Question 1 was answered reasonably in parts although answers often tended to be too vague and general.

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1 General Comments Overall, performance was good. Well-prepared candidates were capable of obtaining clear passes. Weaker candidates tended to avoid the requirements of the question, either through a failure to grasp what was required or as an attempt to obtain marks for repetition of memorised facts and information. Generally, where candidates did not achieve a pass, the main problems were a failure to apply their knowledge to the scenario and missing out parts of the questions. When information is given in the scenario candidates are expected to use it to illustrate the main issues in their answer. It is very important that all parts of the syllabus are revised, - there is little choice in the paper so only one question can be missed out. Also the financial risk part of the syllabus is 35%. This means that Question 1 will contain some financial risk. Few candidates chose to do question 4 which was the financial risk question on this paper. Using the reading time wisely can be of huge benefit; candidates should always plan their answers and ensure they read the questions carefully before starting the paper. Candidates who answer the specific question asked could achieve high marks. Candidates waste valuable time if they fail to be specific in their answer, as only the points which answer the question requirements will gain marks. Question 1 was answered reasonably in parts although answers often tended to be too vague and general. Question 2 was the most popular of the section B questions. This question was often very well answered. Question 3 was a question on dysfunctional behaviour which could be caused by transfer pricing and also about auditing transfer prices and tax avoidance. Performance on this question was disappointing, which was surprising given the interest in the financial press over recent months. Candidates struggled to do more than scrape a pass overall. Question 4 was the financial risk question. In this question financial instruments were used for speculation but many candidates did not realise the difference between hedging and speculation. This question was the least popular of the optional questions and was done very badly. Note that the attached marking scheme often makes more marks available than indicated on the question paper. This reflects the fact that questions at this level can often be approached in more than one way and that there is no single perfect answer. In applying this marking scheme, marks are always restricted to the total offered by the question and so there is no advantage to be gained from over-developing the answer to one question at the expense of another that may appear more difficult. The Chartered Institute of Management Accountants 2013 Page 1

2 SECTION A 50 MARKS ANSWER THIS QUESTION Question 1 (a) Evaluate the risks to TCL s reputation arising from the newspaper stories concerning the punctuality of its trains. (1) (b) (i) (ii) Evaluate the control issues arising from the fact that T Railways has no direct access to the IT facility that processes long-distance revenue data. (11 marks) Advise the railway companies of the factors that they should consider when selecting an IT company to run the IT facility when the current contract expires. You should explain why the factors are important. (10 marks) (Total for part (b) = 21 marks) (c) Evaluate possible actions that the Government of Country T might take in response to the proposal for Country F s new railway line. (5 marks) (d) F-rail is concerned that the Government of Country T may not react favourably when it is announced that F-rail plans to build the high speed line. Recommend, with reasons, three possible strategies that F-rail might adopt when hearing that there could be adverse reactions by the Government of Country T. (1) (Total for Question One = 50 marks) The Chartered Institute of Management Accountants 2013 Page 2

3 Rationale This question is based on both the common pre-seen scenario and the unseen scenario. Part (a) deals with the reputation risks arising from reporting inaccurate information concerning the quality of the company s service. Part (b) deals with the IT risks associated with shared service providers. Part (c) deals with the risks arising from the need to maintain satisfactory relationships with foreign governments. Part (a) draws mainly on Section B of the syllabus (Risk and Internal Control). This part discusses the risks arising from reports published in the national press that the company manipulates reports concerning the punctuality of its services. This is an important commercial and political matter because the operation of rail services has significant implications for customers, many of whom have no alternative means of travelling to work. Part (b) draws mainly on section E (Risk and Control in Information Systems). The company depends on a shared service provider to operate its IT function. As is common in such arrangements, the company is unable to conduct its own tests on the operation of the system and that will have implications for the ability of management to ensure that their responsibilities for safeguarding assets and accurate record keeping are discharged properly. Part (c) draws mainly on section D (Management of Financial Risk). A rail operator located in a neighbouring country plans to build a new line that will reduce T Railways revenue. The rail operator is concerned that T s government will retaliate in some way, which could prove disruptive because the rail operator will still wish to route its services via T Railways lines. Suggested Approach Part (a) asks candidates to think about the significance of the revelation that a railway company is not responsive to the needs of its customers, particularly commuters who depend on the rail service. The operation of public transport is a major political issue in most countries and so the implications of these reports will require careful consideration. There is, for example, a risk that the government will impose new regulations. Part (b) requires some thought about the implications of being unable to observe the operation of the IT system directly. That arises in both the context of checking on day to day operations and also the selection of a service provider (either retaining the same firm or finding a replacement) when the present contract comes to an end. Part (c) requires practical suggestions in order to defuse a potentially costly dispute before it gets out of hand. The railway operator must find some practical ways to prevent a dispute that will make it difficult to continue to operate through Country T. The key issue is to recognise that there is no need to harm T Railways and it may be possible to offer some concessions that will lead to a mutually advantageous outcome. The Chartered Institute of Management Accountants 2013 Page 3

4 Marking Guide Part (a) 1 mark per reasonable point: Importance of punctuality Perception that TCL does not care Cynical response Company using dysfunctional policies Need to whistleblow Part (b)(i) 1 mark per reasonable point: Control environment T has different issues from others Customer data External auditor Favouring other rail companies Part (b)(ii) 1 mark per reasonable point: Relevant experience Management expertise Staffing Financial security Part (c) 1 mark per reasonable point: Retaliation Compromise Part (d) 1 mark per reasonable point: Consultation Cooperation Government support T more vulnerable Maximum mark awarded Marks Max 1 Max 11 marks Max 10 marks Max 5 marks 4 marks 4 marks 4 marks 1 mark Max 1 50 marks Examiner s Comments In (a) most candidates managed to say something sensible in order to gain a pass. The better candidates discussed each individual newspaper story picking up on failure to meet objectives, lack of integrity etc. The weaker scripts concentrated on revenue loss and not much else. Part (b) caused serious problems for the average candidate who failed to understand the situation. The inability to verify the data provided by the other railway companies was key along with the validity of the audit function but only the better candidates picked up on this. The average script picked up on the inability to vet staff quality and input/output controls etc but wasted too much time on how T Railways could not ascertain whether the revenue formula was no longer appropriate or how it could not be ascertained whether it was being properly applied or that their ticket inspectors might make mistakes. There also seemed to be a belief that there would be no information available from the IT Company for resource planning and budgeting which seems highly unlikely. Part b (ii) was answered quite well but a sizeable minority failed to answer the question set, going into potential new IT systems rather than new outsourced management of systems. In part (c) most candidates gained a pass despite failure to apply common sense to the scenario and appreciate that if a small landlocked country takes strong action such as border closure and banning neighbouring countries trains there can only be one loser - the small landlocked country. The Chartered Institute of Management Accountants 2013 Page 4

5 In (d) weaker candidates advocated a joint venture without specifying much detail and had not thought it through at all. Better candidates came up with appropriate sweeteners such as supplier contracts with T companies and employment provision to T workers to enable the HS link to be built. Common errors Part (b) was poor with candidates often writing only about the revenue formula. Part (b)(i) was also surprisingly poor with quite a few candidates writing about new IT systems rather than the problems of outsourced management of systems. Part (d) was a problem for some candidates as they did not really think about the specific question requirements and wasted lots of time discussing joint ventures instead of thinking of other ways of mitigating the risk. The Chartered Institute of Management Accountants 2013 Page 5

6 SECTION B 50 MARKS ANSWER TWO QUESTIONS ONLY Question 2 (a) (b) Discuss the benefits that the dental practice may obtain from the risk mapping exercise described above. (5 marks) Critically evaluate the placing of each of the identified risks in the risk map, stating with reasons whether or not you agree with the placement. (20 marks 5 marks per risk) (Total for Question Two = 25 marks) Rationale Question 2 draws on section B (Risk and Internal Control). Part (a) deals with the benefits that might be obtained from mapping risks using the TARA framework. Part (b) asks candidates to comment on the manner in which four risks have been mapped using TARA. Suggested Approach Part (a) requires candidates to think about the benefits that can be obtained from a management team taking time to formally list and comment on the risks that are faced by the entity. it would be worth considering the nature of the risks faced by this particular type of entity. Part (b) asks candidates to consider the results of a mapping exercise and to comment on their agreement or disagreement with the placing of particular risks. It is perfectly acceptable to disagree with the suggestions that have been made provided that disagreement is justified by a sensible argument. Having said that, the risks are already classified in a credible and defensible manner. The fact that some of the risks cannot be reduced or avoided should be taken into account in this evaluation. The Chartered Institute of Management Accountants 2013 Page 6

7 Marking Guide Part (a) 1 mark per reasonable point: Subjective Identify risks Agreement on resolution Part (b) 1 mark per reasonable point: Each risk Maximum mark awarded Marks 1 mark Max 5 marks Max 5 marks per risk Max 20 marks 25 marks Examiner s Comments This question was extremely popular and there were many good answers. Common Errors The better scripts related the risk map to the dental practice stating for example that better risk prioritisation meant fewer compensation claims and fewer work hours lost through cross contamination. Weaker candidates answered textbook style on the objective/benefits of risk management with little reference to the question scenario. In (b) most candidates managed a comfortable pass with better scripts gaining high marks. There was some lack of clarity regarding gross and net risk situations with candidates assuming low probability because controls had been applied but this was perhaps acceptable. The Chartered Institute of Management Accountants 2013 Page 7

8 Question 3 (a) (b) (i) (ii) Discuss the possibility that M s transfer pricing arrangements will cause dysfunctional behaviour. (10 marks) Advise the board on the matters that it should cover when briefing the Head of Group Internal Audit in order to be certain that its requirements are met by the internal audit investigation into M s transfer pricing practices. (7 marks) Discuss FOUR factors that the Head of Group Internal Audit should consider when assessing the possibility that a subsidiary could be investigated by its local tax authority. (8 marks) (Total for part (b) = 15 marks) (Total for Question Three = 25 marks) Rationale Part (a) of question 3 draws mainly on section A (Management and Control Systems). It deals with the motivational issues arising from intra-group transfer prices that lead to individual companies reporting artificially inflated or deflated profits. Part (b) draws on section C (Audit and Audit of Control Systems) asking how the internal audit department might pre-empt a tax investigation by reviewing transfer process for compliance with tax law. Suggested Approach Part (a) requires some thought about the natural concerns that a management team might have when reporting very small profits. Even setting aside the possibility of profit-related pay and bonus, there is a natural tendency for managers to wish to report substantial profits. Local boards may be concerned that their role in the company is undervalued if they are required to manufacture parts for resale at little more than cost. Part (b) asks for some thought about the risks associated with the objectives of the audit. Auditors are generally keen to identify the areas which are most likely to have an impact on the audit s findings. They counter those risks with the most cost-effective evidence that is available. All audits are planned on the basis of understanding the issues and then using common-sense to evaluate the possible responses. The Chartered Institute of Management Accountants 2013 Page 8

9 Marking Guide Part (a) 1 mark per reasonable point: Transfer prices imposed Little control over reported performance Sacrificing quality to cut costs Management time Demotivation Disrupt internal sales Improve system Part (b)(i) 1 mark per reasonable point: Clear objective Evidence collection Confidentiality Timetable Part (b)(ii) 1 mark per reasonable point: Tax rates Effective tax rates Past behaviour of tax authorities Nature of products and their market Maximum mark awarded Marks 1 mark Max 10 marks Max 7 marks 4 marks Max 8 marks 25 marks Examiner s Comments The candidates found this question the most difficult to respond to. Problems evolved around failure to understand the question and failure to answer the question set. Common Errors In (a) even the better scripts spent far too much effort explaining how transfer pricing can cause dysfunctional behaviour. Candidates often ignored the requirement to explain why this company s specific transfer pricing policy (market value basis) could cause dysfunctional behaviour. Part (b) should have produced an easy 7 marks but it did not do so. The answers often could not be related to what had been asked. Very few scripts directly covered the requirement by specifying simple points such as objective, scope and timeline. In (c) the identical comment is applicable. The question was answered very badly with few candidates demonstrating any understanding of how transfer pricing could be used to manipulate taxation. Given the recent coverage in the press on companies doing just this, it was surprising. Answers were unrelated or too vague and brief to be intelligible, e.g. size of profit with no further development or transfer price and cost with no subsequent explanation. The Chartered Institute of Management Accountants 2013 Page 9

10 Question 4 (a) Calculate the gain S will make writing a futures contract, assuming that she invests the maximum possible amount that she can afford in the initial margin and that her expectations turn out to be accurate. (8 marks) (b) Discuss the risks that S will be taking if she enters into this contract. (10 marks) (c) Explain why S chose to use a futures contract as the basis for her speculation in the market. (7 marks) (Total for Question Four = 25 marks) Rationale Question 4 draws on section D (Management of Financial Risk). Part (a) deals with the calculation of a speculative profit from the use of a forward contract to exploit an overpriced currency. Part (b) deals with the risks associated with such speculation. Part (c) deals with the advantages of using derivatives to gear up speculative investments. Suggested Approach Part (a) requires some basic calculations, albeit in an unusual form. It is important to understand the operation of the main types of financial instrument listed in the syllabus. Part (b) requires some thought about the risks that this speculative investment might involve. The instrument is exchange traded and so there are no real counterparty risks. There is every chance that the investment will fail to show a profit. Part (c) is looking for the ability to explain the uses of derivatives for investment purposes. The Chartered Institute of Management Accountants 2013 Page 10

11 Marking Guide Part (a)(i) 1 mark per reasonable point: Calculate gain Max 8 marks Part (b) 1 mark per reasonable point: Upside risk Downside risk Worst case Margin call Counterparty Part (c) 1 mark per reasonable point: Only practical way to profit Profits otherwise restricted Regulated market Limited downside Maximum mark awarded 4 marks 1 mark Max 10 marks Max 7 marks Total 25 marks 25 marks Examiner s Comments This was the least popular of the optional questions. Many candidates failed to understand margin payments and the use of such financial instruments for speculation. Common errors In (a) candidates did not grasp the significance of the margin payment and the leverage effect this could produce. Consequently most calculations were made on the basis of a single contract not six contracts. The vast majority of scripts gained an own figure single mark instead of the eight available. In (b) candidates generally gained marks for stating the obvious forex risks and the likelihood of future margin calls. Many wasted valuable effort in identifying all the elements contributing to exchange rate movement e.g. inflation risk, interest risk, political risk etc. In (c) the weaker candidates often missed the whole speculative nature of the proposed transaction and introduced arguments relative to hedging. Nevertheless, candidates gained marks for identifying that futures are market traded, easy to obtain, cheaper than options etc. Only the really good candidates picked up on the leveraging effect mentioned in (a) enabling greater potential return from the limited finance available. The Chartered Institute of Management Accountants 2013 Page 11