The UK Code of Governance - Assignment Example

Introduction As defined by official document of UK of corporate governance, corporate governance is an effort to facilitate firms with a particular systematic code of conduct to make company a long-term success mark (FRC, 2014). Compliance with the code of conduct allows firms to employ best practices for procedural flow of the organization in many aspects (Şerban, 2009). Below considered is the case of Ramero for assessing its compliance level with UK code of governance as well as locate weaknesses and propose recommended notions as corrective actions. Question No.1 Circumstances where Ramero Company did not comply with the UK Code of Corporate Governance (i.e. evidence from the case is required) The number/title of the principle & provision violated the code Evidence from the Code of Corporate Governance The impact of non-compliance on the company’s performance or success 1. Mr. James is the CEO and Chairman of the board of directors. Section A (FRC, 2014): Leadership A.2: Division of responsibilities Code Provision A.2.1 It is suggested in provision A.2.1 that a single person cannot hold two authoritative positions namely CEO and Chairman of the board of directors. Moscu, (2013) researched the matter of CEO duality and found that this phenomenon negatively impact on the performance of the organization in terms of returns due to the lack of CEO’s control and monitoring. Elsayed, (2007) on the other hand empirically found that duality of CEO status does not impact on the performance solely however impact of CEO duality depends on the industry in which company is performing which is aligned with the definition of stewardship and agency theory. 2. Description about duty of the board suggests that it is only opted to generate high returns and meet expectations of investors. However, there is no any description of the set of rules, achievable goals and/or other duties associated with the board of directors as per UK governance code. Section A: Leadership A.1 role of the board Code provision A.1.1 A.4 non-executive directors Code Provision A.4.1, A.4.2 The document explains that there must be non-executive directors should participate in strategy building of an organization. Further, board of an organization is as wholly responsible for generating long-term goal achievement. Hendry and Kiel, (2004) exploring the role of board in strategy building reported resource dependence theory which suggests that board is a system of linking organization with its external environment, generating resourcing and save it from risks. 3. As evident by the quote “he (Mr. James) sets criteria for company’s employees” as well as he solely make all the transactional decisions of the organization. Almost all of the powers are concentrated in him including management, hiring, accounts and control, and he is the only authority who reports to the board of directors. Section A (FRC, 2014): Leadership A.2: Division of responsibilities Code Provision A.2.1 It is reported in code of governance that there must be a fair division of responsibilities among board of directors Hendry and Kiel, (2004) defining the roles of independent board argue that there is no consensus about impacts of board on firms’ performance. However, it is the boards’ skills resources, capabilities, and decision-making authority that impact on performance of firms according Hendry and Kiel, conceptual, intellectual capital model. 4. Company is highly exposed to multiple risks associated with the delegation of duties to single personnel in many departments, negative market image, and financial crisis and risks of internal frauds. Section C: Accountability C.2 Risk management and internal control Code Provision C.2.1 C.2.2 C.2.3 It was defined in the reports that directors should actively participate in monitoring and internal controlling as well as should clearly define their strategies off mitigating prospect risk in annual reports. According to GARP, 2012, fourth layer of authority, in corporate governance code model is sufficiently filled with senior management who is responsible for developing plans and execute operations smoothly. Further, important pillars of corporate governance include independence and transparency. However, departments in Ramero are highly dependent on the decisions of CEO and singular authorities which is affecting the meanings of executive and transparency of functions. KPMG, (2006) in a report describes that incidents of fraud let down the image of the firm in the general public and capital market thus impact badly on the performance of the firm. Woods, (2009) added to the matter that now risk management is become a compulsory element of governance and found three variables that contingently affects the phenomena. 5. According to Mr. David, there is no internal audit department. In fact, there is no any defined finance department or manager. C.3 Audit Committee and Auditors Code provision C.3.2 C.3.6 Further, internal audit and financing practice should be monitored by auditing committee, as well as annually need of internal audit department, should be assessed by the audit committee. Al-Matari, Al-Swidi, & BtFadzil, (2014) highlighted the importance of having an internal audit department and suggested that internal audit is an essential department to look after overall accounting system. The study was an effort to develop relational significance of characteristics of internal audit and performance of a firm and concluded with notion that internal audit records accounting activities of firm and report with a level of quality that in turn positively impact on the performance of firm. 6. Lack of procedural appointment of external auditors. As reported Mr. David is the Single auditor of the company since its birth. Further, there is no Auditing Committee Section C: Accountability C.3 Audit Committee and Auditors Code provision C.3.1 Firstly, there must be a team of two or more to perform auditing duties. Secondly, there must be a procedural way to appoint and reappoint auditors with the agreement of shareholders and board. Alabede, (2012) suggests that the external auditor is a responsible authority of giving feedback to stakeholders about the firm’s conduct and financial statements that allow the company to refrain from entangling in accounting scandals. Further, it is the duty of the external auditor to report fair performance review. However in the underlying case Mr. David are not practicing right conduct in revealing the actual health of firm and company has to face multiple media scandals. 7. Lack of transparency in audit reports as reported by Mr. David that he always issues a clear report in favor of the organization despite having sense of discrepancies. This practice is adopted due to board’s integrity and cooperation with him. Section C: Accountability C.3 Audit Committee and Auditors Code provision C.3.2 C.3.4 C.3.5 There is a chain of duty description of external audit and notion about the external auditor’s role to assess the integrity, internal control, and work arrangement. Rezaee, Olibe, and Minmier, (2003) discussed the audit committee character in reporting actual health as well as disclose of responsible reporting that in turn saves organizations from a scandals and accounting traps. Despite having lots of located errors Mr. David are reporting the firm clear which in turn increasing the risk of scandals. 8. Manipulation in the accounting process can be sensed as reported company utilized aggressive accounting approach to achieving higher returns. No annual report is published Section C: Accountability C.1: financial and business reporting Code provision C.1.1 Code provision suggests that the board is not only responsible for authentic reporting but also should be committed to providing fair and balanced information in the form of annual reports. Cooke (1989) discussed the importance of the extent of disclosure of financial health of the firm and its impact on multiple variables. It was maintained that degree of disclosure impact on the performance of the firm in capital and stock markets. 9. Frequency of general meetings Section E: Relations with shareholders E.2 constructive use of general meetings Code Provision E.2.1 Multiple meetings should be held with Chairman as well as with non-executive directors. Discussion of all sensitive matters including board committee appointment, performance and strategy should be communicated Ma and Tian, (2014) investigated the impact of general meetings on firm’s performance and suggested the frequencies of general meetings are directly associated with the firm’s value and the companies who practice considerable general meetings and relationship building with shareholders have greater positive firm value. In fact evidences in the underlying case are opposite to the description, no any evidences of strong communication and sound frequency of general meeting is found thus it can be understood that it is damaging firm’s value of Ramero. 10. Poor shareholder coordination and relationship is maintained as reported corporate shareholders only communicate to Mr. James, while director of corporate communication is only monitoring chat rooms there is no any evidence of communicating the rising matter to the board. No SFS are sent to shareholders and shareholder not satisfied with the performance. Not any defined number of general meetings. Section: E Relations with shareholders E.1: Dialog with shareholders Code Provision E.1.1 E.1.2 As reported, chairman should address the concerns of shareholders Further, company’s strategy and governance issues should be well communicated to major shareholders. Barell, and Watkins (2012) highlighted the importance of shareholders communication in governing a company and maintained a matter of stand that how recent scenario is increasing need of shareholders’ satisfaction in terms of required actions. It was presented that shareholders now want to participate interactively and asks for corporate governance improvements that in turn benefits in terms of long-term good relationship and improve company’s performance. Question No.2 Weaknesses in Ramero’s internal control system (i.e. evidence from the case is required Justification for weaknesses The internal control component in COSO framework that was not complied with Justification for the choice of COSO internal control component 1. Lack of compliance with the code of governance First of all, as reported in question one company extremely lacks in compliance with governance practices (Saad, 2010) that is defined by UK code of governance. Numerous current practices are not complied with the defined set of conduct. For instance, there is election and re-election system for board or auditor is practiced. There is no distribution of responsibility, and most importantly CEO duality is subjected to the code of governance. Overall COSO framework All the five components are not complied with the said practice of the firm. First, control environment clearly defines that there should be developed set of standards, structures and processes to employ internal control in the organization however in Ramero there are no any maintained standards to control internal processes. Second, no concept of risk assessment is found at any instance in the case; even there is clear evidence of avoiding admitting possibility of associated risk via accepting no need of formal departments and procedures. Third, control activities refer to a particular code of conduct and its implementation at every level of the entity but Ramero case depicts that there is no any documentation or practice code of conduct. Information and communication are not disseminated properly in both internal and external areas. Finally, monitoring practices are all dependent on the perception of CEO 2. No monitoring and control of CEO As implied in the code of governance that there should a non-executive director with the description of monitoring CEO’s activities but unfortunately not any practice is found in the case. Control Environment By the definition, control environment is not comply with the practice as there are no standards maintained by the practices of CEO as well as an organization. 3. Lack of hierarchical authority for the purpose of internal control Simply evident and reported in other questions that authority of control is not shared with subordinates (Feldman and Khadimain, 2001), departments and procedures are not defined Control Activities Lack of controlling activities is evident as explained above there is no formal code of conduct to define right conduct of the process at different levels. 4. Poor reporting systems As evident from accounting practice, IT authority to single a person, auditing practice and missing of SFS and annual reports Information and communication By definition, communication in terms of educating external stakeholders and in terms of internal engagement is not present in the organization’s conduct. 5. Data is highly exposed to fraud Multiple evidences support the verdict, IT authority, shared systems and authority of CEO and single external auditor. Monitoring activities No one is to monitor the procedures with the security regards. All the authorities are directly reporting to CEO. Further, shared computers are highly subjected to data security. 6. No formal departmental structure There are no formal HR, finance, and other departments. Efficient business work with specialized departments that possess specialized skills and necessary to form a strong organizational structure. Control activities and monitoring activities By definition, both of the activities are performed by multiple departments during operations of the firm. 7. Security lapses and environmental concerns Clearly sighted about the abused level of security and environment that is not suitable for keeping food products. Further, no corporate social responsibility clauses are defined which is the basic need of the firm s in current obligated business scenario (Ismail, 2009). Risk assessment, control and monitoring activities Company is not involved in risk assessment thus does not consider the fraud, as well as a scandal and legal risks associated with such deteriorated conditions. 8. Employees’ perception Employees’ perception of unfair management behavior (Steiner, Gilliland and Skarlicki, 2002) is emerging as crucial weakness with the threat of losing efficient workforce. Control environment No standards for assessment, control, and monitoring employees’ performance are either defined or practiced thus impacting negatively on productivity of employees 9. Poor shareholders relations management Critics argued that shareholders relationship is highly crucial while firm’s value is highly damaged via malpractices in managing relations with shareholders (Maher and Andersson, 2000). Control environment Information and communication Lack of shareholders’ interaction with the board. No processes and/or standards are defined o maintain relationship with shareholders. Further, there is no focus on communication area with shareholders. 10. Negative corporate image in the media Negative corporate image in media highly expose entities to multiple risks (Eccles, Newquist, & Schatz, 2007). As reported company is entangled in many scandals. Information and communication, risk assessment, and monitoring activities Lack of risk assessment associated with the matter as well as a serious lack of monitoring about how things happen can be sensed. Moreover, there is a communication gap in explaining to the media about the incidents reported. Question No.3 Circumstances that might increase the risk of internal fraud at Ramero company (i.e. evidence from the case is required Justification The type of internal fraud that might be committed (ACFE, 2014) Justification 1. Authoritative roles concentration and lack of fraud assessment. CEO duality Single IT Personnel to record the transaction Single accounting recording personnel Terms of external auditors with CEO No issuance of annual reports Dependency on CEO’s perception for trusting and promoting employees As reported in the case that authority of command is centralized only to the CEO suggests that there is no check and balance on him for his course of action which is depicted in most of his actions including hiring, finance supervising, promotion and remuneration on personal judgments and all approvals of businesses. Further as evident in the case there is single IT personnel who keeps all backups, posting rights and security codes of data that expose firm a higher degree of corruption and financial statement frauds. AICPA (n.d.) in the report added in the practical guide of tackling with fraud that fraud assessment is a thought process of organizational authorities to map and understand the possibilities of fraud and necessary to address possible internal business risks. Exposed highly to all three types and multiple sub-types of frauds including corruption, assets misappropriation, and financial statement frauds. In the case of singular authorities, mainly company is exposed to corruption fraud chances at each hierarchical level. First and foremost, the control and influence of CEO overall functional and strategic move allow him to involve in a variety of corruptions and other fraud practices as there is no monitoring authority to his actions. In the same regard not only the single accountant or CEO himself but also IT Manager who is responsible for accounting software and information entry and external auditor as well possess the authority of practicing fraud due to their said description of singular roles. 2. Improper and incomplete response to past fraud incident It was maintained by AICPA (n.d.) that there must be a clear definition of tolerance level of fraud and defined code of action that would be taken while caught any involved in such practices. However, in the case it was reported that the company caught a fraud practice but not prosecuted for legal action. Further, not developed practices to control such incidents. Asset misappropriation With the definition of theft and misuse of assets and cash Last recorded incident of fraud could be taken as alarming alert, and appropriate legal action could aid the company defining the consequences of being involved in such practice. This could aid company shape employees’ behavior about misconduct. However, the relaxation given to employees sent wrong message to the employees and increased the chances of misappropriation. People perceiving relaxed with any legality can get involved in more misappropriation practices which in turn increases chances of the on-going misappropriation fraud for the company. 3. Inappropriate inventory management with the extreme lack of physical and data security Khanna and Arora, (2009) investigated the matter that how security lapses and loose internal control aid employee practicing frauds. As mentioned in the study there is no check and balance or control of internal processes and deteriorated security level as even CCTV cameras are not working, guard are not appointed and even inventory is not piled up in secured rooms. Highly exposed to asset misappropriation frauds in many aspects. Some major risks are: Billing mismanagement Misuse of inventory Theft False and/or hypothetical requisitions, receiving and purchasing and selling Lack of security and monitoring allows employees to move freely in the premises of the stock room as well as number employees sharing some systems. Both increases risks of misappropriation frauds for the firm. 4. Lack of definition of the ethical code of conduct, control, and monitoring Ernst & Young (2013) highlighted the importance of fraud control via particular practice and stated that trust cannot be solely employed to give authority to the employees. Further, there must be a demonstration of an authentic and transparent code of ethical conduct as well as trainings that help employees in working under guidelines and reduce chances of frauds. However, as reported, there is no code of conduct as well as no any other practices to define codes of ethics. AICPA (n.d.) favored the notion by adding that there must be properly documented code of ethical conduct. All three areas can be considered including corruption, misappropriation and specifically fraud in statements. There is no code of conduct. If an employee found committing, a fraud can justify her practice by suggesting that there is no any code of conduct which tells that the practice is inappropriate. Many type of corruptions including conflicts of interest and misappropriation including manipulation in sales and purchase or misuse can be easily justified due to lack of ethical conduct definition. 5. No whistleblowing practice and/or any other fraud tracing technique is adapted The CEO of the company does not favor and practice of monitoring and thinks that he is, all in all, able to judge the needed course of action. It is clearly mentioned that there is no whistleblowers in the organization and no any other authority excluded CEO is involved in employee monitoring. (Ahmad, Ismail and Azmi, 2014) In the effort of presenting a conceptual model about internal audit practices that affect by internal frauds explained that whistleblowing is an efficient technique that allow organization to assess the risks of fraud by the feedback and ongoing fraud reporting by spy employees. Further, auditors are opted to trace fraudulent practices while performing audits (Wilson, 2000). However, there are no whistleblowers or authentic auditing department in the firm, so both of the said practices are not applied to detect frauds. Corruption and misappropriation and subtypes Extreme lack of control and monitoring gives the sense of freedom in practices to employees. This perception can lead them to involve in a particular or multiple fraud practices. Question No. 4 – Recommendations to reduce control risks at Ramero Company Below presented are the recommendations to mitigate the fraud risks at Ramero Company (Hong Kong Institute of Certified Public Accountants, 2005). 1. Compliance with UK code of governance enhances the ease of enforcement of corporate governance and enhanced accountability. Develop a compliance with the UK code of governance will aid company practice internal control via right board practices. As it has been encountered that company is violating the A.2.1 and A.1.1 code of UK governance and CEO is overburdened and in pressure to enhance the returns. 2. In compliance with COSO model, company should develop control environment via developing standards, policies, and procedures of internal control to achieve compliance, operations, and reporting objectives. 3. Transparency is important and only can be attained by making external audit, but at Ramero company’s auditor always issue clean report due to personal relations with CEO. Company is violating the section C code 3.1, 3.2, 3.4, and 3.5 that in result reducing the accountability capability of Ramero. Clarity, openness, and transparency up to needed level should be practiced to implement developed standards of internal control. Further, scrutiny of procedures with transparency at each level is important. 4. Defined and formulized structure of organization enhances the effectiveness and control; but at Ramero, there is no defined structure of departments and the hierarchical authority is lacking. Formalized firm structure with the strong definition of control environment to make control possible at each level of business entity. 5. Control in terms of risk assessment, management, and mitigation is important for the organization. With the strategy of cost effectiveness, there must be a clear and well-communicated description of internal control at each level (Hong Kong Institute of Certified Public Accountants, 2005). Internal audit plays huge role in risk assessment and management; even helps in developing cost effective strategies by analyzing the costly operations. However, Ramero is violating the code C.3.2 and C.3.6 and does not acquire any audit committee and department. Question No. 5 – Recommendations to reduce fraud risks at Ramero Company Below presented are the recommendations to mitigate the fraud risks at Ramero Company. 1. First and foremost, in compliance with UK code of governance, a procedure of board re-election under given guidelines should be practiced for the purpose of eliminating the duality of authority, as well as fair distribution of responsibilities. As it has been encountered that CEO is involved in duality roles and IT manager is performing multiple duties at a time that is affecting the effectiveness of operations. 2. There must be appointment of an effective official external audit committee as per governance codes guidelines to assess the actual need of formal accounting system, departments, and internal audit team, as well as other functional areas. This will prevent organizations from potential risks of frauds which occur due to lack of resources and sharing of data. 3. Development of standardized ethical code of conduct and making sure the implementation and practice of that standards via communication, training and mentoring (ACFE, 2014). However, at Ramero ethical code is missing; employees are not exposed to consequences if found guilty that encourage them to be involved in unethical or fraudulent activities. 4. It has been encountered that there is no proper system to detect frauds; and no proper system to handle consumers complains. Employment of most prominent technique of detecting fraud that whistleblowing along with highly effective overall monitoring is essential. 5. It has been encountered that there were no security guards for stock room, lockers were not closed properly, and CCTV cameras that were placed for monitoring, most of them were not working properly. Company needs to implement a more secured and controlled operational environment via employing sound physical and technological security systems as well as develop physical working environment with privacy concerns Conclusion Reviewing the case of Ramero and assessing the on-going practices critically it is evaluated that company is not practicing compliance with UK Code of Conduct, COSO internal control framework and risk management practices to mitigate internal fraud risks. 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