At the end of this module you should be able to:
explain the importance of recognised frameworks for risk management and internal control and apply these to specific scenarios
explain the regulatory requirements that apply to organisations
identify and explain the key elements of an effective governance framework for financial risk management
explain the key controls over financial risks
evaluate controls over derivatives in a corporate environment
explain an organisation’s financial risk management framework.
Activity - ASX principles on good governance
John is the CFO in an ASX-listed company and is preparing the year-end financial report. The CEO, Darren, is a very forceful, domineering individual with only a general awareness of accounting and financial risk management principles.
Darren has instructed John to make sure that he arrives at the "correct" accounting outcomes with regards to certain hedging positions held by the company. Darren noted that the fair values of the hedges held by the company have decreased, and therefore he wishes to process these fair value losses entirely to other comprehensive income (equity), regardless of whether the hedges were effective.
As in previous years, John has performed the calculation in line with Darren's instructions.
Using the ASX principles on good governance, assess the appropriateness of the behaviour of Darren and John in the scenario provided above.
ASX Principles
Lay solid foundations for management and oversight
Structure the board to add value
Act ethically and responsibly
Safeguard integrity in corporate reporting
Make timely and balanced disclosure
Respect the rights of security holders
Recognise and manage risk
Remunerate fairly and responsibly
(X) 1. Lay solid foundations for management and oversight
Board responsible for overseeing the integrity of accounting and corporate reporting, and the process for making timely and balanced disclosure.
Management responsibly for providing the board with accurate, timely and clear information.
( ) 2. Structure the board to add value
(X) 3. Act ethically and responsibly
requires individuals to act with honesty, integrity and in reasonable expectations of investors
management has a responsibility to create a culture that promotes ethical and responsible behaviour.
being domineering and aggressive, and forcing another person to perform their job in a biased way, would likely not be considered ethical or responsible.
(X) 4. Safeguard integrity in corporate reporting
entity should have an audit committee that makes recommendations as to whether the financial statements provide a true and fair view, and the appropriateness of accounting judgements or choices.
entity requires formal and rigorous processes that independently verify and safeguard the integrity of corporate reporting.
CEO/CFO should declare that the financial statements comply and provide a true and fair view and have been prepared properly.
(X) 5. Make timely and balanced disclosure
entity should make 'balanced' disclosure, both positive and negative information
(X) 6. Respect the rights of security holders
provide security holders with appropriate information, communicating openly and honestly
(X) 7. Recognise and manage risk
requires an appropriate framework to identify and manage risk
a risk committee's role would include reviewing any incident involving the breakdown of internal controls.
an internal audit function can bring a systematic, disciplined approach to evaluating and continually improving risk management and internal controls
( ) 8. Remunerate fairly and responsibly
8.1. Culture of risk management
Culture is critical
culture of risk management
set by the tone at the top
permeates throughout the organisation
every decision, activity and initiative has a degree of risk
appropriately manage risks based on risk appetite
not risk aversion... but risk intelligence
Quiz. Elements of fraud
Which element of fraud can an organisation best manage?
motive
pressure
opportunity
rationalisation
other than striving for an ethical culture other aspects are more likely to be out of an organization's control - so removing the opportunity is the best way an organisation can reduce the risk of fraud
Fraud triangle
8.2. Risk management framework
establish context
identify risk
analyse risk
evaluate risk
treat risk
monitor and review
communicate and consult
Directors' duties
- obligations under Corporations Act 2001
duty of care
act in good faith
proper use of information and position
not trade while insolvent
- ASIC and ASX requirements
financial reporting declarations
board audit committee
financial risk management reports and strategies
- other obligations
e.g. setting realistic goals - avoiding excessive risk taking behaviour
Case study - mismanagement cited as irrigation trust sponged dry (First Mildura Irrigation Trust)
FMIT received a $2.2 m investment from Treasury Corporation of Victoria (loan)
FMIT invested the proceeds in an unapproved investment
the funds subsequently lost $2m in value due to sub-prime fallout
Victorian Water Minister subsequently forced FMIT to merge with Lower Murray Watter
1. how many the directors have breached their duties and obligations?
duty of care - to safeguard organisation funds
not avoiding excessive risk taking
breach of organisation policies
2. what were the financial risks that the investment exposed the organisation to?
interest rate risk
counterparty risk
foreign exchange risk
3. how could this have been prevented or better managed?
by investing in authorised institutions only
better research into the broker and investment options
Organisational structure - example
Quiz. ASX principles
Which of the ASX Principles are mandatory for listed Australian companies?
none
Principle 7
all principles
they are not actually mandatory even for listed companies - but there is an "if not, why not?"approach to the adoption of these corporate governance principles
Quiz. Mandate of a risk committee
Which of the following would least likely be considered by a risk committee?
recommending risk management policies and guidelines
reviewing exposures relating to the funding and liquidity risk
setting senior management remuneration and performance targets
assessing and reviewing current and future market conditions
8.4. Governance framework for financial risk management
FRM Policy
- framework
how risks are measured
how risks are to be managed
- authorities (and delegations)
approval limits
segregation of duties
- authorised financial instruments
borrowings and investments
derivatives and hedging instruments
- performance measures
- reporting requirements
Risk register
Significant financial risks and related controls
GK is a corn farming and processing operation located in Western Australia.
GK has three sources of income:
GK sells the majority of its corn to Australian supermarkets in the form of canned corn. After harvesting, GK processes and cans the corn and arranges for it to be delivered to the supermarkets' central distribution warehouse
in addition to locally sold canned corn, GK also exports canned corn to customers in NZ, the US and China
GK sells any surplus corn cobs to wholesale buyers that could not be canned for sale at farmers' markets
as at 30 June 2016 GK had current assets worth $1.3 m, current liabilities of $1.1 m and long-term borrowings of $800,000
What are the most significant risks that the board of GK should be aware of?
Key controls over financial risks?
- liquidity: do the customers pay quickly? enough cash to pay suppliers? current ratio of 1.18 (1.3m / 1.1m)
cash flow forecasts
maintaining cash buffers
offsetting cash and overdrafts
debtor management policy
- funding: $800k in long-term borrowings - able to rollover?
maintaining credit rating
preparing long-term forecasts
monitoring funding facilities
diversifying funding sources/maturities
- interest rate: long-term borrowings on floating rates or fixed?
diversified maturity profile
hedge targes and ranges
sensitivity analysis
authorised hedge instruments
- foreign exchange: exporting to overseas markets - affected by the value of the AUD
exposure limits
hedge targes and ranges
sensitivity analysis
authorised hedge instruments
- commodity price: corn prices rise and fall - locked in?
exposure limits
hedge targes and ranges
sensitivity analysis
authorised hedge instruments
- credit: are sales paid in advance or cash sales, or on credit? majority of sales are to supermarkets
approved counter-parties
minimum credit rating criteria
exposure limits
diversifying counter-parties
- operational: cash collection processes, internal controls in payments function
proper recording keeping
strong policies and procedures
internal control framework
high-quality staff plus training
8.5. Internal control framework
Quiz. COSO framework
which of the following is not a component of the COSO cube for internal controls?
risk assessment
control activities
monitoring activities
accounting principles
control environment
Purpose of internal controls
to assist in the achievement of organisational objectives:
effectiveness in operations
efficiency in operations
reliability of financial reporting
compliance with laws/regulations
8.6. Operational risks
Stationery Pty Ltd is a small company owned by Sam.
The primary business is the sale of stationery. The company has not been very profitable and Sam is concerned that this might be related to poor internal controls within the company. He has approached you for assistance in this regard.
Previously, Sam never bothered with internal controls as there are only five full time employees and Sam was of the opinion that investing in internal controls would be a waste of money.
Identify the weaknesses evident from the below case study on Stationery Pty ltd.
Provide recommendations for improvement.
8.7. Controlling financial risks
Quiz. Financial statement assertions
Which of the following assertions does not relate to fixed assets?
rights
existence
valuation
obligation
Assets are the rights of the entity.
Liabilities are the obligations of the entity
Risks and assertions (errors)
Types of internal controls
prevent - policies, procedures, supervision, access restrictions
detect - reviews, reconciliations, verifications
correct - reporting breaches, changing authorisations
Example of controls - general v application
what are the general and application (input, processing, output) controls that apply when you visit an ATM?
general IT controls are controls, policies and procedures that relate to many applications and support the effective functioning of application controls
network protection and information security policy
bank card
access PIN - numbers only
pre-existing options
standard screen layout
limit restriction
receipt (output)
counting cash
Quiz. Segregation of duties
which of the following tasks would most likely be performed in a back office function?
buying hedging instruments
monitoring credit exposures
processing deal settlements and invoicing
front - deal execution, logging terms
middle - capturing, monitoring, assessing positions
back - deal confirmation, settlement, accounting, invoicing
Attributes of derivative controls - documentation
8.8. Financial risk management policy
Example:
authorities
financial condition
protection of assets
cash management
cash disbursement and cash handling
cash expenditure assessment
risk management (interest rate risk, counterpart risk, bank reconciliation)
monthly/quarterly reporting
government - treasury management guidelines
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