Paper P3 Management Accounting Risk and Control Strategy Post Exam Guide May 2008 Exam

General Comments Overall, performance was reasonable. Well-prepared candidates were capable of obtaining very clear passes. Weaker candidates tended to avoid the requirements of the question, either through a failure to grasp what was required or as an attempt to obtain marks for repetition of memorised facts and information. Generally, where candidates did not achieve a pass, the main problem was a failure to relate the answers to the situation portrayed in the question. Candidates who did this achieved high marks. When information is given in the scenario candidates are expected to use it to illustrate the main issues in their answer. Using the reading time wisely can be of huge benefit; candidates should always plan their answers and ensure they read the questions carefully before starting the paper. Candidates who answer the specific question asked could achieve high marks. Candidates waste valuable time if they fail to be specific in their answer, as only the points which answer the question will get marks. One of the main problems with candidates scripts this diet was a complete failure to answer what was asked. There was evidence of time pressure in a number of scripts; this can be avoided by use of an answer plan and by using the reading time to plan answers. At the Strategic level candidates are expected to use knowledge gained at the Managerial level to inform their answers. It would have been useful had candidates used the knowledge gained in P5 integrated management, in particular, when answering Q1. This is one of many examples of where prior knowledge of previous subjects is expected. Questions 4 and 5 were not as popular as the other three questions. It is very important that candidates prepare for the exam by learning all parts of the syllabus. Numerical questions will always be a part of this exam and it narrows down candidates choice if the numerical topics have not been studied. Question 4 was very badly done, few candidates made a reasonable attempt at part (c). Question 5 (b) was very poorly done as candidates did not answer the question. The question asked what factors should be taken into account when deciding what to include in the section of the report, not what should be included. This is another instance where candidate have not read the question properly. Note that the attached marking scheme often makes more marks available than indicated on the question paper. This reflects the fact that questions at this level can often be approached in more than one way and that there is no single perfect answer. In applying this marking scheme, marks are always restricted to the total offered by the question and so there is no advantage to be gained from over-developing the answer to one question at the expense of another that may appear more difficult.

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Paper P3 Management Accounting Risk and Control Strategy Post Exam Guide May 2008 Exam SECTION A 50 MARKS ANSWER THIS QUESTION

Question 1 (a) (i) Construct a 2x2 likelihood/consequences matrix according to whether they are high, medium and low. (4 marks) Explain, with examples, an appropriate response for each of the risk categories. (4 marks) Apply the matrix to categorise each of the seven risks identified by MFTs auditors and state your reasons. (11 marks) (Total for Part (a) = 19 marks) (b) As the sole internal auditor within MFT, write a report recommending to the Audit Committee which of the external auditors suggestions should be adopted and which should be rejected. Give reasons to support your recommendations. (26 marks including 5 marks for report style) (c) Explain the ethical issue faced by the internal auditor when responding to the external auditors report. (5 marks) (Total for Question One = 50 marks) Rationale This case study is set in a restaurant chain where auditors have identified various risks and have recommended improvements to overcome internal control weaknesses. The question requires candidates to relate the already identified risks to a likelihood/consequences matrix, and in doing so to make judgements about the severity of risks and the need for the recommended internal controls. Candidates are asked to write a report, for which marks are awarded. There is also an ethical dimension to the scenario as the report candidates are asked to produce is from the perspective of the accountant who designed the existing internal controls. The main syllabus areas covered are B (ii) measuring and assessing risk; B (iv) evaluating risk management strategies; B (vi) the costs and benefits of controls; and the ethical issue is part of syllabus outcome C (vii).

(ii)

(iii)

Suggested Approach Candidates should first construct a 2x2 likelihood/consequences matrix and allocate each risk and the risk response to areas of high, medium and low risk on the matrix. Candidates should then adopt a report format to address each of the auditors recommendations. Candidates must give reasons to support their argument as to whether the audit recommendations should be implemented or rejected. Candidates should note that merely accepting the audit recommendations for computerised systems without consideration of the costs and benefits of doing so is not likely to be a soundly based answer to the question. Candidates should then apply CIMAs Code of Ethics to the scenario to explain how their role of internal auditor may not be an objective assessment of the external auditors recommendations.

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Paper P3 Management Accounting Risk and Control Strategy Post Exam Guide May 2008 Exam

Marking Guide (a) Constructing a matrix and making judgements about relative risk and response, broken down as follows: Matrix Risk responses with examples Placing of the 7 risks on matrix and discussion of reasons for placing in that position - 2 marks per risk to a max of 11 marks (b) For each of the seven audit recommendations, assessment of risk; the most appropriate risk response; and the cost/benefit of the external auditors suggestions: 3 marks for discussion of each point raised by the auditor Format Ethical issues and objectivity

Marks

4 marks 4 marks 11 marks

21 marks 5 marks 5 Marks

(c)

Examiners Comments This question was done reasonably well by most candidates. Part (a) was straightforward and generous marks were available for the diagram and for placing the risks into the most likely position. This should have led to candidates achieving very high marks for this section. Many candidates did, but some had poor results for this part of the question. Reading the question carefully was the key to a high mark. Many of the risks could have been in a number of different positions on the diagram so a good explanation justifying the position was very important. Part (b) was well done by most candidates. Part (c) was very poor. CIMA has a section of its website devoted to ethics and it would be helpful if candidates read this in preparation for the next diet of exams. It was disappointing to see how few candidates gave a satisfactory answer to this part of the question. Common Errors Part (a) This part of the question was done reasonably. Some candidates did not appear to understand the requirements of the question and did not achieve a high mark for this part of the question. The attempts at the matrix were poor and many candidates just mentioned where the risks would be placed on the matrix and did not justify their decision. Many of the risks could have been placed in a variety of positions and the justification by the candidates was vital in deciding whether their decision was worth any marks. Marks were not awarded unless the candidates discussed the reasons for the risks being in that particular position on the matrix. Part (b) This part of the question was done well by many candidates. Part (c) This part was very poorly done by most candidates. This was disappointing given the emphasis on ethics by all the professional accounting bodies in the last few years. Candidates tended just to repeat words like integrity and honesty rather than answer the question. The main problem was that the internal auditor was the sole internal auditor and was responsible for ensuring that there were adequate internal controls in the system. He would find it difficult to be objective. Few candidates answered this correctly.

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Paper P3 Management Accounting Risk and Control Strategy Post Exam Guide May 2008 Exam

SECTION B 50 MARKS ANSWER TWO QUESTIONS ONLY

Question 2 (a) Explain the risks faced by CSX in relation to its inventory control system and recommend specific improvements to the systems internal controls. (15 marks) Recommend (without being specific to the CSX scenario) the tests or techniques, both manual and computerised, that internal auditors can use in assessing the adequacy of inventory controls. (10 marks) (Total for Question Two = 25 marks)

(b)

Rationale Question Two is a distribution scenario with particular problems in relation to inventory control which is carried out using an older computer system. Candidates are asked to identify the relevant risks and to recommend appropriate internal controls consistent with those risks. Candidates are also asked to recommend the kinds of tests that internal auditors could adopt in testing for the adequacy of inventory controls, both in terms of manual systems and in the particular context of an IT system. The syllabus areas covered are A (iv) Evaluate the appropriateness of an organisations management accounting control systems and make the recommendations for improvements; B (i) Define and identify risks facing an organisation; C (i) Explain the importance of management review of controls; and C (iii) Produce a plan for the audit of various organisational activities including management, accounting and information systems. The IT elements of the scenario relate to syllabus items E (iv) Evaluate and recommend improvements to the control of information systems, and E (v) Evaluate specific problems and opportunities associated with the audit and control of systems which use information technology.

Suggested Approach Candidates need to read the scenario carefully and identify the specific risks identified in the scenario. For each risk so identified, candidates need to make recommendations for internal control improvements that address those risks. Candidates then need to identify the internal control improvements that are necessary to mitigate weaknesses in the internal control system. This could either be done generally, e.g. through input, processing and output controls or by listing specific audit tests relating to inventory control

Marking Guide (a) Identify the risks of the inventory control system and recommend specific improvements to internal controls: 1 mark for each risk and 1 mark for each suggested improvement to the internal control for each risk to a maximum of 15 (b) Identify the tests or techniques, both manual and computerised, that internal auditors can use in assessing the adequacy of inventory controls: 3 marks for each test or technique to a maximum of 10 marks

Marks

15 marks

10 marks

Examiners Comments This question was a very popular question and was done very well by the majority of candidates. Part (a) was very well done but part (b) was disappointing. Candidates showed a low level of knowledge of the tests and techniques used by internal auditors. Again reading the question carefully was the key. Instead of discussing tests and techniques of internal auditors many candidates just listed internal controls. This approach did not get any marks.

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Paper P3 Management Accounting Risk and Control Strategy Post Exam Guide May 2008 Exam Common Errors Part (a) this part was done very well by most candidates. Part (b) this part was done very poorly with many candidates just listing internal controls rather than possible audit tests. Many candidates duplicated what they had said in part (a) but just added some comments suggesting the auditor should check whether the control was in place. A list of suggested tests and techniques was all that was required, marks were given for broad suggestions and also for detailed tests specific to inventory. This should have been a straightforward question for a well prepared candidate. Marks were disappointing in some cases. This is an area which future candidates would benefit from studying further.

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Paper P3 Management Accounting Risk and Control Strategy Post Exam Guide May 2008 Exam

Question 3 (a) You have recently been appointed Head of Risk and Internal Audit at LXY. (i) Identify, with a brief justification, three categories which may be used to classify and manage the risks faced by LXY. (3 marks) For ONE of the categories that you have selected in (i) above, identify three possible risks and recommend appropriate tools for their control. (9 marks) (Total for Part (a) = 12 marks) (b) A caf owner in Danon has approached LXY with a proposal to provide food and drink facilities on board long-distance bus services. Identify the additional risks that need to be considered by LXY in the evaluation of the proposal, and how they might be managed. (4 marks) (c) Many companies are too small to justify the existence of separate risk management and internal audit functions. Briefly explain the distinctive roles performed by each of these functions and recommend ways of maintaining their separate effectiveness within a combined department. (9 marks) (Total for Question Three = 25 marks)

(ii)

Rationale Question Three describes a bus operating company which is exposed to a very broad range of risks. Candidates are asked to select a categorisation system for the management of risks, in addition to identifying relevant tools of control. There is also a requirement to comment upon the respective roles played by risk management and internal audit in a generic context. The syllabus areas covered are B (i) Define and identify risks facing an organisation; B (ii) Explain ways of measuring and assessing risks facing an organisation, including the organisations ability to bear such risks; and B (vii) Discuss the principles of good corporate governance for listed companies, particularly as regards the need for internal controls.

Suggested Approach It is important for candidates to draft an answer that relates directly to the scenario, and so in answering part (a) the categories selected need to be appropriate to the context. Part (b) raises issues relating to the risks arising from lack of direct control of an operation in addition to the obvious health and safety concerns. In answering (c) candidates need to note that the requirement contains two distinct elements, and focusing on one only will earn limited marks.

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Paper P3 Management Accounting Risk and Control Strategy Post Exam Guide May 2008 Exam

Marking Guide (a) Identification of suitable risk categories Identification of related risks and appropriate controls for one of the categories: up to 3 marks for discussing each of 3 risks (b) (c) Identify the risks of allowing food and drink to be sold on board the bus services Explanation of respective roles and recommendation of tools for control: explanation of roles - 1 mark per relevant point tools for control - 2 marks for discussion of each tool.

Marks 3 marks

9 marks 4 marks

max 9 marks

Examiners Comments Generally candidates scored high marks for this question. Parts (a) and (b) were done well, the question allowed for a wide variety of risks to be selected by candidates and most candidates did achieve high marks. Part (c) was less well done as candidates could not suggest reasonable ways of maintaining separate effectiveness. Common Errors Part (a) and (b) were done well by candidates. A huge variety of risks were suggested by candidates and all reasonable suggestions gained marks. Part (c) was poor. Candidates could describe the separate roles of risk management and internal audit but had difficulty in suggesting ways of maintaining separate effectiveness. Again this was straightforward and a well prepared candidate should have achieved high marks.

Question 4 (a) Calculate the spot and six-month forward cross rates between the Australian and US dollar. (4 marks) Explain the meaning of the term arbitrage profit and explain why such profits may be available in the scenario outlined above. (No illustrative calculations are required). (6 marks) Calculate the profit available to the dealer from exploiting the opportunity shown above, clearly showing all of your calculations. (10 marks) Explain the importance of trading limits and value at risk as tools for managing the risks within a financial trading operation. (5 marks) (Total for Question Four = 25 marks)

(b)

(c)

(d)

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Paper P3 Management Accounting Risk and Control Strategy Post Exam Guide May 2008 Exam

Rationale Question Four required an understanding of exchange rate theory and hedging techniques in order to apply that knowledge to identify an arbitrage opportunity. In addition to calculating cross rates, candidates are required to explain the concept of arbitrage, identify the relevant opportunity, and calculate the resulting profit. General comment upon specific risk control tools makes up the remainder of the question. The whole question falls into syllabus area D - Management of Financial Risk, and in particular D (iii) Evaluate the effects of alternative methods of risk management and make recommendations accordingly; D (iv) Calculate the impact of differential inflation rates on forecast exchange rates and D (v) Explain exchange rate theory.

Suggested Approach Parts (a) and (b) require simple explanations or calculations to earn ten marks, and so it is suggested that these are tackled first. In answering (c), candidates need to look carefully at the rates given in the question, to get an initial sense of where potential profit might be made. This should be done by applying basic exchange rate theory to show the mismatch between forward exchange rates and current interest rate differentials. In part (d) candidates need to answer both elements of the question to gain maximum marks.

Marking Guide (a) Spot and forward cross rates: 2 marks for each (b) Explanation of arbitrage profit : 6 marks (c) Calculation of profit available: 1 mark for each part of calculation (d) Explanation of trading limits and VaR Max of 3 marks for discussion of VaR + max of 3 marks for discussion of trading limits

Marks 4 marks 6 marks 10 marks

5 marks max

Examiners comments Parts (a) and (b) were done well by most candidates but parts (c) and (d) were poor. It was very disappointing to see so few candidates attempt this question and how poor some of the attempts at part (c) were. Common errors Part (a) was done well. Part (b) many candidates confused speculation with arbitrage. Arbitrage is very specific and takes advantage of very short windows of opportunity to make money in the markets. There is very little speculation involved as arbitrageurs are almost certain that if they act quickly enough they will make money, before the markets adjust. Candidates who just discussed speculation achieved low marks. Part (c) This part was very poorly done. A handful of candidates got this right. It was clear that candidates had not learned this part of the syllabus and did this question out of desperation. It is wise to cover all aspects of the syllabus when revising. There is always a numerical element in this paper and assuming that the question can be avoided is not a good study technique. Many candidates made very poor attempts and others simply missed part (c) out altogether. Starting off correctly was essential as was choosing the correct rates. Part (d) was also poor. Many candidates explained trading limits and did not comment on value at risk, this suggests a lack of revision of this area. It also meant that few candidates passed this part of the question as they were only completing half the question.

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Paper P3 Management Accounting Risk and Control Strategy Post Exam Guide May 2008 Exam

Question 5 (a) With specific reference to risk management: (i) Define and discuss the role of the Treasury function within an organisation; and (6 marks) (ii) Discuss the arguments for and against operating a Treasury function as a profit centre. (6 marks) (Total for Part (a) = 12 marks) (b) Explain the factors a Board of Directors should consider when deciding what to include in the section entitled Risk Exposure and Control Systems, in their companys report. (13 marks) (Total for Question Five = 25 marks)

Rationale Question Five combines aspects of Treasury management and financial reporting in one question. The first part requires candidates to define the role of Treasury and understand the issues to be considered in operating it as a profit centre. The second part of the question requires understanding of the issues underlying decisions to report risk information in the annual report. The syllabus areas covered are B (vi) Evaluate the costs and benefits of a particular internal control system and C (vi) Discuss the principles of good corporate governance for listed companies, for conducting reviews of internal controls and reporting on compliance.

Suggested Approach Candidates should define and discuss both the investment and funding roles played by treasury in addition to its function in hedging financial risks. The answer should be framed in the context of the risks that are being managed, or are potentially created, by treasury activities. Part (ii) of (a) reflects this emphasis in requiring discussion of the case for and against treasury being run as a profit centre. Candidates should comment on the risk appetite implied by choosing for or against a profit centre approach. Candidates need to write ONLY about external risk reporting in answering part (b). Comments on internal reporting practice would earn no marks. Additionally, the answer should focus not on the content but on the factors to consider in writing the report. These include the commercial sensitivity of the relevant information, as well as the extent to which it is understandable by the average user of the financial statements.

Marking Guide (a) Role of the Treasury function - 1 marks per relevant point Case for/against a profit centre - max 3 marks for and 3 marks against (b) Factors to take into account in producing a narrative report on risk and control Max of 2 marks for discussion of each factor

Marks 6 marks 6 marks max 13 marks

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Paper P3 Management Accounting Risk and Control Strategy Post Exam Guide May 2008 Exam

Examiners Comments Part (a) was done very well by most candidates. This question has been asked before and candidates had clearly taken note and revised this area. It is always gratifying to see candidates achieving high marks. Part (b) was poor with few candidates producing a reasonable attempt. Failing to read the question properly was the main problem. Common Errors Part (a) was done well by most candidates. Part (b) was done very badly. The most common error was that candidates did not answer what was asked. The question asked what factors should be taken into account when writing the report, not what should go into the report. Many candidates wrote a list of what should be included in the report and did not comment on the factors affecting the decision of what was reported. Reading the question is very important. Candidates will not be awarded marks unless they answer what is asked.

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