Audit – what to revise?

All of you do “audit-like” activities at work… its just not called audit unless you are in audit! So there is familiar ground and not alien territory. Question tend to be very practical and require little book learning

So what/how do you revise this area?

1. Make sure you know how to suggest audit tests. Think about information you would like to get hold to be able to make a judgement on how a dept/process is working: This is a very common question in the exam: Practise May 12 Section Apart ci & cii; Nov 12 “F” part c in particular. NB don’t worry to much about whether its compliance or substantive. Don’t suggest controls; suggest tests!
2. Make sure you think about what can make Audit effective. A good exercise would be to think about IA at Y for instance: How would you set up this dept so it was effective?
3. Exam questions are very practical and can focus on how hard it can be to audit. Take a look at March 12, Section A biii – IA asked to audit journalists expenses. But why is that hard to do?
4. Post investment audits come up more often than any other type of audit. See Feb 14 Section A b, March 11 Section B “T”
5. Be clear on the connection between audit and Corporate Gov. The Board are meant to tell the shareholders that the internal controls system in an orgn has been checked and is sound. This is an annual requirement. But Directors don’t do any checking themselves. They delegate this to the Audit Committee (if there is one) and they in turn, delegate to the auditors.Auditors are the eyes and ears of the Board. If they don’t tell the Board, the Board don’t know. If they lie to the Board, the Board are unaware of what is really going on.     The Board rely on audit. So audit must be effective for Corp Gov to be effective. Take a look at May 14 Q3 “J”; Nov 12 Section B “F”.

The one thing you must mention in Audit questions:

Independence.

This is the main benefit of having IA. They are not meant to be biased in anyway. If IA comes up, get the word “independent” in their somewhere. (And if IA are not independent then they are not effective).

Don’t forget…

Auditors are not perfect. They miss “things” because of:

• materiality limits
• human error
• sampling risk
• collusion (if collusion is going on IA tests may totally miss a fraud. See May 11 Section B College)

My tip for Nov 14

Doing an analytical review on a few stores to see which to close.

Financial risk – what to study Part 3

There is not much in P3 that needs to be learnt off by heart – but this is one of the things that does!

Pros and Cons of Foreign Exchange External Hedging Methods (for Transaction Risk)

 

PROS	CONS
Forward Contracts
Fixed Rate, certainty Easy Cheap Tailored Can be used for almost all currencies	Inflexible Lose out on the upside Must ensure that FX receipt arrives Closes off credit lines with banks Transparency
Forward contracts are suitable for organisations (large and small) with FX exposures, in all traded currencies. More commonly used because of their simple administrative requirements.
Money Market Hedge
Exchange happens today (advantageous if you are expecting a receipt) Cheap Tailored Flexible (for instance if the customer does not pay, you can extend your loan)	Complicated May not apply for FX receipt – may be hard to get an overseas loan.
Tend to be used by larger companies.
Futures
Effectively fix the rate No cost Flexibility – the position can be closed off at any time (at a profit or loss) before settlement. Price transparency	Complicated (foreign futures market must be used for UK £ futures). Need cash for margin No tailoring
Currency futures are more suitable for organisations with large currency exposures and staff that are familiar with futures as hedging instruments, such as large multinationals with centralised treasury departments.
Options
Best “perfect” hedge as you can participate in the upside while still covering the downside Flexibility – the option can be allowed to lapse if your future transaction does not arise. Lots of choice (choice of strike price, dates and premiums etc). Price transparency	Complicated (traded sterling currency options are only available on foreign markets). No tailoring Expensive – non refundable upfront premium)
Who can use options – see comments above re Futures.

Facebook ask a P3 tutor session – 9.30am 5th November.

Meet me there!

I am the P3 tutor answering questions tomorrow on the CIMA facebook page.

9.30 till 11.30

Fireworks and space travel….. P3 in the news again

Over the last couple of days hope you have been listening to the news and thinking P3…. a fireworks factory has a fire: surely in that seasonal business they have now lost their stock and all their main revenue for the year. Remind you of any seasonal businesses with just one factory????
And lets not forget that staff were injured and died. Did the Board exercise due care?
Were procedures being followed… or in the run up to Nov 5th were corners being cut just to get stock out to the shops?

You should be thinking about the parallels between this story and your preseen.

And then there was the Virgin Galactic crash:

Did the risks outweigh the potential income (upside)?
Will people fly on the aircraft even if Richard Branson says he & his family will?

Would you say that Richard Branson has a different risk appetite to most people. He has nearly lost his life in very risky adventures a couple of times. (And been in prison!) So if he flies, does it mean you would?

Financial risk. What to study? Part 2

Economic risk

Currency risk splits down into

1. Translation
2. Transaction
3. Economic.

The examiner often sets questions on economic risk in section a and b.  This causes two problems for students:

Firstly students don’t realise it’s economic risk. The question may ask them to “comment on the currency risk“. Students forget that currency risk includes translation and economic, focus only on the transaction risk and lose two thirds of marks available.

Sometimes a question will make it abundantly clear that there is no transaction risk. The company only buys and sells in its home currency. Students then invent some transaction risk only get a score of zero.

Secondly, even if the student does understand the question wants them to mention economic risk, they don’t know what to write.

What to write on economic risk questions

Remember these two words: price and competition.

Price

Let’s say you purchase raw materials from abroad. The exchange rate goes against you and your costs go up. Can you increase your prices to cover the cost, without it affecting demand ie will people pay any price for your product? If so, you do not need to worry or hedge for economic risk. (You could go as far as saying your product is inelastic).

So key question to ask is: If I put prices up to cover the increase in costs (due to exchange rate movement) will it affect demand?

Competition

You may have already mentioned this under price. For instance, you have no competition for the product you are selling so you can increases prices easily.

But there is another reason to mention competition. Can you purchase from elsewhere? If you can diversify your suppliers especially resulting in you buying in a different  currency then you are less likely to be worried about economic risk. I fact, maybe your supplier knows this and will drop prices so you don’t leave them ie they may absorb the exchange rate risk.

So key question to ask is: Can I purchase from elsewhere/sell elsewhere i.e. can I diversify?

***

Economic risk questions require you to think commercially, like in E3 rather than using maths to hedge.  By discussing the price and competition, students can assess the extent of economic risk.

Good questions to review:

section A (DEF airport) nov 10 part c; May 11 section b “G Retail”;  May 14 section B “School uniform”.

Financial risk – what to study? part 1

I often get asked what I think is going to come up
“If swaps came up last time, will it come this time?” ….that sort of thing.

Its extremely difficult to predict!
However, there are three types of questions that come up over and over:

1. Should the co hedge or not?
Typically you have a Board that have a no hedging policy and are considering whether this should be changed.
Or maybe its a cos first export order – evaluate whether they should hedge?
You need to look for lots of clues in the scenario to help you with your answer:

• the materiality – is the amount big enough to worry about? (Look for netting opportunities which may bring the figure down further)
• prediction of what may happen to exchange rates – if going in your favour, why hedge? Can you do a quick IRPT calc if they give you IR to predict the direction the exchange rate is going in?
• Obscure currency – so very little external hedging choices open esp futures and options.
• Stable vs volatile currency. If stable and predictable, maybe not worth hedging?
• One off or regular payments? One off may make it bigger so hedge? Or one off may mean its the one and only export order ever and small value, so no incentive to hedge? Or is the payment regular – so a loss one month may be evened out by the profit the following month?
• Expertise in the company. Is there anyone in the co that can deal with the hedging transactions and the accounting
• Cost. 

These sorts of things can also be discussed when you suggesting how to hedge as well as whether to hedge.

Good question to look at as an example: September 10, section B, N (about fire engines).

Part 2 tomorrow

New recordings posted up today

I’ve loaded up all the recordings I have done so far onto the blog… Take a look at the recordings heading on the right.

Most of these are debriefs I have done after marking a question. I wanted to give some feedback plus help you understand what you could have written in the exam. (The examiners answer is not the only answer!).

Please leave comments and suggestions. There is a month before the exam so time for me to add further information.

3 more executives leave Tesco today….

… which take the total to 8.

I did say that this story would not go away. And that more staff would have to go… if senior staff set the tone at the top, there will be problems through out the company ie control environment is weak.

P3 Preseen is based on Thorntons…

The preseen is out.
You’ve probably read it by now.
It seems to be based on Thorntons.
So its worth you having a look at their annual report which has a risk section.

http://investors.thorntons.co.uk/

Thorntons risk report is on page 16 of the annual report for 2013.
You can find it under the financial performance tab, company reports, then look under 2013 for the annual report.
It’s useful to scan the initial pages too (for instance it deals with how they are trying to move away from Thorntons business being seasonal), but at a minimum read the risk section.

Hints for the Final Assessment

There have been many question from students I have taught in classes about the Final Assessment that needs to be handed in.
Here are some hints:
FIRSTLY – and most importantly, the exam in section A does NOT follow the style I said P3 exams do. There are 4 requirements (a-d) and yet only 3 paragraph headings. So beware! (b) refers to the first paragraph headed “African Subsidiary plans” AND the second “Asian trading company”.

Next…
in ai) the risks are separate/independent of one another and that needs to be reflected in your table.
re aii) if you having forgotten VaR have a look at my recordings on this blog site
re c) remember that if you are evaluating an argument give a balanced view – pros/cons or why they are correct/not correct etc..
d) A guide to the marking scheme: di is 10 marks, dii is 5 marks and 1 mark for report format.
and dii is refers to the effectiveness of a control system. You have a model that runs through the 5 things that make a control system effective….
Good luck!