Section A – This question is compulsory and must be

attempted

Question 1
SeaShells is a small company operating from an island near continental Europe. SeaShells is a private company
with 25 shareholders; its shares are not traded on any stock exchange. The main shareholders of SeaShells include
relatives of the company's first CEO, and also private investors from whom the first CEO sought finance and who
have since retained their shares. 25% of the share capital is held by members of the current board.
Although SeaShells is a private company, its board is constituted in accordance with good corporate governance
practice. Half of the directors are executive directors and half of the directors are non-executive directors who are
independent in accordance with the guidance in the UK Corporate Governance Code. The board also operates
nomination, remuneration and audit committees. The members of all these committees are all non-executive
directors.
The main business of SeaShells is packaging of fresh seafood (fish, oysters, crab etc) and selling these to
supermarkets and other retailers. The company employs 750 people, mainly in the packing departments. Packing is
labour intensive due to the need to clear and prepare fish etc. by hand prior to packing. Supplies of seafood are
obtained from the island's fishing fleet. Previously the fleet supplied a number of companies on the island. However
recently a couple of the fleet's other major customers have closed down, and the result is that SeaShells is now the
only significant customer of the fleet. SeaShells is also one of the island's major employers. There is some concern
that SeaShells' increased demand for seafood is causing over-exploitation of some fish species, and that the
population of these fish may 'crash' or decrease dramatically in the near future.
In the last few weeks, the directors of SeaShells have decided to transfer almost all of the packaging of seafood to
another country. The seafood will be moved by refrigerated ships to this other country, packaged by workers there
and then moved back by ship to SeaShells for resale as before. The rationale behind this move is that labour costs
are only 1/10th of the costs on the island. Even taking into account transportation costs, this move will halve the
packaging costs of SeaShells. As a result of the move, the workforce will decrease to 200 people. The decision has
resulted in significant adverse publicity for SeaShells on the island. The trade union representing the employees has
threatened strike action, saying that this is a typical example of exploitative employment practices. However the
reaction from customers has been positive as the company can offer reduced prices on many products. A
government minister on the island on which Sea Shells is based has recently welcomed developments that limit the
price of food to consumers. However the government has recently come under attack from the opposition for
allowing jobs to be exported from the island. Both these issues are expected to be campaign issues when an
election is held on the island next year.
The directors of SeaShells believe that the decision to transfer the packaging of seafood is correct because, as the
CEO explained, the decision is 'best for the company, best for the shareholders and best for the directors'. The CEO
has dismissed the objections to the transfer of employment as 'predictable whinging and politician grandstanding.'
He has noted that the move has been very popular in the country to which employment will be transferred.
However a couple of the non-executive directors have raised doubts about the move. One has raised the objection
that SeaShells depends on sales on its island. However it is removing purchasing power from the island by
transferring employment overseas. The other non-executive director has wondered about the impact of moving the
packaging operations on SeaShells' environmental footprint and whether it can be regarded as sustainable. He has
also wondered about the impact of the move on SeaShells' financial accounts. If the impact on the figures in the
accounts is limited, he has raised the issue whether, on grounds of corporate social responsibility, the accounts
should include more information about the impact on the environment, or whether this information should be
included in a separate report.

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 The CEO's comment concerning directors is certainly true in terms of directors' remuneration. 75% of the total
remuneration package of the directors is based on performance related pay, the main element of this being the net
profit of SeaShells. The chairman of the remuneration committee believes that it is important that directors'
bonuses can clearly be related to tangible measures. 'Our shareholders want profit, so if the company makes
profits, it's only fair that the directors should benefit.' The remaining 25% of remuneration relates to salary and is
based on a three year contract with SeaShells. Other (non-salary) remuneration includes company contributions to
a pension scheme and a share option scheme, with options being exercisable in five years based on the share price
one year ago.
The CEO believes that it is important that the board of SeaShells continues to be staffed by high-calibre executive
directors. He believes that the package offered to executive directors must be more than competitive, since
SeaShells is a private company. He feels that there is a risk that directors who are seeking to develop their careers
may seek to do so in companies listed on an international stock exchange, because of a perception that the
opportunities, and therefore the rewards, at these companies are greater. The CEO's arguments have persuaded the
remuneration committee and a number of features of directors' remuneration packages are designed to bind them
to SeaShells in the longer term.
There have recently been two changes to the board of SeaShells. The Finance Director has retired, and has been
replaced by his deputy, who was previously Financial Controller. SeaShells has also recruited a new Marketing
Director. The director was previously a senior employee at a large marketing consultancy on the European
mainland.
Required
(a) Explain Mendelow's theory of stakeholder power. Identify the stakeholders involved in the decision to
transfer packaging of seafood to another country, and assess the response of each group to this decision.
(14 marks)
(b) Using Gray, Owens and Adams' viewpoints on social responsibility as a framework for your answer, evaluate
the decision to transfer packaging seafood to another country. (14 marks)
(c) Prepare a memo for the board that:
(i) Defines the concept of 'sustainability' and assesses the extent to which SeaShells' activities can be
considered sustainable (7 marks)
(ii) Evaluates methods of reporting that can be used by SeaShells to explain the environmental impact of
its activities. (7 marks)
(part (c) also includes 4 professional marks)
(d) Explain corporate governance best practice in terms of directors' remuneration and assess the extent to
which remuneration in SeaShells meets these requirements, making any recommendations you consider
appropriate. (4 marks)
(Total = 50 marks)

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 (a) Mendelow's matrix
Mendelow classifies stakeholders on a matrix (shown below). The matrix is used to identify the type of
relationship the organisation should seek with its stakeholders, and how it should view their concerns. The
two axes show the level of interest the stakeholder has in the company and the amount of power that
stakeholder has to influence the decisions of the company
Using these two axes, stakeholders can be divided into four groups as follows.

Level of interest
Low High
Low

A B
Power

C D

High
Section A
Stakeholders in this section have a low level of interest in the company and have minimal power to
influence the decisions of the company.
Government
For SeaShells, Section A stakeholders may include the government of the island. As long as SeaShells pays
the correct amount of taxes, the government may not be able to interfere with the company.
Section B
Stakeholders in this section have a high level of interest in the company, but have minimal power to
actually influence its activities. This group will normally attempt to influence the company by lobbying
groups that have high levels of power.
For SeaShells, stakeholders in this category include the following.
The local community
SeaShells is a major employer on the island. This means the community has an interest in the company
maintaining that level of employment. It is unlikely therefore that the community will agree with the
decision to decrease the number of jobs at SeaShells. However, apart from applying pressure in terms of
adverse publicity, the community cannot actually stop SeaShells taking this action.
Suppliers
SeaShells purchases from the fishing fleet on the island. As SeaShells is the only major customer of the
fleet, then the fleet has little power to affect SeaShells. While in theory the fleet could refuse to sell to
SeaShells, the lack of an alternative buyer decreases the effectiveness of this option.
Employees
This group is obviously interested in the success of the company as they receive a salary from SeaShells.
However, the only method of influencing SeaShells is by withdrawal of labour; this is ineffective given that
transferring the packing to a different country has this effect anyway for Seashells. The only other option for
influencing the company appears to be generating bad publicity, as for the local community above.

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 Section C
Stakeholders in this section have a low level of interest in the company, although they have the ability to
exercise power over the company if they choose to do so. The group will have to be kept satisfied to ensure
that their power is not used.
Shareholders
In SeaShells, this group is likely to include the shareholders. As long as the return on investment from
SeaShells is acceptable, and the directors are running the company effectively, then the shareholders will be
happy. Certainly the decision to decrease input costs will be acceptable if this also means increased profits
and dividends. Given that knowledge of cost savings is now available, it can be argued that the directors
must take this option, or else the shareholders may become dissatisfied and attempt to remove the
directors.
Section D
Stakeholders in this section have a high level of interest in the company and also a high level of power.
These stakeholders are therefore able to influence the company. For SeaShells, this group will include
customers and directors.
Customers
Customers have high power because they can presumably obtain supplies of seafood from other
companies. SeaShells must therefore keep this group satisfied or lose important sources of income. The
decision to decrease packaging costs will be supported by customers as SeaShells' prices will also fall.
Directors
Directors can influence SeaShells because they make decisions regarding the running of the company. In
this sense, moving packaging to a different country is in the interests of Seashells, as it provides the
company with additional competitive advantage in terms of price and therefore helps ensure its survival.
(b) Viewpoints of social responsibility
Gray, Owen and Adams in their book Accounting and accountability identify seven viewpoints of social
responsibility. These viewpoints can be applied to many situations, including the actions of companies, as
explained below.
Pristine capitalists
Pristine capitalists support the idea that in a liberal economic democracy, the private property system is the
best system. This means that companies exist to make profits and seek economic efficiency. Businesses
therefore have no moral responsibilities beyond their obligations to shareholders and creditors.
In terms of moving packaging to another country simply on the basis of cost, then SeaShells has acted in
terms of this belief; the obligation to maximise shareholder profit has been met and the social issues of
making people redundant and the adverse effect on the island community are irrelevant.
Expedients
Expedients believe in a modified liberal economic democracy, noting that economic systems do generate
some excesses. This means that businesses have to accept some, albeit limited, social legislation and
moral requirements, particularly if this is in the businesses' best interests.
SeaShells is potentially caught between two countries here. On the one hand in its home country SeaShells
does not appear to be acting morally because the loss of jobs will adversely affect employment and the
island's overall economy. However, in the country to which the packaging is being moved, more jobs will be
created, potentially in areas of lower employment. In these terms SeaShells is acting morally.
Proponents of the social contract
Proponents of the social contract believe in a contract between society and organisations. Both parties
must therefore interact to their joint benefit.

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 SeaShells is continuing to provide employment in terms of purchasing fish etc from the fishing fleet – and
the island is providing support services to SeaShells (some employment, land etc). SeaShells has possibly
breached the contract by removing some employment from the island; some adverse impact in terms of bad
publicity is therefore expected.
Social ecologists note that economic processes that result in resource exhaustion, waste and pollution
must be modified. In other words, the transfer of seafood to another country for packaging only to be
returned to SeaShells for distribution is not environmentally friendly. To be responsible in this area
SeaShells should continue to package the seafood at its current location.
Socialists
Socialists see two classes in society – capitalists owning businesses exploiting workers. Within this
framework, equality is difficult to achieve. In SeaShells, shareholders and directors appear to be capitalists
because they stand to 'win' from the packaging decision. However, the workers on the island stand to 'lose'
in that their employment is terminated (although other workers will gain in the overseas country).
Radical feminists
Radical feminists see a trade off between masculine qualities such as aggression and conflict and
feminine values of cooperation and reflection. Moving the packaging work to another country does appear
to create conflict. However, whether the feminine view of cooperation is better is unclear – even if say only
half the packaging function was moved, there would still be conflict on the island. Similarly, not moving the
packaging function could create resentment in the other country as Seashells is not taking advantage of their
cost advantage in terms of labour wages.
Deep ecologists
Deep ecologists believe that human beings have no greater rights to resources or life than other species.
At the extreme therefore the entire business of SeaShells cannot be justified, especially where fish
populations are threatened. Similarly, the economic decision to move packaging cannot be justified in
environmental terms. The viewpoint that businesses cannot be trusted to maintain something as important
as the environment is therefore correct.
(c) To: Board
From: Accountant
Date: 23 May 20X7
Subject: Sustainability and environmental reporting
Definition of sustainability
Sustainability involves developing strategies so that the company only uses resources at a rate that allows
them to be replenished. This means that those resources will continue to be available into the foreseeable
future. Similarly, emissions of waste are confined to levels that do not exceed the capacity of the
environment to absorb them.
In other words, sustainability has been defined as ensuring that development meets the needs of the present
without compromising the ability of the future to meet its own needs. Sustainable development is
development that meets the needs of the present without compromising the ability of future generations
to meet their own needs.
In terms of the activities of SeaShells, they could be termed to be not sustainable on two counts.
Demand on fish stocks
In terms of capitalism, the fishing fleet will continue to try to meet this demand and SeaShells will continue
to sell seafood as both parties are making a profit from these activities. However, the warning that some fish
stocks may crash indicates that fishing and the economic activity of SeaShells as a company are not
sustainable. How activities can be amended to be sustainable is unclear, unless there is some way to limit
demand for fish or limit the amount of fish actually used by SeaShells.

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 The transport of seafoods for packaging in another country
The use of fuel simply to take seafood to a different location and back again to be packaged does not appear
to be justifiable economically, and is not sustainable given that oil is a limited resource.
Disclosures
The extent to which SeaShells may actually want to disclose the environmental impact of its activities is
unclear; in other words entirely voluntary disclosure is unlikely, particularly in view of the lack of
sustainability referred to above. Methods of reporting the environmental impact of SeaShell's activities
include the following.
Financial accounts
The basic financial accounts of SeaShells will disclose the financial impact of its activities, although these
will only show the direct costs in terms of fuel used to transport fish for packaging etc. As many
environmental costs are intangible eg pollution or potential over-fishing, these will not be included in the
financial accounts, making this method of reporting incomplete.
Full cost accounting
This is a system that allows current accounting to include all potential/actual costs and benefits including
environmental and possibly social externalities. The aim is to arrive at a 'full cost' of the activities of an
organisation.
While the idea is good, it is not necessarily clear what the 'full cost' of an organisation's activities are. Full
cost accounting suggests various 'tiers' of costs from the tangible through to the intangible. Using this
system SeaShells would disclose not only actual costs incurred (transport, wages etc), but also hidden
costs of maintaining environmental monitoring systems. The accounts would also disclose contingent
liability costs, such as fines for any environmental damage.
More widely the accounts would show intangible costs, including loss of customer goodwill (possible given
the packaging policy) and reputation risk (again this risk will be there with the packaging policy). However, it
is unclear how these costs will be 'measured'. Lastly the accounts would show environmentally focused
costs – prevention costs, the costs of ensuring the company's activities have a zero environmental impact.
The transport of seafood for packaging is likely to be environmentally negative; there is then the query of
how these costs are 'offset' – should SeaShells plant trees to offset CO2 emissions?
The emphasis on costs and the difficulty of estimating some of those costs again implies that this method of
disclosure may not be effective.
CSR/GRI
An alternative to financial reporting is to provide information in a separate, predominantly narrative, report.
The Corporate and Social Responsibility (CSR) report in the UK or the recommendations of the Global
Reporting Initiative (GRI) are examples of this type of report. The GRI has a vision that reporting on
economic, environmental and social importance should become as routine and comparable as financial
reporting. The emphasis is therefore on voluntary disclosure, but based on some ethical standards. The
additional information may be expected by society, and therefore perhaps companies should provide it.
SeaShells appears to be under some pressure at present, although this is more in terms of economic
pressure on jobs than on environmental reporting. Either additional legislation or social pressure appears to
be required to ensure that additional environmental reporting is provided.
(d) Remuneration
The overriding requirement is that adequate remuneration has to be paid to directors in order to attract
individuals of sufficient calibre. Remuneration packages should be structured to ensure that individuals are
motivated to achieve performance levels that are in the company and shareholders' best interests as well
as their own personal interests.
Within SeaShells it is difficult to determine whether total remuneration is sufficient to meet this objective.
However, the fact that there does not appear to be any problems recruiting directors indicates that
remuneration is sufficient, or may even be excessive.

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 Setting remuneration
Directors' remuneration should be set by a remuneration committee, which SeaShells has. The reason for
this is to ensure that there is no bias in setting remuneration levels.
Performance related remuneration
Corporate governance guidelines indicate that a significant proportion of the rewards should be focused on
measurable performance, which SeaShells does. What is meant by a significant amount is not always
stated but 50% is a reasonable figure. A 75% amount may again be considered as excessive.
The other element of guidance regarding the performance element of remuneration is that this should be
balanced and not relate to the short term only, as short term performance can be manipulated. The current
focus simply on net profit is therefore inappropriate.
Share options
Share options give directors the right to purchase shares at a specified exercise price over a specified
time period in the future. If the price of the shares rises so that it exceeds the exercise price by the time the
options can be exercised, the directors will be able to purchase shares at lower than their market value. This
provides a good incentive to the directors to increase share prices.
However, corporate governance regulations normally suggest a three year maximum term for share
options. The five year term in SeaShells may be unrealistic as the term is too far in the future to motivate
the directors now. Decreasing the term for future option grants should be considered.
Service contract
Length of service contracts can be a particular problem. If service contracts are too long, and then have to
be terminated prematurely, directors may receive excessive payments for breach of contract. Most
corporate governance guidance therefore suggests a 12-month term.
The current length of service contracts in SeaShells of three years therefore appears to be excessive.
Although there is no indication that directors are looking for compensation for loss of office, decreasing the
term to one year would be advisable.

Question 2
Text references. Chapters 4, 6 and 10.
Top tips. (a) appears to be in two parts, first description of good control systems and then application to FF. The
description paragraphs appear to be quite generously rewarded. Don't assume that this will necessarily be the case
in your exam; remember what we said in the front pages about the majority of marks being given in many questions
for application of knowledge to the scenario.
The Turnbull report generates a number of ideas for (a). You should note a couple of things which the answer to (a)
stresses. Firstly the importance of embedding internal control which has been stressed by the examiner; secondly
the need for control systems to respond quickly to changing risks. You may well see scenarios in the exam where
the company's business situation is changing, hence its risks are altering, and you will need to explain that the
control systems have to respond.
(b) stresses the importance of reputation risk. The level of reputation risk is partly determined by the level of other
risks, but, as this answer stresses, it also depends on stakeholder responses. Lost sales is the obvious
consequence, but note also the non-financial consequences such as recruitment problems or increased regulator
attention.
The key question (c) brings out is when the duty of confidentiality might be overridden. The discussions of
professional responsibilities brings out how accountants should have recourse to the basic principles of integrity,
probity and public interest in situation where the detail in codes isn't helpful.
Easy marks. The first parts of (a) and (b) are descriptive rather than application based, requiring knowledge of
Turnbull and the definition of reputation risk.

326 Mock exam 1: answers