P3 Risk and Control Strategy

Transcription

1 Management Accounting Pillar Strategic Level Paper P3 Management Accounting Risk and Control Strategy 26 November 2009 Thursday Morning Session Instructions to candidates You are allowed three hours to answer this question paper. You are allowed 20 minutes reading time before the examination begins during which you should read the question paper and, if you wish, highlight and/or make notes on the question paper. However, you will not be allowed, under any circumstances, to open the answer book and start writing or use your calculator during the reading time. You are strongly advised to carefully read ALL the question requirements before attempting the question concerned (that is, all parts and/or subquestions). The question requirements are contained in a dotted box. ALL answers must be written in the answer book. Answers or notes written on the question paper will not be submitted for marking. Answer the ONE compulsory question in Section A on pages 2 to 5. The question requirements are on page 5, which is detachable for ease of reference. Answer TWO questions only from Section B on pages 7 to 13. Maths Tables and Formulae are provided on pages 15 to 18. These pages are detachable for ease of reference. The list of verbs as published in the syllabus is given for reference on the inside back cover of this question paper. Write your candidate number, the paper number and examination subject title in the spaces provided on the front of the answer book. Also write your contact ID and name in the space provided in the right hand margin and seal to close. Tick the appropriate boxes on the front of the answer book to indicate which questions you have answered. P3 Risk and Control Strategy TURN OVER The Chartered Institute of Management Accountants 2009

2 SECTION A 50 MARKS [the indicative time for answering this Section is 90 minutes] ANSWER THIS QUESTION. THE QUESTION REQUIREMENTS ARE ON PAGE 5, WHICH IS DETACHABLE FOR EASE OF REFERENCE Question One RDC manufactures electronic products. The products are manufactured in the UK but are sold globally. The company also has a global supply chain. The company is highly centralised and is based in London. There are 12,000 employees in the UK but the company uses overseas agents for sales and purchases in other countries. RDC is listed on the Stock Exchange. The company is dependent on its computer systems for customer order processing, manufacturing planning, inventory control, purchasing, and accounting. These computer systems have been used for many years and are not integrated. Data has to be extracted from one system and manually keyed into other systems. This lack of integration has caused a major problem for RDC due to the inconsistency of the data held in the different systems. The inconsistencies have resulted in unreliable management information. Although it is thought that information from the accounting system can be relied on, it is difficult to reconcile it with information from the sales, purchasing and production systems. The reports that are provided to the senior managers of RDC include spreadsheets that show summarised data that has been extracted from several systems. Three departments have openly criticised the management information system at RDC: The Information Technology Department is responsible for the maintenance of hardware and software. The department operates a Help Desk to monitor and respond to software problems. A small team of programmers from this department attempt to solve the software problems. It is evident that the number of problems has been increasing recently. The department has about 40 staff and is headed by the Chief Knowledge Officer (CKO). The CKO has for many years argued the need to update the company s computer systems. The Finance Department employs 30 staff under the Chief Financial Officer (CFO). The department s responsibilities include producing management reports for the Board and the senior management team. The team comprises the Chief Executive Officer (CEO), CFO, and functional managers for Marketing, Sales, Manufacturing, Warehousing, and Purchasing. The CFO is very critical of the accuracy of the information he receives from the various computer systems when he presents his reports to the Board. The Chief Internal Auditor (CIA) has a team of six staff which carries out the internal audit plan that has been ratified by RDC s Audit Committee. The CIA has openly criticised the lack of integration of the computer systems and has highlighted the weaknesses in financial and non-financial management information that can result from systems which use inconsistent data, and the possible effects this could have. A benchmarking exercise with RDC s main competitor revealed: The competitor had lower inventory levels but was able to meet customer orders quicker than RDC. Supplier relationships were better than at RDC. Urgent and unplanned requests for the delivery of components put a strain on relationships between RDC and its suppliers. In comparison with its main competitor, manufacturing processes at RDC suffered more downtime as a result of waiting for materials or because of data processing errors. P3 2 November 2009

3 RDC has grown significantly over the last five years and its strategy is to continue to grow, but also to improve its profitability, which has been under pressure in recent years. The CEO of RDC wants to move the company to a Just in Time production environment. He fully supports the need for a new integrated system which could be linked to suppliers and customers systems. This will enable better integration of RDC s business with that of its supply chain and customer base. The CEO firmly believes that failing to improve the systems will lead to an increased loss of competitive position. He believes that this is the most significant risk facing RDC at the present time. Last year, the Audit Committee reported to the Board of RDC that weaknesses in internal control caused by the current computer systems needed to be rectified as a matter of urgency. Subsequently a Systems Committee was formed comprising staff from the Information Technology Department to review RDC s current computer systems and recommend solutions. The Internal Audit team had limited time and was unable to contribute to this review. The IT Systems Committee recommended the development of: An information systems (IS) strategy based on the integration of customer order processing, manufacturing planning, inventory control, purchasing, and accounting. An information technology (IT) strategy based on the implementation of an enterprise resource planning (ERP) system to meet the IS strategy. A tender specification for the new ERP system, to be written by the CKO. The Systems Committee s recommendations have been passed to RDC s Audit Committee. The requirement for Question One is on page 5, which is detachable for ease of reference TURN OVER November P3

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5 Required: (a) Evaluate management control within RDC. (8 marks) (b) (c) (d) Discuss the advantages and disadvantages to RDC of introducing an enterprise resource planning system instead of improving its management information system. (8 marks) Discuss the risks arising from the design and development of RDC s proposed ERP system. (9 marks) Discuss the role of the Audit Committee in relation to the design and development of RDC s proposed ERP system. (5 marks) The Audit Committee is unsure about the role, responsibilities and membership of the steering committee and project team during the design, development and implementation of the new ERP system for RDC. (e) Advise RDC s Audit Committee on: (i) the role of the steering committee and the responsibilities of each of its individual members; and (12 marks) (ii) the role of the project team. (8 marks) (Total for Question One = 50 marks) (Total for Section A = 50 marks) Section B begins on page 7 TURN OVER November P3

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7 SECTION B 50 MARKS [the indicative time for answering this section is 90 minutes] ANSWER TWO QUESTIONS ONLY Question Two MPS is a listed company that seeks to apply sound corporate governance principles. The composition of MPS s Board of Directors complies with the Combined Code on Corporate Governance. MPS has established a Risk Management Group chaired by the Chief Risk Officer. It also has an Internal Audit section managed by the Head of Internal Audit. Both the Risk Management Group and the Internal Audit section recommend and monitor internal controls and report directly to the Audit Committee of the Board of Directors. Required: (a) Discuss the relationships between the following activities: governance; risk management; internal controls; and internal audit. (13 marks) Note: You are required to discuss the relationships between the above four activities. It is not sufficient to describe each one individually. (b) Discuss, from the perspective of shareholders, one benefit and one limitation of each of the following: (i) (ii) (iii) Good corporate governance, Good risk management, and Good internal control. (12 marks) (Total for Question Two = 25 marks) Section B continues on the next page TURN OVER November P3

8 Question Three KSP has sales of about 100 million per annum. Sales are business-to-business and payments are required on 30 day net terms. The sales representatives of KSP are set demanding targets that require them to win new customers and also to increase the size of individual orders. The sales representatives have considerable autonomy over the amount of discount they allow as a deduction from the published list price to their customers. The list price is the only price that is held in KSP s computer system. Sales, and discounts, are frequently negotiated over the telephone. The sales representatives note the discounts they have agreed with each customer on an order form completed by the sales representatives. The credit limit for each customer is approved by the Sales Manager. Each one of the sales representatives is paid a commission. This is based on the sales they have made, but the commission is calculated on a sliding scale according to the discount that they have granted. A high discount results in a low commission (and a low discount gives a higher commission). There are 20 staff in KSP s Accounts Receivable Department, which is headed by the Accounts Receivable Manager. The department relies heavily on information technology for processing and management of invoicing and accounts receivable. All accounts receivable staff are multiskilled, working in small teams with customer-specific rather than single-function responsibilities. For each team, which looks after a defined group of customers, responsibilities include invoicing, and data entry to customer accounts of customer payments paid direct into KSP s bank account or received by cheque through the post. In addition, Accounts Receivable staff carry out debt collection activity by telephone and letter. The performance of the Accounts Receivable Department is measured against three targets: Ensuring that credit notes are no greater than 1% of sales value. At present aggregate credit notes across the company amount to three times this level. Achieving an average days sales outstanding (DSO) of 45. Actual DSOs over the past year have ranged between 56 and 62 days at the month ends. Keeping bad debt write-offs below 2% of sales turnover. Actual bad debt write-offs over the last two years have averaged 3 5%. An internal audit report has recently identified the below-target performance of the Accounts Receivable Department. The Accounts Receivable Manager has responded by explaining that a significant number of customers dispute their accounts due to the prices charged on the invoice. This results in slower collections whilst the query is being investigated, and subsequently a large number of credit notes have to be issued. The Accounts Receivable Manager also stated that bad debts should not be her responsibility as the department has no control over the credit limit granted to customers. P3 8 November 2009

9 Required: (a) Internal control weaknesses throughout KSP may have led to KSP s Accounts Receivable Department not achieving its performance targets. Recommend, with reasons, controls that KSP should implement to improve the Accounts Receivable Department s performance in relation to its targets. (18 marks) (b) Discuss the importance of the internal control environment for KSP. (7 marks) (Total for Question Three = 25 marks) Section B continues on the next page TURN OVER November P3

10 Question Four VTB sells canned vegetables to large stores and supermarkets. The company operates by monitoring crop harvests throughout the world. It identifies countries where there are surpluses of particular crops and then takes advantage of the situation by buying at low prices. VTB then arranges for local companies to process and can the vegetables before shipping them back to VTB s home country. This strategy has been successful because VTB can supply good quality products at prices lower than those of other food processing companies. VTB has grown rapidly since it was founded five years ago. The company has several major supermarkets in its home country as its customers and is continuing to expand. VTB has to manage its cash flows very carefully. Its buying strategy does not permit it to develop long-term relationships with any of the growers or factories that it uses and so it does not have trade credit. VTB must pay for goods at the time of purchase. Conversely, the supermarkets which buy from VTB often take significant periods to pay for the goods that they have purchased. There is a further complication because VTB buys from a host of different countries and so it needs to enter into transactions in a variety of currencies. The Finance Director and Chief Accountant have shared the responsibility for managing VTB s cash position since VTB s creation. This is a major responsibility because the company must keep a substantial cash surplus, with balances in several currencies. This can be very time consuming because VTB must constantly convert cash between currencies to meet operating requirements, without building up excessive balances in any of them. There is also a complicated bookkeeping process in order to reconcile the effects of exchange differences. It has been decided that the cash position should be managed by a dedicated team. The board has agreed to establish a corporate treasury department, with a full-time Treasurer who will be appointed to deal with the cash flows, supported by a small staff who will undertake the associated administration. None of VTB s existing employees are suitably qualified for any of these posts and so all will have to be appointed externally. The Chief Accountant is concerned that this team of new employees will have a great deal of discretion over making payments which will increase the risk of fraud. The Finance Director feels that the Internal Audit department can monitor the Treasury department on a day to day basis. The Finance Director also feels that the new Treasury department will give VTB the opportunity to profit from currency movements by actively taking positions in currencies that are going to appreciate in value. Required: (a) (b) (c) Explain the steps that the HR department of VTB should take when appointing the Treasurer and support staff for this new department. (12 marks) Discuss the merits of the suggestion that VTB should control its planned Treasury department by having the Internal Audit department monitor its routine activities. Discuss the merits of VTB attempting to earn profit from speculating on currency movements. (8 marks) (5 marks) (Total for Question Four = 25 marks) P3 10 November 2009

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12 Question Five RGT is a large industrial construction company with several branches throughout the world. It has a large centralised Treasury department which ensures the company is making the most advantageous financial arrangements possible, while keeping financial risk at an acceptable level. It has some cash flow difficulties at the moment as it has been building in the Middle East and some customers are having problems keeping to their payment schedules. Two customers have gone into liquidation and the buildings they had ordered are half completed. RGT has a full order book and the directors have decided that it can continue in business. This does mean that RGT will have to be extremely efficient and make the best use of all its resources in order to meet payment commitments and make profits in these difficult times. RGT took out a $10m loan at LIBOR plus 3%, repayable after ten years. This loan still has eight years to run. The Directors of RGT are now concerned that there is likely to be a substantial rise in interest rates. They would prefer to pay a fixed interest rate. RGT could take out an eight year loan at a fixed rate of 10%. However a swap broker identified a counterparty which needs to borrow $10m, and is able to get a loan for eight years either at LIBOR plus 1 5% or at a fixed rate of 8%. The swap broker will require a commission of 20 basis points for arranging this swap. The commission, along with any remaining benefit, will be shared equally by RGT and the counterparty. Required: (a) (i) (ii) (b) Explain how a swap arrangement would work using the figures in the scenario and calculate the effective rate that RGT will pay if it enters into the swap arrangement with the counterparty. Discuss the advantages to RGT of entering into this arrangement. (6 marks) (3 marks) Explain why a company might choose to borrow at a floating interest rate when there is always greater certainty concerning the amounts payable with fixed rate loans. (8 marks) Question five continues on the opposite page P3 12 November 2009

13 Coincidentally, RGT has just repaid a 12 year floating rate loan that matured earlier in this financial year. The directors of RGT had entered into a swap arrangement at the end of the fifth year of that loan to fix the rate payable. With the benefit of hindsight it is now apparent that RGT would have paid less over the remainder of that loan if they had continued with the floating rate. Some of the shareholders are annoyed that the directors have wasted money on this arrangement and have suggested that the Treasury department is not doing its job properly. (c) Discuss the shareholders concerns that the directors of RGT wasted money when they entered into the swap arrangement on the 12 year loan. (8 marks) (Total for Question Five = 25 marks) (Total for Section B = 50 marks) End of question paper Maths Tables and Formulae are on pages 15 to 18 TURN OVER November P3

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16 PRESENT VALUE TABLE Present value of $1, that is ( 1+ r ) n where r = interest rate; n = number of periods until payment or receipt. Periods Interest rates (r) (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Periods Interest rates (r) (n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% P3 16 November 2009

17 Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n years n 1 (1+ r ) r Periods Interest rates (r) (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Periods Interest rates (r) (n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% November P3

18 Formulae Annuity Present value of an annuity of 1 per annum receivable or payable for n years, commencing in one year, discounted at r% per annum: PV = r [1 + r ] n Perpetuity Present value of 1 per annum, payable or receivable in perpetuity, commencing in one year, discounted at r% per annum: PV = r 1 Growing Perpetuity Present value of 1 per annum, receivable or payable, commencing in one year, growing in perpetuity at a constant rate of g% per annum, discounted at r% per annum: 1 PV = r g P3 18 November 2009

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23 LIST OF VERBS USED IN THE QUESTION REQUIREMENTS A list of the learning objectives and verbs that appear in the syllabus and in the question requirements for each question in this paper. It is important that you answer the question according to the definition of the verb. LEARNING OBJECTIVE VERBS USED DEFINITION 1 KNOWLEDGE What you are expected to know. List Make a list of State Express, fully or clearly, the details of/facts of Define Give the exact meaning of 2 COMPREHENSION What you are expected to understand. Describe Communicate the key features Distinguish Highlight the differences between Explain Make clear or intelligible/state the meaning of Identify Recognise, establish or select after consideration Illustrate Use an example to describe or explain something 3 APPLICATION How you are expected to apply your knowledge. 4 ANALYSIS How are you expected to analyse the detail of what you have learned. 5 EVALUATION How are you expected to use your learning to evaluate, make decisions or recommendations. Apply Calculate/compute Demonstrate Prepare Reconcile Solve Tabulate Analyse Categorise Compare and contrast Construct Discuss Interpret Produce Advise Evaluate Recommend To put to practical use To ascertain or reckon mathematically To prove with certainty or to exhibit by practical means To make or get ready for use To make or prove consistent/compatible Find an answer to Arrange in a table Examine in detail the structure of Place into a defined class or division Show the similarities and/or differences between To build up or compile To examine in detail by argument To translate into intelligible or familiar terms To create or bring into existence To counsel, inform or notify To appraise or assess the value of To advise on a course of action November P3

24 Management Accounting Pillar Strategic Level Paper P3 Management Accounting - Risk and Control Strategy November 2009 Thursday Morning Session P3 24 November 2009