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01 technical

changes to the
study guide part 1 relevant to acca qualification paper P1
June 2011 sees a number of new figure 1: the nature of risk assessment
additions to the Paper P1 Study
Guide. I will explain these changes Static Dynamic
in two consecutive articles. In this
issue, I discuss the dynamic nature
of risk, management responses
to changing risk assessments,
risk appetite, and the concepts of Increasing environmental
business and financial risk. In the change and turbulence
next issue of Student Accountant, I
conclude my discussion of the Study
Guide changes. New C1(c): Explain the dynamic nature of This means that no risks ever
In seeking to maintain the currency risk assessment change from year to year – no new
and relevance of the P1 Study Guide, I This entry into the Study Guide was risks materialise and no existing ones
have made a few changes which come added to emphasise the fact that disappear or weaken. Of course this
into effect from the June 2011 exam risks are not static: they change over is only a theoretical situation and
onwards. All are in the risk sections of time and between situations. One doesn’t exist in practice. It’s the same
the syllabus and reflect some of the of the key features of any business at the other extreme – a situation in
latest thinking in risk management as environment is that the things that which the environment changes so
well as some issues that have arisen as affect an organisation, either internal or frequently that all risks are changing
a result of recent events in business. external factors, are very changeable. In all the time. Again, this situation
In this article I discuss each of the some situations, environmental factors doesn’t exist in reality, but situations
changes I have made. change relatively little, but in other close to it do exist. It is also the case
I am also introducing the possibility environments, risk factors can change a that the risks that an organisation
of bringing in some simple arithmetic great deal. These are sometimes called faces can change with changes in
calculations into Paper P1 exam ‘turbulent’ environments, shown in the internal activities as well as with
papers (again, from June 2011 Figure 1. external environmental changes. New
onwards). This is to enable some As with environmental analyses product launches, changes in financial
aspects of risk to be examined that in strategic analysis, it is important structure, changes in markets served,
cannot be examined in a solely to recognise that the extent of etc, can also change the risks faced by
narrative-based answer. This is a environmental change can be an organisation.
change to the advice I gave when understood as a continuum (see What matters is to appreciate that
the Paper P1 Study Guide was first Figure 1 above). Continua of any type organisations differ in how exposed they
introduced. Students should not describe two extremes and a variable are to changes in internal and external
expect complicated calculations but state between the two extremes. risks. Some are very changeable,
should be prepared to manipulate At the left extreme is the situation perhaps in industries that are subject to
numerical data and accordingly, a in which nothing in the internal or a wide range of local and international
calculator may be helpful in future external environment of an organisation influences (perhaps shipping,
Paper P1 exams. ever changes. telecommunication and technology)
student accountant issue 09/2010
Studying Paper P1?
Performance objectives 1, 2 and 3 are relevant to this exam

paper p1
for june 2011
while others are subject to fewer and impact (position B). A change in the risk management must match the
less changeable risks. In other words, environment might decrease the complexity of its risks. To fail to do
they occupy different positions along potential impact of the risk, moving it this would be an incongruity between
the static‑dynamic continuum. on the map to position B’. In both cases, risk and response which could, in
The result of this is that the the risks have moved, as a result of the turn, be a failure in the strategy of
assessment of any given risk can environmental change, to a new area the organisation. Some of the themes
change and, thereby, the strategy for of the map. In both cases, the strategy relevant to this entry are touched on
managing that risk. adopted for managing the risk will be in the other additions to the Study
The probability or impact of a risk likely to change. Guide which I have described in the
can change over time and this change remainder of this article and in the
can move a risk on the likelihood/ New C1 (d): Explain the importance and follow-on article in the next issue
impact map which is often used in risk nature of management responses to of  Student Accountant.
assessment (see Figure 2). changing risk assessments
Suppose, for example, Risk A has a Following on from the discussion New C1 (e): Explain risk appetite and how
high potential impact and is assessed as above about changing risks, it follows this affects risk policy (2)
having a 60% likelihood of materialising that management must tailor its This addition to the Study Guide
in a given period of time. Then a change risk management to match the introduces the notion of risk appetite
in the environment or in the company’s nature of the risk threat. In terms which, as its name suggests, is a
internal controls occurs which makes of policy, those organisations in measure of the general attitude to
the likelihood much less, say down more changeable (or more dynamic) accepting risk. Some individuals live
to 25%. The risk would then move on environments must make a greater their lives in a very careful way, seeking
the graph, as shown on Figure 2, from investment in risk management to avoid risks and withdrawing from
position A to A’. strategies in order to manage the situations in which a risk might be
Similarly, suppose a risk is very range and changeability of those experienced. Other people, conversely,
unlikely but with a high potential risks. It follows that an organisation’s positively seek out and thrive on
risk. They might enjoy gambling,
figure 2: risk assessment probability parachuting, scuba diving and similar
activities with very high potential
High hazards/impacts.
In the same way, some organisations
are risk averse while others are risk
A seeking. Rather than doing this for
Likelihood the ‘thrill’ of it, however, risk-seeking
(probability) organisations generally seek risk in
the belief that higher risk is often
A’ associated with higher returns.
B’ B This range of possible attitudes
Low to risk can be represented on a
Low Consequences (impact/hazard) High continuum (see Figure 3 on page 3).
03 technical

figure 3: risk attitude continuum A typical way of considering business

risk is to examine the probability
Risk averse Risk seeking of a period of poor earnings and
possible failure, and also to consider
the potential impact of that failure.
This brings us back to the notion of
stakeholders because the issue is
More likely to refuse and More likely to ‘impact upon whom?’
avoid risk accept risk The stakeholders most affected by
business risk depend on the situation.
If the business fails altogether, the
As with any other continuum, the New C2 (c): Describe and evaluate the employees will be greatly affected but
two ends represent to two possible nature and importance of business and the shareholder loss will depend on
extremes while ‘real life’ takes place financial risks the individual exposure (the proportion
at various points along the continuum In the original Study Guide for Paper of a portfolio invested in the failing
between the two extremes. P1, I listed a range of common risks company). If the business experiences
At the left-hand extreme is the encountered by organisations in a period of poor performance, the
situation of an organisation that section C2b. This list was far from shareholders may be more adversely
always accepts risk and is actively comprehensive but did serve to affected than the employees.
risk seeking. At the other extreme are illustrate some of the specific risks that One of the major causes of business
organisations (also mainly hypothetical are commonly faced. In adding this risk is financial risk. Large variability
rather than real) that never accept new entry to the Study Guide, I want to in cash flow and liquidity introduces
any risks and manage the strategy to clarify the fact that there are other risks instability to the financial health of the
always avoid situations in which risk that can affect organisations. business. While these can be caused
may occur. Business risks are strategic risks by trading fluctuations, the financial
Risk appetite has an important that threaten the health and survival of structure of a business can also be a
influence on the risk controls that the a whole business. A number of factors strong contributory factor. High gearing,
organisation is likely to have in place. can increase business risk and one of for example, can place pressure on
Organisations that actively seek to the purposes of the annual audit is to cash flow because of the need to
avoid risks, perhaps found more in the review the factors that might increase service debt in a way that would not
public sector, charitable sector and in business risk such as the presence be necessary with a higher proportion
some ‘process’-oriented companies, of any operational, financial or of equity capital. So while debt can be
do not need the elaborate and costly compliance failures that might affect a favourable means of financing when
systems that a risk seeking company the business as a ‘going concern’. interest rates are low or when equity
might have. Organisations such as Business risk varies greatly between capital is difficult to raise, it increases
those trading in financial derivatives, companies and sometimes over time, financial risk because of the increased
volatile share funds and venture and is generally thought to be greatest likelihood of strained cash flow and
capital companies will typically have for young businesses or those in defaulting on debt repayment.
complex systems in place to monitor cyclical industries such as tourism. Financial risks are typically of most
and manage risk. In such companies, The banking crisis in 2008 and 2009 concern to lenders and those that
the management of risk is likely to taught us, however, that business risk depend upon a company’s cash flow
be a strategic core competence of can also apply to much older and more such as suppliers who rely on prompt
the business. established companies. payment of payables.

David Campbell is examiner for Paper P1