acca p1 2013 notes

ACCA Paper P1 Governance, Risk and Ethics For exams in 2013

Notes

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ExPress Notes ACCA P1 Governance, Risk & Ethics

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Contents

About ExPress Notes 3

1. Some Key Things to DO at Paper P1 7

2. Corporate Governance and Responsibility 10

3. Risk Management and Internal Control 22

4. Professional Values and Ethics 27



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START About ExPress Notes

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Chapter 1

Some Key Points to DO at Paper P1

START The Big Picture

• Use mnemonics to help recall lists of facts (but then apply them – see below!)

• Prioritise the three areas of the syllabus within your study:

• Give more time to studying corporate governance than the other two areas, since there is more detail in this area to be learned. But make sure that you know all three areas well before the exam. You will not pass with expert knowledge of one or two of the core syllabus areas.

• Use facts and names from the scenario in your answer to show that you have applied the knowledge that you have. The P1 syllabus learning outcomes are all at “level 3” knowledge. This means that you get few (if any) marks for repeating or listing knowledge – it has to be applied somehow to get decent marks.

• Resist the temptation to write things you know. If it’s not relevant to a scenario in the question, don’t use it.



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• Be prepared to feel a little “cheated” by the exam itself, as you will not get the opportunity to show off everything you have learned. It’s very hard not to show off what you know, but it wastes time and annoys the marker, if it’s not relevant.

• Download the full text of the UK Corporate Governance Code (2010) from http://www.frc.org.uk/corporate/ukcgcode.cfm. It’s well written and brief. Reading the primary source document is less dull and academic than reading a text book.

• Illustrate the relevance of your knowledge by reference to recent real business events, where they are relevant. This shows that you understand that the subject matter of P1 is evolving and relevant to real business.

• Watch the requirements of each question very carefully. If the examiner asks you to “argue the case for...” you will not get good marks by presenting a balanced case of arguments for and arguments against.

• Write in full, but short, sentences. Avoid bullet point lists in the exam.

• Present answers in the required format (eg letter, briefing notes, etc). You will lose gift marks if you use a different format to the one that the examiner wants.

• Respect P1! It looks far less daunting than some other professional level papers, but it is worthy of time.

• Practice writing answers in full, under exam conditions and exam time pressure. Remember that you pass exams by what you write and how you write it. Reading past answers won’t help you practice this core skill.

• Consider taking a course in effective English if you feel that your business English isn’t good. A significant part of the professional marks are awarded for effective, businesslike communication.

• Get feedback on your sample answers. Possibly the most difficult part of passing P1 is knowing what the “target” is. It’s very hard to work this out without tutor feedback.

• Download all the past questions and answers from the ACCA website. Read them all through in full before the exam – it will help you think into the way the examiner thinks and writes and allow you to copy his style effectively in the exam room.

• Download and read all the examiner’s reports from previous sittings.

http://www.frc.org.uk/corporate/ukcgcode.cfm�



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• Keep calm! Paper P1 is a relatively easy paper to pass, if you’re fairly clear about what the examiner is looking for.

• Book on an ExP course if you can possibly afford it.



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Chapter 2

Corporate Governance and Responsibility


Corporate governance is the system by which a business is managed in the best interests of its stakeholders, the relationships between stakeholders and often constraining the executive power of directors to reduce the chance of dysfunctional behaviour. The UK Corporate Governance Code (2010) states “Good corporate governance should contribute to better company performance by helping a board discharge its duties in the best interests of shareholders; if it is ignored, the consequence may well be vulnerability or poor performance. Good governance should facilitate efficient, effective and entrepreneurial management that can deliver shareholder value over the longer term”.

It is underpinned by nine core concepts. In the exam, you may have to define these and apply them. This is their inter-relationship and very abbreviated definitions. You should attempt to remember fuller definitions from your course notes in addition to these.



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Fairness

This is a neutral attitude between stakeholders,

having respect for rights and views of any other group with a legitimate interest.

Integrity

Honesty, fair dealing and truthfulness (IFAC definition)

High moral character

Judgment

Making decisions that will maximise organisation’s

prosperity, using evidence-based decision making to

reach good decisions.

Independence (objectivity)

Objectivity is a state or

quality that implies detachment, lack of bias, not

influenced by personal feelings, prejudices or

emotions.

Responsibility

This is the responsiveness to the need for corrective

action. A director showing responsibility is one who is

“taking ownership” of a problem in order to solve it.

Accountability

This is being answerable for the consequences of decisions and actions.

REPUTATION

Quality decision making

FairnessNeutral between all

legitimate stakeholders

Integrity Straightforward, honest, fair dealing

JudgementDecisions based on

quality evidence and rational criteria

Independence/ objectivity

Free from bias, disregarding

matters irrelevant

Investor confidence

Honesty/ probityTruthfu, not

misleading. Fee from "spin"

Openness/ transparency

Presumption of full and frank disclosure

ResponsibilityActing in a timely fashion to correct

weaknesses

AccountabilityAnswerable to

stakeholders for actions/ decisions



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Probity

Probity means truthfulness and not misleading people.

It is linked to openness.

Reputation

This is the view that other

people have of the business. A strong reputation will

contribute to share price and thus to shareholders’ wealth.

Openness/ transparency

This is a default assumption that transparency is best.

KEY KNOWLEDGE Agency Theory and Costs

Directors manage the business on behalf of the shareholders. This makes the directors agents of the shareholders (who are the principal). The shareholders in a large business cannot possibly have all the information available to the directors, for practical reasons and also commercial sensitivity (a rival company would buy shares to get information about competitors if full disclosure of all facts to principal were required).

This agency problem arises from the different self-interest of the principal (eg wants to minimise costs and risk) and the agent (eg wants to maximise their own remuneration) and the information asymmetry between them.

Examples of agency costs (costs that would not be incurred if the principal managed the business themselves directly):

• Directors’ remuneration • Internal audit department • External audit fee.

KEY KNOWLEDGE Transaction Cost Theory

Transaction cost theory explains why companies exist. If stakeholders in a company (eg customers) were to try to engage in the company’s activities on their own, the costs would be prohibitive. So companies naturally grow as a means of reducing individuals’ transaction costs. As companies grow, however, agency costs tend to arise.



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KEY KNOWLEDGE Stakeholders

Definition: Any person, group of people or entity that may be affected by the activities of an organisation. Each stakeholder has their own wishes (stakeholder claims) which are often in conflict with the wishes of other stakeholders. This is stakeholder conflict.

Johnson & Scholes classify different types of stakeholder using the ICE mnemonic:

Internal Within the business itself

Connected Outside the business itself, but closely affected, often with a direct financial link

External Affected by the business but only remotely or non-financially.

Internal and connected stakeholders may be referred to as “narrow” and all stakeholders including external stakeholders may be considered “wide” stakeholders.

Possible exam relevance:

• How well are the directors identifying stakeholders and prioritising the conflicting claims of stakeholders?

• How legitimate is a claim of an individual stakeholder (ie how fair is their expectation that they can influence the business?)

KEY KNOWLEDGE Mendelow Matrix

This gives an indication of how directors of a business should prioritise their time and give relative weighting to different stakeholder claims in the event of stakeholder conflict.

Leve

l of

influ

ence

Level of interest

Low High

Low Minimal effort required Keep informed

High Keep satisfied Key players (core stakeholders)



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KEY KNOWLEDGE Pervasive Issues in Corporate Governance


• A useful checklist for assessing the performance of a board of directors. • Could be used to identify conflicting directors’ duties, eg in a takeover situation. • Lots of scenarios when this could be useful, not least to possibly define what

constitutes good corporate governance.

• Fiduciary duties of directors (legal duty arising from trust law) • Directors’ remuneration and rewards: alignment of directors’ interests to

stakeholders’ wishes • Board composition and balance • Reliability of financial reporting • Risk management and internal control • Rights and responsibilities of shareholders • Business ethics • Corporate social responsibility • Compulsory and voluntary best practice: does the entity go beyond what is legally

required?

KEY KNOWLEDGE Roles of Chairman and CEO

This is an important issue and a frequently occurring exam topic.

Chairman (the “head of state” of the company)

CEO (the “prime minister” of the company)

• Provide leadership to the board,

ensuring its effectiveness and setting its agenda.

• Ensuring the board receives accurate and timely information, so directors

• Execute the business plans

determined by the board. • Provide leadership to the business,

ensuring the effectiveness of business operations and leading the



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can’t be railroaded into following an over-dominant CEO’s wishes.

• Ensuring effective communication with shareholders and that their views are communicated to the board as a whole.

• Facilitate effective contribution from non-executive directors (NEDs), ensure constructive relations between execs and NEDs.

• Meet with the NEDs without the executives present.

• Facilitating appraisal of board members.

• Generally required to conduct the appraisal of the CEO each year.

• Encouraging active engagement by all the members of the board.

• Ensure NEDs are properly chosen, trained on induction and appraised.

• Ensure that all directors’ continuing professional development is up-to-date.

process of setting strategy. • Communicating effectively with

significant stakeholders. • Cooperate in induction and

development, especially of NEDs and senior management staff

• Cooperate by providing any necessary resources.

• Cooperate in appraisal of board members.

• Often conducts the appraisal meeting of other executive directors.

• Cooperate with all the members of the board.

It is a core principle of many corporate governance codes that the chairman and CEO should be different people.



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KEY KNOWLEDGE Key Board Committees

KEY KNOWLEDGE Role of Non-Executive Directors

This is an important issue and a frequently occurring exam topic. A criticism made of non-executive directors in the past is that they have been either symbolic only and contributing very little, or have become so involved in the company’s affairs that they are effectively executive directors. This may be a difficult balance to strike.

The board including some non-executive directors is required by almost all corporate governance codes. Their role was clarified by the Tyson Report (UK).

Audit committeeLiaises with external auditor, is the point of reference for the internal

auditor. Reviews the financial statements and in smaller entities probably also does the tasks of the

risk management committee. Comprises only non-executive

directors.

Remuneration committeeResponsible for advising on executive

director remuneration, probably through external benchmarking.

Determines the "cocktail" of remuneration types for executive driectors. Comprises only non-

executive directors.

Risk committeeOversees risk management.

Responsible for embedding risk awareness in culture. Risk

manager reports to this committee. In smaller entities,

possibly part of audit committee. Comprises mostly non-executives.

Nominations committeeRecommends appointments to the

board. Legally, shareholders appoint directors, but almost

always follow board recommendations. Comprises

mostly non-executive directors.



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Non-executive directors

• have no executive (ie day-to-day management) responsibilities. Executive directors are generally director of finance, director of HR (or some other stated area of operational responsibility). Non-executive directors never have any specific portfolio of responsibilities, other than the chairman’s responsibilities.

• have a key role in reducing conflicts of interest between management and shareholders

• share the same legal duties and potential liabilities as full executive directors. This enhances their responsibility and accountability, even though they are part-time.

• bring independent viewpoint as they are not full time employees. They are often called independent directors as a result.

The role includes four principal areas of responsibility:

• People. They are responsible (perhaps via board committees) for selection, remuneration and assessment of directors.

• Internal control and risk awareness. They will normally lead the company’s efforts to ensure that data about risks is properly obtained, collated, assessed and action taken upon it.

• Strategy. They contribute to strategy determination, mostly through an external viewpoint and by challenging the executive directors’ decision making. Their external experience is often useful.

• Scrutiny. They scrutinise the performance of management in meeting goals and objectives and monitor it. Their role of scrutiny is such that their job is mostly to challenge how decisions are made, rather than to make the decisions themselves.

KEY KNOWLEDGE Unitary v Multi-tier Board

Unitary and Multi-tier board structure

A unitary board is one where all directors, both executive and non-executive, participate in the same board meeting. A multi-tier board often has a separate supervisory board.

Advantages of a unitary board structure (disadvantages of a multi-tier structure) include:

• All participants have equal legal responsibility for management of the company and strategic performance.

• A single board promotes easier co-operation and co-ordination.



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• The presence of NEDs should lead to better decisions being made. • Independent NEDs are less likely to be excluded from decision-making and given

restricted access to information.

Drawbacks of a unitary board structure (advantages of a unitary structure) include:

• A NED or independent director cannot be expected to both manage and monitor. • The time requirements on non-executive directors may be onerous, meaning that

only weaker quality non-executive directors are willing to accept the role. • There is no specific provision for employees to be represented on the management

board (this is common in countries where multi-tier boards are common) • Emphasises the divide between the shareholders and the directors, as the

supervisory board is another layer between management and the shareholders.

KEY KNOWLEDGE Director’s Remuneration

Directors’ pay is set by the remuneration committee, which is made up entirely of non-executive directors. Their aim is to pay a high enough amount to attract and retain the directors who have the greatest potential to add value to the business. Directors’ salaries are an agency cost that should be minimised as far as possible, of course. It is necessary for the remuneration committee to incentivise directors in a way that will align their wishes with those of shareholders. Shareholders are likely to want the following, some of which pull in opposite directions!

• To take a level of risk that aligns with their own risk appetite (see notes below) and discourage directors from taking excessive levels of risk with shareholders’ money.

• Encourage directors to take a longer-term view of the business • Maximise current year earnings, subject to not disregarding the need to have some

view on the longer-term. Note that if a stock market is acting rationally (or “efficiently”) then excessive risk taking that adds only a small amount to earnings should result in a drop in the company’s share price. So if the directors are paid only a commission based on current year profits, they will have an incentive to take excessive risks with company assets. It’s relevant also to remember that directors often change jobs every three to five years, so it’s necessary to give them some incentive not to manage the company’s performance only to that time horizon.



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In order to ensure that directors have a form of balanced scorecard with which to make decisions, the remuneration committee will normally put together a cocktail of different elements of remuneration to align shareholders’ and directors’ interests. These may include:

• Basic salary • Benefits-in-kind (BIKs) such as company cars and other short-term perks • Pensions payable after retirement • Share options, which are likely to have a lock-in vesting period and be dated over a

range of dates into the medium- and long-term • Shares in the company itself • Bonus linked to current year profit • Discretionary bonuses based on year-end performance evaluation.

The relative mix within the remuneration package will hopefully align the directors’ incentives with the shareholders’ wishes. Basic

salary and BIKs

Profit related pay

Options and shares

Pensions Discretionary bonuses

Discourages excessive risk taking?

No effect No. Profits will increase with greater risks

Yes. Excess risks will depress share price

Yes. Very high risks could bankrupt the company and lose pension

Could do, depending on how it’s awarded

Encourages current year profit maximisation

No Yes Yes, though not without regard to long-term effects

No effect Could do, depending on how it’s awarded

Encourages longer-term view

No No Yes, especially if a range of exercise dates is given

Yes Could do, depending on how it’s awarded



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KEY KNOWLEDGE Governance Disclosures

Most governance codes require disclosures concerning the following:

• Sustainability reporting • Information about the board of directors • An operating and financial review (OFR) • Reports from the board committees. • Details of relations with auditors including reasons for change. • A statement that the directors have reviewed the effectiveness of internal controls. • A statement of relations and dialogue with shareholders. • A statement that the company is a going concern and the directors’ basis for

concluding that the company is a going concern.


• These are best practice disclosures. They are a useful checklist for evaluating if a board is doing all that it reasonably can to ensure that its key stakeholders are kept informed.

KEY KNOWLEDGE Rules Based v Principles Based Corporate Governance

There are many different codes of corporate governance around the world. They may broadly be categorized as those that focus on principles (some of which have supporting rules) and those which are rules-based only with few or no overriding principles that companies must follow. In reality, companies in a principles based jurisdiction will develop their own policies and rules that must be followed. In a rules based approach, any non-compliance is likely to be legally challenged by looking at the intention behind the law. This means that there will always be some interaction between the two approaches.



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Principles based Rules based

Key features “Comply or explain” approach. Investors then decide if any breaches are satisfactorily explained.

Objectives stated, eg the CEO must not be able to gain excessive power and entities design their own specific procedures to enact the principle.

Quasi-legal approach, with a series of specific rules that all entities must follow.

Strict liability approach to compliance; non-compliance cannot be justified on grounds of compliance being not cost-beneficial.

Often legally enforced, eg via the USA’s legal mechanisms and SFA for companies with shares traded in the USA.

Examples UK Corporate Governance Code 2010

OECD guidance

Sarbanes-Oxley Act (USA)

Relative advantages

Allows common sense judgment.

Leaves stakeholders to assess if non-compliance with every rule is a problem or not.

Allows flexibility between companies, so companies are addressing their own business-specific risks.

Lists of rules are unlikely to anticipate every possible situation. Wider, clear principles are less likely to have loopholes in regulation than detailed rules.

Rules-based compliance becomes a form of bureaucratic filling exercise. Principles based compliance requires companies to think and analyse their own risks.

Prevents wastage of resources with heavy compliance costs for small risks.

Requires compliance with the spirit of the law, rather than the minutiae of its wording.

Clear and unambiguous. In an environment where directors are often criticized, it’s fairer to directors to give clear rules for them to follow.

Clarity gives consistency of compliance between companies.

Lack of exemption via “comply or explain” gives greater confidence in compliance.



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Chapter 3

Risk Management and Internal Control


Risk can be a good thing in business – do not say in the exam that risk must be eliminated. Some risk is necessary for companies to be able to generate a return greater than the risk free return. However, risk that adds nothing to value is risk that ought to be identified and eliminated where possible. This is the process of risk management.

There are a number of approaches to risk management that have been identified such as:

• The Turnbull Report in the UK (now part of the Corporate Governance Code 2010) • The COSO (Committee of Sponsoring Organisations) framework.

The COSO Framework provides a good system for tackling questions in the exam as it takes a step-by-step approach. This is the system we will focus on.

You can obtain a considerable amount of free reading on enterprise risk management from COSO’s website at http://www.coso.org/default.htm.

The “COSO cube” diagram below indicates how enterprise risk management is something that ought to pervade the entire organisation. It has eight key steps in risk management, which should happen automatically all around the company, at all levels of operation from top level strategy formation to operations and compliance. It should also cut across all strategic business units within the entity.

http://www.coso.org/default.htm�



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Internal environment: The internal environment encompasses the tone of an organization, and sets the basis for how risk is viewed and addressed by an entity’s people, including risk management philosophy and risk appetite, integrity and ethical values, and the environment in which they operate. Objective setting: Objectives must exist before management can identify potential events affecting their achievement. Enterprise risk management ensures that management has in place a process to set objectives and that the chosen objectives support and align with the entity’s mission and are consistent with its risk appetite. This involves identifying the stakeholders and understanding the risk appetite of shareholders in particular. Management must ensure that the level of risk taken by the business is the level of risk that the shareholders would wish. Event identification: Internal and external events affecting achievement of an entity’s objectives must be identified, distinguishing between risks and opportunities. Opportunities are channeled back to management’s strategy or objective-setting processes. Risk assessment: Risks are analysed, considering likelihood and impact, as a basis for determining how they should be managed. Risk response: Management selects risk responses – avoiding, accepting, reducing, or transferring/sharing risk (the “TARA” responses). This develops a set of actions to align risks with the entity’s risk tolerances and risk appetite. Control activities: Policies and procedures are established and implemented to help ensure the risk responses are effectively carried out. In the exam, you may use the SOAPSPAM mnemonic to help generate ideas for control activities.



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Information and communication: Relevant information is identified, captured, and communicated in a form and timeframe that enable people to carry out their responsibilities. Effective communication also occurs in a broader sense, flowing down, across, and up the entity. Monitoring: The entirety of enterprise risk management is monitored and modifications made as necessary. Monitoring is accomplished through ongoing management activities, separate evaluations, or both. Monitoring means that the risk management system itself should remain effective over time and will be continuing to identify the most serious and up-to-date risks.

KEY KNOWLEDGE Risk Responses

Probability of event happening

High Low

Expected impact on the business

Low Reduce Accept

High Avoid Transfer

Reduce: Implement control procedures to reduce the incidence of the risk event. Avoid: Do not undertake the activity if possible. If it’s unavoidable, choose the

next best response. Accept: It’s unlikely to be cost-beneficial to attempt to further reduce this risk Transfer/ share: For example, by insurance. In the exam, state why the facts of the case suggest that your classification of probability of occurrence and expected impact on the business is appropriate, then conclude on an appropriate “TARA” response and give an example of at least one way to make this happen, eg by implementing stronger controls over inventory if theft is considered high probability and low impact. Risks that are avoided are ones that the entity manages to remove, or that part that they manage to reduce. Risk retention is where risk is either deliberately retained within the business because it is viewed as adding value or which is impossible to remove.



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KEY KNOWLEDGE Risk Manager

A risk manager is a full time employee, who is probably not a director. They report to the risk committee of the board. Their job is full-time identification and management of risks as well as ensuring that risk awareness is embedded in the corporate culture at all levels. A risk manager will generally have specialist knowledge of the industry. The risk manager needs to combine technical skills in credit, market and operational risk with leadership and persuasive skills to persuade all staff to consider risk in every decision that they make. This is embedding risk culture.

KEY KNOWLEDGE Types of Business Risk

Common sources of business risk include: • Market: Risks affecting every player in the market as a whole. “Systematic risk” as

used in CAPM in paper F9. • Credit: Risk of payables not paying, or of not being able to replace borrowings as they

fall due for renewal. • Liquidity: Risk of running out of cash, even if the business is profitable. • Technological risk: Risk of technology making current methods unprofitable and

redundant. • Legal: Pervasive risk of changes in law having an adverse effect on the business. • Health, safety and environmental: Partly a sub-set of legal risk, but also the risk of

the stakeholders’ expectations increasing beyond what is legally required and economically viable.

• Reputation: Damage done by loss of reputation, fairly or otherwise. • Business probity: Risk of dishonesty affecting the business. • Derivatives: Risk from holding highly volatile financial instruments.



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KEY KNOWLEDGE Types of Controls

• Corporate controls = general policy statements, established core culture and overall monitoring procedures, corporate governance

• Management controls = planning and performance monitoring • Business process controls = authorisation limits and reconciliation • Transaction controls include = accuracy and completeness checks

You may use the mnemonic SOAPSPAM to generate ideas for types of control: • Segregation of duties • Organisational controls (eg set authority limits) • Authorisation • Physical • Supervision • Personnel, eg background checks • Arithmetical and reconciliations • Management – the tone from the top, including existence of an internal audit

department.



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Chapter 4

Professional Values and Ethics


Ethics will feature significantly in the exam, often as part of a case study, but possibly as a stand alone question. It is unlikely that you would be asked your own ethical views on something. Indeed, it is likely that you may be asked to advocate the case for an argument that you personally do not believe in. More probably, you will be asked to define these terms and use them to categorise or explain the views of a person in a case study scenario.

KEY KNOWLEDGE Absolutism v Relativism

Absolutism (dogmatic ethics) is the view that there is an unchanging set of ethical principles that will apply in all situations at all times and in all societies.

These include religion, law, natural law and deontological approaches.



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Advantages:

• Set of rules that can be followed and knowing actions are right. • The absolute rules make application of corporate governance more achievable.

Disadvantages/ limitations:

• Takes no account of evolving norms within society and development of ‘advances’ in morality.

• Still subject to human interpretation = different views on the same issue. • There will never be universal agreement. • Two absolutist positions may be incompatible and therefore irreconcilable = can tell

lie to save an innocent life?

Relativism (pragmatic ethics) is the view that a wide variety of acceptable ethical beliefs and practices exist.

It recognises the differences that exist between the rules of behaviour prevailing in different cultures. Significant in the context of international business as ethical opinions may change over time.

KEY KNOWLEDGE Deontological Ethics v Teleological Ethics

The deontological approach judges the action, while the teleological approach judges the outcomes.

Deontology (the word is linked to the word “duty”) looks at all actions as being the result of a duty or “categorical imperative”. It is irrelevant what the consequences are of the action – the ethical behaviour is judged by the action itself, not its consequences. This school of ethical thinking is associated most strongly with the work of Emmanuel Kant.

For a deontological rule to exist, it must be capable of following a number of fundamental rules or “maxims”, including:

• It must be possible to apply the rule universally and consistently (the “universality” test)

• The rule should show respect for human dignity

Teleology makes moral judgements about the action by reference to their outcomes or consequences. The act itself is not relevant in assessing whether it is ethical or not, it is the consequences or potential consequences of an action that matters. Hence teleological



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thinkers may support the idea that victimless crimes may exist, if nobody is hurt by an action.

It may be sub-divided into two parts:

Utilitarian ethics – an action is morally right if it benefits the greatest number of people, even if it does harm to a minority.

Egotistical – the rightness or wrongness of an action is assessed only by references to the person making the ethical judgement, not society as a whole.

Under teleological thinking, right or wrong becomes a question of benefit or harm.

KEY KNOWLEDGE Development of Ethical Thinking: Kohlberg

Kohlberg's six stages can be more generally grouped into three levels of two stages each: pre-conventional, conventional and post-conventional. The theories were developed from analysis of child psychology and how children’s views of ethics morph into time by experience. Progression through each level (or “plane”) is sequential and no stage can be skipped, though not all people reach the final level.

Plane/ level 1: Pre-conventional ethical thinking

1. Obedience and punishment orientation (How can I avoid punishment?)

2. Self-interest orientation (What's in it for me?)

Plane/ level 2 (Conventional)

3. Interpersonal accord and conformity (Social norms, desire to fit in with the crowd, the good boy/good girl attitude)

4. Authority and social-order maintaining orientation (law are obeyed as an expedient in order for society to function, but its core rightness or wrongness is not challenged. A level 4 thinker would be willing to obey laws that were imposed by a non-democratic government).



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Level 3 (Post-Conventional)

5. Social contract orientation (laws are obeyed only because the individual recognises that laws must exist, evolve and require a degree of personal compromise in order for society to function. A stage 5 thinker would be willing to accept laws implemented in a democratic society only).

6. Universal ethical principles (Principled conscience. Laws and the reasoning of others are not viewed as necessarily to be obeyed. Indeed, if a government passes a law that violates a natural justice, such as imprisonment without trial, individuals have a duty to disobey the law and overthrow the government).

KEY KNOWLEDGE Resolving Ethical Conflicts

There are two principal models in the exam for attempting to resolve ethical conflict:

1. Tucker’s five questions 2. The American Accounting Association model.

In past exams, the examiner has stipulated which model to use, so you need to know both in complete form. Tucker’s five questions Ethical decisions, such as whether to proceed with an investment, should be evaluated by asking five core questions and obtaining evidence to reach an appropriate conclusion:

• profitable • legal • fair and equitable • right, which is prone to subjective judgement • sustainable or environmentally sound.



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American Accounting Association American accounting association model – ethical decisions as a series of answers to questions.

• Establish the facts of the case • Identify the ethical issues at stake, eg stakeholder claim conflict • Identify the norms, values and principles related (this could be particularly relevant if

assessing the behaviour of a person in a different culture/ country) • Come up with alternative course of action possible (brainstorm all possibilities) • Identify the best courses of action in alignment with the norms, values and

principles, ie produce a short list of viable choices • Assess the consequences of each course of action • Reach your decision.

Ethics and the accounting profession specifically There is a substantial overlap in the syllabus for paper P1 and the syllabus for F8 and P7 in this regard. IFAC (International Federation of Accountants) fundamental ethical principles

Objectivity

Members should not allow bias, conflicts of interest or undue influence of others to override professional or business judgements.

Professional behaviour

Members should comply with relevant laws and regulations and should avoid any action that discredits the profession.

Professional competence and due care

Members have a continuing duty to maintain professional knowledge and skill at a required level. Members must be seen as acting diligently and in accordance with applicable technical and professional standards



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Technical standards

Members should ensure all undertaken work is performed to the highest standard.

Integrity

Members should be honest and straightforward in al business and professional relationships

Confidentiality

Members should respect the confidentiality of information acquired as a result of professional and business relationships and should not disclose it to third parties without authority to do so. Such information should not be used for the personal advantage or members or third parties

Categories of threat to accountants’ independence:

• Self-interest (eg financial involvement) • Self-review (eg auditing financial statements that include figures based on the

auditor having advised on implementation of an accounting standard) • Advocacy (eg having a reason to believe a certain figure is right, when it’s

actually wrong such as attempting to neutrally assess a tax provision after fighting the client’s case for a reduction in taxes payable).

• Familiarity (excessive personal knowledge of the client, resulting in progressively hardened views of the client’s ethics and competence, thus destroying scepticism)

• Intimidation (eg threat of humiliation, blackmail).

KEY KNOWLEDGE Defining “Profession” and “Professionalism”

A profession is distinguished by having a:

• specialised body of knowledge • commitment to the social good • ability to regulate itself • high social status.



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Accountants should seek to promote or preserve the public interest. If the idea of a profession is to have any significance, then it must make a bargain with society in which they promise conscientiously to serve the public interest. In return, society allocates certain privileges. These might include one or more of the following:

• the right to engage in self-regulation • the exclusive right to perform particular functions, such as conduct audits or speak in

court on behalf of somebody • special status.

There is more to being an accountant than is captured by the definition of the professional. It can be argued that accountants should have the presentation of truth, in a fair and accurate manner, as a goal. This is because members of society at large are generally impacted by the actions of a profession, even if they have no direct involvement in that profession themselves.

Members of any profession therefore have an ongoing wider duty to society at large rather than solely to their own professional body.

KEY KNOWLEDGE Corporate Social Responsibility

The CSR Network (a not-for-profit NGO) defines corporate social responsibility (CSR) as being “about how businesses align their values and behaviour with the expectations and needs of stakeholders - not just customers and investors, but also employees, suppliers, communities, regulators, special interest groups and society as a whole”. In other words, it is the degree to which companies voluntarily engage with perceived duties beyond their minimum legal duties, if any legal duties even exist.



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KEY KNOWLEDGE Gray, Owen & Adams Viewpoints on Corporate Social Responsibility

Gray, Owen & Adams identified seven possible viewpoints that stakeholders might take, ranging from the most limited view of social corporate responsibility (pristine capitalists) to the most extreme (deep ecologists). In the exam, you may be required to define each of these, or suggest which of these viewpoints a particular stakeholder appears to fit into and why. The ones that we feel are the most important for the exam are in red.

Pristine capitalists: Business has no moral responsibilities beyond their obligations to shareholders and creditors.

Expedients: Social responsibility may be appropriate if it is in the business’s economic interest.

Proponents of the social contract (“social contractarians”): There is effectively a contract or agreement between the organisation and those who are affected by their decisions.

Social ecologists: Believe that business activities result in resource exhaustion; waste and pollution must be modified. Organisations must be socially responsible.

Socialists: Seek to promote egalitarian equality.

Radical feminists: Aim to promote feminine values such as co-operation. Note that this is not associated with the women’s rights movement.

Deep ecologists: Suggest that man has no greater rights to resources or life than other species.



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KEY KNOWLEDGE Sustainability

Sustainability is the ability to continue to generate the same return without causing permanent damage to the environment. • Weak sustainability:

This believes that the focus should be on sustaining the human species and the natural environment can be regarded as a resource. The weak sustainability viewpoint tends to dominate discussion within the Western economic viewpoint.

• Strong sustainability:

This stresses the need for harmony with the natural world; it is important to sustain all species, not just the human race. They see a requirement for fundamental change, including a change in how man perceives economic growth (and whether it is pursued at all).

(end of ExPress Notes)

acca p1 2013 notes

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