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BA4 - CIMA > Chapters 5&6 > Flashcards

Chapters 5&6 Flashcards

1
Q

Role of the board

A

Take major policy and strategic decisions (mergers, acquisitions, financing)

  • monitoring and even dismissing the chief executive
  • overseeing strategy
  • monitoring risks and control systems
  • monitoring human capital
  • ensuring effective communications with stakeholders
  • developing corporate social responsibilities and ensuring they’re met
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2
Q

The board of any company are expected to be

A

directors should have relevant expertise and there should be a mix of experience on the board

  • independent (pursuing company interests above own)
  • objective (capable of rationale and bias free decision making)
  • sceptical (question info given to them)
  • resourceful (capable of innovative leadership)
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3
Q

Shareholders and boards

A
  • shareholders of a listed company = most important so directors run company on their behalf . They only become involved at a very high level. If they’re dissatisfied with the performance of the board, they can exercise their power by voting on the re election of the current exec team.
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4
Q

UK model of corporate governance and board structure (single board)

A

Single/Unitary board
- mix of exec and non exec directors; mix is down to company but best practice = 50% should be subject to annual re-election

Advantages

  • NED’s = bring considerable expertise to the board and are empowered and more active
  • compromise is sought as no extreme decisions are presented
  • better collective decision making
  • wider involvement -> reduced instances of fraud and malpractice
  • higher investor confidence
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5
Q

European countries = Dual board structure

A 
Supervisory Board (reviews company direction/strategy and responsible for safeguarding stakeholders' interests and appoints the management board) 
Management Board (composed entirely of managers)

Advantages
+ power separation between managers and those that control for shareholders
+ implicit shareholder involvement
+ more independent thinking as separate meetings are hold
+ managers are empowered

Disadvantages

  • Dilution of power and confusion
  • extra bureaucracy
  • supervisory board are remote
  • the agency problem occurs when they act on behalf of each other
  • lack of transparency over appointments to the supervisory board
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6
Q

Development of corporate governance?

A

cadbury - stock exchange and split roles of board directors

Greenbury - director remuneration

turnbull - directors and internal control systems

Higgs - role of the NED’s

Tyson - NED’s recruitment and development

smith - auditors/ committees

sir David walker and the FRC - complete review and renamed to UK Corporate governance code

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7
Q

Stock market listing rules

A

Companies must COMPLY OR EXPLAIN in their annual report. The statement of how the company complied with the main principles of the UK corporate governance code and the instances of non compliance with explanations. Its then up to the shareholders to decide if they’re satisfied THEREFORE UK CORP GOVERNANCE is voluntary.

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8
Q

Principles of the UK Corporate Governance Code

A 
LEARR
Leadership
Effectiveness
Accountability
Remuneration
Relations with stakeholders
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9
Q

Leadership

A
  • board should be effective and accept collective responsibility
  • a division of responsibility is required; no person to have unfettered powers
  • chairman to be leading the board
  • NED’s to constructively challenge and help develop strategy
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10
Q

Effectiveness

A
  • Board to have a balance of skill, experience, knowledge, independence
  • a formal, rigorous and transparent procedure for appointing directors
  • directors should commit sufficient time to the role
  • directors should refresh and develop their skills and knowledge
  • boards should be supplied with quality info on a timely basis
  • the board should rigorously appraise its own performance annually
  • all directors to be subject to annual re-elections
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11
Q

Accountability

A
  • boards should present a balanced and understandable assessment of the company’s position
  • board should maintain sound risk management and internal control systems
  • audit committee should maintain an appropriate relationship with the company’s auditors
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12
Q

Remuneration

A
  • Exec Directors Remuneration should be designed to promote the long term success of the company. Performance related elements should be transparent, stretching and rigorously applied
  • no director should be involved in setting their own pay
  • should be enough to attract, retain and motivate directors but not excessive
    as linked to performance
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13
Q

Relations with shareholders

A
  • boards should maintain a dialogue with shareholders based on a mutual understanding of objectives
  • the AGM should be used to communicate with investors (ensuring a satisfactory dialogue takes place with investors)
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14
Q

how countries decide between comply/explain principles based vs rules based

A
  • what the dominant ownership structure of companies is
  • the nature of its legal system and its power and ability to interfere with how companies run
  • how the gov is structured
  • state of the economy
  • culture and history
  • capital/investment
  • general global political/economical environment
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15
Q

Advantages disadvantages of rules based to corporate governance (opposite for corporate gov to rules based)

A

+ clarity of what to do
+ binding and penalties
+ deterrent for poor governance
+ confidence in compliance

  • legal loopholes
  • less flexibility
  • increased regulation
  • box ticking approach
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16
Q

Codes for public sector / not for profit organisations

A

The Good Governance Standard for Public Services

  • organisational purpose
  • clearly functions/roles
  • promoting values
  • informed, transparent decisions and managing risk
  • capacity/capability
  • engaging stakeholders

The Code of Governance for the Voluntary and Community Sector 7 Principles;

  • board leadership
  • board In control
  • high performance board
  • board review/renewal
  • board delegation
  • board/trustee intregrity
  • board openness
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17
Q

Advantages and disadvantages of governance codes

A

+ improved performance
+ access to investment (global investors may pay premium)
+ reduced fraud
+ risk reduction

  • reduced competitiveness
  • can limit but not prevent fraud
  • restriction on director power
  • increased bureaucracy
  • reactionary to corporate failures and not proactive about potential issues
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18
Q

NED’s exert their power through sitting on 3 committees…

A

Audit
Appointments/Nominations
Remuneration

\+ reduces board workload
\+ improved decision making
\+ directors take big decisions seriously
\+ improved shareholder confidence
\+ risk/remuneration are important 
\+ compliance with codes etc
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19
Q

Audit Committee

A
  • NEDS entirely atleast 2 for smaller businesses and 3 for larger with at least 1 with recent/relevant financial experience
  • chaired by an independent NED who cannot also be the chairperson of the board
  • meet x3 a year and at least one meeting with the the auditors without the executive directors
  • responsible for the organisations controls/overseeing internal and external audits.
  • first required by cadbury code
  • appointing/compensating/overseeing external auditors
  • monitoring the accounts
  • reviewing internal controls
  • risk management systems
  • considering the external auditors independence and objectivity
  • approving non audit work awarded to external auditors
  • reviewing internal auditors work
  • reviewing whistleblowing procedures
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20
Q

Appointments/Nominations Committee

A

Majority should be independent NED’s
Help determine the structure of the board and appoint new executive directors.
- reviewing the size structure composition of the board
- considering the balance between exec and independent NEDs
- ensuring diversity
- providing appropriate balance of power between CEO and Chair
-evaluating the skills, knowledge, experience of board
-succession planning
-preparing job descriptions
- identifying new appointees to the board
- recommending whether directors should be reappointed
- act independent by shareholders

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21
Q

Remuneration Committee

A

Primary role in determining the general remuneration policy and the specific remuneration packages for each director.

  • seen to be independent all NEDs
  • clear policy accepted by shareholders
  • performance packages are aligned long term
  • clear/concise reporting
  • determining and reviewing policies
  • monitoring senior manager levels
  • detailed remuneration for executives
  • exec/key management fairly rewarded
  • agreeing compensation for loss of office
  • establishing a pension policy for board members

recommendations are put to a non-binding shareholder vote at least every 3 years

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22
Q

USA Sarbanes-Oxley (SOX)

A
  • rules based approach
  • complied with by all US companies, directors of subsidiaries of US listed companies and auditors working with US listed companies
  • all companies must provide a signed certificate from the CEO confirming accuracy of their financial statements
  • CEO and CFO must repay any bonuses received in the last 12 months of statements are restated
  • senior audit partner must be rotated at least every 5 years
  • 5 member board Public Company Oversight Board was established
  • regulations on off balance sheet reporting have been tightened
  • directors are prohibited
    from dealing in their own company shares during sensitive times
  • must have an audit committee to trade
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23
Q

South Africa King Report III

A 
The King reports in South Africa set out the corporate governance requirements for all entities, irrespective of their manner and form of incorporation. 
Broken down into 9 sections. 
- ethical leadership/corporate citizenship
- boards/directors
- audit committees
- governance of risk
- governance of IT
- compliance with rules
- internal audit
- governing stakeholder relationships
- integrated reporting and disclosure 
The code operates on the same basis as the UK Code eg Comply or Explain but refers to it as apply or explain.
24
Q

External Audit

A

Type of assurance engagement carried out by an audit practitioner to give an independent opinion on a set of financial statements. The objective is to enhance the confidence that intended users (rather than the responsible party) have in them by evaluating the content against certain criteria.

The Practitioner (auditor)
The Intended User (eg shareholders/investors)
The Responsible Party (directors)

Objective is to enable the auditor to express an opinion on whether the financial statements are prepared in all material respects in accordance with financial reporting framework.

25
Q

Exceptions of firms excluded to be audited

A

All companies required to be audited by statute unless they’re exempt by satisfying 2 of the following:

  • turnover less than £10.2 million
  • total assets less than £5.1 million
  • no of employees are less than 50
26
Q

Auditors objectives and requirements

A
  • obtain reasonable (not 100%) assurance that the financial statements are free from material misstatement due to fraud or error
  • express an opinion on whether the financial statements have been prepared in accordance with the applicable financial reporting framework
  • write a report and communicate accordingly

external required as
- shareholders, directors can’t due to lack of say/incentives to misrepresent etc so need an independent view according to law

27
Q

5 elements of an external audit

A
  1. three parties, the prepares, users and practitioner
  2. the subject matter (financial statements)
  3. sufficient and appropriate evidence
  4. evaluation in accordance with appropriate financial reporting framework
  5. audit report presented to shareholders

However there’s an expectations gap that auditors check every transaction but rlly they check a sample

28
Q

5 limitations to external audit FIRED

A

Financial statements contain numerous subjective statements/figures

Internal controls have inherent weaknesses

Representations from management have to be relied upon but not always honest/accurate

Evidence often persuasive rather than conclusive

Don’t test all transactions/balances (auditors work on samples)

29
Q

Purpose / assumptions / rights

A
  • purpose = enable auditors to give an opinion on the financial statements. Auditors are stewards and agents with shareholder = the principle.

audit opinion relies on adequate accounting records have been kept and are true, all information and explanations have been received and everything else has been correctly disclosed eg director benefits etc.

auditors have:

  • access to accounting records
  • access to info/explanations needed
  • company AGM can attend and speak to shareholders
  • legal rights corrected to their job role
30
Q

Fair presentation

A

The auditors report on the company’s financial statements is expressed in terms of truth and fairness. This is generally taken to mean that the financial statements are factual, free from bias, reflect the commercial substance of the business’s transactions.

True (factual, reality, standards and law, correctly extracted)

Fair( free from discrimination and bias, standards and law, good reflection)

31
Q

Materiality

A

Subjective concept often described as the level of error at which a reader’s view of a set of financial statements changes. No statutory definition but these benchmarks are used:

  • 5% of profit before tax
  • 0.5-1% of gross profit
  • 0.5-1% of revenue
  • 1-2% of total assets
  • 2-5% of net assets
  • 5-10% of profit after tax

A material misstatement compromises the fair presentation of the financial statements.

32
Q

Audit Design

A
  1. Audit Plan (terms, risk assessments, timetable)
  2. interim audit (firm systems of control documented, tests of control undertaken, limited substantive testing)
  3. Final audit (substantive testing, 3rd party confirmations, analytical review, agreeing statements to records, considering the going concern status)

+ important aspects given attention
+ resolves issues fast
+ organises staff effectively
+ ensures audit team has necessary skills
+ is a reference to help direct/review the work of an audit team
+ helps co-ordinate 3rd party input

33
Q

Audit Planning

A
  1. Pre-engagement activities
    - forming an agreement with management on engagement terms eg communication with all 3 parties, subject matter, sufficient/appropriate evidence, audit report.

This letter covers

  • objective/scope of the audit
  • auditors responsibility
  • identification of reporting frameworks
  • audit limitations
  • reference to the expected form of any reports to be issued
  1. Planning Activities
    - audit strategy ( setting the scope, timing, direction of the audit)
    - developing an audit plan (specific detailed plan on how to implement the strategy)
34
Q

Audit risks

A

The risk that an auditor gives an incorrect opinion (ie the risk that the financial statements contain a material error)

AR = IR x CR x DR

Inherent Risk: the susceptibility of a transaction or balance to material misstatement.

Control Risk: The risk that a misstatement would not be prevented or detected by internal control procedures

Detection Risk: The risk that the auditor fails to detect any material misstatement

35
Q

Audit Processes

A

the audit processes will focus in gathering evidence that supports the figures and statements found within the financial statements.

Audit evidence should be:

  • sufficient (quantity of it)
  • appropriate (reliability and relevance)
36
Q

Tests of control

A

Audit procedures designed to evaluate the operating effectiveness of controls in preventing/detecting/correcting material misstatements.

auditors will:

  • enquire and document controls
  • reperform transactions
  • inspect control mechanisms
37
Q

Substantive Tests

A

Designed to detect material misstatements

they include:

  • reconciling the financial statements to the underlying accounting records
  • examining material journal entries
  • examining other adjustments made in preparing the financial statements
38
Q

Analytical Review

A

Testing large volumes of predictable data by developing an expected balance, comparing to the actual data, and reconciling any material differences.

39
Q

Written Representation

A

is a written statement provided by management to the auditor in support of other evidence. They’re used to obtain confirmation from the clients management that those charged with governance have fulfilled their obligations.

Formal letter from management addressed to the auditor.

40
Q

Audit report

A

The audit report allows the auditor to express their opinion on whether the accounts have been prepared in all material aspects in line with applicable financial reporting frameworks. Where this is true - unmodified opinion has been expressed. If there’s no other matters on which the auditor wishes to draw out they’ll issue an unmodified report.

When this isn’t the case:

  • modify the report without modifying the opinion
    eg additional paragraphs to highlight something
  • modified report with a modified opinion
    statements arent true/fair or the auditor hasnt got enough evidence to make that conclusion
41
Q

Management reporting

A

After audit, they’ll report to those charged with governance (audit committee and directors) and submit a management letter.

42
Q

Audit firm governance code

A

The FRC and ICAEW published the code in 2010. Its split into 5 sections, 20 principles and 31 provisions.

Leadership
(firms need effective management)

Values
(firms work should be of the highest quality and conform with the IFAC code of ethics)

Independent Non-Executives
(NED’s should be appointed)

Operations
(firms should comply with all professional standards/regulations)

Reporting
(firms should publish audited financial statements)

43
Q

Internal Audit

A

Independent, internal appraisal activity - examining and evaluating the adequacy and effectiveness of other controls. Its two features are independence and appraisal.

not compulsory but listed companies who don’t have a function should annually review the need for one. Headed by a chief internal auditor who responds to the audit committee board of directors. formal report to management, shared with the audit committee and where necessary the external auditors.

  • review accounting / internal control systems
  • examination of financial / operating info
  • review of economy, efficiency, effectiveness
  • review of compliance
  • review of corporate objective implementation
  • review of asset safe guards
  • risks and risk management
44
Q

Advantages and disadvantages of internal audit

A
  • internal may not speak if they fear their job
  • familiarity threat so auditing colleague work
  • might not be practical to have a separate reporting channel
  • needs to be reviewed by independent managers so more work
  • lack of independence

+ well organised
+ sufficiently resourced
+ full access through whole organisation

45
Q

Internal vs External Audit

A

Internal

  • management
  • any task requested by management

External audit

  • shareholders
  • opinion on truth and fairness
  • testing
  • publicly available report
  • laws and regulations standards eg GAAP IAS
46
Q

Internal audit: financial Controls

A

essential to ensure that an organisation is accurately recording its transactions

Need to check:
revenue and cash collections

acquisitions and expenditures

production and conversion

financial capital and payment

personnel and payroll

external financial reporting

Internal audit function will rely on audit checks and audit trails

47
Q

Internal Audit: adding value

A
  • value for money audits (improving economy, efficiency etc)
  • project/IT audits (assess IT systems and project performance)
  • operational audits (management and processes)
  • procurement audits (purchasing options)
  • financial audits (preventing fraud and identifying trends/variance in performance)
  • social/environmental audits (CSR and environmental practices)
  • management audits (managers and corporate structure)
  • compliance audits (laws and regulations)
48
Q

Outsourcing internal audit

A

The internal audit function can be outsourced to specialist providers much like any other non core function within a business.

+ greater focus on cost and efficiency
+increased expertise
+ not permanently employed so reduce employee costs
+ more independent

  • lack of company specific knowledge
  • lower flexibility
  • lack of control
  • risks of lines blurring between external and internal audit
49
Q

Types of error

A

Errors of omission - such as failing to record a sale

Errors of commission - such as recording/posting a sale at an incorrect value

Errors of principle - failure to follow accounting standards

can prevent errors by:

  • authorisation
  • documentation
  • staffing
  • asset safeguarding
  • detecting errors
50
Q

Fraud

A

Involves deliberate falsification:

Ghost employees
(collecting payments for employees who dont exist)

Collusion
(with third parties)

Inflating expense claims

Stealing assets
(either physically/virtually)

Manipulation of financial statements
(or false accounting)

Money Laundering
(and advance fee fraud)

E-crimes (eg hacking)

51
Q

For fraud to occur?

A

Dishonesty
Opportunity
Motive

52
Q

Fraud prevention

A

preventative methods aim to reduce the opportunity and temptation for fraud.

EG

  • creation of an anti fraud culture
  • raising awareness through training programmes
  • encouraged to whistle blow on suspicion
  • sound internal control systems to identify fraud risks and monitor and report on those
53
Q

Fraud prevention/detection plan

A
  • segregation of duties
  • documentation and audit trails
  • prohibition of certain activities
  • limitation controls
  • internal audit investigations
  • investigating warning signs

and:

  • spot checks
  • reconciliations
  • control accounts
54
Q

Fraud responses

A

fraud response plan

  • internal disciplinary action (to punish wrongdoers and be deterrent)
  • civil litigation procedures (to recover monies/properties lost)
  • criminal procedures (reporting to the police)
55
Q

fraud publications in CIMA 2008

A
  • organisations may lose up to 7% of their annual turnover due to fraud
  • corruption is estimated to cost the global economy $1.5 trillion each year
  • organisations only recover a small percentage of their fraud losses
  • senior management and executives commit a high percentage of frauds
  • greed is a main motivator for committing fraud
  • those who commit fraud often work in finance functions
  • losses due to fraud are not limited to specific sectors or countries
  • the prevalence of fraud is increasing in emerging markets
56
Q

Executive directors

A

should only hold one FTSE 100 board membership

BA4 - CIMA (7 decks)

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