Professional Level – Essentials Module

Governance Risk and

Paper P1
Ethics

Time allowed: 3 hours 15 minutes

This question paper is divided into two sections:

Section A – This ONE question is compulsory and MUST be attempted

Section B – TWO questions ONLY to be attempted

Do NOT open this question paper until instructed by the supervisor.

This question paper must not be removed from the examination hall.
Section A – This ONE Question is Compulsory and MUST be Attempted

Question 1
M & A Consulting has recently floated on a European stock exchange. It was established in 1990 and has
grown to be a major player in government sector consultancy with large clients including both the Home
Office and the Foreign Office of its country of operation. The company has just been successful in the bid
to run JTrack, a scheme it designed to track prolific offenders through the criminal justice system for the
Government. M & A Consulting have always believed their Information Management procedures, drawn
up 3 years ago, to be both robust and secure, guaranteeing a minimum risk exposure to rogue
incursions, incompetence, ignorance, complacency, corruption and poor technical choice.

The laptops issued to all consultants do not have disc or CD drives, and restrictions are placed on large
files within the email accounts preventing data being transferred by this method. Two months ago,
however, the internal auditor highlighted that the training of new consultants on information security
matters was poor, and that the procedures themselves were out of date with current technology. His
concern was met with a response of “they’re all clever people, so they’ll use common sense and won’t
cause us any problems” from the Chief Operating Officer (COO).

Within the last week it has come to the attention of the COO, Michael Parsley, that a senior consultant
James Dill, has lost a memory stick containing Home Office data on all 84,000 prisoners in the country
and 43,000 of the country's most serious offenders. A decision was made to immediately inform the
Home Secretary. One of the more junior consultants, Marjorie Basil is a qualified accountant and felt very
strongly that this security breach should be made public knowledge. She decided therefore to write a
whistleblowing letter to the Times newspaper, who published the story. The Home Secretary has come
under pressure to explain why the Home Office, which had known about the loss, had not made it public
for three days when the whistleblower intervened.

"This was data that was being held in a secure form, but was downloaded onto a memory stick by an
external contractor," the Home Secretary said. "It runs against the rules set down for the holding of
government data and set down in the contract that we had with the external contractor."

Fears were also raised that the loss of the memory stick could leave the Government open to a multi-
million pound compensation bill in payouts to the 127,000 prisoners and persistent criminals whose
details were on it. Louise Christian, a leading Human Rights lawyer who has defended detainees at
Guantanamo Bay, said: "This represents a gross breach of the privacy of each prisoner whose data is on
the stick."If any of those whose details are on it can show that they came to harm because of their
information being in the public domain, they could sue the British Government for misfeasance of office
and for a breach of the Data Protection Act, both of which could carry damages.”

The Home Secretary has announced that an inquiry was underway and that the Home Office had
suspended its deal for the company to run JTrack, the offender tracking system. The statement said it
had breached the terms of its contract by failing to encrypt the criminals' data when downloading it on to
the memory stick. A spokesman for M & A Consulting, where one member of staff has been suspended
over the incident, said: "We are collaborating with the Home Office very closely on this matter. We would
like to assure all our customers that we will be looking to learn lessons from this incident and will review
our systems and upgrade to meet the highest standards of information security and encryption in the
future."

Prior to this incident breaking Thomas Mint, the sales director for M & A Consulting, had been making
plans for the purchase of a summer residence in southern Europe, largely funded by the bonus he
expected to receive as a key player in winning the J Track contract. Upon hearing the Home Secretary's
comments he contacted Jack Grass, a friend and head of the remuneration committee for M & A
Consulting, and suggested that they meet for dinner at a nearby restaurant.

Their dinner conversation was overheard by one of the fund managers at a major shareholder of M & A
Consulting who was having dinner with a client. He heard Jack reassuring Thomas that his bonus would
not be affected due to some careful wording of his contract stating that a bonus was earned upon
winning a contract, irrespective of whether the contract was retained subsequently.

The fund manager carried out some further investigation the next day and discovered that Mr Mint had a
cross directorship with Mr. Grass at another consulting firm. He immediately tabled a question for the
next AGM, due in a fortnight, regarding the problem ofindependence of Jack Grass and the
inappropriateness of the terms of Thomas Mint’s remuneration package.

Required:
(a) Explain, with reference to M & A Consulting as appropriate, the ethical responsibilities of
a professional accountant both as an employee and as a professional.
(8 marks)

(b) Define ‘reputation risk’ and evaluate the potential effects on M & A Consulting of this
incident.
(8 marks)

(c) Describe how the internal control systems at M & A Consulting differ from a ‘sound’
system of internal control. (10 marks)

(d) Prepare a speech to be delivered by the Chairman at the AGM to investors in response to
the concern about independence of the remunerations committee and associated issues.
The speech should address the following topics:
i. A definition of the term cross directorship. (2 marks)

ii. An explanation of FOUR roles of a remunerations committee and an assessment of

how the cross directorship undermines these roles at M & A Consulting.
(14 marks)

iii. Recommended governance actions that will be implemented to deal with this
situation. (4 marks)

iv. Professional marks for layout, logical flow and persuasiveness of the speech.
(4 marks)
(Total 50 marks)
Section B – TWO Questions ONLY to be Attempted

Question 2
Jonah Lewis was appointed as a junior member of the internal audit team at ABC Co in October. He had
just qualified as an accountant and was looking forward to the challenges involved in being part of the
internal audit team of a large corporation. Jonah's research, prior to beginning work, had identified that
the board structure of the ABC Co followed the recommendations of the principles based corporate
governance code used in its home country. For example, the audit committee consisted of three NEDs
and reported to the main board on a regular basis. Internal and external auditors both reported to the
audit committee, with the committee making recommendations for the appointment of both auditors.
Members of the committee had either relevant financial experience or sat on other boards (although not
in contravention of any corporate governance code).

On his first day at work, Jonah was asked to report to Mabel Currie, the chief internal auditor. She
explained that ABC Co's internal audit department was relatively new and had reported infrequently to
the audit committee. In her opinion this worked well, since she didn't always have anything to report on.
She had been recruited from ABC's main competitor, where she had worked as a management
accountant for several years, and was still 'getting to know the ropes' in relation to internal audit. S he
added that Jonah (and the other team member - an Information Technology specialist) was just as likely
to report to the Finance Director as her for the next few months whilst she got up to speed. Jonah was
given a department work plan for the next financial year and told to study it.

On reviewing the work plan, Jonah noticed that all of the projects to be completed related to internal
controls. He was also surprised to see that the departmental staff list included members of the accounts
department who were able to help out in internal audit testing whenever required. When Jonah next met
with Mabel Currie, he asked her for some more detail on the roles of the department. Mabel Currie stated
that whilst she was still learning her job, the scope of the department must be kept narrow. The finance
director had offered to help and in Mabel Currie's opinion he was much better suited to oversee the
department. She was hoping to be moved to the accounting department in time, where she felt she
would be much better suited to the work.

Required:
(a) Discuss the advantages and disadvantages of the ABC Company having an audit
committee with specific reference to the role of that committee
(10 marks)

(b) Critically evaluate the internal audit department in ABC Company. Include reference to
the roles of an internal audit department in your answer
(8 marks)

(c) Assess Mabel Currie's understanding of her role as chief internal auditor
(7 marks)

(Total: 25 marks)
Question 3
John Pentanol was appointed as risk manager at H&Z Company a year ago and he decided that his first
task was to examine the risks that faced the company. He concluded that the company faced three major
risks, which he assessed by examining the impact that would occur if the risk were to materialise. He
assessed Risk 1 as being of low potential impact as even if it materialised it would have little effect on the
company’s strategy. Risk 2 was assessed as being of medium potential impact whilst a third risk, Risk 3,
was assessed as being of very high potential impact.

When John realised the potential impact of Risk 3 materialising, he issued urgent advice to the board to
withdraw from the activity that gave rise to Risk 3 being incurred. In the advice he said that the impact of
Risk 3 was potentially enormous and it would be irresponsible for H&Z to continue to bear that risk.

The company commercial director, Jane Xylene, said that John Pentanol and his job at H&Z were
unnecessary and that risk management was ‘very expensive for the benefits achieved’. She said that all
risk managers do is to tell people what can’t be done and that they are pessimists by nature. She said
she wanted to see entrepreneurial risk takers in H&Z and not risk managers who, she believed, tended to
discourage enterprise.

John replied that it was his job to eliminate all of the highest risks at H&Z Company. He said that all risk
was bad and needed to be eliminated if possible. If it couldn’t be eliminated, he said that it should be
minimised.

(a) The risk manager has an important role to play in an organisation’s risk management.

Required:
(i) Describe the roles of a risk manager.
(4 marks)

(ii) Assess John Pentanol’s understanding of his role.

(4 marks)

(b) With reference to a risk assessment framework as appropriate, criticise John’s advice
that H&Z should withdraw from the activity that incurs Risk 3.
(6 marks)

(c) Jane Xylene expressed a particular view about the value of risk management in H&Z Company. She
also said that she wanted to see ‘entrepreneurial risk takers’.

Required:
(i) Define ‘entrepreneurial risk’ and explain why it is important to accept entrepreneurial
risk in business organisations;
(4 marks)

(ii) Critically evaluate Jane Xylene’s view of risk management.

(7 marks)
(Total 25 marks)
Question 4
Hogg Products Company (HPC), based in a developing country, was recently wholly acquired by American
Overseas Investments (AOI), a North American holding company. The new owners took the opportunity
to completely review HPC’s management, culture and systems. One of the first things that AOI
questioned was HPC’s longstanding corporate code of ethics.

The board of AOI said that it had a general code of ethics that HPC, as an AOI subsidiary, should adopt.
Simon Hogg, the chief executive of HPC, disagreed however, and explained why HPC should retain its
existing code. He said that HPC had adopted its code of ethics in its home country which was often
criticised for its unethical business behaviour. Some other companies in the country were criticised for
their ‘sweat shop’ conditions. HPC’s adoption of its code of ethics, however, meant that it could always
obtain orders from European customers on the guarantee that products were made ethically and in
compliance with its own highly regarded code of ethics. Mr. Hogg explained that HPC had an outstanding
ethical reputation both locally and internationally and that reputation could be threatened if it was forced
to replace its existing code of ethics with AOI’s more general code.

When Ed Tanner, a senior director from AOI’s head office, visited Mr. Hogg after the acquisition, he was
shown HPC’s operation in action. Mr. Hogg pointed out that unlike some other employers in the industry,
HPC didn’t employ child labour. Mr. Hogg explained that although it was allowed by law in the country, it
was forbidden by HPC’s code of ethics. Mr. Hogg also explained that in his view, employing child labour
was always ethically wrong. Mr. Tanner asked whether the money that children earned by working in the
relatively safe conditions at HPC was an important source of income for their families. Mr. Hogg said that
the money was important to them but even so, it was still wrong to employ children, as it was
exploitative and interfered with their education. He also said that it would alienate the European
customers who bought from HPC partly on the basis of the terms of its code of ethics.

Required:
(a) Describe the purposes and typical contents of a corporate code of ethics.
(9 marks)

(b) ‘Strategic positioning’ is about the way that a company as a whole is placed in its environment and
concerns its ‘fit’ with the factors in its environment.

With reference to the case as appropriate, explain how a code of ethics can be used as
part of a company’s overall strategic positioning.
(7 marks)

(c) Assess Mr. Hogg’s belief that employing child labour is ‘always ethically wrong’ from
deontological and teleological (consequentialist) ethical perspectives.
(9 marks)

(Total 25 marks)