Section B – TWO questions ONLY to be attemptedFive years ago, George Woof was appointed ch

Section B – TWO questions ONLY to be attempted

Five years ago, George Woof was appointed chief executive offi cer (CEO) of Tomato Bank, one of the largest global banks. Mr Woof had a successful track record in senior management in America and his appointment was considered very fortunate for the company. Analysts rated him as one of the world’s best bankers and the other directors of Tomato Bank looked forward to his appointment and a signifi cant strengthening of the business.

One of the factors needed to secure Mr Woof’s services was his reward package. Prior to his acceptance of the position, Tomato Bank’s remuneration committee (comprised entirely of non-executives) received a letter from Mr Woof saying that because his track record was so strong, they could be assured of many years of sustained growth under his leadership. In discussions concerning his pension, however, he asked for a generous non-performance related pension settlement to be written into his contract so that it would be payable whenever he decided to leave the company (subject to a minimum term of two years) and regardless of his performance as CEO. Such was the euphoria about his appointment that his request was approved. Furthermore in the hasty manner in which Mr Woof’s reward package was agreed, the split of his package between basic and performance-related components was not carefully scrutinised. Everybody on the remuneration committee was so certain that he would bring success to Tomato Bank that the individual details of his reward package were not considered important.

In addition, the remuneration committee received several letters from Tomato Bank’s fi nance director, John Temba, saying, in direct terms, that they should offer Mr Woof ‘whatever he wants’ to ensure that he joins the company and that the balance of benefi ts was not important as long as he joined. Two of the non-executive directors on the remuneration committee were former colleagues of Mr Woof and told the fi nance director they would take his advice and make sure they put a package together that would ensure Mr Woof joined the company.

Once in post, Mr Woof led an excessively aggressive strategy that involved high growth in the loan and mortgage books fi nanced from a range of sources, some of which proved unreliable. In the fi fth year of his appointment, the failure of some of the sources of funds upon which the growth of the bank was based led to severe fi nancing diffi culties at Tomato Bank. Shareholders voted to replace George Woof as CEO. They said he had been reckless in exposing the company to so much risk in growing the loan book without adequately covering it with reliable sources of funds.

When he left, the press reported that despite his failure in the job, he would be leaving with what the newspapers referred to as an ‘obscenely large’ pension. Some shareholders were angry and said that Mr Woof was being ‘rewarded for failure’. When Mr Woof was asked if he might voluntarily forego some of his pension in recognition of his failure in the job, he refused, saying that he was contractually entitled to it and so would be keeping it all.


(a) Criticise the performance of Tomato Bank’s remuneration committee in agreeing Mr Woof’s reward package. (10 marks)

(b) Describe the components of an appropriately designed executive reward package and explain why a more balanced package of benefi ts should have been used to reward Mr Woof. (10 marks)

(c) Construct an ethical case for Mr Woof to voluntarily accept a reduction in his pension value in recognition of his failure as chief executive of Tomato Bank. (5 marks)


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The Committee of Sponsoring Organisations (COSO) of the Treadway Commission is an American voluntary, private sector organisation and is unconnected to government or any other regulatory authority. It was established in 1985 to help companies identify the causes of fraudulent reporting and to create internal control environments able to support full and accurate reporting. It is named after its fi rst chairman, James Treadway, and has issued several guidance reports over the years including important reports in 1987, 1992 and 2006.In 2009, COSO issued new ‘Guidance on monitoring internal control systems’ to help companies tighten internal controls and thereby enjoy greater internal productivity and produce higher quality reporting. The report, written principally by a leading global professional services fi rm but adopted by all of the COSO members, noted that ‘unmonitored controls tend to deteriorate over time’ and encouraged organisations to adopt wide ranging internal controls. It went on to say that, the ‘assessment of internal controls [can] ... involve a signifi cant amount of ... internal audit testing.’After its publication, the business journalist, Mark Rogalski, said that the latest report contained ‘yet more guidance from COSO on how to make your company less productive by burdening it even more with non-productive things to do’ referring to the internal control guidance the 2009 report contains. He said that there was no industry sector-specifi c advice and that a ‘one-size-fi ts-all’ approach to internal control was ‘ridiculous’. He further argued that there was no link between internal controls and external reporting, and that internal controls are unnecessary for effective external reporting.Another commentator, Claire Mahmood, wrote a reply to Rogalski’s column pointing to the views expressed in the 2009 COSO report that, ‘over time effective monitoring can lead to organisational effi ciencies and reduced costs associated with public reporting on internal control because problems are identifi ed and addressed in a proactive, rather than reactive, manner.’ She said that these benefi ts were not industry sector specifi c and that Rogalski was incorrect in his dismissal of the report’s value. She also said that although primarily concerned with governance in the USA, the best practice guidance from COSO could be applied by companies anywhere in the world. She said that although the USA, where COSO is based, is concerned with the ‘rigid rules’ of compliance, the advice ought to be followed by companies in countries with principles-based approaches to corporate governance because it was best practice.Required:(a) Distinguish between rules-based and principles-based approaches to internal control system compliance as described by Claire Mahmood and discuss the benefi ts to an organisation of a principles-based approach. (7 marks)(b) Mr Rogalski is sceptical over the value of internal control and believes that controls must be industry-specifi c to be effective. Required: Describe the advantages of internal control that apply regardless of industry sector and briefl y explain the meaning of the statement, ‘unmonitored controls tend to deteriorate over time’. Your answer should refer to the case scenario as appropriate. (10 marks)(c) The COSO report explains that ‘assessment of internal controls [can] ... involve a signifi cant amount of ... internal audit testing.’ Required: Defi ne ‘internal audit testing’ and explain the roles of internal audit in helping ensure the effectiveness of internal control systems. (8 marks)
‘Happy and healthy’ is a traditional independent health food business that has been run as a family company for 40 years by Ken and Steffi Potter. As a couple they have always been passionate campaigners for healthy foods and are more concerned about the quality of the foods they sell than the fi nancial detail of their business. Since the company started in 1970, it has been audited by Watson Shreeves, a local audit fi rm. Mr Shreeves has overseen the Potters’ audit for all of the 40 year history (rotating the engagement partner) and has always taken the opportunity to meet with Ken and Steffi informally at the end of each audit to sign off the fi nancial statements and to offer a briefi ng and some free fi nancial advice in his role as what he calls, ‘auditor and friend’. In these briefi ngs, Mr Shreeves, who has become a close family friend of the Potters over the years, always points out that the business is profi table (which the Potters already knew without knowing the actual fi gures) and how they might increase their margins. But the Potters have never been too concerned about fi nancial performance as long as they can provide a good service to their customers, make enough to keep the business going and provide continued employment for themselves and their son, Ivan. Whilst Ken and Steffi still retain a majority shareholding in ‘Happy and healthy’ they have gradually increased Ivan’s proportion over the years. They currently own 60% to Ivan’s 40%. Ivan was appointed a director, alongside Ken and Steffi , in 2008.Ivan grew up in the business and has helped his parents out since he was a young boy. As he grew up, Ken and Steffi gave him more and more responsibility in the hope that he would one day take the business over. By the end of 2009, Ken made sure that Ivan drew more salary than Ken and Steffi combined as they sought to ensure that Ivan was happy to continue in the business after they retired.During the audit for the year ended 31 March 2010, a member of Watson Shreeves was performing the audit as usual when he noticed a dramatic drop in the profi tability of the business as a whole. He noticed that whilst food sales continued to be profi table, a large amount of inventory had been sold below cost to Barong Company with no further explanation and it was this that had caused the reduction in the company’s operating margin. Each transaction with Barong Company had, the invoices showed, been authorised by Ivan.Mr Shreeves was certain Ken and Steffi would not know anything about this and he prepared to tell them about it as a part of his annual end of audit meeting. Before the meeting, however, he carried out some checks on Barong Company and found that it was a separate business owned by Ivan and his wife. Mr Shreeves’s conclusion was that Ivan was effectively stealing from ‘Happy and healthy’ to provide inventory for Barong Company at a highly discounted cost price. Although Mr Shreeves now had to recommend certain disclosures to the fi nancial statements in this meeting, his main fear was that Ken and Steffi would be devastated if they found out that Ivan was stealing and that it would have long-term implications for their family relationships and the future of ‘Happy and healthy’.Required:(a) Explain how a family (or insider-dominated) business differs from a public listed company and, using evidence from the case, explore the governance issues of a family or insider-dominated business. (10 marks)(b) Mr Shreeves is a professional accountant and auditor. Explain why he is considered a professional by society and describe the fundamental principles (or responsibilities) of professionalism that society expects from him and all other accountants. (7 marks) (c) Discuss the professional and ethical dilemma facing Mr Shreeves in deciding whether or not to tell Ken and Steffi about Ivan’s activity. Advise Mr Shreeves of the most appropriate course of action. (8 marks)



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