Paper P3 Management Accounting Risk and Control Strategy Post Exam Guide November 2009 Exam. General Comments

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1 General Comments Overall, performance was reasonable. Well-prepared candidates were capable of obtaining clear passes. Weaker candidates tended to avoid the requirements of the question, either through a failure to grasp what was required or as an attempt to obtain repetition of memorised facts and information. Generally, where candidates did not achieve a pass, the main problems were a failure to apply their knowledge to the scenario and a failure to answer what was asked. When information is given in the scenario candidates are expected to use it to illustrate the main issues in their answer. Using the reading time wisely can be of huge benefit; candidates should always plan their answers and ensure they read the questions carefully before starting the paper. Candidates who answer the specific question asked could achieve high marks. Candidates waste valuable time if they fail to be specific in their answer, as only the points which answer the question will get marks. One of the main problems with candidates scripts this diet was a complete failure to answer what was asked. There was evidence of time pressure in a number of scripts; this can be avoided by use of an answer plan and by using the reading time to plan answers. One of the main problems in this sitting was that a significant numbers of candidates narrowly failed Question one, which was the 50 mark compulsory question. Parts (a) and of Question one were answered more poorly than expected. Question four was not as popular as the other questions. Question five, which was an interest rate swap, was reasonably popular and generally done well by the candidates who attempted it, which was pleasing to see. It is very important that candidates prepare for the exam by studying all parts of the syllabus. There were a number of areas where it was apparent candidates had spent little time studying. Note that the attached marking scheme often makes more marks available than indicated on the question paper. This reflects the fact that questions at this level can often be approached in more than one way and that there is no single perfect answer. In applying this marking scheme, marks are always restricted to the total offered by the question and so there is no advantage to be gained from over-developing the answer to one question at the expense of another that may appear more difficult. The Chartered Institute of Management Accountants Page 1

2 SECTION A 50 MARKS ANSWER THIS QUESTION Question 1 (a) Evaluate management control within RDC. (8 marks) (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) The Chartered Institute of Management Accountants Page 2

3 Rationale The case study involves RDC a large company which manufactures electronic products. The company is dependent on its computer systems for customer order processing, manufacturing planning, inventory control, purchasing and accounting. The computer systems are not integrated. The computer systems have been openly criticised by several other departments. The Information Technology department operates a help desk and has noticed an increased number of issues with the system that it is required to solve. The finance department are concerned about the accuracy of the information it receives from the computer systems and the internal audit department has highlighted the financial and non-financial information that can result from systems that use inconsistent information. A benchmarking exercise with its main competitor has revealed several issues that are cause for concern: the competitor has lower levels of inventory but can still meet customer orders faster than RDC. Supplier relations are better at the competitor s company and manufacturing processes suffer more downtime at RDC. The CEO wants the company to move to a JIT production environment and to have an integrated system. The audit committee says that the weaknesses in internal control need to be addressed quickly. The IT Systems committee recommends the development of an IS strategy based on an integrated system, an IT strategy based on implementation of an ERP system and a tender specification for the ERP system to be written by the CKO. The syllabus areas covered are A (i) Evaluate and recommend appropriate control systems for the management of organisations, B (vi) Evaluate the costs and benefits of a particular internal control system, B (vii) Discuss the principles of good corporate governance for listed companies, particularly as regards the need for internal controls, E (i) Evaluate and advise managers on the development of IM, IS and IT strategies that support management and internal control requirements and E (iv) Evaluate and recommend improvements to the control of information systems. Suggested Approach Candidates were expected to evaluate several suggestions about IT and accountancy. They had to consider risks of designing and developing a new system and discuss some of the stages of implementing a new system. The role of the audit committee at the design and development stage was also tested. They also had to discuss the roles and the membership of the steering committee and the project team. The Chartered Institute of Management Accountants Page 3

4 Marking Guide (a) per relevant point Points might include the following: RDC has a growth strategy and needs to improve profitability The company s computer systems do not support that strategy as information is piecemeal, inconsistent and unintegrated. Management control should provide information to support the business strategy and this information needs to be on time, complete, accurate and reliable. Max of 4 for discussion of ERPS Max of 4 for discussion of improving MIS Points could include the following: ERP systems typically capture transaction data for accounting purposes as well as operational data about customers and suppliers. ERP system data can combine financial with non-financial performance measures in a Balanced Scorecard-style system However, ERP systems can be very costly to purchase, involve large-scale organisational change and consume large amounts of staff time to implement By contrast, MIS systems are relatively inexpensive, often being able to be purchased as off-the-shelf packages. (c) per relevant point The following are examples of some relevant points: Having the CKO produce a tender specification is a potentially dangerous approach that could lead, for example, to a technical solution that does not meet user needs or is not auditable. The Systems Committee should not have been composed only of IT Department staff. There is a risk that an ERP system is not the most suitable to meet business needs and a more comprehensive study should be undertaken. Marks Max 8 marks for part (a) Max 8 marks for part Max 9 marks for part (c) The Chartered Institute of Management Accountants Page 4

5 (d) for identifying risk and 1 for discussing The following are examples of some relevant points: The Board is responsible for the company s system of internal control. The progress of design and development should be monitored by the Audit Committee. All the key stakeholders: the CKO, the CFO and the CIA need to be involved in the design and development. The Audit Committee will also rely extensively on the work of the internal auditors in their involvement in the design and development process for the new system. The Audit Committee will therefore ensure that the internal audit function has the right level of skills and resources to undertake this role, supplementing those resources where necessary. (e) (i) (ii) Steering committee and member responsibilities per relevant point (see Examiner s answers for example points) Project team per relevant point (see Examiner s answers for example points) Max 5 marks for part (d) Max 12 marks for part (e)(i) Max 8 marks for part (e)(ii) Examiner s Comments Marks for question one were poor compared to previous diets. Parts (a), and (d) were not answered as well as expected. The main problem was a failure to answer what was asked. Parts (e)(i) and e(ii) were answered quite well with most candidates demonstrating a good level of knowledge on the role of the steering committee and the project team. Common Errors Not answering what was asked was the biggest problem. Candidates wrote about all sorts of controls, regardless of whether they were management controls or not. In part most candidates did not mention updating the MIS system at all which meant they could not achieve a very high mark. A lack of knowledge of the audit committee s role was evident; many candidates seemed to think it had a very extensive role and conducted audit testing. This is clearly not the case. Candidates would be advised to revise this syllabus area before the next diet. The Chartered Institute of Management Accountants Page 5

6 SECTION B 50 MARKS ANSWER TWO QUESTIONS ONLY Question 2 (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. 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) Rationale Question Two provides the scenario of a company which seeks to apply good corporate governance principles. The governance structure is described in the brief scenario. The candidates are asked to discuss the relationship between governance, risk management, internal controls and internal audit and to discuss the advantages and disadvantages of some of the above. The syllabus areas covered are B (iii) Discuss the purposes and importance of internal control and risk management for an organisation, B (v) Evaluate the essential features of internal control systems for identifying, assessing and managing risks and B (vi) Evaluate the costs and benefits of a particular internal control system. Suggested Approach In part (a) candidates should have discussed each of the items in turn and then explained the links between them in depth. Part was more straightforward as a discussion of the advantages and disadvantages of each was all that was required. The Chartered Institute of Management Accountants Page 6

7 Marking Guide (a) per relevant point Marks Points could include some of the following-: Governance is the system by which companies are directed and controlled Risk management is the process of understanding and managing risks that the organisation faces in attempting to achieve its objectives Because governance is concerned with achieving objectives then it must be concerned with any risks that impede those objectives being achieved The risk-based approach to control leads to the development of controls that are a response to risks Internal control is the whole system of financial and other controls established to provide reasonable assurance of effective and efficient operation; internal financial control; and compliance with regulation Management not the Board - is responsible for establishing an adequate system of internal control However, reviewing the effectiveness of internal control is one of the Board s responsibilities under the Combined Code The role of internal audit is to examine and evaluate, add value and improve the operations of the organisation Risk-based internal control will develop an audit plan based on risk assessments and test the most important controls Internal audit will also review the whole risk management process. Governance therefore is involved in monitoring risks, internal controls in relation to those risks and the process of internal audit that provides the Board with assurances that risks are being effectively managed Max 13 part (a) A range of answers is possible. The following represents an example of one approach to structuring an answer. There are other approaches worth marks. Max 2 benefits and 2 limitations of each category. for identification and 1 for discussion of each benefit/limitation Max 12 part The Chartered Institute of Management Accountants Page 7

8 Examiner s comments This question was done reasonably well although candidates did not tend to go into enough detail in either part of the question so higher marks were seldom awarded. A good answer should have explained each of the terms in turn and then discussed the links between them in detail. Some revision of this area would be advisable as high marks were not achieved by many candidates. Part was done well by many candidates. Low marks were given where there was little or no discussion. Common Errors The most common error was not to link the items in part (a). Candidates were explicitly asked to link all of the concepts together and when they did not do this low marks were awarded. The Chartered Institute of Management Accountants Page 8

9 Question 3 (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) Discuss the importance of the internal control environment for KSP. (7 marks) (Total for Question Three = 25 marks) Rationale Question Three requires candidates to identify weaknesses in internal controls in order to explain why the controls are needed and suggest controls which would strengthen the internal control in the company. Sales representatives are set demanding targets and have to win new customers and increase orders. They have autonomy over discounts and sales and discounts can be negotiated over the phone. The sales reps are paid commission. The accounts receivable department relies on IT for processing invoices and managing debts. The accounts receivable department s performance is measured by ensuring credit notes are no greater than 1% of sales value, achieving an average debtors days outstanding of 45 days and keeping bad debts write offs below 2% of sales turnover. The internal audit department has identified below average performance for the department. Candidates also have to discuss the internal control environment. The syllabus areas covered are A (iv) Evaluate the appropriateness of an organisation s management accounting control systems and make recommendations for improvements, B (iii) Discuss the purposes and importance of internal control and risk management for an organisation and B (v) Evaluate the essential features of internal control systems for identifying, assessing and managing risks. Suggested Approach Candidates should have gone through the scenario and systematically picked out the weaknesses in internal control. They then had to suggest what controls should be put in place to improve the situation. Part should have been straightforward as candidates had to discuss the internal control environment. The Chartered Institute of Management Accountants Page 9

10 Marking Guide (a) The examiner s answer is structured so that the weaknesses are identified and then the controls discussed. In most cases the weaknesses are the reasons for recommending the controls. Max for reasons and max 5 for controls Marks Max 18 part (a) for each relevant point must be fully discussed Max 3 marks if bullet points used Max 7 part Examiner s Comments This question was done reasonably well by many candidates. Candidates were able to pick out lots of weaknesses but then struggled to suggest an internal control that would improve the situation. There were many points in the scenario that could have been discussed so marks were reasonable for part (a). Part was however answered poorly. Common Errors The main error was in part where candidates showed no knowledge of the internal control environment. Candidates tended to discuss internal controls in detail rather than the internal control environment. Good strong ethical principles being embedded in the organisation plus a good tone at the top should have been focussed on. The Chartered Institute of Management Accountants Page 10

11 Question 4 (a) (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) Rationale Question Four is a question with a scenario about a company which sells canned vegetables to supermarkets. It sources vegetables from all over the world and gets local companies to process them. VTB has to manage its cash flows carefully; it does not get trade credit and the supermarkets can take a long time to pay VTB. The other complication is the number of foreign currencies VTB deals with. The bookkeeping is also very complex and time consuming. The finance director and the chief accountant have dealt with these problems up until now but they now wish to create a treasury department and allow it to deal with these complex issues. The syllabus areas covered are B (i) Define and identify risks facing an organisation, C (ii) Evaluate the process of internal audit, C (vi) Discuss the principles of good corporate governance for listed companies, for conducting reviews of internal controls and reporting on compliance and D (vi) Recommend currency risk management strategies. Suggested Approach In the first part, candidates need to explain the steps that the HR department should take when appointing the Treasurer and support staff for the new department, it then asks candidates to discuss the merits of having the internal audit department monitor the treasury department and then asks for a discussion on the merits of VTB attempting to make profits from speculating on the currency markets. The Chartered Institute of Management Accountants Page 11

12 Marking Guide (a) per relevant point. Marks Max 12 part (a) per relevant point- must be fully explained. Max 3 marks if bullet points used Max 8 part (c) per relevant point- must be fully explained. Max of 3 marks if bullet points used Max 5 part (c) Examiner s Comments This question was the least popular of all the questions and was poorly answered. Part (a) was done well by candidates but parts and (c) were disappointing. It was surprising that most candidates believed Internal Audit monitoring Treasury on a daily basis was a good idea and that companies should speculate on the currency markets to make money. Common errors Part was done poorly by most candidates. Internal Audit should not be closely involved with any department; it is supposed to be independent. Many candidates thought it was a very good idea for Internal Audit to monitor Treasury closely and to check up on it every day. This approach got a very low mark. This topic should be revised before the next diet. Part (c) was similar in that it is very difficult and risky to try and earn money from speculating on the currency markets but most candidates thought it was a good idea. Again, some revision of this topic would be advisable. The Chartered Institute of Management Accountants Page 12

13 Question 5 (a) (i) 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. (6 marks) (ii) Discuss the advantages to RGT of entering into this arrangement. (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) (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) Rationale Question Five is the scenario of an industrial construction company with a treasury department which wishes to enter into a swap arrangement. The candidates are asked to work out the effective interest rate which will be paid if the swap takes place and then to discuss the advantages of the arrangement. The candidates then have to consider why a company might prefer a floating rate rather than a fixed rate and finally to discuss whether the company wasted money on a swap which was not beneficial in the past. The syllabus areas covered are D(i) Identify and evaluate financial risks facing an organisation, D (ii) Identify and evaluate appropriate methods for managing financial risks and D (iii) Evaluate the effects of alternative methods of risk management and make recommendations accordingly. Suggested Approach The candidates are asked to work out the effective interest rate which will be paid if the swap takes place and then to discuss the advantages of the arrangement. The candidates then have to consider why a company might prefer a floating rate rather than a fixed rate and finally to discuss whether the company wasted money on a swap which was not beneficial in the past. The Chartered Institute of Management Accountants Page 13

14 Marking Guide (a) The swap arrangements are as follows: Counterparty RGT Quality spread Fixed rate (%) 8% 10% 2% Floating rate LIBOR + 1.5% LIBOR +3% 1.5% Quality spread differential 0.5% Marks (max 6) The quality spread differential is split: Broker 0.2% Counterparty 0.15% Counterparty RGT 0.15% The counterparty borrows at a fixed rate of 8% and pays RGT a floating rate of LIBOR plus 2%. RGT pays the counterparty a fixed rate of 8.75%. Each party pays the broker 0.1% commission The overall outcome would, therefore, be as follows: Borrows at 8% Receives from RGT (8.75%) Pays to RGT LIBOR + 2% Commission 0.1% Net cost LIBOR % RGT Borrows at LIBOR +3% Receives from counterparty (LIBOR + 2%) Pays to counterparty 8.75% Commission 0.1% Net cost 9.85% Max 6 part (a)(i) The Chartered Institute of Management Accountants Page 14

15 (ii) (c) The cost saving to RGT from the swap is so small that it is hardly worth considering (0 15% on a loan of 10m is worth only $15,000 per year ) The main advantage of the swap is that it enables RGT to convert to a fixed rate without the penalties and fees that would have been payable if it had repaid the variable rate loan early and taken out a fixed rate loan in its place per relevant point to a max of 8 marks per relevant point to a max of 8 marks 2 mark Max 3 part (a)(ii) Max 8 marks for part Max 8 marks for part (c) Examiner s Comments Part (a) was very well done by most candidates, which was pleasing to see. Part was also reasonable as most candidates managed to come up with several reasons why a floating rate might be preferable. Part (c) was not done very well at all. Common Errors Part (c) was poor. Many candidates thought that the directors should be taken to task over the waste of money and did not acknowledge the fact that although hindsight has revealed that things turned out differently, it does not mean that the swap was the wrong decision. This area requires some revision before the next diet. The Chartered Institute of Management Accountants Page 15