ACCA Paper P1 Professional Accountant On-line 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:
Please attempt this exam under test conditions and attach the frontsheet complete with your name and address to your script. The completed package should be sent to BPP Marking Department. 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

ACP1FM10(J)

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.

SECTION A ONE compulsory question

Question One
Company overview MePacks Inc is a large multi-national company producing and selling goods within Europe, but also exporting to most countries in the world. MePacks specialises in the manufacture of sporting equipment ranging from tennis rackets to parachutes used in sky-diving. The company always attempts to be one step ahead of its competitors by incorporating the latest technology into its products. For example, the latest parachute has built-in GPS and the next generation of skis carry homing beacons which are activated if the skier is caught in an avalanche. The GPS system simply tells the user of the parachute where he or she is, but has no effect on the functionality of the parachute itself. MePacks is very profitable: the use of new technology and being the first to market goods incorporating that technology enables MePacks to charge a premium price. MePacks also has a good reputation for quality, and its returns policy slogan if its not good for YOU, return it to ME provides a high level of market awareness. The company attempts to ensure its products are technologically up-to-date by involving executive directors full time in key decision areas. Joe Patronie the company Chairman also uses his business knowledge and influence to ensure new innovations are incorporated into company products on a timely basis. The board of MePacks comprises 4 executive and 2 non-executive directors, with all directors having worked for the company for at least 8 years to ensure they have good knowledge of the company and its products. To ensure focus on company success, Joe Patronie maintains the roles of Chairman and CEO in MePacks. There are separate audit and nomination committees, which comprise the non-executive directors and are chaired by an executive director (not Joe). Recent events at MePacks Joe Patronie is always in the news utilising various attention grabbing activities which promote MePacks products such as taking balloon flights across the Atlantic or skiing down glaciers. Recently, his private life came under closer scrutiny when it was realised he had purchased a fleet of antique Rolls Royce cars and was employing his children to maintain the cars as MePacks employees. Unfortunately the children concerned were all at various universities and had never seen the cars, let alone maintained them. Following intense media and shareholder pressure, Joe finally resigned and received a termination payment based on the previous years profits of MePacks of 4 million. Shortly after the departure of Joe Patronie, a number of key research and development staff in MePacks main research building were accused of stealing memory chips and were immediately dismissed. The employees concerned maintain that they are innocent and have commenced litigation against MePacks for breach of employment legislation. MePacks HR manager has refused to comment on the situation stating that the matter is now in the hands of the courts. MePacks are also being sued by a customer for supplying what the customer describes as a defective snowmobile (this is a recreational vehicle using powered skis as a form of transport). The customer was left stranded on ice close to the Arctic Circle in winter when a solar powered emergency transmitter failed to work after the customer crashed the snowmobile. The customer was rescued by a passing group of Inuit but sustained severe frostbite.

Required: (a) Write a report to the board of MePacks to include the following: (i) (ii) Briefly explain the principles based approach to corporate governance and discuss the advantages of this approach. (6 marks) Discuss, using appropriate examples from the scenario, the extent to which MePacks may not have an appropriate system of corporate governance, explaining why improving this may be of benefit to MePacks. (8 marks) Professional marks for structure, style, layout and logical flow. (4 marks)

(iii) (b)

Reputation and integrity are principles that apply to the company as a whole and to individual directors. Explain what is meant by the principles of integrity and reputation and evaluate their relative importance in the context of corporate governance at both a corporate and personal level. Your answer should refer to the scenario where appropriate. (14 marks) Explain the process MePacks should undertake to manage the risks associated with a new product such as the parachute with built-in GPS. (10 marks Explain what is meant by consequentialist / teleological ethics and explain which form of teleological ethics the CEO Joe Patronie is demonstrating. (8 marks) (Total: 50 marks)

(c) (d)

SECTION B TWO QUESTIONS ONLY TO BE ANSWERED

Question Two
WishKeys main activity is the production and installation of site services management systems (SSMS) in office buildings. The organisation is able to evaluate the need for SSMS in an office, quote for and then install that system. The SSMS ranges from installation of air conditioning through to electrical wiring and provision of secure networks for computer use. The board of WishKeys has decided to prepare and publish a Corporate and Social Responsibility report for the companys next financial year end. An initial draft of the report includes the phrase: WishKeys will always guarantee that all environmental legislation are met in any installation and that all ethical and social requirements over and above legislative requirements are catered for. This report aims to confirm that WishKeys will not compromise on environmental or social issues. This risk manager has read the draft report and remains concerned regarding the overall approach to the report, as stated above. Specific concerns relate to implementation of specific SSMS which are ethical according to WishKeys but not to other organisations. For example, WishKeys uses bio fuel to power backup generators in case of power outages in preference to oil based products as this is ethical. However, bio fuel farming can cause rainforest depletion, which may not be seen as ethical. The chairman of the companys Audit Committee has suggested that the CSR report be certified by WishKeys external auditors to give added assurance. Required: (a) (b) Explain the difference between mandatory and voluntary reporting and evaluate the reasons why a company may wish to undertake voluntary disclosure. (6 marks) Explain the roles of the risk manager and assess the concerns of the risk manager in WishKeys regarding the statement in the CSR report with reference to those roles. (12 marks) Discuss the work of the Audit Committee, making specific reference to voluntary disclosure of information by WiskKeys where appropriate. (7 marks) (Total: 25 marks)

(c)

Question Three
ZooInc produces a limited range of anti-inflammatory drugs (an anti-inflammatory drug is one which reduces swelling) for different parts of the body. The companys latest drug is aimed at reducing heart inflammation and is due to be marketed in the next few weeks. As with other drugs it produces, ZooInc expects to make a significant profit from this drug providing shareholders with a high return on their investment. All trials of the new drug have been successful, although the majority of those trials were carried out on animals. Although there is no confirmed information available, various unofficial reports suggest that at least 200 rats and 175 mice were killed during the testing phase. However, the drug is expected to benefit over 40,000 people world-wide during its first year of use alone, with 15,000 deaths being averted. A pressure group of animal activists have recently attacked ZooIncs premises, releasing a significant number of test animals and stealing a copy of the shareholders register. The group insist that they will continue action against the company and all those involved with it until animal testing is stopped. As a result of the attack and threats, ZooIncs share price has fallen by 15% in the last week. Required: (a) (b) (c) Using an ethical decision making model, (eg the American Accounting Association Framework) evaluate the choices facing the shareholders. 10 marks) Assess the factors that the board might consider in deciding how to respond to the controversy and comment on the legitimacy of the animal activists claims on ZooIncs activities. (8 marks) Explain the concept of the company as a corporate citizen of society and discuss the rights and responsibilities of the company, making reference to the situation at ZooInc. (7 marks) (Total: 25 marks)

Question Four
GetUm Inc researches, develops, manufacturers and finally markets cutting edge technology products. The company has five research and manufacturing buildings in different cities and a head office in the capital of the country it is located in. The company invests significant amounts of money in research and development, but tends to spend minimum amounts in other non-key areas such as human resources and training. Staff, managers and directors are paid well, but also expected to learn on-the-job with little or no formal training. The company takes this stance to maximise R&D effectiveness and limit the amount of time a new product takes to get to market. The shareholders of GetUm are normally asked to appoint one or two new directors each year. Again, rotating directors on a regular basis is seen as a method of obtaining new ideas and ensuring that the company does not stagnate. On appointment, directors are introduced to their senior management team, and then expected to work closely with this team within the companys head office. Contact with other departments and third parties is minimal; for example the newly appointed finance director is only expected to meet the auditors at the completion of the audit. Following appointment, the only formal evaluation of the effectiveness of the board is the amount of profit made by GetUm. This approach is taken to again limit the amount of time and expenditure on non-core activities. Required: (a) (b) (c) Critically evaluate the current induction training for directors in GetUm Inc and recommend improvements to ensure minimum governance requirements are met. (12 marks) Explain the role of the remuneration committee in a company such as GetUm Inc and assess the elements of an appropriate remuneration package for the directors in GetUm. (7 marks) Explain how the performance of the board as a whole and the performance of individual directors should be assessed. (6 marks) (Total: 25 marks)

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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ACCA Paper P1 Professional Accountant On-line Final Mock Examination

Commentary, Marking scheme and Suggested solutions

ACP1FM10(J)

Commentary
Tutor guidance on improving performance on the exam paper
The key to success in P1 is application of wide and varied syllabus knowledge, flexibly and in enough depth in the time allowed. This mock examination is a realistic test of your ability towards the final stages of your preparation for the real event.

Section A Q1
The MePacks scenario focussed on reputation. The company had a reputation for profitability and quality. It then suffered events which had a negative impact on the reputation of the Chairman/CEO, on the companys fairness in dealing with employees and on the quality of its products. Its Corporate Governance regime was not to best practice and it faced the sudden departure of the joint Chairman/CEO The five requirements were drawn from all parts of the syllabus. Part (a) required a report and attracted 4 professional marks. It covered the principles based approach to corporate governance and specific improvements to MePacks Corporate Governance regime. Part (b) covered two fundamental principles, reputation and integrity. It was a demanding requirement with 14 marks available, Part (c) was a straightforward question about the risk management process. In part (d) there was straightforward recall of technical knowledge on ethical theories, but the second half of the requirement was to identify which theory was being used.

Section B Q2
WishKeys addressed the issues surrounding voluntary disclosure of information in this case in a Corporate Social Responsibility Report. It looked at voluntary disclosure from the point of view of why a company would do it to the risks involved in providing extra information and finally the role of the Audit Committee when non-financial, voluntary information is published. Part (a) started with straightforward definitions of voluntary and mandatory reporting and why companies undertake voluntary reporting. Part (b) looked at the risks of reporting extra information and the role of a risk manager. Part (c) touched on voluntary reporting but also covered the wider work of the Audit Committee.

Q3
ZooInc set the scenario of a company which undertook animal testing. It raised ethical questions for both the company and its shareholders when animal rights protestors made threats against them. In part(a) the requirement was to work through the problems faced by shareholders using an ethical decision making model such as that of the AAA, OECD, ACCA or Tuckers five questions. Part (b) was a fairly open question similar to one of the supplementary questions published by the examiner. It requires careful thought and planning to ensure that the answer is well structured. Part (c) tests Corporate Citizenship and is typical of the fairly academic questions that the examiner can ask.

Q4
GetUm set up the scenario of a fast moving business which does not waste too much time or money complying with Corporate Governance principles. It looked specifically at some of the issues affecting the board of directors. Part (a) was about induction for new directors. Part (b) was about the role of the remuneration committee and remuneration packages and part (c) covered assessment of board and directors performance. This was probably the most straightforward of the three optional questions.

SECTION A 1
Marking scheme
(a) (i) Explanation of principles based approach up to 2 marks, advantages of this approach up to 4 marks. (ii) Up to 3 marks for each point about MePacks (1 mark for the flaw in current system, 1 mark for best practice and 1 mark for how MePacks will benefit) up to a maximum 8 marks- 3 areas to be covered to achieve high marks (iii) Up to 4 professional marks for structure, style, content and layout of the report. Explanation of integrity and reputation up to 2 marks each Discussion of relevance and importance of ethics on a corporate Level up to 6 marks Discussion of relevance and importance of ethics on a personal level up to 6 marks Marks 6 8

4 18 Up to 4 Up to 6 Up to 6 14

(b)

(c)

Up to 2 marks for each section of a risk management process. To obtain 2 marks, a point MUST be related to the MePacks. Only 1 mark available if not. Flexibility allowed on wording of stages Up to 2 marks for discussing consequences in contrast to action. Up to 2 marks for discussing utilitarianism Up to 2 marks for discussing egoism Up to 2 marks for explaining Joes actions as form of egoism

10 8

(d)

50

Suggested solution
(a) Report Corporate Governance at MePacks Prepared By: A N Other Date: 1/5/08 (i) Introduction A principles-based approach to corporate governance focuses on setting objectives rather than mechanisms by which those objectives will be achieved. For example, a code of governance could have the objective that minority shareholders will be treated fairly, rather than stating in precise terms how to communicate to those shareholders, how to involve them in meetings or providing lists of decisions or information which those shareholders must always receive. Principles-based systems are normally used in jurisdictions where the main regulatory body for setting standards for companies to follow is the stock exchange.

Advantages of a principles-based approach Avoids the need for inflexible legislation, or the need to change that legislation on a regular basis. The principle can be applied across many situations or different types of companies. It is normally less burdensome in terms of expenditure. There is less governmental interference with companies and consequently a reduced need to show compliance with potentially excessive legislative requirements. The approach allows companies to develop their own methods of applying the codes of governance, rather than follow a strict regime. The method of monitoring corporate governance is normally comply or explain. This means that companies can provide information on how they have decided to apply governance codes to their own specific situation. The overall approach means companies provide investors with information on how the company has applied codes of governance. It is therefore up to the investors to determine the extent to which the company has a good corporate governance regime. They can either then take action to improve governance if this is seen to be failing, or divest if they disagree with the governance situation.

(ii)

Lack of non-executive directors (NEDs) The board of MePacks comprises 4 executive and 2 non-executive directors. This raises issues of poor governance because the 2 NEDs may have insufficient power to either monitor the activities of the executive directors or provide an effective mechanism to disagree with their actions. The NEDs will always be out-voted at board meetings. Most codes of governance suggest that there is a balance of executive and non-executive directors with the chairman (again normally non-executive) having the casting vote. This balance helps to ensure that executive directors remain focused on taking decisions in the companys interest. Combined Chairman and CEO In MePacks, Joe Patronie maintains the roles of Chairman and CEO. This means that Joe runs MePacks and also the board. He will therefore have a significant amount of power within the company. Codes of governance normally suggest that the roles of Chairman and CEO are kept separate so no one individual can dominate the board. Separation also helps to ensure that the CEOs decisions on running the company can be challenged in the board meeting by the chairman and other directors. Board sub-committees The main board sub-committees in MePacks are the audit committee and nominations committee. While codes of governance normally require these committees, they are not completely independent; both committees are chaired by executive directors rather than a NED. Having a NED chair helps ensure independence from the executives of the company; the NED can ensure reports of internal and external audit are actioned and that nominations for board positions are made on merit, rather than personality. Length of service of board members All members of the board of MePacks have been with the company for more than 8 years. This may be a disadvantage, particularly for non-executive directors, as they will lose their independent view of the company and may not be able to challenge decisions of executive directors because they are too close to the company.

Most codes of governance suggest that NEDs be appointed for no more than 6 years to ensure their independence is not compromised. Lack of remuneration committee In MePacks, Joe Patronie sets the remuneration levels and contracts of all board members. The main disadvantage of this situation is that there appears to be no independence in the determination of remuneration levels. Codes of governance suggest that a remuneration committee is established, comprising mainly NEDs. The Chairman of the board could be a committee member but not the chair of that committee. (b) The principle of integrity means straightforward dealing. In terms of reporting it means completeness and as a personal quality it means having a high moral character and being honest. Joe Patronies personal integrity could be questioned because he allowed his family to benefit from payments that would not have been made had all the facts been known. The companys integrity could be in doubt because of the disparity between the way in which the employees accused of stealing have been treated, with no apparent investigation into the accusations and Joes treatment with a generous bonus being paid to him despite evidence of deceit. Reputation as a principle of corporate governance could be said to consider not just what you do but what you are seen to be doing. Both personal and corporate reputations depend on the perception or expectations of others. In the case of MePacks they have developed their customers perception of their product as high quality and worth a premium. They have also worked to develop the perception that they will settle customer disputes without quibbling. This expectation has been challenged by the event involving the snowmobile. For companies integrity can have a positive impact on reputation and as such can be a source of competitive advantage since customers, suppliers and employees will all prefer to work with companies of high integrity. It may lead to a greater tolerance from society of companies self regulating. Similarly for individuals, personal integrity will have a positive effect on their reputation. Acting with integrity also has the advantage of allowing one to focus on actually doing ones job rather than have to expend effort on covering up failings or frauds. In both cases the disadvantage is when one is competing with companies or fellow employees who lack integrity but who have managed to maintain their reputation. Joe enjoyed a financial advantage over fellow directors with greater integrity until his deception was uncovered. Corporate reputation is important as an asset of the company that needs to be managed. Events which damage a companys reputation can have an adverse effect on share price, on market share, on the ability to find suppliers and to recruit employees. In the case of MePacks the company is likely to lose market share as a result of the snowmobile incident and suffer problems recruiting because of the dismissed employees. However if the company acknowledged its shortcoming in respect of both these events and took steps to deal fairly with both the employees and the customer its long term reputation would not be harmed and its reputation would recover faster in the short term. Personal reputation can affect an individual's career prospects and how effectively they are able to do their job. Joe had to resign once his reputation had suffered irreparably as he would have found it harder and harder to lead the company with any kind of moral authority. From the point of view of others, integrity is the most valuable quality, since it will reduce agency costs (for shareholders) or transaction costs (for customers, suppliers, employees etc). However, since one usually only finds out about a company or an individuals lack of integrity once it is too late, we are left using reputation as a proxy for integrity. From a utilitarian, long term point of view

integrity is the most important quality and from the point of view of short term egoism, reputation is more important. (c) A framework for risk analysis is: Risk identification Risk assessment Risk profiling Risk quantification Risk management Risk consolidation Risk identification Risk identification involves attempting to identify potential risks before they materialise. This implies knowledge of the industry the company is in, the products being manufactured and potential uses of those products. When risks are identified, they are usually categorised into strategic and operational risks, so that they can be appropriately assessed and managed. Regarding the parachute, MePacks will need to list potential risks such as the parachute failing from poor manufacture or materials, or users being sent the wrong way due to GPS failure. Presumably, parachute failure is paramount to avoid as this will normally result in death of the user. Investigation into potential uses of the GPS will help to identify risk in this area. Risk assessment/Risk Profiling Risk assessment is an attempt to understand the nature of the risk in terms of how likely it is to present itself and what the impact or consequences of it would be. A likelihood consequences matrix can be used to group and analyse risks effectively, and can then be used as a method of setting priorities for risk mitigation. The greater the likelihood of the risk occurring and the higher the impact of the risk, then the greater the need for risk mitigation strategies. In MePacks, parachute failure has been identified as the low likelihood, but high consequence risk. This risk can be mitigated by ensuring quality products are used in production and that the parachute and GPS systems are tested prior to product release Risk quantification Risks that require more analysis can be quantified. This means that possible results or losses can be calculated using probability analysis, to provide an estimate of the total exposure of the organisation, should a risk actually crystallise. The outcome of the analysis will show the risk manager the frequency and magnitude of loss that the organisation could face. For MePack, financial loss from parachute failure is difficult to quantify. The effect on lost sales, court cases etc., may simply be estimated. However, it would be inappropriate to sell the parachute knowing failure could occur. At best, the estimate of cost will be obtained and agreed with insurers, if risks are to be mitigated this way. Risk Response When risks have been clearly identified and managed, suitable responses need to be planned. The four types of risk response are as follows: Transfer, Accept, Reduce, Avoid (known as the TARA model) In terms of the new product that Mepacks is hoping to launch, the risk of failure could perhaps be reduced by extensive pre-launch product testing. Risk transfer could be achieved by taking out product liability insurance. Risk Consolidation Finally, risks that have been identified in individual products or divisions will be aggregated to company level. The aggregation shows the total risk the company is facing so additional work, e.g. ensuring the risk appetite has not been exceeded, can be undertaken.

MePack will need to aggregate risks from all products, not just parachutes, to ensure the company can bear the total risk. Where risk is excessive, changes in the product portfolio can be considered, e.g. focusing more on the manufacture of lower risk items such as footballs or tennis rackets. (d) A consequentialist approach to ethics makes judgements about an action in terms of the value of the outcomes of those actions rather than the value of an action itself. It can be contrasted with a deontological approach which judges the value of the action itself. So for example the decision whether to kill a terrorist who is about to blow up hundreds of other people made from a deontological point of view would judge whether it is right to carry out the action of killing another individual. From a consequentialist point of view one would consider the outcomes of killing or not killing the terrorist, ie bring in the fact that it would save other lives. There are two types of consequentialist thinking, utilitarianism and egoism. Utilitarianism judges the outcome in terms of the greater good, which could be either a few people valuing the outcome a great deal or many people placing a small positive value on the outcome. In terms of egoism, an action is ethically justified when decision makers can be shown to be pursuing their own short-term desires or long-term interests. Although in terms of egoism, an individual will be seen to be pursing what they want, it is also thought that actions taken under egoistic principles will also be good for society. Two assumptions, free competition and perfect information, mean that the reasons for actions will be clearly seen to others. This means, for example, that a company will strive to produce goods which provide value-for-money as information on those goods, and competitors goods, will be freely available in the marketplace. Consumers will therefore purchase goods which do provide the best value for money. In terms of the CEO Joe Patronie, it can be argued that he is only following an egoistic approach because his actions show him pursuing his and his familys interests. Employing family members ensure that they have some financial security, while receiving a high salary and having a large termination payment ensure that he does not have to look for other work outside of MePacks. It can be argued that egoism has not worked for MePacks due to lack of information. The CEOs children were employed by MePacks without full knowledge of the board or the stakeholders. Similarly, the high salary provided to Joe allowed him to pursue other interests and possibly spend less time working for his main employer. Only by providing perfect information could egoism be expected to work.

SECTION B 2
Marking scheme
(a) Up to 2 marks for explaining mandatory disclosure. Up to 2 marks for explaining voluntary disclosure Up to 2 marks for reasons of voluntary disclosure For each role identified Up to 2 marks for explaining the role Up to 2 marks for discussion of concerns (1 only if not related to the role) Each area of work Link to voluntary disclosure Maximum per point 1 1 2 Marks 6

(b)

12

(c)

7 25

Suggested solution
(a) Mandatory and voluntary disclosure Mandatory disclosure means that an organisation must disclose various items or information in its annual report and accounts as this is required by statute law or by the regulations of its governing body. For example, in the UK, the Companies Act requires various accounting disclosures to be followed while the stock exchange prescribes various governance disclosures. The latter in theory could be ignored, although delisting may well be a result of this action. Voluntary disclosure can be defined as any disclosure above the mandatory minimum. In other words disclosure is not required, but organisations decide to produce the information anyway. Examples of voluntary disclosure include, at present, a Chief Executive Officers report and a social / environmental report. Voluntary reporting may be company specific or follow a specific format such as the Global Reporting Initiative. Reasons why organisations may choose voluntary disclosure include: (b) To show compliance with environmental or other standards To promote the organisation as a good corporate citizen As a method of advertising the organisation, for example to attract environmentally conscientious customers to purchase its products.

The COSO framework and other sources identify the key roles of the risk manager. The main role of the risk manager is to provide overall leadership in the risk management strategy of an organisation. This role has many other subsidiary roles as outlined below. Risk management framework The risk manager will establish an integrated risk management framework for all aspects of risk across the organisation. This means integrating risk management with other business planning to ensure that authority and accountability for risk management is considered in all business units and individual business activities. While risk management can be integrated into company activities, the CSR report appears to indicate that WishKeys will always comply, not only with all legislation but also with ethical

10

requirements. Given ethical requirements change over time, there is a risk that WishKeys may fall behind current ethics or simply take action that the company believes is ethical, but it may not be ethical from a different viewpoint. WishKeys is therefore exposing itself to the risk of not following appropriate ethics. Embedding Risk Management throughout the organisation The manager will promote an enterprise risk management competence throughout the organisation which will include assisting managers to identify risks, applying appropriate responses to those risks and developing appropriate controls to ensure that risks to not crystallise. Regarding the CSR report, this will mean monitoring ethical values and identifying situations where WishKeys does not follow those values. Again, given there is no definitive list of ethics this will be a difficult task for the risk manager. Risk management policies The organisation will need to develop risk management policies which will include quantification of risk appetite and setting limits for risks. The risk manager will use his expertise to assist in this activity. Quantification of risk is difficult when risks cannot easily be identified. It is possible that WishKeys could be subject to adverse publicity for using bio fuels, although there are some environmental benefits. Risk identification systems The manager will need to maintain systems for identifying risks and then recording losses and incidents where risks crystallise. Recording will assist in identifying potential areas for risk in the future as well as quantifying those risks. Again, systems for identifying unknown risks will be difficult to establish with reference to the CSR. Dealing with insurance companies The manager will also be the point of contact for dealing with insurance companies to determine cover available for specific risks and negotiate appropriate premiums where the risk management strategy indicates transference is the appropriate option. Regarding the CSR, a risk transference strategy may be impossible where risk identification is also impossible. Risk minimisation may require alternate strategies, as discussed below. Amendments to risk management strategy Finally, the manager will report to the risk committee and ultimately the chief executive on the overall process of risk management, recommending amendments to the organisations risk management strategy where appropriate. In this situation, the risk manager will need to recommend to the CEO that either the statement on ethics is amended or removed, or alternatively a disclaimer put into the CSR showing that the report provides guidance on the approach being taken by WishKeys, but it is not a legal document or formal statement of intent. This should help to remove the risk of being sued for inappropriate comments. (c) Work of internal audit committee Review of financial statements and systems The committee will review quarterly and annual financial statements. The aim is to ensure the accuracy of the information and to ensure it is presented fairly. Internal reports will also be monitored and key performance indicators checked to ensure the organisation is meeting its objectives. The committee should therefore query the reasons for any voluntary disclosure and ensure that amendments are made, where necessary, to avoid unnecessary liability.

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Liaison with external auditors The committee will be involved in appointing external auditors, setting their remuneration and monitoring their work and independence to WishKeys. The committee will also discuss external audit work and reports from the auditor prior to final board consideration of those reports. External auditors will not, at least as part of a statutory requirement, audit voluntary disclosure information. However, they may be asked to review voluntary information as part of a separate engagement (a different firm of auditors will normally undertake this work due to independence considerations). In this case, the internal audit committee will again discuss this report and suggest amendments to voluntary disclosure as appropriate. Review of internal audit The committee will monitor the work of internal audit, including adherence to standards, scope of work, method of work and discussing internal audit reports. The impact of internal audit work on voluntary disclosure is likely to be minimal as internal audit normally focus on internal control systems and mandatory disclosure items. Review of internal control The committee will ensure that WishKeys systems of internal control are working correctly and monitor systems to ensure compliance with legislation including areas such as environmental legislation where necessary. Some detailed monitoring work will be delegated to internal audit, but overall responsibility remains with the committee. Ensuring compliance with legislation does not necessary lead to additional voluntary disclosure (e.g. compliance with environmental legislation does not mean a statement is needed that the law was complied with). Voluntary disclosure is not necessarily affected by this work. Review of risk management Where there is no risk management committee, the internal audit committee ensure WishKeys has a risk management policy which is regularly monitored and updated, and ensure that managers are aware of their risk management responsibilities. As noted in part (b), voluntary disclosure may impact on the review of risk management where the organisation makes inappropriate claims in its reports, which could lead to liability being incurred.

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3
Marking scheme
(a) Facts. Ethical issues Alternative actions Recommendation Justification 1 mark for each relevant point discussed up to a maximum of 6 for the factors to consider. 1 mark for each relevant point discussed on legitimacy up to a maximum of 3. 1 mark for explaining each perspective (max 3) Up to 2 marks for discussing the companys rights Up to 2 marks for discussing the companys responsibility 1 3 3 1 2 10 (b) Marks

Max 8

(c)

7 25

Suggested solution
(a) Ethical decision making model Identify the facts. The ZooInc Company produces new drugs using animals as test subjects. The company is very profitable and provides a significant return to its shareholders.

Identify the ethical issues at stake The shareholders have a conflict in that although they are obtaining a good return on their investment, this is in conflict with the values of other groups in society, in this case animal activists. The activists have different ethical values to the company and the shareholders and are attempting to impose those values by force. Some shareholders may be concerned that ethically their investment is inappropriate because of attitudes towards animal testing. Other shareholders may regard their investment as highly ethical because of the contribution the company makes to human health. Ethically, shareholders may want to be seen by wider society to be taking correct actions. There is also an element of self-interest; the fact that activists have targeted ZooIncs premises and obtained a copy of the share register could mean similar attacks against properties of shareholders. Alternative reasonable actions There are four actions that the shareholders can take: (1) Firstly, sell their shares in ZooInc. This will alleviate any ethical concerns that the shareholders may have regarding investment in ZooInc and their animal testing, although the company itself may continue and activists will continue their activities. However, shareholders will also be protected from further falls in the value of their investment. Secondly, retain their shares. This action will satisfy two ethical issues, the social need for safe drugs to improve human health and the social need not to reward violence. It runs the risk of further capital loss if share prices continue to fall.

(2)

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(3)

The third option is to increase their holding in the company. This has the same ethical benefits as option two and additionally some shareholders may feel that the lower price of the shares makes them an even more economically attractive investment. Finally if they do not sell their shares, they can attend the annual general meeting and put pressure on the directors to amend the method of testing drugs. This action has some merit in that it will satisfy the ethics of the shareholders and the activists, although potentially damage the profits of ZooInc. However, the action will require members with a significant percentage shareholding to force any change.

(4)

Recommended action The recommended action is for small individual shareholders to sell shares in ZooInc. Justification for action This action provides the least harm and least risk of loss to the shareholders. Activists will hopefully not make the (ex) shareholders homes a target of attack and there will be no further loss in value of their shares. Note: any recognised model could be used here. (b) Factors for the board to consider Economic Factors The controversy has already clearly had an economic effect with the 15% fall in share value. The board will need to consider what wider effects this will have on its activities. There has been reputational damage which has led to the share price fall. The board will need to consider how the investment communitys perception of the company has changed as a result of the controversy. Clearly the companys activities were already within the public domain, so perhaps the perception problem that needs to be dealt with is one of security of premises and data. They may wish to coordinate a response with the police in order to deal with the possible threat to individual shareholders and will need to consider improving their own security arrangements. The affair may change the risk profile of the company and as such lead to not necessarily a total loss of shareholders but a change in shareholders. Social & Political Factors The company will need to consider the attitudes of society towards its activities which do provide benefits to the rest of society. It may also have to deal with widespread sympathy towards the objectives of the animal activists although not necessarily their methods. The board may also need to consider why the killing of rodents in scientific tests attracts approbation whereas the killing of rodents as vermin does not. The company may need to consider whether the political will exists to support and protect its legal activities or whether there is likely to be increased control and restriction of its activities. Legitimacy of activists claims The animal activists fall within the definition of a stakeholder as a group which affects or is affected by an organisations activities. They have clearly had a significant effect on the company. As to the legitimacy of those claims, that is a matter for the board, the shareholders and, through the legislative and judicial system, wider society to determine. The legitimacy of claims by various stakeholder groups could be said to run from those with complete legitimacy such as the shareholders (since the company has to be run bona fide in their interests) to groups (such as terrorists) determined by society as having no legitimate claim. The company may choose to enter into a dialogue with moderate animal welfare groups in order to isolate the extreme animal activists.

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(c)

Corporate citizenship Corporate citizenship is the business strategy that shapes the values underpinning a companys mission and the choices made each day by its executives, managers and employees as they interact with society. In terms of corporate citizenship, there are three core principles that companies should attempt to apply; minimising harm, maximising benefit and being accountable and responsive to stakeholders. Mattens three perspectives on corporate citizenship are: Limited view The company undertakes voluntary philanthropy based primarily on its own business interests. The company involves and supports a limited number of stakeholders mainly local communities and employees. Philanthropy is based on placing the company in a good light e.g. making donations to local schools or providing basic welfare facilities such as showers and fitness equipment for employees (ie the view that Corporate Citizenship is just a new fashionable description of the charitable activities that companies have always carried out.) Equivalent view The company takes a wider view of citizenship, responding to legal requirements and ethical expectations of the company. The company goes beyond self-interest, engaging different stakeholder groups based more on the demands of society than anything else. For example, the company will still provide fitness equipment for society, but will also be more philanthropic perhaps by providing its products at reduced prices for disadvantaged groups in society. The equivalent view is that Corporate Citizenship and Corporate Social Responsibility mean the same thing as each other (ie they are equivalent) Extended view In this view, the company takes a more active role in advocating social and political citizenship. The company will attempt to treat a wide range of stakeholders fairly, going above statutory requirements and recognising the rights of the different groups. It goes beyond CSR and takes the view that Corporate Citizens are analogous with natural citizens and can legitimately claim to have a political life. A justification for this is the view that corporations are now more powerful than governments and therefore legitimate targets of political activity or protest. Examples of rights that can be enhanced include: Social providing good working conditions for employees and safe products for consumers Civil promoting the rights of citizens either directly or by pressure on governments Political allowing individuals to promote their causes using corporate power.

The basic right that is afforded to the company by society is the right to exist as a legal entity able to sue and be sued. The company has the right to carry out lawful activities and to receive the protection of the police and the courts if it is acting within the law. The right that a company does not have that is afforded to human citizens is the right to vote. The basic responsibility of the company is to maximise shareholder wealth. The company also has the responsibility to adhere to laws and regulations. Beyond that it depends on what stance you take as to whether the company has a responsibility to act in the best interests of society or to fulfil a philanthropic role. Its role in improving the health and wellbeing of patients could be considered as within this responsibility.

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4
Marking scheme
(a) Explanation of area for induction training. Recommendation for change Total per point Up to 4 points to obtain 12 marks Role of remuneration committee Elements of remuneration Application to GetUm Note need for transparency Board performance difficult to evaluate Could do better Specific performance measures each scores 1, to a maximum of 4 2 1 3 12 2 2 2 1 7 (c) 1 1 4 6 25 Marks

(b)

Suggested solution
(a) Induction training Induction training in GetUm appears at present to be little more than ensuring that directors are aware of their areas of responsibility, and then introducing each director to the senior managers who report to that director. There is an implied assumption that these senior managers will effectively train any new directors on the job. While this method of induction is effective in terms of directors learning quickly about their specific role, it does have various weaknesses: Directors do not receive a broad understanding of the company or its work and objectives. For example, the finance director obtains information to control costs and budget for future expenditure regarding new products in GetUm. However, the director does not necessarily understand how products are manufactured or the market for those products. This means that future expenditure plans may be incorrect or incomplete, especially where senior managers within the finance department have a similar blinkered view of GetUm. Directors are also expected to work from the companys head office and with their own individual teams of senior managers. This approach does have the benefit of ensuring close team working, but only within that department. There is little or no possibility for networking, finding out how other departments work or building informal communication systems which can be essential in most companies. For example, the finance director will not meet senior management in the production department. This means that early warning of production issues may not be given and appropriate finance obtained to resolve those problems on a timely basis. Waiting for the monthly management accounts may be too late for effective financial control. The finance director in particular is only expected to meet the auditors of GetUm following completion of the audit, the audit committee being charged with all liaisons with the auditors. This procedure does help to ensure independence of the auditors from the Finance Director. However, it also means that the director is effectively barred from obtaining advice and information on accounting treatment of items (very important given the significant amount of R&D expenditure in GetUm) which would help to ensure that the financial accounts are prepared correctly. Finally, directors are not given any specific targets of their own to work towards regarding their own evaluation and review. This means that they will have no objective method of checking how successful their individual contribution to GetUm actually is.

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Improvements to induction training within GetUm must include: Provision of formal training and familiarisation with GetUm for each directors individual role. Directors must be given an overview of the company, so a broad understanding of how the company works, which products are manufactured and why etc., so they can carry out their roles effectively within their individual departments. For example, the finance director will be able to provide more accurate budgets from knowing more about the production processes. Directors must be introduced to other key managers in other departments. This will help them establish more clearly specific requirements of those managers and enable informal networking to occur. Introducing directors to key third parties such as customers, suppliers and in the case of the finance director, the auditors. While the concept of auditor independence is important to any company, both GetUm and their auditors must work together to produce accurate accounts and a cost effective audit report; placing barriers to professional working relationships is not in the interest of GetUm or their auditors. Finally, specific targets are needed so each director knows how he/she will be evaluated, and can link that evaluation through to specific changes in remuneration and/or additional training requirements. (b) The main role of a remuneration committee is to determine the amount of directors remuneration. The precise amount of remuneration for each director depends on the general policy of remuneration within the organisation and the specific remuneration package for each director. To carry out this role effectively, the members of the remuneration committee will normally be independent of the company, i.e. the committee will be staffed by non-executive directors. Specific remuneration will be difficult to set within GetUm as the only indication of financial motivation for directors is achievement of profit with the term profit not being defined is this gross or net for example? Normally the remuneration package will be based on two main elements; a fixed amount representing the use of the directors skills in the company, and a variable amount based on how well the directors have used those skills to promote the success of the company. The remuneration committee should therefore set remuneration as follows: A fixed amount depending on each directors skills and the amount of time spent in GetUm. A variable amount based on controllable targets. In this case profit would be acceptable, although the precise term does need defining, as noted above.

The mix of these two elements should be about 50:50, to provide some stability for directors regarding income but also some motivation to ensure that GetUm is successful. The setting of the amounts of remuneration should also be transparent so both directors and other stakeholders such as shareholders are aware of how the package is determined. (c) Board performance In general terms, the board of GetUm appear to be successful. The company is profitable and major connected stakeholders including the shareholders, board and employees are all receiving what appears to be an acceptable return. However, as there are no precise targets against which to measure board performance, it is actually difficult to state whether or not the board is performing is well as it could be. The very fact that high profits appear to be being made does not mean that those profits could not be higher. The board could be underperforming even when making high profit levels.Board performance should be assessed against more than one criterion. To be clear, the aim of monitoring board performance is to improve board effectiveness, maximise strengths and minimise the effect of any weakness with the aim of assessing whether or not the board should change its methods or objectives.

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Key elements of performance that should be present in GetUm are therefore: Assessing performance against a range of objectives, including perhaps products launched, profits in comparison to competitors etc. Ensuring a robust and effective risk management policy essential where GetUm is producing technologically new products with therefore a higher risk of failure. Producing and adhering to ethical values again important where there could be a temptation to market products with limited testing to ensure an early return on investment is obtained. Ensuring that the board is fully appraised on all the activities of the company at present the board members in GetUm are very insular and may miss the big picture of how GetUm is performing. Individual directors should be assessed by reference to key performance indictors for the company as a whole (to reflect their contribution as part of the board, providing leadership and setting strategy). However, part of their assessment should also be based around targets set for their area of responsibility and key performance indicators that are relevant to that. The board as a whole and individual directors need to be assessed on their performance over longer time frames than might be appropriate for employees lower down the organisation to reflect the strategic nature of their role. The performance of individual directors should be carried out by the Chairman of the board, who, as well as using the results obtained, can judge them on their contribution to board activities and decisions. Ultimately the performance of the board and the individual directors will be judged by the shareholders who (re)appoint them.

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