ACCA paper p1 governance risk and ethics

Professional Examinations Paper P1 Governance, Risk and Ethics EXAM KIT P AP E R P1 : G OVERN ANC E, R ISK AND ETH ICS British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Published by: Kaplan Publishing UK Unit The Business Centre Molly Millar’s Lane Wokingham Berkshire RG41 2QZ ISBN: 978-1-78415-232-1 © Kaplan Financial Limited, 2015 Printed and bound in Great Britain The text in this material and any others made available by any Kaplan Group company does not amount to advice on a particular matter and should not be taken as such No reliance should be placed on the content as the basis for any investment or other decision or in connection with any advice given to third parties Please consult your appropriate professional adviser as necessary Kaplan Publishing Limited and all other Kaplan group companies expressly disclaim all liability to any person in respect of any losses or other claims, whether direct, indirect, incidental, consequential or otherwise arising in relation to the use of such materials All rights reserved No part of this examination may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without prior permission from Kaplan Publishing Acknowledgements The past ACCA examination questions are the copyright of the Association of Chartered Certified Accountants The original answers to the questions from June 1994 onwards were produced by the examiners themselves and have been adapted by Kaplan Publishing We are grateful to the Chartered Institute of Management Accountants and the Institute of Chartered Accountants in England and Wales for permission to reproduce past examination questions The answers have been prepared by Kaplan Publishing ii K A P LA N P UB L I S H I N G CONTENTS Page Index to questions and answers v Analysis of past papers xi Exam technique xiii Paper specific information xv Kaplan’s recommended revision approach xix Kaplan’s detailed revision plan xxi Section Practice questions – Section A Practice questions – Section B 45 Answers to practice questions – Section A 111 Answers to practice questions – Section B 245 In addition to providing a wide ranging bank of real past exam questions, we have also included in this edition: • An analysis of all of the recent new syllabus examination papers • Paper specific information and advice on exam technique • Our recommended approach to make your revision for this particular subject as effective as possible This includes step by step guidance on how best to use our Kaplan material (Complete text, pocket notes and exam kit) at this stage in your studies • Enhanced tutorial answers packed with specific key answer tips, technical tutorial notes and exam technique tips from our experienced tutors • Complementary online resources including full tutor debriefs and question assistance to point you in the right direction when you get stuck K APLAN P UBLI S H I N G iii P AP E R P1 : G OVERN ANC E, R ISK AND ETH ICS You will find a wealth of other resources to help you with your studies on the following sites: www.mykaplan.co.uk www.accaglobal.com/students/ Quality and accuracy are of the utmost importance to us so if you spot an error in any of our products, please send an email to mykaplanreporting@kaplan.com with full details, or follow the link to the feedback form in MyKaplan Our Quality Co-ordinator will work with our technical team to verify the error and take action to ensure it is corrected in future editions iv K A P LA N P UB L I S H I N G INDEX TO QUESTIONS AND ANSWERS INTRODUCTION Paper P1: Governance, Risk and Ethics, was first tested in December 2007 under its previous name Professional Accountant At that time it was a new paper, added to the syllabus to place ethics and governance prominently within the qualification Recent research and feedback from employers on ACCA's 2010 syllabus indicates risk is an important issue, especially in the current economic climate It is therefore essential that this topic is adequately covered by the syllabus In the ACCA Qualification, introduced in 2007, ACCA increased the coverage of risk However, based on employer feedback, ACCA has increased this even further in the revised syllabuses, first examined in June 2011 To reflect this increased coverage of risk, ACCA considered it appropriate to change the name of Paper P1 from Professional Accountant to Governance, Risk and Ethics This is a more accurate description of the syllabus content and will give employers the assurance that risk is adequately covered by the ACCA Qualification The paper name change came into effect June 2011 Note that this kit contains past ACCA exam questions for this paper, which are labelled as such in the index KAPLAN P UBLI S H I N G v P AP E R P1 : G OVERN ANC E, R ISK AND ETH ICS KEY TO THE INDEX PAPER ENHANCEMENTS We have added the following enhancements to the answers in this exam kit: Key answer tips All answers include key answer tips to help your understanding of each question Tutorial note All answers include more tutorial notes to explain some of the technical points in more detail Tutor’s top tips For selected questions, we ‘walk through the answer’ giving guidance on how to approach the questions with helpful ‘tips from a top tutor’, together with technical tutor notes These answers are indicated with the ‘footsteps’ icon in the index ONLINE ENHANCEMENTS Timed question with Online tutor debrief For selected questions, we recommend that they are to be completed in full exam conditions (i.e properly timed in a closed book environment) In addition to the examiner’s technical answer, enhanced with key answer tips and tutorial notes in this exam kit, online you can find an answer debrief by a top tutor that: • works through the question in full • points out how to approach the question • how to ensure that the easy marks are obtained as quickly as possible, and • emphasises how to tackle exam questions and exam technique These questions are indicated with the ‘clock’ icon in the index vi K A P LA N P UB L I S H I N G INDEX TO QUES TIO NS AND ANSWE RS Online question assistance Have you ever looked at a question and not know where to start, or got stuck part way through? For selected questions, we have produced ‘Online question assistance’ offering different levels of guidance, such as: • ensuring that you understand the question requirements fully, highlighting key terms and the meaning of the verbs used • how to read the question proactively, with knowledge of the requirements, to identify the topic areas covered • assessing the detail content of the question body, pointing out key information and explaining why it is important • help in devising a plan of attack With this assistance, you should then be able to attempt your answer confident that you know what is expected of you These questions are indicated with the ‘signpost’ icon in the index Online question enhancements and answer debriefs will be available on MyKaplan: www.mykaplan.co.uk KAPLAN P UBLI S H I N G vii P AP E R P1 : G OVERN ANC E, R ISK AND ETH ICS PRACTICE QUESTIONS – SECTION A Page number Question Answer Past exam (Adapted) Manage Ltd 111 Worldwide Minerals 116 Dec 07 Hayho 124 Jun 12 Swan Hill Company 131 Dec 08 Coastal Oil 138 Dec 11 Fuel surcharges 12 146 AEI 13 151 Global-bank 14 157 Jun 09 Rowlands & Medeleev 16 164 Jun 08 10 Chemco 18 172 Pilot 07 11 Mary Jane 20 178 Dec 09 12 Hesket Nuclear 22 186 Jun 10 13 ZPT 25 193 Dec 10 14 Bobo Car Company 28 200 Jun 11 15 P&J 30 207 Dec 12 16 Hoppo 33 214 Jun 13 17 Wyland 35 221 Dec 13 18 Xaxa 38 230 Jun 14 19 Cheapkit 40 238 Dec 14 PRACTICE QUESTIONS – SECTION B Page number Question Answer Past exam (Adapted) GOVERNANCE AND RESPONSIBILITY 20 Corporate governance guidelines 45 245 21 Geeland 46 248 Dec 11 22 KK 47 252 Dec 10 23 Multi-jurisdictional governance 48 255 Dec 07 24 Football club 48 260 Dec 07 25 Delcom 49 265 26 Vestel 50 267 27 Corporate governance 51 270 28 Laland 51 274 Jun 11 29 Oland 52 278 Dec 12 30 Lum Co 53 282 v i ii K A P LA N P UB L I S H I N G INDEX TO QUES TIO NS AND ANSWE RS Page number Question Answer Past exam (Adapted) 31 Zogs 54 286 Jun 12 32 Rosh and Company 55 291 Jun 08 33 Corporate governance debate 56 294 Jun 08 34 Boom 57 297 35 Eastern Products 57 301 Pilot 07 36 TQ Company 58 304 Jun 09 37 Roles and relevance 59 307 38 Metto Mining 60 310 39 Sarbanes-Oxley 61 313 Dec 13 40 HWL 61 317 Dec 13 41 Badison 62 321 42 Chambon 63 323 Dec 14 43 NIC 64 326 Dec 14 INTERNAL CONTROL AND REVIEW 44 Ding 65 329 Dec 09 45 Tomato Bank 66 332 Jun 10 46 ABC Co 67 335 Pilot 07 47 Yaya 68 339 Dec 12 48 SPQ 68 343 49 Gluck and Goodman 69 346 50 YAHTY 70 350 51 Blup Co 71 355 52 FIS 72 359 53 RG 73 360 54 Supermarket 73 363 55 Treadway 74 366 Jun 10 56 FF Co 75 370 Pilot 07 57 Franks & Fisher 76 374 Pilot 07 58 CC & J 77 376 59 Loho 77 379 Dec 08 Jun 13 Dec 14 IDENTIFYING AND ASSESSING RISK 60 Landmass 78 382 61 Dubland 79 385 Jun 13 62 Ultra Uber 80 389 Dec 10 63 Regional police force 81 392 64 GHI Group 81 394 65 Bob Wong 82 397 KAPLAN P UBLI S H I N G Jun 14 ix P AP E R P1 : G OVERN ANC E, R ISK AND ETH ICS Page number Question Answer Past exam (Adapted) CONTROLLING RISK 66 Chen Products 83 402 Dec 08 67 H&Z Company 84 406 Jun 09 68 Saltoc 85 410 Dec 09 69 BTS Company 86 413 70 Southern Continents Company 86 415 71 TASS 87 420 72 YGT 88 423 73 Doctors’ practice 89 427 Dec 07 Jun 11 PROFESSIONAL VALUES, ETHICS AND SOCIAL RESPONSIBILITY 74 Van Buren 90 430 Jun 08 75 Dundas 91 434 Dec 09 76 Happy and Healthy 92 438 Jun 10 77 Professional codes of ethics 93 442 Pilot 07 78 Pharma 93 444 79 Deontological ethics 94 447 80 RDC 95 449 Dec 12 81 Policy speech 96 453 Jun 09 82 INO Company 97 456 83 IFAC 98 460 84 Five ethical situations 98 464 85 Hogg Products Company 99 466 Dec 08 86 JH Graphics 100 470 Pilot 07 87 Carpets and floor coverings 101 473 88 Jojo Auditors 102 475 89 MATTI 103 479 90 Mahmood 104 481 91 Biggo Manufacturing 105 486 92 JGP Chemicals Ltd 106 490 Dec 10 93 Hum and Hoo 107 492 Jun 14 94 Bribery 108 496 95 Grindle 109 498 x Jun 14 K A P LA N P UB L I S H I N G P AP E R P1 : G OVERN ANC E, R ISK AND ETH ICS x vi i i K A P LA N P UB L I S H I N G KAPLAN’S RECOMMENDED REVISION APPROACH QUESTION PRACTICE IS THE KEY TO SUCCESS Success in professional examinations relies upon you acquiring a firm grasp of the required knowledge at the tuition phase In order to be able to the questions, knowledge is essential However, the difference between success and failure often hinges on your exam technique on the day and making the most of the revision phase of your studies The Kaplan complete text is the starting point, designed to provide the underpinning knowledge to tackle all questions However, in the revision phase, pouring over text books is not the answer Kaplan Online fixed tests help you consolidate your knowledge and understanding and are a useful tool to check whether you can remember key topic areas Kaplan pocket notes are designed to help you quickly revise a topic area, however you then need to practise questions There is a need to progress to full exam standard questions as soon as possible, and to tie your exam technique and technical knowledge together The importance of question practice cannot be over-emphasised The recommended approach below is designed by expert tutors in the field, in conjunction with their knowledge of the examiner and their recent real exams The approach taken for the fundamental papers is to revise by topic area However, with the professional stage papers, a multi topic approach is required to answer the scenario based questions You need to practise as many questions as possible in the time you have left OUR AIM Our aim is to get you to the stage where you can attempt exam standard questions confidently, to time, in a closed book environment, with no supplementary help (i.e to simulate the real examination experience) Practising your exam technique on real past examination questions, in timed conditions, is also vitally important for you to assess your progress and identify areas of weakness that may need more attention in the final run up to the examination In order to achieve this we recognise that initially you may feel the need to practise some questions with open book help and exceed the required time The approach below shows you which questions you should use to build up to coping with exam standard question practice, and references to the sources of information available should you need to revisit a topic area in more detail Remember that in the real examination, all you have to is: • attempt all questions required by the exam • only spend the allotted time on each question, and • get them at least 50% right! Try and practise this approach on every question you attempt from now to the real exam KAPLAN P UBLI S H I N G x ix P AP E R P1 : G OVERN ANC E, R ISK AND ETH ICS EXAMINER COMMENTS We have included the examiner’s comments to specific examination questions in this kit for you to see the main pitfalls that students fall into with regard to technical content However, too many times in the general section of the report, the examiner comments that students had failed due to: • “failure to read the question carefully enough” • “failure to answer at the level of the verbs used in the questions” • “expecting to be able to answer the exam using ‘book work’ or ‘rote learning’” and • not appreciating that “marks will not be awarded for non-case based answers if this was the requirement of the question” Good exam technique is vital xx K A P LA N P UB L I S H I N G THE KAPLAN PAPER P1 REVISION PLAN Stage 1: Assess areas of strengths and weaknesses Review the topic listings in the revision table plan below Determine whether or not the area is one with which you are comfortable Comfortable with the technical content Not comfortable with the technical content Read the relevant chapter(s) in Kaplan’s Complete Text Attempt the Test your understanding examples if unsure of an area Attempt appropriate Online Fixed Tests Review the pocket notes on this area Stage 2: Practice questions Follow the order of revision of topics as recommended in the revision table plan below and attempt the questions in the order suggested Try to avoid referring to text books and notes and the model answer until you have completed your attempt Try to answer the question in the allotted time Review your attempt with the model answer and assess how much of the answer you achieved in the allocated exam time KAPLAN P UBLI S H I N G xx i P AP E R P1 : G OVERN ANC E, R ISK AND ETH ICS Fill in the self-assessment box below and decide on your best course of action Comfortable with question attempt Only revisit when comfortable with questions on all topic areas Not comfortable with question attempts Focus on these areas by: • Reworking test your understanding examples in Kaplan’s Complete Text • Revisiting the technical content from Kaplan’s pocket notes • Working any remaining questions on that area in the exam kit • Reattempting an exam standard question in that area, on a timed, closed book basis Note that: The ‘footsteps questions’ give guidance on exam techniques and how you should have approached the question The ‘clock questions’ have an online debrief where a tutor talks you through the exam technique and approach to that question and works the question in full Stage 3: Final pre-exam revision We recommend that you attempt at least one three hour mock examination containing a set of previously unseen exam standard questions It is important that you get a feel for the breadth of coverage of a real exam without advanced knowledge of the topic areas covered – just as you will expect to see on the real exam day Ideally this mock should be sat in timed, closed book, real exam conditions and could be: • a mock examination offered by your tuition provider, and/or • the last real examination paper (available shortly afterwards on MyKaplan with ‘enhanced walk through answers’ and a full ‘tutor debrief’) xx ii K A P LA N P UB L I S H I N G theories of governance corporate governance approaches − − KA P LAN PUBL I SH ING what is it and why − Corporate governance Topic 1–2 Complete Text Chapter 1–2 Pocket note Chapter Q18 Q29(a) Q26(a) Q27(a) Q2(a) Q9(d)(iii) Questions to attempt KAPLAN'S DETAILED REVISION PLAN Review the introductory sections about corporate governance, including revision of the key concepts in governance These concepts are often tested as a small part of question, such as in Q2 (a) and Q9 (d)(iii) Agency theory is another popular topic, but again rarely forms an entire question on its own Q23 (a) allows you to start with a straightforward theory question Once you are happy with the theory, move onto tackle Q26 (a) and Q27 (a) which requires application to a scenario It would be good to try these questions in full to ensure you can explain the concepts clearly Q18 covers a range of questions on the varying approaches to corporate governance Tutor guidance Date attempted Self-assessment xx i ii xx iv board of directors directors’ remuneration relations with shareholders and disclosure − − − Topic Complete Text Chapter Pocket note Chapter P AP E R P1 : GOVERN ANCE, R ISK AND ETHICS Q4(d) Q19 Q31 Q34 Q11(a), (c)&(d) Q17 Q23 Questions to attempt This is the biggest topic in the area of corporate governance and appears, in some form or another, on every exam Q11 (a),(c)&(d) provides good practice on board composition and structures Q17 allows you to look at the chairman/CEO roles more closely, and it is a good question to try in full Q27 moves onto the areas of nominations and removal of directors Q23 also provides coverage of the induction process This is a highly topical area and hence is examined fairly frequently Q31 covers both the topics of the remuneration package and the committee that sets it Q34 proves to be a challenging question on a number of topics relating to directors and their remuneration Try this one in full, to time, and review the solution carefully This is a small area of the syllabus, and appears occasionally in exam questions When asked, it is only for a few marks Q4 (d) looks at the subject of disclosure for 10 marks Q19 provides coverage of shareholder intervention and some other governance topics – a good recap question Tutor guidance Date attempted K A PLA N PUB L I SH ING Self-assessment audit and compliance − 10 (and part of 6) KA P LAN PUBL I SH ING Identifying and assessing risk 11 − identifying risk information requirements − Complete Text Chapter Internal control and review − internal control systems Topic 11 10 (and part of 6) 9 Pocket note Chapter Q11(b) Q4(b) Q43 Q42 Q47 Q42 Q44 Q46 Questions to attempt Risk identification is usually asked in a broad question requiring you to look within a scenario for examples of risks – this can be seen in Q11 (b) Risk classifications are an alternative way of addressing the subject, as seen in Q4 (b) Internal controls has been examined frequently; sometimes in a theory question, often requiring application It is generally part of a question with either audit or risk Q42 (a) is good practice of the theory in the area (try it later – once you have revised audit) with Q44 and Q46 moving onto an application type question The topic is rarely examined, focussing on the information needs of management in control, risk management and review Q45 provides practice in this area Q43 covers a range of topics within this area Note the overlap with ethical threats in part (d) Q42 (c) provides practical application to a given scenario Try Q42 in full and practise your time management Tutor guidance Date attempted Self-assessment xx v KA PLAN 'S DE TA ILE D REV IS ION PLAN xx vi controlling risk − 12 (and part of 6) Complete Text Chapter 11 Professional values and ethics − CSR risk assessment − Topic 12 (and part of 6) Pocket note Chapter 11 P AP E R P1 : GOVERN ANCE, R ISK AND ETHICS Q35 Q54 Q55 Q57 Q58 Q59 Q60 Q9(b)&(c) Questions to attempt CSR pulls on the governance and ethics syllabus areas It has rarely been examined directly, but is forming a significant part of the reality of the business environment Q37(c) provides practice in this area Q9 (b)&(c) looks at the next stages of the risk management process, risk assessment, requiring a theoretical discussion and then application of the method This is a good question to practise in full It is useful to be aware of the overall risk management process, but be prepared for questions to focus on just one aspect or stage The topics in this area tend to be examined together in a single question Question 54 looks at risk management strategies (a popular question) In addition Q55(c) looks as the concept of embedding risk Q58 is additional practice on risk management strategies Q59 and Q60 provide practice on the overall risk management process along with a couple of other specific topics – try these questions in full, to time Tutor guidance Date attempted K A PLA N PUB L I SH ING Self-assessment Ethical theories − KA P LAN PUBL I SH ING Stakeholder theory − Topic 13 Complete Text Chapter 13 Pocket note Chapter Q67(c) Q78(c) Q8(a) Q21 Q4(c) Q9(a) Q8(d) Questions to attempt Stakeholders are an important part of this exam, and have been tested frequently Generally questions require you to identify, or classify stakeholders in a scenario, and consider their claims in some manner Q9(a) is a good question to start practising on Once you are happy with that, move on and look at Q8(d) and attempt this in full There are a number of ethical theories and at least one pairing or model is examined in every diet, hence there are many questions to practise on − relativism/absolutism: Q67(c) − deontological/teleological: Q70(c) and Q78(c) − Kohlberg’s CMD: Q8(a) − Gray, Owens and Adams: Q21 The latter has appeared a couple of times requiring you to view something from the perspective of a particular social stance This is more challenging, so practise Q4(c) to time and review the solution carefully Tutor guidance Date attempted Self-assessment xx v ii KA PLAN 'S DE TA ILE D REV IS ION PLAN x x v ii i Ethical decision making Social and environmental issues − − 16 15 Complete Text Chapter 14 16 15 Pocket note Chapter 14 Q10 Q4(a) Q67 Q68 Q69(b) Q70 Q71(a) Questions to attempt An underpinning concept to the role of a professional is that of public interest See Q71 (a) for an example of a recent question on this The role of the professional is covered well in Q67 This is an excellent broad question and worth attempting in full to practise many areas Q69 (b) is another example of question in this area Professional codes of ethics can be seen in Q70, and corporate codes in Q75 The two key models here: AAA and Tucker were the subject of an article by the examiner Tucker was subsequently examined in Q4 (a) – a good question to practise your understanding of the model Many scenarios, especially in Section A, contain some environmental reference, so it often forms part of a question Q10 (e) is a good example of this The topic of environmental audit can be reviewed in Q80(b), along with some revision of other audit types Tutor guidance Date attempted Self-assessment K A PLA N PUB L I SH ING Note: Not all of the questions are referred to in the programme above The remaining questions are available in the kit and should be attempted for extra practice for those who require more questions on some areas For many questions the above programme covers just some part, or parts, of the requirements You should complete all questions that you have started as a good basis for further practice Professional and corporate ethics − Topic P AP E R P1 : GOVERN ANCE, R ISK AND ETHICS Section PRACTICE QUESTIONS – SECTION A MANAGE LTD Background information Manage Ltd is a large family-owned private company operating in the UK in the contract services sector The principle business that Manage undertakes is project management on large, long-term building projects in the UK Manage Ltd has no overseas customers The company provides a complete project management service, enabling the customers to deal just with Manage Ltd Manage deal with all sub-contractors The business has been very successful in recent years and as a result has become a potential acquisition target for a major international company, Utopia Inc, based in the US Utopia Inc is listed on the New York Stock Exchange and is interested in furthering its businesses in Europe Some of the members of the family that own Manage Ltd (the Inglesons) are keen to dispose of their shares and it is therefore expected they will sell to Utopia if a suitable price can be agreed The managing director of Manage, Jean Smith (not in the Ingleson family), is currently negotiating with the directors of Utopia over a price for the shares Following the negotiation Jean will make a proposal to the Ingleson family Jean and other selected staff have already been offered positions in Utopia if the acquisition proceeds Financing the acquisition Utopia Inc have a corporate policy of financing their acquisitions through loans In previous foreign acquisitions, they have used either US or foreign loans depending on their views on economic and political factors in the US and in the foreign markets They have no strong views on where to raise finance They expect to need to borrow in months' time to finance the acquisition One factor that the directors of Utopia Inc feel needs to be considered however is that they are considering selling an existing UK division within a year and the proceeds are expected to be in the region of the acquisition price for Manage Ltd The disposal will definitely occur after the acquisition of Manage Ltd, probably six months later Corporate governance In anticipation of Manage Ltd becoming part of the Utopia Group the group CFO, Bert Bailey, has forwarded to Jean Smith a memo he sent last year to all divisional CEOs on corporate governance He told Jean that the same process would operate for Manage Ltd, but with the dates about a year on KAPLAN P UBLI S H I N G P AP E R P1 : G OVERN ANC E, R ISK AND ETH ICS MEMO To: Divisional CFOs and CEOs From: Bert Bailey Subject: SOX compliance Date: 15 January 20X4 As you are all no doubt aware, we are implementing Sarbanes-Oxley (SOX) this year This memo summarises the timetable; more detail on the processes and procedures required will follow later Feb – May Document key financial reporting systems and controls Decide key controls and report any material design weaknesses in systems; Jun – July Divisional management to test key controls to confirm compliance and the effectiveness of the systems; Aug – Sept Group internal audit to review documentation and testing, and report on each division to the audit committee; Oct – Nov External audit to conduct the majority of their attestation work; Dec Management certification and assertions as required by sections 302 and 404 The control framework the US companies will be using is the COSO framework Overseas companies can use a local framework, if desired, provided it is approved in advance by the group SOX project team Documentation must be standard across the group Required: (a) Explain the difference between strategic and operational risks (10 marks) (b) Explain the risks that could exist for Utopia in making the investment in Manage Ltd and discuss how Utopia could assess their likely impact on the company (15 marks) Jean Smith does not understand the memo she has been sent She knows that SarbanesOxley is the American corporate governance requirements but has not heard of any ‘control frameworks’ (c) (i) List some of the typical requirements for corporate governance in the areas of: • • (ii) directors and the board accountability and audit (10 marks) Explain the elements of an effective internal control system (such as in the COSO framework or Turnbull report) giving practical examples of how Manage Ltd could demonstrate they have met all elements (15 marks) (Total: 50 marks) K A P LA N P UB L I S H I N G PRA CTICE QUES TIO NS – SECTION A : S E CTI ON WORLDWIDE MINERALS (DEC 07) Walk in the footsteps of a top tutor The board of Worldwide Minerals (WM) was meeting for the last monthly meeting before the publication of the yearend results There were two points of discussion on the agenda First was the discussion of the year-end results; second was the crucial latest minerals reserves report WM is a large listed multinational company that deals with natural minerals that are extracted from the ground, processed and sold to a wide range of industrial and construction companies In order to maintain a consistent supply of minerals into its principal markets, an essential part of WM’s business strategy is the seeking out of new sources and the measurement of known reserves Investment analysts have often pointed out that WM’s value rests principally upon the accuracy of its reserve reports as these are the best indicators of future cash flows and earnings In order to support this key part of its strategy, WM has a large and well-funded geological survey department which, according to the company website, contains ‘some of the world’s best geologists and minerals scientists’ In its investor relations literature, the company claims that: ‘our experts search the earth for mineral reserves and once located, they are carefully measured so that the company can always report on known reserves This knowledge underpins market confidence and keeps our customers supplied with the inventory they need You can trust our reserve reports – our reputation depends on it!’ At the board meeting, the head of the geological survey department, Ranjana Tyler, reported that there was a problem with the latest report because one of the major reserve figures had recently been found to be wrong The mineral in question, mallerite, was WM’s largest mineral in volume terms and Ranjana explained that the mallerite reserves in a deep mine in a certain part of the world had been significantly overestimated She explained that, based on the interim minerals report, the stock market analysts were expecting WM to announce known mallerite reserves of 4.8 billion tonnes The actual figure was closer to 2.4 billion tonnes It was agreed that this difference was sufficient to affect WM’s market value, despite the otherwise good results for the past year Vanda Monroe, the finance director, said that the share price reflects market confidence in future earnings She said that an announcement of an incorrect estimation like that for mallerite would cause a reduction in share value More importantly for WM itself, however, it could undermine confidence in the geological survey department All agreed that as this was strategically important for the company, it was a top priority to deal with this problem Ranjana explained how the situation had arisen The major mallerite mine was in a country new to WM’s operations The WM engineer at the mine said it was difficult to deal with some local people because, according to the engineer, ‘they didn’t like to give us bad news’ The engineer explained that when the mine was found to be smaller than originally thought, he was not told until it was too late to reduce the price paid for the mine This was embarrassing and it was agreed that it would affect market confidence in WM if it was made public KAPLAN P UBLI S H I N G P AP E R P1 : G OVERN ANC E, R ISK AND ETH ICS The board discussed the options open to it The chairman, who was also a qualified accountant, was Tim Blake He began by expressing serious concern about the overestimation and then invited the board to express views freely Gary Howells, the operations director, said that because disclosing the error to the market would be so damaging, it might be best to keep it a secret and hope that new reserves can be found in the near future that will make up for the shortfall He said that it was unlikely that this concealment would be found out as shareholders trusted WM and they had many years of good investor relations to draw on Vanda Monroe, the finance director, reminded the board that the company was bound to certain standards of truthfulness and transparency by its stock market listing She pointed out that they were constrained by codes of governance and ethics by the stock market and that colleagues should be aware that WM would be in technical breach of these if the incorrect estimation was concealed from investors Finally, Martin Chan, the human resources director, said that the error should be disclosed to the investors because he would not want to be deceived if he were an outside investor in the company He argued that whatever the governance codes said and whatever the cost in terms of reputation and market value, WM should admit its error and cope with whatever consequences arose The WM board contains three non-executive directors and their views were also invited At the preliminary results presentation sometime later, one analyst, Christina Gonzales, who had become aware of the mallerite problem, asked about internal audit and control systems, and whether they were adequate in such a reserve-sensitive industry WM’s chairman, Tim Blake, said that he intended to write a letter to all investors and analysts in the light of the mallerite problem which he hoped would address some of the issues that Miss Gonzales had raised Required: (a) Define ‘transparency’ and evaluate its importance as an underlying principle in corporate governance and in relevant and reliable financial reporting Your answer should refer to the case as appropriate (10 marks) (b) Explain Kohlberg’s three levels of moral development and identify the levels of moral development demonstrated by the contributions of Gary Howells, Vanda Monroe and Martin Chan (12 marks) (c) Critically discuss FOUR principal roles of non-executive directors and explain the potential tensions between these roles that WM’s non-executive directors may experience in advising on the disclosure of the overestimation of the mallerite reserve (12 marks) (d) Draft a letter for Tim Blake to send to WM’s investors to include the following: (i) why you believe robust internal controls to be important; and (ii) proposals on how internal systems might be improved in the light of the overestimation of mallerite at WM Note: Four professional marks are available within the marks allocated to requirement (d) for the structure, content, style and layout of the letter (16 marks) (Total: 50 marks) K A P LA N P UB L I S H I N G ... of risk, ACCA considered it appropriate to change the name of Paper P1 from Professional Accountant to Governance, Risk and Ethics This is a more accurate description of the syllabus content and. .. Identifying and assessing risk Risk and risk management process  Categories of risk  Identification, assessment and measurement of risk                    Controlling risk Targeting... verify the error and take action to ensure it is corrected in future editions iv K A P LA N P UB L I S H I N G INDEX TO QUESTIONS AND ANSWERS INTRODUCTION Paper P1: Governance, Risk and Ethics, was