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CHAPTER 1 Governance, Ethics, and Managerial Decision Making. © 2009 Cengage Learning. Introduction. Companies need strong corporate governance and sound ethical practices : Scandals cause the public to lose faith in the company

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CHAPTER 1 Governance, Ethics, and Managerial Decision Making

© 2009 Cengage Learning

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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

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Corporate Governance

Embodied in the processes that companies use to promote:

  • Corporate fairness

  • Complete and accurate financial disclosures

  • Management accountability

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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

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    Corporate Governance

    Key Concept

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

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    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:

    The control environment.

    Risk assessment

    Control activities

    Information and communication


    Key Concept

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    Elements of Internal Control

    The Control Environment









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    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

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    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

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    Control Activities

    • Segregation of Duties

    • Transaction Authorization

    • Safeguarding of Assets

    • Independent Reviews of Work

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    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

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    • A company’s periodic assessment of its internal controls

    • Should be performed by employees who don’t have responsibility for recordkeeping or internal control

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    The Impact of Information Technology on Internal Control

    Risks in a Technology- Intensive Environment

    Threats by current employees

    Insider perpetrators

    Perpetrators intercepting

    credit card information,

    e-mail messages,

    company data

    Sabotage by former




    Fictitious customers

    posing as legitimate


    Unauthorized access to data



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    The Importance of Ethics

    Business ethics

    The interaction of personal morals with the processes and objectives of business

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    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

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    The Importance of Ethics

    Key Concept

    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.

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    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:

      • Identify stakeholders

      • Understand stakeholders’ interests

      • Assess stakeholders power and influence

      • Assess social, legal, ethical, and economic responsibilities to stakeholders

      • Develop strategies to address demands of stakeholders

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    Stakeholder Analysis

    Key Concept

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

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    Ethics Programs

    Ethics programs include:

    • Written codes of ethics

    • Employee hotlines and ethics call centers

    • Training programs

    • Ethics offices

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    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

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    Code of Ethics

    Key Concept

    Three common types of codes of ethics include codes of conduct, mission statements, and corporate philosophy statements.

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    Corporate Scandals

    Key Concept

    Fraud costs businesses and consumers billions of dollars each year. Accordingly, its prevention is of paramount importance.

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    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.

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    Defined as a

    Knowingly false representation of a material fact made by a party

    With the intent to deceive and induce another party to justifiably rely on the representation to his or her detriment

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    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

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    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

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    Types of Fraud

    Key Concept

    There are two types of fraud: fraudulent financial reporting and misappropriation of assets.

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    Management Fraud

    Key Concept

    Fraud involving upper management can be very difficult if not impossible to detect.

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    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

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    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

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    The Fraud Triangle

    Situational Pressures

    & Incentives


    Personal Characteristics

    & Attitudes

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    Key Concept

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