Monitoring Test MT1A

Governance,
Risk & Ethics
P1GRE-MT1A-Z14-A

Answers & Marking Scheme

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1 KEY UNDERPINNING CONCEPTS

Fairness
Openness and
Reputation Transparency

Innovation
Integrity
CORPORATE GOVERNANCE
KEY UNDERPINNING
CONCEPTS Scepticism
Judgment
Independence

Accountability
Probity and
Honesty
Responsibility

Fairness

The systems and values within the company must be balanced in taking into account all those that have
an interest in the company and its future.

There should be equality and even-handedness within directors deliberations with the ability to reach
an equitable judgement in a given ethical situation.

The rights of various groups (stakeholders) have to be acknowledged and respected. For example,
minority shareowner interests must receive equal consideration to those of the dominant shareowner(s).

Innovation

Innovation is the process through which economic and social value is extracted from knowledge
through the generation, development, and implementation of ideas to produce new or improved
strategies, capabilities, products, services, or processes.

Entities operate in open and dynamic environments. To remain competitive and increase stakeholders'
wealth and be of increasing benefit to society as a whole, they must "innovate and adapt their corporate
governance practices so that they can meet new demands and grasp new opportunities." (OECD)

This implies that entities should be innovative in the way they apply good corporate governance
practices. Not just a case of "following the rules" or "doing the same as last year" but applying
substance over form to ensure that stakeholders and society as a whole have increased understanding of,
and benefit from, governance procedures (e.g. greater openness and transparency in reporting to
stakeholders and society through innovative Web-based applications and integrated reports).

Scepticism

In audit terms, scepticism is the attitude that includes a questioning mind, being alert to conditions
which may indicate possible misstatement due to error or fraud and a critical assessment of audit
evidence.

In corporate governance, and in many other applications, scepticism requires a questioning mind, being
alert for possible errors and a critical assessment of facts and evidence.

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One key element of good corporate governance is the oversight role applied by non-executive directors
and shareholders (especially institutional shareholders). For example, under the UK Corporate
Governance Code, NEDs should constructively challenge and help develop proposals on strategy. To
do so requires appropriate levels of scepticism.

As an underpinning concept, scepticism is, perhaps, unique in that it can also play a role in other
underpinning concepts. For example, application of healthy scepticism may assist the development of
fairness, openness and transparency, independence, probity and honesty, integrity and judgement within
the entity (e.g. challenging any system within the entity that may not appear to be fair to diversity or
could result in a reduction of transparency relating to a particular transaction)

Openness/transparency

Openness and transparency is the ease with which stakeholders are able to make meaningful analysis of
a companys actions, its economic fundamentals and the non-financial aspects pertinent to that
business.

It is a measure of how good management is at making necessary information available in a candid,

accurate and timely manner. This includes management developing the appropriate culture within the
company at all levels, strategic and operational

Such information is not only the statutory and listing disclosures required within financial statements,
but also general reports (eg to financial institutions), press releases, sustainability reports, general
corporate social responsibility reporting and other voluntary information.

It reflects whether or not investors and other stakeholders obtain a true picture of what is happening
inside the company.

Strong controls and systems have to be in place to be able to capture, analyse and present reliable
information on a timely basis to facilitate the appropriate level of openness and transparency.

Independence

Independence is the extent to which mechanisms have been put in place to minimise or avoid potential
conflicts of interest that may exist, such as dominance by a strong chief executive or large shareowner
(eg separation of the roles of chief executive and chairman of the board).

These mechanisms range from the composition of the board (eg equal or a majority of independent non-
executive directors to represent the interest of the shareholders and other stakeholders) to appointments
to committees of the board (eg independent non-executive directors composition on appointment and
remuneration committees to counter potential abuse by executive directors) and external parties such as
the auditors (eg use of the audit committee and limiting non-audit work).

The decisions made, and internal processes established, should be objective and not allow for undue
influences nor allow overt personal motivation to prevail, ie the company should be run for the benefit
of all stakeholders (shareholders being a primary grouping).

Probity and honesty

Probity and honesty are fundamental to corporate governance systems (regardless of their origin)
involving integrity, honour, virtue and fair dealing.

In the basic form, this implies not misleading stakeholders, eg shareholders, the market, employees. At
a higher level, the chief executive director provides all appropriate information to fellow executive
directors and non-executive directors.

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Responsibility

With regard to management, responsibility pertains to behaviour that allows for corrective action and
for penalising mismanagement. It is a willingness by management to accept liability for the outcome of
governance decisions.

Responsible management would, when necessary, put in place what it would take to set the company on
the right path no matter how painful this may be (eg dismissing an underperforming chief executive) or
against their own interests (eg the chief executive realising that it is time for them to go).

Whilst the board is ultimately accountable to the company shareholders, recent corporate governance
development means that it must act responsively to and with responsibility towards all stakeholders of
the company.

With regard to shareholders, it is argued that they have responsibilities as owners. That is to use the
available mechanisms (e.g. annual general meetings and voting) to query and assess the actions of
management.

Accountability

Individuals or groups in a company, who make decisions and take actions on specific issues, need to be
accountable for their decisions and actions.

Mechanisms must exist and be effective to allow for accountability. These provide investors with the
means to query and assess the actions of the board and its committees.

Current developments within corporate governance imply that management are not only just
accountable to shareholders but to all stakeholders. This is reflected within the development of
corporate social responsibility, sustainability reporting and research into the content of financial
statements showing that additional costs (eg environmental and social costs) other than pure economic
production costs should be accounted for.

Judgement

Entities operate within a complex and diverse range of events, activities and environments. Achieving
objectives requires a series of decisions to be made based on a solid and sound judgement of the
relevant information and environments the entity operates in.

An entitys management must be able to consider numerous issues and interrelationships, give each due
consideration, reach meaningful conclusions (that will enhance the prosperity of the entity) and
communicate/enact such conclusions.

This implies managers have a thorough understanding of the entity, its operations, business
environment and risks/opportunities as well as the necessary and appropriate skills to maximise benefits
and minimize risks.

As indicated by the World Bank, sound and appropriate judgement is essential to strong corporate
governance as corporate governance is concerned with holding the balance between economic and
social goals and between individual and communal goalsthe aim being to align as nearly as possible
the interests of individuals, corporations and society (Cadbury, World Bank report 1999)

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Integrity

Under the ACCA Code of Ethics and Conduct, integrity requires that in all professional, business,
personal and financial relationships, members should be straightforward and honest. This implies
honesty, fair dealing and truthfulness. Members should not be associated with (eg sign off) reports,
returns, communications or other information where they believe that the information:

contains materially false or misleading statements;

contains statements or information furnished recklessly; or

omits or obscures information required to be included where such omission or obscurity

would be misleading.

This understanding of the concept of integrity is fundamental for strong corporate governance. The
perceived integrity of the entity (eg as a corporate body), the integrity of the actions taken by the
management and employees of the entity, the integrity of its external and internal reports and
information cannot be greater than the integrity of those involved.

Individual integrity describes a person of high moral value. an individual who observes a steadfast
adherence to a strict moral code or ethical code notwithstanding other pressures on them to act
otherwise. The virtue of the individual rather than the ethics of the action is emphasised integrity
provides the necessary ethical framework.

As in many situations in life, within corporate governance trust is vital. Integrity underpins this.

Reputation

Although reputation has both a personal and entity aspect, an entitys reputation depends heavily on the
reputation of its managers and employees.

An entitys reputation is effectively the cumulative result of all of the other underpinning concepts of
good corporate governance.

Reputation risk is a business risk that many entities now consider to be the greatest risk to their market
standing. Evidence suggests that reputation carries an appropriate market capitalisation premium (good
reputation) or discount (bad or declining reputation) for listed companies.

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2 AZURE
Tutorial note: As part (b) is clearly related in the requirement to part (a), it is appropriate that a
tabular approach be adopted.
(a) Business risks
Rights to operate
All terms and conditions of the rights to
operate, which provide assurance that Azure
is a going concern for the time-being, must
be met. For example, twice-weekly flights
may be a guaranteed minimum.
Terms and conditions attached to the rights
may threaten Azures operational existence
if, for example, there are any circumstances
under which the rights could be withdrawn,
e.g. if the standard of service falls below a
minimum specified level.
Competition
Although at the moment there appears to be
none (as the rights are exclusive), any
competition in the future could reduce
profitability (e.g. if the right were to become
non-exclusive or an indirect service between
Sepiana and Lyme should be established).
Age of aircraft
The age of the aircraft (15 years) is likely to
have a bearing on fuel consumption and
other costs (e.g. repairs and maintenance).
Engine overhaul
If the lease is a finance lease it is likely that
Azure will have to bear the costs of the
overhaul which may have a detrimental
effect on cash flows.
The service would need to be suspended
while the engine is being overhauled unless
an alternative is planned for.
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(b) Processes for managing
Accept at the present level (as one that has to
be borne) but bear in mind (e.g. when
making strategic decisions) the impact that
managements actions could have on any
renewal of the rights.
Relevant terms and conditions should be
communicated to all staff so they are clear
about the importance of their areas of
responsibility.
Monitor the progress of applications for
flights to destinations which could provide
transit to Lyme.
Reduce the risk by increasing the reliability
and reputation of Azures service, improving
comfort etc (e.g. by increasing leg room and
air-conditioned lounges).
Azure should manage its cash flows and
borrowing capability (e.g. bank loan facility)
to carry out ongoing operating repairs as and
when needed.
As above, Azure should budget its financial
resources to meet the costs of the overhaul,
the timing of which can be planned for.
The lease agreement with the airline should
provide that an equivalent aircraft be
available.
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 Leased asset
Azure operates with just one leased asset
which may be withdrawn from service:
in the interests of passenger safety (e.g.
in the event of mechanical failure);
for major overhaul;
if Azure defaults on the lease payments.
Legislation
Noise and carbon emission legislation may
be introduced at some future date by the
government of Sepiana or Pewta.
Fuel prices
Increases in fuel prices (a major operational
cost) will reduce profitability.
Weather
Weather conditions may delay or cancel
flights. Actual and potential customers may
choose not to plan trips if the flight schedule
is so unreliable that they expect to face
disruptions and uncertain journey times.
Horticultural cargo
Certain produce may be prohibited from
import (e.g. due to the risk of spread of
disease). Azure may face fines for carrying
banned produce.
Growers may seek to hold Azure liable for:
produce which perishes (e.g. if
successive flights are cancelled);
impounded goods.
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Azure should enter into a contractual
arrangement (e.g. may be included within
the terms of an operating lease) for a
replacement aircraft in the event that the
aircraft be grounded.
Azure should carry adequate insurance cover
for remedying and/or providing
compensation to customers for significant
disruptions to the scheduled service.
Close monitoring of political situation in
each country plus international requirements.
Fuel surcharges should be included in the
flights price structure so that significant
increases can be passed on to the customers.
Hedging against the effect of energy price
(and exchange rate) risks through forward
contracts.
Manage the impact of the risk/modify the
business activity. For example, as any form
of travel may be hazardous if weather
conditions are so bad as to disrupt the flight
schedule, there should be air-conditioned
facilities in which travellers can relax before
their journey.
Contracts with growers should clearly state
items of produce that cannot be carried.
Azures operational controls should include
verification checks on produce carried.
Azure should have adequate insurance cover
against claims for damaged/lost cargo.
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 Economy
With significantly less demand for Business
Class than for Economy (which gets over-
booked) and still less for First Class, the
service is operating at well below capacity
(economy is only 54% of seating capacity).
Azure may not be recouping fixed operating
costs in the long run making the service
uneconomical.
Service levels
Azures schedule is described as efficient
and timely. If the level of service delivered
does not meet expectation it is unlikely that a
regular customer base will be established.
On-board services
Passengers are expressing dissatisfaction
with meals provided, especially on the
return flight from Darke. The food
prepared in Lyme may be stale or
contaminated by the time it is served.
Passengers may be deterred from using this
flight if they are subject to the risk of illness.
Passenger safety
Penalties for non-compliance with safety
regulations (e.g. maintenance checks on life
jackets, etc) may be incurred if inspection
logs are not kept.
Azure may face lawsuits for personal injury
or illness (e.g. deep vein thrombosis
dvt),
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Keep demand for the classes of tickets under
review and respond to the excess of supply
over demand for Economy seating (and
demand shortfall for First and Business
Class seats). For example:
charge higher prices for economy on
peak flights;
offer larger discounts for advance
bookings on First and Business Class
seats;
introduce a loyalty scheme for frequent
users which offers preferred customer
seat upgrades.
Azure should benchmark the timeliness of its
service, against a comparable airline service
operating under similar weather conditions.
Azure should consider:
changing caterer in Lyme;
a contract with a caterer in Darke;
expert advice (e.g. of a chef) on
preserving the quality of meals for long-
haul flights.
Staff training should be on-going with
regular safety drill procedures (e.g. in
evacuation procedures and the use of life-
rafts).
Safety procedures must be demonstrated
before take-off on every flight and
passengers referred to safety information,
including how to reduce the risk of dvt,
provided with each seat.
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 Air stewards/Cabin crew safety
Azure will have difficulty recruiting and
maintaining the services of appropriately
qualified cabin crew if it does not have
sufficient regard for their health and safety.
Emergency
A serious accident (e.g. fire), collision or
breakdown may threaten operations in both
the short and longer-term.
Flight personnel
Azure may not be able to service the flight in
the event of non-supply of flight personnel
by the international airline (e.g. due to strike
action).
Flight tickets
Tickets are sold by more than one party
(Azure and travel agents) and at more than
one location. Also, pricing is complex, with
a range of tariffs depending on many factors.
This increases the risk that:
revenue may be lost if passengers are
under-charged or ticket sales
unrecorded; and
flights may be over-booked, with
consequent loss of customer goodwill.
The configuration of the aircraft does not
currently meet the current demand profile of
passengers and under the terms an operating
lease may not be changeable.
Tutorial note: Candidates are not expected to have specific knowledge of the airline industry.
However, marks will be awarded for relevant comments, for example, concerning quotas for
landing/take-off slots and IATAs levy. The preceding answer is not exhaustive. For example, that the
aircraft is flying for only 24 hours a week is a risk as this is a low capacity at which to operate for the
recovery of overheads.
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Flight personnel rotas should ensure, for
example, that:
pilots take ground leave between
flights;
there is adequate cover when crew are
sick or taking leave.
Accept at the present level, but taking all
practicable safety checks now implemented
in the airline industry to ensure that Azure is
not exposed to preventable risks. For
example:
x-ray screening of checked-in baggage;
security screening of cabin baggage and
passengers, etc.
The agreement with the airline should
indemnify Azure for all costs and losses
incurred if flights are cancelled due to non-
availability of flight personnel.
Strict controls must be exercised over:
unused tickets;
ticket pricing;
real-time reservations; and
ticket refund and exchange transactions.
Commence negotiations with the
international airline for an amendment to the
current lease terms allowing flexibility in the
seating arrangements.
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 Marking Scheme

1 UNDERPINNING CONCEPTS

Generally 1 mark for each appropriate comment and description.

Max of 3 marks for each concept. max 25
____

25
____

Note the detail of each answer point required to obtain a mark.

2 AZURE

(a) Business risks

Generally mark for identification +
1 mark each point of explanation max 12

Ideas
Environment risks
competition
weather
emergency
Financial risks
overhaul costs
fuel prices
lease obligations
economy
loss of revenue
Compliance risks
rights to operate
safety management
Operations risks
age of aircraft
poor service levels (e.g. catering, timely operation)
passenger/crew safety
over-bookings

Tutorial note: Although in practice an analysis of the risks would be structured around
suitable classifications (e.g. those suggested above) many candidates would identify them as
they come to them in reading through the case. This suggested answer has been left in such
an order. However, candidates struggling to identify sufficient risks in the scenario could
have drawn on a classification to give them ideas on what to look for.

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 (b) Risk management processes
Generally 1 mark each point max 13

Ideas
Accept the risk
low impact risks
benchmark (or could reduce risk)
Reduce the risk
by implementing improved internal controls
staff training
hedge against it (e.g. fuel prices)
Avoid unacceptable risks
non-compliance
Transfer the risk
by insurance (amount/type)
contractual risk sharing
____

25
____

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