Ethics & Corporate Governance

Question 1

Briefly explain the basis of good corporate governance

Answer 1

Corporate governance is the system by which companies are directed and controlled. Following several influential reports, many organisations of all kinds now adhere to certain key principles of good corporate governance such as:
• having a governing board of adequate size and competence,
• promotion of ethical decision making,
• independent verification of accounts,
• disclosure of all material matters to shareholders,
• sound risk management and internal control systems,
• having remuneration reasonable in relation to responsibility and performance,

Good corporate governance would benefit any organisation in a number of ways.

1. Separation of duties, UK Corporate Governance Code includes a separation of Chairman and CEO duties as part of a wider system of checks and balances within an organisation.
2. Potential for fraud, Fraudulent actions damage companies themselves, and outcomes of fraud impact negatively on both employees (who fear job losses) and shareholders (who suffer a fall in the value of their investment). There is a saying that ‘absolute power corrupts absolutely’ and too much-unregulated power can lead to abuses and potential for fraudulent actions.
3. Leadership, Good leadership is crucial to the future success of all organisations including the companies. Good corporate governance can improve company leadership. It allows increased expertise to be brought to bear on strategic decision-making, through the influence of non-executive directors (NEDs). NEDs offer a wider pool of knowledge and experience to the board. This should lead to a closer examination of strategies and hopefully an improvement in leadership decision making.
4. Scrutiny over the actions of an individual, Good corporate governance ensures that there is proper scrutiny over the actions of individuals in positions of power. Good corporate governance would help ensure that the personal objectives of executive managers, directors and the company’s strategic objectives are brought into line with those of its stakeholders.
5. Framework for reviewing development risk, Good corporate governance can provide a mechanism to review many forms of risk. Potentially, it can, through rigorous questioning, reasoning and justification provide a framework for reviewing and assessing new projects, developments and investment proposals. As such, strategic decisions which have a lasting impact on the future of an organisation can be properly considered.
6. Impetus to performance enhancement, A system of corporate governance that includes the operation of a remuneration committee (a principle of the UK Corporate Governance Code) can ensure that there is an effective link between performance and rewards. In this way an impetus will be offered to stimulate, encourage and enhance performance. Remuneration committees would also help curb so-called unjustified fat cat salaries and bonuses which can attract unfavourable publicity particularly at a time when economies are failing and standards of living in society as a whole are falling.
7. Access to funding and capital markets, The Cadbury report recommends that a board of directors should use the AGM as a vehicle to have a dialogue with its shareholders. Shareholder confidence is of critical importance. Good systems of corporate governance can reduce the perceived level of risk and can instil confidence in external stakeholders- not least shareholders and funding institutions.
8. Improved stakeholder confidence, The use of an independent management consultant and the appointment of a new Director of Compliance and Ethics should, through effective communication and good public relations activities, improve stakeholder confidence. Stakeholder groups such as employees, customers, suppliers and partners in joint ventures are vital to the future success of any company.
9. Transparency and social accountability, Negative press speculation, financial scandals and protests by anti-capitalist groups can raise uncomfortable questions about the operation of large businesses. Good corporate governance is therefore vital in terms of transparency and social accountability.

Question 2

The ethical code identifies five areas that provide a threat to the fundamental principles.

Answer 2

๏ Self-interest – a ‘conflict of interest’ which may inappropriately influence judgement
or behaviour.
๏ Self-review – When you are required to evaluate the results of a previous judgement
or service
๏ Advocacy threat – Arising if promoting a position or opinion to the point that your
subsequent objectivity is compromised.
๏ Familiarity – When you become so sympathetic to the interests of others as a result
of a close relationship that your professional judgement becomes
compromised.
๏ Intimidation – When you are deterred from acting objectively by actual or perceived
pressure or influence

Question 3

Fundamental principles contained in CIMA’s code of ethics:

Answer 3

1. Integrity
   A professional accountant should be straightforward and honest in all professional and business
   relationships. Integrity also implies fair dealing and truthfulness. A professional accountant should not be associated with reports, returns, communications or other information where they believe that the information:
   ๏ Contains a materially false or misleading statement;
   ๏ Contains statements or information furnished recklessly; or
   ๏ Omits or obscures information required to be included where such omission or obscurity would be misleading.
2. Objectivity
   A professional accountant should not allow bias, conflict of interest or undue influence of others to override professional or business judgments. Relationships that bias or unduly influence the professional judgment of the professional accountant should be avoided.
3. Professional Competence and Due Care, A professional accountant has a continuing duty to maintain professional knowledge and skill at
   the level required to ensure that a client or employer receives competent professional service
   based on current developments in practice, legislation and techniques. A professional accountant
   should act diligently and in accordance with applicable technical and professional standards when
   providing professional services.
   The principle of professional competence and due care imposes the following obligations on
   professional accountants to:
   ๏ Maintain professional knowledge and skill at the level required to ensure that clients or
   Employers receive competent professional service; and
   ๏ Act diligently in accordance with applicable technical and professional standards when
   providing professional services.
4. Confidentiality
   A professional accountant should respect the confidentiality of information acquired as a result of
   professional and business relationships and should not disclose any such information to third parties without proper and specific authority unless there is a legal or professional right or duty to disclose.
   A professional accountants should therefore refrain from:
   ๏ Disclosing outside the firm or employing organization confidential information acquired as a
   result of professional and business relationships without proper and spec
   ๏ Using confidential information acquired as a result of professional and business relationships
   to their personal advantage or the advantage of third parties.
5. Professional behaviour, A professional accountant should comply with relevant laws and regulations and should avoid any action that discredits the profession.

Question 4

Explain what are the regulatory bodies

Answer 4

The regulatory bodies ensure that both local and international frameworks and standards are upheld to take account of the ever-changing nature of corporate business.
1. Financial reporting standards
๏ International Financial Reporting Standards (IFRSs) – A global set of accounting standards that are prepared on international conceptual frameworks
๏ Local Generally Accepted Accounting Principles (Local GAAP) – Accounting standardsmthat are prepared following local conceptual frameworks.
2. Principles of financial reporting standards
๏ Principles based – the preparation of the accounting standards follows the principles/idea laid out in the conceptual framework, which results in more judgement in the preparation of the financial statements
๏ Rules based – the preparation of the accounting standards follows rules, as there are no fundamental principles to follow.
3. Role and structure of regulatory bodies IFRSs are developed and published by the International Accounting Standards Board (IASB). The IASB has 14 members, 12 of whom are full-time employees. Appointment of members is primarily based on their having sufficient technical expertise to ensure the IASB has the experience to tackle the relevant business and economic issues. Seven of the full-time members of staff are responsible for liaising with national standard-setters in order to promote the convergence of accounting standards.
The IASB has complete responsibility for all technical matters, including the preparation and publication of international financial reporting standards (IFRS) and exposure drafts; withdrawal of IFRSs and final approval of interpretations.

Question 5

What is IFRS Foundation and which is its objective? Explain also its relation with other bodies.

Answer 5

IFRS Foundation oversees the processes of the IASB. Its objectives are:
๏ Develop a set of high, quality, understandable, enforceable and globally accepted international accounting standards.
๏ Promote the use and application of those standards
๏ Take account of the financial reporting needs of emerging economies and small and medium-sized entities
๏ Bring about convergence on national accounting standards and IFRSs

• IFRS Advisory Council will consult with local standard setters, academics and other interested parties to determine their views on a range of issues.
• IFRS Interpretations Committee is responsible for reviewing new financial reporting issues and issuing guidance on the application of IFRSs. As well as the IASB and its associated bodies, other bodies can also influence the setting of IFRSs.
• International Organisation of Securities Commissions (IOSCO) – represent the worlds’ securities
  markets regulators
• Financial Accounting Standards Board (FASB) – US accounting standards-setting body

Question 6

Explain the standard setting process for IFRS

Answer 6

Since 2002 both the FASB and IASB have been working closely to bring together both US GAAP and IFRSs, in what has been known as the Convergence Project.
This has led to the development of several new/updated IFRSs, notably IFRS 9 Financial Instruments and IFRS 13 Fair Value.
The process of developing a new accounting standard follows a four-step process.
1. Advisory Committee, receives the report of other parties and develop a “working paper” to be reviewed.
2. Discussion Papers, all the papers developed will be discussed and develop a discussion paper, receive comments to analyze the nature and size of the issue.
3. Exposure Draft, they develop a draft of new standard based on the working paper and the discussion papers,
4. Issue new IFRS, finally a new IRF is officially issued and published to fix the issue.