ACCA P1 Revision Mock - Questions J11

ACCA REVISION MOCK

Governance, Risk and Ethics June 2011

Question paper

Time allowed

Reading and planning: 15 minutes

Writing: 3 hours

This paper is divided into two sections:

Section A: BOTH questions are compulsory and MUST be attempted.

Section B: TWO questions ONLY to be attempted.

Do NOT open this paper until instructed by the supervisor.

This question paper must not be removed from the examination hall.

Kaplan Publishing/Kaplan Financial

Pape

r P1

PAPER P1 : GOVERNANCE, RISKS AND ETHICS

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© Kaplan Financial Limited, 2011

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REVIS ION MOCK : QUESTIONS

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SECTION A

This question is compulsory

QUESTION 1

The BMB Company provides rail passenger services between 152 different towns in one country. BMB is relatively successful in providing this service and has just had its lease to operate rail services renewed by the government. The terms of the lease state that BMB must provide payments of €100 million (or about 15% of turnover) to the government each year for the benefit of having a protected market in the areas where it provides rail services. However, the €100 million lease is a fixed sum not dependent on the number of passengers carried. So far, BMB has always been able to meet payment dates on the lease. Provision of rail services below the standard set out in the lease is also a breach of the lease terms, which is punishable by a fine.

Payment for rail transport is straightforward; customers purchase tickets prior to travel using cash, debit or credit cards. Creditors include loans and payment for new trains as well as lease payments to the government.

As part of the bid to renew the lease, BMB stated that it was investing in a new type of train which will use bio-diesel as a fuel. Biodiesel is a substitute for ordinary diesel and is produced from crops such as rape seed and soy bean. The blend used by the new train is ‘BF25’, so called because it consists of 25% biodiesel and 75% ultra low sulphur diesel. The directors hope that launch of the new train will help to maintain and enhance the image of BMB as an innovative and forward-looking company and will also satisfy the government, who are committed to reducing carbon emissions across all the country’s transport methods.

Design and initial testing of the trains has been completed by the overseas supplier N&D, and results are promising. The tests were carried out in the suppliers’ home nation where they generated extensive publicity which raised awareness of low carbon fuels. Consequently both the public and authorities in N&D’s country are beginning to consider the possibility that bio-fuels could be used to power trains without impacting on safety and performance.

Although final speed and safety trials are currently outstanding, BMB is committed to purchasing 15 train units from N&D. Any failure of the trains to pass the safety tests and be available to carry passengers will mean that BMB cannot meet its performance targets with the government, leaving the company open to fines for not meeting conditions in its lease. BMB’s contract with N&D is denominated in N&D’s home currency which has a volatile exchange rate. For the purchase to go ahead is it likely that BMB will need to take out additional loans.

The use of bio-diesel fuel represents an attempt by BMB to obtain good publicity from reduction in carbon emissions as well as showing that train services can be provided in a more sustainable way using renewable fuel sources. There is a growing international interest in bio-fuels, not just to power trains but as a general replacement for fossil fuels.

However, several high profile environmental pressure groups do not agree that bio-fuel represents a sustainable source of energy.

A spokesperson for one of these groups recently pointed out that few current bio-fuel programs are economically viable, and most have social and environmental costs: upward pressure on food prices, intensified competition for land and water, and possibly, deforestation. These risks are now well publicised and BMB may be under pressure to prove that the new trains do offer benefits for all concerned, not least in terms of reduced environmental damage. The directors of BMB have recently been told by their project manager that bio-diesel is in short supply whilst new crops are cultivated to provide the fuel.


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The ability of BMB to meet strict performance targets for provision of train services is further limited by government policy on updating of the rail network. Whilst demand for rail transport has grown for each of the last five years, investment in the rail network has fallen to an all-time low and government funding has been directed instead to building more roads. This means that BMB is locked into a lease to provide more rail services where the rail network infrastructure may not be able to cope with the number of trains that BMB wants to run.

The board of directors (whose remuneration in BMB is heavily weighted towards a percentage of net profits) are aware that their organisation is operating in a changeable environment. Whilst the new train launch is exciting, BMB is subject to a wide range of local and international influences posing significant risk factors, such as changing government regulations, pressure to deliver on targets and now the publicity surrounding bio-fuels. The directors do not wish to incur excessive costs in managing these risks and propose to continue following the ALARP principle, as approved by the national Rail Safety and Standards Board (RSSB).

The Directors are also keen to release some information to stakeholders on the innovative new trains they are confident will be running very soon, in order to generate some positive publicity. The directors also believe this could be an opportunity to reassure the public that any risks posed by the new trains and bio-fuel will be properly managed.

Required:

(a) Explain the concepts of risk and risk management and a process for managing risks in an organisation. (10 marks)

(b) Explain the dynamic nature of risk assessment, using examples from the scenario where relevant (6 marks)

(c) Describe 3 business risks that could affect BMB. For each risk, assess the impact of the risk on BMB. (12 marks)

(d) Explain the ALARP principle in risk assessment (6 marks)

(e) Draft a press release for issue by BMB’s Board of Directors to include the following:

(i) Why management believe investment in risk management strategies is important (6 marks)

(ii) An explanation of the advantages of BMB’s investment in Biodiesel trains to stakeholders (6 marks)

Professional marks for drafting a statement that is clear, has a logical flow, is persuasive and is appropriately structured. (4 marks)

(16 marks)

(Total: 50 marks)


KAPLAN PUBLISHING 5

SECTION B

Two questions only to be attempted

QUESTION 2

WFW (Worldwide Family Welfare) is a non-governmental organisation that provides charitable support to disadvantaged families throughout the world.

It is currently involved in a number of community projects to assist in the provision of clean water supply to families in countries in South America, Africa and Asia. In its home European country it focuses more on assisting clients in accessing state granted financial support as well as providing counselling and psychological support to those struggling with the demands of modern living.

The NGO has grown very rapidly in recent years as demand for its services have increased. In line with this rising need it has begun to slowly evolve from an enterprise primarily run by volunteers to an institution founded on a more commercial basis employing professional management drawn from the private sector. These changes are considered essential in supporting the sustainability of the charity’s function into the future.

The board of governors at the NGO recognise the need to adopt a relevant code of ethics as part of necessary governance support structures. They are however concerned over recent criticism of such codes and wish to ensure that any code created is effective throughout the organisation.

Required:

(a) Advise WFW advice as to the content of a code of ethics and its successful implementation. (12 marks)

(b) Explain the benefits of good corporate governance to this organisation. (8 marks)

(c) Define “sustainability” and discuss its meaning in the context of this organisation.

(5 marks)

(Total: 25 marks)

QUESTION 3

Roman Homes is a housing construction company which has been trading for approximately 15 years. At a time when everyone else is reducing development due to the falling demand for new houses, the board of Roman Homes have just announced plans to acquire two major sites near large cities with development estimates of 400 new properties. This is not the first time that the board have taken decisions that appear to be contrary to industry sentiment, but so far the financial results report that past decisions have been successful.

The largest shareholder of Roman Homes is Faretime, a pension fund, owning 18% of total shares. The remainder is held by other institutions (none with a holding exceeding 8%) and private shareholders, including current and ex-employees and board members. The fund manager, Anna Killian, responsible for this fund at Faretime has been looking closely at the annual report of Roman Homes and its recent acquisition decision, and has a number of queries.

The Annual General Meeting (AGM) for Roman Homes was scheduled for last week and Anna Killian planned to use this as an opportunity to ask some questions. Anna was disappointed to learn that a number of the board members were absent from the meeting, including the chief executive, Dean Robertson, the head of the audit committee (the finance director of Roman Homes) and the sales director. The chairman was present, but it soon became apparent that he had not been involved in much of the strategic decision making, and many questions were met with an explanation that “they were decisions made by Dean Robertson, the chief executive”.


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The chairman announced the decision of the audit committee to establish an internal audit function for Roman Homes. This function will ensure that all controls within the business are reviewed on a regular basis and that operational activities are efficient and economical, hopefully providing reassurance to shareholders of the strong control environment within the company. The audit committee was considering two alternative proposals for setting up such a function:

(1) Internal audit department is created which reports directly to the audit committee.

(2) Internal audit activity is outsourced to the firm of external auditors used by Roman Homes, with them taking direction from, and reporting their findings to, the audit committee.

Required:

(a) Define the term “agency cost” and describe examples of agency costs that may arise in the case of Roman Homes. (9 marks)

(b) Explain the methods by which shareholders may seek to resolve any agency problems that arise. (4 marks)

(c) Discuss, with reference to the case, the factors that would prompt an institutional investor to intervene in the affairs of a company whose shares it holds. (8 marks)

(d) Evaluate the two proposals for establishing internal audit within Roman Homes. (4 marks)

(Total: 25 marks)

QUESTION 4

National Airways (NA) is an ex state-owned national airline. Ten years ago it was privatised, with share ownership being taken up by a selected group of ex-government officials and wealthy business officials. This group of eight shareholders constituted the board of directors for NA, led by the charismatic figure of Raymond Kennedy, executive chairman.

To raise finance for updating the fleet of aircraft, NA floated on the stock exchange last year, against the wishes of many of the board members. They only accepted this course of action after Mr Kennedy promised that their position and power within the corporation would remain unaffected. Two of the original directors have already given up their positions to younger members of their family, a course of action agreed on by My Kennedy as head of the board.

The flotation was successful enough to place the majority of shares with outside investors for the first time in the company’s history. Following the flotation the board of NA reluctantly agreed to employ a company secretary to support their activities as a listed company. Despite their new situation the board are still reluctant to organise an AGM in the future since they feel that this may affect Mr Kennedy’s position as key decision maker within the company - he tends to make most of the executive decisions himself since the irregular board meetings generally only discuss directorial remuneration issues.

The company has always had a turbulent relationship between senior management and other employees. The Airline Workers Union (AWU) claims over 90% of all operational staff, including pilots, cabin crew and airport staff are members of the union. This figure is disputed by the executive chairman, who publicly announced that he believed the figure to be nearer 70%.


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National Airways has just reported a significant operating loss for the last financial year. At a meeting of the executive chairman and senior operational management the reasons for the loss were discussed in detail. The key factors contributing to this were the global economic decline hitting passenger numbers, the higher than industry average salaries paid to operational staff and an increasingly expensive final salary pension scheme. Three new strategies, which are due to be announced within the next few days, were approved by the board at this meeting. These are a pay freeze for all operational employees for at least 12 months, closure of the final salary pension scheme to new employees and, lastly, estimated job losses of 10% of all operational staff. There are no plans for salary freezes, job losses or changes to pension arrangements for senior management.

Raymond Kennedy commented at the meeting: “I can just imagine what the unions will make of our plans. They live in a dream world if they think we can survive without major changes to the way we work. Why can’t they support the company rather than threatening strikes as soon as management make a decision they don’t understand or like? Let’s just get on and impose these changes no matter what strike action they threaten!”.

Required:

(a) Describe the roles of a company secretary. (5 marks)

(b) Define the corporate governance structure within this company and critically evaluate the benefits of such a structure, with reference to the situation of National Airways where appropriate. (12 marks)

(c) Analyse the comments made by Raymond Kennedy at the board meeting with operational management. (8 marks)

(Total: 25 marks)


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ACCA P1 Revision Mock - Questions J11