P3 Risk and Control Strategy

Transcription

1 Management Accounting Pillar Strategic Level Paper P3 Management Accounting Risk and Control Strategy 20 November 2008 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 8 to 11. Maths Tables and Formulae are provided on pages 13 to 16. 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 2008

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 PLM: Background, organisational structure and financial controls PLM is one of the world s largest manufacturers of energy saving products for use in construction. The group specialises in the manufacture of timber framed sections and of insulated panels, both being used in domestic and commercial construction. The insulated panels take the form of a sandwich of outer layers of wooden board with a polystyrene core, and so PLM is very dependent on access to timber supplies for the manufacture of both of its products. PLM owns manufacturing plants and distribution centres in various locations around the world. The group is largely based in Europe, and has its headquarters and Research and Development Unit in Germany, as well as manufacturing sites in Germany, Scotland and Poland. The European manufacturing operations are supported by distribution centres located in each of Germany, France and Scotland. An additional manufacturing plant and two distribution centres are located in Canada, to serve both the Canadian and US markets. PLM sells to customers located in 15 different countries in Europe and North America. The control structure in PLM is regionally rather than product based. Manufacturing and distribution centres are managed in combination as regional profit centres, whilst the Research and Development Unit is treated as a cost centre. For example, the Director of Operations for Western Europe is responsible for a single profit centre that covers the German and Scottish manufacturing plants together with the distribution centres in Germany, France and Scotland. Similarly, the Director of Operations for North America is responsible for a profit centre that includes all of the Canadian manufacturing and distribution centres. The Polish manufacturing plant is a separate profit centre managed by a UK based Director. Profit centre results are calculated before inclusion of the impact of any foreign exchange or interest rate movements. Product Development The Board of Directors regards new product development as vital to the continued success of the business, and 5% of group profit is allocated to Research and Development. All new products have to obtain certification on their suitability for purpose and compliance with health and safety and building regulations. Certification is granted by an internationally approved body such as the UK based Building Research Establishment, but obtaining certification can take up to three years to complete. Environmental Issues PLM s timber based products appeal to customers because of the fact that timber is a renewable building material. There is, however, growing consumer concern about illegal logging and global depletion of major forestry resources. In response to these concerns, PLM s strategic plan states that it aims, by 2010, to have 75% of timber supplies sourced from sustainable woodland. The timber used for both the timber framed sections and the insulated panels is primarily softwood which, in forestry terms, is fast growing. Trees reach the necessary level of maturity in approximately 20 years. Reliable market forecasts suggest that demand for sustainably produced timber is growing faster than its supply, and that severe competition for this resource will emerge over the next five to eight years. P3 2 November 2008

3 A number of international schemes have developed with the aim of providing customer assurance on the sustainability of a timber source. PLM uses suppliers which are registered under a number of different such schemes including the Forestry Stewardship Council, Sustainable Forestry Initiative, and the Canadian Standards Association. Consumers, however, appear to be poorly informed about the different assurance systems and are unable to clearly distinguish between genuine and rogue assurance schemes. Market Conditions The business has expanded very rapidly since 2000 as a result of a growing awareness amongst architects of the need to use environmentally friendly building systems, combined with the potential of both product types to halve construction times. In the 1980s and 1990s there was a degree of mistrust within the industry about the use of timber frame construction techniques, and in Europe there were only a small number of contractors who were knowledgeable and experienced in their use. In contrast, the Canadian market for the product has been well established since the 1950s. Insulated panels have also been in widespread use in North America for many years, but PLM was the first company to introduce this building system into Europe in Since then a number of competitors have entered the European market, some of which provide customers with on site installation services as well as acting purely as panel manufacturers. An important reason for the market appeal of the panels lies in the fact that they offer very high levels of insulation, and the European market has expanded hugely following the introduction of strict new regulations on the energy efficiency of new buildings. The MD is aware of the impact of the 2007 credit crunch and has taken that into account when preparing the budget by suggesting that there will be zero sales growth. The customer base for both timber framed sections and the insulated panels is highly concentrated. For timber framed sections, 40% of global revenue is earned in Canada, whilst 80% of PLM s substantial European revenue from the sale of the insulated panels comes from ten main construction companies. Retention of key customers is pursued by PLM through its policy of guaranteeing delivery, anywhere in the world, of all orders in excess of 0 5 million, within six weeks of the order being received. As a result, there are times when PLM is manufacturing in Canada for delivery in Europe and vice versa. Sales Mix and Profit Margins Year ended 30 June Sales: m m Global North America UK France Germany Other countries Global Ratio of timber frame to panel sales (by value) 60 : : 48 Average profit margin on panels 9 5% 9 0% Average profit margin on timber framed sections 12 5% 14 0% The question, including the requirements, continues on page 5, which is detachable for ease of reference TURN OVER November P3

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5 Question One continued Risk Management in PLM Overall responsibility for risk management systems within PLM rests with a senior manager (ranked immediately below Board level) who holds the title of Group Risk Controller. He was appointed five years ago, after promotion following 20 years service as PLM s Head of Group Insurance. He works closely with the Head of Internal Audit, although their respective roles are not clearly defined and documented and they jointly report monthly to the Audit Committee and the Finance Director. The Board of Directors approach to risk management is to either avoid risk or transfer it. One consequence of this policy is that the insurance bill for the group is extremely high in comparison to its peers. The existing risk averse culture also means that all overseas customers are billed in Euros, and the Treasury unit is barred from using derivative financial instruments, even for hedging purposes, because they are too risky. The Group Risk Controller of PLM is due to retire in July 2009, and in its most recent review of internal controls within PLM the Audit Committee recommended that the Board of Directors should work with the new appointee to undertake a major review of current risk management practice within PLM. Required: Using the information provided in the above scenario you are required to: (a) Discuss the extent to which each of the following aspects of the operational and business environment of PLM creates potential risks for the group s shareholders: (i) (ii) (iii) (iv) (v) Product development Environmental issues Market conditions Sales mix and profit margins Financial controls (20 marks) (b) (c) Recommend, with reasons, a risk management control system that could be used by PLM as a mechanism for recording, prioritising and managing the group s risks. (20 marks) Explain why the role of the Group Risk Controller extends beyond issues of insurance and conformance and is also concerned with performance against strategic objectives. (10 marks) (Total for Question One = 50 marks) (Total for Section A = 50 marks) Section B begins on page 8 TURN OVER November P3

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8 SECTION B 50 MARKS [the indicative time for answering this section is 90 minutes] ANSWER TWO QUESTIONS ONLY Question Two Required: (a) The shift towards fair value accounting has potentially increased the financial risks faced by companies that own high volumes of financial assets. (i) (ii) Discuss the above statement. Explain the tools that might be used to monitor such risks. (6 marks) (4 marks) (Total for requirement (a) = 10 marks) (b) KRL plc is a UK based transport company that specialises in large scale business to business contracts, delivering items from original manufacturers to assembly plants across the whole of Western Europe. Fuel is one of the company s main costs, and the Treasurer has decided to purchase oil futures to try and protect the company from the risk of rising fuel prices. The aim is to use any gains on the futures price to offset any increase in costs resulting from a fuel price rise. KRL forecasts that it will consume approximately 158,000 US gallons of fuel over the three month period to 1 March 2009 at an average cost of 5 45 per gallon. Crude oil futures are traded in the market in units of 1,000 US barrels (42,000 gallons) and on 1 December 2008 the price for delivery in three months time is US $ per barrel. The current spot rate is US$ = Assume that on 1 March 2009 the spot exchange rate is US$ = 0 51 and KRL is able to close out its contracts at a value of US$ per barrel. Required: (i) (ii) Calculate, ignoring transaction costs, the profit or loss arising from the decision to use futures contracts to hedge fuel costs. (10 marks) Discuss the risks associated with hedging fuel prices via the purchase of crude oil futures. (5 marks) (Total for requirement (b) = 15 marks) (Total for Question Two = 25 marks) P3 8 November 2008

9 Question Three FDS is a large diversified company whose information technology and information management activities are carried out by a shared service centre. FDS25 is one of many business units operating as an investment centre within FDS. FDS25 has developed a new business strategy which requires a major new investment in information technology to support its business strategy. FDS25 needs to implement the new system as quickly as possible and within budget in order to meet its objectives. Required: (a) Recommend the controls that could be implemented by a business unit like FDS25 to mitigate against risk at each stage of information system design and implementation. (15 marks) (b) From the perspective of FDS25, identify the risk management advantages and disadvantages of each of (i) (ii) utilising the shared service centre; and outsourcing for the design and implementation of a new information system. (10 marks) (Total for Question Three = 25 marks) Section B continues on the next page TURN OVER November P3

10 Question Four HFD is a registered charity with 100 employees and 250 volunteers providing in-home care for elderly persons who are unable to fully take care of themselves. The company structure has no shareholders in a practical sense although a small number of issued shares are held by the sponsors who established the charity many years previously. HFD is governed by a sevenmember Board of Directors. The Chief Executive Officer (CEO) chairs the Board which comprises the Chief Financial Officer (CFO) and five independent, unpaid non-executive directors who were appointed by the CEO based on past business relationships. You are one of the independent members of HFD s Board. The CEO/Chair sets the Board agendas, distributes Board papers in advance of meetings and briefs Board members in relation to each agenda item. At each of its quarterly meetings the Board reviews the financial reports of the charity in some detail and the CFO answers questions. Other issues that regularly appear as agenda items include new government funding initiatives for the client group, and the results of proposals that have been submitted to funding agencies, of which about 25% are successful. There is rarely any discussion of operational matters relating to the charity as the CEO believes these are outside the directors experience and the executive management team is more than capable of managing the delivery of the in-home care services. The Board has no separate audit committee but relies on the annual management letter from the external auditors to provide assurance that financial controls are operating effectively. The external auditors were appointed by the CEO many years previously. HFD s Board believes that the company s corporate governance could be improved by following the principles applicable to listed companies. Required: (a) (b) Recommend how HFD s board should be restructured to comply with the principles of good corporate governance. (16 marks) Explain the aspects of CIMA s ethical principles and the conceptual framework underlying those principles which you would consider relevant to continuing in your role as an independent member of HFD s board. (9 marks) (Total for Question Four = 25 marks) P3 10 November 2008

11 Question Five SRN is a small listed clothing retailer operating a chain of 18 stores in suburban shopping centres together with a city-based Head Office. Orders for stock are placed centrally by Head Office and are delivered to Head Office by suppliers. Details of goods received are entered by Head Office employees to the company s computer system. The goods are then despatched to the retail locations. There are typically between two and three full-time employees in each store (one of whom is the store manager) plus part-time employees during the busiest periods. They are responsible for display and sales. All sales are processed using the electronic point of sale (EPOS) terminals which have the facility for cash, and debit and credit card sales. Cash sales are banked daily by store employees and each day Head Office reconciles bank deposits with the EPOS reports for each store. Sales through the EPOS terminals automatically reduce stock levels and support Head Office purchasing and stock replenishment decisions. A physical stocktake is carried out by store employees six monthly. Usually the stocktakes reveal stock shortfalls for almost half the stores. Store employees attribute this to theft. Prices are set initially by Head Office as a standard mark-up on the purchase cost. This price is automatically displayed on the EPOS terminals. However, employees have the authority to discount prices based on the length of time stock has been in their store and the need to ensure constant stock rotation. Sales revenue and price discounts are monitored weekly by Head Office to ensure that sales levels and margins are on target and that excessive discounting does not take place. Sales, gross profits and net profits are reported quarterly for each store. A Head Office manager visits each store once per week, typically on the same day and at the same time, so that store employees can discuss any problems with the Head Office manager. Required: (a) (b) Identify the risks of fraud and theft faced by SRN in relation to its employees. (6 marks) Recommend (with reasons) the policies and internal controls that SRN could implement to prevent employee fraud and theft. In making your recommendations, you should consider both (i) working conditions and the role of the Human Resource function; and (ii) operational internal controls. (19 marks) (Total for Question Five = 25 marks) (Total for Section B = 50 marks) End of question paper Maths Tables and Formulae are on pages TURN OVER November P3

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14 PRESENT VALUE TABLE Present value of $1, that is payment or receipt. ( 1+ r ) n where r = interest rate; n = number of periods until 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 14 November 2008

15 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

16 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 16 November 2008

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19 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

20 Management Accounting Pillar Strategic Level Paper P3 Management Accounting - Risk and Control Strategy November 2008 Thursday Morning Session P3 20 November 2008