that allows both two-tier and unitary structures for corporate boards. A group of shareholders has now combined to call a general meeting of the company, to propose a resolution that WERs board should change from its current unitary structure to a two-tier structure. They argue that under the current structure the non-executive directors have been ineffective, and the executive directors dominate the board and its decision-making. They argue that this is harmful for the corporate governance of the company and highlights the scale of the agency problem that has affected WER. Thomas Yip has asked for a briefing note on the governance issues that Per Nilsson had raised and the arguments for and against a two-tier board structure. Required: (a) (i) (ii) (b) Explain agency and the nature of the agency problem in the context of corporate governance and describe what agency costs are. (6 marks) Analyse the issues that have resulted in agency problems at WER and recommend ways in which these issues can be resolved. (6 marks)

Describe the main features of environment management accounting and environment risk management and construct a case for WER complying with the ISO 14000 family of quality management standards (12 marks) Prepare a briefing note for Thomas Yip that: (i) (ii) (iii) Evaluates the proposal of the shareholders to change the structure of the board to a two-tier structure. (8 marks) Describes measures that should be introduced at WER to improve the effectiveness of the contribution of the non-executive directors. (8 marks) Constructs a case for external evaluation of the performance of the whole board. (6 marks)

(c)

Professional marks will additionally be awarded in part (c) for preparing a briefing note that is clear, has a suitable tone and is appropriately structured. (4 marks) (Total: 50 marks)

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SECTION B TWO Questions only to be answered

Question Two
Hans Trek was appointed as chief executive officer of RTY, a company listed on a European stock exchange, six months ago. He arrived at a time when the company was struggling to survive following the abandonment of an ill-advised and unprofitable capital investment project. He believes that RTY is now much more secure. The board has re-considered its risk appetite, business strategy has been reviewed and the company now has a portfolio of attractive medium-risk businesses. He thinks that he can now turn his attention from business strategy to internal control. Several incidents in the past few months have concerned him and he believes that the internal control system of RTY needs to be improved. (a) The company has been found guilty of issuing misleading advertising for one of its products, and has breached the countrys advertising code. It has been required to pay a substantial fine by the government regulators. Over the last few years the marketing department has run successful campaigns for other products, and the marketing team has been rewarded by substantial bonuses. However these campaigns have been controversial, and RTY was reported to the government regulator on a previous occasion, although that time the complaint was dismissed. The financial forecast for the year was revised by a significant amount after it was discovered that a member of the accounting department had made a mistake in estimating the level of irrecoverable trade receivables. As the staff members work was not reviewed within the accounting department, the mistake was not identified. Hans Trek has also noticed that the accounting department is staffed largely by untrained young staff. The head of IT had reported his suspicion that a rival company had successfully hacked into the RTYs database and acquired the technological details of a new product and a new processing system that RTY has been developing.

(b)

(c)

At a recent board meeting, Hans Trek expressed his concerns about weaknesses in internal control and recommended that an internal audit section should be established by the company with specific responsibility for monitoring internal control in RTY. The Chairman of the audit committee argued that the companys external auditors could be appointed to do this work, without the cost of a full-time internal audit section, but the board finally agreed with the recommendation of Hans Trek. He has been authorised to establish an internal audit unit, in consultation with the Finance Director (FD) and the Chairman of the audit committee. The job description they have drawn up for the Head of Internal Audit (HIA) states that the HIA will report to the FD. Required: (a) (b) Define the control (internal) environment and analyse what the recent problems and developments illustrate about the current control environment at RTY. (8 marks) (i) (ii) (c) Explain, with reference to RTY as appropriate, how an internal audit department can contribute to improvements in internal control. (8 marks) Construct the argument against appointing the external audit firm to carry out a review of internal control in RTY. (4 marks)

Explain the nature of the threat to the independence of the Head of Internal Audit (HIA) at RTY and describe the reporting arrangements that should be put in place in order to protect the HIAs independence. (5 marks) (Total: 25 marks)

ACP1GRE12(D) EFM 5 The examination has been prepared for the December 2012 sitting

Question Three
The past eighteen months have been a bad time for Downdeep Mining (DDM). Eighteen months ago, there was a major accident at one of DDMs mines, resulting in a large loss of life among employees and the closure of the mine, leading to extensive redundancies in the local area. The catastrophe attracted global media coverage. The local regulators and police authorities are currently investigating the accident, suspecting a breach of health and safety regulations as its cause. More recently, DDM has been forced to abandon a joint mining venture with a company owned by the son of the political dictator in a newly-established country when it was discovered that the son was using the company as a front for drug trafficking and money laundering. The joint venture company was wound up and DDM has lost all mining rights in the country. As a result of these incidents, and their aftermath, the reputation of DDM with investors and the general public has fallen to a very low level. The share price has fallen over 25 per cent in the past eighteen months. DDM has a large bank loan that will mature in the next few months, which it is hoping to renew, and it also has plans to launch a new issue of bonds. The finance director (FD) is not sure, in view of the poor reputation and share price performance of DDM, whether it will be possible either to renew the loan or make a successful bond issue. In the FDs view, the company must recognise the damaging consequences of reputation risk and that risk management within DDM must be improved. The FD argues that a separate risk management function should be established, staffed by specialists with relevant risk management experience and reporting directly to the Chief Executive Officer (CEO), rather than placing full responsibility on operational managers and using external consultants for advice as required. In addition the FD proposes that the ALARP principle of risk management should be applied to all risks within the company. Required: (a) (b) (c) Define reputation risk and assess the impacts that DDM has suffered and might suffer in the future from the events that have resulted in the damage to its reputation. (10 marks) Explain the roles of a risk management function and assess the contribution that a separate risk management function could make to risk management within DDM. (8 marks) Define the ALARP principle of risk management and explain how this principle may be applied to risk management within DDM. (7 marks) (Total: 25 marks)

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Question Four
CVB is a petrochemicals company but its Chairman, Chief Executive Officer (CEO) and Finance Director (FD) are all professional accountants. Under the countrys greenhouse gas (GHG) regulations, companies are required to submit regular reports to the government authorities about the quantities of their GHG emissions. These reports are posted on a government web site and are available for public inspection. In CVB, the accounts department has responsibility for gathering the information for submission to the government authorities, but the report must first be submitted to, and approved by, the board of directors. Following a high level of GHG emissions in the previous period, the board demanded that the level of emissions should be reduced substantially in the future. There was a risk that, unless this happened, the authorities would demand the immediate closure of some of the companys manufacturing plants. The Chairman however also wanted to reduce emissions levels beyond what the authorities were likely to require and include more environmental data in the accounts than was required by law or accounting standards. The Chairman argued that going beyond what was required would benefit CVB by promoting its ethical credentials. The GHG report for the most recent period was received from the accounts department and submitted to the authorities. This showed a large fall in GHG emissions compared with the previous period. The CEO was surprised by the figures in the report, since he had been concerned about the possibility of an increase in emissions in the period. After the figures were published, the board received feedback from a member of the accounts department querying the figures and the CEO decided to investigate what had happened. After close questioning by the CEO and the Chairman, the FD admitted that the figures were incorrect and the emissions had been under-stated. As his excuse, the FD said that he had been under intense pressure from the CEO to provide improved figures on gas emissions. At the same time he had been under severe emotional pressure due to family problems at home. His daughter had been seriously ill in hospital for a while and the FD did not have the time to prepare the GHG emission figures with the care that was needed. He subsequently realised mistakes had been made, but was worried about losing his job and the impact on his family that this would have. The FD said that the faulty figures were a once-only failure and that in future the GHG emissions figures would be reliable. The chairman expressed the view that the FD had acted both unethically and unprofessionally in reporting misleading figures.. He also believed that the whole board would be held responsible by shareholders and regulators for the mistakes made by the FD. In his view disciplinary action should be taken against the FD. The CEO was not so sure. He recognised that there was an error in the report, but if accurate figures were submitted to the authorities the company might be ordered to close some of its plant, putting people out of work. This would be devastating for them, their families and the communities in which they lived. In addition, the FD had been under pressure at work and at home, so his actions could be understood. The CEO asked for time to think about what he believed should now be done. Required: (a) Assess the boards decision to reduce emissions to a greater extent than is required, and provide more environmental data in the accounts than is required, in the light of Gray Owen and Adams expedient position on corporate social responsibility. (7 marks) Explain responsibility in the context of corporate governance and explore the extent to which the board as a whole could be held responsible for the actions of the Finance Director. (8 marks) Using Tuckers model for decision-making, assess the CEOs dilemma on whether or not to disclose the information publicly. (10 marks) (Total: 25 marks)

(b) (c)

ACP1GRE12(D) EFM 7 The examination has been prepared for the December 2012 sitting

Student self-assessment
Having completed this paper take a few minutes to consider what you did well and what you found difficult. Use this as a basis to focus your future study on effectively improving your performance.

Common problems
Timing and planning
Did you finish too early? Did you overrun? Y/N Y/N

Future emphasis if you answer Yes

Focus your planning time on generating more ideas. Use models to help develop width to your thinking. Focus on allocating your time better. Practise questions under strict timed conditions. If you get behind leave space and move on. Focus your planning time on developing a logical structure to your answer.

Did you waffle?

Y/N

Layout
Was your answer difficult to follow? Y/N Use headings and subheadings. Use numbering sequences when identifying points. Leave space between each point. Show why the point identified answers the question set. Give yourself time and space to make the marker's job easy.

Did you fail to explain each point?

Y/N

Were some of your workings unclear? Y/N

Content
Did you struggle with: Interpreting the questions? Y/N Learn the meaning of question words (inside front cover). Learn subject jargon (See the Key Terms in your Study Text). Read questions carefully noting all the parts. Practise as many questions as possible. Review your notes/Text. Work through easier examples first. Contact a tutor for help. Quiz yourself constantly as you study. You need to develop your memory as well as your understanding of a subject.

Understanding the subject?

Y/N

Remembering the notes/Text?

Y/N

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ACP1GRE12(D) EFM The examination has been prepared for the December 2012 sitting