00 CHAPTER 1 Governance, Ethics, and Managerial Decision Making © 2009 Cengage Learning

1 1 Introduction Companies need strong corporate governance and sound ethical practices : Scandals cause the public to lose faith in the company Strong governance and sound ethics serve to make management more accountable to a range of stakeholders, including employees, investors, and customers Both internal and external forces shape a company’s system of corporate governance and internal control

2 2 Corporate Governance Embodied in the processes that companies use to promote: Corporate fairness Complete and accurate financial disclosures Management accountability

3 3 Corporate Governance Legal and regulatory requirements impact corporate governance Board of Directors meets with auditors Audit committee composed entirely of independent directors No one set of corporate governance processes will fit all corporations Tailored to fit size, complexity of operations, stakeholders, and unique business risks

4 4 Corporate Governance Corporate governance systems are used by a company to promote fairness, complete and accurate financial reporting, and accountability. Key Concept

5 5 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

6 6 Elements of Internal Control The Control Environment Risk Assessment Control Activities Information & Communication Monitoring

7 7 Control Environment  Owners’ and managements’ attitudes and general philosophy about Internal control and accountability  Organizational structure  Human resources policies  Commitment to competence  Oversight by company’s board of directors

8 8 Risk Assessment  Steps a company takes to identify and evaluate risks that can adversely impact its ability to successfully conduct business  Assessment occurs at every level in the company  Once identified, management evaluates risks and takes steps to reduce risk to an acceptable level

9 9 Control Activities  Segregation of Duties  Transaction Authorization  Safeguarding of Assets  Independent Reviews of Work

10 Information and Communication  The accounting system used to initiate, record, process, and communicate the company’s performance  Technology has made computerized information systems widely available

11 Monitoring  A company’s periodic assessment of its internal controls  Should be performed by employees who don’t have responsibility for recordkeeping or internal control

12 The Impact of Information Technology on Internal Control Risks in a Technology- Intensive Environment Internet-based business Threats by current employees Insider perpetrators Perpetrators intercepting credit card information, messages, company data Sabotage by former employees Unauthorized access to data Fictitious customers posing as legitimate customers Denial-of-service attacks

13 The Importance of Ethics Business ethics The interaction of personal morals with the processes and objectives of business

14 The Importance of Ethics Integrity is the cornerstone of ethical business practices  Failure to build a business on integrity carries costs  May lower employee morale, reduce customer loyalty, harm a company’s standing in the community

15 The Importance of Ethics Establishing an ethical business environment encourages employees to act with integrity and conduct business in a manner that is just and fair to other stakeholders. Key Concept

16 Stakeholder Analysis  Stakeholders affect or are affected by the company  Stakeholder analysis alerts the company to various stakeholder issues including political, social, and ethical  Steps include: 1)Identify stakeholders 2)Understand stakeholders’ interests 3)Assess stakeholders power and influence 4)Assess social, legal, ethical, and economic responsibilities to stakeholders 5)Develop strategies to address demands of stakeholders

17 Stakeholder Analysis A stakeholder analysis approach is useful for identifying stakeholders and the social, legal, ethical, and economic responsibilities to those stakeholders. Key Concept

18 Ethics Programs Ethics programs include:  Written codes of ethics  Employee hotlines and ethics call centers  Training programs  Ethics offices

19 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 frequently asserts a commitment to key stakeholders  Corporate philosophy statement An broad outline of the company’s principles

20 Code of Ethics Three common types of codes of ethics include codes of conduct, mission statements, and corporate philosophy statements. Key Concept

21 Corporate Scandals Fraud costs businesses and consumers billions of dollars each year. Accordingly, its prevention is of paramount importance. Key Concept

22 Sarbanes-Oxley Act of 2002  Management must provide certifications about internal controls.  Management must make its own assessment of the effectiveness of those internal controls.  Must have external auditor attest to those controls.  Criminal penalties for financial statement fraud increased.  Whistleblower protection.

23 Fraud Defined as a 1) Knowingly false representation of a material fact made by a party 2) With the intent to deceive and induce another party to justifiably rely on the representation to his or her detriment

24 Fraudulent Financial Reporting  Intentional misstatement of or omission of material, very significant information from a company’s financial statements  Generally requires management’s active involvement

25 Management Fraud Management fraud is typically the result of pressure on management to report good operating results. Commonly involves:  Improper revenue recognition  Overstating assets  Understating liabilities

26 Types of Fraud There are two types of fraud: fraudulent financial reporting and misappropriation of assets. Key Concept

27 Management Fraud Fraud involving upper management can be very difficult if not impossible to detect. Key Concept

28 Misappropriation of Assets  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

29 Causes of Fraud People engage in fraudulent activity as a result of an interaction of forces within an individual and the external environment. Combinations of pressure, opportunity, and attitude are likely to lead to fraud  The Fraud Triangle

30 The Fraud Triangle Situational Pressures & Incentives Opportunities Personal Characteristics & Attitudes

31 Three forces typically contribute to fraud: situational pressures and incentives, opportunities, and personal characteristics and attitudes. Fraud Key Concept