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Risks

A. Strategic – from outside environment, long term effect:


o Business risk – decisions on products supplied (Tech. changes, Macroeconomic ~)
o Non-business – collapse in trade due to adverse event, natural disaster
B. Operational risks – day-to-day business, failure of internal business and controls:
o internal controls, audit inadequacy, regulations, internal procedures, IT failures, human error, fraud, loss of key person, business
interruption

Treats in - Competitors – new products, decrease of price


SWOT - - Product – become old-fashioned, need to improve, quality
Business - Supply – shortages, increase price
risks - Stakeholders – poor relationship
- Product – become obsolete

- Compliance and regulations


- Financial
o Structure of finance – debt/equity base in long term, providing finance
o Currency
Transaction, Translation, Economic (effect on international competitiveness)
o Interest
o Market – stock, bond price down
o Financial records and reports
- Trading
o Physical (lost), trade (refuse order), liquidity (not pay)
- Investment
o Wrong assessment, cost of capital, NPV, time horizon, data
- Property/physical
- International
o Trade, credit, tax, FX
o Cultural – misunderstanding
o Political – nationalization
o Legal - not meet regulation
- Information systems and controls
- Fraud
- Reputation

Risk management model


1. Risk appetite – shareholders, management and culture SEVERITY
2. Risk analysis LOW HIGH
a. Identification F Accept Transfer
R LOW Risks not significant. Insure risk. Reduction of severity
b. Assessment – severity, frequency E Keep under review will minimise the premiums.
c. Profiling and prioritisation ------------------ Q Control or reduce Abandon or avoid
d. Quantification – loss, frequency, probability... U Take some action, eg Take immediate action eg
E enhanced control changing major
3. Risk management –develop response
N
HIGH
systems to detect
a. Accept
C problems, to reduce
b. Transfer
Y impact
c. Control/reduce – contingency plan, back-up
d. Abandon, avoid
4. Review and feedback

CIMA
RISK MANAGEMENT
Develop response
Identify Assess with respect to appetite

Implementing, and monitoring risk controls and reviewing their effectiveness


Management control systems (MCS)
Organisation as a system – SCAN PICTURE PAGE 48

Control – ensuring that activities lead to desired outcome


Problems of traditional management accounting
- Timing – 85% of the cost is “defined” at design stage. ↑↓ Accountants however, continue to direct efforts to production stage
- Controllability – 10 % direct cost and 30 % overhead are controllable in short term. Accounting spend 3 times more on direct cost.
- Customers – most of the cost driven by them but not recognised by cost accounting. – e.g. after sales, number of transactions, quality issues
- Costing method – in JIT system, small batches result in thousand s of transactions that serves nothing. Back flush as alternative.
- Absorption costing – ABC rather than labour hours or machine hours
- Standard costing – More appropriate in large scale production but less when flexibility or customisation needed
- Performance indicators properly set – may produce wrong response – if “cost of scrap, return factor” is KPY production may be tide up with reworking
(in order to decrease returns) instead of trying to “get it right first time”
- Investment appraisal – problem with assumptions

Control systems
- Single and double loop
- Feedback and feed forward Good INFORMATION
- Relevant
- Management accounting control - scorekeeping, directing attention, used for problem solving - Accurate
o Standard cost accounting - Reliable - user confidence
o Cost allocation – ABC, machine hours - Timely
o Lean accounting – focus on value and waste of recourses - Well communicated
o Lifecycle costing - Cost – effective
o Target costing Management accounting information
o Back-flush costing - Forward–looking
o Investment appraisal - Fin and Non-financial
- Controlling H Recourses - Free from bias
- Budget and budgetary control - Comparative
- Balanced scorecards

INTERNAL CONTROL SYSTEM

Internal
Control environment controls
– Attitude of the :management
policies and on
procedures to ensure
significance of control:
values effective and efficient conduct of business:
style Safeguard of assets
structure Regulatory compliance
responsibilities Prevention & detection Fraud and Errors
Accuracy and completeness of accounting
Timely and reliable financial information

Internal controls – example


Financial
- Variance analysis
- Stock recording system
- Fixed assets register
Non-financial
- Customer satisfaction
- Employee turnover
- Product wastage
Non-financial qualitative
- policies and procedures
- physical assets control
- structure of authority and reporting
- HR controls – contracts, job description, performance appraisal
-
Corporate governance – system by which organizations are directed, managed and controlled
Features of poor corporate governance:
a) Domination by a single individual:
b) Lack of involvement of board:
c) Lack of adequate control function:.
d) Lack of supervision.
e) Lack of independence – auditors not independent:
f) Lack of contact with shareholders:
g) Emphasis on short term profitability
h) Misleading accounts and information:

Benefits of good corporate governance:


a) Reduces risk
b) Shows transparency/accountability
c) Stimulates performance
d) Improves access to capital markets
e) Good PR to all stakeholders
f) Imposes leadership

Directors and Board - issues


- Chairman <> CEO
- Board balance - Non-executives, independence fro operations, balanced position
- Responsibilities and role
o Non-executives – Strategy; Performance; Risk; Directors – remuneration and change
- Remuneration – dependent on performance, clear policy

Internal control and Audit committee


- Participation of independent non-exec.
- Responsibilities:
o Review of financial statements and systems
o Liaison with external auditors
o Review of internal audit and auditors
o Review of internal controls
o Risk management policy review

Internal audit
Audit committee – helps the board, review risk policy and internal controls

Objectives
- Risk policy and strategy review
- Accounting system review
- Internal controls review
- Review finance and operational information
- Compliance review – law, regulations, internal procedures
- Safeguarding of assets
- Implementation of corporate objectives – review

Type of audits
- Accounting system
- Operational system
- Value for money
- Management audit – examine management performance
- Social &Environment audit

- Transactions
- Systems
- Risk-based audits
- Internal
- External
Financial risks
Type of risks
SHORT LONG
- Financial structure - Currency
- Credit risk - Interest rate
- Liquidity
- Cash management

Quantification
- Sensitivity analysis and NPV
- Certainty-equivalent cash flows approach – cash flows * probability
- Expected values – forecast * probability
- Standard deviation of NPV – higher deviation – higher risk
- Value at risk – maximum loss at given probability level
- Regression analysis
- Decision tree and matrix
- Scenarios
Futures vs Forward
+ Lower transaction cost
Exchange / Currency RISK + Exact date not have to be known
- Economic risk – exchange rates impact competitiveness + Available to smaller companies, no credit rating required
o Match assets and liabilities (loans) + Can be closed at any time
o Diversify suppliers and customers - Contract can not be tailored nor negotiated
o Diversify world-wide - Inefficiency – size and time standardized, basis risk (backwardation)
- Transaction risk – adverse exchange rates movement - Limited number of currencies
o Matching receipts and payments - For both non-USD currencies – procedure twice complex
o Invoice in own currency
o Leading and lagging of payments Options vs Forward and Futures
o Netting receivables and payables + Possible profit
+ Support tenders
o Forward contracts
+ Where uncertainty exist
o Money market hedging – borrow in foreign currency
o Futures and options - Additional premium cost
- Translation and accounting risk - Premium paid immediately
o Not a cash flow - Not negotiable
- Not in every currency

International risks
Trading & Credit risk
- Physical
- Credit
- Trade – customer refuse to accept goods
- Liquidity – not able to finance the creit
- FX

Exchange / currency risk – discussed above

Cultural risk

Political risk
- Quotas
- Tariffs (import, export)
- Legal standards (non-tariff barriers)
- Nationalization
- Min or max shareholding
- Exchange control – blocked funds, limit in-out transactions

Legal risk
- Export/import control through bureaucratic procedures (environment, health…)
- Favorable trade status e.g. EU
- Monopoly and mergers legislation
- Law of ownership – e.g. majority of local shareholders
- Taxation law – discourage import / export
- International trade mark acceptance, intellectual property recognition
- Pricing regulations
-