ACCA P1 Governance, Risk and Ethics PDF Study Text
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This document is a study text for the ACCA P1 exam on Governance, Risk and Ethics. It includes syllabus information, and exam question banks. Published by BPP Learning Media, it is designed to help students prepare for their professional accounting examinations. The textbook emphasizes key points and provides exam practice.
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ACCA S T U...
ACCA S T U D Y T PAPER P1 E GOVERNANCE, RISK AND X ETHICS T BPP Learning Media is the sole ACCA Platinum Approved Learning Partner – content for the ACCA qualification. In this, the only Paper P1 study text to be reviewed by the examiner: We discuss the best strategies for studying for ACCA exams We highlight the most important elements in the syllabus and the key skills you will need We signpost how each chapter links to the syllabus and the study guide We provide lots of exam focus points demonstrating what the examiner will want you to do We emphasise key points in regular fast forward summaries We test your knowledge of what you've studied in quick quizzes We examine your understanding in our exam question bank We reference all the important topics in our full index BPP's i-Pass product also supports this paper. FOR EXAMS IN 2011 First edition 2007 Fourth edition November 2010 ISBN 9780 7517 8927 0 (Previous ISBN 9780 7517 6374 4) British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Published by All our rights reserved. No part of this publication may be BPP Learning Media Ltd reproduced, stored in a retrieval system or transmitted, in BPP House, Aldine Place any form or by any means, electronic, mechanical, London W12 8AA photocopying, recording or otherwise, without the prior written permission of BPP Learning Media Ltd. www.bpp.com/learningmedia We are grateful to the Association of Chartered Certified Printed in the United Kingdom Accountants for permission to reproduce past examination questions. The suggested solutions in the exam answer bank have been prepared by BPP Learning Media Ltd, unless otherwise stated. Your learning materials, published by BPP Learning Media Ltd, are printed on paper sourced from sustainable, managed forests. © BPP Learning Media Ltd 2010 ii Contents Page Introduction Helping you to pass – the only P1 Study Text reviewed by the examiner.............................................................................v Studying P1.........................................................................................................................................................................vii The exam paper.................................................................................................................................................................. xvii Syllabus and Study Guide................................................................................................................................................ xviii Part A Governance and responsibility 1 Scope of corporate governance...................................................................................................................................3 2 Approaches to corporate governance........................................................................................................................39 3 Corporate governance practice and reporting...........................................................................................................63 Part B Internal control and risk 4 Internal control systems.......................................................................................................................................... 109 5 Risk attitudes and internal environment................................................................................................................. 127 6 Risks....................................................................................................................................................................... 159 7 Risk assessment and response............................................................................................................................... 181 8 Information, communication and monitoring......................................................................................................... 213 Part C Professional values and ethics 9 Personal ethics...................................................................................................................................................... 247 10 Professional ethics.................................................................................................................................................. 277 11 Corporate social responsibility.............................................................................................................................. 307 Exam question bank.................................................................................................................. 347 Exam answer bank..................................................................................................................... 355 Index................................................................................................................................................... 383 Review form and free prize draw Contents iii A note about copyright Dear Customer What does the little © mean and why does it matter? Your market-leading BPP books, course materials and e-learning materials do not write and update themselves. People write them: on their own behalf or as employees of an organisation that invests in this activity. Copyright law protects their livelihoods. It does so by creating rights over the use of the content. Breach of copyright is a form of theft – as well as being a criminal offence in some jurisdictions, it is potentially a serious breach of professional ethics. With current technology, things might seem a bit hazy but, basically, without the express permission of BPP Learning Media: Photocopying our materials is a breach of copyright Scanning, ripcasting or conversion of our digital materials into different file formats, uploading them to facebook or emailing them to your friends is a breach of copyright You can, of course, sell your books, in the form in which you have bought them – once you have finished with them. (Is this fair to your fellow students? We update for a reason.) But the e-products are sold on a single user licence basis: we do not supply ‘unlock’ codes to people who have bought them second-hand. And what about outside the UK? BPP Learning Media strives to make our materials available at prices students can afford by local printing arrangements, pricing policies and partnerships which are clearly listed on our website. A tiny minority ignore this and indulge in criminal activity by illegally photocopying our material or supporting organisations that do. If they act illegally and unethically in one area, can you really trust them? iv Helping you to pass – the ONLY P1 Study Text reviewed by the examiner! BPP Learning Media – the sole Platinum Approved Learning Partner - content As ACCA’s sole Platinum Approved Learning Partner – content, BPP Learning Media gives you the unique opportunity to use examiner-reviewed study materials for the 2011 exams. By incorporating the examiner’s comments and suggestions regarding the depth and breadth of syllabus coverage, the BPP Learning Media Study Text provides excellent, ACCA-approved support for your studies. The PER alert Before you can qualify as an ACCA member, you do not only have to pass all your exams but also fulfil a three year practical experience requirement (PER). To help you to recognise areas of the syllabus that you might be able to apply in the workplace to achieve different performance objectives, we have introduced the ‘PER alert’ feature. You will find this feature throughout the Study Text to remind you that what you are learning to pass your ACCA exams is equally useful to the fulfilment of the PER requirement. Tackling studying Studying can be a daunting prospect, particularly when you have lots of other commitments. The different features of the text, the purposes of which are explained fully on the Chapter features page, will help you whilst studying and improve your chances of exam success. Developing exam awareness Our Texts are completely focused on helping you pass your exam. Our advice on Studying P1 outlines the content of the paper, the necessary skills the examiner expects you to demonstrate and any brought forward knowledge you are expected to have. Exam focus points are included within the chapters to highlight when and how specific topics were examined, or how they might be examined in the future. Using the Syllabus and Study Guide You can find the syllabus and Study Guide on page xviii of this Study Text Testing what you can do Testing yourself helps you develop the skills you need to pass the exam and also confirms that you can recall what you have learnt. We include Questions – lots of them - both within chapters and in the Exam Question Bank, as well as Quick Quizzes at the end of each chapter to test your knowledge of the chapter content. ⏐ Introduction v Chapter features Each chapter contains a number of helpful features to guide you through each topic. Topic list Topic list Syllabus reference What you will be studying in this chapter and the relevant section numbers, together the ACCA syllabus references. Puts the chapter content in the context of the syllabus as Introduction a whole. Study Guide Links the chapter content with ACCA guidance. Highlights how examinable the chapter content is likely to Exam Guide be and the ways in which it could be examined. Knowledge brought forward from earlier studies What you are assumed to know from previous studies/exams. Summarises the content of main chapter headings, FAST FORWARD allowing you to preview and review each section easily. Demonstrate how to apply key knowledge and Examples techniques. Definitions of important concepts that can often earn you Key terms easy marks in exams. When and how specific topics were examined, or how Exam focus points they may be examined in the future. Formulae that are not given in the exam but which have to Formula to learn be learnt. Gives you a useful indication of syllabus areas that closely relate to performance objectives in your Practical Experience Requirement (PER). Gives you essential practice of techniques covered in the Question chapter. Case Study Real world examples of theories and techniques. Chapter Roundup A full list of the Fast Forwards included in the chapter, providing an easy source of review. A quick test of your knowledge of the main topics in the Quick Quiz chapter. Found at the back of the Study Text with more Exam Question Bank comprehensive chapter questions. Cross referenced for easy navigation. vi Introduction ⏐ Studying P1 The P1 Governance, Risk and Ethics syllabus (up until 2010 called Professional Accountant) has been written with a different focus to the exams that you have sat so far. The exam is not about learning law, accounting standards or complicated calculation techniques. Instead it seeks to promote the underlying themes of professionalism and accountability. You cannot be professional in one area and unprofessional in another. The examiner The examiner of P1 is David Campbell, an academic at the University of Newcastle in the UK. He sees knowledge of governance concepts and ethical standpoints as foundations for the accountancy profession acting in the best interests not just of its clients or employers, but other stakeholders as well. He has emphasised it is vital for the profession to maintain the respect and trust in which it is held. David Campbell is also keen to explore wider social responsibility issues. He has highlighted the paper’s focus being at strategic level, looking at board management issues, and also the underlying environment and culture factors that impact upon the management of an organisation and how well its risks are addressed. David Campbell does expect students not only to know the theories but apply them as well. He has stressed that the paper will test higher skills. Syllabus update The P1 syllabus has been updated for the June 2011 sitting onwards. The full syllabus and study guide can be found in this Study Text on pages xviii to xxvii. The main change is the increased emphasis on risk management topics. A full summary of the changes to the P1 syllabus is given below. Summary of changes to P1 Rationale for changes to Study Guide Paper P1 ACCA periodically reviews its qualification syllabuses so that they fully meet the needs of stakeholders such as employers, students, regulatory and advisory bodies and learning providers. As a result of the latest review, ACCA is making changes to the ACCA Qualification effective from June 2011. With each syllabus is included a specific rationale for these changes as far as each examination syllabus and study guide is concerned. As a result of specific feedback about the ACCA qualification, some significant stakeholders expressed a view that there needed to be more general high level risk management covered within the ACCA Qualification. It was decided that this area is best augmented within the two risk sections of the P1 syllabus. The main additions are summarised in Table 1 below: 14 Table 1 – Additions to P1 Syllabus content Section and subject area C1 – Add as new (c) Explain the dynamic nature of risk assessment. (2) C1 – Add as new (d) Explain the importance and nature of management responses to changing risk assessments. (2) C1 – Add as new (e) Explain risk appetite and how this affects risk policy. (2) C2 Move existing C2(c) up to C2(d) and add new C2(c) as follows: Describe and evaluate the nature and importance of business and financial risks. (3) ⏐ Introduction vii Table 1 – Additions to P1 Syllabus content Section and subject area C3(d) Insert ‘and importance of’. Remove brackets. So sentence now reads: Describe the process and importance of externally reporting on internal control and risk. (2) C3 – add new (f) Explain and assess the ALARP (as low as reasonably practicable) principle in risk assessment and how this relates to severity and probability. (3) C3 – add new (g) Evaluate the difficulties of risk perception including the concepts of objective and subjective risk perception. (3) C3 – add new (h) Explain and evaluate the concepts of related and covariant risk factors. (3) Section D Rename as ‘Controlling and managing risk’ D2 – add new (e) Identify and assess how business organisations use policies and techniques to mitigate various types of business and financial risk. (3) D3(a) change Should now read: Explain, and assess the importance of, risk transference, avoidance, reduction and acceptance. (3) In addition the following new books will be listed to support additional areas: Primary texts: Merna, A. and AlThani, FF. (2008). Corporate risk management. Second edition. John Wiley & Sons. Secondary texts: Crouhy, M., Galai, D., and Mark, R. (2006). The essentials of risk management. McGraw Hill Professional. 1 What P1 is about 1.1 Underlying themes The syllabus shows how accounting is underpinned by governance and ethics, and the need for accountants to repay the trust that society puts in them. The examiner has emphasised the agency relationship between stakeholders and business managers, including directors and accountants. Governance is itself supported by sound internal control systems, internal audit and rigorous risk management. Judgement, underpinned by professional competence and ethics, is also a key theme. The examiner has stressed that the paper’s main themes should be seen as interconnected: "Every right implies a responsibility; for each opportunity there is an obligation and all rewards carry related risks." 1.2 Governance and responsibility Chapter 1 demonstrates the importance of the underlying themes of the syllabus. Corporate governance is a central part of the syllabus. Instead of going straight into the detailed requirements of the corporate governance reports, it discusses in detail the concepts that underpin good corporate governance, the agency relationship, the constituencies (shareholders and other stakeholders) that corporate governance is designed to serve and the extent of responsibilities towards different stakeholders. Chapter 2 deals with the basis of corporate governance legislation and codes, whether they are based on principles or a detailed rulebook and how governance codes incorporate wider ideas of social responsibility. Chapter 3 covers governance best practice, drawing on examples from different codes from all over the world. viii Introduction ⏐ 1.3 Internal control and risk We consider Sections B to D of the syllabus together in Section B of this book. The examiner has explained that the syllabus highlights the issues of: Internal control The identification and assessment of risk Controlling and mitigating risk as they have proved to be problematic in recent corporate failures. These issues also play a crucial part in an accountant’s responsibility to act in the public interest and the interests of shareholders: ‘Sound systems of internal analysis, control and audit underpin all effective corporate governance systems. Effective management at the strategic level rests on the assumption that internal control activities can be controlled, verified and reported on internally. If management loses control of internal systems and procedures, any claim of sound governance is lost… The same is true of risk. Being aware of all possible risks, understanding their potential impact, as well as the probability of occurrence, are important safeguards for investors and other shareholders.’ In Chapter 4 therefore we examine the objectives of control and risk management systems. We also look at a number of systems that have been developed internationally, including the COSO enterprise risk management model. Chapter 5 to 8 are organised around the stages identified in the COSO enterprise risk management model. Chapter 5 deals with the underlying factors that affect how a business is controlled and how risk is managed. These include how much appetite the business has for risk, and how environmental factors within the business affect control and risk management. We also look at the importance of setting business objectives that are consistent with the risk that directors, shareholders and other stakeholders wish the business to bear. Chapters 6 and 7 deal with the various stages of risk assessment and management, including internal control procedures that act to reduce risk. Chapter 8 brings out two other elements that are vital in control systems. These are a two-way flow of appropriate information between the board and managers and staff. This should enable the board and managers to carry out effective monitoring of operations, and provide feedback so that systems and controls can be improved. The results of business monitoring will also form the basis for external reporting about the company’s systems. 1.4 Professional values and ethics This section of the syllabus requires you to think carefully about the ethical assumptions that guide individual behaviour and underpin the role of accountants. Chapter 9 is a very important chapter in this text, dealing with the ethical stances of individuals and also the factors that determine the ethical decisions individuals take. In the exam you may have to argue from a specific ethical position, even if you don’t agree with the position. In Chapter 10 you need to look critically at the ethical codes accountants follow as well as the codes that businesses operate. It is true that you need to have a good knowledge of what the accountancy profession’s codes say on ethical threats and conflicts and to be able to use that knowledge in recommending solutions to ethical dilemmas. However you are also expected to question how much help the codes actually are in resolving dilemmas and whether the ethical frameworks are in the best interests of society and the accountancy profession. The examiner wishes you to question the role of the accountant in protecting shareholder wealth and focusing on the performance of capital investment. Does this mean that accountancy is a servant of capital and makes the implicit assumptions about morality that capitalism does? Chapter 11 looks at corporate social responsibility, concentrating on what organisations have done to address issues such as sustainability and the implications for accounting, disclosure, control systems and audit. ⏐ Introduction ix 2 Skills you have to demonstrate 2.1 Knowledge and application Even with exams you’ve previously taken, you'll remember that passing didn't only mean reproducing knowledge. You also had to apply what you knew. At Professional level, the balance is tilted much more towards application. You will need a sound basis of technical knowledge. The exams will detect whether you have the necessary knowledge. However you won't pass if you just spend your time acquiring knowledge. Developing application skills is vital. 2.2 Application skills What application skills do you need? Many P1 questions will include detail in a scenario about a specific organisation. The following skills are particularly important when you're dealing with question scenarios. (a) Identifying the most important features of the organisation and the organisation's environment. Clues to these will be scattered throughout the scenario. The technical knowledge that you have should help you do this, but you will also need business awareness and imagination. There will be a main theme running through most scenarios that you'll need to identify. (b) Using analysis techniques that will give you more insight into the data that you're given. (c) Selecting real-life examples that are relevant to the scenario. The examiner has stated that students should look at contemporary business stories and try to identify P1 issues, for example directors’ remuneration. (d) Making informed judgements that follow from your analysis about what the organisation is doing and should be doing (e) Communicating clearly and concisely your analysis and recommendations. Perhaps you will be reporting to a specific individual. If so, you should take into account the needs of this individual 3 How to pass 3.1 Study the whole syllabus You need to be comfortable with all areas of the syllabus. Compulsory Question 1 will always span a number of syllabus areas and other questions may do so as well. In particular you must have a very good knowledge and awareness of the themes in the ethical section of the syllabus, since the examiner has stated that compulsory Question 1 will always include an element on ethics. The examiner has also stressed that study and revision should cover all of the syllabus in detail. Students should not question spot or prioritise one area of the syllabus over another. 3.2 Focus on themes, not lists There are quite a number of lists in the texts. This is inevitable because corporate governance guidance quoted as best practice is often in list form. Lists are also sometimes the clearest way of presenting information. However the examiner has stressed that passing the exam is not a matter of learning and reproducing lists. Good answers will have to focus on the details in the scenario and bring out the underlying themes that relate to the scenario. The points in them will have more depth than a series of single-line bullet points. 3.3 Read around Wider reading will help you understand the main issues businesses face. Reading the business pages of newspapers will highlight key business risks organisations face and topical corporate governance issues. General news pages may cover significant ethical and corporate responsibility issues. Have a look as well at websites of organisations promoting social responsibility such as CERES. x Introduction ⏐ 3.4 Lots of question practice You can develop application skills by attempting questions in the Exam Question Bank and later on in the BPP Learning Media Practice and Revision Kit. 4 Answering questions 4.1 Analysing question requirements It's particularly important to consider the question requirements carefully to make sure you understand exactly what the question is asking, and whether each question part has to be answered in the context of the scenario or is more general. You also need to be sure that you understand all the tasks that the question is asking you to perform. Remember that every word will be important. If for example you are asked to: 'Explain the importance of identifying all risks that Company X is facing', then you would explain that: Taking risks is bound up with strategic decision-making Some risks may have serious consequences Identifying all risks means they can be prioritised and managed efficiently and effectively You would NOT identify all the risks that Company X would be facing. 4.2 Understanding the question verbs Important! In the report for the December 2007 exam, the examiner highlighted lack of understanding of the requirements of question verbs as the most serious weakness in many candidates’ scripts. The examiner will use the question verbs very deliberately to signal what he requires. Verbs that are likely to be frequently used in this exam are listed below, together with their intellectual levels and guidance on their meaning. Intellectual level 1 Define Give the meaning of 1 Explain Make clear 1 Identify Recognise or select 1 Describe Give the key features 2 Contrast Explain two different positions, highlighting differences between them 2 Analyse Give reasons for the current situation or what has happened 3 Assess Determine the strengths/weaknesses/importance/ significance/ability to contribute 3 Discuss Examine in detail by using arguments for and against 3 Explore Examine or discuss in a wide-ranging manner 3 Construct the case Present the arguments in favour, supported by evidence 3 Criticise Present the weaknesses/problems, supported by evidence 3 Evaluate/critically Determine the value of in the light of the arguments for and evaluate against (critically evaluate means weighting the answer towards criticisms/arguments against). 3 Recommend Advise the appropriate actions to pursue in terms the recipient will understand ⏐ Introduction xi A lower level verb such as define will require a more descriptive answer. A higher level verb such as evaluate will require a more applied, critical answer. The examiner has stressed that higher-level requirements and verbs will be most significant in this paper, for example critically evaluating a statement and arguing for or against a given idea or position. The examiner is looking to set questions that provide evidence of student understanding. Certain verbs have given students particular problems. (a) Identify and explain Although these verbs are both Level 1, the examiner sees them as requiring different things. You have to go into more depth if you are asked to explain than if you are asked to identify. An explanation means giving more detail about the problem or factor identified, normally meaning that you have to indicate why it’s significant. If you were asked to: (i) Identify the main problem with the same person acting as chief executive and chairman – you would briefly say excessive power is exercised by one person. (ii) Explain the main problem with the same person acting as chief executive and chairman – you would say excessive power is exercised by one person and then go on to say it would mean that the same person was running the board and the company. As the board is meant to monitor the chief executive, it can’t do this effectively if the chief executive is running the board. Also you may be asked to explain or describe something complex, abstract or philosophical in nature. (b) Evaluate Evaluate is a verb that the examiner uses frequently. Its meaning may be different from the way that you have seen it used in other exams. The examiner expects to see arguments for and against, or pros and cons for what you are asked to evaluate. Thus for example if a question asked you to: ‘Evaluate the contribution made by non-executive directors to good corporate governance in companies’ you would not only have to write about the factors that help non-executive directors make a worthwhile contribution (independent viewpoint, experience of other industries). You would also have to discuss the factors that limit or undermine the contribution non-executive directors make (lack of time, putting pressure on board unity). If the examiner asks you to critically evaluate, you will have to consider both viewpoints. However you will concentrate on the view that you are asked to critically evaluate, as the mark scheme will be weighted towards that view. 4.3 Analysing question scenarios When reading through the scenario you need to think widely about how the scenario relates to the underlying themes of the syllabus, and also important content from whatever areas of the syllabus the question covers: (a) Corporate governance In questions on corporate governance, you are likely to be looking out for weaknesses in the current arrangements and trying to recommend improvements that are line with governance best practice. (b) Control systems With control systems questions, you are most likely to be interested in the design and appropriateness of the control systems, whether there are obvious shortcomings with them, and also details of the control environment. (c) Culture If you are asked about the organisation’s culture and ethos, you should be looking for evidence of directors’ views and actions, for signs of how the tone is being set at the top of the organisation. You should also look for evidence of how the ethos is being established further down the xii Introduction ⏐ organisation, in particular how the organisation’s culture, systems, procedures, reward mechanisms, human resource policies, training are used to embed the tone of the organisation. (d) Risks With risks you are looking for the most significant risks. If these are not highlighted, you should look for the risks that are connected with the organisation’s strategy or which relate to significant changes that the organisation and its business environment are going through, or are about to go though. You should also try to determine the extent to which risk awareness is embedded in the organisation’s culture. (e) Risk management If you are asked how organisations should respond to particular risks, you’ll need to use the scenario detail to determine how serious these risks are, and suggest responses that are relevant to counter the risks and are appropriate for the organisation. It’s no use for example suggesting that the organisation sets up a large risk management function if it is not big enough to warrant one. (f) Ethics With ethical issues you are not just looking to determine not only the ethical issues at stake. You also need to consider the ethical position of the organisation and individuals and the factors that determine the ethical position. These will be significant when you think about solutions to the ethical problems. (g) Framework Look out in any question scenarios or frameworks for hints that you may have to provide a critique of the overall framework or model that is being operated. If you’re basing your answer on content from corporate governance or ethical codes, will you have to criticise the principles or rules on which they are founded. If you have to make recommendations that benefit shareholders, is the shareholders’ viewpoint the most valid or should other stakeholders’ interests be taken into account. 4.4 Consider the moral and ethical frameworks The examiner has stressed that these will affect the judgements you make when answering questions as they do in real-life. In particular the stakeholders affected by business and strategic decisions and whether some stakeholders are being favoured over others need to be considered. Remember the exam is designed to make you take a questioning approach to wide issues, and this may mean having to argue in favour of a viewpoint with which you don’t agree. 4.5 Content of answers Well-judged, clear recommendations grounded in the scenario will always score well as markers for this paper have a wide remit to reward good answers. You need to be selective. As we’ve said, lists of points memorised from texts and reproduced without any thought won't score well. Important! The examiner identified lack of application skills as a serious weakness in many student answers. What constitutes good application will vary question by question but is likely to include: Only including technical knowledge that is relevant to the scenario. For example, although the SPAMSOAP mnemonic can be a useful memory aid, you shouldn’t quote it in full just because the question requirements contain the word ‘control’ Only including scenario details that support the points you are making, for example quoting from the scenario to explain why you’re making a particular recommendation Tackling the problems highlighted in the scenario and the question requirements Explaining why the factors you’re discussing are significant Taking a top-down strategic approach – remember that at Professional level you’re meant to be adopting the viewpoint of a partner or finance director. Excessive detail about operations is not important ⏐ Introduction xiii 5 Gaining professional marks As P1 is a Professional level paper, 4 or 5 professional level marks will be awarded in the compulsory question. The examiner has stated that some marks may be available for presenting your answer in the form of a letter, presentation, memo, report, briefing notes, management reporting, narrative or press statement. You may also be able to obtain marks for the layout, logical flow and presentation of your answer. You should also make sure that you provide the points required by the question. Important! Whatever the form of communication requested, you will not gain professional marks if you fail to follow the basics of good communication. Keep an eye on your spelling and grammar. Also think carefully, am I saying things that are appropriate in a business communication? 5.1 Layout and format 5.1.1 Reports A report should have the following formal elements at the top: Title Report writer (prepared by) Report recipient Date It should include: An introduction summarising its scope, terms of reference and the information used Findings/points made, in sections with headings. The points should be specific and factual. Recommendations/conclusions at the end Reports should be written in the first person (I, we, our). If the report is going into the annual accounts, remember it can be read by anyone who wants to read it, so the information to be given needs to be thought about carefully. 5.1.2 Memorandum A memorandum should have the following elements at the top: To From Date Subject Its recipient should be referred to as you. A memorandum is less formal than a report. However the points it makes should be emphasised by paragraph headings. A memorandum should finish with a conclusion or recommendation. You should not end it with yours faithfully. 5.1.3 Letter A letter should include at the top: The address of the sender The date it is written If to a single recipient, the right recipient's name and address xiv Introduction ⏐ It should have: An introductory paragraph, explaining the reasons why the letter is written A clear and logical flow. When planning your answer, you should be looking to order the paragraphs so that they follow a logical sequence (for example order of importance or timescale) Content and tone that is appropriate to the audience. It should be written in the first and second person (ie using I, we, our, you, your). It should refer to the recipients and their interests. You will need to explain things in more detail to recipients who are not accountants. Single-line bullet points won’t be enough. You also should avoid using unnecessarily complex terminology. Quoting indiscriminately from accounting standards or governance codes will not earn professional marks A concluding paragraph, re-emphasising the purpose of the letter, drawing the threads of the content together and, if appropriate, inviting further action by the recipients (eg please get in touch if you would like further information). If it is a business letter, addressed formally (Dear Sir), it should be signed Yours faithfully, signing off with the person's role and position. 5.1.4 Speech A speech should: Be easy to read out. If you answer any questions requiring speeches during your revision you should read your answer to yourself to see whether you say it easily (Do NOT however, read your answer aloud in the actual exam!) Begin with a formal introduction, for example Welcome Ladies and Gentlemen Provide an overview of what will be covered Connect each section with narrative designed to make the speech sound convincing, logical and persuasive Not contain bullet points (how would you deliver them) End with an invitation to respond: ‘Thank you for listening. I now open the floor to questions’. 5.1.5 Briefing notes These may be required for use at a board meeting or to inform external stakeholders such as institutional shareholders. They should: Start with the key points, with background information later on or in appendices Be written in the third person, referring to the directors or the company’ 5.1.6 Press statement The statement should have: A first paragraph that emphasises the key points Background information later in the statement or in appendices A third person narrator 5.1.7 All documents – conclusion A good way to end all documents is to invite further communication. For example in a letter or memo, finish with a short paragraph such as: "If you have any further questions or queries, please do not hesitate to contact me." 5.2 Logical flow For the first few sittings of the exam, the scenario and question requirements have included clear requirements about the contents of the written communication. You should follow the guidance the ⏐ Introduction xv question provides, creating a new section for each element that you are required to include. Clear headings will demonstrate the flow to the reader. 5.3 Persuasiveness Before you start writing, consider the recipient of the document. If you are writing to shareholders, you will want to be careful how much information you provide, and how you phrase it. If you are trying to convince the reader that you have made the right decision, you will need to focus on the benefits. If you are apologising for something that has gone wrong, you will need to do this in such a way that the readers are reassured by the information they receive. 6 Brought forward knowledge You will have covered some of the corporate governance, company law and ethics contents of P1 in law and auditing papers that you have previously sat. However because of students studying this paper will have sat different variants of the law and auditing exams, this text includes full coverage of the knowledge you need for this exam even though some of it has been covered in other exams. 7 ACCA ethics module We would strongly recommend that you sit the module before taking P1. The module will give you insights to a range of ethical perspectives that will be valuable in your professional career, and will also assist you in tackling the ethics content of the P1 syllabus and indeed the syllabuses of other Professional level exams. xvi Introduction ⏐ The exam paper Format of the paper The exam is a three-hour paper, with 15 minutes reading time, consisting of two sections. Number of marks Section A: 1 compulsory case study 50 Section B: Choice of 2 from 3 questions (25 marks each) 50 100 Section A will be a compulsory case study question with typically four or five sub-requirements relating to the same scenario information. The question will usually assess and link a range of subject areas across the syllabus. It will require students to demonstrate high-level capabilities to understand the complexities of the case and evaluate, relate and apply the information in the case study to the requirements. The case study will be between 400 and 700 words long. The examiner has stressed the importance of reading the case in detail, taking notes as appropriate and getting a feel for what the issues are. Scenarios may be drawn from any situation involving aspects of governance. This is likely to be, but need not be, in an organisational setting. Professional marks will be available in Section A for presentation, logical flow of argument and quality of argument. Section B questions are more likely to assess a range of discrete subject areas from the main syllabus section headings. They may require evaluation and synthesis of information contained within short scenarios and application of this information to the question requirements. Although one subject area is likely to be emphasised in each Section B question, students should not assume that questions will be solely about content from that area. Each question will be based on a shorter case scenario to contextualise the question. The paper will have a global focus. From June 2011 the exam may include some simple arithmetic calculations. Students should not expect complicated calculations but should be prepared to manipulate numerical data, and accordingly a calculator may be helpful. ⏐ Introduction xvii Syllabus and study guide The P1 syllabus and study guide can be found below. In this document P1 is still referred to as Professional Accountant. xviii Introduction ⏐ ⏐ Introduction xix xx Introduction ⏐ Study guide Intellectual Chapter level reference A GOVERNANCE AND RESPONSIBILITY 1 The scope of governance (a) Define and explain the meaning of corporate governance. 2 1 (b) Explain and analyse the issues raised by the development of the 3 1 joint stock company as the dominant form of business organisation and the separation of ownership and control over business activity. (c) Analyse the purposes and objectives of corporate governance. 2 1 (d) Explain and apply in the context of corporate governance, the key 3 1 underpinning concepts of (i) Fairness (ii) Openness/transparency (iii) Independence (iv) Probity/honesty (v) Responsibility (vi) Accountability (vii) Reputation (viii) Judgment (ix) Integrity. (e) Explain and assess the major areas of organisational life affected 3 1 by issues in corporate governance: (i) Duties of directors and functions of the board (including performance measurement)(ii) The composition and balance of the board (and board committees) (iii) Reliability of financial reporting and external auditing (iv) Directors' remuneration and rewards (v) Responsibility of the board for risk management systems and internal control (vi) The rights and responsibilities of shareholders, including institutional investors (vii) Corporate social responsibility and business ethics. (f) Compare and distinguish between public, private and non- 3 1 governmental organisations (NGO) with regard to the issues raised by, and scope of, governance. (g) Explain and evaluate the roles, interests and claims of the internal 3 1 parties involved in corporate governance: (i) Directors (ii) Company secretaries (iii) Sub-board management (iv) Employee representatives (eg trade unions). (h) Explain and evaluate the roles, interests and claims of the external 3 1 parties involved in corporate governance (i) Shareholders (including shareholders' rights and responsibilities) (ii) Auditors (iii) Regulators (iv) Government (v) Stock exchanges (vi) Small investors (and minority rights) (vii) Institutional investors (i) Analyse and discuss the role and influence of institutional 2 1 investors in corporate governance systems and structures, for example, the roles and influences of pension funds, insurance companies and mutual funds. 2 Agency relationships and theories (a) Define and explore agency theory. 2 1 (b) Define and explain the key concepts in agency theory (i) Agents 2 1 (ii) Principals (iii) Agency (iv) Agency costs (v) Accountability (vi) Fiduciary responsibilities (vii) Stakeholders. (c) Explain and explore the nature of the principal-agent relationship in 3 1 the context of corporate governance. (d) Analyse and critically evaluate the nature of agency accountability 3 1 in agency relationships. ⏐ Introduction xxi Intellectual Chapter level reference (e) Explain and analyse the following other theories used to explain 2 1 aspects of the agency relationship (i) Transaction costs theory (ii) Stakeholder theory. 3 The board of directors (a) Explain and evaluate the roles and responsibilities of boards of 3 3 directors. (b) Describe, distinguish between and evaluate the cases for and 3 3 against unitary and two-tier board structures. (c) Describe the characteristics, board composition and types of 2 3 directors (including defining executive and non-executive directors (NED). (d) Describe and assess the purposes, roles and responsibilities of 3 3 NEDs. (e) Describe and analyse the general principles of legal and regulatory 2 3 frameworks within which directors operate on corporate boards (i) Legal rights and responsibilities (ii) Time-limited appointments (iii) Retirement by rotation (iv) Service contracts (v) Removal (vi) Disqualification (vii) Conflict and disclosure of interests (viii) Insider dealing/trading. (f) Define, explore and compare the roles of the chief executive officer 3 3 and company chairman. (g) Describe and assess the importance and execution of induction 3 3 and continuing professional development of directors on boards of directors. (h) Explain and analyse the frameworks for assessing the performance 2 3 of boards and individual directors (including NEDs) on boards. 4 Board committees (a) Explain and assess the importance, roles and accountabilities of 3 3 board committees in corporate governance. (b) Explain and evaluate the role and purpose of the following 3 3,5 committees in effective corporate governance (i) Remuneration committees (ii) Nominations committees (iii) Risk committees (iv) Audit committees. 5 Directors' remuneration (a) Describe and assess the general principles of remuneration 3 3 (i) Purposes (ii) Components (iii) Links to strategy (iv) Links to labour market conditions. (b) Explain and assess the effect of various components of 3 3 remuneration packages on directors' behaviour (i) Basic salary (ii) Performance related (iii) Shares and share options (iv) Loyalty bonuses (v) Benefits in kind (vi) Pension benefits. (c) Explain and analyse the legal, ethical, competitive and regulatory 3 3 issues associated with directors' remuneration. xxii Introduction ⏐ Intellectual Chapter level reference 6 Different approaches to corporate governance (a) Describe and compare the essentials of 'rules' and 'principles' 3 2 based approaches to corporate governance. Include discussion of 'comply or explain'. (b) Describe and analyse the different models of business ownership 2 2 that influence different governance regimes (eg family firms versus joint stock company-based models). (c) Describe and critically evaluate the reasons behind the 3 2 development and use of codes of practice in corporate governance (acknowledging national differences and convergence). (d) Explain and briefly explore the development of corporate 2 2 governance codes in principles-based jurisdictions (i) Impetus and background (ii) Major corporate governance codes (iii) Effects of. (e) Explain and explore the Sarbanes-Oxley Act 2003 as an example of 2 2 a rules-based approach to corporate governance (i) Impetus and background (ii) Main provisions/contents (iii) Effects of. (f) Describe and explore the objectives, content and limitations of 2 2 corporate governance codes intended to apply to multiple national jurisdictions (i) Organisation for Economic Co-operation and Development (OECD) Report 2004 (ii) International Corporate Governance Network (ICGN) Report 2005. 7 Corporate governance and corporate social responsibility (a) Explain and explore social responsibility in the context of corporate 2 2 governance. (b) Discuss and critically assess the concept of stakeholders and 3 2 stakeholding in organisations and how this can affect strategy and corporate governance. (c) Analyse and evaluate issues of 'ownership', 'property' and the 3 2 responsibilities of ownership in the context of shareholding. (d) Explain the concept of the organisation as a corporate citizen of 3 11 society with rights and responsibilities. 8 Governance: reporting and disclosure (a) Explain and assess the general principles of disclosure and 3 3 communication with shareholders. (b) Explain and analyse 'best practice' corporate governance 2 3 disclosure requirements. (c) Define and distinguish between mandatory and voluntary 2 3 disclosure of corporate information in the normal reporting cycle. (d) Explain and explore the nature of and reasons and motivations for 3 3 voluntary disclosure in a principles-based reporting environment (compared to, for example, the reporting regime in the USA). (e) Explain and analyse the purposes of the annual general meeting 2 3 and extraordinary general meetings for information exchange between board and shareholders. (f) Describe and assess the role of proxy voting in corporate 3 3 governance. ⏐ Introduction xxiii Intellectual Chapter level reference B INTERNAL CONTROL AND REVIEW 1 Management control systems in corporate governance (a) Define and explain internal management control. 2 4, 7, 8 (b) Explain and explore the importance of internal control and risk 3 4, 7 management in corporate governance. (c) Describe the objectives of internal control systems. 2 4 (d) Identify, explain and evaluate the corporate governance and 3 5, 8 executive management roles in risk management (in particular the separation between responsibility for ensuring that adequate risk management systems are in place and the application of risk management systems and practices in the organisation). (e) Identify and assess the importance of the elements of components 3 4, 5, 7 of internal control systems. 2 Internal control, audit and compliance in corporate governance (a) Describe the function and importance of internal audit. 1 8 (b) Explain and discuss the importance of auditor independence in all 3 8, 10 client-auditor situations (including internal audit). (c) Explain and assess the nature and sources of risks to auditor 3 8, 10 independence. Assess the hazard of auditor capture. (d) Explain and evaluate the importance of compliance and the role of 3 8 the internal audit function in internal control. (e) Explore and evaluate the effectiveness of internal control systems. 3 4, 7 (f) Describe and analyse the work of the audit committee in 2 8 overseeing the internal audit function. (g) Explain and explore the importance and characteristics of the audit 2 8 committee's relationship with external auditors. 3 Internal control and reporting (a) Describe and assess the need to report on internal controls to 3 8 shareholders. (b) Describe the content of a report on internal control and audit. 2 8 (c) Explain and assess how internal controls underpin and provide 3 7 information for accurate financial reporting. 4 Management information in audit and internal control (a) Explain and assess the need for adequate information flows to 3 8 management for the purposes of the management of internal control and risk. (b) Evaluate the qualities and characteristics of information required in 3 8 internal control and risk management and monitoring. C IDENTIFYING AND ASSESSING RISK 1 Risk and the risk management process (a) Define and explain risk in the context of corporate governance. 2 5 (b) Define and describe management responsibilities in risk 2 5 management. (c) Explain the dynamic nature of risk assessment. 2 7 xxiv Introduction ⏐ Intellectual Chapter level reference (d) Explain the importance and nature of management responses to 2 7 changing risk assessments. (e) Explain risk appetite and how this affects risk policy. 2 7 2 Categories of risk (a) Define and compare (distinguish between) strategic and 2 6 operational risks. (b) Define and explain the sources and impact of common business 2 6 risks (i) Market (ii) Credit (iii) Liquidity (iv) Technological (v) Legal (vi) Health, safety and environmental (vii) Reputation (viii) Business probity (ix) Derivatives. (c) Describe and evaluate the nature and importance of business and 3 6 financial risks. (d) Recognise and analyse the sector or industry specific nature of 2 6 many business risks. 3 Identification, assessment and measurement of risk (a) Identify and assess the impact upon the stakeholders involved in 3 5 business risk. (b) Explain and analyse the concepts of assessing the severity and 2 7 probability of risk events. (c) Describe and evaluate a framework for board level consideration of 3 8 risk. (d) Describe the process and importance of (externally) reporting 2 8 internal control and risk. (e) Explain the sources, and assess the importance of, accurate 3 8 information for risk management. (f) Explain and assess the ALARP (as low as reasonably practicable) 3 7 principle in risk assessment and how this relates to severity and probability. (g) Evaluate the difficulties of risk perception including the concepts of 3 7 objective and subjective risk perception. (h) Explain and evaluate the concepts of related and covariant risk 3 7 factors. D CONTROLLING AND MANAGING RISK 1 Targeting and monitoring of risk (a) Explain and assess the role of a risk manager in identifying and 3 5 monitoring risk. (b) Explain and evaluate the role of the risk committee in identifying 3 5 and monitoring risk. (c) Describe and assess the role of internal or external risk auditing in 3 8 monitoring risk. 2 Methods of controlling and reducing risk (a) Explain the importance of risk awareness at all levels in an 2 5, 8 organisation. (b) Describe and analyse the concept of embedding risk in an 3 5 organisation's systems and procedures. ⏐ Introduction xxv Intellectual Chapter level reference (c) Describe and evaluate the concepts of embedding risk in an 3 5 organisation's culture and values. (d) Explain and analyse the concepts of spreading and diversifying risk 2 7 and when this would be appropriate. (e) Identify and assess how business organisations use policies and 3 7 techniques to mitigate various types of business and financial risks. 3 Risk avoidance, retention and modelling (a) Explain, and assess the importance of, risk transference, 2 7 avoidance, reduction and acceptance. (b) Explain and evaluate the different attitudes to risk and how these 3 5 can affect strategy. (c) Explain and assess the necessity of incurring risk as part of 3 5 competitively managing a business organisation. (d) Explain and assess attitudes towards risk and the ways in which 3 5 risk varies in relation to the size, structure and development of an organisation. E PROFESSIONAL VALUES AND ETHICS 1 Ethical theories (a) Explain and distinguish between the ethical theories of relativism 2 9 and absolutism. (b) Explain in an accounting and governance context, Kohlberg's 3 9 stages of human moral development. (c) Describe and distinguish between deontological and 2 9 teleological/consequentialist approaches to ethics. (d) Apply commonly used ethical decision-making models in 2 9 accounting and professional contexts (i) American Accounting Association model (ii) Tucker's 5-question model. 2 Different approaches to ethics and social responsibility (a) Describe and evaluate Gray, Owen & Adams (1996) seven 2 11 positions on social responsibility. (b) Describe and evaluate other constructions of corporate and 2 11 personal ethical stance (i) Short-term shareholder interests (ii) Long-term shareholder interests (iii) Multiple stakeholder obligations (iv) Shaper of society. (c) Describe and analyse the variables determining the cultural context 2 9, 11 of ethics and corporate social responsibility (CSR). 3 Professions and the public interest (a) Explain and explore the nature of a 'profession' and 2 10 'professionalism'. (b) Describe and assess what is meant by 'the public interest'. 2 10 (c) Describe the role of and assess the widespread influence of 3 10 accounting as a profession in the organisational context. (d) Analyse the role of accounting as a profession in society. 2 10 (e) Recognise accounting's role as a value-laden profession capable 3 10 of influencing the distribution of power and wealth in society. xxvi Introduction ⏐ Intellectual Chapter level reference (f) Describe and critically evaluate issues surrounding accounting and 3 10 acting against the public interest. 4 Professional practice and codes of ethics (a) Describe and explore the areas of behaviour covered by corporate 3 10 codes of ethics. (b) Describe and assess the content of, and principles behind, 3 10 professional codes of ethics. (c) Describe and assess the codes of ethics relevant to accounting 3 10 professionals such as the IFAC or professional body codes. 5 Conflicts of interest and the consequences of unethical behaviour (a) Describe and evaluate issues associated with conflicts of interest 3 10 and ethical conflict resolution. (b) Explain and evaluate the nature and impacts of ethical threats and 3 10 safeguards. (c) Explain and explore how threats to independence can affect ethical 3 10 behaviour. 6 Ethical characteristics of professionalism (a) Explain and analyse the content and nature of ethical decision- 2 9 making using content from Kohlberg's framework as appropriate. (b) Explain and analyse issues related to the application of ethical 2 9, 10 behaviour in a professional context. (c) Describe and discuss 'rules based' and 'principles based' 2 10 approaches to resolving ethical dilemmas encountered in professional accounting. 7 Social and environmental issues in the conduct of business and ethical behaviour (a) Describe and assess the social and environmental effects that 3 11 economic activity can have (in terms of social and environmental 'footprints'). (b) Explain and assess the concept of sustainability and evaluate the 3 11 issues concerning accounting for sustainability (including the contribution of 'full cost' accounting). (c) Describe the main features of internal management systems for 1 11 underpinning environmental accounting such as EMAS and ISO 14000. (d) Explain the nature of social and environmental audit and evaluate 3 11 the contribution it can make to the development of environmental accounting.. ⏐ Introduction xxvii Analysis of past papers The table below provides details of when each element of the syllabus has been examined and the question number and section in which each element appeared. Further details can be found in the Exam Focus Points in the relevant chapters. Covered in Text Jun Dec Jun Dec Jun Dec Pilot Extr chapter 10 09 09 08 08 07 paper a Qs GOVERNANCE AND RESPONSIBILITY 1 Scope of governance 1b,4a 3a 1c 1a 1a,4a, 1a,3b 1d,3b c 1 Agency 1c 1c 3a 3a 3 Board of directors 1c,2a, 1e,3a, 2c 3c 1c,3a, 1a,c,d, b,c d b 2c 3,5 Board committees 2c,3c 3b 3 Directors’ remuneration 2a,b 3c 2c 2a,b 2 Different approaches to governance 4a 3c 3d 2,11 Corporate social responsibility 1a 1d 4a 3c 3d 3 Reporting and disclosure 3b 1d 1e INTERNAL CONTROL AND REVIEW 4,5,7,8 Management control systems 3a,b 3a 1d 4a 4,7,8,10 Internal control, audit and compliance 3c 1b 1b 3a,b 1e,2a 1c,2 7,8 Internal control and reporting 4b,c 8 Management information 1d IDENTIFYING AND ASSESSING RISK 5,7 Risk and the risk management process 6 Risk categories 1b,3c 1c 1b,4b 5,7,8 Risk identification, measurement and 1d 4b 1b assessment CONTROLLING AND MANAGING RISK 5,8 Risk targeting and monitoring 4c 4a 2a 3c 5,7,8 Risk reduction and control 4a,b 2b 2b 5,7 Risk, avoidance, retention and modelling 4c 2b 2a 1c PROFESSIONAL VALUES AND ETHICS 9 Ethical theories 1a 1a 1a,4c 1b 3c 1b 9,11 Different approaches to ethics and social 2c 4b 1a responsibility 10 Professions and the public interest 2a 2b 4c 10 Professional practice and codes of ethics 4a,b 3a 1a 10 Conflicts of interest and consequences of 4c 3b,c 2b 2a unethical behaviour 9,10 Ethical characteristics of professionalism 2c,4b 3b 2c 11 Social and environmental issues 1d 1d 1e xxviii Introduction ⏐ P A R T A Governance and responsibility 1 2 Scope of corporate governance Topic list Syllabus reference 1 Definitions of corporate governance A1 2 Corporate governance and agency theory A2 3 Types of stakeholders A1 4 Roles of stakeholders A1 5 Major issues in corporate governance A1 Introduction We start this Text by discussing corporate governance, a fundamental topic in this paper. You have encountered corporate governance already in your law and auditing studies, but this syllabus requires a deeper understanding of what has driven the development of corporate governance codes over the last fifteen years. We start by looking at the principles that underpin corporate governance codes. Some will be familiar from what you have learnt about ethics in Auditing. We shall examine ethics in detail in Part C of this Text, but you'll find that certain ethical themes recur throughout this book. In Section 2 we show how corporate governance has partly developed in response to the problem of agency – the difficulty of ensuring that shareholders are able to exercise sufficient control over directors and managers, their agents. In Section 3 we consider the interests of other stakeholders in corporate governance. As we shall see in later chapters, a key issue in the development of corporate governance is how much, if at all, directors/managers have a responsibility to consider the interests of stakeholders other than shareholders. The examiner has stressed the need for understanding that business decisions are affected by, and can affect, many people inside and outside the business. In the last section we introduce other major corporate governance issues. We shall see how corporate governance guidelines address these in the next two chapters. 3 Study guide Intellectual level A1 The scope of governance (a) Define and explain the meaning of corporate governance 2 (b) Explain and analyse the issues raised by the development of the joint stock 3 company as the dominant form of business organisation and the separation of ownership and control over business activity (c) Analyse the purpose and objectives of corporate governance 2 (d) Explain and apply in the context of corporate governance the key 3 underpinning concepts (e) Explain and assess the major areas of organisational life affected by 3 corporate governance (f) Compare and distinguish between public, private and non-governmental 3 organisations (NGO) with regard to the issues raised by, and the scope of, governance (g) Explain and evaluate the roles, interests and claims of the internal parties 3 involved in corporate governance (h) Explain and evaluate the roles, interests and claims of the external parties 3 involved in corporate governance (i) Analyse and discuss the role and influence of institutional investors in 2 corporate governance systems and structures, for example the roles and influences of pension funds, insurance companies and mutual funds A2 Agency relationships and theories (a) Define and explore agency theory 2 (b) Define and explain the key concepts in agency theory 2 (c) Explain and explore the nature of the principal-agent relationship in the 3 context of corporate governance (d) Analyse and critically evaluate the nature of agency accountability in 3 agency relationships (e) Explain and analyse the following other theories used to explain aspects of 2 the agency relationship: Transactions cost theory and Stakeholder theory Exam guide You may be asked about the significance of the underlying concepts in Section 1, or to analyse a corporate governance scenario in terms of the agency responsibilities directors or auditors have towards various stakeholders. The issues highlighted in the last section could well be important problems in a scenario question. To quote the examiner: "Most questions will involve some focus on, or connection with, the stakeholders and how their agents act on their behalf. Students will have to identify the relevant stakeholders primarily by assessing their power and interest." 4 1: Scope of corporate governance ⏐ Part A Governance and responsibility 1 Definitions of corporate governance FAST FORWARD Corporate governance, the system by which organisations are directed and controlled, is based on a number of concepts including transparency, independence, accountability and integrity. 1.1 What is corporate governance? Key term Corporate governance is the system by which organisations are directed and controlled. (Cadbury report) Corporate governance is a set of relationships between a company's directors, its shareholders and other stakeholders. It also provides the structure through which the objectives of the company are set, and the means of achieving those objectives and monitoring performance, are determined. (OECD) Although mostly discussed in relation to large quoted companies, governance is an issue for all corporate bodies, commercial and not for profit, including public sector and non-governmental organisations. Exam focus An exam question on corporate governance might start by asking you to define what corporate point governance is. There are a number of elements in corporate governance: (a) The management, awareness, evaluation and mitigation of risk are fundamental in all definitions of good governance. This includes the operation of an adequate and appropriate system of control. (b) The notion that overall performance is enhanced by good supervision and management within set best practice guidelines underpins most definitions. (c) Good governance provides a framework for an organisation to pursue its strategy in an ethical and effective way and offers safeguards against misuse of resources, human, financial, physical or intellectual. (d) Good governance is not just about externally established codes, it also requires a willingness to apply the spirit as well as the letter of the law. (e) Good corporate governance can attract new investment into companies, particularly in developing nations. (f) Accountability is generally a major theme in all governance frameworks, including accountability not just to shareholders but also other stakeholders. (g) Corporate governance underpins capital market confidence in companies and in the government/regulators/tax authorities that administer them. 1.1.1 History of governance Governance focuses on ownership because ownership, and therefore financing, results in businesses being formed and expanded. Different systems of governance are seen as best practice in different countries, as we shall see later in this text. However much of the governance debate has been seen in the context of the so-called Anglo-Saxon model where ownership and management are separate, and companies can obtain a listing on a stock exchange where their shares are bought and sold. As well as being crucial to passing P1, you also need to be able to define governance and explain its function as part of the effective management and control of organisations to fulfil performance objective 2 of your PER. 1.2 Corporate governance concepts One view of governance is that it is based on a series of underlying concepts. Part A Governance and responsibility ⏐ 1: Scope of corporate governance 5 1.2.1 Fairness The directors' deliberations and also the systems and values that underlie the company must be balanced by taking into account everyone who has a legitimate interest in the company, and respecting their rights and views. In many jurisdictions, corporate governance guidelines reinforce legal protection for certain groups, for example minority shareholders. 1.2.2 Openness/transparency 12/07, 12/08 Key term Transparency means open and clear disclosure of relevant information to shareholders and other stakeholders, also not concealing information when it may affect decisions. It means open discussions and a default position of information provision rather than concealment. Disclosure in this context obviously includes information in the financial statements, not just the numbers and notes to the accounts but also narrative statements such as the directors' report and the operating and financial review. It also includes all voluntary disclosure, that is disclosure above the minimum required by law or regulation. Voluntary corporate communications include management forecasts, analysts' presentations, press releases, information placed on websites and other reports such as stand- alone environmental or social reports. The main reason why transparency is so important relates to the agency problem that we shall discuss in Section 2, the potential conflict between owners and managers. Without effective disclosure the position could be unfairly weighted towards managers, since they have far more knowledge of the company's activities and financial situation than owner/investors. Avoidance of this information asymmetry requires not only effective disclosure rules, but strong internal controls that ensure that the information that is disclosed is reliable. Linked with the agency issue, publication of relevant and reliable information underpins stock market confidence in how companies are being governed and thus significantly influences market prices. International accounting standards and stock market regulations based on corporate governance codes require information published to be true and fair. Information can only fulfil this requirement if adequate disclosure is made of uncertainties and adverse events. Circumstances where concealment may be justified include discussions about future strategy (knowledge of which would benefit competitors), confidential issues relating to individuals and discussions leading to an agreed position that is then made public. Exam focus point Weighing up transparency versus confidentiality may be difficult and hence the examiner has already tested it twice. Remember that sometimes there may be valid commercial reasons for keeping information away from those who may use it against the company. 1.2.3 Independence Independence is an important concept in relation to directors. Corporate governance reports have increasingly stressed the importance of independent non-executive directors, directors who are not primarily employed by the company and who have very strictly controlled other links with it. They should be free from conflicts of interest and in a better position to promote the interests of shareholders and other stakeholders. Freed from pressures that could influence their activities, independent non-executive directors should be able to carry out effective monitoring of the company in conjunction with equally independent external auditors on behalf of shareholders. Non-executive directors' lack of links and limits on the time that they serve as non-executive directors should promote avoidance of managerial capture – accepting executive managers' views on trust without analysing and questioning them. 6 1: Scope of corporate governance ⏐ Part A Governance and responsibility 1.2.4 Probity/honesty Hopefully this should be the most self-evident of the principles. It relates not only to telling the