CIMA Study Notes Q&A for Ethics article (P3) - Strategy LevelRisk and Control Strategy.
Before attempting this Q&A please read the article by Martin Corboy in June 2008
Study Notes.
Example- Past Question
As an example of how to approach an ethics question, using the 5 step
approach, let’s look at a past ethics question. This question came up on the
old Organisational Management and Development paper, (which has largely
been incorporated into the current strategic level Papers 3 and 6 and the
Organisational Management and Information Systems Paper 4). The model
solution is my own and is a mini-answer plan (i.e. points for discussion are
raised but are not as fully developed as they would be in a full written
answer).
Ethical considerations
You were appointed Financial Controller of a firm of builders' merchants
almost a year ago, with the prospect of becoming Finance Director if you
performed well.
The problem customer
An old-established customer, a contractor, X Ltd, which has expanded to take
on a very large contract, is causing problems with delayed payments. X Ltd is
a family firm, largely owned by its Managing Director, Y. Following a
discussion at a management meeting, the Sales Director and a member of
your staff visited the customer with instructions to “try and resolve the matter
of delayed payments”.
The meeting
At the meeting, the Sales Director took the lead, having known Y for many
years. Y provided the last annual accounts and the latest management
accounts and contract accounts. This one large contract that X Ltd had
undertaken represents some 70% of its current activity. If all, or almost all,
suppliers allow additional credit for material, and X Ltd uses its very limited
remaining bank facilities to pay the workforce, Y thinks the company should
be able to complete the next stage of the contract, get the architect to certify
the work has been completed, and obtain a progress payment. This would
enable X Ltd to pay suppliers, get more materials, and finish the contract.
However, Y considers the company will make a significant loss on the
contract and will only be able to trade on a much reduced scale thereafter.
The Sales Director suggested, and Y agreed, an arrangement by which Y
would make a payment from personal funds, against which your company
would release materials to X Ltd. When it receives the progress payment X
Ltd will pay your company from its company's funds and reduce the amount
owing to well within normal terms. Your company will then repay Y the
personal funds he has paid. It was agreed that this arrangement should be
discussed and agreed with your Managing Director in the morning.
After the meeting
On his return, the Sales Director commented that this sort of arrangement
was probably the only way of getting any money back - if X Ltd went into
liquidation nothing would be recovered.
Later you received a telephone message that Z, the Finance Director of
another firm of builders' merchants and whom you know through local CIMA
branch meetings, has asked you to telephone urgently regarding the credit
status of X Ltd.
Required
Write a report to your Managing Director, evaluating the ethical considerations
and recommending the action to be taken on the account and on the
telephone message.
(25 marks)
(2000 words to this point)
Martin Corboy BCL, AITI, FCMA, MBA
Martin Corboy is a former director of BPP Ireland and is currently a freelance
tutor
NOTE: Visit the new ethics area on the CIMA website
(www.cimaglobal.com/ethics) for a summary of CIMA's code of ethics, new
guidance on how to tackle an ethical dilemma and an E-library of ethics
resources.
Suggested solution
Your report would need to consider not just the financial considerations of the
proposal but also the ethical issues involved, like confidentiality-can we tell
the other supplier what we know about X Ltd’s problems?
To apply the CIMA code, you would have to identify the principles involved
like integrity, confidentiality and objectivity -are you being objectiveremember you are looking for a promotion here!
REPORT
To:
The Managing Director
From: The Financial Controller
Date: xx/xx/xx
Re:
Issues arising from meeting with X Ltd
Terms of Reference
Executive Summary
Main body of report
Step 1-Analyse the situation
Get to grips quickly with the key issues facing the company. X Ltd, who are in
trading difficulties, want us to continue to supply them on credit. To secure our
agreement, the directors are willing to offer a personal payment as security,
which would be repaid once the company is able to clear its debt or at least,
get its credit limit back within normal commercial terms. The Sales Director is
keen to give the proposal the OK (not surprising given that he made the
proposal!).
Step 2-Identify the ethical issues
From the CIMA Code, 3 key principles will have to be considered.
1) Integrity –are we being honest with all stakeholders if we accept the
proposed personal payment? If we were to refuse further credit, other
suppliers to X Ltd would take this as a signal that X Ltd were in trouble and
would take steps to protect their own position. However, if we did accept
the payment and supply more materials on credit, there is a risk that other
suppliers might take that as a signal that all was well with X Ltd and could
lose out as a result. Remember, integrity means being party to the supply
of false or misleading information. Would continuing to supply on the
basis of this irregular payment of funds be seen as misleading other
parties? The mirror test, mentioned above, could be used here. How would
we feel if our decision to continue to supply, based on this personal
payment of funds, became public knowledge?
2) Objectivity -we obviously want to get paid. Are we being objective in
accepting this payment? Is the Sales Director being objective in saying we
should accept it-he admits that he has known Y for many years.
3) Confidentiality -can we disclose the content of our meeting with X Ltd
to the Financial Director of the other supplier who is anxious to talk to us
about X Ltd?
Step 3-Identify the Options
These are
1) Accept the payment as proposed
2) Reject it but supply anyway and hope that X Ltd can trade out of their
difficulties
3) Reject it, refuse further credit and pursue the existing debt
Step 4-Analyse the consequences of these options
1) Accept proposal
If we accept the payment, this puts our existing debt at risk, not to mention
the further credit now being sought. It seems unlikely that X Ltd can
survive. They have 70% of their current trading activity tied up on one
contract which they admit, even if they can complete it, they are going to
make a loss on it. (What is the status of this personal payment? If we do
decide to accept it, we would need to seek legal advice as to whether the
director of X Ltd could sue for its return if his company did go insolvent, as
this payment is not a normal commercial business transaction).
Why doesn’t the director Y invest his personal payment into the company
by way of a director’s loan and then seek to trade normally? Is it because
he feels that the company could go out of business in the near future and
that any such director’s loans might never be recovered? If Y isn’t willing to
loan funds to his own company, why should we?
If we go with the proposal, other suppliers may see that as a signal that X
Ltd is OK financially and they will continue to trade with them. The golden
rule from Kant could be considered here, how would we feel if we
discovered that another supplier had continued to supply X Ltd, based on
a personal payment like that proposed and we lost out as a consequence
of continuing to supply?
2 Reject but supply
This really is not an option. It increases our debt and based on what Y said
at the meeting, the prospects of X Ltd surviving is unlikely. It still sends out
a message to other suppliers that it is OK to trade with X Ltd when we
know that is not the case.
We could suggest that if X Ltd gets an agreement from all other suppliers
to supply, based on what Y told us, that we would be willing to reconsider
whether we could offer further credit at this time. Confidentiality is the
issue here-we cannot tell the other supplier what we discussed with Y. We
can and should, however, respond by saying that we have had a meeting
with X Ltd regarding their account. We can’t really say more than that.
3) Reject and sue
This might also increase our debt as we will incur legal costs without any
realistic chance of recovery. X Ltd is given no chance to try to trade out of
their difficulties, however remote that prospect might be. We might also be
seen as too quick to sue.
The threat of forcing X Ltd to face the prospect of liquidation might mean
that we get paid before the remaining creditors. However, based on what
Y said at the meeting, it is unlikely that X Ltd could pay now, the company
would be liquidated and our debt would be written off.
Step 5-Recommendations
It is fairly clear that we should not accept the proposal as it is not a normal
business transaction. Whilst I cannot state, without legal advice, as to
whether the proposal breaks any laws, it does on the face of it appear to
mislead other stakeholders as to the financial status of X Ltd. Our
objectivity could also be questioned as we would accepting the proposal
simply as a means of getting paid ahead of all other creditors affected by X
Ltd’s current position.
So the choice is either option 2 or option 3. There seems little point in
suing for recovery of our debt at this stage. We simply add to our costsneither does there seem much merit in continuing to supply.
The best option would appear to be to reject the proposal and refuse
further credit and see what happens. If the company goes into liquidation,
we can seek repayment along with all other creditors.
We need to respond to the query from the other supplier along the lines
suggested i.e. advise that we had a meeting but don’t divulge the content
of that meeting.
On the wider front, we need to investigate how the current situation was
allowed to develop. We should have been aware of X Ltd’s difficulties well
before now. Tighter credit control should have been in place. Our control
systems for determining customer credit limits and monitoring slow
payments or the financial difficulties of our customers need strengthening.
Signed
-----------------------Financial Controller
Summary
An answer based on the above framework would have covered most of
the angles and would merit a good score. Finally, always try to adopt the
concept of fairness in making ethical decisions. One of the key principles
of Corporate Governance codes around the world is the idea of being fair
to all stakeholders when making decisions.