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• Pages: 319

“ Be honest even if others are not. God is all knowing and all present always ”

2021 - 2022 EDITIO N

MA. ELENITA BALATBAT CABRERA

BBA MBA CPA CMA

GILBERT ANTHONY B. CABRERA

BBA MBA CPA

BERNADETTE ANN B. CABRERA

BBA MBA CPA

SOLUTIONS MANUAL

Solutions Manual – Corporate Governance, Business Ethics, Risk Management and Internal Control

CHAPTER 1

INTRODUCTION TO CORPORATE GOVERNANCE

Answer to Questions

1. Generally, governance refers to a process whereby elements in society wield power, authority and influence and enact policies and decisions concerning public life and social upliftment.

2. It comprises all the processes of governing – whether undertaken by the government of a country, by a market or by a network – over a social system and whether through the laws, norms, power or language of an organized society.

3. Refer to page 3. Students can give examples based on their exposure and experience to the specific area of governance.

4. Refer to pages 3 to 5.

5. False. Transparency means that decisions taken and their enforcement are done in a manner that follows rules and regulations. It means that information is freely available and directly accessible to those who will be affected by such decisions and their enforcement. It also means that enough information is provided and that it is provided in easily understandable forms and media.

6. True. Good governance requires that institutions and processes try to serve the needs all stakeholders within a reasonable timeframe.

7. Corporate governance is defined as the system of rules, practices and processes by which business corporations are directed and controlled. It basically involves balancing the interests of a company’s many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community.

8. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders, and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs.

Solutions Manual – Corporate Governance, Business Ethics, Risk Management and Internal Control

CHAPTER 2

CORPORATE GOVERNANCE REPSONSIBILITIES AND ACCOUNTABILITIES

Answer to Questions

1. NO. Good governance is important not only to large listed public companies but to small and medium-size businesses as well. In fact, SMEs need to apply the characteristics of good governance for two important reasons, namely a. to maximize the income on the limited resources they have b. to steer the company to become a more efficient and effective organization that can spur its growth

2. NO. Good governance is based on principles underpinned by consensus and developed continuously on notions of good practice. Principles and approaches should be tailored to specific needs of an organization at a given point in time.

3. The essence of any system of good governance is to allow the board and management freedom to steer their organization forward and to exercise that freedom whether a framework of effective accountability.

4. The board of directors derives its authority from the shareholders who elect the members during the annual shareholders meeting. Governance starts with the shareholders delegating responsibilities to an elected board of directors to management and in turn to operating units.

5. The board of directors is accountable to all the stakeholders of the company. Stakeholders include shareholders, regulators, external auditors, creditors and the society in general.

6. The shareholders want accountability on a. Financial performance b. Financial transparency c. Stewardship d. Quality of internal control e. Proper composition of the board and the nature of its activities

7. From a financial perspective, management’s responsibility includes a. Choosing the accounting principles that will best portray the economic substance of company transaction b. Implement good internal control system c. Ensure that the financial statements contain accurate and complete disclosure

8. The shareholders elect the board of directors, approve major initiatives from the board such as annual reports on management compensation and issuance or repurchase f ordinary equity shares.

9. The board of directors serves as the major representation of the shareholders. It ensures that the organization is managed according to its charter and that there is proper accountability.

10. Specific activities of the board of directors include the following: a. Overall operation b. Performance c. Compliance and legal conformance

Details of the above activities are found on pages 19 and 20.

Answer to Multiple Choice Questions

1. B 4. B
2. D 5. D
3. B

Answer to Problems

Problem 1

Explain Your Reasoning and the Implications of Poor Governance a. The company is in the financial services sector and has a large number of consumer loans, including mortgages, outstanding.

This is not necessarily poor governance. However, the auditor needs to determine the amount of risk that is inherent in the current loan portfolio and whether the risk could have been managed through better risk management by the

expertise means that the auditor does not have someone independent that they can discuss controversial accounting or audit issues that arise during the course of the audit. If there is a disagreement with management, the audit committee does not have the expertise to make it independent judgments on whether the auditor or management has the appropriate view of the accounting or audit issues.

d. The company has an internal auditor who reports directly to the CFO and makes an annual report to the audit committee.

The good news is that the organization has an internal audit function. However, the reporting relationship is not ideal. Further, the bad news is that a staff of one isn’t necessarily as large or as diverse as it needs to be to cover the major risks of the organization.

e. The CEO is a dominating personality - not unusual in this environment. He has been on the job for six months and has decreed that he is streamlining the organization to reduce costs and centralize authority (most of it in him).

A dominant CEO is not especially unusual, but the centralization of power in the CEO is a risk that many aspects of governance, as well as internal control could be overridden. The centralization of power in the CEO is a risk that many aspects of governance, as well as internal control could be overridden, which of course increases the risk of fraud and the risk faced by the external auditor.

f. The company has a loan committee. It meets quarterly to approve, on an ex -post basis, all loans over P million (top 5% for this institution).

There are a couple of elements in this statement that yield great risk to the audit and to the organization, and that are indicative of poor government. First, the loan committee only meets quarterly. Economic conditions change more rapidly than once a quarter, and thus the review is not timely. Second, the only loans reviewed are (a) large loans that (b) have already been made. Thus, the loan committee does not act as a control or a check on management or the

organization. The risk is that many more loans than would be expected could be delinquent, and need to be written down.

g. The previous auditor has resigned because of a dispute regarding the accounting treatment and fair value assessment of some of the loans.

This is very high risk indicator that is indicative of poor governance. The auditor would look extremely bad if the previous auditor resigned over a valuation issue and the new auditor failed to adequately address the same issue. Second, this is a risk factor because the organization shows that it is willing to get rid of auditors with whom they do not agree. This is a problem of auditor independence and coincides with the above identification of the weakness of the audit committee.

Problem 2

The article provides more details on shareholder voting for directors if the instructor is interested in pursuing that aspect of governance. In terms of the specific questions:

a. The following are the corporate governance principles presented in the chapter. Students could argue that many of the principles could be in question at Bell. Of Great concern is that management has a great deal of control over the governance and there are questions about management’s ethics and integrity. If the financial statements were intentionally misstated, this calls into question the company’s commitment to transparency. Further, given Mr. San tos’ roles, there are questions about the independence of the board. - The Board’s fundamental objective should be to build long-term sustainable growth in shareholder value for the corporation - Successful corporate governance depends upon successful management of the company, as management has the primary responsibility for creating a culture of performance with integrity and ethical behavior - Good corporate governance should be integrated with the company’s business strategy and not viewed as simply a compliance obligation

Solutions Manual – Corporate Governance, Business Ethics, Risk Management and Internal Control

CHAPTER 3

SECURITIES AND EXCHANGE COMMISSION (SEC) CODE OF CORPORATE GOVERNANCE

Answer to Multiple Choice Questions

1. D

2. B

Answer to Exercises

Exercise 1

a. Independent directors are more likely to stand up to management and report fraud than those directors that are not independent. b. Holding meetings without management present enables a frank and open discussion, including enabling board members with concerns about potential fraud or weak management to alert their board members to express those concerns. c. By having a corporate governance committee composed of independent directors, the organization is more likely to attract high quality board members that are not unduly influenced by management. And by having a corporate governance committee, this important element of control achieves prominence in the organization and acts as a deterrent to fraud. d. Having a written charter and an annual performance evaluation ensures that the committee responsibilities are appropriate, and that the responsibilities are actually accomplished (or shareholders are alerted if they are not accomplished). Accomplishing such activities acts as a deterrent to fraud. e. This requirement ensures an adequate size and independence of the audit committee, which acts to strengthen governance and deter fraud. f. Having a written charter and an annual performance evaluation ensures that the committee responsibilities are appropriate, and that responsibilities are actually accomplished (or shareholders are alerted if they are not accomplished). Accomplishing such activities acts as a deterrent to fraud.

Exercise 2

a. This requirement forces audit committees to take internal controls seriously, and to consider any potential independence impairments for the external auditor. Both internal controls and high quality external auditing are critical for the prevention and / or detection of fraud.

b. This requires the audit committee to be engaged and informed about financial accounting at the company; being engaged and informed enhances the ability of the audit committee to detect fraud.

c. Analyst interactions and the pressure to meet their expectations provide incentives for fraud. By requiring that the audit committee discuss the earnings release process, audit committees have more control over what and how management engages with analysts, and that control should assist in deterring fraud.

d. Understanding risk assessment and risk management should alert the audit committee to weakness therein, thereby encouraging positive change, which should thereby deter fraud.

e. Meeting separately with these groups encourages frank conversations about concerns, and such communication is key to deterring or detecting fraud.

f. By understanding the nature of any problems that the external auditor is having with management, the audit committee gets a good sense of potential management aggressiveness, and the sources of disagreement between the auditor and management. In addition, this requirement gives the external auditor someone to turn to in reporting fraud on the part of management.

g. By setting hiring policies regarding employees of the external audit firm, the audit committee can ensure that management is not exerting undue influence over the members of the audit team by possibly promising them employment at the company.

h. By reporting regularly to the board of directors, the audit committee is put in a position of power in the organization, thereby giving them the clout necessary to oversee management and deter fraud.

1. Non-financial reporting is the “practice of measuring, disclosing and being accountable to internal and external stakeholders for organizational performance towards the goal of sustainable development.” Corporate social responsibility reporting is the “continuing commitment by business to behave ethically and contribute to economic development while improving the quality of life of the workforce, their families, the local community and society at large.” Triple bottom-line reporting is the “reporting on financial, environmental and social performance.” These three terms are commonly used to describe what we define as sustainability reporting, i., the voluntary corporate disclosures about sustainability initiatives, plans and associated outcomes.

2. Factors that have driven the demand for sustainability reporting include investor interest, socially responsible investment funds, and the Dow Jones Sustainability Index.

3. There is a demand for independent assurance on sustainability reporting because such assurance enhances the credibility of the reported information. Ad this might be information that management would have incentive for misstating.

The Global Reporting Initiative (GRI) Reporting Framework states that external assurance over sustainability reports should:

• Be conducted by those with competence in the subject matter and assurance practices
• Be performed in a systematic manner that is evidence-based and includes adequate documentation
• Assess whether the sustainability report is reasonable, balanced, and appropriately inclusive
• Be issued by individuals or organizations that are independent of the company issuing the sustainability report
• Assess the extent to which the report preparer has applied the GRI Reporting Framework in reaching its conclusions
• Report result in a report that is publicly available, written in form, and that states the relationship between the preparer of the report and the issuer of the report

1. Is it unethical for a company to provide a sustainability report, but to provide no assurance on the reliability of the information contained therein. Rather, this is simply a corporate reporting decision. Some companies want to provide reasonable (high) assurance on their sustainability reports to lend them greater credibility. In contrast, some companies choose to make only limited assurance, or to provide no assurance at all. The only thing that would be unethical would be for a company to knowingly provide false information in its sustainability reports, but this is a separate issue from that of assurance provision.

Solutions Manual – Corporate Governance, Business Ethics, Risk Management and Internal Control

CHAPTER 6

BUSINESS ETHICS

Answer to Questions

1. Business ethics refers to standards of moral conduct, behavior and judgment in business.

2. The main purpose of observing ethical behavior in business is to guide businessmen in determining the right business practices and at the same time avoiding wrong business practices.

3. Refer to page 104.

4. Refer to page 105.

5. Refer to page 106.

6. Refer to page 106.

7. Refer to page 106.

8. Refer to pages 107 to 108.

Answer to Cases

Case 1

Requirement 1

The fundamental ethical issue in this situation is letting the financial statements tell the truth about the company’s performance for the past year. Performance was bad, and the financial statements should present a bad picture of the company.

Requirement 2

The proposal to transfer personal assets temporarily to the company violates the spirit, if not the letter, of the entity concept. The president implies that these assets can be transferred back to him at will, and the “investment” appears designed to make the company’s financial position appear better than it is. This is dishonest and unethical.

The request to “shave expenses” violates the reliability principle. The president wants the accountant top understate expenses in order to convert a loss into a reported income. This is dishonest and unethical.

The Code of Professional Conduct requires honorable behavior, moral judgments, and integrity of accountants. “Cooking the company’s books” to paint an unduly positive picture of a business violates all three requirements of the Code.

Case 2

The ethical issue is whether Neighborhood Chest is taking advantage of the bank’s generosity.

Students who approve of the Community Chest action can point out that the bank allows Neighborhood Chest to overdraw its cash balance. In this view, Neighborhood Chest is merely using a privilege the bank has granted. Most banks are civic-minded and are relatively generous with charitable organizations.

Students who disapprove may argue that Neighborhood Chest is using the bank’s money without adequately compensating the bank – a subtle form of stealing. In this view, Neighborhood Chest should curtail its spending until it has the money to cover its expenditures and maintain a positive balance. Alternatively, Neighborhood Chest could sign a note payable to borrow the needed money. The related interest is the bank’s compensation.

The bank is the key player in this case. Whether the bank approves or disapproves of the Neighborhood Chest overdrafts is critical to the ethical decision. Approval by the bank turns the overdrafts into a gift to Neighborhood Chest. Disapproval by the bank would no doubt be communicated to Mr. Alas.

Case 4

Requirement 1

Recording the transaction in the general journal (instead of in the cash disbursements journal) does not cause an error in the financial statements. If all journal entries are posted, the cash balance and the amount of total expenses should be correct.

Tan wanted his transaction recorded in the general journal to avoid having the company president review it in the cash disbursements journal.

Requirement 2

The ethical issue is the use of company money to pay Santos expenses. Unless the designated officer of the company approves, having the company pay Santos’ expenses amounts to stealing from the company.

Accounting plays this role: Tan uses accounting to conceal payment and so to avoid the president’s disapproval of the reimbursement to Santos’ wife.

Solutions Manual – Corporate Governance, Business Ethics, Risk Management and Internal Control

CHAPTER 7

COMMON UNETHICAL PRACTICES OF BUSINESS ESTABLISHMENTS

Answer to Questions

1. The two most common types of unethical business practices are misrepresentation and over-persuasion.

2. Direct misrepresentation of products can be accomplished through

a) Deceptive packaging which involves using containers of exaggerated sizes and misleading shapes. b) Mislabeling which involves making false statements on the label of the product or using containers similar to a well-known product. c) False advertising which involves exaggeration of the virtues of a product

1. Indirect misrepresentation is done omitting adverse or unfavorable information about the product or service.

2. “Caveat emptor” means “let the buyer beware.” It is the responsibility of the buyer to determine for himself the defects of the product. This is an unethical practice because the seller takes advantage of the buyer’s lack of information regarding the product he is buying.

3. Over-persuasion becomes unethical when the seller takes advantage of the buyer’s emotional state to buy the merchandise he is offering.

4. “I nterlocking directorship” means a person holding directorial positions in two or more corporation doing business with each other. This situation could lead to unethical practices due to conflict of interest that could result to disloyal selling.

5. Refer from page 114 to 115.