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CHAPTER 1Governance,Ethics, andManagerialDecision Making
© 2009 Cengage Learning
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Introduction
Companies need strong corporate governance and soundethical practices:
•Scandals cause the public to lose faith in thecompany
•Strong governance and sound ethics serve tomake management more accountable to a range ofstakeholders, including employees, investors, andcustomers
•Both internal and external forces shape acompany’s system of corporate governance andinternal control
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Corporate Governance
Embodied in the processes thatcompanies use to promote:
•Corporate fairness
•Complete and accurate financialdisclosures
•Management accountability
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Corporate Governance
•Legal and regulatory requirements impactcorporate governance
•Board of Directors meets with auditors
•Audit committee composed entirely ofindependent directors
•No one set of corporate governance processeswill fit all corporations
•Tailored to fit size, complexity ofoperations, stakeholders, and uniquebusiness risks
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Corporate Governance
Corporate governance systems areused by a company to promotefairness, complete and accuratefinancial reporting, and accountability.
Key Concept
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Internal Control
Internal Control: The policies and procedures that
provide reasonable assurance that a company’s
goals and objectives will be achieved.
Comprised of five elements:
1.The control environment.
2.Risk assessment
3.Control activities
4.Information and communication
5.Monitoring
Key Concept
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Elements of Internal Control
The Control Environment
Risk
Assessment
Control
Activities
Information
&
Communication
Monitoring
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Control Environment
Owners’ and managements’ attitudesand general philosophy aboutInternal control and accountability
Organizational structure
Human resources policies
Commitment to competence
Oversight by company’s board ofdirectors
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Risk Assessment
Steps a company takes to identify andevaluate risks that can adverselyimpact its ability to successfullyconduct business
Assessment occurs at every level in thecompany
Once identified, management evaluatesrisks and takes steps to reduce riskto an acceptable level
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Control Activities
Segregation of Duties
Transaction Authorization
Safeguarding of Assets
Independent Reviews of Work
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Information andCommunication
The accounting system used to initiate,record, process, and communicatethe company’s performance
Technology has made computerizedinformation systems widely available
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Monitoring
A company’s periodic assessmentof its internal controls
Should be performed byemployees who don’t haveresponsibility for recordkeepingor internal control
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The Impact of Information Technology onInternal Control
Risks in a Technology- Intensive Environment
Internet-based
business
Threats by currentemployees
Insider perpetrators
Perpetratorsintercepting
credit card information,
e-mail messages,
company data
Sabotage by former
employees
Unauthorized access to data
Fictitious customers
posing as legitimate
customers
Denial-of-service
attacks
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The Importance of Ethics
Business ethics
The interaction of personalmorals with the processesand objectives of business
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The Importance of Ethics
Integrity is the cornerstone ofethical business practices
Failure to build a business on integritycarries costs
May lower employee morale, reducecustomer loyalty, harm a company’sstanding in the community
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The Importance of Ethics
Establishing an ethical businessenvironment encourages employees toact with integrity and conduct businessin a manner that is just and fair to otherstakeholders.
Key Concept
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Stakeholder Analysis
Stakeholders affect or are affected by the company
Stakeholder analysis alerts the company to variousstakeholder issues including political, social, andethical
Steps include:
1)Identify stakeholders
2)Understand stakeholders’ interests
3)Assess stakeholders power and influence
4)Assess social, legal, ethical, and economicresponsibilities to stakeholders
5)Develop strategies to address demands ofstakeholders
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Stakeholder Analysis
A stakeholder analysis approach isuseful for identifying stakeholdersand the social, legal, ethical, andeconomic responsibilities to thosestakeholders.
Key Concept
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Ethics Programs
Ethics programs include:
Written codes of ethics
Employee hotlines andethics call centers
Training programs
Ethics offices
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Code of Ethics
Three types of ethics codes
Code of conduct
Lays out specific rules or standards of behavior
Credo or mission statement
Describes the vision of a company and frequentlyasserts a commitment to key stakeholders
Corporate philosophy statement
An broad outline of the company’s principles
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Code of Ethics
Three common types of codes ofethics include codes of conduct,mission statements, and corporatephilosophy statements.
Key Concept
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Corporate Scandals
Fraud costs businesses andconsumers billions of dollars eachyear. Accordingly, its prevention isof paramount importance.
Key Concept
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Sarbanes-Oxley Act of2002
Management must provide certificationsabout internal controls.
Management must make its ownassessment of the effectiveness ofthose internal controls.
Must have external auditor attest to thosecontrols.
Criminal penalties for financial statementfraud increased.
Whistleblower protection.
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Fraud
Defined as a
1)Knowingly false representation of amaterial fact made by a party
2)With the intent to deceive and induceanother party to justifiably rely on therepresentation to his or her detriment
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Fraudulent FinancialReporting
Intentional misstatement of oromission of material, verysignificant information from acompany’s financial statements
Generally requiresmanagement’s active involvement
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Management Fraud
Management fraud is typically the result ofpressure on management to report goodoperating results. Commonly involves:
Improper revenue recognition
Overstating assets
Understating liabilities
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Types of Fraud
There are two types of fraud:fraudulent financial reporting andmisappropriation of assets.
Key Concept
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Management Fraud
Fraud involving uppermanagement can be verydifficult if not impossible todetect.
Key Concept
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Misappropriation ofAssets
Involves the theft of a company’s assets.
Usually committed by lower-level employees.
Usually involves small amounts that do not
impact the financial statements.
Usually involves cash, inventory, fixed assets.
Kiting
Lapping
Expense account abuse
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Causes of Fraud
People engage in fraudulent activity asa result of an interaction of forceswithin an individual and the externalenvironment.
Combinations of pressure, opportunity,and attitude are likely to lead to fraud
The Fraud Triangle
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The Fraud Triangle
Situational Pressures
& Incentives
Opportunities
Personal Characteristics
& Attitudes
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Three forces typically contribute tofraud: situational pressures andincentives, opportunities, andpersonal characteristics andattitudes.
Fraud
Key Concept