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Management Accounting – Risk and Control Strategy H8042-FM.qxd 5/27/06 12:39 PM Page i CIMA’S Official Learning System Strategic Level Management Accounting – Risk and Control Strategy Paul M. Collier Sam Agyei-Ampomah H8042-FM.qxd 5/27/06 12:39 PM Page ii CIMA Publishing is an imprint of Elsevier Linacre House, Jordan Hill, Oxford OX2 8DP, UK 30 Corporate Drive, Suite 400, Burlington, MA 01803, USA First edition 2006 Copyright © 2006 Elsevier Ltd. All rights reserved No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical, photocopying, recording or otherwise without the prior written permission of the publisher Permissions may be sought directly from Elsevier’s Science & Technology Rights Department in Oxford, UK: phone (ϩ44) (0) 1865 843830; fax (ϩ44) (0) 1865 853333; e-mail: [email protected]. Alternatively you can submit your request online by visiting the Elsevier web site at http://elsevier.com/locate/permissions, and selecting Obtaining permission to use Elsevier material Notice No responsibility is assumed by the publisher for any injury and/or damage to persons or property as a matter of products liability, negligence or otherwise, or from any use or operation of any methods, products, instructions or ideas contained in the material herein. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library ISBN-13: 978 0 7506 8042 4 ISBN-10: 0 7506 8042 3 For information on all CIMA publications visit our website at www.cimapublishing.com Typeset by Integra Software Services Pvt. Ltd, Pondicherry, India www.integra-india.com Printed and bound in Great Britain 060708091010987654321 H8042-FM.qxd 5/27/06 12:39 PM Page iii Contents The CIMA Learning System xv Acknowledgements xv How to use your CIMA Learning System xv Guide to the Icons used within this Text xvi Study technique xvii Management Accounting Risk and Control Strategy Syllabus xviii Transitional arrangements xxiii 1 Management Control Theory 1 Learning Outcomes 1 1.1 Introduction 1 1.2 Organisation theory 1 1.3 Systems theory 1 1.4 Environmental change 2 1.5 Open and closed systems 2 1.6 Organisational control 3 1.6.1 Target-setting 3 1.6.2 Operations 3 1.6.3 Control 4 1.7 Corrective action 4 1.7.1 Feedback 4 1.7.2 Feed forward 5 1.7.3 Standards for control 5 1.8 Theories of management control 5 1.8.1 The example of low cost airlines 8 1.9 Organisational structure 9 1.9.1 Functional structure 10 1.9.2 Divisionalised structure 10 1.9.3 Matrix structures 10 1.9.4 Network structures 11 1.10 Responsibility centres 11 1.10.1 Divisional performance management 11 1.10.2 Controllability 12 1.11 Summary 12 Readings 15 Revision Questions 23 Solutions to Revision Questions 25 iii 2006.1 H8042-FM.qxd 5/27/06 12:39 PM Page iv iv MANAGEMENT ACCOUNTING – RISK AND CONTROL STRATEGY 2 Alternative Perspectives and Theoretical Frameworks for Control 29 Learning Outcomes 29 CONTENTS 2.1 Introduction 29 2.2 Mechanisms for management control 29 2.3 Alternative perspectives 30 2.3.1 The economic-rational perspective 30 2.3.2 Natural and non-rational perspectives 31 2.3.3 The interpretive perspective and socially constructed reality 31 2.3.4 Radical or critical perspective 31 2.3.5 Pluralist approaches to alternative perspectives 32 2.3.6 Alternative perspectives applied to CIMA students 32 2.4 Theoretical frameworks 33 2.4.1 Agency theory 33 2.4.2 Shareholder value (or value-based management) theory 34 2.4.3 Stakeholder theory 34 2.4.4 Contingency theory 34 2.4.5 Cultural theory 35 2.4.6 Power, politics and influence 36 2.4.7 The value of theoretical frameworks 36 2.5 Summary 37 Readings 39 Revision Questions 45 Solutions to Revision Questions 47 3 Accounting Control and Behavioural Consequences 51 Learning Outcomes 51 3.1 Introduction 51 3.2 Accounting controls 51 3.2.1 Standard costing 52 3.2.2 Capital investment appraisal 52 3.2.3 Overhead allocation 53 3.2.4 Transfer pricing 54 3.2.5 Budgeting 55 3.2.6 Beyond Budgeting 56 3.2.7 Budgetary control and variance analysis 56 3.3 New manufacturing methods and the management accounting response 57 3.3.1 Just in Time 57 3.3.2 Total Quality Management 57 3.3.3 Cost of quality 58 3.4 Emerging management accounting techniques 58 3.4.1 Strategic management accounting 58 3.4.2 Life cycle costing 59 2006.1 H8042-FM.qxd 5/27/06 12:39 PM Page v MANAGEMENT ACCOUNTING – RISK AND CONTROL STRATEGY v 3.4.3 Target costing 60 CONTENTS 3.4.4 Kaizen 60 3.5 Lean management accounting 61 3.5.1 The impact of changes in business practices on accounting controls 62 3.6 Non-financial performance measurement 62 3.7 Consequences of accounting control and dysfunctional behaviour 63 3.7.1 Dysfunctional consequences of budgeting 64 3.7.2 Dysfunctional consequences of non-financial performance measures 65 3.8 Summary 66 Readings 69 Revision Questions 89 Solutions to Revision Questions 91 4 Corporate Governance and the Audit Committee 95 Learning Outcomes 95 4.1 Introduction 95 4.2 Models of corporate governance 95 4.3 Governance, risk management and internal control 96 4.4 Historical perspective 96 4.5 Corporate governance developments in the UK 97 4.5.1 Review of the combined code 98 4.6 International developments 98 4.6.1 The United States 98 4.6.2 South Africa 99 4.6.3 Other international developments 100 4.7 Corporate governance 100 4.8 Principles of corporate governance 100 4.8.1 Directors 101 4.8.2 Remuneration 101 4.8.3 Accountability and audit 101 4.8.4 Relations with shareholders 101 4.8.5 Institutional shareholders 102 4.8.6 Disclosure 102 4.9 Board effectiveness 102 4.9.1 Roles of Chairman and Chief Executive 102 4.9.2 Non-executive directors 103 4.9.3 Remuneration committee 104 4.9.4 Nomination committee 104 4.10 Audit committees and the Combined Code 105 4.11 Smith Guidance 106 4.12 Review of Turnbull Guidance 107 4.13 Role of audit committee 107 2006.1 H8042-FM.qxd 5/27/06 12:39 PM Page vi vi MANAGEMENT ACCOUNTING – RISK AND CONTROL STRATEGY 4.13.1 Audit committees and internal control 108 4.13.2 Audit committees and the external auditor 108 4.14 Reviewing the effectiveness of internal control 109 CONTENTS 4.14.1 Board responsibility 109 4.14.2 Board annual assessment 110 4.15 Benefits of good corporate governance 111 4.16 Enterprise governance 111 4.17 The Operating and Financial Review (or Business Review) 112 4.18 Summary 113 Readings 117 Revision Questions 133 Solutions to Revision Questions 135 5 Risk and Risk Management 139 Learning Outcomes 139 5.1 Introduction 139 5.2 Risk 139 5.3 Types of risk 140 5.3.1 Business or operational risk 141 5.3.2 Financial risk 141 5.3.3 Environmental risk 141 5.3.4 Reputation risk 141 5.4 International risk 142 5.4.1 Economic risk 142 5.4.2 Political risk 142 5.5 Threat, uncertainty and opportunity 143 5.5.1 Risk as hazard or threat 143 5.5.2 Risk as uncertainty 143 5.5.3 Risk as opportunity 143 5.5.4 Risk: from threat to opportunity 143 5.6 Drivers of value and risk 144 5.7 A wider view of risk 145 5.7.1 Managers and risk 146 5.7.2 Risk and organisational culture 146 5.7.3 Risk and national culture 147 5.7.4 Risk and society 147 5.8 Implications for risk management 148 5.8.1 Risk appetite 149 5.8.2 Risk culture 149 5.8.3 Risk thermostat 149 5.9 Risk management 150 5.9.1 Enterprise risk management 151 5.9.2 Risk management and shareholder value 152 5.9.3 Risk management in the public sector 153 5.10 Benefits of risk management 153 2006.1 H8042-FM.qxd 5/27/06 12:39 PM Page vii MANAGEMENT ACCOUNTING – RISK AND CONTROL STRATEGY vii 5.11 Risk managament strategy 154 CONTENTS 5.11.1 Risk management roles and responsibilites 154 5.11.2 Risk management cycle 154 5.12 Risk management process 155 5.13 An approach to managing risk 156 5.14 Risk assessment 156 5.14.1 Risk identification 157 5.14.2 Methods of identifying risk 157 5.14.3 Risk description 157 5.14.4 Risk estimation 157 5.14.5 Methods of estimating risk 157 5.14.6 Critique of methods 160 5.14.7 Risk mapping: the likelihood/consequences matrix 160 5.14.8 The Risk Register 162 5.14.9 Risk evaluation 162 5.15 Risk reporting 163 5.16 Risk treatment (or risk response) 163 5.16.1 Risk mapping and risk response 163 5.16.2 Portfolio 164 5.16.3 Insurance 165 5.16.4 Derivatives and hedging 165 5.16.5 Disclosure 165 5.17 Residual risk reporting 166 5.18 Summary 166 Readings 169 Revision Questions 187 Solutions to Revision Questions 189 6 Internal Control 193 Learning Outcomes 193 6.1 Introduction 193 6.2 Internal control 193 6.3 Internal control system 194 6.4 COSO model of internal control 195 6.5 Internal control and the Combined Code 195 6.6 Role of the board in relation to internal control 196 6.7 Classification of controls 197 6.7.1 Financial controls 198 6.7.2 Non-financial quantitative controls 198 6.7.3 Non-financial qualitative controls 199 6.8 The changing role of management accountants 201 6.9 Accounting controls 203 6.9.1 Cash 203 6.9.2 Debtors 204 6.9.3 Inventory 204 2006.1 H8042-FM.qxd 5/27/06 12:39 PM Page viii viii MANAGEMENT ACCOUNTING – RISK AND CONTROL STRATEGY 6.9.4 Investments and intangibles 204 6.9.5 Fixed assets 204 6.9.6 Creditors 205 CONTENTS 6.9.7 Loans 205 6.9.8 Income and expenses 205 6.9.9 Payroll controls 205 6.9.10 Personnel-related expenses 206 6.10 Limitations of internal control 206 6.11 Cost-benefit of internal control 207 6.12 Internal control and risk management 207 6.13 Summary 207 Readings 209 Revision Questions 219 Solutions to Revision Questions 221 7 Internal Audit and the Auditing Process 225 Learning Outcomes 225 7.1 Introduction 225 7.2
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