Section A – This ONE question is compulsory and MUST be attempted P&J is a long established listed company based in Emmland, a highly developed and relatively prosperous country. For the past 60 years, P&J has been Emmland’s largest importer and processor of a product named X32, a compound used in a wide variety of building materials, protective fabrics and automotive applications. X32 is a material much valued for its heat resistance, strength and adaptability, but perhaps most of all because it is flexible and also totally fireproof. It is this last property that led to the growth of X32 use and made P&J a historically successful company and a major exporter. X32 is mined in some of the poorest developing countries where large local communities depend heavily on X32 mining for their incomes. The incomes from the mining activities are used to support community development, including education, sanitation and health facilities in those developing countries. The X32 is then processed in dedicated X32 facilities near to the mining communities, supporting many more jobs. It is then exported to Emmland for final manufacture into finished products and distribution. Each stage of the supply chain for X32 is dedicated only to X32 and cannot be adapted to other materials. In Emmland, P&J is the major employer in several medium-sized towns. In Aytown, for example, P&J employs 45% of the workforce and in Betown, P&J employs 3,000 people and also supports a number of local causes including a children’s nursery, an amateur football club and a number of adult education classes. In total, the company employs 15,000 people in Emmland and another 30,000 people in the various parts of the supply chain (mining and processing) in developing countries. Unlike in Emmland, where health and safety regulations are strong, there are no such regulations in most of the developing countries in which P&J operates. Recently, some independent academic research discovered that X32 was very harmful to human health, particularly in the processing stages, causing a wide range of fatal respiratory diseases, including some that remain inactive in the body for many decades. Doctors had suspected for a while that X32 was the cause of a number of conditions that P&J employees and those working with the material had died from, but it was only when Professor Harry Kroll discovered how X32 actually attacked the body that the link was known for certain. The discovery caused a great deal of distress at P&J, and also in the industries which used X32. The company was faced with a very difficult situation. Given that 60% of P&J’s business was concerned with X32, Professor Kroll’s findings could not be ignored. Although demand for X32 remained unaffected by Kroll’s findings in the short to medium term, the company had to consider a new legal risk from a stream of potential litigation actions against the company from employees who worked in environments containing high levels of X32 fibre, and workers in industries which used X32 in their own processes. In order to gain some understanding of the potential value of future compensation losses, P&J took legal advice and produced two sets of figures, both describing the present value of cumulative future compensation payments through litigation against the company. These forecasts were based on financial modelling using another product of which the company was aware, which had also been found to be hazardous to health. The finance director (FD), Hannah Yin, informed the P&J board that the company could not survive if the worst-case scenario was realised. She said that the actual outcome depended upon the proportion of people affected, the period that the illness lay undetected in the body, the control measures which were put in place to reduce the exposure of employees and users to X32, and society’s perception of X32 as a material. She estimated that losses at least the size of the best case scenario were very likely to occur and would cause a manageable but highly damaging level of losses. The worst case scenario was far less likely but would make it impossible for the company to survive. Although profitable, P&J had been highly geared for several years and it was thought unlikely that its banks would lend it any further funds. Hannah Yin explained that this would limit the company’s options when dealing with the risk. She also said that the company had little by way of retained earnings. Chief executive officer, Laszlo Ho, commissioned a study to see whether the health risk to P&J workers could be managed with extra internal controls relating to safety measures to eliminate or reduce exposure to X32 dust. The confidential report said that it would be very difficult to manage X32 dust in the three stages of the supply chain unless the facilities were redesigned and rebuilt completely, and unless independent breathing apparatus was issued to all people coming into contact with X32 at any stage. FD Hannah Yin calculated that a full refit of all of the company’s mines, processing and manufacturing plants (which Mr Ho called ‘Plan A’) was simply not affordable given the current market price of X32 and the current costs of production. Laszlo Ho then proposed the idea of a partial refit of the Aytown and Betown plants because, being in Emmland, they were more visible to investors and most other stakeholders. Mr Ho reasoned that this partial refit (which he called ‘Plan B’) would enable the company to claim it was making progress on improving internal controls relating to safety measures whilst managing current costs and ‘waiting to see’ how the market for X32 fared in the longer term. Under Plan B, no changes would be made to limit exposure to X32 in the company’s operations in developing countries. Hannah Yin, a qualified accountant, was trusted by shareholders because of her performance in the role of FD over several years. Because she would be believed by shareholders, Mr Ho offered to substantially increase her share options if she would report only the ‘best case’ scenario to shareholders and report ‘Plan B’ as evidence of the company’s social responsibility. She accepted Mr Ho’s offer and reported to shareholders as he had suggested. She also said that the company was aware of Professor Kroll’s research but argued that the findings were not conclusive and also not considered a serious risk to P&J’s future success. Eventually, through speaking to an anonymous company source, a financial journalist discovered the whole story and felt that the public, and P&J’s shareholders in particular, would want to know about the events and the decisions that had been taken in P&J. He decided to write an article for his magazine, Investors in Companies, on what he had discovered. Required: (a) Define ‘social footprint’ and describe, from the case, four potential social implications of Professor Kroll’s discovery about the health risks of X32. (10 marks) (b) Describe what ‘risk diversification’ means and explain why diversifying the risk related to the potential claims against the use of X32 would be very difficult for P&J. (10 marks) (c) As an accountant, Hannah Yin is bound by the IFAC fundamental principles of professionalism. Required: Criticise the professional and ethical behaviour of Hannah Yin, clearly identifying the fundamental principles of professionalism she has failed to meet. (9 marks) (d) Writing as the journalist who discovered the story, draft a short article for the magazine Investors in Companies. You may assume the magazine has an educated readership. Your article should achieve the following: (i) Distinguish between strategic and operational risk and explain why Professor Kroll’s findings are a strategic risk to P&J; (8 marks) (ii) Discuss the board’s responsibilities for internal control in P&J and criticise Mr Ho’s decision to choose Plan B. (9 marks) Professional marks will be awarded in part (d) for the structure, logical flow, persuasiveness and tone of the article. (4 marks)