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QUALIFICATION PROGRAMME
LEARNING AND PRACTICE

WORKBOOK
Hong Kong Institute of Certified Public Accountants
Capstone
2023 Edition
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Table of Contents
Table of Contents
Page
Director's message iv
About the Capstone Vv
HKICPA Proficiency levels and taxonomy vii
Chapter features xi
Mathematical table xii
Chapters
1 Introduction to the Capstone 1
2 HKICPA Core Enabling Competency Framework Cy,
3 Business strategy 62
4 Effective analysis 118
5 Analysing the Pre-seen Case Study 167
6 Leadership, teams and human resource management 209
a Business ethics and professional negligence 308
8 Raising finance 353
9 Formulate business decisions 396
10 Implement business solutions 442
11. Risk management 487
12 Corporate governance and regulation Sioy
13. Contemporary topics 640
14 Further Capstone activity practice 726
15. Preparing for the Capstone Final Examination 749
16 Capstone Final Examination Practice 763
Index 820
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Capstone Learning and Practice Workbook
Director's message
Welcome to the Capstone! Reaching this final level of the Qualification Programme
(‘QP’) marks an important milestone in your journey to becoming a member of the
Hong Kong Institute of Certified Public Accountants (‘HKICPA’).
The world is evolving rapidly, so is the business environment. The accounting

profession faces a number of challenges and trends including technological
enhancement, changing societal expectations and more. We, professional
accountants, are no longer asked only to deal with numbers, but also to analyse and
advise. We are also expected to be highly strategic, collaborative, and building trust
by demonstrating relevance and value to many aspects of the society.
The HKICPA QP aims at qualifying accountants with the agility needed to embrace the
changing environment. Particularly, the Capstone is designed with learning outcomes
covering fundamental knowledge, skills and ethical mindset in tackling complex, real-
life situations in today’s business world.
This Capstone Learning and Practice Workbook provides you with the valuable
resources for your preparation of achieving the learning outcomes when you
participate in the Capstone Workshops and sit for the Capstone Final Examination.
We wish you every success in the Capstone and hope that you will find the experience
enriching in preparation for your future career as a Certified Public Accountant.
Kit Wong
Director of Education and Training
Hong Kong Institute of Certified Public Accountants
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Introduction to Capstone
About the Capstone
Welcome to the Capstone, which is the final level of the Qualification Programme (QP)
of the Hong Kong Institute of Certified Public Accountants (HKICPA). This is the
2023 edition of the Capstone Learning and Practice Workbook.
Studying the Capstone involves your self-study over roughly twelve weeks,
participation in three full-day Capstone Workshops and sitting a four-hour open-book
Capstone Final Examination. We encourage you to read this Capstone Learning and
Practice Workbook which is a valuable resource to guide you through the Capstone
journey.
The Capstone comprises two elements: the Capstone Workshops and Capstone Final
Examination. This Capstone Learning and Practice Workbook has been structured so
that the order of the topics in which you study is the order in which you will
encounter them in the Capstone Workshops. There is a very close inter-relationship
between the Capstone Learning and Practice Workbook and the Capstone Workshops
within the Capstone structure. It is extremely important that you have studied the
chapters of this Capstone Learning and Practice Workbook relevant to the Capstone
Workshops before you attend each of them. This will help support your learning and
participation at the Capstone Workshops and derive the maximum benefit from the
interactive activities.
This Capstone Learning and Practice Workbook is designed to support your learning
and study preparations for the Capstone Workshops and Capstone Final Examination.
It has been written specifically to provide a complete and comprehensive coverage of
the Capstone learning outcomes devised by HKICPA for use by those studying for the
qualification. If you wish to learn how each learning outcome will be covered in the
specific chapters in this Capstone Learning and Practice Workbook, you may read
Chapter 1, Section 1.4 for more details.
Before your study, you should prepare yourself by organising access to the learning
materials for HKICPA Associate Level and Professional Level (HKICPA Learning
Materials). As you complete each chapter of this Capstone Learning and Practice
Workbook, it is essential that you read and research any relevant materials from the
applicable Codes, Standards, Statutes, Regulations, and Guides, which can be found
from either HKICPA Learning Materials or internet. To help you, we have listed out
some useful references to HKICPA Learning Materials in “Essential Chapter Reading”
in each chapter for supporting your further reading on specific topics. This will help
refresh your knowledge on some key concepts developed from your prior learning.
The Capstone journey is approximately twelve weeks long. You should establish your
own detailed study guide that fits in with your work and other commitments.
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Chapter 1, Section 4, includes a suggested weekly study guide to direct your Capstone
learning process before you attempt the Capstone Final Examination.
A key element in examination success at the Capstone is practice. It is important that,

you not only fully master the technical knowledge contained in this Capstone
Learning and Practice Workbook, but also take the necessary steps to apply the
techniques that you have learned in the Capstone Final Examination.
In order to achieve the above, you should:
° Watch the online tutorial videos, where provided, before reading the topics
further. You can have an overview of the topics and get the key points handily.
° Complete the examples / activities within each chapter, and then compare your
answer with the suggested answers provided at the end of the chapter.
° Attempt all Case Study Activities (for Chapter 6 to Chapter 12, inclusive) which
are set based on the case in Chapter 5. It will also help you develop the higher
analytical and evaluation skills expected to be demonstrated in Capstone
Workshops and Capstone Final Examination. Case study activities and their
suggested answers can be found at the end of relevant chapters.
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HKICPA Proficiency Levels and Taxonomy
The proficiency level indicated in the table below reflects the level at which the topics
covered in particular learning outcome is tested. There are three levels of proficiency:
° Level 1 is the foundation level, covering the skills of knowledge and

comprehension.
° Level 2 is the intermediate level, covering the skills of application and analysis.
° Level 3 is the advanced level, covering the skills of integration and evaluation.
You are expected to understand which skill is exercised based on the taxonomy verbs
with which it is associated.
Please note that the list of taxonomy verbs below is for reference only and does not
represent an exhaustive list.
Level 1: Foundation
Skill Verb Definition
Knowledge: Define Give the accepted meaning of
The remembering of | Identify List or ascertaining possibilities before analysis; Point to the
previously learned essential part or parts
material (recall of
facts) List Provide a concise summary of the relevant points, often in
bullet point format
Outline Give the main facts about something
State Accurately articulate established principles, concepts, terms

etc
Comprehension: Describe Communicate the key features of something, present a

Demonstrative detailed account of something focusing on depth of
understanding of knowledge
facts and ideas b . . .
. Y Explain Make clear the details of something; or show the reason for,
organising, or underlying cause of, or the means by which something
comparing,
. occurs
translating,
interpreting, giving Illustrate Offer examples, to show how something happens, that
descriptions and something happens, or make concrete a concept by giving
stating main ideas examples
Interpret Make clear the meaning of something and its implications
Summarise Describe something concisely; bring together the main facts
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Level 2: Intermediate
Application: Account for / Give details of accounting entries to be made for in the
Using new Demonstrate context of financial reporting or justify (if used in a more
knowledge. Solve coe context); Demonstrate the accounting treatment
problems to new by using a set of accounts
situations by Apply Demonstrate knowledge, concepts or techniques; Use

applying acquired established methods/tools/procedures to resolve
knowledge, facts, relatively straightforward scenarios or problems
techniques and
rules in a different | Calculate / Determine by computation or arrive at by mathematical
way Compute means or processes
Prepare Follow established procedures/methods to create a report

of financial information or commentary (e.g., using a
proforma spreadsheet)
Solve To work out to a result or conclusion
Use Apply in a practical way
Analysis: Examine Analyse To examine methodically by separating into parts and

and break studying the interrelationships in order to discover
information into essential features
arts by identifyin os : : - :
P ; Y IRE Compare Critically consider two or more things, emphasising their
motives or causes. wo
; similarities
Make inferences
and find evidence | Contrast Critically consider two or more things, emphasising their
to support differences
generalisation ; —_
Classify / Apply concepts to categorise information or groups into
Categorise categories
Justify Explain the reason for recommendation made, or

underlying cause of, based on an analysis of a range of
available options
Prioritise / Determine the order for dealing with a series of items or

Determine tasks according to their relative importance
e.g., determine the priorities/determine the level of
importance
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Level 3: Advanced
Integration: Construct To form an idea, a process, or procedure by bringing

Compile together various theoretical and conceptual elements
information . :
. Design Develop a procedure/process or course of action based
together ina : : —
. on selection of the optimum combination from a range of
different way by : 3
. available options
combining
elements inanew | Develop To bring something into existence that has not previously
pattern or existed, or to reshape something from its initial position
proposing into something more refined; Use judgement to bring to a
alternative more advanced or effective state or to create a plan
solutions Formulate Devise and put a plan into words
Integrate Combine one aspect of learning with another to form a

holistic understanding of a process, procedure or course
of action
Plan / Propose Formulate a detailed proposal for doing or achieving

something
Produce Draw together similar or disparate items to form a report

containing financial and/or non-financial information
Evaluation: Advise Communicate appropriately the recommended course of

The ability to judge action based on an analysis of specific circumstances in a
the value of manner suited to the recipient
material for a given
purpose Appraise Assess the value or quality of something; or to assess its
performance
Consider Think carefully about something before making a decision,

to look closely or attentively at something through a
process involving critical thinking
Evaluate Assess and determine the value, importance or qualities

of something, normally with reference to specific criteria
and draw conclusions
Recommend Select the best course of action or choice; Advocate a

particular outcome or course of action based on an
analysis of a range of available options
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References
Anderson, L. W., Krathwohl, D. R., Airiasian, W., Cruikshank, K. A., Mayer, R. E., &
Pintrich, P. R. (2001). A taxonomy for learning, teaching and assessing: A revision of
Bloom's Taxonomy of educational outcomes: Complete edition. New York: Longman.
The International Federation of Accountants. (2016). Framework for International

Education Standards for Professional Accountants and Aspiring Professional Accountants.
(2075). Retrieved from: https://www.ifac.org
The Government of the Hong Kong Special Administrative Region. (2016). Qualification
Framework - Generic Level Descriptors. Retrieved from: https://www.hkaf.gov.hk

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Chapter features
Chapter features
Each chapter of the Capstone Learning and Practice Workbook contains a number of
helpful features to guide you through each topic.
Topic list The topic list informs you of what you will be studying in each
chapter. The topic items form the numbered headings within the
chapter.
Learning The list of Capstone learning outcomes which reference to the
Outcomes chapter in the Learning and Practice Workbook within which
relevant topics are covered.
Key terms Definitions of important concepts. You will need to know and
4 understand these before the exam, and understanding will be
useful at the Workshops too.
Key takeaway Key takeaways emphasise important learning or insights from a
topic.
Weblink A weblink will navigate to publicly available content available on

the internet which is useful and relevant to a learning topic.
Suggested online Suggestions for internet browser-based candidate own research

research intended to deepen and broaden learning ofa specific topic.
Le
Example Examples illustrating particular techniques or concepts with a
worked solution or explanation provided immediately afterwards.
3)
Activity Activities are designed to enable you to practise a technique or
f=] test your understanding based on a scenario and requirement(s).
if You will find the answer to an activity at the end of the respective
chapter.
Real life Real life illustrations are examples of events which have occurred
illustration in the real world which contextualise specific topic learning and
AE demonstrate how the topic may impact on organisations
operating in the real world.
Tutorial Video The tutorial video icon indicates where there is a recording to
6) support topic learning or activity.
- —

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Mathematical table
Present Value Table
Present value of 1 i.e. (1 + 1)”

Where r = discount rate
n = number of periods until payment
Discount rate (r)

Periods
(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0-990 0980 0-971 0-962 0952 0943 0935 0926 0917 0-909 1
2 0-980 0-961 0943. 0925 0907 0890 0873 0-857 0-842 0:826 2
3 0-971 0942 0915 0889 0864 0-840 0816 0-794 0772 40-751 3
4 0-961 0924 0888 0-855 0823 0-792 0-763 0735 0-708 0-683 4
5 0-951 0906 0863 0822 0-784 0-747 0713 0-681 0-650 0-621 5
6 0942 0888 0-837 0790 0-746 0-705 0666 0630 0-596 0-564 6
7 0-933 0-871 0-813 O760 0-711 0-665 0623 0-583 0547 0:513 7
8 0923 0853 0-789 0-731 0-677 0-627 0-582 0540 0-502 0-467 8
9 0914 0837 O-766 0703 0645 0592 0544 0500 0460 0-424 9
10 0905 0820 0744 0676 0614 0-558 #0508 0463 0422 £0:386 10
11 0896 0804 0722 0650 0-585 0-527 0475 0-429 0-388 0-350 ll
12 0-887 0-788 0-701 0-625 0557 0-497 0-444 0397 0356 0-319 12
13 0-879 0773 0-681 0-601 0-530 0469 0415 0368 0326 £0:290 13
14 0-870 0-758 0-661 0-577. 0505 0442 0-388 0:340 0-299 0-263 14
15 0-861 0-743 0642 0-555 0-481 0-417 0362 0315 0-275 0:239 15
(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0-901 0-893 0885 0877 0870 0-862 0855 0-847 0-840 0-833 1
2 0812 0-797 O-783 O769 0-756 0-743 £40-731 0718 0-706 0-694 2
3 0-731 0712 0693 0675 0658 £0-641 0-624 0609 0-593 0-579 3
4 0-659 0636 0613 O592 0572 O-552 0534 0516 0-499 0-482 4
5 0593 0567 0543 0519 O497 0476 0456 0-437 0-419 0-402 5
6 0535 0507 O480 0456 0-432 0410 0390 0370 0-352 £0:335 6
7 0-482 0452 0425 0400 0376 0354 0333 O314 0296 0279 7
8 0-434 0-404 0376 0-351 0-327 0-305 0:285 0:266 0-249 0-233 8
9 0-391 0-361 0333 0308 0-284 0-263 0243 0:225 0-209 0-194 9
10 0-352 0322 0295 0270 0-247 0-227 0208 0-191 0-176 0-162 10
ll 0317 O287 0:261 0237. O215 0195 0178 O162 0148 £40:135 ll
12 0-286 0-257 0-231 0-208 O187 0-168 O152 0137 O124 0-112 12
13 0-258 0229 0204 +O182 +O163 O145 O130 O116 0104 0-093 13
14 0:232 O205 0181 0-160 0-141 0125 O111 0099 0-088 0-078 14
15 0-209 O183 #0160 0140 0123 0108 0095 0084 0074 0-065 15
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Introduction
to the
Capstone
Topic list
WN =
Capstone Workshops
Capstone Final Examination
Capstone Study Guide for
KR
candidates
Learning focus
This first chapter provides a comprehensive introduction to the Capstone for

candidates and explains the structure and assessment of the Capstone
Workshops and Capstone Final Examination. It is recommended that all Capstone
candidates follow the detailed week-by-week Capstone Study Guide for
Candidates which is included at the end of this chapter and directs candidates
through all sixteen chapters of this Capstone Learning and Practice Workbook.
Chapter Summary
| |
Introduction to Capstone Capstone Final
Capstone Workshops Examination
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* Capstone objective Workshop focus Overview
e Capstone requires integration e Consider business strategies in 80% of the marks available
and application of professional a range of complex and Pre-seen five working days
knowledge and skills acquired unpredictable circumstances prior to the exam
from any part of the HKICPA e Advise individuals and entities Additional information and
syllabus on the optimal decisions requirements on the day
e Capstone Students will need to: e Construct effective and efficient
- Use the core enabling processes to implement
competencies (CECs) to projects Before you start your
drive thinking and analysis e Evaluate the appropriate
Capstone studies
- Structure their discussions course of action upon
and presentations encountering ethical dilemmas e Consider your study approach
- Plan their written work for e Develop team leadership skills to the Capstone exam
the Capstone Assignment Learn to analyse pre-seen and
and Capstone Final practice this
Examination
Workshop structure:
. Introduction
Ice breaker/Reboot
Capstone structure
Technical sessions
. Capstone is integrated and Takeaway assignments
comprised of three full-day, Reflection
face-to-face Workshops and a Capstone Study
4-hour open-book Capstone
teeta Leeman
Guide for
Final Examination Workshop materials:
candidates
. Complete Prework
. Receive Handouts
Capstone syllabus
e The Capstone syllabus is Se oak Capstone Learning and
focused on strategic leadership
Workshop outline: Practice Workbook
and analysis leading to
. Business acumen Capstone Learning and Practice
strategic decision making and
Workbook
solution implementation . Leadership
e Consider your study approach to
coerce rn ° Ethics the Capstone exam
e Important new technical content to
Ca pstone assessment
cover
e Capstone three-day e Aim to attempt all activities and
Workshops: 20% end of chapter case study activities
e Capstone Final Examination: isi Vecbsenshat bbacrvsdaccctawactest eactuseesedstibonisicois
80%
Suggested Capstone study
guide
e Follow the weekly study plan in
Section 4
e Ensure you plan your study time

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1: Introduction to the Capstone
1.1 Welcome to Capstone Learning and Practice Workbook
Reaching the final level of the Qualification Programme (QP) marks an important
milestone in your journey to becoming a member of the Hong Kong Institute of
Certified Public Accountants (HKICPA).
The world is evolving rapidly, and so is the business environment. The accounting
profession faces a number of challenges and trends, including technological
enhancement, changing societal expectations and more. We, professional
accountants, are no longer asked only to deal with numbers, but also to analyse and
advise. We are also expected to be highly strategic and collaborative, building trust by
demonstrating relevance and value to many aspects of society.
The QP of the HKICPA aims at qualifying accountants with the agility needed to
embrace the changing environment.
Particularly, Capstone is designed with learning outcomes covering the fundamental

knowledge, skills and ethical mindset needed to tackle complex, real-life situations in
today’s business world.
The learning materials provided in this Capstone Learning and Practice Workbook
and for the three Capstone Workshop days will prepare you to achieve these learning
outcomes. You should be prepared to sit the Integrated Workshop Assessment on
Day 3 of the Capstone Workshops and the Capstone Final Examination.
1.2 Objective of Capstone

The objective of Capstone is to provide you with a learning experience where you
can further develop and demonstrate the ability to integrate and apply prior
knowledge and skills acquired from the Associate Level, the Professional Level,
practical experience, and Capstone additional syllabus.
Capstone's focus is to develop your ability to deal competently with situations

involving the integration and application of professional knowledge and skills
acquired from any part of the syllabus across all fields of technical and enabling
competences.
The development of knowledge and skills from the Associate Level to the Professional
Level to Capstone is summarised below.
Weblink
Further information and a short video can be found on the HKICPA website.
https://www.hkicpa.org.hk/en/Become-a-Hong-Kong-CPA/The-Capstone
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Development of Knowledge and Skills
Ma Capstone
Integration of technical
‘ knowledge from previous
Professional Level modules and the additional
Modules syllabus
Associate Level ee =
Modules 3
a
Foundation technical 7
knowledge
. WwW rs
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Professional Workshops $
Workshops Based on enabling &
Introductory Practise enabling skills skills previously
Workshop through application in built and apply
technical context such with formal
Theories of fundamental during workshops assessment in an
enabling skills to be integrated
introduced with scenario
practices during
workshop
You will notice in the diagram above that learning at each level is supported by
practical experience. This remains as important for Capstone, as it focuses on
providing professional advice in case studies which are designed with the real world
in mind.
Key takeaway
& Capstone Students will need to use the core enabling competencies (CECs) naturally
to drive their thinking and analysis, and to structure their discussions and
presentations in the Capstone Workshops and in planning their analysis and
evaluations in their writing work for the Capstone Assignment and Capstone Final
Examination. Chapter 2 of this Learning and Practice Workbook provides a
comprehensive recap of each CEC which forms part of the professional skills which
Capstone candidates must demonstrate.
1.3 Structure and features of Capstone

Capstone is integrated and comprised of three full-day, face-to-face Workshops, and
a 4-hour open-book Capstone Final Examination. Capstone will be offered twice a
year in the June and December sessions.
Full attendance of the three full-day Workshops is a pre-requisite for sitting the Final
Examination.

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Completion of Capstone requires meeting the overall assessment of the three full- day
Workshops and the Final Examination. Please note, students who fail Capstone
are required to retake the whole Capstone.
The three, full-day Workshops are equally spaced apart and must be taken in
sequence. The first of the three Workshops will be held between two and three
months before the date of the Capstone Final Examination.
The Capstone learning journey for candidates is summarised in the following

diagram.
CAPSTONE LEARNING JOURNEY

Workshop 1 Workshop 3
Assessment
Final Examination
By
Individual contribution
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Sara
Assessment Assessments
Individual contribution individual contribution &

Team presentation
Workshop 2
1.4 Competence areas and Capstone syllabus

Capstone aims to develop students' ability to integrate and apply knowledge and
skills acquired from the Associate Level and the Professional Level (such as financial
reporting, business finance, auditing, and taxation, etc.) and from the practical
experience. The focus is on the ability to deal competently with professional type
situations, involving the integration and application of knowledge and skills across all
areas of accounting and related fields in the analysis of complex professional
problems and the formulation of solutions.
In addition to all the core knowledge and skills acquired from previous modules of
the QP which will be assessed, Capstone also includes, but is not limited to, the
following key syllabus areas.
Develop business strategy 10-20
Formulate business decisions 10-20
Implement business solutions 5-15
Raising finance 5-15
Corporate governance 10-20

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Risk management 10-20
Regulatory compliance 5-15
Business ethics and professional negligence 10-20
Team management and leadership 10-15
The key syllabus of Capstone includes principal learning outcomes and supporting
learning outcomes arranged along a series of proficiency levels.
Key takeaway
& The Capstone syllabus is focused on strategic leadership, with strategic business
analysis leading to strategic and short-term decision making which requires
consideration not only of the business case, but consideration of risk, how strategic
options can be financed and are there corporate governance, regulatory, sustainability,
financial reporting, assurance, tax or ethical implications which must be considered.
These are likely to influence how the business proceeds. Once a decision is made,
then a plan is required to implement the required solution; an organisation must
consider the impact of good leadership and effective teamwork to ensure the
outcome is as the Board expects.
The syllabus weighting table serves as a guide to the percentage of study time
suggested to be spent on each syllabus area.
Each of the specific syllabus areas is covered in a specific chapter in this Learning
and Practice Workbook. Additionally, the Capstone Learning and Practice Workbook
includes Chapter 13 on contemporary topics, which discuss areas of change in
the world of business, regulation, technology, ESG and sustainability reporting.
This chapter is essential learning and supplements the learning covered in
Chapters 6 to 12.
The detailed Capstone learning outcomes are set out in the table which follows.
This Capstone table of learning outcomes includes a reference to the relevant chapter
in this Capstone Learning and Practice Workbook where relevant learning content can
be found which covers each learning outcome.

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Capstone detailed learning outcomes
Develop business strategy
Analyse the strategic position of an entity from a 2 3,9, 13

business strategy, financial and performance
management perspective, taking into account:
° Internal resources, capabilities and
competences
° Governance
° Competitive forces
° Marketing
° Conflicting stakeholder needs and
expectations
° Corporate social responsibility and
environmental factors
° Sustainability
° Influences of ethics and culture
Consider some of the major forces for change which 3 3,13

influence businesses and the strategic planning
process
Evaluate options from a business analysis 3 3,4
perspective, assessing strategic and financial
consequences using relevant financial management
and performance management techniques
(including the use of big data analytics)
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Formulate strategy and tactics and evaluate 3 3,9

potential investment decisions in a domestic or
multinational environment, taking into account the
financial reporting, finance and taxation
implications, including the responsible management
of financial risk This includes:
° Strategy formulation and development
° Financial decision-making to formulate and
support business strategy
° Valuation of acquisitions and investments
° Effective management of funds
° Financial and tax implications of implementing
strategic alternatives
° Risk tolerance and management
° Tactics to support the chosen strategy
° Organising and enabling success
° Managing strategic change
Recommend methods for an organisation to 3 4
monitor implementation of strategy
Formulate business decisions
Evaluate information and make informed and 3 9

balance judgments in the absence of consistent data
Recommend integrated solutions to complex 3 9

business problems, drawing on wide-ranging
information in an unpredictable variety of
professional contexts
Consider alternative strategies enabling clients to 3 9

reach balanced and appropriate decisions

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Implement business solutions
Demonstrate an understanding of project 2 10

management concepts, methodologies and
procedures through application to a Case Study
Plan and manage a team that meets project 3 10

management requirements, makes decisions
concerning the required processes and organises
the human, physical and financial resources
necessary to achieve project goals
Recommend and implement strategic processes to 3 10

accomplish project outcomes and communicate
these to management to achieve their support
Raising finance
Outline the main types of debt and equity finance 1 8

used by companies in Hong Kong and the mainland
Outline the important factors that affect the debt- 1 8

equity mix decision in a company - flexibility (F), risk
(R), income (I), control (C), timing (T), and other (O)
(FRICTO)
Apply the FRICTO framework for analysing capital 3 8
structure to the Case Study
Recommend the most appropriate alternative to 3 8

financing for the Case Study
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Corporate governance
Outline the theories, policies and principles related 1 12

to corporate governance in Hong Kong, including
but not limited to the following areas:
° Company meetings and resolutions passed by
directors and members
° Shareholders' rights and remedies
Apply the corporate governance theories, policies 2 12

and principles to practical business situations
Demonstrate a thorough knowledge of fiduciary 2 12

duties and responsibilities owed by directors,
auditors and officers
Demonstrate a thorough knowledge of the statutory 2 12

requirements on the contents and format of a
company's financial statements and the accounting
related provisions of The Rules Governing the Listing
of Securities on the Stock Exchange of Hong Kong
Limited
Develop corporate governance policy by applying 3 12

corporate governance principles
Risk management
Identify business risks (including the risks associated 1 11

with cyber security)
Develop and apply an appropriate risk management 3 11

model
Develop a risk management plan 3 11
Identify potential taxation and audit risks 1 11
Develop and apply appropriate strategies for 3 11

managing taxation and audit risks
Hong Ki Institute of
10 CPA CertifiedPublic Accountants
~~ a &
Regulatory compliance
Consider the statutory rules and requirements 3 12

governing the application for, and maintenance of,
the listing status in Hong Kong under practical
business situations
Consider the impact of the regulations on 3 12

corruption, anti-money laundering, and counter-
terrorist financing on transactions, individuals and
entities under practical business situations
Consider the impact of the regulations on takeovers, 3 12

schemes of arrangement, reconstruction, share buy-
backs and compulsory acquisition, including the
provisions under the Codes on Takeovers and
Mergers and Share Buy-Backs, and under
Companies Ordinance on transactions, individuals
and entities under practical business situations
Business ethics and professional negligence
Appraise business situations using a questioning 3 7

mindset and through the application of ethical
frameworks
Recommend appropriate solutions to ethical 3 7

dilemmas in business
Advise clients on solutions in the context of the IFAC 3 7

Code of Ethics and HKICPA Professional Ethics and
Conduct
Analyse the interrelationship of ethics and law 2 7
Consider the consequences of unethical behaviour 3 7

to the individual, the profession and the society

Certified Public Accountants 11
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Consider the long-term consequences of unethical 3 7

decisions
Consider the perspective of others and the concept 3 7

of social responsibility when reviewing ethical issues
Explain how professional accountants should 1 7

exercise their care and skills when performing their
duties
Explain how professional accountants may be 1 7

exposed to professional negligence liabilities and
damages
Advise on how professional accountants can 3 7

manage professional negligence exposure
Team management and leadership
Design and build a cohesive team 3 6
Develop an environment which enables innovation 3 6

and creativity
Apply a model for decision making in a team 2 6
Apply the leadership skills for getting the best out of 2 6

others
Demonstrate the ability to run efficient and effective 2 6

meetings
Evaluate the performance of team members and 3 6

provide timely and constructive feedback
Identify the value and implications of being client 1 6

centric
Integrate the success factors for client service 3 6
Develop a client perspective and effective client 3 6

relationships
Hong Ki Institute of
12 CPA CertifiedPublic Accountants
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Develop a service quality program 3 6
Determine and monitor the drivers of client 2 6

satisfaction
Demonstrate leadership skills on projects or 2 6

assignments
Plan human resources requirements for a project or 3 6

assignment, including definition of roles, training,
motivation, leadership, and appraisal
Recommend solutions to business problems in an 3 9

understandable manner
Prioritise a course of actions within a business 2 9

problem
Construct a report, presentation or equivalent, using 3 9

style, content and language appropriate to the
particular user, to communicate complex finance
information
Integrate and consider qualitative and quantitative 3 9

information in a manner appropriate to the user
Appraise the culture of an entity 3 6
Consider different management styles and 3 6

recommend enhancements to match styles to
business objectives
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Evaluate the quality of a corporate governance 3 6

framework in an entity in the context of the
business objectives and professional and legislative
frameworks
Design an appropriate management structure for an 3 6

entity matching leadership styles and governance
requirements to the objectives and culture
Describe the impact of change on people's 1 6, 10

effectiveness
Determine the critical success factors for change 2 6, 10
Determine how to sponsor and integrate the change 2 6, 10

in ateam or business
Prepare team members so they are change ready 2 6, 10
Determine ways to respond to people's reactions to 2 10

change taking into consideration different levels of
change readiness amongst team members
Apply a systematic approach for creating and 2 10

implementing change
Demonstrate recognition of the importance of 2 10

communicating throughout all phases of change
Describe the role of the leader 1 6
Describe factors contributing to effective leadership 1 6
Apply the mindsets for effective leadership 2 6
Outline personal leadership aspirations 1 6
Identify current leadership style 1 6
Determine the impact of personal style on leading 2 6

others
Determine action to develop their leadership 2 6

capabilities

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Learning Outcomes Colour
Principal learning outcomes
Supporting learning outcomes
Detailed learning outcomes
Key takeaway
At Capstone, it is useful to periodically remind yourself of topics contained in the
syllabus. This will help you identify learning gaps and help you to direct your studies
back into relevant Associate Level and Professional level module learning materials,
or to specific chapter content in this Learning and Practice Workbook.
1.5 Capstone assessment overview

The assessment of the Capstone three-day Workshops and the Final Examination will
respectively contribute to 20% and 80% of the overall assessment results for the
completion of Capstone.
To ensure an enriched learning experience and to achieve the Workshop's learning

objectives, participants are required to prepare for, and to actively participate in, the
Workshop, as well as to demonstrate their core enabling competences (CECs) and
technical skills in order to fulfil the assessment criteria. Participants may refer to
Chapter 2 of the Capstone Learning and Practice Workbook for a full description of
the CECs.
The Capstone Workshops will include simulation, case studies and assessment tasks.
Students are required to demonstrate their achievement of the prescribed learning
outcomes and meet the assessment criteria of the Workshop.
During the Workshops, facilitators will assign participants to work together in teams.
Participants will also contribute to larger group discussions led by facilitators with all
participants.
Participant's performance in individual contribution and team presentation will be

assessed during the Workshops and be agreed by both facilitators at the end of each
day of the Workshop. The Capstone Final Examination will be marked separately.
The Capstone Final Examination will be a four hour open-book examination. Pre-seen
materials will be provided for preparation five working days before the examination
date.

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Candidates will be assessed throughout the three-day Capstone Workshops. There is

no minimum pass mark required in the Workshop and the Capstone Final
Examination separately.
A summary of the Capstone assessment components is outline below:
Three-day Workshop 20%
Day1 Individual contribution 5%
Day 2 Individual contribution 5%
Day 3 Individual contribution 2%
Integrated assignment - Team 8%

presentation
Final Examination 80%
Total 100%
Please note: Capstone candidates who fail to pass the overall assessment will be
required to retake the whole Capstone assessment, which includes the Capstone
Workshops and Capstone Final Examination.
2 Capstone Workshops
2.1 Focus of Capstone Workshop learning outcomes
The Capstone Workshops are a series of three non-consecutive workshop days, which
include technical sessions and an integrated assignment. Upon completion of the
Workshop, participants are expected to be able to:
° Demonstrate ability to integrate technical knowledge and professional skills

across all areas of accounting and related fields in the analyses of complex
professional problems and formulate solutions.
° Consider current and alternative business strategies in a range of complex and

unpredictable circumstances.
° Advise individuals and entities on the optimal decision, considering a range of

complex and unpredictable circumstances.
° Construct effective and efficient processes to implement projects.
° Evaluate the appropriate course of action upon encountering ethical dilemmas.
° Develop team leadership skills.

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2.2 Capstone Workshop structure

Each day of the Capstone Workshop is designed with the following structure:
Introduction: This session is designed to bring the large group together to

understand the purpose of the Workshop and establish expectations. In
addition, it provides an opportunity for participants and facilitators to introduce
themselves and get to know each other.
Day 1 ice breaker/Day 2 and Day 3 reboots: This session creates an energetic
learning environment that encourages the teams to form an effective working
relationship.
Technical sessions: The active learning activities in the technical sessions are
designed to provide the participants with opportunities to demonstrate their
CECs and knowledge on the related topics.
Assignment: There will be a practice take-away assignment at the end of Day 1

and Day 2 and an integrated assignment during Day 3 of the Workshop. The
practice take-away assignments on Day 1 and Day 2 are written practice
assignments designed to progress your written communication skills in
preparation for the Day 3 integrated assignment which comprises an individual
writing assignment and team presentation.
Reflection: Towards the end of each day of the Workshop, you will reflect on
the activities of the day.
Workshop feedback: In the last session of the day, you will have the
opportunity to provide constructive feedback on the Workshop via the
feedback form.
2.3 The role and responsibilities of a Workshop participant

As a Workshop participant, you are expected to:
Complete all Prework activities for each Workshop day individually before
attending the Workshop. Candidates are required to submit their answers to
the relevant Prework activities for each Workshop day online before each
Workshop day. For example, Day 1 Prework activity answers to be submitted by
the Wednesday before Capstone Workshop Day 1.
Prepare according to your study guide. This includes reading the relevant
Prework materials and completing any Prework assignments in accordance
with the instructions therein, prior to attending the Workshop.

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Arrive at the workshop venue on time. If you arrive at the venue later than
15 minutes, you will be treated as absent. You are not allowed to attend the
Workshop and must leave the venue immediately.
Actively participate. During the Workshop, you should proactively engage

with your fellow participants during all team activities and discussions.
Seek to demonstrate your skills. As you participate in the Workshop,

you should strive to demonstrate your ability to integrate and apply
technical knowledge and CECs by contributing to all discussions and team
activities.
Observe the Workshop rules. On the day of the Workshop, facilitators will
announce the rules of conduct for the Workshop.
Keep all Workshop materials confidential. All Workshop materials and topics
(e.g., activities, discussion points, questions/answers, etc.) must be kept
entirely confidential. You are not allowed to share or discuss such contents
in any form with anyone outside of your immediate Workshop group. Taking
photographs or recording any Workshop materials, or any portion of the
Workshop session, is strictly prohibited, as is removal of any Workshop
materials from the classroom. Students should not bring any unauthorised
materials (e.g., Workshop contents from earlier batch, materials from course
providers) to the Workshop class.
Keep electronic devices away unless otherwise approved. All mobile phones,
recording devices and other electronic tools (e.g., tablets, video cameras, etc.)
should not be used. These items must be secured in a bag and may not be
taken out during the Workshop. All phones should be silenced before the
Workshop begins.
2.4 Participant Workshop materials

Capstone Workshop participants should bring their completed Prework contained in
the Capstone Participant Prework, which every participant is required to complete
before each day of the Capstone Workshop.
On each day of the Workshop, participants will receive handouts during each
session, which will include additional case information, questions and activity
requirements. Participants will be required to ensure all handouts are returned
at the end of each day.
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2.5 Workshop outline and learning methodologies

Each Capstone Workshop day is structured as follows:
Session | Methodologies
Day 1
Introduction and icebreaker Large-group discussion
Small-group activities
Technical sessions Case Study
Presentation
Business strategy Individual reflection
e Strategic and/or risk analysis
e Performance analysis

e Leadership qualities and styles
Business ethics and professional

negligence
Business strategy
e Strategic choice and selection
Reflection
Session Methodologies
Day 2
Reboot Large-group discussion
Small-group discussion/activities
Technical sessions Opening class sharing
Case Study
Business acumen Presentation
e Formulate business decisions Individual reflection
e /mplement business solutions
e Business communications
Reflection
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SY=s1(0] 8) | Methodologies
Day 3
Reboot e Large-group discussion
e Small-group discussion
Technical sessions e Opening class sharing
e Presentation
Team management and leadership e Individual reflection
e Creating high-performing teams
Integrated assignment
e /ndividual written report
e Team presentation
Reflection
Note: Capstone Workshop participants may refer to the Capstone Participant Prework
for the detailed Workshop Outline for each session.
2.6 Capstone Workshop assessment rubrics

20% of the Capstone assessment is assigned to the Workshops. 5% is allocated
to Day 1, 5% is allocated to Day 2 and 10% is allocated to Day 3. The rubrics for
assessment criteria for each day covering individual contribution and team
presentations are as follows.
Individual contribution - Day 1 (5%) / Day 2 (5%)
Assessment area | Exceed | | Wea | Below standard
2 marks 1 mark 0 mark Weighting
1 Preparation The participant Participant Participant Participant 2%

completed all completed all completed all completed some
Prework and was _ Prework Prework or none of the
well prepared assignments assignments. Prework
before the demonstrating assignments.
Workshop. the knowledge
required.
2 Level of The participant Participant was Participant was Participant was 1%

engagement/ was engaged in actively engaged _ engaged in the disengaged in the
Participation the activities and __ in all activities activities and activities and
with other and with team with team with team
participants. members, members, members, did
consistently contributed to not/seldom
contributed to large group and contribute to
larger group and __ team discussions large group and
team discussions — of the day most team discussions
of the day. of the time. of the day.
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3 Demonstration The participant Participant Participant Participant did 1%

of core demonstrated consistently demonstrated not/seldom
enabling their demonstrated reasonable level § demonstrate
competences competences in the analytical of analytical analytical skills,
CECs, including skills, problem- skills, problem- problem-solving
the analytical solving skills solving skills and skills and
skills, problem- and/or communication communication
solving skills, communication skills in skills in
communication skills in performing most — performing
skills and/or performing all of Workshop Workshop
ethical dilemma, Workshop activities. activities.
required forthe —_ activities.
Workshop
activities.
4 Demonstration The participant Participant Participant Participant 1%

of technical demonstrated consistently demonstrated a demonstrated
competences the technical demonstrated reasonable level __ very little, or no,
skills required for the knowledge of knowledge on __ understanding of
the Workshop on the technical the technical the technical
activities. content being content being content being
covered during covered during covered during
all Workshop most of the most of the
activities. Workshop Workshop
activities. activities.
Note: Interval marks, i.e. 0.5 and 1.5, are allowed for all assessment areas.
Individual contribution - Day 3 (2%)
Assessment area ot -10) | tg | Below standard
1 Preparation The participant Participant Participant Participant 2%

completed all completed all completed all completed some
Prework and was _ Prework Prework or none of the
well prepared assignments assignments. Prework
before the demonstrating assignments.
Workshop. the knowledge
required.
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Team presentation - Day 3 (8%)
Assessment area Below standard Assessed

on team
(Interval marks, i.e. 0.5 and 1.5 are eo

2 marks 1 mark 0 mark Individual
allowed.) :
eT
1 Participat- §Theparticipant Participant Participant Participant Individual 2%

ion actively actively engaged during took part in basis
engaged during engaged during thepreparation very few of
the team the preparation andteam the
preparationof | andteam discussion for preparations
the discussion for the team for the
presentation. the team presentation presentation
presentation with one and was not
with one another other engaged with
another participants one another.
consistently. most of the
time.
2 Presentati- Theparticipant Participant Participant Participant Individual 2%

on skills demonstrated demonstrated demonstrated was basis
effective confidence in clarity in unconfident
presentation delivering delivering in delivering
skills that presentation. presentation. presentation.
engage the
audience.
3 Organisat- Theteam Team Team Team Team 2%

ion and demonstrated demonstrated demonstrated demonstrated basis
teamwork skills in strong fair poor
managing and organisation organisation organisation
structuring a skills and skills and fairly skills and did
presentation allocated allocated not effectively
that conveyed presentation presentation allocate the
the intended tasks among tasks among presentation
message, and team members teammembers with
appropriately evenly. The during the significant
allocated transition was presentation. domination
presentation smooth and by one or two
tasks among natural, and members,
team members. team members and transition
helped each was poor.
other as
needed.
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(Interval marks, i.e. 0.5 and 1.5 are Weight

2 marks 1 mark 0 mark -ing
allowed.)
4 Visual aid The team Team made use Teammadeuse Teamdidnot Team 1%
effectively used of visual aids of visual aids in| make use of basis
visual aids to effectively. the visual aids.
support the presentation.
presentation
and to engage
the audience.
5 Handling The team was Team Team Team failed to Team 1%

difficult able to handle addressed addressed address basis
question questions well questions questions questions
during the Q&A asked during asked during asked during
session. the Q&A the Q&A the Q&A
session session. session.
effectively.
& Key takeaway

It is helpful to review the Workshop assessment rubric prior to your attendance of the
Capstone Workshops. You should use it to direct your participation, so you are more
likely to demonstrate the required competencies to the Workshop facilitators during
group discussions and presentations.
3 Capstone Final Examination

3.1 Overview of the Capstone Final Examination
The Capstone Learning and Practice Workbook has been designed to support
Capstone candidates through the Workshop and be ready to attempt the Capstone
Final Examination. If you recall, 20% of the marks available are attributed to
participation at the Capstone Workshops. Therefore, the remaining 80% of the marks
available are attributed to the Capstone Final Examination.
The Case Study presented in the Final Examination will relate to a fictitious Hong
Kong-based company. Unlike the examinations for the previous technical New QP
modules, for the Capstone Final Examination, you will receive some pre-seen
information before the examination day and then additional information and
requirements on the day of the Capstone Final Examination.
CPAa Hong Kong Institute of

SRSHGLR
23
You will receive the Capstone Final Examination pre-seen information five working
days prior to the day of the Capstone Final Examination. Before the day of the exam,
you will need to familiarise yourself with all the information contained in the pre-seen
Case Study and analyse it.
You are advised to analyse any numerical information that you are given about the
company's financial performance and position, or complete strategic analysis about
the business, its products and competitor in the external market.
In addition, you are advised to complete your own internet-based research on the
industry and general trends in business and economic environment which will help to
contextualise current business performance and market opportunity.
Thorough preparation is essential for success in the Capstone Final Examination, in
view of the breadth of the subject matter and its assessment of your critical thinking
skills, decision-making ability and professionalism.
Your preparation for the Capstone Final Examination can be summarised as follows:
(1) Familiarisation with the company, using the pre-seen information
(2) Complete strategic analysis to understand the current position and future
possibilities
(3) Complete financial performance analysis to understand the current position
(4) Develop awareness of the industry and its markets through internet-based
research
(5) Integration and organise your work in preparation for the Capstone Final
Examination Day
You will receive the further case study information and the case study requirements
for you to attempt on the day of the examination. This information will then complete
the Case Study scenario. You will then have four hours (240 minutes) to read, plan
and complete your answers to the examination requirements.
You will need to combine your pre-reading and analysis of the pre-seen information,
your other pre-examination research, and the new information contained in the
examination to plan the content and structure of your answers, and then to write
the report.
3.2 Advice before you start your Capstone studies

Learning how to apply good exam technique at Capstone, from the beginning of your
Capstone studies, can make all the difference between examination success and
failure.
Before you begin studying, it is a good idea to consider your approach to the
Capstone exam, as this will determine how you study for Capstone and develop the
skills you will need to demonstrate in the exam.

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As Capstone is an open-book, knowledge and skills-based exam, it requires you to

demonstrate that you can apply your existing technical knowledge in a practical and
professional manner. It is important that all Capstone students adopt an approach of
learning through Case Study question practice in order to develop the skills necessary
to be successful in this examination.
The Capstone Learning and Practice Workbook is designed to help you to develop
your knowledge, professional skills and exam techniques by completing the activities
in each chapter, in particular the end of chapter activity which is based on the
practice case study introduced in Chapter 5.
Candidates will receive the actual examination pre-seen information five working
days before the Capstone examination. During this time, candidates are advised to
complete the following.
(1) Review the knowledge and application skills you have learned from working
through the Capstone Learning and Practice Workbook.
(2) Carefully read through and consider each exhibit of the pre-seen information
for the real Capstone examination.
(3) Use the internet to research the industry included in the Capstone Case Study
and compare this with the company information included in the pre-seen
information.
(4) Apply the techniques you have practiced from working through the Capstone
Learning and Practice Workbook to analyse the information and data included
in each of the exhibits in the pre-seen information for the real Capstone
examination.
(5) Candidates are strongly advised to practice the activities at the end of each
chapter and the practice activities contained in Chapters 14 of this Learning and
Practice Workbook on their own. Candidates should produce their own
completed report before referring to the suggested answer. This is critical for
Capstone Final Examination success.
Further Capstone Final Examination advice is provided in Chapter 15 and Chapter 16,
which contains activities to help you prepare for the Capstone Final Examination.
Key takeaway
Remember, your investment of time and effort into Capstone is just a few months
away and, if successful, a rewarding lifetime professional career awaits as a qualified
Hong Kong CPA.

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4 Capstone Study Guide for candidates

4.1 Capstone Learning and Practice Workbook
The Capstone Learning and Practice Workbook is designed to support your learning
and study preparations for the Capstone Workshops and Capstone Final Examination.
The Capstone Learning and Practice Workbook is designed so you have a better
understanding of the learning journey ahead of you. Before you begin reading the
Learning and Practice Workbook, you should prepare yourself by organising access to
the HKICPA Associate Level and Professional Level module learning materials, as well
as prepare using internet based research, so you can complete commercial, industry,
financial and regulatory research as required by each Capstone Case Study scenario.
As you complete each chapter of the Capstone Learning and Practice Workbook, it is
essential that you also research any relevant section(s) from the applicable Codes,
Standards, Statutes, Regulations and Guides from your HKICPA Associate Level and
Professional Level module learning materials and from internet based research. This
will help you to remind yourself of key concepts in the relevant HKICPA Associate
Level and Professional Level modules.
The Capstone semester is approximately twelve weeks long. You should establish
your own detailed study guide that fits in with your work and other commitments. To
help you, we have provided a suggested study guide for Capstone, to help you
organise and optimise your available study time.
4.2 Suggested study guide for Capstone

This suggested study guide divides the Capstone semester into the following elements.
Use this Capstone study guide to direct your learning each week so you Stay on track!
Chapter 2, Chapter 2 of the Capstone Learning and Practice

HKICPA Core Workbook is intended as a 'whistle-stop' reminder of the
Enabling important core enabling competency guidelines (CECs)
Competency which will improve your Capstone group discussion and
Framework presentation communications. This chapter will also help
you to address ethical dilemmas, make decisions by
applying the critical analysis guidelines, and provide advice
to implement leadership, strategic and other solutions
using the problem-solving process. Focus on completing
the activities in this chapter will refresh your familiarity
with the CECs so you can naturally use the CEC guidelines
when participating in Capstone Workshop activities.

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Semester Xaaie Suggested study guidance

week
Week 1 Chapter 3, Chapter 3 will take you through the tools which will
Develop help you to effectively evaluate the external business
business environment and the key strengths, weaknesses,
strategy opportunities, and threats of a company operating within
that industry. This analysis provides evidence to support
an evaluation of strategic options for growth in new
markets or launching new products or services. The
activities in this chapter are intended to be short
exercises to familiarise you with the strategic analysis
tools which you may be required to apply to the Case
Study scenario of Capstone. Once you have completed
the chapter reading and activities in Chapter 3, you are
ready to move onto Chapter 4 which will develop the
complimentary skills you will require at Capstone to
analyse a company's financial performance.
Chapter 4, Chapter 4 examines the different types of financial

Effective analysis and non-financial analysis which may be used
analysis for analysing the pre-seen information, or during the
Capstone Workshop or Capstone Final Examination.
This chapter will provide the tools to complete effective
analysis but, also, critically enable you to interpret
your analysis and consider how it explains existing
performance by shedding light on underlying factors.
It will likewise exampling what interpretations can infer
about future company performance and the strategic
direction which an organisation could take. It is also
important to look beyond the numbers and be sceptical
about who prepares the financials and for what purpose.
Effective financial analysis and non-financial analysis is a
skill which must be practiced for it to improve. Therefore,
it is essential for you to work through all the activities in
the chapter.

ae Accountants 27
= 4

week
AVY) ar Chapter 5, Chapter 5 provides guidance on how to analyse the

Analysing the pre-seen information for the Capstone Workshop and
Capstone Final Examination. Section 1 explains why analysing the
Pre-seen Case pre-seen information is essential and provide you with
Study some useful analytical tools for supporting your studies.
Section 2 sets out the pre-seen information for the
HKKBS Case Study on which a series of activities in
Section 3 will be built. You are encouraged to attempt
all activities in Section 3 as you may face similar
activities during the Capstone Workshop and in the
Final Examination.
Chapter 6, Chapter 6 deals with the role leadership plays in the

Effective success of an organisation and is important for your
leadership, preparation for the 3-day Capstone Workshops.
teams and Chapter 6 begins by explaining the role of a leader, and
human the difference between a leader and a manager. It then
resource goes on to discuss the qualities of a good leader with
management an effective and high performing team. This chapter
(HRM) considers the role of leadership in driving a customer-
focused strategy and outline the importance of HRM in
ensuring an organisation has the knowledge and skills it
needs to meet its strategic objectives. You are
encouraged to attempt the activities in Chapter 6 and
complete the end of chapter Case Study activity which is
based on the Chapter 5 HKKBS Case Study.
Chapter 7, Ethics is about doing the right thing. The application of

Business ethics ethical principles will be required at Capstone as you will
and encounter challenging Case Study situations where you
professional must make judgments on the right thing to do and
negligence explain these. Cases where there is not an immediate
rule that can be followed are known as ethical dilemmas.
Chapter 7 provides ethical principles and a framework for
addressing ethical dilemmas which we can apply in
Capstone scenarios where it is not entirely clear a
business is doing the right thing. Part of addressing
ethical dilemma is being able to use appropriate
x3, CPA
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week
language which helps to justify why certain business

actions are unethical. The chapter contains several
activities which will develop your ability to apply a
framework to resolving ethical dilemmas. Once these
are completed, you can attempt the end of chapter
Case Study activity which is based on the Chapter 5
HKKBS Case Study.
Attend The first Capstone Workshop introduces the importance

Capstone of leadership attributes to good strategic performance
Workshop and good governance practices. It focuses on strategic,
Day 1 risk and financial performance analysis and using the
CEC framework for addressing ethical dilemmas. In
preparation for Workshop Day 1, read the Capstone
Workshop Case Study and complete the Prework
activities contained in the Workshop Day 1 Prework
Guidance.
Chapter 8, Choosing the most appropriate source of finance,

Raising finance whether long or short term, is a key decision for any
organisation seeking to expand or financially
restructure. Alongside the theoretical considerations
concerning the optimal amount of debt compared to
equity, there are many practical factors that will play
a major role in choosing the most appropriate finance
source. You need to be able to recommend an
appropriate source of finance and to explain and
justify your choice. You are encouraged to attempt
the activities in Chapter 8 and complete the end of
chapter Case Study activity which is based on the
Chapter 5 HKKBS Case Study.
C P, A Hong Kong Institute of

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Semester | Activity Suggested study guidance

week
Week 5 Chapter 9, Business problems are infinitely varied. Usually, they

Formulate do not conform exactly, or at all, with a formulaic
business approach. The key to solving a business problem
decisions optimally is structuring the problem in an appropriate
way. You need to be clear on your objectives and scope,
derive a logical structure, gather sufficient data to
inform your choice, consider a range of alternatives and
make a clear recommendation. The consequences of
your decisions, including financial reporting and
taxation consequences, should be factored into your
reasoning, and explained as part of your justification.
You should be prepared to, for example, justify your
choice using the 'suitability, acceptability, feasibility,
sustainability’ (SAFS) framework, and to present suitable
cost-benefit analysis. You are encouraged to attempt
the activities in Chapter 9 and complete the end of
chapter Case Study activity which is based on the
Chapter 5 HKKBS Case Study.
Chapter 10, Once a business strategy has been decided, following

Implement approval ofa business case by the Board, the process of
business practical implementation of the strategy can commence.
solutions Strategic implementation should be achieved to the
timeframe and objectives set by the Board of Directors.
For Capstone, an organisation will require advice on
how to manage the implementation of a business
solution successfully. This may require project
management to allow existing business operations to
continue during a period of change. A project is
specifically resourced, has defined objectives and an
agreed start and target end point. This chapter will take
you through the principles and tools used by project
managers and change managers to deliver solutions
which meet all of the required objectives, on time and
on budget and to overcome obstacles encountered
along the way and resolve any stakeholder resistance
to change.

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Once you have completed all the activities in Chapter 10,

ensure you attempt the end of chapter Case Study activity
which is based on the Chapter 5 HKKBS Case Study.
Attend The second Capstone Workshop day focuses on

Capstone developing business acumen with workshop sessions on
Workshop formulating business decisions, implementing business
Day 2 solutions and business communication.
During the first workshop session, as part of team, you
will evaluate short- and long-term decisions and make
recommendations. You will also provide practical
approaches to implementing short-term operational or
systems solutions or long-term strategic solutions during
the second workshop session. During the final workshop
session, you will focus on improving their business
communication skills by addressing a new case study
business issue. At the end of Capstone Workshop Day 2,
these will be a takeaway practice writing assignment for
you to complete which will prepare you for the writing
assessment on Capstone Workshop Day 3. In preparation
for Workshop Day 2, ensure you complete the Pre-work
activities contained in the Workshop Day 2 Prework
Guidance.
Chapter 11, Formal risk management is a key responsibility for the

Risk Board of Directors. It is also expected by corporate
management governance best practice. The Board typically manages
this responsibility through a formal board committee,
who in turn establishes a risk management group and
processes to identify, assess, manage, and monitor risk.
It is also very important that risk management is
embedded into the culture and practices of the whole
business. You need to be able to evaluate existing risk
management resources and procedures and to be able
to recommend improvements with reference
internationally accepted best practice (using, for
example, ISO 31000 and COSO Enterprise Risk
Management Framework). A key takeaway is that risk

ae Maa Accountants Sy
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Semester | Activity Suggested study guidance

Wate
management is a shared responsibility from the top down,
but ultimate responsibility will always remain with the
Board of Directors. Attempt the activities in Chapter 11
and complete the end of chapter Case Study activity which
is based on the Chapter 5 HKKBS Case Study.
Chapter 12, Chapter 12 covers the following important laws and

Corporate regulations:
governance e Main Board Listing Rules
and regulation e Corporate Governance Code and Corporate
Governance Report
e Codes on Takeovers and Mergers and Share buy-backs
e Other legislation relating to anti-money laundering
and counter financing of terrorism and anti-bribery
The principles and rules are summarised in this chapter.
At Capstone, you have to consider how organisations can
apply the above regulatory requirements in specific
situations and provide recommendations to ensure
compliance with laws and regulations. Once you have
attempted the activities in Chapter 12, you can complete
the end of chapter Case Study activity which is based on
the Chapter 5 HKKBS Case Study.
Chapter 13, By the time you have reached Capstone Level, we have
Contemporary gained sufficient professional practical experience to
topics appreciate that the external business and regulatory
environment is in constant change. Organisations must
be agile to adapt to these changes to maintain their
competitive advantage, as well as a sustainable business
model. Chapter 13 examines various important
contemporary topics, including e-commerce and the
benefits of big data analytics; supply chain management;
data analytics and information security; environmental,
social and governance issues and sustainability reporting;
as well as business continuity and disaster recovery
planning. You should attempt all the activities in Chapter
13 and complete the end of chapter Case Study activity
which is based on the Chapter 5 HKKBS Case Study.

WA CPA Certified Public Accountants
=a *

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Week 9 Chapter 14, This chapter contains the individual written assignment
Further of the Capstone workshops for the December 2021
Capstone session provided by HKICPA. This is for you to practice
activity practice and develop your Capstone competencies.
Attend The third and final Capstone Workshop day continues to

Capstone develop the importance of leadership with a practical
Workshop activity focused on effective and high performing teams.
Day 3 You will then be required to complete the Capstone
Workshop integrated assessment, which is in two parts.
Part 1 is an individual writing assignment. You will be
provided with a further case study handout and
requirements and be given 75 minutes to complete a
written assignment in preparation for team presentation.
For Part 2, you will deliver a team presentation based on
the requirements set out earlier for the individual writing
assignment. Remember, in preparation for Workshop
Day 3, complete the Day 2 takeaway practice writing
assignment and the Pre-work activities contained in the
Workshop Day 3 Prework Guidance.
Week 10 Chapter 15, Once strategic and operational decisions have been
Preparing for made by management, the options need to be
the Capstone communicated in a clear, reasoned, and concise business
Final format. This is true not only in the real world but also in
Examination your Capstone Final Examination. In Chapter 15, you are
reminded of effective report writing, and what you
Chapter 16,
should do in the final approach to the Capstone Final
Capstone Final
Examination. In Chapter 16, you are provided with
Examination
questions from a previous Capstone Final Examination. It
practice
is strongly recommended that all candidates attempted
all three questions and following the advice provided in
this chapter.

ae Maa Accountants 33
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week
Week 11 Chapter 16, Candidates will receive the actual examination pre-seen
Continued information five working days before the Capstone
preparations examination. In this period, candidates are advised to
for Capstone complete the following:
Final 1. Review the knowledge and application skills you have
Examination learned from working through the Capstone Learning
and Practice Workbook.
2. Carefully read through and consider each exhibit of
the pre-seen information for the real Capstone
examination.
3. Use the internet to research the industry included in
the Capstone Case Study and compare with the
company information included in the pre-seen
information.
4. Apply the techniques you have practiced from
working through the Capstone Learning and Practice
Workbook to analyse the information and data
included in each of the exhibits in the pre-seen
information for the real Capstone examination.
Candidates are strongly advised to work on the
practices in the Capstone Learning and Practice
Workbook and the past Capstone examination papers
on their own and produce their own completed
answers before referring to the suggested answers.
This is critical for Capstone examination success.
Week 12 Capstone Final Revisit Chapter 15 which contains guidance on exam

Examination techniques, which candidates are advised to read
through. Spend 30 minutes prior to the exam, summaries
your own technique to manage new information
introduced in the exam and your approach to effectively
manage the time available during the exam.
Remember, your investment of time and effort into the
Capstone is just a few short weeks away from rewarding
you with a professional career that will last a lifetime. So,
do all you can to be prepared for your Capstone Final
Examination and best wishes for your exam success!
<y CPA
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Key takeaway
There is significant learning contained in the Capstone Learning and
Practice Workbook to cover during the weeks leading up to the Capstone Final
Examination.
Capstone students are advised to plan to commence their study from Week 1
and use the plan above to maintain the pace and discipline of study which you
will need.
Study time is best used studying learning content in each of the chapters and
attempting the activities contained in each chapter, which is why we have prepared
this Capstone study guidance for you to follow.

mae Sear
Chapter learning takeaways
° Capstone is designed to:
- Develop students’ ability to integrate and apply knowledge and skills

acquired from the Associate Level, the Professional Level and practical
experience; and
- Develop students’ ability to deal competently with professional type

situations, involving the integration and application of knowledge and
skills from any part of the syllabus in the new QP, across all fields of
technical and enabling competence.
° At Capstone, students will need to use the core enabling competencies (CECs)
naturally to drive their thinking and analysis.
° The key syllabus of Capstone includes:
- Develop business strategy (10-20%)

- Formulate business decisions (10-20%)
- Implement business solutions (5-15%)
- Raising finance (5-15%)
- Corporate governance (10-20%)
- Risk management (10-20%)
- Regulatory compliance (5-15%)
- Business ethics and professional negligence (10-20%)
- Team management and leadership (10-15%)
° The assessment of the Capstone Workshops contributes 20% to your Capstone

overall assessment result for the completion of Capstone. 5% is attributed to
Day 1, 5% is attributed to Day 2 and 10% is attributed to Day 3.
° The Capstone Final Examination contributes 80% of the overall assessment

results for the completion of Capstone.
° The Capstone Final Examination will be a four-hour open-book examination.
° Pre-seen materials will be provided for preparation five working days before the
Capstone Final Examination date.
° Capstone candidates are advised to plan to commence their study from week 1
and use the plan above to maintain the pace and discipline of study which you
will need.

mae =SRRHHOR
HKICPA Core
Enabling
Competency
Framework
Topic list
1 Importance of the Core
Enabling Competencies (CEC)
at Capstone
Ethics
WN
Communication
Critical analysis guidelines
BR
Problem-solving process
Mm
Learning focus
At Capstone, you will be expected to use the HKICPA Core Enabling

Competencies during the Capstone Workshops and the Capstone Final
Examination. This chapter is essential reading to recap the application of the
framework to address ethical dilemmas, the critical analysis guidelines, the
problem-solving process and communication guidelines. Candidates are advised
to apply CECs, where relevant. This will broaden and deepen your analysis and
evaluations, which is expected at Capstone Level.
Learning outcomes
In this chapter, the Core Enabling Competencies (CECs) will assist you in meeting
Capstone learning outcomes where evaluating, problem solving, addressing ethical
dilemmas and communicating during group discussion, presentations and written
assignments are required. Examples of learning outcomes where CEC guidelines will
be helpful include:
Learning outcomes Proficiency level
Recommend methods for an organisation to monitor 3

implementation of strategy.
Evaluate information and make informed and balance 3

judgments in the absence of consistent data.
Recommend integrated solutions to complex business

problems, drawing on wide-ranging information in an 3
unpredictable variety of professional contexts.
Consider alternative strategies enabling clients to

reach balanced and appropriate decisions.
Recommend and implement strategic processes to

accomplish project outcomes and communicate these 3
to management to achieve their support.
Recommend the most appropriate alternative to

3
financing for the Case Study.
Develop corporate governance policy by applying 3

corporate governance principles.
Develop a risk management plan. 3
Develop and apply appropriate strategies for 3

managing taxation and audit risks.
Appraise business situations using a questioning

mindset and through the application of ethical a
frameworks.

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2: HKICPA Core Enabling Competency Framework
Chapter Summary
HKICPA Core Enabling

Competency Framework
Importance of the
Ethics Communication
Core Enabling
Competencies a — ici lcinaamnctiomniny
(CEC) at Capstone Resolving ethical The three pillars
dilemmas framework Topic, Audience, Purpose
1 Identify the ethical dilemma

Ethics 2 Identify the fundamental Writing guidelines
e Five HKICPA fundamental principle wiolated
principles Discover alternative solutions e Be professional, Define your
Recommend a solution which purpose, Imagine your reader,
e Address unethical behaviour
resolves the ethical dilemma structure content, Get to point,
and resolve ethical dilemmas
Simplify!
5 Explain your choice
OE RE eR mometiienne:dieenieinenestiniemeishenls
Communication
Presentation guidelines
e How you communicate matters
e Imagine your audience, Stick to the
at Capstone
basics, Keep slides few and simple, Be
e Capstone includes discussion,
ready for questions, Speak with
presentations and written
confidence
communication
esi Ruane lcekdnnay

- Critical analysis
Critical analysis Problem-solving
_ guidelines
guidelines process
e Boards of director require well-
rounded advice from CPAs
e Completing critical analysis
Apply naturally six steps Apply naturally five steps
often forms part of a business
case to improve analysis to improve problem
¢ Must consider all multi- 1 Identify the issue solving
disciplinary dimensions 2 Research the facts 1 Define the problem
3 Determine relevance 2 Determine the root causes
4 Infer based on adequate evidence 3 Involve the right resources
Problem-solving process 5 Stay objective 4 Identify alternatives
e Ensures solutions are properly epevala enous 5 Choose a solution

considered
e Resolves the root causes of the
business problem and
considers alternatives
e Using the problem-solving
process will provide evidence
to persuade a board

S#ereaae
39
| Importance of the Core Enabling Competences (CECs)

at Capstone
At Capstone, you will be expected to apply the HKICPA core enabling competencies
(CECs) during the Capstone Workshops and Final Examination, where it is relevant
to do so.
This chapter provides a summary of the framework for addressing ethical dilemmas,
communication guidelines, critical-analysis guidelines and the problem-solving
process. This chapter aims to be a brief refresher so you can move on to further
chapters which contain new learning at Capstone.
Firstly, this chapter reintroduces the concepts of ethics, communication, critical

analysis and problem-solving processes.
1.1 Ethics
Remember, the five HKICPA fundamental principles exist to govern the behaviour of
all CPAs and will influence your choices, decisions and recommendations at Capstone.
Once you qualify as a CPA, you are required to remain within the parameters of the
five foundation principles.
As you are studying the Capstone case studies, you are advised to consider any
evidence of behaviours or pressure to recommend actions which may be perceived
as outside the parameters of the five HKICPA fundamental principles. You can then
offer and justify advice to organisations to address unethical behaviour or avoid
further unethical business practices by applying the approach to resolving ethical
dilemmas.
1.2 Communication
How you communicate matters at Capstone, whether it is during group discussions
and presentations at Capstone Workshops, or writing your answers during the
Capstone Workshop written assignment or Final Capstone Examination.
All your Capstone communications must be at the level expected of a professional

CPA. This includes presentations, written communication and discussion. The three
pillars of communication guidance will help you to achieve this. It is recommended
that you spend time in this chapter to refresh your familiarity with all the
communication guidance. This is readily available to guide and improve your written
communications and your performance in group discussions and presentations at
the Workshops.

mae =SBRUNHAAR
1.3 Critical analysis guidelines

In the real world, boards of directors and senior managers rely on the well-rounded
advice from CPAs either working in practice or for organisations. This is because CPAs
are highly regarded to consider business problems, solutions and opportunities from
different perspectives and in a measured and unbiased way.
In doing so, CPAs must consider many influencing internal and external factors and
explain the potential business consequences or different options or courses of action.
The impact of new business strategic options should be considered not only from a
financial and commercial perspective but should also consider impact on capability,
available resources, sustainability, reputation, taxation, financial reporting and audit
and assurance.
Completing critical analysis often forms part of a business case which is required by a
board to evaluate and communicate an optimal solution to address a specific
operational or strategic issue, or persuade a board of directors to pursue a particular
strategic opportunity. Therefore, your ability to apply the critical analysis guidelines is
very important.
Remember, the quality of analysis performed by accountants enables organisations

to reduce their risk exposure by considering all possible outcomes. At Capstone, it is
essential that you analyse a business issue or opportunity across all multi-disciplinary
dimensions.
1.4 Problem-solving process

The CEC problem-solving process framework ensures that any business solution
which is proposed has been properly considered and resolves the root causes of the
business problem. This will provide a more permanent and cost-effective solution,
rather than a surface or temporary fix.
The framework also ensures that alternative solutions are fully considered, with pros
and cons, rather that focusing on a singular solution, which may be the easiest to
implement but may not offer the best long-term, optimal solution for the
organisation.
Using the problem-solving process will provide evidence to a board of directors of

the best course to follow and support a decision to implement the solution. Making
recommendations can lead to significant expenditure or risk taking, so it is important
that a proposed solution is supported by evidence and has considered all viable
options.
At Capstone, it is essential that we use the problem-solving process to fully evaluate

potential business solutions before these are accepted and implemented by an
organisation.

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Key takeaway
As you attempt activities contained in the Capstone Learning and Practice Workbook
chapters, it is advised to keep a summary of the core enabling competences close
to hand to guide your thinking, answer planning, analysis and evaluations. As you
progress, using these frameworks and processes will become more natural and
instinctive.
Ethics
2.1 Ethics: Five fundamental principles

HKICPA has detailed five fundamental principles to guide accountants in all their
dealings with clients and colleagues. A professional accountant in public practice
should not knowingly engage in any business, occupation or activity that would be
incompatible with these fundamental principles.
Professional
telat
Gal
Ethical
principles
Professional
Confidentiality Colne nes)
and due care
2.1.1 Integrity
This principle imposes an obligation on all professional accountants to be
straightforward and honest in all professional and business relationships. Integrity
also implies fair dealing and truthfulness.
A professional accountant should not knowingly be associated with reports, returns,

communications or other information where the professional accountant believes
that the information contains a false or misleading statement, contains statements
or information furnished recklessly or omits or obscures information where such
omission or obscurity would be misleading.

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2.1.2 Objectivity
This principle of objectivity imposes an obligation on all professional accountants not
to compromise their professional or business judgment because of bias, conflict of
interest or the undue influence of others.
A professional accountant should not perform a professional activity or service if a

circumstance or relationship bias unduly influences the accountant's professional
judgment with respect to that service.
2.1.3 Professional competence and due care

This principle imposes the obligation on all professional accountants to:
° Maintain professional knowledge and skill at the level required to ensure that
clients or employers receive competent professional service.
° Act diligently in accordance with applicable technical and professional

standards.
° Exercise sound judgment in applying professional knowledge and skill.
2.1.4 Confidentiality
The principle of confidentiality imposes an obligation on all professional accountants
to refrain from:
° Disclosing outside the firm or employing organisation confidential information

acquired as a result of professional and business relationships without proper
and specific authority, or unless there is a legal or professional right or duty to
disclose; and
° Using confidential information acquired as a result of professional and business

relationships to their personal advantage or the advantage of third parties.
2.1.5 Professional behaviour
This principle imposes an obligation on all professional accountants to comply with

relevant laws and regulations and to avoid any conduct that the professional
accountant knows or should know may discredit the profession. This includes
conduct that a reasonable and informed third party would be likely to conclude
adversely affects the good reputation of the profession.
2.2 Ethics: Addressing ethical dilemmas

Accountants must ensure that organisations document and report their finances in
complete accord with all relevant standards. However, whenever money is at stake,
ethical or even legal dilemmas may arise.
Throughout the Qualification Programme, you will be asked to consider the ethical
dimensions of your day-to-day work. You will identify ethical dilemmas, understand
their implications and determine an appropriate approach.

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The following five-step process can help guide your initial steps in resolving an ethical
dilemma:
2. Identify
Pe Coats the 3. Discover vi
5. Explain
the ethical fundamental alternative Recommend
your choice
dilemma principle solutions a solution
violated
1: Identify the ethical dilemma
Common ethical dilemmas include:
° Manipulation: Altering data to mislead or create a false impression in others
° Omission: Removing data to mislead or create a false impression in others
° Confidentiality: Misuse of, or failure to protect, sensitive or proprietary

information
° Conflict of interest: The interests of one party conflicting with those of another
° Raise the alarm? When reporting violations may bring serious ramifications
2: Identify the fundamental principle violated
This is considered further in Chapter 7. It is important to explain why aspects of the

five fundamental principles are not being observed or where the actions of an
organisation are resulting in harm in some way or there is a lack of truth, fairness or
inequality in the treatment of individuals or the provision of information.
3: Discover alternative solutions
Common solutions to ethical dilemmas include:
° Assess the relative severity of the dilemma

° Identify the potential legal issues
° Identify the parties affected
° Document the ethical dilemma
° Take an outsider's view to think differently
° Seek legal advice
° Inform the proper authorities
4: Recommend a solution which resolves the ethical dilemma
5: Explain your choice

mae KRHA
Weblink
https://nkbedc.icac.hk/enewsletter/accounting/index.html.
The Hong Kong Business Ethics Development Centre (HKBEDC) of the Independent
Commission Against Corruption (ICAC) has developed this series of feature articles
in consultation with the HKICPA. These articles highlight some common ethical
risks faced by different accounting professionals, namely external auditors, internal
auditors, financial accountants and management accountants, and the legal
obligations and professional principles they should pay heed to in tackling these
challenges.
Using the approach to resolve ethical dilemmas is developed further in Chapter 7.
Communication
3.1 Communication: The three pillars

It is challenging for CPAs to make themselves heard in today's blizzard of
over-communication. To succeed, you will need to write effective proposals, reports,
emails and other documents, as well as make concise, vivid presentations. Regardless
of its form, every effective message rests on three 'pillars' of communication, these
being topic, audience and purpose. Think them through carefully both before, and
while, you write for, or speak to, others.
3.1.1 Topic
Be clear about your subject matter. What is the essential information you want to
convey? It is easy to 'err' on either end, of course - saying so little that your audience
cannot see its importance or so much that the importance is buried.
3.1.2 Audience
Knowing what and how much to say depends, in part, on knowing your audience.
How much do they already know about this topic? If it is a lot, do not cover the
obvious. If it is not much, include any information needed to clarify your main points.
3.1.3 Purpose
Finally, write with a clear purpose in mind. Even in a simple 'FYI' email, you often want
your audience to do something - support an idea, provide information, complete a
task and so on. Be very clear in your communications about the action or actions you
want your audience to take.

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Knowing your purpose also helps you decide how much information to include. If
information does not clarify your main points, provide needed background or
encourage the audience to do something (e.g., leave it out). In general, the shorter
your communication, the better, as long as it achieves your purpose.
When these three pillars support your communications, you are much more likely to
achieve your desired effect.
3.2 Communication: Writing guidelines

As in most professions, your success in accounting depends in part on your ability to
communicate clearly. The following recommendations will help you create polished
written messages.
3.2.1 Be professional
Maintain a professional tone in everything you write because everything your write
either builds or diminishes your reputation and your future. Keep in mind that,
regardless of your intended reader, any email can end up in anyone's inbox.
3.2.2 Define your purpose

Often, you will want readers to take action, as we have said - to support a proposal,
provide information or take a step. Make your purpose clear early in the document, if
it is not in your first sentence. Then, add needed background or reasons for your
request or proposal.
3.2.3 Imagine your reader

Think about your reader before and while you write. Imagine what readers might say
in person and address likely questions or reactions. For a simple email, this process
can be quick. For a complex or controversial topic, take your time and get it right.
3.2.4 Choose and structure your content

Content and structure should reflect your purpose and audience. Include only
content - facts, ideas, data or anything else - likely to motivate a reader to do what
you want. Highlight benefits to the reader for taking action. Structure communication
for ease of reading. Consider breaking up dense paragraphs with numbered or
bulleted lists or, in longer documents, sub-headings.
3.2.5 Get to the point

Effective writing starts by drawing in your reader. A first sentence or paragraph
should lead the reader to the body of your message. Quickly explain why a reader
should care. In an email subject line, for example, "Team meeting postponed" works
far better than the vague subject line "Team news". Make your first sentence clear,
concise and to the point. Often it clearly states your purpose in writing.

mae =SBRUNHAAR
3.2.6 Simplify, simplify, simplify

Especially when communicating complex information, it is a good idea to 'simplify,
simplify, simplify’. Readers want to understand quickly, often skimming for main
points. For those reasons, adopt a conversational tone, as much as possible, using
words understood by all. Business writing is no place for fancy language, convoluted
sentences or accounting jargon that some readers will struggle to understand.
3.3 Communication: Presentation guidelines

Accountants often need to present technical or financial information to internal or
external groups, including clients. Let us consider what it takes to make a powerful
impact on your audience.
3.3.1 Imagine your audience

As you would for written communication, analyse your audience before you speak.
Are they experts? What do they expect from you? What will they do with the
information you provide? An important rule is not to talk over or under the level of
your audience. As a CPA, you are an expert in financial matters, which may or may
not be true for your audience.
3.3.2 Stick to the basics
It is always a good idea to stick to the basics in your presentation. If necessary, you
can provide detailed metrics later to anyone who wants them. For most people, even
experts, the most important numbers are enough. For a non-expert or mixed group,
use simple terms to explain what those numbers are and what they measure.
3.3.3 Keep slides few and simple

Make slides as few and simple as possible, given what you are trying to accomplish.
Speak to important points but avoid reading any slide aloud. Even experts usually
want only the highlights. If you are unsure how much to Share, ask the group if they
would like more depth for a given slide. Keep your graphics simple. Fewer elements
make a chart or graph easier to understand. Simplify a spreadsheet before turning it
into a slide. Use minimal text, which takes time for the group to process. Consider
building a graphic to ease your explanation.
3.3.4 Be ready for questions

As you prepare, look at your data from the listeners' point of view and be ready to
answer any questions they are likely to ask. At the end of your presentation, and after
you explain anything complex or controversial, ask the group, "What questions do
you have?"

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3.3.5 Speak with confidence

Do your best to show confidence in what you are saying. Listeners may depend on
the clarity and accuracy of your data to make financial decisions. Equivocal terms like
‘maybe’, 'possibly' or 'it seems like' communicate a lack of confidence in your data.
Check and double-check your data to be sure your numbers match in different
places. One person pointing out a discrepancy can undermine confidence in your
whole presentation.
4 Critical analysis guidelines

An ineffective CPA might think, "I just follow the rules. It is not my job to think
critically." However, nothing is further from the truth. How well you apply the skills of
critical analysis can make or break your career.
Critical analysis of an issue or situation focuses on facts, data or evidence. The best
critical analysis is objective, with as little effect as possible from your feelings,
opinions or biases.
4.1 Six critical analytical techniques

This is hard work made much easier when you apply the following six analytical
techniques.
4.
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Identify Noto] Ket Tac aaaliats based on Stay Naar a)
the issue the facts WoatVel aa adequate objective curious
evidence
1: Identify the issue - What problem are you going to resolve?
A first step of critical analysis is painting a clear picture of the situation and the
people, group or issue involved. In any confusing situation, ask a few basic questions:
Who is doing what? Why is it happening? What is the result and how could it be
different?
2: Research the facts - Gather related information about the issue; apply a
questioning mindset to test current information (what who when where why how)
When considering another person's point of view - or developing your own - get the
facts straight. Supporting information can be inaccurate or come from a questionable
source. Look especially for any claims unsupported by factual data, a common sign of
an opinion reflecting a bias with little or no basis in reality.

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3: Determine relevance - Manage and evaluate information from multiple sources

and perspective; pick out only the relevant information from the researched facts
for analysis
Not all the researched facts are relevant for analysing the issue. To decide what
evidence is relevant to a belief or assertion, weigh any supposed evidence against the
goal or purpose you are trying to achieve.
4: Infer based on adequate evidence - Identify alternatives; weigh the cost and
benefit; forecast the results for each of the alternative
Inferring simply means to draw a conclusion based on available data, but it is easy to
go wildly wrong. If | see strange lights in the night sky, | might infer that | am seeing
visitors from another planet. On the other hand, daylight might reveal a high-flying
helicopter. Therefore, a reliable inference depends on your ability to consider all
relevant evidence.
5: Stay objective - Review and recognise any uncertainty and bias in the data and
assumptions; make evidence-based evaluative judgments
Even if our own biases are plain to others, they are often invisible to us. Critical
analysis requires objective evaluation. An ideal judge assesses conflicting claims, first
by identifying the biases that colour almost every one of them. Setting aside your own
biases is both difficult and vital to an objective evaluation of the views of others.
6: Remain curious - Note any variance from time to time; be open to new
perspectives
Skilled critical thinkers remain curious because they know how tempting it is to take
unfounded assertions at face value. As children, we were all curious to ask one 'why?'
question after another. Do not be afraid to tap into your inner child. Continue to ask
'‘why?' and other questions about opinions, assertions, established processes and
other confusing aspects of your professional life.
Far from being a 'nice-to-have' skill, the ability to analyse complex subjects and
situations is vital for every competent CPA. While it is important to apply and refine
these techniques over a lifetime, the sooner you start, the greater the benefits to you
and your career in accounting.
Example: Critical analysis guidelines

Dennis, a Junior Accountant in a CPA firm, has been asked to give his opinion ona
personnel situation. The situation is this: Dennis' CPA firm has the budget to hire two
additional staff to support the accounting department offload the work currently
being done by Dennis and his colleague, Rachel, so that Dennis and Rachel can
perform tasks that better utilise their experience.
HR has received plenty of applications from qualified applicants. We have one
applicant who is overqualified for the advertised role. However, if the firm hires the

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one applicant, we could obtain that applicant's experience and insights into an
industry that the CPA firm is currently lacking but is interested in expanding into.
Hiring the experienced candidate would cost us as much as it would to hire the two
staff accountants.
Solution
Identify the issue. What problem are you going to resolve?
e Should we hire the two staff accountants or hire the one experienced
accountant with experience and expertise in an industry the firm is
interested in?
Research the facts. Gather related information about the issue; apply a questioning
mindset to test current information (what who when where why how)
° Two staff accountants would perform the tasks currently performed by Dennis
and Rachel, freeing Dennis and Rachel to pursue work that better utilises their
experience.
° Hiring the experienced accountant would afford the firm experience and
expertise in an industry the firm is interested in entering. This experience and
expertise are currently lacking in the firm.
° The firm can only hire the two inexperienced staff accountants or the
experienced accountant.
Determine relevance. Manage and evaluate information from multiple sources and
perspective; pick out only the relevant information from the researched facts for
analysis
° The additional revenue brought in by the experienced staff member is

relevant.
° The additional revenue due to an unexpected new client by an existing partner

is irrelevant.
Infer based on adequate evidence. Identify alternatives; weigh the cost and benefit;
forecast the results for each of the alternative
° Measure the productivity provided by adding two staff accountants in

additional potential revenue or reduced costs (i.e., an incremental change in
the operating income).
° Measure the additional revenue and market share potential provided by the
experienced accountant.
° Decide based on which decision provides the greatest value to the

organisation.

a HRRUNALR
Stay objective. Review and recognise any uncertainty and bias in the data and
assumptions; make evidence-based evaluative judgments
° Dennis is being asked to provide an opinion that impacts his future workload,
which may result in a bias in his opinion.
° The experienced candidate may not be interested in providing the expertise/

experience in the industry the firm is interested in expanding to. After all, the
experienced candidate is responding to an open staff accountant position.
Remain curious. Note any variance from time to time; be open to new perspectives
It is important to remain curious about the:
e Potential to ask for additional funds to hire all three qualified candidates; and
° The firm's genuine interest in the new industry.
Activity 1
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HKMed is a large chain of retail pharmacy stores based in Hong Kong, which supply
pharmaceuticals and healthcare products as well as a wide range of beauty products.
The directors hope to list in less than five years once it is large enough. HKMed
understand that a failure to grow and expand outside Hong Kong means it will not
realise its listing objective.
The operations director is excited about a similar chain of stores in neighbouring

Shenzhen and believes HKMed could acquire this company for approximately eight
times its current earnings after tax of HK$8 million. He has suggested at the recent
board meeting that HKMed make an offer quickly of HK$64 million to secure the deal
to achieve swift expansion in China.
Currently, HKMed does not have enough cash to fully fund an acquisition. However, it
currently does not have any borrowing.
Required
Use the critical analysis guidelines to evaluate this scenario.
(The answer is at the end of the chapter.)
Problem-solving process
Most of us have a basic ability to tackle problems. What is hard is quickly finding
solutions while involving others in meaningful ways. Applying a clear and efficient
process can help everyone remain calm and productive under pressure.
Cc PA Hong Kong Institute of

a Searsae
The CEC problem solving process contains the following five steps:
1. Define the
problem
2. Determine
the root
causes
3. Involve
Maral
resources
Celia
alternatives
5. Choose a
solution
Define the problem - Figure out what exactly the problem is; how does it hinder
your goals; why is it happening?
To find a good solution, it is vital to know where you are and where you want to
go. Only then can you close the gap between the two. Defining a situation in this
way also helps uncover ways to do even more with your solution than simply
closing a gap.
Determine root causes - What are the trigger factors causing the problem;
which factors are changeable and which are not? Establish cause-and-effect
relationships
You will find the best solution more quickly with accurate information about the
causes of the problem. Without knowing the contributing factors, you may find
yourself exploring options that do not address the real problem.
Involve the right resources - Consider the strengths, time, cost etc. on each
resource that would be involved in the solution plan
Resources include time, cost and people, both internal and external. When you
involve the right resources at the right time in choosing the best solution, the
problem can be solved more effectively and efficiently. Understanding the
strengths possessed by you, your team and your organisation will also help you
determine the best solution for your particular situation.
W CPAa Hong Kong Institute of

SRAHHAB
4. Identify alternatives - Derive alternate solutions and consider perceived

benefits and risks
Having a range of creative options to choose from makes it easier to craft a

solution that takes things to a new level - and delights everyone affected by the
problem.
5. Choose a solution - Work on the solution with specific actions; check back the
solution and revise the plan as needed
Once you leverage the team to choose the best solution, develop an action
plan that outlines accountability, resources and schedule. Once under way,
measure progress and maintain momentum by celebrating milestones and
SUCCESS.
These five steps can help you identify, analyse and solve persistent problems.
Example: Problem-solving process

Ee A press release just landed on the desk of Erik Tan, CEO of Software, Inc (SI)
announcing the acquisition of a thriving start-up software company, MovingUp
Software, by our greatest competitor, OnTop Software. The acquisition combines the
powerhouse of the industry, OnTop, with the entrepreneurial ambition of MovingUp
and leaves Erik wondering how his customers will respond.
SI specialises in payroll software, like OnTop. However, SI leads the industry in

integration capabilities with financial reporting software. Likely, acquisition targets
include one of those financial reporting software companies.
Solution
Application of the five stages of the problem-solving guidelines can be applied as

follows:
1. Define the problem
An industry competitor has expanded their capacity, their resources and their
reach and Software, Inc is unprepared to do the same quickly.
2. Determine root causes
Competition expanded through acquisition.
3. Involve the right resources
Mergers and acquisitions require due diligence. One of the first actions Erik
should take is to have a finance team member perform due diligence on the
software companies of interest and explore others that are not currently on the
‘of interest’ list.

Certified Public Accountants boy}
me SHeaGo8
4. Identify alternatives
° Do nothing.
° Increase marketing and sales efforts to keep existing customers and

potentially increase market share/revenue.
° Acquire a financial reporting software.
5. | Choose a solution
° Immediately increase marketing and sales efforts.

° Set up an acquisition target after performing proper due diligence.
f=], Activity 2
5
a
44-54.
A Hong Kong based budget airline is facing significant cash flow problems as it has
~
5
overexpanded its fleet of aeroplanes to serve additional routes in Southeast Asia.

The company is currently very highly geared as a result. Whilst all its fly routes
are currently profitable, the increase in short-term passenger demand has been
slower to materialise than forecast resulting in a cash shortfall. The company has
forecast that it will fail to service its existing loan and aeroplane lease payments
within nine months.
Required
Using the problem-solving process, address the problem outlined in the scenario.

me SRRHHOR
° The five ethical principles should govern all our professional behaviours as
CPAs, and the approach to resolve ethical dilemmas should be routinely
considered when making advice. Remember, the five ethical principles are
integrity, objectivity, professional competence and due care, confidentiality
and professional behaviour.
° When an ethical dilemma is encountered, the CEC approach to resolving ethical

dilemmas should be applied.
- Identify the ethical dilemma

- Identify the fundamental principle violated
- Discover alternative solutions
- Recommend a solution
- Explain your choice
° At Capstone, you will need to write effective reports and other documents, as
well as make concise and effective discussions and presentations. Remember,
every effective message rests on three 'pillars' of communication, those being
topic, audience and purpose.
° The communication writing guidelines suggest the following six points to ensure
CPAs get their points across in a concise and effective way, and so are more
likely to engage their reader and achieve the intended outcome. As a reminder,
the six areas are: (1) be professional, (2) define your purpose, (3) imagine your
reader, (4) choose and structure your content, (5) get to the point and
(6) simplify, simplify, simplify.
° The communication presentation guidelines provide advice on maximising the

impact of your business presentations at Capstone and in the real world.
Imagine your audience

Stick to the basics
ee
Keep slides few and simple

Be ready for questions
Speak with confidence

ae searwae
° The critical analysis guidelines should be applied for all analysis of business
problems or opportunities at Capstone as follows:
Identify the issue

YS
Research the facts
Determine relevance
Infer based on adequate evidence
Saat
Stay objective
Remain curious
e The problem-solving process should be applied for all evaluation of potential

business solution at Capstone as follows:
Define the problem

SP
Determine the root causes

Involve the right resources
ew
Identify alternatives
Choose a solution

bolo) Certified Public Accountants
mw ShRIHAR
Answers to activities
Answer 1
Identify the issue
The Board of HKMed understand that revenue growth within the current market
is limited so must look to international markets in order to grow.
HKMed must achieve sufficient growth to be able to list on the Hong Kong Stock
Exchange in approximately five years’ time. This is less likely to be achieved if its
strategy excludes growth by acquisition and remains and is limited to operating
domestically.
Potential company acquisitions should not be limited to recommendations

made by the Operations Director only. This is too narrow a choice and the
search for potential acquisitions should be wider to ensure any acquisition
provides the best value and best strategic fit.
The company has limited cash so will require new capital either by borrowing or
raising new equity. Equity sources are limited (as HKMed is a private company)
and the company is currently not large enough to list on the HK Stock Exchange.
Whilst raising debt finance is quicker, there is no guarantee a bank will be willing
to lend large amounts to a company with an existing loan.
Acquisitions and company valuations carry a high degree of risk, as valuations

based on future earnings are uncertain and, therefore, it may be better to set
up overseas to avoid these risks.
However, HKMed has not expanded internationally before, so there may be

legal issues, competition, regulatory and other barriers to overcome in order to
expand themselves. This may take time to investigate and additional investment
to overcome, so an acquisition may be preferred to avoid this.
Research the facts
The information available to make a fully informed acquisition decision is not

available and is limited to an estimated value of HK$64 million provided by the
Operations Director. Assumptions can be made on profitability and growth,
however corroborating evidence must be sought before a decision is made.
The company should commence discussions with its own bank and other banks
about how much HKMed could borrow to fund an acquisition, as this will avoid
spending time investigating unaffordable possibilities.
A further action is to identify alternative affordable strategic targets.

Certified Public Accountants yA
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Determine relevance
The multiple earning valuation technique proposed by the Operations Director

will provide a useful approximation of value, however it is far from accurate,
and may lead to overvaluation.
A risk adjusted, discounted cashflow valuation, evaluated at HKMed's weighted

average cost of capital, should be completed based on target company
information.
All valuation assumptions should be verified by due diligence procedures.
A valuation is only a starting point for negotiation; the directors are advised to
be cautious, given that this is their first acquisition.
Infer based on adequate evidence
An acquisition will enable HKMed to gain an international footing on which to

build, or enter new product/service areas it may otherwise not have the
expertise or time to do themselves.
There are advantages of pursuing a growth by acquisition strategy, as opposed

to setting up a new operation themselves. An acquisition provides swift access
to a market through the purchase of an already successful company which
avoids the risk of set-up failure.
The company has never operated internationally and has never acquired
another company before. Its lack of experience adds to the risk that an
acquisition fails, either by paying too much through naivety and/or insufficient
due diligence processes.
The Board cannot rely on multiple of earnings valuation of HK$64 million

provided by the Operations Director, as this is an estimate only and not based
on actual target company information.
The Board of HKMed are advised to commence discussions with the

Shenzhen-based retail chain to determine if it is for sale and, if so, obtain
company information with a view to completing valuation and due diligence
procedures.
However, HKMed are advised to be risk adverse in its decision making

regarding a potential acquisition. The impact of a poor choice could be
Strategically damaging.
58 CPAa Hong Kong Institute of

HARUALR
Stay objective
° HKMed has an overall strategic ambition of publicly listing HKMed on the

Hong Kong Stock Exchange in five years. This may result in optimistic or risky
acquisition decisions in order to achieve this goal.
° The Operations Director is a strong advocate for the acquisition of the target
company and, whilst he is likely to be acting in the best interests of HKMed,
there is a risk that his judgment could be biased.
° Also, the Operations Director is not a qualified accountant or corporate finance

expert, so his valuation has not been evaluated by an expert.
° It is business critical that the Board remains objective when considering a

potential acquisition, given the risks.
Remain curious
e Despite the concerns raised, there is benefit in proceeding to investigate the

potential acquisition target identified by the Operations Director.
° One barrier to acquisition in the short term is available funds. The Finance
Director should begin making enquires with banks about how much HKMed
could potentially borrow.
° The company must not ignore the financial reporting and taxation implications
as a result of its first-time acquisition (e.g., the requirement to prepare
consolidated accounts and any stamp duty taxes which may arise on the
acquisition of shares). Hong Kong does not have a group relief system for
losses, So losses incurred by the acquired company cannot be used to offset
HKMed's taxable profits.
° The Board should commence investigating alternatives whilst it commences

discussions with the target company.
Answer 2
Define the problem
° The company has serious forecast cashflow issues which will result in loan and
lease default within nine months.
° If default occurs, the company has to be forced to cease trading if it cannot

negotiate a new term with its existing loan and lease finance providers.
Determine the root causes
° The company has significantly overtraded but, using debt finance to finance
optimistic growth assumptions to fund expensive plant and machinery, is
required to operate an airline.

ae SRN OR
The speed of growth has been less than forecast which is resulting in its cash
outflows, in the form of financing costs and payments and other operating
expenditure, being greater than cash inflows.
The company is profitable and, if it can survive this cash flow problen,, it is likely
to recover and be successful in the longer term. Therefore, all effort should be
made to solve the problem.
Involve the right resources
Given the severity of the cash flow problem, the company needs to commit its
finance team to fully analysing the problem to determine if refinancing
repayments can be met by delaying other payments.
The company should determine what proportion of its finance needs to be

refinanced to avoid insolvency. If only some of the loans, or just some of the
leases, need to be refinanced then the issue may be less severe and easier
to solve.
The company should analyse its least profitable routes and look to save costs
to improve the cash shortfall position.
It may be possible to sell surplus assets, such as aircraft or rights to certain

routes, in order to meet its short-term finance cash flow obligations.
If the conclusion is that this is not possible, then alternative solutions need to
be pursued with urgency. The Board should commit its teams to solving this
most important risk.
Identify alternatives
The company should immediately look at cost saving actions which could buy
more time to find a solution.
Discuss the issue with the bank and lease providers as soon as possible. These
finance providers may be sympathetic and assist by restructuring the existing
finance by lengthening payment terms as they appreciate the transparency
provided by the company in advance.
Agree with current other suppliers to lengthen credit terms to reduce short-
term cash pressure.
There remains time to raise new equity finance in the form of a rights issue, to
ensure survival of the business.
As a last resort, the company could put itself up for sale to minimise the losses
to its shareholders. A competitor is likely to be interested given the underlying
business is profitable.

HARUALR
Choose a solution
It is unlikely that the airline's other suppliers will lengthen credit terms. This
would mean taking on additional risk themselves. Knowledge of cashflow issues
is likely to alarm them and this may reduce future supply, which could impact
on the airlines ability to continue its current flight timetable.
The airline should commence discussions with its existing finance providers as
soon as possible to provide time for refinancing to be considered. If this fails,
there may be time to refinance with other banks. Either option is likely to
increase interest costs, and may incur additional arrangement fees or penalties.
This is worthwhile due to the alternative of ceasing trading or company disposal.
At the same time, a potential rights issue should be discussed with major
shareholders. Whilst this is likely to cause alarm and may result in a short-term
fall in the airline's share price, this will be a short-term bump if a rights issue is
arranged in time to solve the short-term cashflow crisis.

ae SHRNGAR
Business
Strategy
Topic list
1 Introduction
2 Business strategy
3 Strategic position analysis
4 Analysing the internal position
of the organisation
5 Analysing the external position
of the organisation
6 Stakeholder analysis
7 SWOT analysis
8 Strategic choice
9 International strategic choice
10 Evaluation of strategic options
11. Marketing
12 Strategic risk
13 Strategic analysis and the
Capstone
Learning focus
In this chapter, we look at tools which will help you to evaluate the current
strategic position of an organisation in order that you can advise a board of
directors on a preferred strategic direction, using credible analysis and evidence.
This chapter then considers appropriate marketing which an organisation could
use to achieve its agreed strategy.
In advance of the Capstone Workshops, you will be provided with a Case Study.
One of your first planning tasks will be to complete a strategic analysis so you
understand what the Case Study company has been and how it could grow in
the future.
3: Business Strategy
Learning outcomes
In this chapter, you will cover the following learning outcomes:
Consider current and alternative business strategies

in a range of complex and unpredictable
circumstances
Analyse the strategic position of an entity from a

business strategy, financial and performance
management perspective, taking into account:
e Internal resources, capabilities and competences
N
e Governance
NY
e Competitive forces
NY
e Marketing
NY
e Conflicting stakeholder needs and expectations
NHN
e Corporate social responsibility and environmental
NUN
factors
e Sustainability
N
e = Influences of ethics and culture
Consider some of the major forces for change which

influence businesses and the strategic planning
process.
Evaluate options from a business analysis

perspective, assessing strategic and financial
consequences using relevant financial management
and performance management techniques (including
the use of big data analytics).
CPA-— Hong Kong Institute of

S#RHGOR
is)
Formulate strategy and tactics and evaluate potential 3

investment decisions in a domestic or multinational
environment, taking into account the financial
reporting, finance and taxation implications,
including the responsible management of financial
risk. This includes:
Strategy formulation and development;
Financial decision making to formulate and
support business strategy;
Valuation of acquisitions and investments;
Effective management of funds;
Financial and tax implications of implementing

strategic alternatives;
Risk tolerance and management;
Tactics to support the chosen strategy;

Organising and enabling success; and
Managing strategic change.
Essential reading chapters

Module 12: Business Finance, Chapter 1: Implementing and Monitoring Business
Strategy
This will remind you of the foundations of generating a business strategy.
Module 12: Business Finance, Chapter 2: Business Strategy Performance
This chapter looks at organising organisational strategies and monitoring

performance against that strategy.

SRRHHLR
Chapter Summary
Business strategy
I | | |
Introduction Business Strategic Position . Analysing ane
strategy analysis internal position
Strategic e Steps in e Strategic position Strategic capability

position: formulating a analysis involves: The M's model
Analysing current Busiies> strategy - Evaluating the e “The vawecnaii
internal and include: internal situation
external factors - Deciding on (products,
e Stakeholders: goals and aE resources, issues)
Influence the ii time period ii - Evaluating the
strategy of an : - Setting the i external business
organisation : strategy to environment
e Identify and achieve these: : (PESTEL)
evaluate i goals i - Weighing up the
strategic options; j - Implementing internal and
e Strategic risk: a strategic external factors
Strategy fails plan (SWOT)
Sic i sabicsiok ers ecole.” Second Ua ScaDNNRa NSN eoeeoceskaoel Impacts on
strategy?
Strategic SWOT Stakeholder Analysing the

choice analysis analysis external
| | position
e Competitive advantage e Strengths (how to e Internal
- Cost leadership exploit) stakeholders bn cccececeeeeeene | ees
- Differentiation * Weakness(howto = : © Connected : ie PESTEL
~ Focus address) stakeholders : e Porter's five forces
differentiation e Opportunities (how : : e External
. . to seize) nt stakeholders
¢ — Strategies to grow: ; 1
Ansoff matrix : } ¢ Threats (how to : | « Stakeholder
- Market penetration : read) mapping analysis
- Market
development
- Product
development
- Diversification

Certified Public Accountants fJ.e}s)
e_ FeAatHAe
| | | |
International Evaluation of Marketing Strategic
strategic choice strategic options risk
e —- Porter’s diamond : e = Suitability Marketing mix > ie Risk and

- Factorconditions | | « Acceptability - Product ii uncertainty
_. i nr - Pri i : :
- Demandconditions : : e Feasibility ue : : : ¢ Risk appetite and
-~ Related and Ft | facavengecnesnennssneonssnncnssesennsoneseseneanee -» eeomnenten
Place a risk tolerance
supporting : : — People e Strategic and
industries : : = Process operational risks
- Strategy, structure =:: : - Physical evidence :
and rivalry 3 A sissibeciinneciesesiidiaioaidiisititeniti 3
e Modes of entry to
foreign markets
- Export i
- International
production * *
- Joint venture/
Strategic analysis at Capstone
into : ——S a 3
subsidiary
e What are the facts involved in the Capstone Case Study?

e Do you know its current business?
e Where is the organisation aiming?
e Howwill they cope with changes?

ee FBR
Introduction
This chapter deals with strategic planning and follows a rational approach to
determining the strategic options available to a company based on its performance,
capabilities, product, market, location and economic environment. We start by
looking at the meaning of strategy in Section 2.
Strategic position refers to the internal and external factors that will help or hinder
the success of particular strategies. We consider how to evaluate the strategic
position of a company in Section 3.
Section 4 looks at analysis of the internal factors in more detail including the Ms and
Value Chain models. Section 5 deals with the external environment, which can be
analysed using the PESTEL model and Porter's Five Forces.
The strategy of an organisation can be affected by the stakeholders, who may have
specific objectives that they want from the business. This is covered in Section 6.
Section 7 looks at a model called SWOT analysis, which is a useful way to summarise
the strategic analysis that has been performed, and to start to think about some
opportunities and threats.
Having analysed the strategic position of an organisation, strategic planners will want
to identify some strategic options. Section 8 looks at various strategies, including the
generic strategies (price leadership and differentiation) and Ansoff's Matrix. Ina
globalised business world, strategies often include an international dimension, and
international strategies are discussed in Section 9.
The strategic options identified need to be evaluated to determine if they are

suitable, feasible and acceptable to the stakeholders (Section 10). Marketing is
another important dimension of strategy and is covered in Section 11.
Finally, Section 12 looks at the risks of strategies not succeeding (strategic risk).
Business strategy
Key term
Business strategy is the direction and scope of an organisation over the long term,
which achieves advantage in a changing environment through its configuration of
resources and competences with the aim of creating competitive advantage and
fulfilling stakeholder expectations.
Strategic decisions are made under conditions of complexity and uncertainty; they
have wide impact on the organisation and often lead to major change. Therefore,
there will be uncertainty that the organisation faces, when it has decided to follow
through the plan it has formulated.

Certified Public Accountants Cy
ee FBR
The steps in formulating a strategy include:
° Deciding on the organisation's overall goal and its time period

e Setting the strategy that is needed to achieve the goal
° Putting a plan into place to get the strategy achieved, including the resources
that are needed, assuming these are available
This involves looking internally at the organisation to see how it is placed and the
risks in the external situation, which will cause uncertainties in achieving its goal. It
will involve setting the objective that it wants to meet over the time period it is facing
and putting in place more detailed targets for it to achieve. The actions that will need
to be taken to achieve its objective and targets will need to be decided.
In Capstone, it is likely that you will need to give a recommendation, which is backed
up by evidence from the strategic planning process. Hence it is worth thinking this
through carefully.
It will be valuable to conduct your own research into the industry of any organisation
that you are considering. You can find out a lot from internet searches, which will
allow you to see some typical organisations in the industry and how they are
performing. You may well see financial statements, newspaper articles and details
about the competition in the market in order to boost your knowledge.
2.1 Formulating strategy

The process for formulating a strategy for an organisation is:
° Evaluating the current position of the organisation
e Asking where the organisation wants to be in the future and quantifying the
targets that need to be set to get there
° Setting out what needs to happen to get there
The uncertainties that are facing the organisation should always be taken into
account; the plan could be affected by unforeseen changes, such as a new entrant
into the market or changes in legislation.
The strategic plan will involve deciding the actions needed to achieve it and finding
resources to make that possible, assuming that is possible for the organisation.
It is important that the strategy chosen in any one case reflects the organisation's
overall strategy. In addition, strategic change often involves significant change to
processes and people that may be of a transformational nature, so careful thought
and leadership are needed to maximise the chances of successful deployment of
strategic plans.

mae =SBRUNHAAR
3 Strategic position analysis

The start-point of approaching the strategic analysis is to know where the current
position of the organisation is. Once that is decided, it will help to decide how to plan
from that position. This involves looking at:
e The internal situation that the organisation faces; the resources that the
organisation has available to it, from the people working in the organisation
through to its infrastructure.
° The external business environment that it faces, and the impact those issues
have on the organisation. This can include, for example, the political situation in
the country/countries the organisation operates in. It will also involve looking at
closer influences on the success of the strategic plan, such as the actions and
responses of competitors.
° Weighing up the internal and external factors to perform an overall analysis of

the organisation's current situation. This is called a SWOT analysis because it
looks at the strengths, weaknesses, opportunities and threats that the
organisation faces.
° Once the organisation has seen its current position from the SWOT analysis, it
can progress into formulating its strategic plan, deciding where it wants to be
and whether it can get there.
& Key takeaway

The more that you can find out about an organisation that you are investigating the
better (e.g., how the bigger issues, such as technology, the environment and so on
are likely to affect the organisation).
4 Analysing the internal position of the organisation

One of the first steps is to look at the internal position of the organisation. This
means that the resources and expertise of the organisation can be considered to see
how the organisation is currently placed. A SWOT analysis will tell us the strengths of
the organisation but also its weaknesses. These can be weighed up initially but can be
reassessed once the external factors have been analysed, so that they can be put in
context. An apparent weakness of the organisation may not be as large a concern if
all the competitors in the marketplace have the same weakness.
4.1 Strategic capability

The first question to ask is on the organisation's ability to make goods or provide
services. The capability of the organisation is usually divided up into the resources

mem SAGA
that the organisation has and its competences. A resource of the organisation is
something that it can use, such as its computer system or its chain of retail outlets.
Resources that the organisation controls are a strength, though the missing piece
is the people that the organisation employs and their competences. If you have
competent employees of the organisation, as well as strong resources for them to be
using, then you end up with a successful organisation.
An example is the technology-based companies that have grown up in the 21st century
that provide social media platforms or online shopping. They have the resources
available to achieve success, with the use of apps and online sites that their users
can access and are happy using, allied to the expertise of staff to help them achieve
SUCCeSS.
If the resources that the organisation owns and uses are unique then that is a big
advantage, though it is unlikely that other organisations cannot have the same
resources over time. If, however, an organisation can cover themselves with a patent,
that will help them have a unique resource. Resources can be either intangible, via a
patent or the knowledge the organisation has, or tangible, such as the financial
resources it has access to, the location of its stores and so on.
4.2 The M's model

The first model that we will see to analyse the position of an organisation is called the
M's model. This can be used to perform an inventory of the resources that the
organisation has at its disposal.
The M's is a list of the resources for an organisation.
4.2.1 Men and women
It is key for most organisations to have the right people involved in it, from the top of
the organisation to the bottom. There may be some areas of the organisation that
require special skills, such as on the technology side, but all areas will require
competence. It may be that the technical side works well but the customer-facing
staff are poor, and this will put off customers. The skills and knowledge of the
employees are key for most organisations.
4.2.2 Money
Enough of this is important, in order to pay the organisation's short-term bills as well
as repay its long-term financing when that falls due.
4.2.3 Markets
This can refer to geographical markets as well as online markets. Are they good
markets, with enough size to justify operating there? What products and services are
likely to be successful in each market? How is the brand of the organisation rated, is it
well regarded in its market?

a HRRUNALR
4.2.4 Machinery
Depending on the industry, the machinery needs to be appropriate and working
correctly. This can be to manufacture the goods sold as well as the infrastructure to
sort and deliver orders.
4.2.5 Make-up
This means the culture that the organisation possesses. Invariably, the organisation
will need a customer-facing orientation that makes its customers happy. However, it
may be that different cultures are needed internally, e.g., in the technology
department of the organisation.
4.2.6 Materials
For an organisation that is providing food to be sold in shops or cafes, the underlying
materials need to be available on a daily basis to make sure that the demand is met.
It needs to be at the right price and enough in quantity to meet the demand for it.
4.2.7 Methods
These are the processes that are in place in the organisation to make sure that the
resources are working together well. If customers are ordering online there needs to
be satisfactory processes so that the item purchased is delivered when promised and
customers are kept informed of the timing.
4.2.8 Management
There are lots of skills that need to exist in an organisation below the Board of
Directors to make sure that each part of the organisation is properly managed. This
can involve management of the human resources, the factory, the offices or whatever
functions exist in the organisation.
4.2.9 Management information

Feedback is important, so that the management of the organisation can respond to
any events facing the organisation, such as negative feedback from a customer, a
drop in sales or whatever is needed to help operate an organisation successfully.
Management information systems have improved with the technology that is
available. They are likely to hear about a dissatisfied customer quickly when the
customer feeds back that a purchase has not been up to expectations.
4.3 The Value Chain

The Value Chain was devised by Michael Porter. This is a very useful model to look at
the activities of an organisation, as it breaks the functions of the organisation into its
primary activities and its support activities. Importantly, the Value Chain looks at the
activities that add value to the organisation, thereby creating sources of competitive

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advantage and, possibly, unique selling points which differentiate the organisation's
products and services from those of its competitors.
FIRM INFRASTRUCTURE \
ACTIVITIES
HUMAN RESOURCE MANAGEMENT \
SUPPORT TECHNOLOGY DEVELOPMENT
‘Ss
PROCUREMENT
les
INBOUND |OPERATIONS| OUTBOUND | MARKETING | SERVICE
LOGISTICS LOGISTICS | and SALES
PRIMARY ACTIVITIES
4.3.1 The parts of the Value Chain

On the right side of the Value Chain is the 'margin’. This represents the profit that the
organisation is making; how much extra the organisation makes over the costs that
are generated by the rest of the Value Chain. Hence, the revenue of the organisation
represents the full area of the Value Chain, which is divided into the costs and the
profit/margin.
4.3.2 Primary activities

There are the activities involved in the basic functions of the organisation, forming a
chain from obtaining resources through to selling the products made and then
providing after-sales service. The parts of the Value Chain are:
Inbound logistics - These are the steps that are needed to get the raw materials
into the organisation. This can include receiving goods ordered into the
warehouse, the delivery there and the storage of the goods in the warehouse.
Operations - This takes the raw materials/resources that have been ordered
into the warehouse and converts them to a final product. This will involve the
organisation's workforce as well as the machinery and factories the organisation
uses.
Outbound logistics - Once final products are stored in the warehouse, the
outbound logistics delivers them to the customers of the organisation. They
may well need to be packed and then delivered to the customer.
Marketing and sales - Potential customers need to be aware of the products

that the organisation is selling, so there needs to be sales and marketing to
make that happen. This can be via social media sites, KOLs, TV advertising
and so on.
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FRAHAAR
° After-sales service - Not everything works perfectly, so there will be the need to
repair or replace products that are not working as expected, or repairing or
upgrading, if needed and covered by the contract with the customer.
4.3.3 Support activities

There is a need to have other functions in an organisation above the primary
activities. Personnel in an organisation do not just appear as needed and may well
move onto another job once employed for some time. The materials, technology,
delivery vans, etc. all must be purchased. Hence there are another set of activities
that support the primary activities. These comprise:
° Human resource management - Not only do staff need to be recruited but

they need to be trained for their role, looked after if they encounter personal
difficulties, paid appropriately for the contribution they are making and
developed over time to take on higher-level roles. This is all part of human
resource management. There is likely to be a department that is involved in
these activities as human resources are key to an organisation and should be
looked after by their bosses and the directors of the organisation.
° Technology development - There is an increasing need to have good technology

in an organisation, whether this is for a high-tech organisation or even a small
vendor of snacks on a side street. The customers of the small vendor will need
to have some way of knowing where it is and even for ordering in advance, so
technology comes into play there.
° Procurement - All primary activities will need to be purchased, from the raw
materials through to the delivery vans. Hence a procurement department is
needed.
° Firm infrastructure - This will involve the accounts department, the planning
department and quality control, as well as the directors. This can include the
overall governance of the organisation; how it is run from the top.
The activities of the organisation are given in the points above. They will have to be
adjusted to take into account the type of business that the organisation is operating.
However, it needs to be noted that another hidden part of the Value Chain is the
linkages that are between each part of the chain. These linkages need to be
acknowledged and managed. On one level, there will be co-ordination to make sure
everything works smoothly; that a product ordered is in the warehouse and is passed
though the Value Chain to the customer. Another level is that the activities do affect
each other, so need to make sense together. For example, an upmarket seller of food
will need to make sure that the raw food purchased is ofa suitable quality for its
customers (i.e., is cooked to a high standard) and will still be a quality product once
delivered.

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Activity 1
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44
ComFy is a Hong Kong based company that specialises in the production of luxury
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445
bespoke sofas for the home furnishing retail market. ComFy sells its furniture directly
to the end customer via its website which avoids paying the overheads associated
with selling through retail stores. It also means that ComFy can offer a competitive
price for a bespoke product. Its sales order website allows customers to select every
feature of the furniture from a wide number of options. A customer is able to place
their own order online by entering their personal details and payment information.
Once an order is accepted, an estimated delivery date is given and the order is
confirmed at the ComFy factory; a product production schedule is automatically
created. Most delivery dates are ten weeks after the order has been placed. Some
customers find this delivery period is too long, so a small proportion of customers
cancel their order at this stage.
ComFy's procurement department orders materials such as wood, upholstery and

textiles from long-established suppliers based on the orders received. Purchase
orders with suppliers are placed by the procurement department and order
confirmations are emailed to suppliers. Recently, an expected order was not
delivered because the supplier claimed that no email was received, which caused
delays for some orders.
The sofas and chairs are built in ComFy's factory. ComFy maintains relatively high
materials inventory levels to ensure that production is rarely disrupted. Despite this,
the company is unable to meet 25% of the estimated delivery dates given when the
order is placed, due to the required goods not being finished in time. Consequently, a
member of the sales team has to contact the customer and discuss an alternative
delivery date.
Telephoning the customer to change the delivery date is difficult and costly. Also,
many customers are disappointed that the promised delivery date can no longer be
met. Customers often get less than a week's notice of the new date and, so, have to
defer delivery to later than the revised completion date. This means that the goods
have to remain in the warehouse for longer.
About 30% of intended deliveries do not take place because there is no-one at the
address to accept delivery, which means goods need to be returned to the factory
warehouse and stored. A member of the sales staff will then negotiate a new delivery
date, but additional storage and redelivery causes delay and further cost.
The company's original growth was primarily due to the innovative business idea
behind specifying competitively priced bespoke furniture. However, established rivals
are now offering a similar service. In the face of this competition, the Managing
Director of ComFy has urged a thorough review of the supply chain. She feels that
costs and inventory levels are too high and that the time taken from order to delivery

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is too long. In a recent customer satisfaction survey, there was major criticism about
the lack of information about the progress of the order after it was placed.
Required
Using the Value Chain, evaluate operations, inbound and outbound logistics at ComFy
and recommend where improvements can be made.
(Suggested answer point are at the end of the chapter.)
Tutorial video: Activity 1

This tutorial video provides a walkthrough of this activity.
4.4 Internal analysis

Internal analysis is valuable to see how the organisation is placed initially and what
its strengths and weaknesses are. However, the organisation also needs to be
assessed for its external position and this may mean that the internal analysis will
be updated for any new information that emerges from that analysis. It could be
that a competitor has a particular strength that threatens the organisation or that the
organisation finds it has a particular strength that can be exploited better externally.
Once the SWOT analysis is completed, the internal position can be reassessed.
Key takeaway
Make sure that you know and use the models regularly.
Analysing the external position of the organisation

The external position of the organisation needs to be considered to look at the
opportunities that the organisation can take advantage of. These will link to the
strengths that we have seen in the organisation in the internal analysis. The
organisation will also see some external threats, and these will link to the weaknesses
of the organisation, relative to its competitors. The external analysis will first look at
the bigger issues, such as politics and the economy, using a model called PESTEL. It
will then consider the factors for the specific industry or market that the organisation
operates in, using a model called Porter's Five Forces.
5.1 PESTEL
PESTEL looks at the big issues happening around the organisation. The issues here
are likely to affect every organisation to some extent (e.g., the environment we all
live in). This has been seen to be increasingly important, with the threats of global

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warming and pollution affecting everyone and every organisation on the planet,
over time.
PESTEL is made up of six elements.
1. Political factors
2 Economic factors
3 Socio-cultural factors
4. Technological factors
5 Environmental factors
6. Legal factors
5.1.1 Political factors
Different political systems operate in various parts of the world, some dictating what
is allowed for the people ruled by the system, through to others where there is far
less political involvement in the day-to-day lives of the population. There are lots of
possible situations that an organisation will face, from changing tax rates, restrictions
on trade, changing political parties and/or their leadership, political unrest due to
demonstrations, and leaders using their power to their own advantage. There will be
a system of government, and this will vary dependent on the country involved.
Organisations in all countries will have to make sure that they do not upset their
government or there could be a price to pay.
5.1.2 Economic factors
Countries will have years when they boom, and everything seems good, and years
when they enter into recession and the economy shrinks, which is difficult, and years
that are somewhere in-between. There are lots of factors to take into account,
including the inflation rate, exchange rates with other countries, interest rates,
unemployment and taxation included. These are reliant on many different economic
drivers, some out of control of the country.
5.1.3 Socio-cultural factors
The people in the country will have demographics, such as the age of the population,
whether the population is increasing or declining in numbers, the health of the
population, its education levels, the religious and similar influences on the beliefs of
the population, control of the country's borders and immigration and its culture and
lifestyle choices. If an organisation is considering moving into a new market, it needs
to be very aware of what it will face and how to be a success.
5.1.4 Technological factors
There has been a huge change in technology in most countries in this century. In the last
century, there was not much or any use of the internet, smartphones and social media in
comparison to this century. There will be more changes in coming years, whether that is
advances in artificial intelligence, robots and ways to control climate change. This will

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have a huge effect on the products and services that are available for consumers and
how organisations are affected. The current large technological companies may be
affected by a new competitor that offers something better in their market.
5.1.5 Environmental factors
There are lots of effects on the overall environment, from pollution of the
atmosphere to changes in the air temperature that have been seen to affect icebergs
and increase sea levels. Some of the 'assets' of the world that have driven economic
success are declining, such as oil, and are also seen to have a negative effect on the
environment. There may be new resources found but a lot of effort will need to be
put into protecting key resources, such as the atmosphere.
5.1.6 Legal factors

There are many laws that affect organisations, including employment law, company
law, health and safety and consumer protection laws.
PESTEL looks at the current situation for each of the factors in the model but should
also look at the potential changes that could happen. For example, a new government
may change the way that a country runs and could have devastating effects on an
organisation, if, for example, it is banned from operating in an overseas market due
to a political change.
A lot of PESTEL considers bad things that can happen to an organisation, but any
opportunities should also be looked for. An organisation that has a solution to global
warming that works well is likely to be very successful.
Activity 2
Cathay Pacific is a major airline company. An analysis of the company has found the
following points that relate to it.
° Lower oil prices can reduce fuel costs and decrease ticket prices.
° Antitrust laws are regulations that encourage competition by limiting the market
power of any particular airline and are increasingly used.
° Governments are increasingly looking towards carbon emissions trading and

carbon reduction initiatives in a bid to combat the effects of climate change.
° Investment in data analytics and mobility are suggested to improve the

customer experience.
° Political unrest in cities and countries can result in a decrease in flight traffic.
° There are increased regulation and initiatives taken by port enforcement

services to reduce trafficking of illegal goods and tracking of supplier (freight)
compliance using new technologies.

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Required
Categorise the points above into the correct categories of PESTEL and explain the
potential impact of each point.

Weblink
https://howandwhat.net/pestel-analysis-hong-kong/
PESTEL can also be used at a higher level. This link gives a PESTEL analysis for
Hong Kong as a whole.
5.2 Porter's Five Forces

Porter's Five Forces model looks externally to an organisation but not as widely as
PESTEL, concentrating on the more immediate issues that face the organisation in the
industry that it operates in. Hopefully, the industry is favourable to the organisation
but, even if so, some of the factors are likely to be changing over time. The industry
may be wiped out over time by a new market starting that provides a better service.
We can see this from the past: transport evolved when the car was introduced, with
previous methods of travel being relatively slow and expensive in comparison.
Porter's Five Forces model
Potential
entrants
Threat of
new entrants
rig x —
= power Industry competitors ! power eet ;
— Rivalry among ——
existing finns
Threat
of substitute
products
or services
Substitutes

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As the name implies, there are five major forces in an industry that need to be
assessed:
5.2.1 Industry competitors
There will be rivalry amongst the existing companies in the market. There will be
some competitors that are the biggest and dominant in the market but there may
also be some up-and-coming competitors, too. The organisation will have to review
where it sits in comparison to the competition.
5.2.2 Supplier power
Do the organisation's suppliers have the power to raise their prices when they want
to, or is there a lot of competition in their markets so that price rises are unlikely? This
depends on how the supplier stands in relation to the organisation being considered
as well as to the supplier's own competitors. If the organisation can switch suppliers
easily, then supplier power is likely to be low.
5.2.3 Customer power
Similar to supplier power, the organisation will have to look at its customers and think
about how they stand in relation to the organisation. If they are powerful, they may
well put pressure on the organisation to lower its prices or offer a better product or
service for the same price.
5.2.4 Potential entrants
Is the market fairly mature with less scope for new entrants into the market, or is it a
growing and attractive market, enticing new entrants? The more entrants that come
in and take away market share from the organisation, the worse for its profits.
5.2.5 Substitutes
Can an organisation's customers buy from a different supplier of another product or
service that provides similar benefits to the organisation's own products or services?
A bus company that provides transport on defined routes may suffer if there is a
separate market that supplies on-demand taxi journeys at a price that is competitive
and which saves the users time, as they get a direct journey home rather than having
to wait for a bus, take a trip on the bus and then walk home from the bus stop.
The competitive forces in Porter's Five Forces model will vary over time and this
should be considered, based on the information available at the time. The forces
affect some obvious financial variables, costs, sales volumes and sales prices.
Consider which financial variable each of the forces will make a difference to and
how large the forces are.
Example: Merlin Theme Parks

Merlin Ltd (Merlin) operates a medium-sized theme park in Hong Kong. The Board
is looking to expand and has decided to consider its position in an increasingly
competitive market.

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The Merlin theme park is family oriented and is themed around magic and wonder.
The theme park offers roller coasters and other thrill rides, as well as live
entertainment. It also offers a restaurant and café, and sells its own merchandise at
three gift shops located around the park.
The leisure and entertainment industry in Hong Kong and neighbouring countries
is a growing market, as families with leisure time and disposable income seek to
spend more quality time with their young families. However, families are price
sensitive and there is an increasing and wide range of alternative forms of
entertainment available to tourists and domestic customers (e.g., cinemas, sport
events and cultural attractions).
Once a theme park is operational, a major supply cost are the park's employees most
of whom are permanent staff with employment contracts. Staff turnover has
remained stable at 20% for many years. Given the nature of the industry, this is low,
suggesting Merlin's employees are generally content.
The main competitors are chains of theme parks, such as Disney, which are operated
worldwide by large multinational entertainment corporations. The multinational
entertainment corporations gain marketing benefits by linking rides with famous film
and television characters. They also have access to the significant funds to develop
exciting new rides and some add at least one new ride per park per year to attract
new and recurring visitors. A number of the multinational operators have started to
look at other markets in Asia as markets in Europe and America become saturated.
Required
Analyse the theme park industry using Porter's Five Forces.
Solution
Threat of new entrants
The barriers to entry are high due to the expense of acquiring land and constructing a
new theme park. Also, the maturity of the market and the strong market position of
the existing independent theme parks, such as Merlin, also act as a barrier to new
entrants. Therefore, the threat of new entrants is low.
Competitive rivalry
The maturity of the existing market and the opportunity for growth as populations
increase and families are increasingly willing to treat their children, grandchildren and
nieces and nephews, means competition is increasing. Large corporates are spending
annually on exciting new rides, which means independent theme parks like Merlin are
unable to compete with the scale or technology. Therefore, the threat from
competitive rivalry is very high.

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Threat of substitutes
There is increasing options for leisure time including TV, cinema, computer games,
and other tourist attractions which are all competing for a share of household
expenditure. Therefore, the threat of substitutes is high, as children can be
entertained with many different alternatives, many of which are cheaper than a
day at the theme park.
Bargaining power of consumers
Consumers are price sensitive, and many will require promotions to persuade them
to attend which puts pressure on margins. Some consumers will also control their
expenditure in theme park restaurants and gift shops. Therefore, the threat from
consumer demand is high as customers are price sensitive.
Bargaining power of suppliers
Once a theme park is operational, the main supplier is employees. Theme parks tend
to be labour intensive to staff ticketing, rides, live entertainment, restaurants and gift
shops and a theme park cannot operate below a minimum staffing level. Therefore, in
theory, the threat from suppliers is high, however staff turnover is not exceptionally
high and employment contracts are agreed individually which reduces this threat.
Conclusion
The biggest threat is from corporate competitors where the scale of annual
investment in theme park technology and marketing cannot be matched by small
independent parks, like Merlin. Therefore, Merlin's long-term strategic focus must be
on enhancing its unique magic theme to continue to attract new visitors.
Key takeaway
The external factors for an organisation are very important, so get used to applying
them and assessing which are the most important.
Stakeholder analysis
When analysing an organisation, another aspect worth considering is the
stakeholders the organisation has. These are the individuals or groups that have an
interest in what the organisation is doing. Hence, they can be inside or outside the
organisation; the important consideration is their interest in the organisation. There
are three main classifications of stakeholders: internal, connected and external.

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6.1 Internal stakeholders

Internal stakeholders are the management and the employees of the organisation.
They will be well versed in knowing the organisation, given their everyday
involvement in it. They will be interested in what the organisation is doing but will
also be looking after their own interests. These include their pay, bonuses and
whether they get promoted, as well as their overall happiness in their role. If the
organisation is successful and growing, it is more likely that these stakeholders will
be happy. Unfortunately, that is not true for all organisations all the time so there is
the possibility of some conflict.
The culture and ethics that are inherent in the organisation are both big drivers of
how internal stakeholders behave, and this is covered at the end of this section and
in a later chapter of this study guide.
6.1.1 Possible responses

The negative responses that may happen if there are problems include: leaving the
company; following their own goals rather than shareholders' goals; going on strike,
slowing down any new changes in the organisation.
6.2 Connected stakeholders

Connected stakeholders are those that benefit on a financial basis from the
organisation and include the organisation's shareholders, any bankers, suppliers and
customers. They will be looking to gain from the organisation, through dividends and
an increase in shareholder wealth (shareholders), loan security (bankers), profitable
sales and prompt payment (suppliers) and receiving the goods and any future
benefits they have been promised (customers).

Shareholders sell their shares, and the share price drops.
e Bankers deny credit or charge more interest.
° Suppliers refuse to supply any more or take court action.
° Customers buy elsewhere.
6.3 External stakeholders

External stakeholders include the Government, local authorities, pressure groups and
professional bodies. Although not involved much, they can still have an influence due
to the issues that involve them. The Government and local authorities are interested
in keeping employment high, education, training and the collection of taxes. Pressure
groups will be interested in defending the rights of the population and protecting
them from issues such as racism and pollution.

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° The Government and local authorities may change the laws, increase taxation
and invoke the courts.
° Pressure groups may stage protests, get publicity to put pressure on the
Government and the organisation and even take action to disrupt the
organisation.
° Professional bodies may impose ethical standards.
6.4 Stakeholder mapping

Mendelow devised a matrix to assess how important stakeholders are, based on their
power and interest. He then suggested an approach to each of the stakeholders once
the power/interest had been calculated. The matrix is:
Level of interest
Low High
High
Cc D
Power
A B
Low
6.5 D = Key players

High power and interest mean the stakeholder is very influential for the
organisation. A possible example is a major customer of the organisation, where the
effect of the customer leaving would have a serious effect on the organisation's
revenue and profits.
6.6 C = Keep satisfied

Although these stakeholders are not involved regularly with the organisation, they do
have a lot of power if they choose to use it. Large shareholders are an example.
6.7 B = Keep informed

This group of stakeholders needs to be kept informed of what is happening due to
their level of interest. It could be a group in the local community(ies) involved with the
organisation, who have little power to change anything themselves but may try to

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influence the organisation, say by protesting, if they are unhappy with an issue, such
as the pollution that the organisation is causing in the area.
6.8 A= Minimal effort

There is unlikely to be much time or money spent on this group of stakeholders.
Once mapped, the organisation should see what their responses will be and how to
manage each group, if needed. Where there are significant groups of stakeholders,
it is likely that the organisation will benefit from dealing with them well. Employee
and customer loyalty are two benefits of doing so. Reducing the amount of change
in the organisation can also have benefits, so keeping stakeholders like suppliers,
investors and customers happy will help the organisation work better and boost its
chances of success.
6.9 Influence of culture and ethics

For internal stakeholders, culture and ethics are important factors on how they
behave and how successful an organisation will be over time. A Deloitte survey in
2016 of CEOs and HR leaders had 82% of them say that "culture is a potential
competitive advantage". More CEOs and executive teams are taking responsibility for
their organisation's culture. However, only 28% of the respondents to the survey
believed they understood their culture well, for example. Culture describes "the way
things work around here". It includes values, beliefs, behaviours and reward systems
that influence employee behaviour. It is something that can drive business strategy
and boost corporate success. Culture needs to have engagement (i.e., employees
feeling good about the way that things work in the organisation). It is very important
when things go wrong, as a good culture can help an organisation work out solutions
to the problems more quickly.
Culture is an obligation of the Board of Directors, who should understand both the
current culture and the desired culture in the organisation. Ideally, culture should be
measured via staff surveys so that it is better understood.
Ethics is covered later but, again, it is a fundamental part of an organisation

and indeed the culture that exists. Poor ethics will inevitably lead to scandals,
the value of an organisation falling and, possibly, the organisation going out of
business. A failure to do the right thing will cause social, environmental and
economic damage. Conversely, good ethics will often contribute to long-term
success, so it should be built into the organisation's business models and decision-
making processes.

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Weblink
https://www2.deloitte.com/us/en/insights/focus/human-capital-trends/2016/impact-
of-culture-on-business-strategy.html
The Deloitte article on the effect of business culture, with the research they have done
around the world and examples of companies, can be viewed via this link.
Key takeaway
Stakeholders can have a large say in whether an organisation's strategy will be
accepted and work. Make sure you decide who are the most important.
SWOT analysis
Now that the strengths and weaknesses have been determined from the internal
analysis (and reconsidered once the external analysis is done) and the opportunities
and threats have been considered from external analysis, then a SWOT analysis can
be performed.
This allows us to decide:
° What are the most important issues, internally or externally, facing the
organisation?
° Are there significant opportunities to grow the organisation?
° Does it look like there is a threat to the organisation's current position that
needs to be addressed?
° What does the organisation have already that will give it the chance to survive
and grow?
° Is there something in its internal make-up that will reduce the chance of the
organisation being successful?
Considering if any PESTEL factors will make favourable or unfavourable changes to

the issues in Porter's Five Forces, is worthwhile. Could a competitor get stronger or
weaker due to a PESTEL factor?
Also, look at combinations in the SWOT analysis. For example, think if there are any
opportunities that make use of the strengths of the organisation, or any strategies
that address weaknesses to help success at an opportunity, or any strengths that can
be used to address weaknesses.
If it is possible to put numbers to the parts of SWOT that will be useful, to try to judge
how the factors will impact the profit of the organisation. Knowing a factor is an issue

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is a good start but finding out that it is has a huge, or small, effect on the
organisation's profit is more valuable.
Activity 3
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Cathay Pacific has had a SWOT analysis performed for it, highlighting its key internal
and external issues.
The factors are:
° Cost reduction initiatives leading to unpleasant measures
° Expansion in air freight sector, in cargo hubs like Dubai
° Volatility in jet fuel prices
e Code sharing agreements along with membership in OneWorld Alliance
° Huge fleet and mix of aircraft
° Regulatory issues pertaining to continuing operations in both domestic and
international segments
° Future finance lease liabilities affecting expansion
° Technology backed services leading to improved operations and reduces costs
Required
(a) Decide which are internal strengths and weaknesses and which are external
opportunities and threats.
(b) Assess the strategic position of Cathay Pacific and say what information would
help to make a better assessment.

Key takeaway
SWOT analysis allows time to weigh up the importance of the external and internal
factors and, particularly, their interaction.
Strategic choice
Strategic analysis is a foundation for moving to the next stage of business strategy,
which is the consideration of possible business strategies that build on the strengths
of an organisation, address the weaknesses, take advantage of any opportunities and
attempt to deal with any threats. Firstly, the organisation needs to think about where
CPA Hong Kong institute of

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it will want to be placed in its markets to be successful. It will also need to think about
how it can grow in its existing market and whether there are new products or services
and markets that it can grow into.
Once this has been decided, the mechanics of the strategy can be decided - is it best
to grow by itself or to acquire another organisation?
Once decided, the strategic options need to be evaluated and will be judged as to
whether they are suitable, acceptable and feasible. If a strategy passes those three
criteria, the organisation is likely to want to follow that strategy.
Firstly, we will examine sustainable competitive advantage as achieving or

maintaining competitive advantage is the foundation of strategic choice.
8.1 Strategic competitive advantage

Planning to achieve or maintain strategic, competitive advantage must be part of the
strategic choice. Sustainable competitive advantage must be:
e Value to consumer
e Rare
e Robust
e Non-substitutable
8.1.1 Value to consumer

This is the reason the customer purchases a specific product or service. It could
be product price, features, design, brand, convenience or ease of purchase.
Understanding the core drivers of demand helps organisation to adapt their
product or services or focus on maintaining and improving the reasons why
customers chose an organisation's products or services over another. Porter's
Value Chain is essential in identifying sources of value. Organisations also invest in
marketing-based research and feedback to identify the critical success factors.
8.1.2 Rarity
A single unique resource may have the potential to create competitive advantage
by itself. The importance of rarity is that, if a resource or skill is generally available
(i.e., not rare) then an organisation's competitions will also have access to it. Rarity
includes:
e A unique tangible resource in the form of ownership of extraction rights to an

easily worked deposit of a scarce and valuable mineral
° A unique intangible resource in the form of ownership of the copyright of a

best-selling novel
° A core competence in a dangerous and demanding process, such as

extinguishing oil well fires

Certified Public Accountants WA
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8.1.3 Robustness
Robustness is an attribute of a product or service which is difficult for competitors

to imitate. Robustness most frequently resides in the competences involved
in linking activities and processes in ways that both satisfy the critical success
factors defined by customer priorities, and which are difficult for competitors
to imitate.
There are three main aspects of a competence that tend to make it robust.
(1) Complexity arises from the linkages between the activities the organisation
undertakes and the way it organises them. It also appears when organisations
develop complex links with their customers.
(2) The culture and history of the organisation provided tacit knowledge (see below)
and capability in the form of an accepted, if ill-defined, way of doing things.
(3) Causal ambiguity occurs when the processes and linkages that produce the
organisation's competences are opaque, so competitors are uncertain about how
to imitate them.
8.1.4 Non-substitutability
Substitutability of strategic capability has two forms and managers must be alert to
the emergence of either, since both are a threat to even a competence that possesses
the other three vital qualities.
(a) The substitute product you are familiar with from our earlier discussion of the
Porter's Five Forces model
(b) The substitute competence; an example is the deployment of expert systems as

substitutes for expensive professional advisers
8.2 Cost leadership or differentiation

Michael Porter, who also developed the Porter's Five Forces model, set out a further
model to bring competitive advantage to an organisation. There are two ways that an
organisation can be successful in the model, either by reducing costs in order to
boost profit or by being able to charge higher prices due to special features of the
organisation's products or services.
The two ways that Porter said that organisations could achieve a competitive
advantage are:
8.2.1 Cost leadership

Cost leadership means becoming the leader in the market on the basis of cost
reduction. Ideally, this would happen without a drop in price, though it is likely that
the way that the organisation uses its lower costs is by reducing its prices, so that it
attracts more customers relative to its competitors. This could help the organisation

a HRRUNALR
obtain the biggest market share in the market. One way that the organisation can
reduce its costs is by being the biggest organisation in the market, meaning it has
large buyer power and can spread its overheads over a larger number of units sold.
There can only be one cost leader in a particular market, though that depends on
how the market is defined. It can be that an organisation is only interested in
competing in one region of a country and aims to be the cost leader there. Other
organisations may take a broader view of the market and are likely to have lower
costs if they supply all the regions of a country.
How to achieve overall cost leadership
° Set up larger production facilities to obtain economies of scale.

° Use the latest technology to reduce costs and/or enhance productivity (or use
cheap labour, if available).
° In high technology industries, and in industries depending on labour skills for

product design and production methods, exploit the learning curve effect. By
producing more items than any other competitor, an organisation can benefit
more from the learning curve, and achieve lower average costs.
° Concentrate on improving resource efficiency, economy and effectiveness to
increase productivity.
e Minimise overhead costs.
° Get favourable access to sources of supply.
Real life Illustration: Cost leadership

The following link gives seven illustrations of cost leadership, including Lidl,
McDonald's and IKEA which all have operations in Hong Kong.
https://mktoolboxsuite.com/cost-leadership-examples/
8.2.2 Differentiation
Differentiation involves offering something different in the organisation's products or
services. By doing so, the organisation hopes to be able to charge a higher price. The
difference could be the brand that the organisation has, which probably needs to be
supported by higher marketing costs in order to make the brand well-known. So long
as the extra revenue involved from sales and profits of the brand means that the
extra marketing costs are worthwhile, a differentiation strategy is worth following.
Similar to cost leadership, the organisation may decide to focus on a particular sector
of its market. A high-class fashion label will have a set of wealthy customers that it
hopes to attract and will offer features that it hopes that the customers will be
attracted to. These include the prestige of wearing the particular brand but are likely

me 44argeea
to include other features, such as attractive material that the clothes the organisation
sells are made from.
Differentiated products may be divided into three categories:
(a) Breakthrough products offer a radical performance advantage over

competition, perhaps at a drastically lower price.
(6) Improved products are not radically different from their competition but are
obviously superior in terms of better performance at a competitive price
(e.g., microchips).
(c) Competitive products derive their appeal from a particular compromise of cost
and performance. For example, cars are not all sold at rock-bottom prices, nor
do they all provide immaculate comfort and performance. They compete with
each other by trying to offer a more attractive compromise than rival models.
How to differentiate
(a) Build up a brand image (e.g., Pepsi's blue cans as opposed to Coke's red ones).
(6) Give the product a radical design or special feature to make it stand out in the
market.
(c) Provide a value adding service, for example, a warranty, quality of after-sales
service or speed of delivery.
Real life Illustration: Differentiation
The following link gives one view of how Apple can inspire Hong Kong's success in the
future.
inspiration-for-innovation-in-hong-kong
8.2.3 Focus differentiation

A focus differentiation strategy requires an organisation to concentrate its attention
on a particular market segment and does not try to serve the entire market with a
single product. A good example are luxury brands, as these products are inaccessible
to most, yet command a substantial price premium for the status of ownership. A
good example is Rolex watches.
Advantages
(a) Anicheis more secure due to its brand value so an organisation is protected
from competition.
(b) The organisation does not spread itself too thinly.

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Drawbacks of a focus strategy
(a) The organisation sacrifices economies of scale which would be gained by

serving a wider market.
(6) Competitors can move into the segment and competitor brands can ascend
upwards.
8.2.4 Improving strategic capability

Strategic capability only exists where an organisation can continue to Satisfy its
customers' needs. Competitive advantage cannot be created if customers do not
value a product or service.
There may be opportunities to stretch existing capabilities and to add new ones.
(a) Competences can be extended. Competences that support an existing business

may be equally relevant to new activities.
(6) Non-essential activities can cease. It may be possible to make significant cost
savings by abolishing, minimising or outsourcing current activities that do not
support critical success factors.
(c) Best practice can be extended. Strategic capability identified in one part of the
organisation might be introduced in other parts; though the difficulties
associated with the management of change can make this very difficult.
(d) Activities can be added and existing ones improved in order to better support
critical success factors.
(e) Activities can be re-structured. System overlaps and inconsistencies may require
attention, particularly when there are marked differences between the
requirements of the various market segments served.
(f) Weaknesses can be remedied. Known weaknesses in resources or activities

might have the potential to create competitive advantage if suitable market
opportunities exist. Such weaknesses must then be remedied by suitable
investment and management activity.
(g) External capability can be introduced by acquisition and through alliances and
joint ventures.
(h) People capabilities can be enhanced by targeted recruitment and training.
8.3 Strategies to grow

Ansoff's model is based on the possibilities for an organisation to grow. It gives some
possibilities that the organisation can consider and decide if it is best for it to change
what it does with the products that it sells, perhaps introducing new products, the
markets it is involved in, perhaps entering new markets, or both, having new
products and new markets at the same time. The organisation may decide to follow

ae SRN OR
more than one of these strategies, so it is worth considering each of them to see if
more than one is worthwhile for the organisation. The matrix that Ansoff set out is
below. It involves two axes, looking at products and services on one axis and markets
on the other.
Ansoff's growth strategies
Products or services
Existing products New products
New market Market development strategy Diversification strategy
Market
Product development
Existing market Market penetration strategy strategy (or innovation
strategy)
8.3.1 Market development

A strategy of market development looks at the organisation's existing products
and thinks about whether there are new markets that these products could be
sold into. An obvious possibility is a new country or region where the products
have not been sold before. Obviously, it depends on whether there will be
substantial costs of entering that market and whether it makes sense financially,
but it is worth considering, particular if the market targeted has weak or no
competition for the organisation's product. However, another possibility is for
the organisation to see if there is another segment of the same market that could
be targeted. A car company could find that it could offer a new variant of its cars
to a different segment of its market.
8.3.2 Market penetration

A strategy of market penetration is targeting the organisation's existing market
and trying to sell more of its products there. This could be by lowering prices or by
offering new attractive features to its products. This strategy may be difficult if the
market is well established with lots of competition already existing. Any changes in
strategy by the organisation are likely to see responses by the opposition to combat
the strategy. Hence, it may be that the organisation takes a lot of money, time and
effort to develop this strategy only to find that its competition take defensive action
and it does not gain anything.
If it is possible to make the overall market grow by attracting more customers into the
market that may well be more successful, as the competition will not be seeing their

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sales and profits drop by so much. However, with many mature markets, this will not
be possible and, if the organisation were to win by selling more products into the
market and gaining market share, then competitors would lose and, hence, a battle
would commence.
8.3.3 Product development

Product development means devising a new product or service that is sold into
the organisation's existing market. This can be successful if the organisation is
well known in the market and has a good reputation already. It is likely to be
growing the size of the market due to customers deciding to buy the new products
as well as the existing ones. It could be relatively easy to achieve. For example, if a
company develops a new app that can be used on smartphones, PCs and tablets
which it can sell to its existing customers as well as new customers in the same
overall market. This does not mean that it will not involve costs to achieve success,
from developing the app through to marketing it and then providing support after
the app is launched. There is a danger that the app may not be successful, as lots of
new products do not work out.
8.3.4 Diversification
This strategy involves a new market and a new product. Hence, it can be regarded
as one of the riskier strategies due to the novelty of both market and product.
There is more that can go wrong. Diversification can be conglomerate diversification,
into totally new products and markets, or concentric diversification, into new
products and markets that bear some relationship to existing products (e.g., a new
app that offers physical health advice and support to women, when the existing
app is for meditation and is provided for men only). The advantage with concentric
diversification is that it does use some skills that the organisation has already.
Another version of this is called vertical integration, where an organisation
purchases a Supplier or an outlet of the organisation. A food producer may decide
to expand by buying a chain of retail outlets, meaning it has expanded forward into
the market. There are risks involved, especially if its other retail customers are
upset by this action.
Key takeaway
Often, the strategy to progress will be suggested, so see if it fits into cost leadership
or differentiation and a suitable growth strategy.
Example
Hong Kong's Ocean Park is an interesting example of a company that has had Porter's
generic strategies (cost leadership and differentiation) as well as Ansoff's Matrix
applied to it. lt competes with Disney.

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It has had the following comments:
Cost leadership - It has efficient value chain management to reduce costs while
possible allowing it to expand market share by attracting the middle class, an
important target market. This is Ocean Park's main strategy. However, it also
considers the following.
Differentiation - It has extended its product line due to consumers' changing interest
and invests heavily in marketing, advertising and celebrity endorsement, as well as
using a distinctive logo.
In terms of Ansoff's Matrix, one of Ocean Park's key strategies is market penetration.
This ties into the cost leadership approach to attract more customers and increase
sales. This helped gain success in its home market.
A secondary strategy is product development, which helped Ocean Park to grow

more easily. It helped them target existing customers and grow sales with them. Also,
they are considering market development to use their expertise to grow into new
markets, particularly into developing countries.
It places low importance on diversification. It has enough happening with its principal
aim of market penetration, backed by product and market development.
Further details are given at: https://www.essay48.com/case/18069-Hong-Kong-s-

Ocean-Park-Taking-on-Disney-Porters-Generic-Strategies
9 International strategic choice

Ohmae (1999) suggests there are five reasons why companies are moving towards
international markets:
1. Customer. Widespread international customer demand for products with

similar characteristics
2. Company. The need for economies of scale driving international expansion to

achieve value for money from company infrastructure and production capacity
3. Competition. The existence of international competitors driving companies to

expand or seek out cost-sharing strategic alliances
4. Currency. Stable rates of currency exchange providing confidence for

international expansion
5. Country. Multiple locations enable a company to exploit customer and cost

advantages. The ability of adapting products and services to the culture ina
country makes it easier to trade

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There are other factors encouraging the globalisation of world trade.
(a) Availability of finance to fund international expansion. A change in attitude by

lenders means capital is more readily available.
(b) Political and trade connections between countries reduce tariffs and restrictions
between countries. Conversely, government policy in many countries seeks to
control the balance of payments by discouraging imports, which encourages
companies to manufacture in the country where the product is intended to be
sold (or exported).
(c) Internationally recognised legal and regulation principles, such as industrial

standards and protection of intellectual property, provide confidence to develop
innovation and design for international markets.
(d) The internet. Many companies are developing online systems of sales and
internal co-ordination and procurement which go beyond traditional borders.
The availability to resource materials and labour readily from international
sources and delivery to another country to a specific destination at some future
time make internationally based productions and sale easier to manage from a
different country.
When making a decision as to which international market to enter or country to

manufacture in, a risk analysis, business case and strategic implementation plan are
all required. The Diamond model (Porter, 1990) can help in the selection of suitable
countries.
9.1 Porter’s Diamond

Porter (1990) identifies four principal factors which assist in the suitability of a country
in which to expand sales and manufacturing. This is known as Porter's Diamond.
Factor
conditions
Strategy,
Demand
structure and
conditions
rivalry
Related and
supporting
industries
(Source: Porter, 1990)

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9.1.1 Factor conditions

Factor conditions are a country’s endowment of inputs to production.
° Human resources (skills, price, motivation, industrial relations)

° Physical resources (land, minerals, climate, location relative to other nations)
e Knowledge (scientific and technical know-how, educational institutions)
° Capital (amounts available for investment, how it is deployed)
° Infrastructure (transport, communications, housing)
Porter (1990) distinguishes between basic and advanced factors.
(a) Basic factors are natural resources, climate, semiskilled and unskilled labour.
They are inherent or, at best, their creation involves little investment. They are
unsustainable as a source of national competitive advantage since they are
widely available. For example, the wages of unskilled workers in industrial
countries are undermined by even lower wages elsewhere.
(b) Advanced factors are associated with a well-developed scientific and

technological infrastructure and include modern digital communications
infrastructure, highly educated people (e.g., computer scientists), university
research laboratories and so on. They are necessary to achieve high order
competitive advantages, such as differentiated products and proprietary
production technology.
An abundance of factors is not enough. It is the efficiency with which they are
deployed that matters. The former Soviet Union had an abundance of natural
resources and a fairly well-educated workforce but was an economic catastrophe.
Porter (1990) also notes that generalised factors, such as transport infrastructure,
do not provide as decisive and sustainable bases for competitive advantage as do
specialised factors. These are factors that are relevant to a limited range of industries,
such as knowledge bases in particular fields and logistic systems developed for
particular goods or raw materials. Such factors are integral to innovation and very
difficult to move to other countries.
9.1.2 Demand conditions

Similarity with an organisation's current domestic market determines how
organisations perceive, interpret and respond to international buyer needs and being
successful in the domestic market is often a launch pad for international ambitions.
Factors to consider if an international country is suitable are:
(a) There are no cultural impediments to communication.
(b) The segmentation of the home market shapes an organisation's priorities:

companies will be successful globally in segments which are similar to the home
market.

mae =SBRUNHAAR
(c) Sophisticated and demanding buyers set standards. If the home market sets
high standards, achieving these high standards will put an organisation in a
strong position to be competitive on the international market.
(d) Anticipation of buyer needs. If consumer needs are expressed in the home
market earlier than in the world market, the organisation benefits from
experience.
(e) The rate of growth. Slow growing home markets do not encourage the adoption
of state-of-the-art technology.
(f) Early saturation of the home market will encourage an organisation to export.
9.1.3 Related and supporting industries

Competitive success in one industry is linked to success in related industries.
Domestic suppliers are preferable to foreign suppliers, as they offer continuing close
co-operation and co-ordination. The process of innovation is also enhanced when
suppliers are of high quality since information is transmitted rapidly and problems
are solved by joint effort.
9.1.4 Strategy, structure and rivalry

Nations are likely to display competitive advantage in industries that are culturally
suited to their normal management practices and industrial structures.
Industries in different countries have different time horizons, funding needs and
so forth.
(a) National capital markets set different goals for performance. In Germany and
Switzerland, banks are the main source of capital, not equity shareholders.
Short-term fluctuations in share prices are not regarded as of great importance
as funds are invested for the long term. In the US, most shares are held by
financial institutions whose own performance indicators emphasise short-term
earnings growth.
(6) National attitudes to wealth are important. The egalitarian Swedes are rarely
successful in industries that have the potential to create individual fortunes but
depend on new Start-ups.
(c) National culture affects industrial priorities through the relative prestige it allots
to various industries and their leaders. Italy values fashion and furnishings, for
instance, while in Israel the most prestigious industries are agriculture and
those related to defence.

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=) Example: Porter's Diamond

BI ANT is an international retail bank with operations internationally. ANT has a good
international brand image and a record of success, with branches as well as internet
banking. It provides:
° Personal accounts with debit cards

° Credit cards
e Mortgage lending
° Loans for individuals, including pay-day loans
ANT has offered retail banking services in India for the last four years (since 20X8).
India liberalised its economy twenty-five years ago which means it now allows the
free flow of capital into and out of the country. The largest state-owned bank, SB, has
just over 50% of India's retail banking business and, hence, is very powerful. It has
been improving its strategy and offering some new products, which have gone down
well in the country.
ANT invested in India because India had a rapidly growing economy and, in 20X8, ANT
considered there to be good retail banking opportunities with 75% of the population
of India having a bank account. ANT initially invested $200 million entering India and
establishing its own branch network there. It also purchased a local bank in India for
$150 million.
The Indian Government prefers SB over foreign competition. The Indian population
are generally conservative and happy to follow what the Government says is best. In
India, mortgage and consumer lending has grown at 17% per annum compound in
recent years. This looks as though it will continue.
There are a number of foreign banks which have been established in India and are
all profitable. They have 35% of India's retail banking market. There are two foreign
banks which entered India at the same time as ANT, but which have withdrawn from
India due to not making a profit.
Advise ANT on using Porter's Diamond for investing in an overseas country based on
its experience in India.
Solution
Porter's Diamond looks at the issues affecting a country's competitiveness against

other nations. This can be used to look for a company like ANT to see if the country is
a good place to invest in. It is best to work through the parts of Porter's Diamond in
order to be able to advise ANT using India as an example, and then allowing them to
use the same technique for another country.

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It may be best for ANT if the country is not so competitive, so there is a chance for
them to get a competitive advantage and make the investment worthwhile. When it is
considering future investment in new foreign countries, ANT should try to invest in
countries which have a favourable environment for retail banking, and so will
maximise the chances of its investment being successful. The Government in India
does not seem keen on having foreign competition due to the state bank, which may
affect competitiveness in India. We have seen that two foreign banks have withdrawn
recently, which is not a good sign. ANT should look out for this in deciding to invest in
other countries.
Following through Porter's Diamond:
° Factor conditions - Will the necessary inputs be there for ANT? This is likely
in India where there is an intelligent pool of potential employees, for
example. The quality of ANT's employees will be important in a service
industry. This should be considered for any countries where it is making
new investments.
° Demand conditions - Demand looks good, with 17% per year growth being an
attractive figure for new lending. There will be more demand for bank accounts
as all the adult population obtain one. The high borrowing rate looks attractive
in India. In another country, a similar assessment would need to be done. Is
there demand for the products that ANT would offer?
° Related and supporting industries - There must be a good infrastructure in the

industry to make sure that ANT is supported. This includes support for the
technology offering of ANT. It must be robust against outages and hackers so
will need help from the technology industry in the new country.
° Firm strategy, structure and rivalry - The situation in India illustrates how the
structure and rivalry of the banking industry (dominated by the state-owned
bank, SB) have a major impact on the competition any potential new entrants
will face there. Hence, in a new market, ANT should be thinking about its
potential rivals and the advantages they will have.
However, if ANT does use Porter's Diamond to help assess possible new countries
to invest in, it should be careful. Some people argue that it is companies, not
countries, which work out their competitive advantage. Hence, a company's success
is determined by its strategies and management, rather than being in a particular
country. If a company like ANT has a strong competitive advantage, it has a chance
to be successful in any country.

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9.2 Modes of entry to foreign markets

The two main ways of entering foreign markets are exporting to another country or
basing manufacturing (or service provision) in another country.
9.2.1 Exporting
Goods are made at home but sold abroad. It is the easiest, cheapest and most
commonly used route into a new foreign market. Attributes include:
(a) Sales to final user. Typical customers include industrial users, governments or
mail order customers.
(b) An international export agent or distributor is an international organisation

hired to act on an organisation's behalf to effect a sales contract between
the principal (i.e., the exporter) and a customer. Agents earn a commission
(or profit).
(c) Company branch offices abroad. An organisation can establish its own office in
a foreign market for the purpose of marketing and distribution as this gives
greater control.
Advantages of exporting
Exporters can concentrate production in a single location, giving economies of

scale and consistency of product quality.
Firms lacking experience can try international marketing on a small scale.
Firms can test their international marketing plans and strategies before risking
investment in international operations.
Exporting minimises operating costs, administrative overheads and personnel

requirements.
Disadvantages of exporting
Export is easier, however some countries will allow only a restricted level of
imports whilst others welcome an organisation if it builds manufacturing
facilities which provide jobs.
Furthermore, goods and services may need to be delivered locally (e.g., high
technology goods needing installation, maintenance and servicing by personnel
in the local market with specialist technical skills.
Also, there may be a lack of suitably qualified distributors or agents which would
preclude the export, direct or indirect.

HARUALR
9.2.2 Overseas production

An organisation can manufacture its products internationally, either by itself or by
using an international manufacturer.
Advantages of international manufacture
° A better understanding of customers in the international market
° Economies of scale in large markets
° Production costs are lower in some countries than at home
° Lower storage and transportation costs
° Overcomes the effects of tariff and non-tariff barriers
° Manufacture in the international market may help win orders from the public
sector
Disadvantages of international manufacture
° Cultural differences may make it difficult to manage international operations.
° Practices may be common in the location of the manufacturing that are

considered unethical in the home country, and this may impact the reputation.
° There may be additional political risk (e.g., governments who do not favour
inward investment).
9.3 Manufacturing internationally

There are four methods to achieve manufacturing in a different country. These are
operating from a branch office, licensing, a joint venture or setting up a subsidiary.
9.3.1 Operating from a branch office

Operating as a branch of the main company avoids setting up a new company
however there are many downsides. These include potential tax disadvantages
(higher rates, loss of local reliefs), restrictions on hiring local workforce, difficulties
setting up a bank account and repatriating profit. There may also be a legal
requirement to set up and register a new entity in that country in order to trade.
9.3.2 Licensing
Licensing is a quite common arrangement as it avoids the cost and problems of
setting up internationally.
In the case of a licensed manufacture, an organisation (the contractor) makes a

contract with another organisation (the contractee) abroad whereby the contractee
manufactures or assembles a product on behalf of the contractor. Contract
manufacture is suited to countries where the small size of the market discourages
investment in plant and to organisations whose main strengths are in marketing
rather than production.

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Advantages of licensed manufacture

° No need to invest in plant internationally
° Lower risks associated with currency fluctuations
° Risk of asset expropriation is minimised
° Control of marketing is retained by the contractor
e Lower transport costs and, sometimes, lower production costs
Disadvantages of licensed manufacture

° Suitable international producers cannot always be easily identified
° The need to train the contractee producer's personnel
° The contractee producer may eventually become a competitor
° Quality control problems in manufacturing may arise
9.3.3 Joint venture
Some governments discourage or even prohibit foreign organisations setting up
independent operations in a country, so a joint venture with a local company may
be the only option. Under a joint venture control, revenue is shared in accordance
with a joint venture agreement. Usually, a new entity is registered in the country of
manufacture or trade, and ownership is shared, which will have financial reporting
implications as the share or trade and separate assets and liabilities are consolidated
in annual group accounts.
A key upside to a joint venture is it provides local knowledge, quickly.
9.3.4 Set up of a wholly owned subsidiary
A company can choose to manufacture in a new country. Usually, a subsidiary will
need to be created, rather than a branch office to take advantage of local labour
markets and tax reliefs. Production capacity can be built from scratch, or an existing
manufacturing organisation can be acquired. Therefore, timing, cost and the need for
local knowledge are all considerations.
(a) Acquisition has all the benefits and drawbacks of acquiring a domestic
company.
(b) Creating new capacity can be beneficial if there are no likely candidates for
takeover, or if acquisition is prohibited by the government.
Advantages of a wholly owned international production
° The organisation does not have to share its profits with partners of any kind.
° The organisation does not have to share or delegate decision-making.
° There are none of the communication problems that arise in joint ventures.
° The organisation is able to operate completely integrated international systems.
° The organisation gains a more varied experience from international production.

a HRRUNALR
Disadvantages ofa wholly owned international production
° The high value of the investment needed prevents some organisations from
setting up operations international.
e Suitable managers may be difficult to recruit at home or abroad.
° Some international governments discourage, and sometimes prohibit, 100%

ownership of an enterprise by a foreign company.
° This mode of entry forgoes the benefits of an international partner's market

knowledge, distribution system and other local expertise.
9.4 Evaluating export vs manufacturing overseas

At Capstone, there are many considerations before a recommendation is made
whether or not to export or manufacture/provide service in another country.
Advantages Concentrates production in one — Lower distribution costs;

place; small start possible; overcomes trade barriers;
minimises overheads possibly lower production costs
Key issues Exchange rates; government Political risk; partnership;

protectionism of domestic trader managing international facilities;
more risky
Involvement Usually less involved, but it Usually more involved, but

might depend on the international subsidiaries might
international market act independently: varying levels
of control and risk
Other considerations include:
° Setting up an international production facility would be inappropriate if sales

are expected to be low in volume.
° A small organisation is less likely than a large one to possess sufficient

resources to set up and run a production facility international.
° When an organisation is unable to recruit suitable staff, either at home or

international, indirect exporting or the use of agents based internationally may
be the only realistic option.
° Companies which are already active in international markets are better placed
to expand into new countries than a company without international experience.
° Production international by a wholly owned subsidiary gives an organisation

absolute control while exporting or licensing offers only limited control.

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10 Evaluation of strategic options

A lot of thought will have gone into the previous steps in the strategy process. We
have followed through, from seeing the internal and external factors in an
organisation; deciding which are most important, to looking at the strategic
possibilities and generating possibilities for the organisation to advance.
A final evaluation of the options the organisation is considering needs to be achieved.

There are three dimensions to this: suitability, acceptability and feasibility.
10.1 Suitability
The first big question that needs to be asked is whether the strategy takes the
organisation in the direction that it wants to. It could be that the strategy deals with a
problem that the organisation has, say declining market share, and that is good news
for the organisation. So long as the strategy is likely to achieve what the organisation
needs to do, it is good news and is likely the strategy will be adopted.
10.2 Acceptability
Acceptability refers to the main groups of people involved in the organisation, the
stakeholders. The most obvious of these for a major strategic decision are the
shareholders and the Board of Directors, those that own the organisation and those
that are responsible for its success. If either of these stakeholders object to the
strategy, there is a likelihood that it will not be followed. However, other groups of
stakeholders for an organisation include its management and employees and these
may have an impact on the success of the strategy, especially if they are not able or
happy implementing it. Hence, it is worth considering the acceptability of the strategy
across the stakeholders in the organisation, in case there could be problems with its
implementation.
10.3 Feasibility
Is this really going to work? We first need to look here at the resources of the
organisation and its competences.
Resources and competences involve the employees of the organisation to see

whether there are the skills and ability to achieve what is needed. If not, the strategy
may not be achieved, though there is the possibility of expanding this resource so
that the needed skills are obtained. Finance is another resource. There needs to be
enough cash available to be able to buy whatever is needed. If the shareholders are
not able to provide more money and the organisation is highly geared, then that
borrowing may not be possible and the strategy will not be feasible

a HRRUNALR
It is always worthwhile to evaluate options in the exam by applying the tests of

Suitability, acceptability and feasibility. lt may be that a strategy meets each of these
tests but is also likely that they indicate a need for work needed to achieve the
strategy, say the recruitment of new staff or selling the benefits of the strategy to
the employees of the organisation so that they are motivated to achieve it.
Real life Illustration: Walt Disney

You can download a link to a strategic assessment of Walt Disney. This covers the
models used in the chapter and has various strategic options considered, including
Hong Kong and China. The suitability/acceptability/feasibility framework is given
on page 16 but there is a lot of other models used so you can assess what they
have done.
NWW.TeCSCd
or Walt Disney Amended_on_16102015
Key takeaway
Learn ‘suitable, acceptable and feasible’ to apply to any strategy as a final check.
11 Marketing
Once a strategy is identified, tested and assessed as Suitable, acceptable and
feasible then the strategy will need to be implemented. There are lots of aspects to
this and a key part of this is how the organisation approaches the marketing of the
new strategy. Marketing is the process responsible for identifying, anticipating and
satisfying customer requirements profitably. It will help an organisation achieve its
goals better than its rivals in the market(s) the strategy involves.
Definition of the market that is being targeted is a good Start. It may not be the full
market for a product or service but could be one part that is targeted. It may be that
a company is targeting the market for selling sushi but only for home deliveries.
Consideration of the matters that are important for the customers in that market is
key and the marketing needs to emphasise that the company knows what they
customers want. The organisation will need to be convinced that the market is a
suitable size, or will grow to be, as well as there is enough profit in the market.
Once an organisation has decided the market that it wants to compete in, and how it
intends to compete, it can decide how it sets up its marketing. A useful tool here is
the marketing mix.

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11.1 Marketing mix

The marketing mix consists of seven elements: product, price, promotion, place,
people, processes and physical evidence. However, the final three are particularly
related to the marketing of services. The aim is to obtain a competitive advantage for
the organisation, so the elements will need to be adjusted until they are considered
optimal and may well change over time as market conditions change.
11.1.1 Product
The starting point for any marketing is the product or service that the organisation
is wanting to provide for its customers. Although a product is easily defined by its
physical features, any product or service needs to consider all the features that it
provides and what the customer values. For a product like a meal in a restaurant, the
table service and the location of the restaurant are other features that are important,
on top of the actual food provided on the plate.
11.1.2 Price
Consideration of price comes back to what we have seen already with Porter's generic
strategies. Is the organisation a cost leader or differentiated? This strategy should
have been decided and the marketing should reflect this. There can be other aspects
of price as well as the amount paid, if there are customer loyalty benefits that are
offered for customers that keep buying. This is obviously a good strategy if it
generates happy customers and an improved market share.
11.1.3 Promotion
How best to reach the customers? This can be online via a social media app, as part of
an internet search or when customers search for a product on an online shopping
site and certain products are suggested as best for the customer. It can also be via
other methods, such as mailings and TV adverts.
11.1.4 Place
Where is the best place to reach customers? Will they respond to physical adverts on
public transport or in a shopping mall? Is online better? Or should the place be via an
intermediary?
The three additional parts of the marketing mix for services are:
11.1.5 People
People are important to deliver a service. Ifa company provides massages and other
health boosts, then it will be important that the people providing that service are
'sold' as experienced and providing a good service. Hence, getting good staff in the
first place is very important.

mae =SBRUNHAAR
11.1.6 Process
This can depend upon the strategy for the service. A differentiated service will have
extra benefits in its provision so that the customers feel they are getting more for
their money. A high-class hotel will have extra offerings to please its customers. A
cost leader process will often be marketed on its speed and simplicity, how efficiently
it provides what is required.
11.1.7 Physical evidence

A service still needs some physical evidence, such as a receipt or a legal document or
online testimonials saying how good the service was. A hotel will need to show how
well looked after it is, so that its customers are glad to be there.
Weblink
://www.m kool.com/marketing-mix/services/17 -cathay- ific.htm|
This link shows the marketing mix applied to Cathay Pacific.
Key takeaway
Make sure you use the elements of the marketing mix, if required, to boost the
strategy suggested.
Strategic risk
With all strategies there are risks involved. It is impossible to predict the future
perfectly unless one is very lucky. Hence, the identification of the risks and the ways
to deal with the risks is important.
Risk is where there exists a quantifiable dispersion in the possible results of

an activity. At the lowest level, this means, for a single decision, there is more
than one potential outcome which can be measured as a probability from
historical data.
Uncertainty is the possibility that an organisation generates lower income or incurs
higher costs than it expects. However, there is no data to measure the probability
of a risk event occurring.
Also note that, although risk and uncertainty sound negative, they both work in either
direction; there are positive as well as negative risks. The upside and downside of
risks need to be assessed to see if they are acceptable to the organisation and its
stakeholders.

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It is helpful at this stage to consider how a board of directors manages strategic risk
by quantifying its risk exposure and capacity and by setting the risk appetite and risk
tolerance for the organisation, as follows:
e Risk exposure is the degree of impact should a risk event occur, i.e., by how
much income falls, or by how much costs rise, from the predicted level.
° Risk capacity is the amount of risk that the company could accept without
serious threat to its financial stability and continued existence.
° Risk appetite is the degree of desire to take on risk in order to obtain a

financial return. This refers to the type of risk and the amount of risk that
the board of directors wants for the company. Risk appetite is constrained
by risk capacity.
° Risk tolerance is the amount of risk that the company is willing to accept,
expressed as a quantified measure, threshold for deviation from a specified
target, or a risk limit.
Risk management is also advised to plan mitigations ifa negative risk event happens.
For example, if there is a risk of a particular supplier going out of business then it is
prudent to have in place a supply chain strategy to maintain supply using alternative
suppliers. This means an organisation has a planned response to the risk and its
impact has been mitigated.
12.1 Types of strategic risk

There are a large number of risks that an organisation will take. They include:
° How the economy grows or shrinks
° New technologies that come into place
° A change in government
° Legal issues that emerge, say from new laws introduced
° Competitors that introduce new products to the marketplace
° Competitors merging or acquiring one another
° A rise in input prices
e A change in prices due to competition
° New features of products that are required
° Changes in interest rates, exchange rates and other financial issues
Most of the above risks are identified by using the models that we have already seen
in this chapter and thinking about what may change in the future. Hence a model
such as PESTEL or Porter's 5 Forces are worth thinking through to see what could
change going forward.

mae =SBRUNHAAR
12.1.1 Operational risks

There can also be issues that arise from more day-to-day problems. A useful model to
look at the operational risk is Porter’s Value Chain. What can happen to the supply of
goods to the organisation, its operations and distribution? Further, is there anything
that could go wrong with its technology, human resources or procurement?
Risk analysis is explored further in Chapter 11, Risk Management.
Key takeaway
Strategies can go wrong, so risk analysis is key. Note how it ties into the earlier
analyses such as PESTEL. The models you have seen are a good framework for
generating strategies as well as thinking about what can go wrong with the strategies.
Suggested online research

Searching for 'Hong Kong risk management can give interesting content; for example
the following KPMG report on risk management in Hong Kong. If you add to the search
an industry in which you are interested (say 'tourism’), it may help you find more.
https://assets.kpmg/content/dam/kpmg/cn/pdf/en/2015/10/risk-management-
looking-at-the-new-normal-in-hong-kong.pdf
13 Strategic analysis and the Capstone

For Capstone Level case studies, it will be important to assess the business
environment, the position of the organisation and the strategy of an organisation
along with the risks that are likely to arise after the selected strategy has been put
into place. There will be a lot of information to take in and assess, so having a good
process is key. There are a series of steps that are worth following.
13.1 What are the facts involved in the Capstone Case Study?
° What is it selling? Products, services, or both? Where does it operate, locally,
overseas, or both?
° A lot of the initial work will be done here. There are a series of details about the
organisation involved, its environment and position that you should focus on:
13.1.1 Do you know its current business?

° What is it selling? Products, services, or both, and how many products or
services does it sell? How do they fit together; is one dominant or not?
° Where does it operate, locally, overseas, or both?
e Is it doing well? Is it profitable or not and how has this been changing?

mae Seas
Does the economy look good or bad for it?
Are there competitors and how well are they doing?
Are there key political factors the organisation should be concerned with?
Is there anything in the organisation's value chain that is a problem, a supplier

that may fail, manufacturing that may be becoming out of date, and a lack of
technology relative to its competitors?
13.1.2 Where is the organisation aiming?

Do we know what the organisation's current plan is? And do they lack a plan
which we can provide them?
Are they a cost leader or differentiated, or neither? What would they need to do
to get there?
Are they following a strategy of entering new markets or are they considering
new products?
Are they considering buying a competitor or a supplier or a retailer of their

product?
13.1.3 How will they cope with changes?

Do their strategies appear to be risky, are there reasonable arguments to back
up the plan and do they have a risk management strategy?
Do we know what is happening internally and what could go wrong?
What is happening externally and is there anything that threatens the

organisation's strategy?
Are they strong at the top of the organisation, so they have the skills at both
director level and management level, or do they have obvious gaps?
Is there someone who seems to make all the decisions and how well qualified
are they to do so?

HARUALR
° Know the importance of strategy to any organisation.
° Learn the key internal models, being the 9Ms and Value Chain.
° Remember the key external models to help understand the environment, being
PESTEL and Porter's Five Forces.
° Always remember the effect of stakeholders; they can encourage or disrupt an

organisation's business strategy.
° SWOT analysis takes the internal and external factors and analyses the most
important and also the combinations (e.g. a strength that will help an
opportunity).
° Given the SWOT analysis, the organisation's direction will be decided based on
the choices that are available.
° Marketing is needed to clarify the organisation's direction and enhance

performance, so make sure you know the marketing mix - the 7Ps for service
organisations, and the 4Ps for manufacturing organisations.
° With any strategy chosen, there are risks and uncertainties involved. Although
no-one can reliably predict the future it is important to attempt to see what the
risks for the organisation are and develop a risk management policy for them.

ae sea
Activity 1 answers
Required
The logistics industry includes planning, executing, and regulating the movement and
storage of goods and services from the origins to final consumption. Using the Value
Chain, think what activities are likely to be included in the logistics industry for
operations, inbound and outbound logistics.
Suggested answer points:
Inbound logistics relate to the receiving, handling and storing of inputs to the
production system.
The inputs at ComFy include wood, upholstery, textiles and other raw materials; the
inbound logistics relate to the storage and inventory of these items prior to their use
in production.
A key weakness in this area of the value chain relates to the issues with the e-mail
purchase order system. At least one large order was not received due to a failure of
this system. Also, the high levels of inventory indicated in the scenario may indicate a
further weakness and the rationale for this should be investigated. ComFy should
consider an automated material order processing and inventory management
system. This would ensure the timely placing of purchase orders based on inventory
levels and anticipated demand. This will ensure materials are ordered on time, arrive
on time, and avoid excessive inventory or risk of running out of essential materials.
Operations relate to the processes of converting the resource inputs (including

materials and human resources) into finished products.
At ComFy, this is the manufacturing processes used to make the furniture. ComFy
keeps high levels of inventory to ensure the production process can continue
uninterrupted. However, the company still fails to meet 25% of its estimated delivery
dates due to products running late. This could be caused by inefficiencies in the
production process, or simply be down to over-optimistic quoting of delivery dates.
Investigations into the cause of this failure should be carried out, as it causes
increased administrative costs to be incurred as well as causing disappointment and
disruption to the customer.
Outbound logistics includes the storing of the finished product (i.e., the completed
furniture and distributing it to customers). This will include the safe packaging of the
furniture for transit and delivering it to the customer on the specified date.

112 CPA Certified Public Accountants
mae SHRHHOR
The failure of ComFy to provide sufficient notice to customers ofa revised delivery
date means that customers have to defer this date yet further to a more suitable
date. This causes their completed item of furniture to remain in storage longer than
necessary, causing an increase in inventory holding costs. A second cause of the
requirement for increased storage results from the return of delivered goods where
no-one was available to collect the delivery. This causes an increase in the cost of
holding inventory, as well as increases in both administrative and transport costs as
the delivery date has to be re-arranged.
Activity 2 answers
Required
Arrange the six points given into the correct part of PESTEL.
Suggested answer points:
Political Political unrest in cities and countries can result in a decrease in

flight traffic. The scale of political unrest may reduce passenger
numbers, reduce flight frequency or, if the airport closes, even
make a route unviable or too dangerous. UN sanctions might
prevent commercial operations, also.
Economic Lower oil prices can reduce fuel costs and decrease ticket prices.
However, fuel prices are volatile which can significantly impact
airline profitability as fuel is significant proportion of cost. Many
airlines choose to use hedging techniques to reduce their
exposure to increased fuel prices, however hedging cannot limit
the impact of a long-term or permanent increase in fuel prices.
Unless this can be passed on in ticket prices, it will reduce
profitability.
Social There are increased regulation and initiatives taken by port

enforcement services to reduce trafficking of illegal goods and
tracking of supplier (freight) compliance using new technologies.
Airlines have a duty to know what freight they are carrying as
dangerous or illegal freights can result in inflight problems or
regulatory fines or sanctions. Airlines must have processes to
check and vet all freights and have policies of what freight is
acceptable. The application of new technologies to track each
freight start to end journey is costly to implement and use,
however it will protect the airline in the long term as it provides
a digital audit trail of compliance. Airline freight policies must be
continually reviewed as air regulations often change.
€ PA Hong Kong Institute of

mae SeRtAe
Technological Investment in data analytics and mobility are suggested to

improve customer experience. Air travel and freight is a highly
competitive market and, therefore, it is vital for airlines to
understand customers buying choices and preferences to retain
loyal customers and market share. Investment in data analytics
will provide detailed analytics on seat utilisation per flight,
excess demand (i.e., early sold-out flights) and important
customer feedback on the flight experience.
Environmental Governments are increasingly looking towards carbon emissions

trading and carbon reduction initiatives in a bid to combat the
effects of climate change. An airline is an emitter of carbon and,
therefore, airlines must look for ways to limit this by plotting
efficient routes, not flying below a minimum seat utilisation and
investing in fuel efficient engine technology. Airlines can also
look to offset this impact by supporting green initiative such as
reforestation.
Legal Antitrust laws are regulations that encourage competition by

limiting the market power of any particular airline and are
increasingly used. The airline industry is one of the more highly
regulated industries and government changes are not always
predictable. Some antitrust proceedings have started in various
jurisdictions against companies to limit market share. Airlines
may be forced to give up or share lucrative routes with airlines.
This means airlines should no longer rely on the long-term
security of specific routes and look to increasing their
destinations to avoid over reliance.
Activity 3 answers
https://www.swotandpestle.com/cathay-pacific/ gives the full PESTEL and SWOT analysis
for Cathay Pacific.
Cathay Pacific has had a SWOT analysis performed for it, highlighting its key internal
and external issues.
Required
(a) Decide which are internal and which are external factors.
(b) Assess the strategic position of Cathay Pacific.

ee FKARHHOR
Suggested answer points include (but are not limited to):
(a)
Strengths Weaknesses
Huge fleet and mix of aircraft. This Future finance lease liabilities add
provides capacity and flexibility to gearing and will affect future
changing consumer demands. It also expansion by limiting the capacity for
allows the airline to offer many flight further borrowing. One option will be
options which will attract customers. to refinance or raise new equity.
Code sharing agreements along with Cost reduction initiatives leading to
membership in OneWorld Alliance reduced service levels. This may lead
allows the airline to extend it global to staffing issues and will be brand
routes by offering tickets with issue if the customer notices
connections to other airlines. decreases service levels, particularly in
Cathay Pacific is a highly rated airline the first class or business seats.
known for its excellent service levels. With high brand value comes high
Continuing to leverage on this brand expectations, and any slippage of
value is vital to sell first class and service levels can disproportionately
business class, so is a point of harm the brand, as it is seen as "not
marketing focus. as good as it used to be".
Like many airlines, Cathay Pacific's
loyalty scheme rewards loyal and
frequent flyer customers. The
company could look at
competitiveness of its loyalty
programme by benchmarking with
other airlines.
CPA= Hong Kong Institute of

SAOHBAG
115
Opportunities Threats
A focus on emerging markets, where a Volatility in jet fuel prices provide

great proportion of citizens are an unpredictable impact on profit.
gaining wealth, so can afford to fly, This can be mitigated by hedging
such as China, will provide access to techniques, but it could be that fuel
new routes and passengers. is fixed at a higher price and hedging
Technology backed services leading introduces new risk of inappropriate
to improved operations and reduced or inaccurate hedges.
costs. For example, larger, more Regulatory issues pertaining to
reliable aircraft and improved fuel continuing operations in both
efficiency. domestic and international segments
Expansion in air freight sector in cargo can curtail operations or increase
airport hubs, such as Dubai, will utilise costs, such as restrictions on night
existing fleet capacity. take-offs and landing at some

airports. It is also expensive to
The extension of routes and the
monitor regulatory requirements and
possibility of using its high brand
the fines for non-compliance can be
value to spin off into a low-cost, short-
significant, however is common to all
haul market, as customers tired of "no
airlines.
frills" may be attracted to the Cathay
Pacific brand. This carries the danger
of harming the long-haul business if
not executed well.
(b) As with any organisation, Cathay Pacific has good and bad issues. Overall,
there are positive strengths and opportunities that appear beneficial for
Cathay Pacific.
The long-haul flight market is mature and the overall market is unlikely to grow
significantly as all major routes are covered. Therefore, an airline must focus on
its brand image, its service level delivery, comforts and frequent flyer benefits
and its safety record.
Overall, the main asset of Cathay Pacific is its brand value which stems from its
very high service levels, so the company must endeavour to maintain this to
retain its strategic position and market share.
Therefore, Cathay Pacific must continue to periodically update its seats, cabins,
staff uniforms and menus, to remain fresh and appealing to loyal and new
customers. It must also look to new routes in emerging markets for growth
such as Africa, China and India.

SHRHHAB
The frequent flyer loyalty programme is essential as it is easy for customers to

switch airline given the choice available so they need a reason not to do so. The
gaining of flyer points for additional benefits, exclusive flight prices or free
flights should be periodically benchmarked against other airlines and revised
to remain competitive.
Extending its service levels by updating the fleet with newer, larger and more
cost effective planes, will increase passenger numbers on each flight. The airline
could also examine business class only flights to gain a higher share of the
premium customer market.
In order to assess the strategic opportunities fully, financial analysis will be

important and an evaluation of the size of the risks involved.
€ PA Hong Kong Institute of

Certified Public Accountants ns
ae ShaGAR
Effective
analysis
Topic list
1 Introduction to effective
analysis
2 Financial analysis
3 Non-financial performance
indicators
4 Data analysis
5 Comprehensive analysis activity
Learning focus
Chapter 4 is important and relevant to the Capstone learning journey as

candidates will be required to effectively analyse financial and non-financial
information contained in the case studies provided for the Capstone Workshops
and the Capstone Final Examination.
Capstone candidates will not only need to consider the financial results of a
company that they are provided with but also to consider the underlying factors
that have caused these results. Hence, the analysis should be broader than purely
looking at the numbers. Candidates will need to demonstrate professional
scepticism regarding the preparation of numerical information and, in particular,
the assumptions which underpin any profit or cash flow forecasts.
At Capstone, candidates are required to use the results of financial and non-
financial analysis as evidence to support business conclusions and make
recommendations to improve the operational and strategic performance of an
organisation. This chapter provides candidates with the necessary tools to do so.
4: Effective Analysis
Learning outcomes
Consider current and alternative business strategies in S

a range of complex and unpredictable circumstances
Evaluate options from a business analysis perspective,

assessing strategic and financial consequences using
relevant financial management and performance 3
management techniques (including the use of big data
analytics)
Recommend methods for an organisation to monitor

implementation of strategy
Essential reading chapters

Module 12: Business Finance, Chapter 6: Working Capital Management,
Section 6.3, Analysing liquidity and working capital efficiency
Module 12: Business Finance, Chapter 8: Performance Measurement,

Section 8.2.4, Financial performance

Section 8.2.6, Operational measures

Section 8.3.1, Balanced scorecard

Section 9.5.2.3, Managing its key financial health indicators
Module 5: Information Management, Chapter 2: Measurements in Performance

Management, Section 2.3, Data analytics
Module 5: Information Management, Chapter 3: Applying Information Systems in

a Corporate Setting, Section 3.5, The role of big data in decision making

ee tS
©] Chapter Summary
ee
Effective analysis
| |
Introduction to Financial analysis Non-financial
effective analysis performance
* Value of past financial analysis: ! Overview of financial : | Common areas of

Non-financial analysi ig
siaeennieieemeiaion, {a analysis. ae
: | financial. analysis:
e Looking to the future : |
e Statement of profit or loss : : ¢ Advantages of non-financial
* Statement of financial position performance indicators
© Statement of cash flows | ie Disadvantages of non-financial
i performance indicators
e ; : ¢ Examples of non-financial
>: Common areas of : : performance indicators
financial analysis : - Product and service NFPIs
: i i - Employee NFPIs
pe “tend analysis - Brand NFPIs
* Profitability / e — Interaction with financial
~ Gross profit margin performance indicators
— Operating profit Margin a ccccssussnsnessnesssnsennvansnesnnsenssenneenne!
- Net profit margin
e Liquidity
- Current ratio
- Inventory days
- Receivables days
- Trade payables days
- Return on capital
employed (Return on
investment)
Other financial analysis

considerations
e Accounting policies, bias,
misstatement, drivers
¢ Problems with financial
performance indicators
long Kong Insti if

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Data analysis
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Big data
e Volume, Velocity, Variety,
Veracity
Data analytics
e Descriptive data analysis
e Predictive data analytics
e Specific data analysis
- Breakeven analysis
- Financial forecast
- Sensitivity analysis
e Critical success factors (CSFs)
e Key performance indicators

(KPIs)
e Balanced scorecard
- Financial
- Customers
- Internal processes
- Learning and growth
e — Reliability of information

ae Aa HA
Introduction to effective analysis

This chapter provides essential guidance for delivering effective analysis at Capstone
Level.
We begin by looking at the value of financial analysis and how it can be used to
analyse the past performance of an organisation. Financial analysis can be
performed by looking at the statement of profit or loss and other comprehensive
income of the organisation, assessing whether the organisation has achieved a
profit or loss and how the organisation is performing in the current year against
previous years.
Financial analysis will also look at the statement of financial position to see if the
organisation has achieved a good financial position or not, and the statement of cash
flows to assess the organisation's liquidity position. This analysis is valuable but note
that it is backward looking and is concentrating on numbers. As we need to develop
effective business strategy of an organisation, we need to examine the underlying
causes of the final financial results of an organisation.
Candidates must also consider non-financial analysis to understand an organisation
more fully. Non-financial performance indicators are considered so that the
performance and operations of the organisation can be evaluated. It is also essential
for an organisation to establish appropriate non-financial performance indicators
since an organisation may gain some valuable insight in developing the appropriate
business strategy or making informed decisions.
Finally, this chapter considers the value of data analysis. An organisation can
collect data about its customers and suppliers, its process effectiveness and
efficiency or its product or service innovations. An organisation can regularly
analyse its data in a consistent and pre-determined way to measure and evaluate
how it is performing against its strategic and operational targets, or against
stakeholder expectations. Also, data analysis can be used to project the future so
that an organisation can take action now to enhance positive predictions and
mitigate negative predictions.
Financial analysis
Financial analysis involves the analysis of relationships among the different items in
the financial statements, which is useful for assessing an organisation's performance
in the past and making recommendations so it can do better in the future.
Typically, the following three financial statements will be reviewed:
° The statement of profit or loss and other comprehensive income
° The statement of financial position
e The statement of cash flows

a HRRUNALR
In performing financial analysis, we will look at the increasing or decreasing trends

of financial data over time. We may also identify fluctuations in a ratio between one
period and the next, or relationships that seem inconsistent with other relevant
information or that differ from their expected value by a significant amount. Ratio
analysis could provide us with some useful information such as profitability,
liquidity, solvency and capital efficiency. Nevertheless, we should stay curious and
ensure that the effectiveness of financial analysis will not be undermined.
You should be able to perform comprehensive analysis on the financial information

included in Capstone Case Study and ask critical questions relevant to the company
or industry.
Below is a list of the questions that you might ask. Be aware that this is not an
exhaustive list:
Nature of the Is it a private or listed organisation or is it not for profit?

business e Is the organisation in the manufacturing sector, service sector,
retailing sector or others? What is your profitability assessment
and is that being achieved?
e Does the available information indicate whether this
organisation is operating well in an industry sector which is
growing or declining? Or, are there concerns?
Growth e ls the organisation growing or declining in terms of revenue?

e Howis the organisation achieving growth, by acquisition or
organically?
e Does it appear to be making good profits, or is the organisation
making losses? If so, what would it take to turn this round?
e Have profits (or losses) fluctuated by large amounts from one

year to the next?
Size e ls ita private or private/listed organisation?

e Does it seem to be a small, medium-sized or large
organisation?
e Does the organisation have international operations?
a PA Hong Kong Institute of

mae Seana
Stability e From an initial review, does the organisation appear to have

positive cash flows and a good balance of debt and equity
financing?
e Does the organisation appear to be capable of meeting its
current liabilities?
e Is it anew start-up organisation or is it well-established?
e Does the information indicate that the organisation may be
achieving its budget targets?
Wider business Is the economy in a state of growth or recession?

context e Is the rate of inflation in the economy significant?
e Are there industry factors which may be affecting (or may
affect) performance?
You may find from your initial analysis that there could be one or two issues which
may jump out. You should now be in a position to complete more detailed analysis to
confirm (or not) your initial conclusions.
2.1 Overview of financial analysis

The various financial statements have likely aspects that will be considered in the
analysis.
2.1.1 Statement of profit or loss and other comprehensive income

We will usually perform analysis by asking the following questions:
° Are sales growing or declining by comparing year on year revenue growth?
° Is there a change in the balance of the different types of sale being made? For
example, sales mix between online and instore sales?
° How are profits changing and in relationship to the sales being made?
e Are costs under control as compared with the budget?
It is important first to consider the nature and size of the organisation, what is
expected from the statement of profit and loss and other comprehensive income? Is
there any information about the past performance and whether the organisation has
been growing or declining and why this might be so? Has there been new competitors
entering the market, is the general economy doing well or not, how are interest rates
and inflation rates changing? This may help put the results that are obtained from the
analysis of the statement of profit or loss and other comprehensive income into
context.

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The following ratios can be calculated to evaluate profitability performance:
° Percentage change in revenue overall
° Percentage change in revenue for each division of the organisation and/or the
products it sells
° How much profit is the organisation making - gross and net - and how is this
changing?
° What are the profit margins that the organisation is achieving overall and for
each division/product? This can help us see the level of costs relative to the
sales, So gross profit, operating profit margin and net profit margins can be
calculated. The calculation of these profitability ratios is covered in Section 2.2.2.
Once the numbers have been calculated it is necessary to take a look at the
performance based on any other information given. If we are told that the country
that the organisation is operating in is in recession, then a decline in sales and weaker
profit margins may not be a surprise. Similarly, if inflation in the country is low on the
inputs that the organisation buys, that may help explain better margins that the
organisation has made. If the change in the numbers could not be directly explained
by the external factors (e.g., global economy, industry lifecycle), then we may consider
whether any internal factors (e.g., enhanced efficiency due to streamlined workflow,
new launch of marketing campaign) can explain the situation.
2.1.2 Statement of financial position

The statement of financial position helps us see how the organisation is placed at a
point in time. We can see the situation for each part of the statement of financial
position:
° Non-current assets - how tangible and intangible assets may create value and
derive income for the organisation?
° Current assets and liabilities - how they may impact the liquidity and working
capital of an organisation?
° Liabilities and equity - does the organisation have an appropriate capital

structure to finance its operations and growth?
2.1.2.1 Non-current assets

Non-current assets are analysed to see how important they are to the organisation.
Consider:
° Are non-current assets made up of tangible assets, such as property and

machinery, or are there intangible assets too?
° Does the business have any unique non-current tangible or intangible assets
that help it to maintain its competitive position?

ae SRN OR
Is the investment in non-current assets appropriate for the scale and type of
business activities?
If we are considering the tangible non-current assets, are they recorded at cost
less any depreciation, or have they been revalued? If the tangible non-current
assets are valued too highly, this may reflect inefficient use of capital, or may
suggest that assets are impaired.
Analyse the age of tangible non-current assets and consider the depreciation
policies to see if this fairly reflects the actual decline in value. If old tangible non-
current assets are requiring more repairs and maintenance then this may be
having an impact on the profit the organisation is making.
Analyse the value of sales measured against the level of non-current assets and
see if this is ratio is making sense. If there are increasing sales, it is likely there
will be a need to investment in further non-current assets to service the sales.
2.1.2.2 Current assets and current liabilities

We can compare the balance between current assets and current liabilities to see if
the organisation is able to pay its purchases on time and whether the overall ratios of
current assets to current liabilities appears appropriate or not of the type of industry.
We can drill down into each type of working capital to assess each one:
Inventory balances. Have inventory levels, measured by inventory days or

inventory turnover ratios, increased? If inventory balances increase significantly,
this leads to additional costs in terms of finance and storage. It may indicate
that there is a problem with obsolescence. If finished goods are rising
significantly as this could mean that demand for the products has fallen. If there
is an unusual high level of finished goods, this could mean that the products
demand has fallen and could be indicative ofa products obsolescence.
Trade receivables. We can compare trade receivables to sales revenue to see

how long an organisation is taking to collect its debts from its credit customers.
The ratio of trade receivables to revenue will give us a useful ratio to see how
the organisation is doing - is it collecting more of its sales in a decent timescale
or not? Has there been any change in credit terms offered to customers? This
would affect the receivables days ratio. Significant increases may also cast
doubt on the recoverability of trade receivables.
Trade payables. We can compare trade payables to the cost of revenue to see
if we are paying quicker of more slowly than before. Increases in the trade
payables days ratios may indicate that the business is suffering from liquidity
and finding it difficult to pays its suppliers on time.
Ac) CPAa Hong Kong Institute of

HARUALR
2.1.2.3 Balance of debt to equity

We can consider the organisation's long-term financing and see what proportion of
that is debt finance and what proportion is equity which either the shareholders have
invested or the profits that the organisation has retained over time. A gearing ratio
will usually look at the debt divided by the equity of the organisation.
However, the amount of interest relative to the operating profit of the organisation is
worth considering too. In a country with very low interest rates, having higher levels
of debt may be perfectly possible if there are enough profits being made to
comfortably cover the amount of interest that is due.
An appropriate balance of debt and equity should be maintained. Otherwise, there
may be negative consequences such as high interest expense and risk of default on
obligations.
2.1.3 Statement of cash flows

Cash flow is an important short-term and long-term issue. If an organisation does not
have enough cash to pay its liabilities, short or long-term, when they fall due, this will
cause it problems.
The statement of cash flow should make this obvious and it is worth looking at the
following to see how they are performing:
° Cash flows from the organisation's operating activities. Is this positive or
negative and is there a trend over time for how the organisation is operating? Is
there sufficient cash flows from operating activities to fund short-term working
capital requirements?
° Cash flows from the organisation's investment activities. Is the organisation
investing in non-current assets or selling assets off? This will depend on whether
the organisation is growing or not.
° Cash flows from the organisation's financing activities. Is the organisation
performing share issues, borrowing from its bank or other investors? What is
going out of the organisation in terms of interest and dividends and does that
look correct against the amount of debt and equity that the organisation has?
Further questions which can be asked include:
° Has this been a good year overall for cash flow?
° Has cash flow been positive or negative and by how much?
° Are cash flows most affected by operating, investment or financing activities?
° What is the overall cash position?
° Is a company likely to exceed its overdraft and run out of cash?
° Does the business have sufficient cash to fund new capital expenditure, or does
it need to borrow?

Certified Public Accountants Va
ae SRN OR
If there are problems in the cash flows of the organisation, the long-term situation
needs to be weighed up - will the organisation be able to continue like this or is there
a chance its existence will come under threat? Is this a short-term problem or not?
Are there steps that the organisation can take in its long-term finance that will work
and be sustainable?
2.2 Common areas of financial analysis

2.2.1 Trend analysis
A good place to start with financial analysis is to look at trends - to see how areas
such as sales and costs are changing over time. Two approaches commonly used for
trend analysis are common size analysis and index analysis.
2.2.1.1 Common size analysis

In common size analysis, all numbers in the financial statements are expressed as a
percentage of revenue for a period. The advantage of this is that since the various
income and expense items in the statement of profit or loss and other
comprehensive income are expressed as a percentage of revenue, it is easy to
compare the financial performance of different companies.
Example: Common size analysis

Paradise Hotel Limited owns one hotel in Hong Kong. The hotel is managed by a well-
known international hotel operator. The statement of profit or loss and other
comprehensive income for the most recent financial year, along with comparatives
for the previous financial year, has been prepared using absolute values, along with
common size analysis.
20X1 has been a difficult year in the tourism sector - the number of tourists has fallen
due to an increase in the value of the Hong Kong dollar, and there has also been an
increase in wages due to a shortage of labour.
Required
Analyse the trends that you identify using common size analysis:
20X1 20X0
HK$ million HK$ million
Revenue 274 100% 323 100%
Cost of revenue (107) —39% (116) 36%
Gross profit 167 61% 207 64%
Administrative expenses (15) 5% (14) 4%
Marketing (33) 12% (32) 10%
Energy (8) 3% (8) 2%
Salaries (50) 18% (50) 15%
Management fees (11) 4% (13) 4%

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20X1 20X0
Operating profit 50 18% 90 28%
Interest (5) 2% _(5) 2%
Profit before tax 45 16% 85 26%
Tax _(7) 2% (13) 4%
Profit after tax 38 14% 72 22%
Suggested solution:
The common size analysis makes the following important trends clear:
1. There has been a fall in the gross profit margin from 64% in 20X0 to 61% in
20X1. This is most likely related to the higher wage costs paid due to the
shortage of labour. Hotels are labour intensive businesses. The decline in the
number of tourists may also have pushed room rates down.
Most operating expenses increased as a percentage of revenue. This is due to

the fact that revenue has fallen whilst operating expenses stayed the same or
increased. Marketing expenses, for example, increased from 10% of revenue in
20X0 to 12% in 20X1. The marketing expenses themselves increased by only 3%,
so the increase in the percentage is due largely to the fall in revenue. This
suggests that most of these costs are fixed in nature, and the small increase in
the expenses between 20X0 and 20X71 is due to inflation.
Management fees remains constant at 4% of revenue. This suggests that the fee
paid to the operator of the hotels is a fixed percentage of revenue.
The operating profit margin has fallen from 28% in 20X0 to 18% in 20X1. This
appears to be due to a combination of the lower revenue and slightly higher
operating expenses. This means that in 20X1, fixed costs represent a higher
percentage of revenue.
Interest has remained constant in absolute terms and accounts for 2% of

revenue in both years, which is not a significant amount. Tax has fallen from 4%
of revenue in 20X0 to 2% of revenue in 20X1. Tax still remains at 15% of profit
before tax, so the fall as a percentage of revenue is due to the fall in profit
before tax as a percentage of revenue.
Overall, profit after tax has fallen from 22% of revenue in 20X0 to 14% of
revenue in 20X1, a fall of 8%. This is less than the fall in operating profit, which
fell from 28% of revenue in 20X0 to 18% in 20X11, a fall of 10%. The reason that
the after-tax profits fell by less is due to lower revenue whilst fixed costs have
remained.

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2.2.1.2 Index analysis

Index analysis enables trends over time to be easily seen. The quantities of all items
in the financial statements for a base period to represent 100%.
Items in subsequent years are expressed as a percentage of the base year item - so if
an item in Year 2 is 30% higher than that item in Year 1, the Year 2 amount would be
shown as 130%.
=~) Example: Index analysis

Required
Using the financial information from the previous example, use index analysis to
analyse the trends of Paradise Hotel Limited, using 20X0 as the base year.
Comment on the trends identified.
Suggested solution:
20X1 20X0
Revenue 274 85% 323 100%
Cost of revenue (107) 92% (116) 100%
Gross profit 167 81% 207 100%
Administrative expenses (15) 107% (14) 100%
Marketing (33) 103% (32) 100%
Energy (8) 100% (8) 100%
Salaries (50) 100% (50) 100%
Management fees _ (11) 85% _ (13) 100%
Operating profit 50 56% 90 100%
Interest __(5) 100% __(5) 100%
Profit before tax 45 53% 85 100%
Tax __ (7) 54% _ (13) 100%
Profit after tax __ 38 53% 72 100%
The index analysis shows the following trends:
1. Revenue in 20X1 fell to 85% of that of 20X0, which is a significant fall. This is
most likely due to the drop in the number of tourists visiting Hong Kong
because of the strength of the Hong Kong dollar.
2. In 20X1, cost of revenue fell to 92% of that of 20X0. Given that revenue fell by
more than this, it suggests that while revenue fell, cost of revenue per unit
increased. In hotels, many of the costs are staff costs, and there has been a rise
in wages costs due to a shortage of labour, which may explain the fact that cost
of revenue did not fall as much as expected. This has resulted in gross profit of
20X11 falling to only 81% of that of 20X0, which means that the profit margins
have fallen.

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3. | Administrative expenses increased by 4% between 20X0 and 20X1, and

marketing expenses increased by 3% over the same period whilst energy
expenses and salaries remained unchanged. Since the level of revenue fell, it
suggests that these costs may be fixed in nature, and do not vary with the level
of activity. There may have been some inflation, which would explain the
increase in these costs.
4. There was no change in salary costs which suggests that either there wasn't a
pay rise this year, or headcount has slightly fallen. If headcount has fallen, then
management should confirm this is due to planned efficiency. Otherwise, it is
possible some staff members are over worked, which is not sustainable in the
longer term.
5. Management fees in 20X1 were 85% of those of 20X0. This is the same
percentage as the revenue, which suggests that the management fee is a
percentage of revenue.
6. Operating profit in 20X1 was only 56% of that of 20X0. This is likely to be a big
disappointment to the owners. This is the result of the fall in gross profit
combined with the increases in administrative costs and other expenses
discussed above.
7. — Interest in 20X1 is 100% of that of 20X0, meaning there has been no change.
Interest depends on the value of the company's debt and the rate of interest.
The fact that the cost has not changed suggests that the amount of debt and the
interest rate did not change.
8. The tax charge in 20X1 was 54% of that of 20X0, due to the fall in profit before
tax. Profit before and after tax in 20X1 was also 54% of that of 20X1.
2.2.2 Profitability
An assumption often made is that one of main objectives of a business is to maximise
the wealth of shareholders. Profit can be used as a short-term measure of how well
the business is doing in terms of generating wealth for shareholders.
Profitability can be further analysed by calculating profit margins.
Gross profit margin
Gross profit margin = 22S", 190%

. : G it
Sales revenue
Gross profit measures the financial results by deducting costs of sales (or costs of
revenue) from sales (or revenue). It shows how an organisation's ability to generate
income to cover operating expenses, interest and tax. It is therefore one of the good
indicators for profitability analysis.

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Falls in gross profit margins might suggest that a business had reduced its selling
prices to achieve more sales. This may be attributed by some unfavourable factors
(e.g. new competitors have entered into the market or the products have reached the
end of their lifecycle.). Alternatively, falls in the margin could reflect increases in the
prices of labour, materials and other inputs, which the business does not wish to pass
on to the customer through increased selling prices.
Operating profit margin
Operating profit margin = Operaing profit . 4 Q9%

Operaing profit
Sales revenue
Operating profit (or profits before income and tax) is usually calculated by deducting
various operating expenses from gross profit (see above). Operating profit margin is
useful for analysing the financial performance of an organisation without the impact
of interest and tax.
Net profit margin

Profit after tax
Net profit margin = Sales revenue
x 100%
Net profit is often referred to as "the bottom line". It is calculated after deducting
interest and tax. Therefore, it shows what the company has left after deducting all
costs and taxes from its revenues.
Note, Some analysts use profit before tax in the net profit margin, on the basis that
tax is an expense that is outside of the control of the managers of the company.
The use of profitability ratios in performance analysis may lead to the following
issues:
1. | Managers may tend to increase the current year’s profits possibly at the
expense of longer-term performance. For example, by not giving staff pay rises,
which may save costs, may lead to dissatisfied staff, who may decide to leave,
leading to higher costs of recruiting and training new staff.
2. Analysis of profitability ratios does not take into account the cost of equity
capital. Managers may increase profits by investing in projects where the return
on those projects is less than the return required by shareholders.
3. Calculation of profitability ratios often includes the use of judgements and

assumptions. Managers may be tempted to exercise judgements or make
assumptions in such a way that profits will increase.
While being aware of the potential issues of profitability analysis, it is still essential to
fully analyse profitability as part of financial performance analysis.

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Example: Profitability analysis

Yummy Food Company Ltd (Yummy) is a small chain of three street food restaurants.
It has the following results in the last few years.
Analyse the profitability of Yummy and list out the financial and non-financial
information which may also be relevant to the analysis.
20Y1 20Y0 20X9

HK$m HkK$m HK$m
Sales 29.3 28.0 25.7
Cost of goods sold (11.7) (10.5) (10.3)
Gross profit 17.6 17.5 15.4
Other operating costs (15.5) (14.8) (13.3)
Operating profit 2.1 27 21
Solution
Profitability analysis
20Y1 20Y0 20X9

% % %
Year-on-year growth in sales 4.6 8.9
Gross profit margin 60.1 62.5 59.9
Operating profit margin 7.2 9.6 8.2
Overall, sales revenue has increased by HK$1.3m to HK$29.3m in 20Y1 as compared

with 20Y0. However, operating profit has declined to HK$2.1m in 20Y1 from HK$2.7m
in 20YO. At first hand, this indicates a disappointing performance.
The rate of sales growth has fallen to 4.6% in 20Y1 compared with 8.9% in 20Y0.
This could indicate that sales growth in the future may be even lower. The impact
of price information and change in sale volumes would be helpful to understand
the change.
The gross profit margin fell to 60.1% in 20Y1 and from 62.5% in 20Y0, but is still above
the 59.9% achieved in 20X9. These movements are relatively small suggesting a fairly
stable gross profit margin. This indicate that costs are under control and that prices
are stable.
The operating profit margin was down to 7.2% in 20Y1 from 9.6% in 20Y0. This fall is
bigger than the 2.4% fall in the gross profit margin, so reflects an increase in
overheads. Further detailed cost analysis is required to identify the cause of the
increase in overheads.

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Further information required

° An operating statement by the directors to explain performance
e Financial budgets for each of the three restaurants
° Actual performance statements for each of the three restaurants
° Sale volume data for each of the three restaurants
° Breakdown of operating costs for each of the three restaurants
Activity 1
4 44-55-54.
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Confidence Ltd (Confidence) has been working towards helping people reduce the
amount of single use plastic that they use, as plastic is not biodegradable and
therefore can only be disposed of in landfill sites. Confidence sells coffee cups made
ofa hardened plastic that can be re-used many times. The product was launched in
Hong Kong five years ago in 20X9.
Demand increased quickly initially, as many chains of coffee shops have ordered cups
from Confidence with their own logo on. Customers of the coffee shops who buy
these mugs can get a refill on subsequent visits for a reduced price.
In the last financial year, Confidence has not won any new major customers, but has
managed to supply its existing coffee shop customers with replacements, as the cups
have a finite life, so final customers replace their cups once every year.
The cups are manufactured in a factory in Hong Kong. In the last two years, the price
of energy used in the factory has increased by 20% due to a general increase in
prices. This has also led to some of Confidence's suppliers increasing their prices for
the inputs used in the cups.
Summarised information from the statement of profit and loss of Confidence for the
last three years is as follows:
Confidence Ltd 20Y3 20Y2 20Y1
HK$m HK$m HK$m
Sales 345.3 330.2 310.2
Cost of revenue (140.7) (119.7) (124.9)
Gross profit 204.6 210.5 185.3
Other operating costs (186.5) (177.8) (159.4)
Operating profit 18.1 _ 32.7 _25.9
Required
Analyse the sales growth ratio, gross profit margin ratio, operating profit margin ratio
and other operating costs-to-sales ratio for Confidence Ltd. Then analyse the
underlying causes for the changes identified.

i cus CPA Certified Public Accountants
mae FRRHHOAR

2.2.3 Liquidity
It can be useful to look at the current ratio or the quick ratio to evaluate the liquidity
of the organisation. The following ratios are commonly used:
. Current assets
Current ratio = ————_
Current liabilities
7 . _ Current assets — inventory

Quick ratio = ——————
Current liabilities
Cost of sales
Inventory turnover = ————————_
inventory balances
Inventory balances
Inventory days = inventory
Castor balances
sales y 365
. ° Sales revenues
Trade receivables turnover ratio = —————_
Trade receivables
7 Trad ivabl
Trade receivables days = ——“"SS’e'
Sales revenues
>< 365
._ __ Credit purch
Trade payables turnover ratio = ———"S$
Trade payables
=
Trade payables days = See Pavaeles

Credit purchases*
x 365
* Note: Cost of revenue may be used as a proxy for credit purchases.

The current ratio and quick ratio aim to evaluate whether the business has sufficient
liquid assets to settle their current liabilities. The quick ratio is more conservative as
it is based on the idea that inventory is not a liquid asset. If these ratios are low
or declining, it may indicate that the business will have a problem paying the bills
when they become due.
On the other hand, if the value of the current or quick ratios is too high, this
indicates overcapitalisation. Over capitalisation is where the business has invested
in inventory, trade receivables and other liquid assets more than it needs. While
this means that there is less risk of not being able to meet liabilities as they become
due, there is a cost in terms of the finance costs required for the additional
investment.
The inventory turnover shows how many times in a year the inventory is replaced.
A higher turnover means that inventory levels are lower. Average inventory balances
should be used, but inventory balances at the year-end can be used if they are not
likely to be significantly different to average.
The inventory days shows how many days' of sales are held in inventory. A higher
balance means that more inventory is held. If inventory days are rising, it could
indicate that inventory has been acquired but is no longer needed or attractive in
the market and may indicate a problem with inventory obsolescence.

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The trade receivables turnover ratio shows how many times the trade receivables
are replaced.
A more widely used ratio for receivables is the trade receivables days. This shows
how many days, on average, it takes customers to pay their invoices. It can be
compared to the businesses credit policies (e.g., to give all customers 30 days credit).
If trade receivable days are increasing, it could indicate poor credit control, or poor
recoverability.
The trade payables turnover ratio shows how many times during the year the trade
payables are replaced.
The trade payables days shows how long it takes, on average, to pay the suppliers.
High trade payable days means that the business is delaying payments to suppliers
and using their money as a short-term source of finance. This can be seen as good
business sense, but it may harm relationships with suppliers. If the trade payables
days increases suddenly, this could indicate that the company's liquidity is declining.
We can also look at the Statement of Cash Flows (see Section 2.1.3 above) in order to
see whether the organisation is generating positive cash flows.
= Example: Working capital and liquidity analysis

BI Calculate liquidity and working capital ratios from the accounts of Scrubs Ltd, a small
business which provides office stationery suppliers to its corporate customers.
20Y1 20Y0
HK$'000 HK$'000
Revenue 3,481.9 3,751.7
Cost of revenue (2,654.4) (2,770.4)
Gross profit 827.5 981.3
Inventories 68.3 124.8

Receivables (see below) 606.3 690.2
Cash and cash equivalents 328.3 232.0
Total current assets 1,002.9 1,047.0
Loans and overdrafts 51.8 129.8

Tax payable 108.6 122.7
Dividend 18.7 27.5
Payables (see below) 779.5 747.5
Total current liabilities 958.6 1,027.5
Net current assets 44.3 19.5

i 36 CPA Certified Public Accountants
ae FKBRHHOR
20Y1 20Y0
HK$'000 HK$'000
Notes
1 Trade receivables 472.3 568.3
2 Trade payables 305.3 301.0
Solution
Current ratio
(Current assets/current liabilities) 1,002.9/958.6 = 1.05 1,047.0/1,027.5 = 1.02
Trade receivables days

(Trade receivable/revenue x 365) (472.3/3,481.9) x 365 (568.3/3,751.7) x 365
= 49.5 days = 55.3 days
Inventory days (68.3/2,654.4) x 365 (124.8 /2,770.4) x 365
(Inventories/cost of revenue = 9.4 days = 16.4 days

x 365)
Trade payables days (305.3/2654.4) x 365 (301.0/2770.4) x 365
(Trade payables/cost of = 42.0 days = 39.7 days

revenue x 365)
Financial analysis
The cash balance has improved by 41.5% to HK$328,300. While the current ratios in
20Y1 (1.05) have improved marginally from 1.01 in 20YO. year on year, the liquidity
position is considered not satisfactory. Ideally, a company would be looking at a ratio
between 1.5 and 2 which suggests the company should improve its overall working
capital levels.
Scrubs Limited appears to be collecting its debts more quickly from its customers
as there is a marginal fall in receivables days from 55.3 days in 20Y0 to 49.5 days
in 20Y1. However, 55.3 days is almost two months of sales. When compared with the
30-day terms it offers to customers, this suggests an area of concern. An aged
receivables analysis is required to understand the extent of the problem. Also, a
review of credit control procedures is advised.
Inventory days have fallen from 16.4 days in 20Y0 to 9.4 days in 20Y1 which suggests
higher efficiency in production processes and improvement in liquidity. Management
needs to consider if inventory days of 9.4 days is within a comfortable buffer. To
minimise the potential risk of stock out, Scrubs Limited could consider carrying
r PA Hong Kong Institute of

ae SAGAR
additional inventory. Alternatively, if the supply chain offers just-in-time delivery,

then the level of inventory may be decreased further.
There is a concern as the company is taking longer to pay its suppliers, taking an
average of 42 days in 20Y1 as opposed to 39.7 days in 20Y0. This has had a positive
impact on cash and has contributed to be improvement in liquidity. However, if credit
terms from suppliers are less than 42 days, we may see problems in the supplier
chain if we are perceived as slow payers.
2.2.4 Solvency
Solvency is about the business's ability to pay its interest and debt repayment
obligations when they become due. The following ratios are commonly used for
evaluating solvency:
Total debt (short and long term borrowings)
Gearing =
Total equity
: Long term borrowings
Capital structure = eens’
—2 Total equity
Interest coverage = Profit before interest and tax (operating profit)
Interest expense
Low gearing and capital structure ratios reflect a less risky approach to financing a
business, as businesses will not have to make high interest payments.
High gearing levels mean that organisations must finance higher fixed interest
payments, and if profits fall, they may be unable to make these payments, leading to
possible actions from creditors, or even corporate failure in extreme cases. High
gearing levels also mean that raising further debt is likely to be difficult and it will
probably be more expensive, in the same way as for an individual who is already
borrowing a lot, any new borrowing will come at a higher interest rate.
Providers of debt may require collateral to secure debt finance, particularly if gearing
levels are high. Collateral means that creditors have a charge over a particular asset
or class of assets, and can take over that asset if the borrower defaults on interest
payments. Creditors also impose conditions, known as covenants on their lenders,
which may place restrictions on additional lending.
The interest coverage ratio shows how many times the company can afford to pay the
interest expense of the year from operating profits. If the ratio is close to one, this is
risky, as it means that the business is only just earning sufficient profits to pay the
interest, and if profits fall, then it may no longer be able to afford the interest. A
higher interest cover (e.g., three times) means that the business can comfortably
manage interest payments.
Loan covenants often specify limits for gearing and interest coverage ratios.

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2.2.5 Capital efficiency

Capital efficiency ratios aim to measure how well a business is using the capital at its
disposal to generate revenues and profits.
Return on capital employed (Return on investment)

Profit before interest and tax (Operating profit) x 100%
Equity plus long-term debt (Total assets less current liabilities)
Profit after tax

Return on equity = s
Equity
x 100%
2.2.6 Insolvency risk and financial distress

To accurately evaluate its financial health, an organisation should adopt an overall
approach to review its financial ratios. Profitability, liquidity, solvency and productivity
efficiency are normally considered as a whole. Relevant non-financial indicators to
measure insolvency risk and financial distress (e.g. any business risk evaluation or
financial distress mitigation measures) should not be ignored. For example, there
may be uncertainty regarding an organisation's ability to meet current liabilities and
short-term loan repayments due to its current liquidity position and short-term cash
flow forecasts.
The Z-score formula has been developed to predict the probability that an
organisation will enter bankruptcy within 2 years. In the calculation of Z-score,
five financial ratios (weighted by different coefficients) are used.
If the overall Z-score is above 2.99, then an organisation is considered ‘safe’. If

it is below 1.8.1 then the risk of insolvency is high and an organisation must
be urgently and actively managed. A Z-score between 1.81 and 2.99 indicates
some concern.
To learn more, you can read Chapter 9.5.2.3: Managing Its Key Financial Health
Indicators and Chapter 13.1.5.1: Z-Score Model from Module 12, Business Finance.
Key takeaway
Financial analysis will always be key to the work that is necessary for accountants.
Make sure that you can calculate ratios from the statements of financial position,
profit or loss and cash flows. However also consider the underlying strategic
factors that underlie the numbers and be aware that the figures can be affected
by one-off issues. Financial statements are historic, from the past, and a lot of
what is needed to run a business successfully is current and may have changed
from the past.

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2.3 Other financial analysis considerations

There are other considerations that need to be made across the different financial
statements:
Accounting policies - Are these having an effect on the organisation's

results, and could the policies be different? There are a lot of decisions
that will have been made on the accounting policies and these should be
assessed. They include depreciation/amortisation rates, revaluations or
impairments, provisions made for decline in value. These can be assessed
to see the effect on the organisation's results and whether they need to
be changed.
Any underlying biases and misstatements that may be in the financial

statements. It could be that the directors, managers or accountants are trying
to change the results of the organisation to show healthier results than are
actually being achieved, so that they can look better, get paid better bonuses
and/or make the organisation look better to investors to raise money or to
avoid insolvency. Equally they may be making the results worse to try to avoid
paying tax.
What are the drivers in the business which are affecting performance? Have
there been unusual events this year that have distorted the numbers, through
unfortunate issues that have hampered the organisation's performance?
Will these distortions continue, or are these one-off impacts on company
performance? Most policies can affect the results that are shown and that needs
to be investigated and resolved.
How are shareholders being affected? Ultimately these are the owners of the
organisation and should be the key long-term stakeholders. In a listed company
it is easier to see the overall effect of the organisation on the shareholders
as the share price can be assessed and hence the level of shareholders' wealth.
However, in a non-listed company we can see the levels of earnings and
dividends and see how the organisation is performing, though the dividends
are the best way of assessing how well the shareholders in non-listed company
are doing.
2.4 Problems with financial performance indicators

There are problems focussing on financial performance as follows:
Performance measures that focus on monetary variables ignore other

important variables which cannot be measured in financial terms e.g.,
customer satisfaction, employee productivity, wastage levels.
Financial indicators are usually historical rather than useful at the current
time, they are a lagging indicator of success.

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° Financial measures are too narrow a measure of success. It may give a measure
of success but doesn't look at the factors that will secure that success, the
organisation's underlying critical success factors. For example, there is likely to
be a lack of information on quality or the organisation's position in the market
in the financial information.
° Financial measures may not be linked to the factors that drive long-term
success (e.g., how and organisation is meeting the needs of customers).
Non-financial performance indicators

Non-financial performance indicators (NFPIs) are measures that are expressed ina
form other than a monetary amount. In section 1.3 above, it was noted that there are
weaknesses associated with financial performance measures. In particular, financial
ratios focus on a narrow range of performance, and do not focus on the drivers of
long-term performance. It is therefore useful to supplement financial performance
measures with a range of NFPIs to obtain a more holistic view of performance, and to
help the management to better guide the organisation to success in meeting its
objectives.
3.1 Advantages of non-financial performance indicators

There are several advantages of using non-financial performance indicators. These
include:
° The information can be provided far more quickly, even real-time.
° The information is more useful to help know what to do. Non-financial

performance indicators are often leading indicators - that is they provide
management with feedback that guides them on how to improve
performance.
° As compare with financial performance indicators, it is generally more difficult

to manipulate the results.
e It is easier to calculate and easier to understand.
Be prepared to say how and why the non-financial performance indicator is useful
for the organisation.
3.2 Disadvantages of non-financial performance indicators

There can be disadvantages of using non-financial performance indicators too.
These include:
° The information may be expensive to obtain, needing the organisation's

information systems to be able to capture this information.

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° Organisations may use too many NFPIs. This can confuse managers when
their performance is judged by many different indicators, and they may find
it difficult to prioritise different areas of performance. The users of the
performance indicators may also suffer from "information overload" which
means that they lose sight of the big picture because they are given too much
detailed information to digest.
3.3 Examples of non-financial performance indicators

Non-financial performance indicators (NFPIs) are used in a variety of areas in an
organisation and relate to operating data, or a measure which is graded on a scale.
3.3.1 Product and service NFPIs
The quality of the product of service that a customer receives is important for
obtaining future sales to that customer, as well as any friends/family that the
customer tells about the quality of the product of service that they have received.
NFPIs include:
° Repeat business percentage/customer retention
° Customer satisfaction ratings
° Number of defective products as a percentage of total units supplied
° Warranty claims per month
These are vital going forward for any organisation. Other measures for the quality of
service include courtesy, reliability, security, availability, access and communication,
all add up to keeping customers happy.
3.3.2 Employee NFPIs
The types of measure used include:
° Staff happiness ratings
° Staff turnover
° Absentee rates
° Learning and development rating
If any of these measures are negative, then the organisation should be considering
how to keep its employees happy.
3.3.3 Brand NFPIs
To measure how well a brand is performing the types of measure used include:
° Loyalty - looks at the brand's ability to get repeat business
° Awareness - do consumers know about a brand, via its advertising or seeing
other people consuming the brand?
Successful branding usually means more sales revenue, less switching to other
brands, fewer consumers making price comparisons and more successful launches
of new products under the same brand.

sr Certified Public Accountants
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i= Activity 2
¢ ©} Which of the following non-financial performance indicators are more open to being
manipulated?
1. Customer satisfaction levels at a call centre that provides online support for an
organisation providing TV and telecoms services
2. The product defect percentage at a cosmetics factory
Required
State which of the measures is easier to manipulate and why.
© Tutorial video: Activity 2

3.4 Interaction of non-financial and financial performance

indicators
Non-financial performance indicators (NFPIs) are very useful for running an
organisation and giving it a better chance of success. However, it may not be clear
how the NFPIs are linked to financial success. If an organisation has set delivery times
as the NFPI for measuring its service quality and achieving customer satisfaction, it
may have to incur extra costs to maintain the delivery times if there are delays in
manufacturing. This may have a marginal benefit in customer satisfaction but a large
effect on the financial consequences. Hence there may need to be a trade-off
between the two.
Similarly, there may be a trade-off between the market share of an organisation

(i.e., a NFPI) against its profit margin (i.e., a financial performance indicator). Cutting
prices may boost market share, but at the cost of the profit margin.
Hence, the financial performance indicators needs to be weighed up with the NFPIs
when making decisions.
3.5 Interaction of effective analysis and business objectives

In performance measurement and management, an organisation should always
consider if it is on target to meet its overall business objectives and whether follow-up
actions have to be conducted to bring back on the target.
The process of measuring and managing performance usually begins with reviewing
the organisation's strategy, identifying the organisation's goals and specifying the
critical success factors.

Certified Public Accountants i 43
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Based on these critical success factors, the management of an organisation can

establish relevant strategic performance objectives which are targets against which
actual strategic performance can be measured and tracked on an ongoing basis.
This is important to the success of every organisation since effective analysis can only
be explicitly and cleared measured according to identified business objectives.
Please read Section 4.7 to learn how an organisation uses key performance indicators
to measure the success of its strategic performance objectives.
Key takeaway
& Non-financial performance indicators (NFPIs) are important for a business as they
look at key operational factors that can make the difference between success and
failure. A problem with customers should be dealt with as soon as possible, rather
than waiting until financial statements are produced and it is discovered then.
4 Data analysis
The analysis of data has become more important for organisations due to the large
amount of data that is available nowadays. Before the internet and smartphones
were so widely used (they have only been used much in this century) then data was
far more limited for organisations. Understanding big data is a useful start point for
looking at the analysis of data. We will then see some of the ways that data can be
analysed and performance assessed.
4.1 Big data

The amount of data that is being collected in the world is incredibly large in
comparison to any other time in the history of the world. There are several PC hard
drives worth of data being collected each year on everyone on the planet, on average.
Most of that data is being collected in the 'cloud'’, in large data centres run by the
largest tech companies in the world. Big data is given four attributes initially:
° The first is the most obvious - volume - data is being collected on everyone's
movement, purchasing, web searches, social media interactions and so on. The
volume of data is mind-blowingly large.
° The next ties into that - velocity - the data must be arriving quickly in order
for the data to mount up. Much data is available in real time, including the
reactions of individuals online to social media posts or the reaction of
customers to a new product via their ratings on an e-commerce site.
e There are lots of different types of data being collected - variety - which means
the data collected can be compared to see if there is consistency or any issues
with the data.

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° It is key that the data being collected is correct - veracity - it needs to be trusted
in order to be used. Whilst potentially very valuable it can also be difficult given
the huge amount that is available.
Three other Vs apply to big data too:
° Variability - The data may be constantly changing, which is tricky if its meaning
needs to be verified constantly.
e Visualisation - The data needs to be recorded in a manner that means it is

readable and accessible.
° Value - The data needs to be checked to make sure that is something that can
be turned into something valuable, if not it is of no use.
All of the 7Vs need careful consideration so that organisations obtain value from big
data. They need to look at the sources of the data that they obtain - processed
information from information systems, open data, which comes from the Government
and the public sector, human-sources data, from social networks, emails and text
messages and machine generated data from computer and website logs and devices
connected to the internet of things.
4.2 Data analytics

Data analytics is the process of exploring data to find useful information that can help
to inform the management of a business and help them make better decisions. Data
analytics includes all activities relating to collection and storage of data, analysis of
the data, sharing the data, and performing visualisations.
There are three broad categories of data analytics:
1. Descriptive data analysis which answers the question, "What has happened?"
2. Predictive data analysis which answers the question, "What could happen?"
3. Prescriptive data analysis which answers the question, "What should we do?"
4.2.1 Descriptive data analysis

Descriptive data analysis involves analysing large sets of data, and providing
summaries for management of what has happened in the past. It uses statistics
such as the mean and standard deviation. Information such as average spend per
customer, increase in sales year on year and average sales by branch are examples
of descriptive data analysis.
4.2.2 Predictive data analytics

Predictive data analytics identifies relationships between different items in the data
and uses these to try to predict what may happen in the future.
Predictive data analytics is often used to forecast what types of products or services
customers may demand in the future, based on factors such as the socio-economic

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background of customers. Many businesses use data analytics to predict individual

customer product preferences based on their customer profile and purchase history
to automatically generate personalised digital marketing communications.
Prescriptive data analytics can also support decision making (e.g. which products to
make, which markets to enter and so on.)
Real life Illustration: Netflix data collection

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Streaming service and film producer Netflix collects data about the viewing habits of
its subscribers. This includes information such as which movies or shows they
watched all the way through, which shows they started and then gave up on, and
which shows they did not watch at all. It can even predict the impact that particular
actors will have on the success of a film.
This information is fed into the film production department, allowing Netflix to
predict much more accurately whether a particular new movie will be a hit or not. If
not, production of the film will be stopped.
4.3 Advantages of data analytics and big data

There are lots of good aspects to the use of data analytics and big data:
° Improving performance - Real-time information can help boost profitability of
organisations.
° informed decision making - Better decisions can be made to determine how to
target a product or how to deal with negative feedback.
° Innovation - New products and services will become apparent.
° Transparency - A lot of things will become clear that were not before.
° Better market segmentation - Allowing better targeting of products.
° Customisation - Services, particularly online ones, can be better tailored to the
needs of customers.
Overall, the benefits are potentially huge, assuming the data is available, and the
skills are in place to analyse it.
4.4 Disadvantages of data analytics and big data

There are huge benefits of data analytics and big data but also some potential
problems:
° Skills of the workforce - Can they cope with it?
° Storage - Does the organisation have enough and can afford more?
° Data dependency - Is the data good enough quality if the organisation is relying
on it?

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° Data privacy - Can the organisation be hacked and lose sensitive customer
data?
° Overload - Is there too much data?
4.5 Fundamentals of data analysis

The purpose of data analysis is usually to help improve the results of an organisation,
both financial and non-financial. However, one important decision to make early on
in data analysis is to decide what the objective is. The objective should be ethical and
is within the bounds of risk the organisation is willing to take. The analysis should
be within a set period of time, and importantly, adds value in a desired way for the
organisation. There will usually be a range of possible objectives that the organisation
can take, but it should be checked that the objective chosen is suitable, acceptable
and feasible.
When analysing data, you are likely to have to:
° Make assumptions about the data that you are given (e.g., if the current profit
margins are sustainable in the future and can be used to predict future profits).
° Use estimates to help make predictions about the future results of the
organisation.
° Be sceptical. See if there is anything that is questionable, say due to someone
wanting to look good, meaning they have over-estimated what is likely to
happen.
4.6 Specific data analysis

There are lots of potential data analysis that you may encounter in Capstone using
the financial and operational data that is given to you. Some of the most common
method of analysis are breakeven analysis, forecasting and sensitivity analysis.
4.6.1 Breakeven analysis

This is where the organisation is looking at how many it needs to sell to start making
a profit, on its normal operations, or more likely on a new project it is undertaking.
Fixed costs
Breakeven point (units) ~ (Selling price — variable costs per unit)
This formula takes the fixed costs for the organisation and to divide them by the
Contribution (sales price less variable costs per unit). This will give the number of
units that need to be sold to break even financially.
The margin of safety is a measure of risk which measures the change in expected
sales required to fall below the breakeven point, as follows.
Margin of safety (%) - (Expected sales volume—Breakeven sales volume)
(Expected sales volume)

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Activity 3
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Fresh Air Company Ltd is a company that manufactures ceiling fans. It is a relatively
444
young company and only sells one type of fan. It currently sells only in Hong Kong but
is already planning to expand operations into mainland China. It is existing capacity is
around 1 million units per year.
HK$
Materials 217.25
Production labour 160.73
Other production costs 322.80
Total cost per unit 700.78
The product sells for HK$1,200 per ceiling fan. Budgeted sales and production are
800,000 units. Sales and distribution costs and other costs should amount to
HK$270,000,000 and are a fixed cost.
Required
(a) Compute the breakeven volume of ceiling fans and the margin of safety if
production labour is a variable cost and other production costs are fixed.
(b) Explain whether the assumptions made in the computations in part (a) are
realistic, and what factors might affect them.

4.6.2 Financial forecast

These look at the estimates and assumptions of the organisation for a future period
of time and look at how an organisation or an investment it will make is likely to
perform. There will have to be a series of computations involved:
° Sales revenue, taking into account assumptions on the level of growth
° The existing gross profit margin can be applied to the forecast sales revenue to
forecast gross profit
° Other costs of the business, such as overheads, in order to obtain net profit
° Taxation
° Dividends
Once these are estimated then the likely results for the organisation and/or its new
projects can be assessed.

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There are several considerations for the financial forecasts to make sure that they
have been prepared carefully and correctly:
e How reliable is the information being used? There will always be uncertainty
when predicting the future, but it is useful to assess the source of the
information and how likely it is to be correct.
° How much are you having to assume? It is worthwhile making sure that you
have stated these assumptions.
° The time period for the financial forecast - The longer the forecast, the less
likely it is to be reliable.
° The likely error tolerance - How accurate is it possible to be and are any
fluctuations likely bad for the final forecasts?
° Is there any information missing? What else would you like to know?
4.6.3 Sensitivity analysis

Due to the assumptions and estimates that are being made in any forecast, it is
worthwhile looking to see how much change there needs to be in the numbers in
order to see the sensitivity of the forecasts to the underlying variables.
To achieve this, it is first worth deciding what the critical variables are in the
calculation. A variable such as the rate of growth in sales revenue could well be an
example of this. If sales are overestimated, this will usually have a big effect on the
overall financial performance. As a result, an organisation may make poor business
decisions such as buying too many stocks.
You may well not have time in the Capstone to produce any detailed calculations, but
it is a good idea to state what you consider to be the important factors in the
calculations and state how that factor would change the financial forecasts that you
have made or have been presented with. Aim for one or two key factors, don't feel
you have to mention everything that could change the forecasts as that will add too
much complexity.
—
Example: Sales price and sales volume sensitivity analysis
—
Consider a four-year project, with a net present value (NPV) of HK$2.3m and a cost
of capital of 10%. Sales revenue in each of these years is forecast to be HK$10m,
HK$11m, HK$12m and HK$13m. The contribution margin is 20%. The profits tax rate
on profit is 16.5%.
The board has asked the finance team to determine the following:
(i) | Sales price sensitivity, i.e., what happens to revenue if the price falls. Here, the
impact is on revenue only as sale volumes are unchanged, so the costs of
production remain unchanged.
NPV
Sales price sensitivity (%) = Present value of post—tax revenue

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(ii) Sales volume sensitivity, i.e., what happens to profit if the volume falls. Here the
impact is on contribution margin, as both revenue and variable costs fall.
NPV
Sales volume sensitivity (%) =
Present value post—tax contribution margin
(i) Sales price sensitivity Year 1 Year2 Year3 £Year4

HK$'000 HK$'000 HK$'000 HK$'000
Sales revenue 10,000 11,000 12,000 £13,000
Post tax sales revenue at 16.5% 8,350 9185 10,020 10,855
Discount factor at 10% 0.909 0.826 0.751 0.683
Present value of post-tax revenue 7,590.9 7,590.9 7,528.2 7,414.1
Project NPV 2,300.0
Present value of post-tax revenue 30,124.1
Sensitivity to sales price 7.6%
(ii) Sales volume sensitivity Year 1 Year2 Year3 £Year4

HK$'000 HK$'000 HK$'000 HK$'000
Contribution margin (20% of revenue
above) 2,000.0 2,200.0 2,400.0 2,600.0
Post tax contribution margin at 16.5% 1,670.0 1,837.0 2,004.0 2,171.0
Discount factor at 10% 0.909 0.826 0.751 0.683
Present value of post-tax contribution 1,518.2 1,518.2 1,505.6 1,482.8
Project NPV 2,300.0
Present value of post-tax contribution 6,024.8
Sensitivity to sales volume 38.2%
Note. Sensitivity is determined post-tax as NPV is also calculated after tax.
In this example, the project is far more sensitive to price than sale volume. If forecast
prices reduced by 7.6% then the project would not be viable as it would not generate
the minimum return required by investors for the risk undertaken.
Sales volumes would need to drop by 38.2% before the project becomes unviable.
Remember, a project's internal rate of return (IRR) is a discount rate used in project
analysis that makes the NPV of the cash flows exactly zero. Therefore, the IRR
represents the highest acceptable cost of capital. If the cost of capital becomes higher
and the project NPV falls below zero, the organisation should change the decision and
reject the project. Capstone candidates need to apply sensitivity analysis to analyse
the cost of capital by calculating the IRR.

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4.7 Critical success factors and key performance indicators
Key term
Critical success factors are desirable feature of a business which are considered as
vital by an organisation in order to achieve its strategic and profit objectives.
Key performance indicators (KPIs) are a type of performance measurement which use
financial and/or operating data to evaluate the success of a particular activity in which
the business engages.
Critical success factors (CSFs) are determined by the needs the customer in terms of
product quality, delivery or price, or the nature of the supplier chain in order to
control costs and deliver profitability.
CSFs and key performance indicators (KPIs) are linked together. For example, a CSF
for a speedy delivery company might include, delivering products to customers
accurately, on time, and without damage. Once decided, the relevant KPIs can be set,
to measure the extent to which success is being achieved, for example, number of
late deliveries (%) (late deliveries per month/total deliveries per month).
4.7.1 Balanced scorecard
Kaplan and Norton were the creators of the balanced scorecard. It aims to provide
management with a multi-dimensional set of information covering all areas of
performance (both financial and non-financial) in an objective and unbiased fashion.
It helps take the financial and non-financial parts of an organisation and have a better
overall view of its key elements of performance.
The balanced scorecard has four key perspectives to take on performance:
1. Financial - How is financial value created for the shareholders of the

organisation and how should the organisation indicate that to the shareholders?
2. Customers - As these are key to most organisations, it is important to know

what they place value on. The organisation can then decide what it needs to do
to be valuable to its customers and which indicators should it use to see
whether customers are happy with the products and services they are being
supplied with.
3. Internal processes - What is the organisation doing internally and what are the
key parts for success? As shareholders and customers are two key stakeholders
of an organisation, what parts of its operations will make the most difference to
them? The organisation will want to be excellent at its operational performance
to please shareholders and customers.

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4. _ Learning and growth - How can the organisation innovate over time to be
successful due to creating value? Will the organisation be able to sustain this
advantage or are there new parts of its business that it will have to move into to
achieve this? Is there new knowledge needed and increased workforce skills
required to be successful?
Once these four perspectives have been considered, the CSF can be decided. What
are the key points that need to be set for each area of the balanced scorecard?
4.7.2 |\dentifying appropriate KPls

Once the important issues and CSFs have been decided for the balanced scorecard
then KPls can be created from it. Remember that the balanced scorecard considers
important strategic concerns as well as financial outcomes. The KPIs that are chosen
should have the following characteristics:
° Focussing on what is most important for the organisation's success
° Help let the organisation see if its strategy is working
° Properly defined in terms of the unit of measurement, the frequency they will
be calculated, what the target KPIs are and who is responsible for gathering
them and for their achievement
° They should be reliable in seeing what is actually achieved, not just the effort
put in
4.7.3 Possible KPls on the balanced scorecard
The following are possibilities for what can be used on the balanced scorecard for
KPIs. They are not exhaustive, others are possible, but they are reasonably common.
Looking at each part of the balanced scorecard:
1. Financial - profitability, sales growth percentage, cost savings, cash flows, return
on capital, shareholder return
2. Customer - repeat orders, customer satisfaction feedback, new customers

gained, share of the organisation's market
3. Internal business processes - production time achieved, product return or

breakdowns, deliveries made on time, new orders won
4. Learning and growth - new products developed and sent to market,

productivity levels of staff, training hours per member of staff, percentage of
sales from new products introduced to the market
Activity 4
[wil
Clever Carriage Company Ltd is a company that is a large delivery company in Hong
Kong and several countries close by, with over 8,000 employees and 4,000 delivery
vehicles. It delivers over half a million packages each day, so it is one of the biggest

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delivery companies in the region. However, it still wants to grow in the countries it
serves and possibly expand to other markets.
Required
(a) List the possible critical success factors for Clever Carriage Company Ltd under
the four key perspectives of the balanced scorecard.
(6) Determine the possible key performance indicators for measuring performance
against each of the critical success factors in part (a).

4.8 Reliability of information

The financial data analysis that you perform in the Capstone Final Examination
may be based on assumptions given to you in the Case Study. For example, there
may be data about historical growth rates in sales revenue, average gross profit
margins within the industry or financial forecasts and estimates projected by the
board of directors.
Information that you prepare as part of your answers may then be based on such
assumptions. Therefore, you should be prepared to professionally evaluate the
integrity of the assumptions that you have been given, where you believe that there
is a possible risk of under or over estimation.
Also, you may need to make assumptions of your own and you will need to explain
them (and justify them) in your report.
As you begin to plan your financial analysis, or evaluate the financial analysis
provided as part of the Case Study, please consider “the preparer”, “the purpose”,
“the precision” and “the predictions”, as part of your evaluation on whether the
financial analysis can be trusted, or whether there are some concerns which limit
its usefulness.
Preparer? Does the person who prepared financial information or provided key
assumption have a vested interest in the decision?
What knowledge or skill does the preparer of the information have?
Purpose? Why has the information been provided and was it prepared for a
specific purpose? If so, is there a possibility that it may contain bias,
given its purpose and the person who prepared it?

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Precision? — What is the likely level of accuracy of the information provided?

Does it come from an audited source, or from formal management
accounts or is it an estimate or does the information come from a
completely new source, or a third party?
Predictions? Are the assumptions realistic about future levels of activity?

To what extent are predictions in the information provided based on
speculation or fact which can be corroborated?
4.9 Improving data analysis

A lot of data analysis involves looking forward and hence it is based on a series
of assumptions. In the Capstone students should consider whether the financial
data and assumptions provided are reasonable and reliable. If there is any bias
possible from the staff preparing or setting the forecasts, this is worth looking out
for. Feel free to challenge any assumptions if they look overly optimistic or if they
are likely to be biased. If so, state any assumptions that you feel are more
appropriate for the situation faced, and make sure that you justify why your
assumptions have been made.
Overall, make sure that you apply professional scepticism to any analysis of financial
data or indeed any non-financial data. They are likely to be connected.
A useful list of means of improving data analysis and applying your professional
scepticism is:
° Deciding the purpose of the analysis
° Deciding if the techniques are suitable
° Making sure the analysis has suitable levels of detail in it
° If any changes are necessary, making sure that you have stated them and the
reasons behind why you have said them
° Is it worth suggesting that sensitivity analysis is used?
° Being clear if there are any reservations you have on any suggestions you have
given
Key takeaway
& Data analysis is very important for most businesses nowadays. This is due to big data,
so much more data is being collected in real-time. There are lots of ways to analyse
the data and also to try to make sure that the critical success factors in a business are
identified and key performance indicators are used to help bring the business to
SUCCESS.

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5 Comprehensive analysis activity

©
-o—— This tutorial video will walk through the comprehensive analysis activity.
This activity is designed to give you practice at calculating financial ratios for an
organisation, as well as thinking about the strategic aspects of the organisation and
the non-financial elements.
Activity 5
Action Sports Company Ltd (Action Sports) owns and operates two gyms in
Hong Kong. Members pay an annual membership fee, which gives them unlimited
access to its gym facilities. The annual membership fee allows members to take
advantage of personal training as well as physical equipment at its premises.
Action Sports was founded 15 years ago and four years ago, the company was listed
on the Stock Exchange of Hong Kong.
It is looking at ways to continue to grow and be successful. The most recent results
have been released and they are contained in the financial statements below.
Over the past ten years, the number of Hong Kong residents exercising regularly at
gyms has been growing by around 12% per annum. However, the number of gyms in
Hong Kong has been growing by 35%. Recently, a large multinational operator of
gyms decided to pull out of the Hong Kong market
Many gyms in Hong Kong have a poor reputation due to the use of unqualified
trainers. Action Sports has always been very careful to ensure that all of its trainers
do hold relevant qualifications, and this has given the company a good reputation in
the market.
Action Sports Company Ltd: Statement of profit or loss and other comprehensive
income for the year ended 31 December 20Y2
20Y2 20Y1
HK$'000 HK$'000
Membership subscriptions 148,680 141,280
Employee costs (76,800) (70,700)

Rental costs (24,900) (23,920)
Property management fees (3,100) (3,000)
Depreciation (6,400) (6,200)
Advertising and marketing (3,700) (3,400)
Bank charges (7,000) (6,800)
Other operating expenses (12,200) (11,300)
Total operating costs (134,100) (125,320)

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20Y2 20Y1
HK$'000 HK$'000
Profit before interest and tax 14,580 15,960

Interest expense (1,500) (1,400)
Profit before taxation 13,080 14,560
Income tax expense (2,500) (2,600)
Profit after taxation 10,580 11,960
Action Sports Company Ltd: Statement of financial position as at 31 December 20Y2

20Y2 20Y2 20Y1 20Y1
Assets HK$'000 HK$'000 HK$'000 HK$'000
Property and equipment 57,960 55,700
Current assets
Inventory 2,100 2,300
Receivables 4,600 3,800
Cash and bank 26,900 23,400
33,600 29,500
Total assets 91,560 85,200
Equity and liabilities

Share capital and reserves 40,200 40,900
Non-current liabilities
Long-term loans 15,000 14,000
Current liabilities
Trade payables and accruals 9,060 6,300
Deferred revenue 25,300 22,000
Taxation 2,000 2,000
36,360 30,300
Total equity and liabilities 91,560 85,200
Note. Action Sports Company Ltd had a positive cash flow in the year ended
31 December 20Y2 of HK$3.5 million. The largest contributor to this were the profits
made in the year, though most of the net profit was paid out as dividends and there
were some new properties purchased.

a SRRHHAB
Required
(a) Analyse the financial performance of Action Sports Company Ltd.
(6b) Identify and explain the critical success factors that apply to Action Sports
Company Ltd under each perspective of the balanced scorecard, and for each
critical success factor, identify and justify an appropriate key performance
indicator.

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° Financial analysis is important to us as accountants, once financial statements

or management accounts have been produced we can see how the numbers
have changed over time and the relationships between the numbers.
° Financial analysis can be performed by looking at the statement of profit

or loss and other comprehensive income, statement of financial position
and statement of cash flows. Know the interrelationships between each of
them and watch out for any assumptions or accounting policies in their
production.
° Financial analysis includes trend analysis and ratio analysis. For trend analysis,
common size analysis and index analysis are frequently used. For ratio analysis,
we will usually look at profitability, liquidity, solvency and capital efficiency of an
organisation.
e As financial statements look backwards and are concentrated on numbers,

make sure that you use the background information provided with the question
to provide explanations and interpretation of the financial analysis.
° Non-financial analysis widens the scope of the analysis and can be performed in
real time. Non-financial performance indicators focus on factors that drive
future success.
° Data analysis is far wider than just financial analysis and is enhanced by big
data, the huge amount of data that it is possible to collect in real-time from the
internet, social media and smartphones. There are seven considerations when
considering the value and scope of big data analysis
1. Volume. How large is the quantity of data generated and collected?
Velocity. How quickly data is generated and collected?

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Variety. What types of data is generated and collected?
Veracity. Accuracy or trustworthiness of data generated/collected

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Variability. The rate of change of data

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Visualisation. Can data be easily read, understood and accessed?

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Value. Can data be converted into valuable information?

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There are three broad categories of data analytics:
1. Descriptive data analysis which answers the question, "What has

happened?"
2. Predictive data analysis which answers the question, "What could

happen?"
3. Prescriptive data analysis which answers the question, "What should

we do?"
The balanced scorecard is a model that aims to provide a more holistic view of
the performance of an organisation by measuring performance from four
perspectives, financial, customer, internal processes and learning and growth.
Critical success factors are worth deciding, to set what is key to helping an
organisation succeed and avoid failure.
Once critical success factors are decided (CSFs), key performance indicators
(KPIs) can be created so that performance can be monitored and reacted to as
needed. KPIs are an important form of internal control as they act as an early
warning that a company may be drifting from its strategic objectives, its
financial targets or achieving its CSF's or competitive advantage.

ae SHRNGAR
Activity 1 answers
Confidence Ltd - computation of ratios
The ratios required are provided below:
20Y3 20Y2 20Y1
% % %
Growth in sales 1.05 6.4
Gross profit margin 59.2 63.7 59.7
Operating profit margin 5.2 9.9 8.3
Other operating costs-to-sales ratio 54.1 53.8 51.4
Analysis of underlying causes

° Sales are rising in all years, but the growth in sales has declined considerably
from 6.4% in 20Y2 to only 1.05% in 20Y3. In the years after Confidence Limited
introduced the cups (20X9), growth was high, as the company found new
customers for a new product. In 20Y3 however the company has not identified
any new customers, so sales are from existing customers replacing their cups.
In terms of the product lifecycle, the product appears to have reached its
maturity phase, where sales growth slows, but sales remain steady.
° Gross profit margin increased from 59.7% in 20Y1 to 63.7% in 20Y2. This suggest
that the company was finding greater efficiencies in its production process,
possibly as a result of economies of scale, and also the effect of learning how to
do things better. It would be expected that this would have continued in 20Y3,
but in fact the gross profit margin has fallen back to 59.2%. This is most likely
due to the increased in energy prices.
° The operating profit margin has declined from 9.9% in 20Y2 to 5.2% in 20Y3, a
fall of 4.7%. This is mainly due to the fall in the gross profit margin, which fell by
4.5%. The remaining fall of 0.2% relates to the increase in other operating costs.
e The other operating costs-to-sales ratio increased from 53.8% in 20Y2 to 54.1%
in 20Y3. This may also be due to a rise in fuel costs, which may have impacted
other operating costs as well as manufacturing costs. The increase is small, but
it does remind management that they must ensure that costs are controlled in
the following years.
° In order to ensure that the business remains sustainable, Confidence Limited
should consider whether they can pass on some of the increase in their cost
base to customers in terms of higher prices, to try to increase their profit
margins.

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Activity 2 answers
Which of the measures is easier to manipulate and why?
1. It is possible to manipulate customer satisfaction levels at a call centre. If the

customer seems pleased, the call centre operator may decide to ask them to
take a customer satisfaction review at the end of the call in order to obtain their
rating. If the customer seemed upset, the call centre operator may decide not to
progress with the feedback.
If work is being done in a factory on an automated system, it is likely that

the results are produced by the manufacturing system and hence harder to
manipulate. Obviously, there may be ways to achieve some manipulation but
if the information about defects is being fed back automatically then the
management of the factory are likely to get unmanipulated performance
indicators.
Activity 3 answers
Required
(a) Computation of break-even volumes for the ceiling fans
Total fixed costs are HK$270,000,000 for the sales and distribution and other
production costs plus HK$258,240,000 (800,000 units x HK$322.80).
The contribution margin for each fan is HK$822.02 (HK$1,200 - (217.25 + 160.73)).
The breakeven volume is 642,612.
Given the expected sales are 800,000, the margin of safety is 157,388 units,
which is 19.6% of the budgeted sales.
(b) Assumptions behind the break-even analysis
An assumption behind break even analysis is that the selling price per unit will
not change. This may not be realistic if the company is considering expanding
into mainland China, where a different market may expect a different price. The
price charged in mainland China will depend on the amount of competition for
fans, and the level of incomes of the population.
Further assumptions relate to variable costs. It is assumed that these remain

constant. However, variable costs may also change as production levels
increase. Typically, the company may enjoy economies of scale as higher
production volumes will allow a company to get larger discounts from suppliers
and achieve greater efficiencies. However, selling into mainland China would
involve additional transport costs.

ae SRN OR
Fixed costs are only likely to be fixed up to the level of maximum capacity, which
is 1 million units per year. If Fresh Air Company Limited wishes to produce more
than this, the company will have to expand its operations - either by extending
capacity at its existing factory, or possibly opening a new factory in mainland
China, closer to the new customers.
Activity 4 answers
Critical success factors and possible key performance indicators for Clever Carriage
Company Ltd
The following CSFs and KPIs follow from the four perspectives of the balanced
scorecard. Others are possible, so long as they are focused on providing a good
customer service at a low cost.
Balanced scorecard Critical success factors Key performance indicators

(compared to target and
previous years)
Financial e Delivering results for e Profit growth, share

shareholders price growth
Customers e Deliveries on time e %of deliveries on time

e Customers are happy e Customer satisfaction
e Cost to customer is ratings
competitive e Comparison of prices
with competitors for
similar deliveries
Internal processes Speed of delivery e Actual delivery times

e Nodamage to the versus expected
packages delivered e Percentage of packages
damaged and needing
replacement
Learning and growth Delivery drivers trained For both: Number of

to work efficiently training days for each
e Customer service staff
offering valuable help to
customers
Note. The order that the CSFs is decided in may not be the order that the balanced
scorecard gives above. For example, keeping customers satisfied is a useful starting
point and the financial outcomes are often the final result of the other parts of the
balanced scorecard.

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Activity 5 answers
(a) Analysis of financial performance of Action Sports Company Ltd
Revenue trends
Membership subscriptions increased by 5.2% between 20Y1 and 20Y2. This is
a good performance in an industry where the growth in the number of gyms
(35%) is much higher than the growth in gym members (12%), and where a
major operator recently pulled out. This growth may be due to the good
reputation that Action Sports Company Ltd has as a result of employing only
qualified trainers. This is a competitive industry, and Action Sports Company Ltd
is doing well in keeping its membership fees high.
Profitability
In spite of the increase in members, the operating profit margin has fallen
from 11.3% in 20Y1 to 9.8% in 20Y2. This is surprising given the increase in
membership. It would be expected that many of the costs of operating a gym
are fixed in nature, so if more members join the gym, the operating profit
margin would be expected to rise.
The employee costs to revenue ratio and other operating expenses to revenue
ratio have both increased. This may reflect inflationary pay rises, which suggests
that membership fees have not risen with inflation. While this may be a good
strategy in the short term, to keep membership high, if the business is to
remain sustainable in the longer term, it must pass on higher inflation to
members through higher membership fees.
Liquidity
The current ratio has fallen from 0.97 in 20Y1 to 0.92 in 20Y2. While this looks
precarious, the biggest current liability is deferred revenue. Deferred revenue
will not be settled by paying cash, but by providing a service that members have
already paid for. The deferred revenue represents 62 days of membership
subscriptions at 31 December 20Y2, while the cash balances represent 73 days
of operating expenses. This suggests that the company will have sufficient
liquidity to continue operating.
Capital efficiency
Return on capital employed fell from 29.1% in 20Y1 to 26.4% in 20Y2. This is
mainly due to the fall in operating profit, due to the factors in the “Profitability”
section above. Capital employed only increased slightly from HK$54.9 million
at 31 December 20Y1 to HK$55.2 million at 31 December 20Y2, representing a
rise of 0.5%.
Gearing
Capital structure ratio increased from 34.2% at 31 December 20Y1 to 37.3%
at 31 December 20Y2. It is interesting to note that the value of equity actually

ae SRN OR
fell over this period by HK$700,000 which indicates that dividends were paid
in excess of the profits earned in FY20Y2. At the same time, the long-term
loans increased by HK$ 1 million. This suggests that management have taken
a conscious decision to change the capital structure to have more debt and
less equity.
Since the interest coverage ratio for the year ended 31 December 20Y2 is
9.7 times, it does not appear that Action Sports Company Ltd will have
any difficulty paying the interest on the loan. Debt also has the advantage that
interest could be a tax-deductible expense, so increasing the level of debt in
the capital structure may reduce the overall weighted average cost of capital.
Conclusion
In summary, Action Sports Company Ltd has done well to increase revenues in
a competitive market which is over supplied. However, there is a trend that
operating costs (e.g. employee costs) are rising. If the business is to be
sustainable in the longer period, it will be necessary to increase revenue by
increasing membership volumes and possibly increasing membership fees.
A fall in profit margins has reduced the return on capital employed. Current
liquidity and level of debt within the capital structure are not an immediate
cause for concern.
At this time, the most important task for management is to restore profitability
levels.
Appendix - Calculation of financial ratios
Revenue growth 5.2%

((148,680 - 141,280)/141,280)
Operating profit 9.8% 11.3%

margin (14,580/148,680) (15,960/141,280)
Employee costs to 51.7% 50.0%

revenue ratio (76,800/148,680) (70,700/141,280)
Other operating 8.2% 8.0%

expenses to revenue (12,200/148,680) (11,300/141,280)
ratio
Current ratio 0.92 0.97

(33,600/36,360) (29,500/30,300)
Cash balances in 73 days 68 days

operating cost days (26,900/134,100) x 365 (23,400/141,280) x 365

SRRAHHAR
| IN) INA |
Deferred revenue 62 days 57 days
membership days (25,300/148,680) x 365 (22,000/141,280) x 365
Return on capital 26.4% 29.1%
employed (ROCE) (14,580/(40,200+15,000)) — (15,960/(40,900+14,000))
Capital structure 37.3% 34.2%
ratio (15,000/ 40,200) (14,000/40,900)
Interest coverage 9.7 times 11.4 times
ratio (14,580/1,500) (15,960/1,400)
(b) Critical success factors and key performance indicators for Action Sports
Using the balanced scorecard will help us see the other aspects of Action Sports
that can be improved. We have already looked at the financial aspects in part
(a), So it is useful to reflect this analysis in the balanced scorecard, but we can
also see how it affects the CSFs and KPIs:
sre] fale =10 Bee) R-e= 1 i CSFs dS
Financial e The business needs to e Revenue growth rate

continue progressing. ° Gearing ratio
° The company can e Costs as a percentage

borrow easily as a of revenue
foundation of its
growth, so the balance
of financing needs to be
improved.
e Costs in some areas
need to be controlled -
employee costs and
other expenses.
Customers e Customers using the Customer retention

gyms need to be rates
encouraged to continue. e Customer satisfaction
e Customers need to be rates
happy with the gym and
the classes they attend
there.

CPA CertifiedPublic Accountants 165
Balanced scorecard | CSFs adks
Internal processes The extra staff costs Staff costs as a

should be controlled, percentage of revenue
if possible. Staff satisfaction rates
A stable workforce is and retention rates
good news for customer
happiness.
Learning and Personal trainers, Training courses/hours

growth equipment maintenance attended per employee
and customer services
staff need to be
encouraged that they
are learning and being
invested in. This may
help staff retention.

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Analysing the
Pre-seen
Case Study
Topic list
1 Analysing the Pre-seen Case
Study
2 Case study: Hong Kong Kitchen
and Bathroom Supplies
Company Ltd (HKKBS)
3 Walkthrough of the HKKBS
Pre-seen Case Study
Learning focus
In this chapter you will cover how to analyse the information in the pre-seen case
study. Pre-seen information can cover any of the Capstone learning outcomes
(see Chapter 1). The Pre-seen Case Study provides context for the questions in
the assessments which enables the examiner to test your ability to give relevant
advice. It is therefore essential that Capstone candidates develop their ability to
effectively analyse the Pre-seen Case Study information.
Chapter Summary
Analysing the Pre-seen

Case Study
Steps to analyse the

Pre-seen Case Study
Capstone participants are

advised to:
e Read through Pre-seen Case Study
e Analyse the financial performance
e Perform an analysis of the external
environment
e Analysis competitive environment
e Internal resource analysis
e Prepare a SWOT analysis
e Analyse current strategy
- Marketing strategy and marketing
mix
- Growth strategy
- Financial strategy
e Consider potential strategies

me F8RNHOR
5: Analysing the Pre-seen Case Study
Analysing the Pre-seen Case Study

In this chapter you will cover how to analyse the information in the Pre-seen Case
Study. Pre-seen information can cover any of the Capstone learning outcomes
(see Chapter 1).
The Capstone focuses on the ability to deal competently with situations professional
accountants regularly face, involving the integration and application of knowledge
and skills from any part of the new QP syllabus (such as financial reporting, business
finance, auditing and taxation), across all fields of technical and enabling competence.
The Pre-seen Case Study will form the basis of the tasks that you can expect during
the Capstone Workshops and the Capstone Final Examination. As such, it is essential
for you to be familiar with the Pre-seen Case Study before your attendance at the
Capstone Workshops and before you attempt the Capstone Final Examination.
The Pre-seen Case Study for the Capstone Workshops is included in the Participant's
Prework. The Pre-seen Case Study for the Capstone Final Examination is available five
working days in advance for candidates to prepare for the examinations.
Note, the pre-seen case study for the Capstone Workshops and the Pre-seen Case
Study for the Capstone Final Examination are based on different companies and are
not linked in any way.
1.1 Objectives of the Pre-seen Case Study

The Pre-seen Case Study provides context for the questions in the assessments.
This enables the examiner to test your ability to give relevant advice to clients
which takes account of their internal and external situation. A recommendation
that would be appropriate to one client may be totally unsuited to another. You
need to demonstrate that you understand the client's situation and can tailor your
advice to suit it, rather than just reciting theories from the HKIPCA learning packs
and this Workbook.
The types of information included in the Pre-seen Case Study may include the
following:
° Company history and background
° Industry background
° Business operations/functions
° Key personnel
° Financial highlights
° Other relevant information about business strategies, corporate governance

and risk management

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What you are aiming to achieve from your analysis of the pre-seen is knowledge of
the following areas:
° Understanding the particular factors that apply to companies in that industry.

This includes areas such as the competitive nature of the industry, external
factors that might affect the industry and key accounting issues that should be
considered by the industry players.
° The internal strengths and weaknesses of the business. These might be spelt
out explicitly in the pre-seen, but it is more likely that you will need to do some
analysis to identify these.
° Details of key personnel. Typically, you are presented with a list of the directors/
senior managers of the company, along with information about their
background. This information may also help you to spot weaknesses in the
governance of the business (e.g., if there are no independent non-executive
directors).
° Financial performance/ financial position. You may be provided with financial

information, such as management accounts, and financial and non-financial key
performance indicators. These can help to identify many of the important issues
in the company.
° Strategic plans/operational issues/risks: Such areas may be presented in

minutes of board meetings, reports from consultants or even newspaper
articles about the company. These show what the management are thinking
about and therefore highlight topical issues. These will often give clues as to
what topics will come up in the final exam.
You need to know the Pre-seen Case Study thoroughly when you get to the Capstone
Workshops and the Capstone Final Examination.
During the Capstone Workshops and in the Capstone Final Examination, candidates
will be provided with additional information for you to plan and write your answers to
the requirement. You will not have time to analyse the pre-seen, so it is strongly
advised that your analysis of the Pre-seen Case Study is completed beforehand.
1.2 How to analyse the pre-seen

The following activities are useful to help you analyse the pre-seen information. You
may not be able to use all of these tools if the information is not provided in your pre-
seen, but do perform these activities if possible. You will be given an opportunity to
practise these here, as there is a case study provided in Section 2 of this chapter, and
activities relating to this in Section 3.
° An initial read through of the pre-seen. Read the Pre-seen Case Study from
beginning to end, without taking notes or highlighting anything, just to gain an
overall awareness of what is included within the pre-seen. This allows you to see

a HRRUNALR
the 'big picture’. After your initial read through, reflect on what you can
remember. Did any issues stand out clearly from your initial read through? If
they did, write them down.
Read through the case study again. Make notes as you go through. Different
people use different approaches to note taking. Use an approach that you find
will help you best to find and remember the information in the case. Here are
some common approaches:
- Highlight key points as you read through the exhibits.
- Draw ‘big picture diagrams' (or mind maps) summarising the information
on one page so you can remember the key points.
- Create brief summaries of each exhibit.
Analyse the financial information. An analysis of the financial information is

likely to make you aware of issues that the organisation is facing. Obvious things
to look for are trends - have sales increased, is the company profitable? Ratios
may also be useful. Refer back to Chapter 4 for further discussion of analysing
financial information.
Perform an analysis of the external environment. PESTEL can be useful for

identifying external factors that will affect the business. Often there may not
be sufficient information in the pre-seen to enable you to analyse all the factors
of PESTEL, so don't try to include analyses for things that are not included
(e.g., if no political factors are provided in the pre-seen, don't try to analyse the
political environment).
Perform an analysis of the competitive environment; for example, using the

Porter's Five Forces model.
Perform an analysis of the organisation's internal resources and competences.

Where does the organisation add value? Does the organisation have any
competences or competitive advantages? Is the corporate governance structure
appropriate? An analysis using Porter's Value Chain might be useful here.
Prepare a SWOT analysis. This will be a useful way of remembering the key
issues that the company is facing and determining the most important strategic
choices.
Analyse the strategy of the company. You could use the following headings:
- Marketing strategy and marketing mix - How does the business place its
products or services?
- Growth strategy - Does the company have a Strategy for growth? Has it
made any acquisitions in the past, or has it grown organically?

Certified Public Accountants A
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- Financial strategy - How is the business financed? Are the management

and shareholders likely to accept different types of finance (debt, equity,
venture capital)?
e Think about potential strategies. What options do you think the business may
consider in the future? There may be suggestions in the exhibits in the case,
hinting at what the directors are thinking of. You may also find it useful to use
Ansoff's Product Marketing Matrix to generate ideas.
The steps included here are not designed to be used mechanically to analyse a pre-
seen case study. Nor are they a comprehensive list of all models that could be used.
They are a list of more commonly used models that could be useful in analysing a
Pre-seen Case Study.
1.3 Additional research

Having analysed the pre-seen case study, you may decide to do some additional
research into the industry. This may be useful if you wish to have a more detailed
knowledge of the main issues affecting a particular industry. Entering key words into
online search engines is a good place to start. The following are areas where
additional research might be useful:
° Identifying any changes in the industry
° Identifying any tricky accounting issues. While the exam will not test your
financial reporting knowledge in detail, you would be expected to be aware of
high-level issues which might be relevant in particular industries, such as
revenue recognition in project-based industries.
° Any recent scandals in the industry. Often real-life scandals may reveal some
industry specific risk management, corporate governance or business ethics
issues.
° Any technical knowledge that you feel might be useful in the exam.
Case Study: Hong Kong Kitchen and Bathroom Supplies

Company Ltd
Tutorial video:
This tutorial video introduces and analyses Hong Kong Kitchen and Bathroom
Supplies Company Ltd Pre-seen Case Study information.

a SRRHHAR
2.1 Exhibit 1: Company history and current operation

Hong Kong Kitchens and Bathrooms Supplies Company Ltd (“HKKBS"”) is based
in Hong Kong. The company helps its customers to design their kitchens and
bathrooms, then provides them with all the materials, furniture and accessories
required. The company does not currently install kitchens and bathrooms, so
customers need to arrange the installation for themselves.
HKKBS was founded over 40 years ago, when Felix Zheng started his first store,
selling kitchen furniture, and helping residents of Hong Kong to design their
kitchens. It enjoyed rapid growth, and Felix opened up a second bigger showroom
in Hong Kong five years later. After another five years, he merged his business with
a bathroom retailer run by another entrepreneur, Dan Lai, and formed HKKBS.
HKKBS was listed on the Main Board of the Stock Exchange of Hong Kong twenty
years ago and used the listing proceeds to expand across into mainland China.
The company employs over 2,500 people. Felix Zheng and Dan Lai retired from
the company at the time of the listing, although their families still own 10% of the
company's shares.
HKKBS operates as two independently operated divisions, Kitchens Division and

Bathrooms Division. Each division operates its own showrooms (i.e., retail outlets)
but shares warehouses. The company only sells to retail customers.
The separate kitchen and Bathrooms Divisions sell the following product ranges:
Kitchens Division Cabinets, workshops, flooring, tiles, electric cookers,

refrigerators and dishwashers
Bathrooms Division Toilets, sinks, baths, shower screens, taps and shower
fittings, gas and bathroom furniture
2.1.1 Corporate objectives and values

HKKBS aims to provide reasonable quality kitchens and bathrooms, aimed at middle
and professional classes. As can be seen from its website, the corporate values of
HKKBS are set out below:
° HKKBS aims to distribute a wide range of affordable products at the

best price to its customers through a network of conveniently located
showrooms.
° HKKBS believes in ethical fair trade and adopts transparent business

practices in all its dealings.
° HKKBS respects wide cultural and social diversity in its workforce, and this is
a key requirement when evaluating potential new suppliers.

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° HKKBS is increasingly aware of the importance of sustainability and seeks

to provide products that are made using renewable materials, are energy
efficient and save water.
Corporate responsibility aims
° HKKBS's aim to be a leader in customer service is underpinned by the following

corporate responsibility aims:
To provide high levels of staff training and development, with a particular

focus on health and safety
To hold suppliers to the highest ethical standards, with new suppliers

having to pass an ethical supplier test
To minimise environmental damage by reducing CO2 emissions,

improving waste management, reducing use of single use plastic and
improving product recycling. These are managed using environmental
performance measures applied by head office.
To promote product integrity through selling only safe and reliable

products that meet required regulatory standards
2.1.2 Business operations

HKKBS's head office and main distribution warehouse for Hong Kong are located in
Kwun Tong District on the eastern part of the Kowloon Peninsula. The head office
function consists of the senior board, the finance function, human resources, IT
services, procurement, logistics and inventory management.
CP. A Hong Kong Institute of

WL) Certified Public Accountants
a HRRUNALR
2.1.3 Showrooms
The start of a customer's journey is the showroom. The company currently has
180 showrooms - three in Hong Kong and the rest in mainland China. Of these,
120 are kitchen showrooms and 60 are bathroom showrooms.
Here, customers can browse demo kitchens or bathrooms, and the highly trained
staff help customers to design their own space. They are supported by the HKKBS
pro design software, which enables the staff to produce a plan of the design and
show the customer a 3D view of how their project will look. The staff make
suggestions as to which particular furniture and accessories would fit the style
and budget of the customer.
If the customer decides they wish to go ahead and order the particular design, they
sign a contract and must pay a deposit of 50% of the total sales price.
It takes up to three months before the components ordered by the customer are
ready. Once they are ready, the customer must pay the remaining 50% of the price.
The components are then delivered to the customer's home, usually within a week
of making the second payment.
While HKKBS does not provide an installation service for its customers, it does
maintain a list of trusted builders, joiners and plumbers, but customers must make
their own arrangements with these tradesmen.
The network of showrooms for both divisions has been built up over the past
AO years. Some of these were set up by HKKBS and some were acquired through
small corporate acquisitions in recent years. The showrooms are fairly large and are
usually located in out-of-town retail or industrial parks.
2.1.4 Procurement
The procurement department is responsible for selecting the suppliers whose

products are offered to customers. The suppliers’ brochures are then placed in all
of HKKBS's showrooms. Many of these suppliers are based in mainland China, but
some of the electrical goods come from Japan and Western Europe.
Inventories of the more commonly purchased items are maintained by the company.
Less frequently ordered items, or customised furniture are only ordered from
suppliers, to meet customer contracts from the showrooms.
2.1.5 Logistics
The company operates a large main warehouse for both divisions to receive goods
from suppliers. Additionally, HKKBS operates regional warehouses, which are located
close to HKKBS showrooms in Hong Kong and China. Each regional warehouse is
shared by the two divisions.
Suppliers deliver in bulk to the large main distribution warehouse in Hong Kong.
Some suppliers deliver directly to regional warehouses that placed the order.

ae SRN OR
Inventory is transported from the large main warehouse to smaller, regional

warehouses based on expected demand for each division for that region.
Each division operates its own logistics and distribution network with their own fleet
of road haulage vehicles to distribute products from the regional warehouses to the
showrooms and directly to customers.
All items for a particular customer contract are collected and packaged in a despatch
outwards section of a regional warehouse. Once all items ordered by a customer are
ready for despatch, the regional warehouse then informs the customer that the order
is ready for collection. The customer then pays the outstanding balance, and the
goods are delivered the customer's home, usually within seven days of the balance
being paid.
2.2 Exhibit 2: Board structure and management

The Board of Directors of HKKBS comprises a Non-executive Chair, a Chief Executive
Officer and three executive directors responsible for human resources, finance and
information systems respectively. Additionally, each division is represented by a
divisional director, whose role is to manage all divisional operations. Two non-
executive directors also sit on the Board.
Whilst some operations are supported by the head office, each division is run as an
independent company with its own management team.
The executive director team are as follows:
Ms Lily Chan Chief Executive Officer (CEO)
Lily joined HKKBS fifteen years ago as Head of Kitchens Division.

During her time in charge, that division enjoyed annual growth in
sales of 20% per year. Lily was promoted to CEO five years ago.
Prior to joining HKKBS, Lily had worked for a well-known builders’
supplies company, where she had started as the chief accountant,
but worked her way up to head of operations.
Mr William Head of Kitchens Division
Huang William has spent most of his working life at HKKBS. He joined
the company's procurement section, and soon became a buyer,
responsible for visiting suppliers and negotiating supply
agreements. He was promoted to being Head of Procurement
five years ago. He was appointed as Head of Kitchens Division
two years ago.

a SERRA
Ms Jasmine Head of Bathrooms Division

Wong Jasmine is a close personal friend of Lily and has been a
member of the Marketing Institute of Hong Kong for 12 years.
Her background is in digital marketing and customer liaison
for a marketing consultancy. She joined HKKBS as Head of
Bathrooms Division two years ago.
Mrs Cherry Pang Human Resources Director
Cherry joined HKKBS one year ago. Previously she worked

for a food marketing company, where she was assistant head
of human resources. Since joining the company, Cherry has
worked hard to improve the staff appraisal process and has
introduced a performance related bonus scheme for all
permanent staff.
Mrs Jessica Chau Chief Financial Officer
Jessica is a qualified chartered accountant in Hong Kong. After

seven years in practice, she moved to industry - initially to
shipping, and was then involved in logistics companies for
10 years. She joined HKKBS five years ago and has worked
extensively with William and Jasmine to develop a more
comprehensive system of performance measurement for
the two divisions.
Mr Felix Lin Head of Information Systems

Before joining HKKBS as head of Information Systems
two months ago, Felix worked for a number of different
businesses as an IT manager. Before that, he worked as a
consultant for a well-known provider of graphic design
software, where he helped clients to understand how to use
the software to achieve their goals. He is currently leading a
project to improve the company's IT security controls and
another project to upgrade the design software used in the
showrooms

me Sears
In addition to the executive directors, there are two non-executive directors:
Mr Kenneth Non-executive Chair
Zheng Kenneth is the son of Felix Zheng, the founder of HKKBS. Kenneth
became the CEO of HKKBS in the year 2000 after his father retired
from the business. Kenneth retired as CEO five years ago and
became Chairman upon his retirement.
Mrs Christine Lai Non-executive Director
Mrs Lai is the daughter of Dan Lai, the co-founder of HKKBS.

Mrs Lai is a retired maths teacher. She represents the interests
of the Lai family, who still own 5% of the shares in HKKBS.
Company ownership
HKKBS is listed on the Main Board of the Stock Exchange of Hong Kong and has
200 million shares in issue. The shares were issued at HK$1 each. 10% of the shares
are held by the families of the two founders, Felix Zheng and Dan Lai. 85% are owned
by financial institutions and other investors and 5% of shares are held by Board
members and employees under a share ownership scheme.
2.3 Exhibit 3: Financial Highlights of HKKBS

The following financial highlights have been extracted from the management
accounts of HKKBS for the last two financial years (20X8 and 20X9), along with some
non-financial performance indicators.
Statement of Profit or Loss and Other Comprehensive Income for the year ended
31 December
Total Kitchens Bathroom Total Kitchens Bathrooms
Division Division Division Division
20X8 20X8 20X8 20X9 20X9 20X9
HK$ million HK$ million = HK$ million HK$ million HK$ million |= HK$ million
Revenue 4,060.0 2,720.0 1,340.0 4,253.0 3,047.0 1,206.0
Cost of sales (2,586.0) (1,719.0) (867.0) (2,551.0) (1,736.0) (815.0)
Gross profit 1,474.0 1,001.0 473.0 1,702.0 1,311.0 391.0
Operating costs (1,165.5) (816.0) (349.5) (1,140.0) (807.0) (333.0)
Operating profit 308.5 185.0 123.5 562.0 504.0 58.0
Finance costs (68.0) (68.0)
Profit before tax 240.5 494.0
Tax (36.1) (74.1)
Profit after tax 204.4 419.9
Dividend (50.0) (60.0)
Retained profit 154.4 359.9

i 78 CPA Certified Public Accountants
mae FBRHHOR
Statement of Financial Position as at 31 December
Total Kitchens Bathroom Total Kitchens Bathrooms

Division Division Division Division
20X8 20X8 20X8 20X9 20X9 20X9
HK$ million HK$ million HK$ million HK$ million HK$ million HK$ million
ASSETS
Non-current assets
Intangible assets:
Goodwill 300.0 170.0 130.0 300.0 170.0 130.0
Property, plant and
equipment 3,435.2 2,129.0 1,306.2 4,330.0 2,813.0 1,517.0
Total non-current
assets 3,735.2 2,299.0 1,436.2 4,630.0 2,983.0 1,647.0
Current assets
Inventories 812.0 598.4 213.6 694.0 450.0 244.0
Trade and other
receivables 32.0 21.0 11.0 29.0 15.0 14.0
Cash and cash
equivalents 510.8 216.8 294.0 617.9 432.5 185.4
Total current assets 1,354.8 836.2 518.6 1,340.9 897.5 443.4
Total assets 5,090.0 3,135.2 1,954.8 5,970.9 3,880.5 2,090.4
EQUITY AND LIABILITIES

Share capital 200.0 200.0
Retained earnings 2,267.0 2,626.9
Total equity 2,467.0 2,826.9
Non-current liabilities
Bank loans 700.0 700.0
Current liabilities
Trade and other
payables 1,585.0 998.6 586.4 2,069.0 1,344.0 725.0
Customer deposits 338.0 226.4 111.6 375.0 268.7 106.3
Total current
liabilities 1,923.0 1,225.0 698.0 2,444.0 1,612.7 831.3
Total liabilities 2,623.0 3,144.0
Total equity and

liabilities 5,090.0 5,970.9

Certified Public Accountants i 79
mae Sea
Long-term debt
The company has a loan from the Hong Kong Private and Commercial Bank that
is repayable in the year 20Y1. Interest is charged on this loan at a fixed rate of 9.7%.
The loan agreement includes the following restrictive covenants:
° The company must maintain an interest coverage ratio above 4 times.
° The gearing ratio (long-term debt + (equity plus Long-term debt) must not
exceed 30%.
° The current ratio must not fall below 50%.
Key performance indicators
The company monitors the following key performance indicators, and compares its
performance with that of Victoria Kitchens and Bathrooms Ltd, a company based in
the UK which has a similar business model to HKKBS:
Key Performance indicators (KPI) HKKBS, 20X9 Victoria Kitchens and

Bathrooms Ltd, 20X9
Average cycle time (time between

customer order and delivery) 45 days 65 days
Complaints - % of customers
who complain 2% 3%
Staff turnover 50% 35%
Visitor conversion rate (% of visitors

to a store who place an order) 40% 25%
Financial benchmarks
Victoria Kitchens and Bathrooms Ltd achieved the following financial performance
in 20X9:
° Revenue growth: 12%

° Gross profit margin: 45%
° Operating profit margin: 13%
° Return on capital employed: 18%
C P, A Hong Kong institute of

es renee Accountants
=, BRHHA
=, = =
2.4 Exhibit 4: Article from “Lifestyle Hong Kong” magazine about

buying new kitchens and bathrooms
Thinking of making that kitchen worthy of a chef? Or perhaps you want to smarten up that
bathroom? Here we take a look at some of the businesses that can help you, whatever
your budget.
If money is no object and, for many in Hong Kong that is the case, you can visit one of
the interior designers. They will design the layout, and help you to choose all the
furniture, stoves, shower units taps, and anything else you will need. They will then
order these for you, often from abroad, and arrange installation. They do cater to
many budgets, but usually on the higher side, and of course, you will have to pay
their fee. A relatively pain free experience, but not a cheap one!
For those on a less extravagant budget, but who still want a good quality room,
that will look nice, there are a number of mid-range retailers. They help you to
design your room, and then sell you everything you need for it. Some of them offer
an installation service, others don’t. These mid-range retailers include market leader
HKKBS, which has three kitchen showrooms, and two-bathroom showrooms in
Hong Kong, as well as a number of smaller, independent businesses that operate
single showrooms, such as Master Kitchens. These suppliers will generally be able
to provide everything you need, including furniture, cookers and refrigerators,
shower cabins tiles, and everything else you need. Their ranges are limited to the
suppliers that they deal with which are often Chinese. The good news is that most
do not charge you for design, provided that you buy the kitchen or bathroom from
them. You can expect to spend between HK$80,000 and HK$250,000 for a kitchen
or bathroom from these retailers.
At the lower end, there is the do-it-yourself approach. There are many retailers
selling some of the things you will need, but you may need to visit several different
stores to get everything you need. These range from small local suppliers of baths
and showers, to representatives of foreign manufacturers. You can spend a small
fortune on German made shower attachment, should you so wish. There is of course

ae sean
our beloved Swedish Pine Furniture Store, where you can buy a lot of the furniture
you would need at very low prices, but do use their installation service - there is
nothing worse than spending a Saturday afternoon trying to figure out how to puta
cabinet together, but | guess it is fun if you are into that kind of thing!
Whatever route you decide to go down, do plan it. It can be embarrassing spending
HK$50,000 on a new bath, only to find that it won't fit in your bathroom!
2.5 Exhibit 5: Minutes of a meeting of the Board

Minutes of a meeting of the Board of Directors of Hong Kong Kitchen and Bathroom
Supplies Company Ltd
Date: 2 February 20Y0
Present: Mr Kenneth Zheng (Chair), Ms Lily Chan, Ms Jasmine Wong,

Mrs Cherry Pang, Mrs Jessica Chau, Mr Felix Lin.
Apologies: Mr William Huang, Mrs Christine Lai
1. Mr Zheng asked Mrs Chau to comment on the management accounts for the
year ended 31 December 20X9 which had been sent to the Board the previous
week (Exhibit 3). Mrs Chau commented that the overall growth in revenue had
been disappointing compared to the longer-term trend. However, profit before
tax had risen significantly compared to the previous year. She would provide a
more detailed analysis and commentary as soon as possible. Sadly, her deputy
chief accountant, Ben Wong has recently resigned, so the commentary had not
been available in time for the meeting.
Ms Chan told the Board about an article that she read recently about the
increasing importance to companies of having a strategy regarding
sustainability (Exhibit 9). She believed this is something the Board should
consider urgently, as HKKBS currently has no strategy relating to increasing
the sustainability of the company. It was agreed that Ms Chan would engage
an external firm of consultants to make some recommendations to the Board
in time for the next board meeting.
Mr Lin referred to the Report which had been sent to the Board by Chu
Consultants, with their recommendations about three areas where the
company could improve the use of IT (Exhibit 6). It was agreed that proceeding
with all three proposals at one time might be unrealistic, but it was agreed that
a steering committee be set up to perform a feasibility study for Proposals 1
and 2 in the report. The steering committee would be chaired by Mr Lin. It
was agreed that Mr Lin would consider who else should be on the steering
committee, and invite them to join it, with a view to it being approved at the
next board meeting.

mae =SBRUNHAAR
4. Ms Chan mentioned the letter that she had received from Jackson Jones
Chartered Accountants, who are looking for parties who may be interested in
acquiring the Singapore company, Singapore Bathrooms and Kitchens Pte
(Exhibit 7). Mrs Chau said that this would certainly be worth considering as an
interesting strategic move. Mrs Chau mentioned that it would be necessary to
raise additional finance to pay for any acquisition. It was agreed that Mrs Chau
would set up a working party to investigate the potential acquisition in more
detail, and report back at the next meeting of the Board.
5. Mr Zheng mentioned that Mrs Lai had been unable to attend the meeting
as she was on vacation, but he was aware that it would be her 75th birthday
next week. It was agreed that the Board would send her a card and some
flowers.
6. Date of the next meeting - it was agreed that this will be held on 2 March 20Y0.
There being no further business, the meeting then ended.
2.6 Exhibit 6: Report from a management consultant relating to

potential use of technology within HKKBS
Report
To: The Board of Directors, Hong Kong Kitchen and Bathroom Supplies
Company Ltd
From: Chu Consultants
Date: 10 January 20Y0
Subject: Greater use of technology within the business
Introduction
This report provides a review of the existing computer systems in use within
Hong Kong Kitchen and Bathroom Supplies Company Ltd (HKKBS) and makes three
recommendations about strategic improvements that could be made. Should any of
these recommendations be of interest to the Board, we would be happy to provide
further help to examine these in more detail.
Existing software
Currently the company's use of technology is limited. The company's website

provides only basic information about the company, and acts as a shop window.
Within the showrooms, the HKKBS pro design software is used to design kitchens
and bathrooms, and this appears to be a good system that staff find easy to use, and
customers are happy with the output that it produces. In the warehouses, an
automated stock control system is used. Orders from the stores are sent by email
to the warehouses, who then place orders with suppliers manually.

ae SRN OR
Overall, the systems in place do work acceptably, but we believe that HKKBS could
take advantage of technology to improve the business's performance.
Proposal 1 - Online sales
Our first proposal is that the function of the website could be expanded so
that it is no longer just a shop window, but would enable visitors to design their own
kitchens and bathrooms, using the HKKBS Pro design system, and then place an
order for all the components they would need. This would mean that customers
could place orders from the comfort of their own homes, without having to visit
the showrooms.
Customers would be required to register with the website before they can use the
HKKBS Pro Design programme, but would not be committed to making a purchase.
The registration process would require them to provide some personal information,
such as age, gender and annual income. Cookies would then be placed on the users'
devices, enabling you to track all their activities while on the site. This information can
then be analysed and used for various purposes, such as identifying what items are
the most popular. It would help the company to know their customers better and
perform customer segmentation analysis.
Proposal 2 - An integrated customer and supplier order system
As described above, customer orders placed in the showrooms are passed on to the
warehouse staff, who then place orders with the relevant suppliers. This process
could be automated so that when customers place an order in the showroom, the
order is passed to the supplier automatically, using electronic data interchange (EDI).
EDI is a system whereby the systems of a business are to our suppliers’ systems.
Electronic orders can be sent to suppliers automatically when a customer places an
order for a new kitchen or bathroom.
Proposal 3 - The greater use of big data
Big Data refers to the vast quantities of data that are available to businesses. These
can be analysed to identify patterns that may be of interest. For HKKBS, comments
from customers about your products and those of your competitors could be
collected from social media, and analysed, to identify how HKKBS performs in the
eyes of customers compared to your competitors. Information could also be gained
about visitors to the web site, and what they do during their visit, which might help
identify what factors lead to a customer deciding whether or not to place an order.
Big Data analysis can also be used to analyse the performance internally, for example
by identifying the relationships between costs and cost drivers, which could be used
to increase efficiency.

mae =SBRUNHAAR
Conclusion
We have outlined three ways in which greater use of technology could be used within
HKKBS. Should you be interested in looking at any of these in more detail, we would
suggest that a feasibility study is carried out. We would be happy to be considered to
perform this study on your behalf.
We hope that you found this information useful. Should you have any further
questions about the information provided, please don't hesitate to contact us.
2.7 Exhibit 7: Letter received from the corporate finance

department of Jackson Jones Chartered Accountants in Singapore
Jackson Jones Chartered Accountants
Capital Tower,
168 Robinson Road
Singapore
Ms Lily Chan,
Chief Executive Officer,
Hong Kong Kitchen and Bathroom Supplies Company Ltd,
Hoi Yuen Industrial Centre
Kwun Tong
Hong Kong
19 December 20X9
Dear Ms Chan,
| am writing to you on behalf of our client Mr Jing Yi Zhang. Mr Zhang is the owner
of Singapore Bathrooms and Kitchens Pte (SBK), a business that | believe is very
similar to Hong Kong Kitchen and Bathroom Supplies Company Ltd in terms of
its business activities. Mr Zhang wishes to retire as CEO of SBK and to sell the
company. He has engaged Jackson Jones to help him find a buyer, and to act on
his behalf as advisor on all matters relating to the sale.
Please find attached to this letter an appendix, providing some preliminary

information about SBK. Should you be interested in discussing this matter further,
we would of course provide more detailed information.
| would ask you to treat this letter and the attached information as being confidential.
Please do not share them with anybody outside of the Board of Directors.
Yours sincerely,
Herbert Jackson
Partner

ae SRN OR
Appendix
Singapore Bathrooms and Kitchens Pte is a retailer of bathrooms and kitchens,

based in Singapore. The company operates three showrooms on the Island,
and a 50,000 square ft warehouse based close to Changi Airport. The company
designs luxury kitchens and bathrooms for its clients, and then sources the
furniture, accessories and electronic devices required for these on behalf of
the client. The company has good contacts with a range of suppliers both within
Singapore and abroad, particularly in Europe. Much of the furniture is specially
made for its clients by local carpenters based in Singapore, using highest quality
timbers.
The company charges a fee to the clients for the design of their rooms and
for sourcing the components. It also makes a margin on the components, which
it buys at trade price from the wholesalers, but charges the customer the full
retail price.
A summarised statement of profit or loss and other comprehensive income,

along with a forecast for next year is presented below. The company is all equity
financed.
Statement of Profit or Loss and Other Comprehensive Income for the year ended
31 December
Actual Forecast
20X9 20X0
SGD million SGD million
Revenue 101.5 126.9
Cost of sales _(55.8) (69.8)
Gross profit 45.7 57.1
Operating costs _(31.5) (31.7)
Operating profits & profit before tax 14.2 25.4
Tax _ (2.4) _(4.3)

Profit after tax 11.8 21.1
1 Singapore dollar = 6 Hong Kong dollars

mae TRRHHOAD
2.8 Exhibit 8: Memo from the chief financial officer to the Board of
Directors relating to the refinancing of the company's debt
MEMORANDUM
To: The Board of Directors
From: Mrs Jessica Chau
Date: 14 February 20Y0
Long term finance
As you know, the company has a loan of HK$ 700 million from the Hong Kong Private
and Commercial Bank. The loan is repayable next year. We need to start planning
how we can refinance it. These are the options as | see them:
1. | Wereduce our cash balances. This would mean that we would not have to raise
the full HK$700 million. If we repaid the loan in full, and then refinanced only
half of it, our cash balances would fall by HK$350 million. The remaining balance
of HK$350 million can be financed by option 2, option 3 or both of them as
mentioned below.
2. We issue bonds. Being a listed company, it would be quite feasible to issue

bonds on the Hong Kong Corporate Bonds market. We could issue bonds for
3 years, 5 years or 10 years.
3. We could have a rights issue to raise sufficient capital to fully repay the bank
loans. This would mean that the company would have no outstanding debt after
the rights issue.
| will keep you updated on discussions that | am having with our advisers.
2.9 Exhibit 9: Newspaper article about sustainability

Having a strategy that embraces sustainability increases the value of a company,
according to a report published by leading consultants Drew and Farrell. Far
from being an expensive luxury, companies that have embraced sustainability
have discovered that it actually helps them improve their bottom line, and their
share price.
Sustainability has come a long way since the Bruntland Commission of 1987, which
defined sustainability as "meeting the needs of the present, without compromising
the ability of future generations to meet their own needs". Initially in the 1990s, a
small number of companies saw sustainability as a means of differentiation in their
marketing. They adopted one or two sustainability projects, mainly focussed on
environment protection or pollution reduction.

ae SRN OR
In the last twenty years or so, sustainability has become recognised as a much more
core business objective and many companies have really embraced a sustainability
philosophy. Sustainability is not just about protecting the environment. It also
includes social sustainability (such as treating employees fairly) and economic
sustainability, which involves developing a business model that can provide
acceptable financial returns in the long run.
The benefits ofa strategy of sustainability are many. Actions such as reducing
waste, and conserving energy help businesses to save money. More importantly,
however, is the increasing desire of stakeholders to support businesses that
they see as genuine in their attempts to become more sustainable. Many
customers will prefer to support businesses that they feel share their own
values. Similarly, many employees prefer to work for businesses that take
sustainability seriously. Investors are increasingly looking to support ethical
businesses, and shying away from investing in companies that they see as
harming the planet.
The report from Drew and Farrell categorises businesses into four classes based
on their approach to sustainability:
1. No action at all
2. A few activities aimed at sustainability; no formal strategy
3. A formal strategy, however, sustainability is yet to be embedded into the

business's culture and processes
4. A formal strategy. Sustainability is embedded in the businesses culture and

processes
According to the report, it is more likely that larger companies within Hong Kong
and the South East Asia region are within categories 3 and 4, and the numbers
are increasing. In 20X8, 65% of the companies surveyed by Drew and Farrell were
in one of these categories, and this had increased to 72% by 20X9.
These businesses have realised that being in category two is not enough.
Sustainability is not just a nice add on, it is something that must be considered to
be a core part of the businesses being. Not surprisingly, it is the companies in these
categories that have experienced the benefits in terms of the increased wealth of
their shareholders.

a HRRUNALR
2.10 Exhibit 10: Transcript of an exit interview carried out by

Mrs Cherry Pang
CP: Hello Ben, thanks for coming to this meeting. Whenever permanent employees
leave the company, | like to have this final informal meeting, really to understand
whether HKKBS is a good employer, and if there is anything we can do to make it
better. In some cases, I've even persuaded employees not to leave the company!
BW: That sounds good. But | have made my decision, so | don't think you will be able
to persuade me to stay, I'm afraid! (laughs)
CP: We'll see! Anyway, how long have you worked for us? | know you were already
here when | joined last year.
BW: Yes. I've been here for three years. This was my first job in industry after
qualifying as a CPA. Before this | worked for one of the international accounting firms,
in the assurance department.
CP: Great. And I see you started as an accounting assistant but became deputy chief
accountant very quickly. Did you enjoy the job?
BW: | did enjoy the job at first, but the hours were long. Jessica is very keen to make
sure that the month end closing is finished on time, and she is also a perfectionist. So,
in the week of closing, we can forget about our lives outside the office.
CP: That must be stressful. Isn't there any way the work could have been organised so
that there was less pressure at the month end?
BW: Yes, | had a few ideas actually. | mentioned some of them to Jessica, but she was
usually dismissive of them. | did manage to develop a spreadsheet that reconciled all
balances with the showrooms. Jessica thought that was great. Later, | heard her tell
David, the Chief Accountant, that she had designed it. | was a bit angry about that, but
| let it go.
CP: | am surprised to hear you Say that. | have always found Jessica to be very
reasonable in my dealings with her - which, to be honest, don't happen that often.
BW: Well, sorry! | didn't want to come here today and say bad things about my boss,
but these were just some of the reasons why | have decided to leave.
CP: Actually, David is your line manager, isn't he?
BW: Yes, that's right - in theory. But Jessica tends to be a hands-on manager, which is
something | do respect (laughs), so | can say some good things about her. So anyway,
Jessica would often speak to me directly rather than go through David.
CP: Can | ask what the atmosphere is like in the finance department?

ae SRN OR
BW: It does tend to reflect the mood of Jessica! She is very strong willed. If she is in a
good mood, and is joking with people, the atmosphere is good. If she is stressed, the
atmosphere becomes very quiet,
CP: Does Jessica lead the team well, would you say?
BW: Yes, | would say she does. She is always very clear in her instructions of what
needs to be done. We have weekly meetings on Monday mornings, where she goes
through the tasks that have to be done, and tells us who is doing what.
CP: Are these meetings collaborative? | mean, do you all join in and make suggestions
about things that need to be done, or if there are better ways to do things?
BW: No! Jessica does not like that. She knows what has to be done, and she tells us.
CP: Do you like that style?

BW: If| am honest, not really. It’s good that we all know what we have to do. But
sometimes | think there are better ways to do things, but | never suggest those. | also
feel that my own career is not developing because | am not being given the
opportunity to participate as much as | feel | could.
CP: | am actually very sorry to hear that. Would you mind if| pass on some of these
comments to Jess? In a positive way of course. | think it would be good if she knew
about them. Perhaps she does not know how she comes across.
BW: Sure. But can you wait until she has written my reference (laughs).
CP: Of course! Well, thank you, Ben. On behalf of HKKBS, thank you for your service to
the company, which has been valued. And we wish you all the greatest success in
your future career.
BW: Thank you.
2.11 Exhibit 11: Extract from "Cornerstone" the trade newspaper of

the Hong Kong building industry
Households spending increases in Hong Kong and mainland China
Our industry is booming this year, following demand from households to invest in
home improvements. Households are spending on upgrading all areas of their living
space, including kitchens and bathrooms.
Within Hong Kong, disposable income has been rising at around 6.6% per annum,
while in mainland China, it has been rising by 7.5% over the last three years.
The most important factors in choosing who to buy from include the attractiveness of
the design, a competitive price, the convenience of the process for the buyer, and the
ability to have significant input into key design choices.
End of pre-seen.

mae =SBRUNHAAR
Walkthrough of the HKKBS Pre-seen Case Study

The activities in this section relate to the Pre-seen Case Study provided in Section 2.
Below are the types of preparatory activities that we recommend that you complete
for the pre-seen for your exam.
1. | Summarise the information in the Pre-seen Case Study.
Analyse the financial information and other key performance indicators.

WD
Analyse the external environment (PESTEL or other).
Analyse the competitive environment (Porters 5 forces).

YF
Analyse the internal resources and competences.
Analyse the corporate governance structure.

ND
Perform a SWOT analysis
Analyse the current and potential strategies of HKKBS

Wo
Identify potential growth options (Ansoff’s Product Market Matrix )

oO
Your analysis of the pre-seen case study is not limited to the list above, there may be
different kinds of information in your case study which will need to be analysed in
different ways, so the list above is only a guide.
3.1 Summarising the pre-seen information

The first activity requires you to produce a summary of the information in the pre-
seen. You may produce this in any format that you prefer.
The suggested solution below is illustrated by using a mind map, which is a useful
tool for summarising a lot of information on one sheet of paper. You can summarise
using other methods if you prefer.
Example: Summary of Pre-seen Case Study

Read through the pre-seen case study and write a summary that contains a bird's eye
view of the company - its business model, ownership, issues, strategic options and
anything else that you consider important. This activity will involve use of all exhibits
in the pre-seen.
a PA Hong Kong Institute of

ee Seat
Solution: Summary of information in the Pre-seen Case Study
Business model Ownership and board structure (listed)

e 180 Showrooms - design e 10% Founders families
and sell (no installation) in e 5% Directors and employees
HK & mainland China e 85% Financial institutions
e Warehouses - store items e Board structure - 6 executive
and deliver to customers directors and 2 non-executive
e Suppliers - mainly Chinese directors
but Japanese and European e Functional managers
e Middle-class customers Pig 4
Hong Kong Kitchen and

Industry and competitors ae Bathroom Supplies
e Small independent shops Company Limited
e International suppliers CHIBRBS)
e Independent designers XS
e Few provide complete Challenging issues
service e Declining revenue in
bathrooms
Strategic options
e Expiry of bank loans
e Sustainability
e High staff turnover
e Three IT projects
e Leadership style of CFO (and
e Acquisition in Singapore
others?)
e Good customer service
3.2 Analyse the financial information and other key performance

indicators
The financial analysis should usually cover areas such as revenue growth, profitability,
liquidity, solvency, capital efficiency as well as risk and financial distress. There may
not always be sufficient information in the case study to analyse all of these areas,
but do try to if you can.
== Example: Analysis of financial and non-financial performance of HKKBS

EI Prepare an analysis of the financial information and other performance indicators
provided in the pre-seen analysis.
An analysis should include the calculation of appropriate ratios and comments

interpreting and explaining the information.

hey Certified Public Accountants
mae FRRHHAR
The information for this can largely be found in Section 2.3: Exhibit 3: Financial
Highlights of HKKBS, although it may be necessary to refer to other exhibits
to find additional financial data and explanations for the trends and ratios
calculated.
Solution - Analysis of financial information and other KPIs

For this activity the calculations have been prepared in Appendix 1, and the results
are referred to in the analysis below.
Revenue growth
The Kitchens Division revenue grew 12% between 20X8 and 20X9. This was the
same as that achieved by Victoria Kitchens and Bathrooms Limited (VKB), which is
being used as benchmark, so it can be said to be satisfactory.
Bathrooms Division revenue fell by 10% between 20X8 and 20X29. This is clearly a
concern. It is not clear what the reasons for this are. It may be that there were some
temporary factors in 20X9, or it may be part of a longer-term trend. At any rate it is
important that the management can identify the reason for this decline and take
actions to arrest it.
Overall, revenue for HKKBS rose by 4.75%, between 20X8 and 20X9 which is a
poor performance compared to the VKB's 12%. This is clearly due to the poor
performance of the Bathrooms Division.
Profitability
In the Kitchens Division, the gross profit margin increased from 36.8% in 20X8 to
43% in 20X9. The reasons for this would either be achieving higher sales prices or,
lower costs from suppliers, or both. In both years, this was below that of VKB,
which achieved 45%, but the Kitchens Division was not far behind this benchmark
in 20X9. If the Kitchens Division continues to make progress next year, then it may
catch up with VKB.
Kitchens achieved an operating profit margin of 16.5% in 20X9 compared to 6.8% in

20X8. This is almost entirely due to the increase in gross profit, as operating expenses
were only slightly down on the previous year. The operating profit margin in 20X9 was
better than that of VKB which achieved 13%. The Kitchens Division has performed
well in terms of profit.
In the Bathrooms Division, the gross profit margin fell from 35.3% in 20X8 to 32.4%
in 20X9. It is possible that the Bathrooms Division is using discount strategies in
order to boost sales, although sales revenues have also fallen. Alternatively, it could
be that suppliers are increasing prices. In both years, this division achieved a gross
profit margin considerably lower than VKB. The operating profit margin for the
Bathrooms Division fell from 9.2% in 20X8 to 4.8% in 20X9. Again, this is explained

ae SRN OR
by the fall in revenue and gross profit. The Bathrooms Division's operating profit
margin was below that of VKB (13%) in both years.
Overall, the operating profit margin in 20X9 for HKKBS was 13.2%, which is almost the
same VKB (13%).
Liquidity
There has been a steep decline in the liquidity of both divisions - the current ratio
of the Kitchens Division has fallen from 68.3% in 20X8 to 55.7% in 20X9. The current
ratio of the Bathrooms Division fell from 74.3% in 20X8 to 53.3% in 20X9. This
suggests that the company may have difficulties in meeting its current liabilities
which could potentially lead to corporate failure. This is particularly worrying given
that the long-term debt is due to be repaid in 20Y1, which is in the next financial year.
On the positive side, the current ratio is above 50% which is the minimum
requirement as specified in the bank covenants.
The cause of the liquidity decline appears to be related to the significant increase in
property, plant and equipment, which has been financed internally rather than by
raising additional capital. Interestingly both divisions have positive cash balances,
but trade payables days have increased from 212 days to 283 days for the Kitchens
Division, and 247 days to 325 days for the Bathrooms Division. Essentially the
company is using trade payables as a source of finance. This could lead to strained
relationships with suppliers or even legal action.
Gearing
The gearing ratio of HKKBS (long-term borrowings + (equity + long-term borrowings))

was 22% in 20X8, falling to 20% in 20X9, due to the fact that the company retained
some profits from 20X9, and did not increase the debt. The gearing looks healthy
on this basis and is below the 30% limit specified by the bank covenants. If current
liabilities are included within debt however, the situation looks more concerning.
In 20X8 the gearing ratio of HKKBS (total liabilities + (equity + total liabilities))
would have been 52% compared to 53% in 20X9. The increase reflects the increase
in trade and other payables. It is clear that the business is using these as a source
of financing, which is a risky strategy, as it has led to a decline in the liquidity of
the company.
Return on capital
The return on capital employed can be calculated by dividing operating profit by

total capital employed, while total capital employed is total assets less current
liabilities. For the Kitchens Division, the return on capital employed rose from 9.7%
in 20X8 to 22.2% in 20X9. Operating profit for the Kitchens Division increased by
272% between 20X8 and 20X9, which should have increased return on capital
employed to 36% (9.7% x (1+2.72)). However, capital employed (total assets less
current liabilities) rose by 18.7% from HK$ 1910.2 in 20X8 to HK$ 2,267.8 in 20X9,

mae =SBRUNHAAR
so this had a negative impact on the ratio. The 20X9 figure is higher than that of
the VKB, which was 18%. The Kitchens Division is performing well and proving a
good return on investment.
The return on capital employed of the Bathrooms Division fell from 9.8% in 20X8
to only 4.6% in 20X9. This was almost entirely due to the fall in operating profits
discussed above, as capital in the division has barely changed. This return is poor
and is below the rate of interest charged on the loan of 9.7%.
Return on capital employed for the company as a whole rose from 9.7% in 20X8 to
15.9% in 20X9. This improvement was due to the great performance of the Kitchens
Division. In 20X8, the return on capital employed was the same as the cost of
financing the loan of 9.7%, but in 20X9, the return on capital employed is higher,
meaning that the company is increasing the wealth of the shareholders.
Non-financial performance
Looking at non-financial performance measures, HKKBS appears to be providing

customers with a better service than VKB. Average cycle time, which is the time
taken from customer order until delivery, was 45 days for HKKBS compared to
65 days for VKB. This is a favourable result to HKKBS as customers would certainly
be happier ordering from a company where they have to wait only one and a half
months, compared to two months.
The number of complaints to HKKBS (2%) is also slightly less than that of VKB (3%)
for the benchmark. This does suggest that HKKBS is providing a good service, which
should enable the company to continue to attract customers.
The visitor conversion rate at HKKBS (40%) is also better than that of VKB (25%).
This could be for a number of reasons. It may reflect a better range of products at
HKKBS, or it could reflect the skills of the staff in helping customers design kitchens
and bathrooms that really meet their requirements.
Overall, HKKBS appears to be providing good customer service, which explains the
increase in revenues at the Kitchens Division, but does not explain the fall in the
Bathrooms Division.
Staff turnover at HKKBS (50%) is much higher than at VKB (35%). This suggests
that staff are not as satisfied with their employment conditions. For customer
facing staff, being unsatisfied could potentially jeopardise the service that they
provide to customers. High staff turnover also leads to extra costs in terms of
recruiting and training additional staff. Mrs Pang, the new Human Resources
Director, should ensure that she spends some time identifying the issues that
cause staff to leave.

ae SRN OR
Conclusion
This report has identified a number of issues. The apparent decline in revenues and
profits at the Bathrooms Division is a cause for concern. The declining liquidity, and
reliance of trade payables as a source of finance could adversely impact the financial
health of HKKBS, and the company should consider obtaining additional long-term
capital to support the business. Staff turnover is also high. On the positive side, the
Kitchens Division was performing well. HKKBS also appears to provide a good service
to its customers.

mae =SHRUAAR
Appendix - Workings
A. _ Divisional performance
Kitchens Kitchens 20X9 Bathrooms Bathrooms 20X9
Division Division change Division Division change
20X8 20X9 20X8 20X9
HK$ HK$ HK$ HK$
million million million million
Revenue 2,720.0 3,047.0 12% 1,340.0 1,206.0 -10.0%
Cost of sales (1,719.0) (1,736.0) 1% (867.0) (815.0) -6.0%
Gross profit 1,001.0 1,311.0 473.0 391.0
Operating costs (816.0) (807.0) -1.1% (349.5) (333.0) -4.7%

Operating profit 185.0 504.0 123.5 58.0
Total assets less current

liabilities (TALCL’) 1,910.2 2,267.8 1,256.8 1,259.1
Ratio analysis
Gross profit margin (gross
profit/revenue) 36.8% 43.0% 35.3% 32.4%
Operating profit margin

(operating profit/revenue) 6.8% 16.5% 9.2% 4.8%
Current ratio (current

assets/current liabilities) 68.3% 55.7% 74.3% 53.3%
Inventory days (inventory/cost

of sales x 365) 127 95 90 109
Trade receivable days

(receivables/revenue x 365) 3 4
Trade payable days

(payables/cost of sales x 365) 212 283 247 325
Return on capital employed

(operating profit/TALCL) 9.7% 22.2% 9.8% 4.6%
CPA= Hong Kong Institute of

S#RHG2a
197
B. Company performance
20X8 20X9
Company gearing
(Long-term borrowing / (Equity + Long-term borrowing)) 22% 20%
Company gearing including current liabilities

(Total liabilities / (Equity + Total liabilities)) 52% 53%
Return on capital employed

(Operating profit / (Equity+ Long-term borrowing)) 9.7% 15.9%
3.3 Analysis of external environment

The purpose of analysing the external environment is to identify factors that
may impact on how successful the company is in terms of achieving its strategic
objectives. Where the macro environment is being analysed then the PESTEL model
is the most commonly used. If the competitive nature of the industry is being
analysed, then Porter's Five Forces model can be used.
Example: Example: Analysis of the external environment and how it affects HKKBS
Analyse the external business environment in Hong Kong and discuss how it is likely
to impact on the strategy and performance of HKKBS.
Solution
There was very little information in the pre-seen relating to the macro environment.
Therefore, some additional internet-based research on the kitchen and bathroom
supplies industry is advisable.
The following PESTEL analysis is based on how macro factors might impact a business
such as HKKBS.
Political: The market for bathrooms and kitchens is not a market that would be
particularly sensitive to political changes (unless the government announced an
initiative such as providing grants to enable everyone to upgrade their bathrooms
and kitchens). This force is not therefore likely to be particularly relevant to HKKBS.
Economic: People are more likely to spend money investing in new kitchens and
bathrooms when economic conditions are good, and disposable incomes are rising.
Social: Social factors are likely to relate to changes in fashion and behaviour (e.g., if
there is trend towards more gourmet style cooking at home, this might impact on the
types of kitchens people want. Busy people, and people living in smaller apartments
probably prefer a shower to a bath.)

a SRRHHAR
Technology: Being a fairly traditional industry, selling kitchens and bathrooms is not
a business that is likely to be disrupted by developments in technology. Technology
could be a tool that can be used to help HKKBS improve the efficiency of their
operations and increase sales via e-commerce. It therefore presents an opportunity
rather than a threat.
Environmental: Society is becoming more aware of sustainability and environmental
issues. Customers are likely to be attracted to businesses that have a strategy to
reduce their harm on the environment and increase sustainability. Currently HKKBS
does not have such a Strategy, so this could impact negatively on the business,
although the CFO has recognised the importance of developing a strategy in this
area (minutes of the Board in Exhibit 5).
Legal: It is probable that laws that affect HKKBS would relate to health and safety in
the warehouses, and possibly building regulations, although since HKKBS does not
actually perform installations, they are probably less relevant.
3.4 Analysis of competitive environment

In this analysis we look more at the micro environment of the industry, and how the
competitive forces may impact on the company's performance and strategy.
Example: Analysis of competitive environment

Analyse the competitive environment within which HKKBS operates. You may use
a model such as the Porter's Five Forces, or provide an analysis without using such
a model.
Solution
Exhibit 4, the article from the Lifestyle magazine provides some information about
the industry. It is not particularly detailed, so some interpretation is necessary.
Threat of new entrants
If we define HKKBS's industry narrowly, as companies that provide the design of

kitchens and bathrooms, and then provide a choice of components to fit that design,
then the threat of new entrants is fairly low. New entrants would have to invest
significant funds in developing design software and building up a network of
suppliers. It may be possible to do this, but it is likely that new entrants would
require time to develop a business that is a threat to HKKBS, which remains the
market leader in this industry.

mae = sears
Bargaining power of customers
Customers, as individuals, usually have little bargaining power. If market competition

is strong, they can easily choose HKKBS's competitors. While HKKBS is the market
leader, there are other smaller independent companies providing a similar service to
HKKBS, so HKKBS face some competition in the market. More wealthy customers can
arrange for designers to design their kitchen and bathroom designs. This means that
there is some competition in the market, but in HKKBS's segment, it appears to be
weak. As such, HKKBS customers' bargaining power is weak.
Bargaining power of suppliers
Not much information is provided in the pre-seen about the number of suppliers. It
can be assumed that there is a choice of suppliers for all components that HKKBS
sells to its customers, so it does not appear that any one supplier would have high
bargaining powers.
Substitutes
There are other options for customer to source their kitchens and bathrooms from;
customers can do their own design and source the components from one of the
many stores in Hong Kong and mainland China such as Swedish Pine Furniture. Since
HKKBS does not charge for its design, this could attract more customers to buy
kitchens and bathrooms from HKKBS.
Many customers may prefer the "one shop stop" service approach taken by HKKBS
whereby they can buy all the items required for their kitchens and bathrooms in
one place, and also have the design provided for them. This makes the substitutes
less attractive.
Competitive rivalry
No information is provided in the pre-seen about this. Based on the analysis of the
other factors above, it does appear that the market is fairly fragmented, and since
HKKBS enjoys a position of market leader in its segment, the company is not really
threatened by direct competitors.
Overall, HKKBS appears to be operating in a market segment that is not too

competitive. The company should be able to sustain its position and prosper
within this industry.

yd SRRHHAR
3.5 Analysis of internal resources

Several approaches could be taken to analyse the internal resources of HKKBS. They
could simply be listed. Alternatively, a value chain approach could be taken. The
information for this analysis is mainly drawn from Exhibit 1, in particular the section
on the company's operations. The information in Exhibit 2 about Board Structure and
Management is also relevant to analyse the infrastructure processes.
Example: Analysis of internal resources

Prepare an analysis of HKKBS's business processes, using Porter's Value Chain model.
Your analysis should show which activities are most important in producing value for
customers.
Solution
The information in this solution is mainly drawn from Exhibit 2: Board structure and
management, but some information has been drawn from other exhibits, such as the
information about the company's technology development, which is based on Exhibit 6.
Porter's Value Chain can be used to analyse the business processes that HKKBS
performs, and from this, to identify which of those processes are most important in
adding value to the customers.
FIRM INFRASTRUCTURE i,
WY
ra HUMAN RESOURCE MANAGEMENT \

as
Or TECHNOLOGY DEVELOPMENT \B
n YQ iN
PROCUREMENT \e
>
&.
INBOUND |OPERATIONS| OUTBOUND | MARKETING | SERVICE LS
LOGISTICS LOGISTICS | and SALES
PRIMARY ACTIVITIES
The primary activities of HKKBS and their importance are as follows:
Inbound logistics: This involves the delivery of the components from the suppliers
to HKKBS's warehouses. The company has regional warehouses that are close
to the showrooms as well as a large main warehouse which is centrally located
for goods purchased in bulk where bulk discounts are available. Most purchase
orders are placed to meet specific customer orders. While it would be good if these

ae sea
arrive quickly to reduce the time that customers have to wait, customers may not
mind waiting a little longer for goods that they have chosen, so this process is not
a key process.
Operations: The operations involve helping customers to design their kitchens and
bathrooms, and then ordering the components for them. This takes place in the
showroom. It is this activity that adds the most value to customers, enabling them to
plan their project in a one stop shop. This is the core activity that HKKBS performs in
the eyes of the customer, so is of crucial importance.
Outbound logistics: The customer orders are collated in the warehouses and then
delivered to customers using HKKBS's fleet of vans and delivery trucks. The company
aims to deliver the final products to customers within 7 days of their final payment,
and it is important that this occurs in order to keep customers happy.
Marketing and sales: Sales occur directly within the showrooms and are part of
operations. Little information is provided about marketing. The business could make
greater use of data analytics to understand its market segment better, and this is one
area that was suggested by the consultants in Exhibit 6.
Service: No specific after-sales service is mentioned in the pre-seen. The company

does not provide an installation service. After sales service would not be important in
this industry.
The secondary activities are:
Procurement: This involves selecting suppliers, and the furniture and components
that will be included in the brochures and offered to customers. This is an essential
activity as the choice that is offered to customers will have a big impact on the
success of the business. If goods are offered that are not popular, the business will
not prosper.
Technology development: Technology is not currently used extensively throughout

HKKBS. Technology presents opportunities to improve the efficiency of the business
processes. It may also provide an opportunity for the business to sell to customers
online without having to visit the showrooms, which potentially could expand sales.
Technology development is therefore an important opportunity.
Human resource management: It is important that the company can employ staff
with the rights skills, particularly in the showrooms where staff will be in contact with
customers. Showroom staff should have good people skills, be helpful to customers
and be good at selling. The calibre of staff at warehouses may be less important.
Currently HKKBS has a problem with high staff turnover, and this should be
addressed. It has been noted that the new Human Resources Director will introduce
a new appraisal system which could be a useful tool in better managing staff.

a HRRUNALR
Firm infrastructure: The company has a centralised head office and main distribution
warehouse in Kwun Tong District. This provides strategic management of the
company, the finance function, human resources, IT services, procurement, logistics
and inventory management. There are 180 showrooms in Hong Kong and mainland
China, each of which is located close to a warehouse. The organisation appears to
be controlled from the centre.
Board structure and management is also relevant to the infrastructure process. The
management team supervises the performance of the organisation, and looks at
ways to improve the service provided to customers .
In conclusion, the activities that are most essential, wnere HKKBS adds value, are the
operations (showroom) and procurement activities. There is scope for greater
support from technology development and human resources management.
3.6 Analysis of corporate governance structure

Corporate governance is an important issue, as poor corporate governance can have
a very large adverse impact on an organisation, or even lead to corporate failure in
extreme cases.
Capstone candidates may be asked to refer to refer to the Corporate Governance

Code and Corporate Governance Report (Appendix 14 of the Main Board Listing
Rules) as HKKBS is listed on Main Board in Hong Kong. Specifically, the analysis may
cover the roles of Chair and Chief Executive, the board composition, appointment,
nomination committee, audit committee and effectiveness of independent non-
executive directors.
Example: Analysis of corporate governance structure

Evaluate the corporate governance structure at HKKBS
Solution
The following positive points can be made about the composition of the Board:
° There appears to be a fairly diverse range of skills and backgrounds. The CEO
Ms Lily Chan has enjoyed a career in the building trade before moving to HKKBS;
Mr. William Huang (Head of Kitchens Division) has extensive experience in
dealing with the suppliers of HKKBS; Ms Jasmine Wong (Head of Bathrooms
Division) has a strong marketing background; and Ms. Cherry Pang, Mr. Jessica
Chau and Mr. Felix Lin all have the relevant expertise in their own fields.
° In terms of gender, the Board is well balanced.
A diverse board has the advantage of seeing issues from different points of view,
which should avoid groupthink.

me Sears
There are however some very clear problems:
There are only two non-executive directors. The Chair, Mr Zheng was previously
the CEO, and is the son of the founder. He is hardly independent therefore, and
may not scrutinise the Board objectively, which could jeopardise the interests of
the non-family shareholders. The other non-executive director, Mrs Lai, appears
to be fairly old, and did not attend a board meeting because she was on holiday,
which suggests that she does not place too much importance on her role.
Mrs Jasmine Wong, the Head of HKKBS’s Bathrooms Division, has no previous
experience ofa business such as HKKBS and is from a marketing background.
While it is good for the Board to have a director with marketing knowledge, it is
questionable whether her background gives her the experience to manage the
Bathrooms Division. Indeed, this division has performed poorly recently, which
might be related to Mrs Wong's management of it.
Mrs Wong is a personal friend of Mrs Chan. This suggests that there may have
been some nepotism in her appointment, particularly given the position that
she was given. This brings into question the integrity of Mrs Chan, and the
effectiveness of the Board to challenge her decisions.
There is definitely a need for some truly independent non-executive directors,

and possibly a nomination committee.
3.7 Overall SWOT analysis

The issues discussed above can be summarised using the SWOT analysis. The SWOT
analysis should not merely repeat all the issues above, but should aim to focus on the
key points and provide an overall picture of the organisation.
Strengths - How can these be exploited for strategic growth or to obtain

competitive advantage?
Weaknesses - How can these be avoided, mitigated against, or addressed?
Opportunities - How can this be optimised using the resources and capabilities
available? Does the organisation need to change or plan to obtain further
resources (borrow, recruit) or extend its capabilities (training, recruitment,
outsourcing, acquisition)?
Threats - How can a board strategically plan to address potential threats

through adaptation or long-term change?
Being aware of these when you arrive at the Capstone Final Examination will
prepare you to write good answers that will take into account the situation that
exists for HKKBS.
204 CPAa Hong Kong institute of

SRRHNABR
Example: SWOT analysis

Perform a SWOT analysis of HKKBS
Strengths | eke eateries)
Long-established business with good Lack of scrutiny of board by effective,

reputation (Exhibit 1) independent non-executive directors
A market leader in the industry (Exhibit 2)

(Exhibit 1) Declining revenues and profits in the
Network of showrooms (Exhibit 1) Bathrooms Division (Exhibit 3)
Good customer service (Exhibit 3) High staff turnover (Exhibit 3)

Good financial performance of the Poor management of staff in finance and
Kitchens Division (Exhibit 3) possibly other departments (Exhibit 10)
No sustainability strategies/policies
available (Exhibit 9)
Opportunities Threats
Acquisition of Singapore Kitchens and Innovative new competition or new online

Bathrooms (Exhibit 7) entrants (Research)
The introduction of online sales by Risk of corporate failure unless liquidity is

offering design capabilities on website improved (Exhibit 3)
(Exhibit 6)
Use of big data to improve marketing
(Exhibit 6)
Use of electronic data interchange to
improve supply chain management
(Exhibit 6)
The introduction of a strategy for
sustainability (Exhibit 9)
Population growth, new housing

project and buoyant construction
industry (Research)

== seereow
3.8 Analyse the marketing, financial and growth strategies

of HKKBS
This activity aims to ensure you understand the company and how it aims to achieve
its objectives.
Example: Analysis of HKKBS's strategies

Analyse the strategies of HKKBS under the headings marketing, financial and growth.
Solution
Marketing strategy:
HKKBS aims to distribute a wide range of affordable products at the best price
to its customers through a network of conveniently located showrooms. At the
same time the company is providing a special service in terms of helping customers
with the design of their kitchens and bathrooms. This is a differentiation strategy
whereby HKKBS is offering a service that is different from its competitors. This
strategy is likely to appeal to a wider market but could potentially leave low
profit margins.
Financial strategy:
The company is financed by equity with a relatively small bank loan. However,
the company is delaying paying its suppliers, and effectively using suppliers as a
source of finance. This is a risky strategy as it could lead to suppliers taking actions
to recover their debts earlier, or suppliers refusing to deal with HKKBS in future,
which could lead to less products to offer to customers.
Growth strategy:
Historically the company has grown by a mix of acquisition of small showrooms and
organic growth. This is likely to continue in the future.
The company has also achieved growth by opening up showrooms in mainland China
in second tier cities. China is a potentially huge market for HKKBS.
3.9 Outline the future strategies of HKKBS

Being able to advise businesses on their future strategy is likely to be one of the most
valuable services that accountants can provide to their clients. It is forward looking
and gives them the opportunity to improve their performance.
Ansoff’s Product Market Matrix is a useful model for finding ideas of strategies for
growth (e.g., market penetration, market development, product development and
diversification). The Generic Strategies Model (Price leadership, differentiation, focus)

a SRRHHAR
can also be used to identify overall strategies. Capstone candidates need to

demonstrate that they can apply these models by coming up with strategies that
are appropriate to the case.
Example: Outline of HKKBS's strategies

Outline the potential future strategies of HKKBS using Ansoff’s Product Market Matrix.
Solution
Market penetration strategies involve increasing revenues from selling existing
products in existing markets. In the case of HKKBS, this would mean finding strategies
to sell more kitchens and bathrooms in its existing markets of Hong Kong and
mainland China. Strategies that could be adopted to achieve this include:
° Acquiring some of the small independent businesses that offer the same
services as HKKBS. Exhibit 4 mentions businesses such as Master Kitchens
° Adopting a sustainability strategy may lead to more demand for HKKBS's

products and services, as potential customers might be more likely to choose a
supplier that has a sustainability strategy
Market development strategies involve offering the same products and services, but
in new markets. New markets could be new geographic markets, or new market
segments within Hong Kong and mainland China. Market development strategies for
HKKBS might include:
° Acquiring Singapore Bathrooms and Kitchens Pte, or other similar businesses in
neighbouring countries
° Starting to adopt online sales, as proposed by the consultants
Product development strategies would involve selling new products or services in
Hong Kong and mainland China. Possible strategies in this category might include:
° Offering an installation service for the kitchens and bathrooms that the
company sells. Currently, this service is not offered.
° Offering a design service for the other rooms in the house, and selling furniture,
paint, floorings and other accessories
Diversification strategies involve selling new products in new markets. Such strategies
involve the highest risk, as the company would be selling products that they have no
current experience of, in markets that they are not familiar with.
Given the higher risk associated with diversification, strategies that involve
diversification should only be used when there are no attractive strategic options in
the other categories of Ansoff's Product Market Matrix . In the case of HKKBS, the
company does already seem to have plenty of potential strategies included within the
other three categories of Ansoff’s Product Market Matrix . For this reason, no
diversification strategies have been proposed.

ee SHaoe
° It is important for you to become familiar with the Capstone exam pre-seen
materials before the Capstone Final Examination. The exam pre-seen materials
will be sent to candidates five working days prior to the examination.
° You may decide to perform further research to understand the industry better.
° You may need to revise technical material on topics that appear to have been
covered in the pre-seen as these may form part of the final assessment.
° Prepare asummary of the exam pre-seen materials in a format that you like
(e.g., amind map).
° Analyse financial information, if there is any.
° Analyse the external environment using models such as PESTEL and Porter's
Five Forces.
e Analyse the internal environment by using Porter's Value Chain.
° Look at the governance structure and regulatory structure (if relevant) and
determine if this is hindering strategic performance in any way, or there are
areas of non-compliance to address or areas for enhancement which could
benefit the organisation.
° Perform a SWOT analysis.
° Develop possible strategies that are appropriate to the case using Ansoff's
Product Market Matrix to help.

mae =SRRHHOR
Leadership,
teams and
human resource
management
Topic list
1 Leadership
2 Organisational culture
3 Effective teams
4 Customer focused management
5 Human resource management
Practice
End of chapter Case Study activity
Learning focus
Chapter 6 focuses on effective leadership by explaining the role of a leader,

the attributes of effective leadership, the impact of different styles of leadership
and suggestions on how leadership capabilities can be enhanced. This chapter
also outlines the attributes of effective teams, how teams can be effectively
managed to improve the outcome for an organisation, how conflict within a
team can be managed and how teams can contribute to managing change within
an organisation. At the end of the chapter, Capstone candidates will learn how
human resources management can help organisation achieve its strategic goals.
MET gall ay Mele

L Mele) a aT ony
Develop team leadership skills
Design and build a cohesive team
Develop an environment which enables innovation and

creativity
Apply a model for decision making in a team
Apply the leadership skills for getting the best out of others
Demonstrate the ability to run efficient and effective

meetings
Evaluate performance of team members and provides timely

and constructive feedback
Develop exceptional client service
Identify the value and implications of being client centric
Integrate the success factors for client service
Develop a client perspective and effective client relationships W

W
Develop a service quality program

WW
Determine and monitor the drivers of client satisfaction

NHN
Develop leadership skills to influence others to work towards

WwW
organizational goals
Demonstrate leadership skills on projects or assignments

N
Plan human resources requirements for a project or

assignment, including definition of roles, training, motivation,
leadership and appraisal
Produce communications appropriate to an informed reader

integrating material across a range of areas
Recommend solutions to business problems in an

understandable manner
Prioritise a course of actions within a business problem

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6: Leadership, Teams and Human Resource Management
Construct a report, presentation or equivalent, using style, 3

content and language appropriate to the particular user, to
communicate complex finance information
Integrate and consider qualitative and quantitative

information in a manner appropriate to the user
Appraise the management and leadership styles and culture

within an entity
Appraise the culture of an entity
Consider different management styles and recommend

enhancements to match styles to business objectives
Evaluate the quality of a corporate governance framework in

an entity in the context of the business objectives and
professional and legislative frameworks
Design an appropriate management structure for an entity

matching leadership styles and governance requirements to
the objectives and culture
Apply change management skills
Describe the impact of change on people's effectiveness
Determine the critical success factors for change
Determine how to sponsor and integrate the change ina

team or business
Prepare team members so they are change ready
Prepare to become a leader
Describe the role of the leader
Describe factors contributing to effective leadership
Apply the mindsets for effective leadership
Outline personal leadership aspirations
Identify current leadership style
Determine the impact of personal style on leading others
Determine action to develop their leadership capabilities

SRAHACR
211
Chapter Summary
eo
Leadership, teams and human

resource management
| |
Leadership Organisational
| culture
Attributes of effective leaderstip | eameieammcadh
* 1 Power Organisational culture
e =©2 Influence
¢ 3 Emotional intelligence pg) Development oF cultire
e 4Control i : - The leadership style
¢ 5 Delegation and empowerment i - The nature of the organisation
Shelia I ici gaasaa can cia teem : - Economic conditions
greseeeeeesececnenccccecccneneccceecccenscceenecceenecceneecceeeaDeceesceceeeeceeeeceeeeseceeececeeeeeeereseeeeeeseseeeeeeeeeeeeett 1 | - Structure of the organisation
Behavioural theory of leadership 7 t ~ Workforce characteristics
¢ Managerial Grid: Concern for production or tasks vs concern for people: - Policies and practices
e Lewin (1939) four leadership styles : } ¢ Four types of culture
- Autocratic - Power
- Bureaucratic - Role
- Democratic - Task
- Laissez-faire - People
Four types of culture: Power, Role,
e Ashridge Management College (1976) model: ° Task oe People'cilture
- Tells - this is the autocratic approach Ciacirakwebsneael
e
- Sells - this is a persuader

- Consults - this involves involvement by the employees ~ ate eee
- Joins - this is a democratic consensus approach - Routines and rituals
e Kouzes and Posner's (2009) Leadership Challenge Model ~ Organisational structure
- Symbols
- Model the way Parsaian
- Inspire a shared vision ae
- Challenge the process SATE SAAS ;
- Enable others to act ne i
= Encouragetheheat «i, eternity | i al ace
us ves Change the culture of organisation:

Contingency theory of leadership & Jovemeorporateniiscon
e Fiedler contingency theory of leadership ° By expressing new attitudes
- Psychologically distant managers (PDMs) ® Rewards
- Psychologically close managers (PCMs)
e Newrecruitment and selection
e John Adair: Action-centred leadership: Style should depend on:
policies
- Concern for the task e Newsymbols of the organisation
- Concern for the team or group as a whole
- Concern for individuals within the group
Modern theory of leadership

e Emotional intelligence led leadership (self-awareness)
e Team leadership (local leadership)
e¢ Compassionate leadership (kindness and compassion)
¢ Moral leadership (ethics drive)
Developing leadership capabilities

e Training and Development
e Learning and Continuing Professional Development
e Motivational factors (ie, promotion, recognition or reward)
¢ Empowerment (ie, new role or responsibilities)
e Personality analysis

va Certified Public Accountants
mae = ska
Effective teams Customer focused Human resource

management management (HRM)
Creating teams Benefits of being customer- : Main aspects of HRM

¢ Characteristic of effective teams centric : ie Objectives of HRM
- Purpose : Increase in customer loyalty oo - Define and implement
- Team identity : i and customer lifetime the most effective
- Loyalty : | Reduction in customer churn organisational
- Diversity i where churn is a measure of structure
- Good size and composition : : how many customers are lost - Enabling strategic
¢ Team formation during a particular year objectives through
- 1 Forming ie Increase in profits knowledge, skills and
. gi talent
- 2 Storming lc = <Compliance
; ; fone fi Customer focussed leadership =: Effsenveies-StaInstion:

e Demonstrate commitment communication and
Selecting team members
from the top conflict management
Experience
e Empower employees
Specialist skills and knowledge
e Show link between employees’
Access to resources Why is HRM important?
actions and customer
Competence
satisfaction = Increased productivity
Political power
Enhanced group learning
Roles of team leader : | Find out what customers really =:
= rit. Reduced staff turnover
To resolve conflicts : 4 a a
To give direction and functional : } Go beyond good services and ca ° Encouragement of initiative
expertise i i products :
To obtain the necessary resources i fe Getit right first time
To assess the performance of its team Key HRM activities
Roles of team members ' | : te Employee selection (and
/ Customer relationship
recruitment)
Sp erainaier : | management (CRM) aims to ; f
Shaper i i : ; i fe Performance Appraisal
: } achieve the following: ; f
Plant Training and development
Monitor-evaluator : i e Attract new customers
: e Improve customer retention Reward policy
* Extension
by improving sales to. | *~~ssnsnnsennnnnnnnnnannnnnnnnnl
customers
e — Identify changes in customer

demand (eg, new products)
e Lifetime value perspective
Developing team capability : Client satisfaction

e Developing effective team characteristics e The six dimensions for
e Dealing with conflict within the team : i measuring client satisfaction
e Encouraging teamwork . 4 are:
* Coaching and mentoring | - Financial performance
e Evaluating and rewarding effective teams i i - Competitiveness
- Quality
ne : i ag i ea - Innovation
Coaching and mentoring zi - Flexibility
e Coaching 4 - Resource utilisation
First-hand experience of the workplace incest cotreee eeamanaaes nce ;
and what needs to be achieved i
Empowering attitudes and assumptions
Strong rapport
Excellent listening and questioning
skills
Mentor
A mentor advises on how the mentee

can do things better

S#earesae
213
Leadership
Leadership is a key aspect of both the Capstone exam and in your professional life as
a qualified accountant. You will work with leaders and be expected to lead aspects, or
even all, of the organisation that you work for.
Knowing what is expected of the role ofa leader, how to be effective as a leader, the
styles that different leaders exhibit, and how to develop capabilities as a leader are all
key to understanding and developing leadership.
You will see that there are a lot of different ideas on what a leader is, as well as the
types of leader that exist. In order to work, a style of leadership will have to interact
well with the followers in the organisation, the ones that will be performing the tasks
necessary for the organisation's success.
Weblink
https://www.bgc-group.hk/blog/2020/08/4-kinds-hong-kong-bosses-we-know-and-
love
You can use this weblink to see if your manager (or you) fit into the categories as
given. You will learn a lot from this chapter so do not treat the four management
types as definitive.
1.1 Role of the leader

Leadership is the process of influencing activities of an organised group in its efforts
toward goal setting and goal achievement.
Effective leadership can be considered as a process of identifying and acting ona

priority then exercising a relevant cluster of roles to meet the various needs of that
priority.
There are lots of aspects in an organisation that a leader will determine or influence:
° The choice of objectives and strategies
° The organisation of work performed
° How motivated employees are
° Interpretation of events that have occurred
° Development of skills and confidence of the workforce
° Maintenance of professional working relationships within the organisation
° External relationships to get their support and cooperation

yar Certified Public Accountants
a SRRHHAB
Leadership is a two-way process as the style of leadership can profoundly affect the
behaviour of others.
Buchanan and Huczynski (2013) said that there are two types of leader:
transformational leaders and transactional leaders.
(1) Transformational leaders treat their followers with motivation and commitment,
to try to inspire them. Examples of transformational leaders are seen in the
smartphone and digital technology industries, where those leaders have
changed the nature of an industry in a short period of time.
(2) Transactional leaders look at leadership in terms of exchange, giving the

followers what they want in exchange for what the leader desires, based on the
necessary tasks to hit a goal that has been set. The types of organisation that
employ transactional leadership include very big corporations and the military,
where rules must be followed, hierarchy is critical and there is not much
emphasis on innovation.
Leadership can be shared amongst employees, with many people acting together,
both formally and in informal, spontaneous roles. The leadership role can be shared,
moving from one person to another as the need arises. However, it likely that there is
an overall leader that the responsibility falls upon when necessary.
1.1.1 Leadership versus management
There are differences between leadership and management.
Drucker and Bennis (2014) define leadership as ‘doing the right things' whereas they
define management is 'doing things right’.
The key difference is leadership deals with deciding where an organisation should be
heading; management solve and implement the best way to achieve this.
Additionally, leaders deal with change, inspiration, motivation and influence whereas
managers deal with implementing the organisation's objectives and maintaining
operational equilibrium to deliver goods and services.
Kotter says that management involves:
e Planning and budgeting
° Organising activities
° Getting the best people to work for the organisation
° Incentivising employees
° Sorting out problems
° Controlling the organisation.

ae SRN OR
To achieve this, management need to demonstrate logic, analysis, structure and

control.
In contrast, leadership involves:
° Setting the sense of direction
° Communication of where the organisation is headed
° Getting the workforce inspired, motivated and energised
Hence, a leader needs great skills in working with people rather than working with
things. They will support, challenge and develop people to try to get the most out of
them for the organisation. Ultimately, leaders should use their influence to facilitate
and empower employees.
Activity 1
Consider your own experience of working for a leader. This could be at school or
university, at work or for a team playing a sport amongst others. Think how they
interacted with you and how they behaved towards you and others.
You can select from the following common leadership qualities in the table below
when considering the attributes of the best leader you have experienced. You may
add your own attributes.
° Assertiveness ° Patience ° Influence
° Decisiveness ° Integrity ° Charisma
° Approachability ° Accountability ° Optimism
° Creativity ° Empathy ° Open to ideas
° Self-confidence ° Humility ° Flexible
° Trustworthiness ° Resilience ° Courage/Bravery
e Achievements, ° Vision ° Trust
SHOW IEOge ana ° Transparency ° Authenticity

experience
Required
Consider who is the best leader you have had and what leadership attributes have
made them different to other leaders that you have known.
(Answer at the end of the chapter.)

a SRAHHAR
1.2 Theories of leadership

There are several 'schools' of leadership theory.
=
Attributes Trait theories of leadership are based on analysing the personality
and traits of characteristics or possession of specific qualities which successful
leadership leaders are believed to demonstrate.
Behavioural Behavioural theories of leadership are based on analysing the

theories of behaviour of leaders and managers, to establish whether some
leadership forms of behaviour are more effective than others. There are
similarities in this approach with style theories of leadership.
Leadership Based on the view that leadership is an interpersonal process and

style theories different styles of leadership behaviour influence people in
different ways. Managers should adopt a leadership style that is
most effective.
Contingency Contingency theory is based on the view that there is no 'one best
theory of way' of leading, but that the most effective style of leadership
leadership depends on circumstances. Effective leaders adapt their behaviour
to the specific circumstances in which they find themselves. For
example, the nature of the task, the personalities of team
members and culture of the organisation.
Modern These focus on how leadership styles affect the behaviour and
leadership morale of those around the leader or managed by them. This
theory theory emphasises the power of self-awareness to be aware of the
impact or perception of the leadership traits and regulate their
reaction, criticism or judgement and adopt self-control to dampen
an impulse to overreact or be excessively critical.
1.3 Leadership attributes and traits

Early theories suggested that there are certain personal characteristics (‘traits’) or
possession of certain qualities (attributes) that are common to successful leaders.
1.3.1 Traits of effective leadership
Various studies have attempted to determine exactly which attributes and traits are
essential in a leader.

S#OHG2e
AW
The following summarises the leadership attributes and traits which are common to
many leadership studies.
Judgement e Relationship skills e Charismatic e Dependability

Drive e Achievements, e Integrity e Ambition
Fairness knowledge and e __ Decisiveness e — Trustworthiness
Dedication experience e Self-confidence e Objectivity
Energy = Emotenal e — Influence e Courage
; intelligence ;
Flexible e Empathy e Gratitude
e Approachability
Self-aware e —_- Self-control e Urgency
. e Ability to delegate ;
Resilience e Co-operation e —_ Respect
. e —_ Learning agility ;
Patience e Foresight
o e Good communicator
Initiative
Study the list of leadership traits above and close the book. Now, write down how
many leadership traits you can remember. Then compare your list with the list above,
and think about those you missed and why they are important to effective leadership.
1.3.2 Attributes of effective leadership
There are a wide range of attributes, or qualities, needed for effective leadership.
These include (but are not limited to):
(1) Power
(2) Influence
(3) Emotional intelligence
(4) Control
(5) Delegation and empowerment
We will now examine each of these leadership attributes in turn.
(1) Power
Power is the ability to get things done. Leaders need some power, or getting
things done would be tricky, if not impossible. Followers tend to follow those
that are powerful. There are many factors that confer power on a leader,
including the ability to affect an employee's pay or bonus and that they can sack
an employee if they do not do what is required.
However, these types of power are not as positive as being an expert in their
field, being admired due to their personality or skills.

HARUALR
French and Raven (1959) determined that there are five types of power models:
° Legitimate - being a CEO, monarch or president, for example, confers

power on that person. These depend on social hierarchies, cultural norms
and organisational structure.
e Reward - being able to give a reward for someone else complying with
their requests or demands
° Expert - having superior skills or knowledge. Good understanding,

appropriate solutions and outperformance of others are powerful
attributes for a leader.
° Referent - ifa leader has appeal, charisma or charm. If you are liked, then
that will give an advantage as a leader.
° Coercive - there will be punishment for non-compliance with the leader's

demand. If you will be demoted, fired or made to do unattractive tasks,
then that gives a leader power.
All forms of power have legitimacy in specific circumstances; however, all

leaders should be aware of abusing coercive power as this can lead to staff
retention, reputation or legal issues.
(2) Influence
This is where the leader is able to affect how their followers act through
methods such as suggestion, giving a preferred alternative from the possibilities
for action, persuasion, where followers are urged or induced to act in a certain
way, or emulation, where employees see a leader acting in a certain way and
decide that they want to copy/emulate them (giving the leader power over those
followers).
Emotional intelligence
Emotional intelligence can be defined as ‘achieving one's goals through the
ability to manage one's own feelings and emotions, being sensitive to and able
to influence other key people and being able to balance one's motives and
drives with conscientious and ethical behaviour.' It involves the thinking parts of
the brain working in harmony with the emotional centres of the brain. It is nota
substitute for competence but is something that will help a leader have an
advantage if they have emotional intelligence as well as competence.
Higgs and Dulewicz (2007) said there are seven types of emotional intelligence:
° Self-awareness - knowing one's own feelings and managing them

° Emotional resilience - maintaining performance under pressure
e Influence - having the ability to persuade others
° Inter-personal sensitivity - being sensitive and empathetic towards others

ae SRN OR
° Motivation - drive and energy to achieve targets

° Conscientiousness - consistency in words and deeds, and being ethical
° Intuitiveness - using reasoning and intuition to make decisions
Emotional intelligence tends to be a natural skill which is why these attributes

are often considered in leader selection and recruitment. The attributes listed
above are difficult to learn, but all leaders can improve through awareness and
effort.
Control
This is the ability of leaders to direct employee behaviours and actions down
through the organisational structure, so all employers are aligned to agreed
strategic and organisational goals. Leaders can control the behaviours and
actions of all employees through a chain of reporting line managers who
supervise all employee behaviours and actions.
Employee behaviours and actions are also directed and influenced by the
following:
° Employment contracts
° Company policies and codes of ethics
° Employee appraisal
° Training and ongoing learning and development
° Structured organisation reporting lines (managers, supervisors)
° Company strategy, targets, budgets and key performance indicators
e Company-wide communications (In person, video, email, intranet)
° Individual job descriptions, defined role, responsibilities, reporting lines

and task deadlines
(5) Delegation and empowerment

Delegation is essential as leaders do not have time to perform tasks and actions
as well as perform a leadership role.
Delegation involves getting someone else to do a task that you want to be done,
by passing on the ability to perform specific tasks. Delegation can involve job
creation and recruitment, objective setting, supervision, coaching,
communication and reporting.
However, for delegation to be effective, then individuals also need to be

empowered to complete tasks and make decisions. Often authority within an
organisation needs to be formalised so it is recognised. For example, purchase
authority limited, or authorisation to access specific information or data.

HARUALR
Delegation can have advantages for the leader as it provides more time to do
other tasks, and possibly gratitude from the person who has been delegated to.
However, it does not mean the employee will not make a mistake with the tasks
and this could affect the leader. The leader may also feel threatened by the
possibility of redundancy from part of their role if it is being taken over by the
employee. Delegation is part of important business continuity and succession
planning, and if organisational structure and culture are supportive and fair
then this will reduce any negative impacts associated with delegation.
1.3.3 Criticisms of leadership trait theory
Leadership trait theory has its critics as:
° The argument that certain traits (or qualities) are absolutely necessary for
effective leadership has never been proved or successfully demonstrated.
e A very large number of characteristics or traits that make a good leader have
been suggested. There are far too many varied traits to make a convincing
theory.
° Trait theory suggests, ‘leaders are born, not made' as individuals either possess
desired traits and attributes, or they do not. In practice, some traits can be
learned or enhanced.
° Trait theories ignore the complexities of the leadership situation. Not everyone
with the desirable 'traits' turns out to be a good leader.
Key takeaway
There are no rules for determining the best traits attributes of leadership. Capstone
candidates should select from the known traits and attribute to evaluate leadership
within a specific organisation.
e Trait theory: Courage and resolution, Assertiveness, Decisiveness, Creativity,

Emotional stability, Self-confidence, Trustworthiness, Need for achievement
° Attributes: Power, Influence, Emotional intelligence, Control and Delegation and

Empowerment
1.4 Behavioural theory of leadership

Robert Blake and Jane Mouton carried out research (The Ohio State Leadership
Studies) into managerial behaviour and observed two basic dimensions of leadership:
concern for production or tasks and concern for people.
Along each of these two dimensions, managers could be located at any point ona
continuum from very low to very high concern. Blake and Mouton observed that the
two concerns did not seem to correlate, positively or negatively. A high concern in

ae seansoe
one dimension, for example, did not seem to imply a high or low concern in the other
dimension. Individual managers could, therefore, reflect various permutations of
task/people concern.
Blake and Mouton modelled these permutations as a grid. One axis represented
concern for people, and the other concern for production. Blake and Mouton allotted
nine points to each axis, from one (low) to nine (high).
A questionnaire was designed to enable users to analyse and plot the positions of
individual respondents on the grid. This was to be used as a means of analysing
individuals' managerial styles and areas of weakness or ‘unbalance’, for the purposes
of management development.
The managerial grid

High 9
A 1.9 (country club (team) 9.9
8
7
Concern for people
"41.4 (i ) 9.
v
Low
1 2 3 4 5 6 7 8 9
Low «—— Concern for production —— Higl
The extreme cases shown on the grid are:
(a) 1.1 Impoverished: The manager is lazy, showing little interest in either staff or
work.
(b) 1.9 Country club: The manager is attentive to staff needs and has developed
satisfying relationships. However, there is little attention paid to achieving
results.
(c) 9.1 Task management: The manager demonstrates almost total concentration
on achieving results. People's needs are virtually ignored.
(d) 5.5 Middle of the road or the dampened pendulum: Adequate performance
through balancing (or switching between) the necessity to get out work with
team morale.
(e) 9.9 Team: High work accomplishment through ‘leading’ committed people who
identify themselves with the organisational aims.

YD Certified Public Accountants
a SRRHHAR
The managerial grid was intended as an appraisal and management development

tool. It recognises that a balance is required between concern for task and concern
for people, and that a high degree of both is possible (and highly effective) at the
same time.
Evaluating the managerial grid
The grid thus offers a number of useful insights for the identification of management
training and development needs. It shows in an easily assimilated form where the
behaviour and assumptions of a manager may exhibit a lack of balance between the
dimensions and/or a low degree of concern in either dimension or both. It may also
be used in team member selection, so that a 1.9 team leader is balanced by a 9.1 co-
leader, for example.
However, the grid is a simplified model, and as such has practical limitations.
(a) It assumes that 9.9 is the desirable model for effective leadership. In some
managerial contexts, this may not be so. Concern for people, for example,
would not be necessary in a context of comprehensive automation: compliance
is all that would be required.
(6b) It is open to oversimplification. Scores can appear polarised, with judgements

attached about individual managers' suitability or performance. The grid is
intended as a simplified 'snapshot' of a manager's preferred style, not a
comprehensive description of his or her performance.
(c) Organisational context and culture, technology and other 'givens' (Handy)
influence the manager's style of leadership, not just the two dimensions
described by the Grid.
(d) Any managerial theory is only useful in so far as it is useable in practice by

managers: if the grid is used only to inform managers that they 'must acquire
greater concern for people’, it may result in stress, uncertainty and inconsistent
behaviour.
1.5 Leadership styles theory

There are many ways to define leadership styles and this section considers the Lewin
(1939) model and the later Sadler, Dean, Ashridge Management College (1976) model.
1.5.1 Lewin (1939) four main leadership styles
Leadership style is the method used by a leader when providing direction,

implementing plans, and motivating people. The aim of leadership is to get the best
of the leader's followers.

me Sears®
There are four main leadership styles according to Kurt Lewin (1939). These four
styles are listed here and discussed further below.
(1) Autocratic
(2) Bureaucratic
(3) Democratic
(4) Laissez-faire
Key takeaway
Each leader will demonstrate different styles in different situations, and will generally
lean to one particular style based on their personality and leadership attributes. It is
important for leaders to recognise this and learn to adapt their style in different
situations to achieve the best outcome. Capstone students need to be aware of the
difference in the four styles, which are explained below.
(1) Autocratic
Here the leadership style is that the leader has control over all decisions made
and uses their own ideas and judgments to decide what the organisation should
be doing. This will have strengths and weaknesses as an approach.
Strengths
e The action taken is decisive, which can be important if there is a lot of

uncertainty for the organisation.
e The decisions made will be based on specific requirements and this makes
it easier for the employees to complete the work on time.
e It can boost the employees' focus and motivation.
Weaknesses
e The decision made may not be the optimal one.
° Creativity can be reduced in the organisation.
° Staff may fear the leader and may not respect him/her.
° It will be hard for employees to progress in the organisation as they will

not have the leadership skills needed, as only the leader is making key
decisions.
(2) Bureaucratic
With a bureaucratic style of leadership, the leader sets down a set of processes
and procedures underneath an overall structure.

YL Certified Public Accountants
ae SRRHHOR
Strengths
° This culture can work its way down to all the employees in the
organisation.
° It is clear what employees should be doing, based on their job title and
what this entails.
e Employees will have a better idea of the bigger picture and direction of the
organisation.
Weaknesses
° The organisation can stagnate if there are a set series of methods of doing
things in the organisation.
e The culture in the organisation will not often change.
e It may be difficult to decide new organisational strategies, if the
organisation is stuck with its existing set-up.
(3) Democratic
A democratic leadership style focuses on collaborative energy, delegation of

responsibilities, and group-level decision making. This means that there are far
more possibilities for employees to have a say.
Strengths
e More input from each level of the organisation should lead to better
decision making.
e Employees will feel more involved with the organisation and its objectives,
and they are likely to feel they have a say in what is happening and the
successes that follow.
° The organisation will be more efficient with the employees working on
what they are best at.
Weaknesses
e It can be slower to make decisions, as leaders and employees are

expected to seek support for decisions made.
e Leaders may feel they have to be liked and this may mean that leaders feel
they have to perform tasks that take their time from more important
issues.
(4) Laissez-faire
With this style of leadership, the leaders are not involved so much day-to-day.
Instead, they make sure that employees are more autonomous to complete the
work needed. Leaders provide the resources needed then give the employees
latitude to complete their duties.

ae SHRNGAR
Strengths
Employees are motivated to perform to their best and will develop skills
for how to do so.
Creativity should be boosted, which should benefit the organisation.
The leaders of the organisation can spend time on other tasks that are
important for the organisation.
New leaders of the organisation will be generated over time, due to the
possibility of taking on the tasks needed for success in the organisation.
Weaknesses
Accountability needs to be high in order for employees to work hard.

Motivation needs to be in place, via promotions, bonuses and so on.
The leaders may be too hands off; employees may not understand what is
required of them.
It is worth you considering when you have been a leader. How did you react to
that position and which of the above styles did you use? Also, what was the driver
behind how you behaved? For example, were you influenced by the behaviour of
your parents, a teacher or someone else you had experienced as a leader? The
next activity is aimed to help you understand your own leadership style.
=]. Activity 2
44-5544
TrTTTT
It is helpful to understand what our own natural leadership style is. With this
N
awareness, we can learn to adapt our own leadership style in different situations, in
order to achieve the desired outcome.
Required
Answer the following questions, then determine your score using the instructions in
the solution to this activity.
1. Which of the following motivates you most at work?
A. Making decision
B. Praise from your boss
C. Teamwork and collaboration
D. Seeing what my subordinates produce
2. | Which of the following best describes how you approach managing a project?
A. | tell my team members exactly what to do and how to do it. This makes it
easy for them to know what | want and how it should be executed. It is a
good way for me to share my experience with them, and it also ensures |
will get what | want.

a SeaHMae
| like to find out what my superiors need and want. It is helpful to know
how they would do something, so | can tell my team to do exactly that.
This way, | Know the final product will reflect well on me.
| like to start with a group brainstorming session to share ideas and
perspectives. Then, we can talk to both superiors and subordinates to
get advice and feedback. My goal is for everyone to feel good about the
end-product.
| think it is useful to let the people who are most familiar with the work
take the reins. They may not do things the way | do, but | like seeing what
they produce. That also leaves me more time to take care of more
pressing issues.
Which of the following qualities do you consider to be most important when
hiring a staff?
A. — Takes direction well
B. Takes my side in debates
C. Takes criticism well
D. Takes initiative
Which of the following would make you most proud?
A. My staff fully follow my direction and instructions
B. Receiving an award from the executive committee
C. Being nominated by my peers for a most-valuable-colleague award
D. Being surprised to see my staff's new ideas
My staff respects me because:
A. They never contradict me or disagree with me.
B. They thank me for showing them how things work at my company.
C. They are not afraid to ask me for help with problems.
D. They get their work done on time.
Which of the following would your staff most strongly identify as a negative
aspect of working for you?
A. You can seem harsh and insensitive when delivering feedback.
B. You are unwilling to try new things because that is not the way you do
things here.
You take too much time to make decisions because you are trying to get
everyone's input.
You are not connected enough to their day-to-day work so it is hard for
you to give constructive feedback.

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When you are on a tight deadline, your first action is to:
A. Make sure your team members understand that you will not tolerate
excuses so they need to do whatever it takes.
Remind your team of the importance of the project to your superiors and
the company.
Call a meeting to figure out how you can do as much as you can to help
your team.
Tell your team that this is a great opportunity for them to take initiative
and get it done.
Which of the following characteristics would your staff most strongly identify as
a positive aspect of working for you?
A. You give clear direction, so they always know what to do.
B. You share your experience, so they understand how to help the

organisation reach its goals.
You make sure everyone has a chance to share their questions, concerns,
and ideas.
You encourage them to test their ideas and not worry too much about
getting approval for the little stuff.
What is at the heart of your leadership philosophy?
A. Bosses know best, so just follow my directions and do not ask why
B. Putting the organisation's goals first
G. Putting people first builds trust so they do their best work
D. Giving people autonomy helps them learn and grow
10. What is your favourite part of being a leader?
A. Feeling a sense of power and accomplishment
B Building my institutional knowledge so | am a valued employee
Cc: Watching my direct reports succeed and advance in their careers
D Having more time to focus on the important projects while my staff

handles the rest
228 CPAdh Hong Kong Institute of

SRRHHAR
Weblink
https://ivypanda.com/essays/pepsi-company-indra-nooyi-leadership-case/
You can use this link to research leadership style of Pepsi Co. You can also research
further interesting essays on leadership styles here.
https://ivypanda.com/essays/subject/leadership-styles/
1.5.2 Four styles of leadership model - Tells Sells Consults Joins
Another prominent leadership style model is the Sadler, Dean, Ashridge Management
College (1976) model, which suggests that there are four styles of leader:
° Tells - this is the autocratic approach
° Sells - this is a persuader
° Consults - this involves involvement by the employees
e Joins - this is a democratic approach to leadership, with leaders and followers

making decisions based on the consensus that comes from meetings held
Leadership styles can be applied and flexed by a leader to decision making within a
team which improve team performance. For example, a leader which "sells" or
persuades a team, is more likely to motivate the team to achieving a common goal, as
opposed to a leader who "tells".
The Lewin model can also be used to evaluate the quality of governance in an
organisation. For example, a governance system which "consults" is likely to share
expertise to make more informed strategic decisions.
1.5.3 Tannenbaum and Schmidt's leadership style continuum theory
Tannenbaum and Schmidt identified seven different leadership styles which change
over time. They did not suggest that one style was the best. However, they did
suggest that leaders might begin with a fairly authoritarian style of leadership, and
then become more democratic over time as their subordinates gain skills and
experience.
They argued that providing leadership has two main elements, an authoritarian
element and a democratic element.
° A leader may take all the decisions, and not allow subordinates any decision-
making role. Leaders who behave in this way are autocratic and authoritarian.
° A leader may delegate some authority and give members of the group some
freedom to make their own decisions. Leaders who behave in this way are
democratic.

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Leaders may combine some authoritarian elements and some democratic elements
in their management style. However, although the leader delegates authority, they
must always retain responsibility for the decisions, actions and performance of their
subordinates. The seven leadership styles identified by Tannenbaum and Schmidt
were as follows:
Leadership Characteristics
style
|Pek The manager takes all the decisions for the team or group.
rma Eka Tile) The manager takes the decisions, but then 'sells' the decision to the
sells group - explaining the reason for the decision, but not inviting the
team members to ask questions or query the decision.
Smet kxelTe) The manager takes the decisions and explains the reasons for the
talks decision in detail. They will tell the team members the ideas that led
to the decision, and then invite questions. This makes it easier for the
team to understand the decision and agree with it.
4, Consults A manager with a 'consults' style announces a provisional decision

and invites the team members to discuss it. They listen to the views
of the team members and may change their decision if they agree
with some of the comments and views that they receive. The team
members therefore have some influence over decision making.
yee) A manager with an 'involves' style engages the team members more
closely in the decision-making process. Instead of making a
provisional decision first, the manager explains the problem to the
team, and may suggest some options for a solution. They ask for
opinions, including suggestions for other things that might be done.
They then decide. This style is appropriate only when the team
members have a high-level of knowledge and experience.
6. Delegates With a delegating style, the manager explains the situation or

problem to the team members and asks the team to make a decision
about what should be done. All decision making is delegated, within
stated limits. This leadership style requires a very experienced and
mature team.
Vel ele|(ae kX This is an extreme form of leadership or management style, whereby

the manager leaves everything to the team members, who are left to
make the decisions within the stated limits of the manager's own
authority. The team members identify the problems, develop options
for a solution, make a decision and develop action plans.

ae KRHA
Weblink
It is very interesting to read about research done on leadership skills in Hong Kong
which are considered necessary for current changing times and in the future.
changing-times/
1.5.4 Five attributes of effective leadership model

In order for leadership to be effective there need to be effective practices. A cohesive
team needs to be designed and built.
Kouzes and Posner's (2009) Leadership Challenge Model says there are five practices
or attributes which contribute to effective leadership, as follows:
1. Model the way

Inspire a shared vision
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Challenge the process

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Enable others to act

Encourage the heart
These attributes are explained further below.
1. Model the way
This means that the leader has to look at the overall business and ensure they
have strong principles that help the employees know how they should pursue
the goals of the organisation.
These goals should originate from shared values within the organisation which
are aligned with the actions that have to be taken.
The leader should look toward how the organisation can be as excellent as
possible and put in place standards for the excellence. This then means the
employees of the organisation have standards to follow.
If there is any uncertainty within the workforce, the leader should make it clear
how to progress by using signposts of the direction that the employees should
be following.
The leader should take overall responsibility for the decisions that are made
and should also take responsibility for the outcomes from those decisions.
Inspire a shared vision
The leader needs to create an ideal image of what the organisation could be. This
will involve brainstorming in order to think what is possible for the organisation
and using that to help decide where the organisations should be heading.

me SHH
This requires knowledge of the world that can be used to make sure that the
organisation's mission ties into the needs of the organisation. It also requires
that a big picture of the future and the organisation is created, that will get the
organisation to where it wants to be.
Once a vision is created, it can be used to appeal to the employees of the

organisation so that they can share the vision and the underlying aspirations for
where the organisation is headed. It should be based on a unique vision of
where the organisation can be so that it can succeed. Underlying that should be
a passionate belief that the organisation can make a difference in the world.
This needs to be shared with stakeholders in the organisation and the
stakeholders should be encouraged to be involved and have the chance to
contribute.
Challenge the process
It is easy to believe that the organisation has sorted out its direction and that
can be relied upon in the future. However, the world outside will change, for a
variety of reasons, including competitor response, legislation, advances in
science and customer preferences. Hence the leader should be on the lookout
for new opportunities to progress and improve the existing position of the
organisation.
This may involve the organisation taking risks so that they learn and improve.
There will be wins and losses from this process, but learning is key for
organisations as well as individuals. Stagnation should be avoided by
challenging what is happening and trying to work out new ways of operating.
It is better to have tried something out and it fail that not to have tried anything
at all. At another attempt there can be a win.
Enable others to act
It is not just down to a single person or small group of people. Getting

involvement from a range of employees will bring more ideas and expertise
forward to help the organisation's chances of success. Hence the others
brought in to help should:
e Be actively involved
° Be helped to feel powerful and able
° Have power and discretion
e Have goals that are cooperated on
° Have trust built
e Evaluate team members
eV CPAa Hong Kong Institute of

HARUALR
Having silos of employees should be discouraged, there are benefits from

having conversations with employees in other parts of the organisation. In this
way there will be more ideas generated and more inspection of the ideas, so
that they can be assessed as to whether they are workable.
Education and training of employees is very helpful for them to learn new
skills and become more valuable for the organisation. This helps develop
and environment suitable for the team, one that enables innovation and
creativity.
Encourage the heart
With the steps above the chances of success are increased. When there are
successes, these should be shared with team members. This means that the
progress made by the organisation will be shared and celebrated. This will help
build a community with a great spirit.
For the individuals involved they should be rewarded by appreciation for their
efforts and their excellence. This can involve financial reward but should
definitely involve strong appreciation. The successes should also be shared
publicly via websites, newsletters or awards.
Weblink
https://journalofleadershiped.org/wp-content/uploads/2019/02/7_3 Abu-
Tineh_Khasawneh_Omary-1.pdf)
You can use this link to read more about Kouzes and Posner's (2009) Leadership
Challenge Model.
Key takeaway
The five attributes of effective leadership model is helpful to evaluate the leaders
within a business. At Capstone, you may choose to apply this model against evidence
of leadership styles and actions as part of a Capstone Case Study.
1.6 Contingency theory of leadership

The contingency theory of leadership is the view that effective leadership, and the
most suitable style of leadership, depends on a number of variable (contingent
factors).
There is no one right way to lead that will be appropriate in all situations. The ability
of a manager to be a leader, and to influence his subordinate work group, depends
on the particular situation and will vary from case to case.

mae SRA
Gillen (Leadership Skills for Boosting Performance, 2002) suggests that: “using only one
leadership style is a bit like a stopped clock: it will be right twice a day but, the rest of
the time, it will be inaccurate to varying degrees. Leaders need to interact with their
team in different ways in different situations.”
There are a lot of factors that can affect a leader's effectiveness, such as the size of
their team, the scope ofa project and the expected delivery date for a result. There
are a range of factors in the average workplace, including:
° Maturity levels of employees

e The pace of the work
° The typical work schedule
° The relationships between co-workers
° Employee morale
e Company policies
° Standards set for behaviour
Therefore, Leadership style must be adaptive as what makes a good leader in one
situation may make a bad leader in another situation. A leader should examine the
situation that they face and decide if their leadership style will be effective.
For example:
° A team may respond best to a 'tell' message. For example, where the team is
under pressure or facing a crisis. Here, a tell leadership style can be adopted.
° A team may respond best to a 'sell' message where, for example, there is
scepticism for a need for change. Here, a sell leadership style can be adopted to
obtain the best result or outcome.
° A team may respond best to a 'consult' message. There are many possible
choices or competing solutions. Here, a consult leadership style can be adopted.
° A team may respond best to a 'join' message where working together is the
critical success factor, and all team members need to agree to a decision. A
good example of such a team is a board of directors, who each have a vote on
board matters. Here, a join leadership style can be adopted.
Leaders need to adapt their style to the needs of the team and situation. This is the
basis of contingency approaches such as:
° Fiedler's 'psychologically close’ and ‘psychologically distant’ styles
° John Adair's 'action-centred' leadership model - based upon ‘situations’ or

‘functions’

Weer Certified Public Accountants
a HRRUNALR
1.6.1 Fiedler contingency theory of leadership
Fiedler has been a leading advocate of contingency theory of leadership. He carried

out extensive research on the nature of leadership and found that people become
leaders partly because of their own attributes and partly because of the situation in
which they find themselves. He studied the relationship between style of leadership
and the effectiveness of the work group and identified two types of leader.
(a) Psychologically distant managers (PDMs). These maintain distance from their
subordinates.
(i) | They formalise the roles and relationships between themselves and their
superiors and subordinates.
(ii) | They choose to be withdrawn and reserved in their interpersonal

relationships within the organisation (despite having good inter-personal
Skills).
(iii) They prefer formal consultation methods rather than seeking the opinions
of their staff informally.
PDMs judge subordinates on the basis of performance and are primarily task
oriented. Fiedler found that leaders of the most effective work groups tend to
be PDMs.
Fiedler also argued that the leadership style adopted is relatively stable, anda
feature of a leader's personality that could therefore be predicted.
(b) Psychologically close managers (PCMs). These are closer to their subordinates.
(i) | They do not seek to formalise roles and relationships with superiors and
subordinates.
(ii) | They are more concerned to maintain good human relationships at work
than to ensure that tasks are carried out efficiently.
(iii) They prefer informal contacts to regular formal staff meetings.
Fiedler suggested that the effectiveness of a work group depended on the situation,
made up of three key variables.
e The relationship between the leader and the group (trust, respect and so on)
e The extent to which the task is defined and structured
° The power of the leader in relation to the group (authority, and power to reward
and punish)

ae SRN OR
A situation is favourable to the leader when:
° The leader is liked and trusted by the group
° The tasks of the group are clearly defined and unambiguous
° The position power of the leader (ie, to reward and punish with organisation
backing) is high
Fiedler suggested that:
(a) Astructured (or psychologically distant) style works best when the situation is
either very favourable, or very unfavourable to the leader.
(b) Asupportive (or psychologically close) style works best when the situation is
moderately favourable to the leader.
(c) “Group performance will be contingent upon the appropriate matching of

leadership styles and the degree of favourableness of the group situation for
the leader” (Fiedler).
This is summed up in the diagram below.
4 Task-
oriented
Style of o—
leadership
People-
Vv centred !
Very unfavourable 0 Very favourable
Favourableness of
the situation
1.6.2 John Adair: Action-centred leadership
John Adair's model (also called 'action-centred' or 'functional’) is part of the

contingency theory school of leadership because it sees the leadership process in a
context made up of three interrelated variables: task needs, the individual needs of
group members and the needs of the group as a whole.
These needs must be examined in the light of the whole situation, which dictates the
relative priority that must be given to each of the three sets of needs.

236 CP. A Certified Public Accountants
a SeenHae
Adair argued that, in any situation, the leadership style of a manager should depend
on three concerns: The task, the group as whole and the individual.
1. Concern for the task: Initiating, Information seeking, Diagnosing, Opinion

seeking, Evaluating, Decision making
2. Concern for the team or group as a whole: Encouraging, Peace keeping,

Clarifying, Standard seeking
3. Concern for individuals within the group: Goal setting: Feedback, Recognition,
Counselling, Training
The concern that the leader should show for each of these issues will vary according
to the nature of the job, the subordinates and the team as a whole.
Additionally, Adair argued that the common perception of leadership as ‘decision

making' was inadequate to describe the range of action required by this complex
situation.
Adair developed a scheme of leadership training based on precept and practice in

each of eight leadership ‘activities' which are applied to task, team and individual.
Hence, it is known as the ‘action-centred leadership’ model.
The eight leadership activities are as follows:
° Defining the task ° Evaluating
° Planning ° Motivating
° Briefing ° Organising
° Controlling ° Setting an example
An appraisal of contingency theory
Contingency theory usefully makes people aware of the factors affecting the choice of
leadership style. However:
(a) Key variables such as task structure, power and relationships are difficult to
measure in practice.
(b) Contingency theories do not always take into account the need for the leader to
have technical competence relevant to the task.
Perhaps the major difficulty for any leader seeking to apply contingency theory,
however, is actually to modify his or her behaviour as the situation changes.

ae SHRNGAR
f=) Activity 3
ia Required
Compare and contrast the democratic leadership style and the authoritarian
leadership style. In what circumstances would you prefer either of them?
(Answer at the end of the chapter.)
1.7 Modern theory of leadership

The principles of leadership suggested by early writers and theorists remain valid
today, but other ideas have been developed that apply more directly to the modern
business environment.
Modern theories of leadership include attributes such as transparency and sharing

information, creating a higher level of trust, and promoting a sense of inclusion and
belonging. These leaders care and invest more time into their team members'
wellbeing, career goals, contributions, and accomplishments as well as directing
teams in a traditional way.
Weblink
The following article, published by Forbes, expands on the theme that the sharing of
power and decision making between leaders and employees and leaders being self-
aware of the impact of leadership decisions on employees is vital for successful
leadership in the 21st century.
https://www.forbes.com/sites/davidhsturt/2021/03/23/do-you-have-what-it-takes-to-
be-a-modern-leader/
Four modern leadership theories are discussed further in this section. These are:
1. | Emotional intelligence led leadership
2. Team leadership
3. | Compassionate leadership
4. Moral leadership
1.7.1 Emotional intelligence led leadership
Some studies have concluded that emotional intelligence (El) is a better indicator of
an individual's leadership qualities than expertise or measures of intelligence (IQ).
Without El, a person may be exceptionally well trained and might have a highly
analytical mind, a long-term vision and an endless supply of terrific ideas, but they will
still not make a great leader.

a SRRHHAR
Good leaders demonstrate El by exhibiting all five of the following component

elements:
(a) Self-awareness is knowing and acknowledging what is happening around you

and understanding how it may impact on you, others, the organisation or the
external business environment.
Self-awareness is demonstrated by:
(1) Self-confidence, which is the ability to make realistic self-assessments and

a self-deprecating sense of humour; and
(2) Resilience, which is the ability to develop sustainable practices and to

control emotional impulses and reactions with other people and events.
(b) Self-management is demonstrated by trustworthiness and integrity and

willingness to accept change.
Self-motivation is demonstrated by a strong drive to achieve, optimism and a

high level of commitment to the organisation.
(d) Empathy is demonstrated by expertise in building and retaining talent in

subordinates, a sensitivity to cross-cultural issues and providing a service to
clients and customers.
(e) Social skills is demonstrated by an ability to lead efforts to make changes, skills
in persuading others and expertise in building and leading teams.
Benefits of developing emotional intelligence include:
Increase in confidence leadership confidence, both actual and perceived by

others
Increase in creativity and innovation
Improved decision making both in terms of quality and speed
Improved relationships with peers and other employees and stakeholders
Improved communication as considers and acknowledges the impact on the

audience
Increased morale and productively in team members
Improved output and overall performance which improves business efficiency

and effectiveness
1.7.2 Team leadership
Leadership is provided within a team. Team leadership is important in organisations

that have a team culture, for example organisations in which there is extensive use of
project work.

ae SHRNGAR
The role of team leaders includes coaching, facilitating, handling disciplinary

problems, reviewing team/individual performance, training and communication.
Effective team leaders manage their team's work efficiently and on a timely basis
by planning, organising, delegating, allocating day-to-day resources and ensuring
the completion of the team's responsibilities on time and to the required standard.
The team looks to an effective team leader for clarity on what to do and what
matters most.
An effective team leader focuses on two priorities, namely managing the team's
relationships with other people outside the team, and facilitating the 'team process’.
These two priorities are further divided into four specific roles.
(a) Team leaders liaise with people outside the team, such as senior management,
other teams within the organisation, customers and suppliers.
(6) Team leaders are 'trouble-shooters' who resolve problems (ofa non-technical
nature) faced by their team.
(c) Team leaders are conflict managers. When conflicts arise, the team leader deals
with the conflict by identifying the cause or source of conflict, who is involved,
and what are the options for resolving the problem.
(d) Team leaders are coaches who clarify expectations and roles of team members,
teach, offer support, act as a cheer leader and do anything else that would
make team members improve their work performance.
Weblink
The National Health Service in the UK has a leadership academy to train and develop
its managers and leaders. The link below set out nine dimensions for effective team
leadership which is used by the NHS to develop team leadership in its organisation.
1.7.3 Compassionate leadership
Compassionate leadership is a particular focus on professional relationships through

careful listening to, understanding, empathising with and supporting other people. It
is leadership by enabling those are directed to feel valued, respected and cared for,
so they believe they can reach their potential and do their best work whilst working
for this leader.
Compassionate leadership works as part of other good leadership traits. It is not a

sole focus.

a SRRHHAR
There are three core elements to incorporate compassionate leadership into a

leader's natural skillset.
(1) Mindfulness: The leader is able to focus on what an individual is saying or

doing at a particular moment, so that person feels heard and valued, without
over-reacting, being overly judgemental or present other negatives response
which can have a detrimental impact on the other person.
(2) Kindness: The leader is supportive and understanding towards themselves

and others where things get challenging or what there are mistakes or failure
as opposed to appearing critical, blaming and judgemental. The leader is
proactively helpful, understanding and sensitive when confronted by personal
issues.
(3) Connected: The leader understands that everyone makes mistakes and
sometimes mistakes are made which are not the fault of the person responsible.
For example, the error can be attributed to a lack of information or expertise. This
leader recognises the wider story and takes time to understand this and
recognises we all learn from our mistakes and experiences and looks to the
positives when addressing the mistake or problem.
1.7.4 Moral leadership
Leadership is not free from moral or ethical values. Leaders may act ethically or
unethically.
(a) Unethical leaders are more likely to use charisma to enhance their power over
their followers, and to direct their power towards self-serving ends.
(b) Unethical business leaders might abuse their power when they give themselves
large salaries and bonuses, when at the same time they seek to cut costs by
laying off long-time workers.
Ethical leaders use their charisma in a socially constructive way to provide benefits to
others. The effectiveness of an individual as a leader should be judged by the means
the leader uses to achieve their goals and the moral content of these goals. Are the
changes that the leader seeks for the organisation morally acceptable?
For example:
Is the leader effective if they build an organisation's success by selling products

that damage the health of its users?
Is a military leader successful by winning a war that should not have been
fought in the first place?

Certified Public Accountants yz}
ae SRN OR
1.8 Improving leadership effectiveness

There will be new leaders required in an organisation. This can be due to the passage
of time, as existing leaders move onto another organisation or retire due to age. It
can be due to changes in the organisation's environment, needing new areas and
skills to keep up or beat the competition.
To have leaders develop within the organisation rather than to have them recruited
from outside, there will be a need for developing the existing employees to move up
and take leadership roles. Added to this will be the need to motivate the employees
to make sure that they are keen to move up in the organisation to take leadership
roles.
We will look at how leadership effectiveness can be improved by the leader

themselves, and with help from the organisation. But first we will consider the signs
that leadership effectiveness may be diminishing.
1.8.1 Signals that leadership effectiveness is diminishing
Over time, leadership can take its toll due to time commitment, day to day stresses
and other anxieties. It is important for leaders to look for signs that their leadership
approach is losing its effectiveness.
The following are common signs which should ask as warning signals, that self-
awareness and corrective practices are required.
(1) Drifting: This is where a leader lacks proactivity and has lost sight of their
original mission, vision or purpose and is unclear about where they are taking
their team or organisation, or “treading water” until clarity emerges.
(2) Superiority: This will where the leader is looks upwards only to keep superiors
happy, but fails to pay attention or take interest in operational challenges for
team members or what their work entails. This leader fails to take the time to
effectively communicate strategic messages from above to lower down the
hierarchy and fail to see value in spending time with subordinate employees.
(3) Isolation: This leaders focus exists only in those objectives or tasks which they
find interesting or on which their personal performance is measured. An
isolated leader fails to notice or have interest in what is happening elsewhere in
the organisation or externally.
(4) Passiveness: This leader fails to take the initiative and is not proactive in
resolving issues or managing a team. A passive leader will delay non-urgent, but
important tasks and will display a tendency of shifting innovation and creativity
to others.
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HARUALR
(5) Resistance to feedback: This leader avoids feedback, healthy debate or

suppresses or dismisses challenge or disagreement from others. This leader
maybe aware of specific shortcoming so will not welcome feedback which these
will be highlighted to be faced.
(6) Never wrong attitude: Due to experience, the leader believes it is no longer
possible for them to make a mistake or make a poor decision and tend to argue
against other opinions in order to get their way.
Resistance to change: The leader is concerned that change will be detrimental to

the status quo which they view as working perfectly well. They view change as
disrupting and a distraction and possibly a threat to their position and status.
(8) General weariness: Stress and effort over a long period and has taken its toll, so
this leader has lost vigour and energy to tackle new challenges and can over
react to bad news or unexpected events. This can impact negatively on the
morale of those working with of for this leader.
1.8.2 Developing leadership capabilities: Self-improvement
No leader is perfect, and recognising this is the first step in improving leadership
effectiveness.
The following are methods which leaders can employ to reinvigorate themselves,
increase their resilience to change and challenges, and improve their emotional
intelligence. All of this will improve their leadership effectiveness.
(1) Active feedback: Actively seek formal and informal feedback from peers, sub-
ordinates, team members and other stakeholders. Reflect on this feedback and
seek out clarification by requesting further discussion. Prepare an action plan to
improve on good feedback and address negative feedback.
(2) Develop mindfulness: Mindfulness is activating the ability to be fully present in

tasks and conversations with others. This means distractions are filtered out,
and uni-tasking takes precedence over multi-tasking, where this is feasible and
practical. Mindfulness is being focused on others during interactions so they
feel valued and motivated. This outcomes from these interactions is likely to be
more effective as a result. Finally, mindfulness is training the mind to not be
overly reactive or overwhelmed by the magnitude of what is going on in the
present time.
(3) Increase self-awareness: One method is maintaining a journal documenting

thoughts to the following types of questions
° What kind of impression are you making?
e What do you thinking someone's perception of you is following an

interaction?

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° Consider a recent meeting, event or conversation. Did you react in the way
you would ideally want to? If not, how can you improve your self-control or
empathy with others?
° Do you think your life is in balance? If no, what can you control and
change?
° Do you possess strengths, skills or talents which are currently underused

or could be developed further?
° How do you handle a disagreement or conflict? Is there anything you

would change?
° Consider how you allocate your time? What do you avoid? Where do you
want to change this?
° Consider specific professional relationships? Are they good or not good?

How could you manage these better?
e What is working well and not working well in the teams you manage or
influence? How be this addressed and changed for the better?
e If you had more money, power or influence, what changes would you
make? Can any of these be achieve without these things?
° What would you like to accomplish in the short and long term? How are
you going to do it?
Personality profiling: Undertake a personality profile which will map your

responses to questions to your indicative behaviours across many leadership
and management character traits and qualities. This objective analysis will
provide insight to confirm a leader's talents and strengths but also where they
can focus to make changes to improve in specific areas. Many online personality
profiling companies exist. This could be done privately or as part of the
formalise programme of learning and development providing by an
organisation.
1.8.3 Developing leadership capabilities: Organisation assisted
Actions which will develop leadership capabilities include:
1. Training and development
2 Learning and continuing professional development
3 Motivational factors (i.e., promotion, recognition or reward)
4. Empowerment (i.e., new role or responsibilities)
5 Personality analysis

ELVA CPA Certified Public Accountants
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Each of these is explained further in more detail here:
(1) Training and development

To train someone to be a leader an assessment of their knowledge, skills,
experience and attitude needs to be made. It is likely that their attitude is
positive if they can see that they will benefit from being a leader, though some
employees may be wary of a step up. So, their drive needs to be noted.
However, it will be rare that an individual will turn down something that
enhances their skills, has a positive psychological benefit to the potential leader
and will bring better job satisfaction.
There are a number of variables to take into account:
e The individual's age, education, intelligence, personality characteristics and

personal circumstances
e The organisation's character, environment and work methods
Once assessed, the best ways of helping train the potential leader can be decided.
Some skills will be in place with the potential leader, and these will need to be
identified. The development strategy can be drawn up, based upon how any of
these skills need to be developed or how new skills can be gained. Once the
strategy has been developed, the development can be implemented.
Learning and continuous professional development (CPD)
People learn through 'behaviourist psychology’, the stimuli that they receive and
their response to it as well as the ‘cognitive approach’, how the brain takes
information and works to make sense of it. The behaviourist theories say that
the potential leader should learn through repetition and feedback. The cognitive
approach says that the training for the leader should be well organised, based
on prior knowledge of the organisation and fit with that knowledge.
CPD involved updating skills and knowledge. This can be useful for a potential
leader to give them, and any potential followers, confidence that the leader is
well up to date in their role and is an authority in the factors that affect the
organisation.
(3) Motivational factors
The potential leader will need to understand the organisational goals

thoroughly, so will need to have access to the current leaders of the
organisation so that they can be briefed. This will boost their motivation to
perform well in their new leadership role. There will be external motivation,
called extrinsic motivation, which is positive or negative incentives. Usually, a
potential leader will have lots of 'carrots' that will add to their motivation, rather
than negative 'sticks' to motivate them. Internal, or intrinsic, motivation comes
from the potential leader's own motivation, which may well be strong if they are

ae SRN OR
seeing themselves progress. However, that depends on their overall attitude

and whether they can see problems with becoming a leader.
There are lots of motivational theories, such as Maslow's Hierarchy of Needs,

which starts at the very basic physiological needs (having food and shelter) and
safety needs, through to the highest level of self-actualisation needs, which is
fulfilment of one's personal potential. Becoming a leader should boost this high-
level need and will also help the other needs that Maslow gives, such as social
and self-esteem needs.
Empowerment
Empowerment involves progressing an employee from encouraging them, to

involving them, through to enabling them. Training to be a leader should take
the potential leader to this highest level of empowerment. If the leader has the
ability to run efficient and effective meetings this will benefit the organisation.
(5) Personality analysis
The potential leader's personality can be assessed using sophisticated

questionnaires, by interview and by collecting feedback. This will help
understand the areas that need development most.
One model for personality development is the DISC model of Willian Marston
which has four basic personality tendencies:
° Dominance: Active and task orientated
e Influence: Active and people orientated
° Steadiness: Passive and people orientated
° Compliance: Passive and task orientated
Once an individual recognises there overall personality tendency, they can apply
self-awareness to adapt their impulses and reaction, to better suit the situation,
individual or group.
The following provides further explanation of the DISC model.
1) Dominance:
This personality trait is related to power, control, assertiveness and pro-active.

Dominant people tend to be direct, fast-paced, task-focused and strong-willed.
The dominant leader is ready to take risk and judges others mainly on results.
This leader offers low support to employees and is rarely consultative. This
leader will look to the future and make decisions with minimal consultation, and
impose decisions from the top down with the expectation that all employees
will comply with the decision and implement the instructions provided. This
leader is prone to delegate objectives to achieve, but without guidance on how

HARUALR
to achieve them. This leader is often unaware as the team, viewing this as a
resource which is necessary to achieve a goal.
This leader will expect problems to be solved with little in the way of
instructions or ongoing support.
Words used for a dominant leadership personality are: dominating, demanding,

driven, determined, directing, competitive, daring, direct, persistent,
adventurous, problem solver and results oriented.
Influence:
This personality trait is related to communication patterns during social

interaction. Influential people tend to be pro-active, sociable, accepting, and
easy-going. The influential leader prepares for the future and is consultative and
considers the opinions of before making decisions. However, instructions can
lack detail, preferring to let employees making decisions. This leaders often
lacks knowledge or interest in operational details as this is which members of
the team are for, however, this leader highly values the team they work with
and will be support and defend them.
This leader will delegate and coach employees through decisions or change,
allowing the employee to find the right solution.
Words used for an influential leadership personality are: charming, confident,

convincing, enthusiastic, inspiring, optimistic, persuasive, impulsive,
encouraging, sociable and influencing.
3) Steadiness:
This personality trait is related to reactive, people-orientated but will exhibit

persistence, willpower and patience. Steady leaders tend to be accommodating
to the wants, feelings, needs and circumstances of others. This leader does not
like to “rock the boat” so is adverse to change unless it is necessary in response
to a situation. This leader offers high support to employees after issues emerge
and will consider how situation affects them before action is taken. This leader
is expert and has a good grasp of detail but prefers to a take a consultative
approach to problem solving and will often go with the consensus rather than
apply a personal view. Allows employees the freedom to implement solutions in
a way they deem best. This leader tends not to panic or react quickly, and will
focus on people and communication to calm matters whilst finding a solution
with the team.
This leader will delegate and coach employees through decisions or change.
Words used for steady leadership personality are: steady, stable, shy, specialist,
submissive, understanding, friendly, good listener, loyal patient, sincere, team-
player, consultative, relaxed.

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4) Compliance:
Conscientious leaders tend to be analytical, sceptical, dedicated, logical and
organised.
The compliant leader is generally reactive and task orientated. This leader is
very much in the detail and will make decisions based on observation of events
or based on evidence provided rather than on opinion, innovation or creativity.
The leaders decision is driven by empirical evidence and avoids consultation or
opinion if it not supported by fact. Once a decision is made, then this leader will
control how a decision is implemented by providing detailed and precise
instructions which employees will be expected to follow. Low support is
provided to employees who may have difficulty following these instructions or is
affected by them. This leader will have low empathy with how decisions affect
certain groups, as a decision has been taken for the greater good of the
company.
This leader prefers not delegate and will expect employees to comply with
instructions provided.
Words used for a compliance leadership personality are: conscientious,

accurate, precise, analytical, fact-oriented, objective, competent, cautious,
compliant, careful and calculating.
f=], Activity 4
“J Column1 Column 2 Column 3 Column 4
Competitive Lively Obliging Open-minded
Restless Talkative Patient Systematic
Brave Trusting Calm Cooperative
Independent Sociable Moderate Humble
Decisive Energetic Pleasant Tolerant
Required
For the above personality traits, tick any of them which apply to you. Then, use the
definitions of Dominance, Influence, Steadiness and Compliance, consider which DISC
leadership personality style applies to you.
Weblink
The Superbeings.ai organisation set out seven interesting tips to improve leadership
effectiveness at the workplace:

SHANA
Organisational culture
We have seen that leadership is dependent on many factors and the effectiveness of
a leader will depend on the situation that they face. In some situations, the leader will
perform very well, whilst in others the leader may struggle.
One of the factors that will make a difference to the leadership effectiveness is how
other respond to the leader. The response by other directors and employees is
influenced by the prevailing culture within the organisation they work for.
Hence it is important to consider an organisations culture and how it fits with the
attributes of the leader.
2.1 Organisational culture

Charles Handy says that culture is simply 'the way that we do things round here’.
Culture can also be defined as the "collective self-image and style of the organisation
and within it, the organisations shared values and beliefs, its norms and symbols.
For an organisation to have been successful, the culture must have worked well
enough in the past to be considered valid. Hence, the culture will be passed along by
leaders to new employees as how they should think and act in the situations that they
face whilst working.
2.1.1 Development of culture

There are many influences on the culture of an organisation, including:
° The leadership style: leaders are vital for creating and 'selling' the culture of
the organisation. They will be putting across the vision of the organisation to
its workforce.
° The nature of the organisation: for example, the type of technology used will
make a difference to the speed at which the organisation is progressing and the
key factors that the organisation needs to concentrate on. The tasks that are
undertaken in an organisation will affect the work environment.
° Economic conditions: if the economy is growing, the culture of the organisation
is likely to be more optimistic, which can lead to complacency or
adventurousness. Alternatively, if there is a recession then that may lead to a
more depressed culture.
° Structure of the organisation: how work is organised and the authority of
leaders is exercised will affect the culture. The rewards of work, and how they
are awarded, will also have an effect.
e Workforce characteristics: the age, sex, personalities and how much manual or
technical labour there is in the organisation will make a difference.
° Policies and practices: are the policies and objectives achieved by rules or
through custom and understanding?

ae SRN OR
2.1.2 Aspects of organisational culture

Leaders have a significant role in influencing the culture of an organisation.
A warning, if leaders are not proactively managing the culture of the organisation, top
down, then people within the organisation tend to generate the culture themselves
through collective interactions. This is a risk to any organisation, as it can lead to
dysfunctional behaviours and resistance to change.
Understanding the following five aspects of culture within an organisation helps
leaders to make positive change.
Evidence of the following five aspects of culture can be gathered through observation,
discussion, and employee survey or third-party consultants:
(1) The underlying assumptions: What is important in the organisation, the focus
on customers, quality, freedom to make decisions, the rewards that are
provided, the importance of innovation. The assumptions will be reflected in the
people employed by the organisation
(2) The overt beliefs of the organisation and employees: These can emerge through
slogans, mottos and sayings. Often this will look to the past and how the
organisation has been successful
(3) Visible signs and symbols: How people dress, how the office looks, the
interactions between leaders and their employees (formal or informal). The
symbols can show how much status there is in a culture. This can be important
for leaders to demonstrate their position
(4) Rules, values, ethical codes: There will be rules and values that the employees of
an organisation must follow. These are likely to be seen in the symbols,
attitudes and stories in the organisation
(5) Rituals, ceremonies and celebrations: This may apply when someone is
promoted or when they leave the organisation. There may be conferences held
each year or celebrations of national holidays. If the rituals are taken seriously
and are predictable then they will help sustain the culture.
Activity 5
Choose an organisation that you come into contact with regularly, say a chain of shops
or an online business, or which you are a member of, such as a social or sports club.
Required
List the various cultural properties of the organisation using the five aspects of
culture (i.e., its underlying assumptions, its rules and values, its stated beliefs and
slogans and any visible signs and symbols.)

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2.2 Types of organisational culture

It is important for leaders to know the type of culture of the organisation that they
are working for or which they are joining. This will affect the way that they can
behave. There are four main types of culture that exist. An organisation will have a
dominant culture but will have aspects of the other cultures. The leader may need to
try to adapt the culture to the circumstances that the organisation faces.
The four types of culture are Power, Role, Task and People culture.
2.2.1 Power culture
This is where the organisation is controlled by the important figures at the centre of
it. There are various characteristics of an organisation with a power culture:
1. Personality based - The key personalities are the leaders of the organisation at
its centre. Decision will always come from there and employees may have to
predict what these leaders will decide.
2. Informal and adaptable - Usually this type of organisation is not rigidly
structured and can adapt to change. However, this will depend on the decision
makers in the organisation.
3. Relatively small - If the organisation is very large then the influence of the
leaders declines. Hence, a power culture is best suited to organisations where
the leaders are in contact with all the employees.
4. Good personal relationships - Despite the power culture it is important for
employees to get on well and empathise with each other.
Hence the leader sits in the middle of the organisation, with circles of close colleagues
and influence surrounding the leader.
2.2.2 Role culture
This is a traditional type of model of an organisation, like a bureaucracy. Its

characteristics are:
1. Personalities are less important than roles - It is the organisational structure
that is important to define the authority of the leaders and managers, who
should follow what is expected of them in their role. If they do not, they will
be moved on.
2. Not entrepreneurial - The leaders and employees of the organisation will often
work at their job without experiencing much risk. Hence the leaders or workers
are usually not very ambitious.
3. | Stable - The work is predictable and usually the organisation is large and stable.
4. — Slow to adapt - The organisation will often be used to doing what it usually does
and is not good at changing to new situations. If there is a change the
organisation will often do more of the same rather than respond quickly.

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This type of organisation is difficult for leaders that see external changes that are
needed but will struggle to get the organisation to respond.
2.2.3 Task culture

Here the concentration is on solving problems and completing projects. Teamwork is
usually important in this type of culture, so it will suit a leader with good
interpersonal skills. The characteristics are:
1. Orientated to results - Performance will be judged by outcomes and the

organisation will regularly change, with project teams formed, completing their
project and then being disbanded.
2. Based on teams - The structure of the organisation is often a matrix structure

or in project teams. There is often not a clear leader and they are unlikely to
be dominant.
3. Experts - Key individuals are experts in their role and will help the organisation
achieve its goal. Hence influence is based on expertise rather than coming from
traditional leaders. This will change as the tasks that the organisation is
concentrating on change.
4. Expensive - There will be a lot to pay to experts, and there will be a lot of
changes and variety needed for the projects that are being undertaken. If the
organisation is successful then this is unlikely to be a problem, but will be if the
organisation is struggling, as the tolerance of costly mistakes will be lower.
5. Job satisfaction - This will tend to be high due to the extent of individuals being
involved and having a say. The teams will have an identity; this is likely to be
positive. The type of employee that is involved is important though, they must
suit the team environment.
This type of culture is more difficult for a leader in some respects, their role is much
less clear than under a bureaucratic structure. Often it will be young and energetic
people that are attracted to this type of organisation, who like solving problems and
short-term projects.
2.2.4 Person culture

This type of culture is found in an organisation that has a purpose of serving the
people in the organisation. This type of culture is much rarer than the other types. It
could be a group of actors who want to express themselves artistically or university
lecturers that want to use their position to take a wider role by writing a book or
public speaking etc.
The organisation will depend on the talent of the individuals in it, they will be a set of
'stars' that operate independently. The managers in the organisation will probably be
subject to these stars and have a relatively lowly role.

Way. Certified Public Accountants
a HRRUNALR
In a person culture, organisations can be very volatile. Ifa key person leaves the
organisation, the organisation may even cease to exist.
Key takeaway
The four types of culture are Power, Role, Task and People culture and certain
cultures lend themselves better to particular industries. For example,
° A power culture where one person is leading complexity or innovation based on

their invention or vision
° A role culture for complex, inter-related processes or very large organisations
° A task culture where delivery is crucial under cost and time pressures
° A people culture where the critical success factor of the organisation lies with
the knowledge or talents possesses by specific individuals
It may be helpful for leaders to recognise that their overall cultural style is no longer
aligned to achieving strategic objectives. For example, the organisation has grown
and it is people culture is no longer relevant as causing delay and inefficiency, and a
role-based culture would be more relevant.
2.3 Cultural web model

Johnson and Scholes (1992) used the idea ofa cultural web to help leaders analyse
the assumptions in an organisation with how that appears physically. The leader can
see if there are any differences e.g., if the assumptions are not matching with the
physical manifestations and take action if needed.
The components of the cultural web are:
e Control systems - This is what is measured and rewarded in the organisation

e.g., is Customer service more important that the volume of sales? If so, then
bonuses may be awarded on this basis.
e Routines and rituals - How employees behave inside and outside the
organisation (routines) and events that are important to the organisation
(rituals), whether the event is a formal one (such as the organisation's review
process) or less formal (e.g., social events).
° Organisational structure - The formal and informal relationships in the

organisation and which employees are most important.
° Symbols - Titles, logos and office decorations are examples of symbols. Some
may denote status.

mae SHAKE
° Paradigm - The assumptions and beliefs of the organisation that are shared
amongst employees and accepted as part of working for the organisation.
° Power structures - Who holds power, due to their position of their expertise.
° Stories and myths - Whether told externally and/or internally, about the
organisation's key points of history, key decisions or key people.
The cultural web allows leaders to look at the culture of the organisation to see the
gaps in any of these parts of the cultural web and then assess how to improve them.
This involves looking at the current organisational culture. The leader can then see
where they want the culture to be and identify the differences between where the
organisation is and where it should be. Those differences will give pointers on what
they need to do to change the organisation and improve the performance of the
organisation.
= Example: Applying the cultural web analysis to a hospital

We can apply the cultural web to understand more about the culture within a hospital
from what we are likely to have observed, as follows.
Control systems. In hospitals, the key measure success is based upon completed
clinical episodes rather than results, although death and accident rates are closely
monitored. Senior professionals exert control over staff and patronage by senior staff
members is a key feature of professional culture in order to advance.
Routines and rituals. Policy and procedures drive all activities within a well-defined
operational framework, such as the timing of medical rounds and the scheduling of
appointments and operations. Deference is shown to managers and doctors in
authority and directives by patients and junior staff, as "doctor knows best". Orders
from hospital managers or senior medical staff are generally actioned without
challenge due to the strict and visible organisational hierarchy. The medical
profession has very formalised rituals for training and promotion with presentations,
gatherings and speeches for certain events such as the graduation of new doctors
and nurses or the retirement of long serving individuals.
Organisation structure. Hospital organisational structures are hierarchical with a clear

chain of command visible for all to see. Services are also placed in a certain pecking
order, with nursing caring services appearing lower down on the list than senior
medical consultants and senior hospital managers. At the informal level there is
evidence of competition between different surgical wards or specialist units.
Symbols. Rank is highly visible using very formal symbols such as doctors, nurses and
surgeons’ uniforms and day-to-day use of formal titles.
Paradigm. A hospital is an organisation that is primarily focused on curing serious

illnesses and preventing death by surgery and treatment rather than preventing

ae =SKRTHOR
illnesses before it manifests. Hospital personnel are guided by medical guidelines and
codes of ethics and a personal objective to do the job well as lives depend on it. There
is pervasive sense that personal reward is gain by helping others to recover and
advancing up the hospital hierarchy to gain status.
Power structures. Power is generally held by those in the most senior positions in two
places and there can be friction between senior medical staff who want to provide
the best possible care and senior managers who want to provide the best possible
care within existing budgets and resources. Generally, managers or medical staff with
authority are obeyed as the individual nurse, doctor or support worker is less
important than the hospital, or particular department. Self-sacrifice may be necessary
for the greater good of patients; stories of long hours and heroism are the norm, and
influence younger how staff members behave within the organisation.
Stories and myths. Stories are regularly told of past patients, hospitals and patient
care being provided particularly well or wrong to reinforce current actions for patient
care or investigations.
2.4 Using the culture to influence change

It is important for leaders to understand the types of culture possible and then how
to use culture to their advantage, and to that of the organisation. For example, Peters
and Waterman found that the dominance and coherence of culture was an essential
feature of successful organisations.
It is argued that the guiding values that the organisation has within its DNA makes a
far bigger impact on employee behaviour than any rule books and controls imposed
formally.
Therefore, leaders can use the culture to influence the organisation in the following
ways:
e The culture can motivate employees. If the leader encourages employees to be

committed to the organisation's values and objectives, the employees will feel
happy if they are meeting those values and objectives. They will feel valued and
trusted.
° The culture can support rapid change. If the culture is set to encourage changes,
this can help the organisation be successful when changes are necessary.
Alternatively, a very traditional culture that has been set and will not change can
be harmful to the organisation in times of change.
° The culture can boost the image of the organisation. If the culture appeals to
customers and potential employees, this can help the success of the
organisation in making sales and expanding.

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2.5 Changing the culture

It may be evident to the leader that the culture is not aligned to the organisations
objectives and needs to change. This could be due to its lack of success, need for
change, or problems with its public image or noted employee dissatisfaction.
There are various tools that a leader can use to change the culture of organisation.
(1) Anew corporate mission can be used to energise employees of the

organisation. It can express the new corporate values needed for the
organisation to progress.
(2) By expressing new attitudes to innovation, participation, control and trust from
the top of the organisation.
(3) Rewards can be important so that employees can see that it is in their benefit to
change and take a new direction.
(4) Newrecruitment and section policies to obtain a workforce with the right
culture. Equally there may have to be a redundancy policy, if some employees
are unable or unwilling to change.
(5) Newsymbols of the organisation, like a new logo or design of the office, can act
as s reset and show that things have changed at the organisation.
Key takeaway
Leaders need to be ready to initiate the need for change where the external business
and competitive environment demands it and make it happen. A drag factor to
change could be the corporate culture which has evolved over time, and a reset of
the culture is required to align to new strategic goals and values. Understanding what
the culture needs to become and how to change it, is a highly challenging undertaking
and can only be achieved by a truly effective leader.
Effective teams
Now that we have seen what leadership involve and the big cultural influences on
leadership, we can move on to look at the benefits of knowing how to form teams
and make them effective. If a leader can achieve the creation of high-performing
teams then they are more likely to be successful in their role. Firstly, we will look at
the purpose of teams and their selection.

a SRRHHCR
3.1 Team formation

An effective team will have the following characteristics that a team leader will aim to
develop.
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Good size
and
composition
INSTAR) j Effective
mens eine Purpose
(1) Purpose. There must be a clear and defined purpose to the team which is
understood and accepted by all team members. There will also be a leader that
will guide them towards that purpose.
(2) Team identity. The team's existence is recognised and the limits of the team,
who is included and who is not.
(3) Loyalty. Team members are happy to be part of the team and accept the norms
and behaviours that the team has.
(4) Diversity. A team possesses a high level of complementary skills relevant to its
objective.
(5) Good size and composition. Too many team members can cause disagreement,
disengagement of team members and duplication of activities.
The types of purpose that a team is likely to have are:
Co-ordination of the efforts of team members within a controlled structure
Encouragement of the exchange of knowledge and ideas, with the creation of

new ideas
Power to control the members of the team (possibly through the team
member's self-control) and to motivate the team members
There are examples of different types of teams, which include:
Project or product/service teams. Project teams handle unique and specific

objectives such as implementing new strategies, or new systems or making sure
that existing products or services are delivered successfully.
Training teams. Training teams learn how the individuals behave in relationship
to others can be observed and improved.

ae SAaHAR
° Brainstorming teams. Brainstorming team generate new ideas and, after

enough time has been spent on this, then to consider the ideas and see if they
have value.
e Quality circle teams. A team meeting to see how the quality of products of the
organisation could be improved, involving employee engagement.
3.1.1 Team formation stages

Tuckman (1965) identifies four stages in the formation of teams, called forming,
storming, norming and performing.
Forming Storming Norming Performing
(1) Forming: This is the start of a team, a collection of individuals coming together
to work together. There will be uncertainty for the new team members; they will
be interested to find out about the aims of the teams and who the other team
members are.
(2) Storming: There will be some conflict as the team settles down at the start. This
can be more or less in the open. There will be changes suggested to the team,
whether at a high level on its objectives, or at a lower level on the team
membership. This can be a time of creativity as well as disagreement.
(3) Norming: Here the group starts to settle down, the conflicts have been largely
resolved and there can be agreement on what the members of the team will be
doing. There can still be changes but the major issues have been resolved and
are started to be put into the actions and procedures of the team. Norms can be
reinforced by sanctions or penalties, or boosted by identification with the group.
(4) Performing: Everything is set for the team to perform at the task that it has.
There should be far less conflict on the agreement of norms and the team can
focus on the future and progress.
The time it takes to reach the performing stage will depends on the urgency involved
and if the aim of the team is affected by competitors or other external pressures.
There is a potential fifth part of the model for a team, that of 'dorming'. This means
that the team has become complacent in what it is doing; the tasks become semi-
automatic and the team is lacking in energy and motivation to change.
For a leader, it is useful to know the stages of team building, so that can progress
through each stage as effectively as possible.

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f=] Activity 6
4 Read the following statements:
(1) There is an allocation of the activities needed for a task.

(2) Areserved member of a team is not participating.
(3) Progress has slowed to close to zero.
(4) There is an argument in the team on the best option.
(5) Progress has been made and targets are being hit.
Required
Assess into which category each of the statements fits best i.e., forming, storming,
norming, performing or dorming.

Key takeaway
The four stages in the formation of teams, called forming, storming, norming and
performing can be aligned to the different stages of running a project, as part ofa
project managed implementation plan.
3.1.2 Selecting team members

A leader may already have a team that has been selected. This may have been
affected by the politics of the organisation and the personnel department, for
example. If the leader can be involved in selection of the team members, they need to
consider the attributes that potential team member offer. The team member could
come from within or outside the organisation. These attributes can be:
° Experience - How much experience has the new team member had in the
industry and how relevant is it? If the other team members are relatively
inexperienced then it could be a boost to bring a new experienced team
member in.
° Specialist skills and knowledge - This depends on the needs of the team.
° Access to resources - This could be to knowledge as well as physical resources.

It could be the new team member was employed in another part of the
organisation that has resources that the team can benefit from, by gaining
access to them.

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° Competence - In the tasks that the team will be involved with.

° Political power - If the new team member comes from within the organisation,
they may have some influence that can add value to the team.
3.1.3 Roles of team leader

A leader has four primary roles in a team environment:
1. To resolve conflicts that cannot be resolved by the team members themselves
2. To give direction and functional expertise to the team and to members needing
assistance
3. | To obtain the necessary resources
4. To assess the performance of its team (ideally using metrics and
measurements) and its individual members
Each of these roles taken by the leader should help boost team effectiveness on its
task performance, the team functioning and team member satisfaction.
3.1.4 Roles of team members
Eight team roles are suggested by Belbin as a guide to forming an effective team.
Ideally, an effective team includes all eight roles. It may be that one person can fill
more than one of them.
The roles ofa team can be categorised as:
(1) Co-ordinator: Overall person who presides and co-ordinates the team
(2) Shaper: Passionate about the tasks and spurred to action to encourage the rest
of the team. Usually dominant and extroverted.
(3) Plant: Introverted but intellectually dominant and imaginative, generating a lot
of ideas
(4) Monitor-evaluator: Analytical and good at spotting problems. Can be aloof and
tactless.
(5) Resource-investigator: Popular and sociable, good at finding new resources and
contacts, but not an originator
(6) Implementer: Practical and a good organiser; turns ideas into tasks and
schedules, a good administrator
(7) Team worker: Wants to keep the team working well together. Popular and
diplomatic but not competitive. Missed if absent.
(8) Finisher: Keeps the team moving to the deadline; focusses on details; urgent but
not always popular
A ninth role, specialist, can join the team when needed to offer expert advice. For
example, legal, technical, financial or regulatory advice.

a HRRUNALR
Key takeaway
A leader should consider if the roles have been filled or if there are gaps in the team.
The leader should be looking at their team and filling any gaps initially or if a team
member leaves.
3.2 Teambuilding
Teambuilding is a task that a team and leaders will benefit from. Once the team has
been selected then the team should be built up to become as effective as possible.
Teambuilding involves:
Encouraging team solidarity and loyalty. Positive communications from the
team leader which describe the team as "we", will encouraged team members
to work hard for the team and go ‘above and beyond'
Forming a sense of collective identity. Also known as team spirit, this can be
achieved by forming connections with other team members.
Shared team objectives. Having team members committed to these objectives
and working hard together to achieve them.
3.2.1 Team identity

A leader can help increase the good feelings in a team by helping the team have an
identity. This can be achieved by:
(1) Choosing a team name - This is similar to how sports teams get support, using a
name that gets them and their fans to group together.
(2) Having a team icon, badge or uniform - This does not have to be clothing, it
could be a logo or something the team recognises as their own.
(3) Mottoes or slogans - A catchphrase that unites the team.
(4) Team methodology - Stories about past successes are useful here, though even
stories about team failures can unite a team.
3.2.2 Team solidarity

There might be challenging times ahead for the team and a need for the team to stay
solid together.
A leader can encourage team solidarity and loyalty by:
Encouraging interpersonal relationships - Team members benefit from trusting
each other and being happy to work together. Celebrating a birthday can bea
powerful way to help these relationships, as an example.
Talking about solidarity - A slogan for the team can help here.

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Conflict control - There may be clashes of personalities or disagreements

within the team. Some of these may even have a positive outcome if they help
sort out an issue. However, a leader will need to manage any such conflicts and
may need to decide who is right or wrong in that situation. Ideally there is a
resolution that satisfies both team members, so both feel that they have 'won'.
Managing competition in the group - At least there should be a level playing

field, so all the members of the group know they will be treated equally and
fairly. It is bad for the leader to show favouritism. All team members should feel
valued and necessary for the success of the team. However, some competition
should be encouraged as this can lead to better ideas and a more successful
team. Looking externally, a leader may also indicate the competition from
outside the team, say from a competitor, so that the team unites against this
external competition.
Overall, a team needs to be encouraged to be work together. Actions to achieve this

should be put in place by the leader.
Team objectives need to be set out and the team needs to have bought into
them.
Help should be provided from the leader to make sure the correct information,
resources and training are available for the team.
Regular feedback on progress and results is valuable. Also, feedback from

within the team will help the team perform better, as team members realise
that they can make a difference.
Being positive, through praise and, is valuable, and championing the team
within the organisation is useful for the leader to do.
3.3 Developing team capability

An effective team is one that meets its objectives through the working together of its
team members. This sounds easy but to achieve this with every team needs a range
of different approaches to develop its capabilities.
Methods develop team capability include:
Developing effective team characteristics
Dealing with conflict within the team
Encouraging teamwork
Coaching and mentoring
Evaluating and rewarding effective teams
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3.3.1 Developing effective team characteristics

There are a series of quantifiable and qualitative factors that can be measured or
observed to see how a team is working. A leader would benefit from working through
these factors' to see how well the team is performing and to take action in areas
where performance is inadequate.
The quantifiable factors include:
Generally, the lower the better:
The rate of labour turnover
Accident rate
Absenteeism
Stoppages and interruption to work
Generally, the higher the better:
Output and productivity
Quality of output
Achievement of individual targets
Qualitative factors include (all the higher the better):
Commitment to achievement of targets
Understanding of the team's work
Understanding of the role of each team member
Open communication and trust between team members
Idea sharing
Innovations
Help for other team members
Group problem solving
Active interest in the team's decisions
Desire for self-development
Motivation and ability to work in the absence of the leader
Consensus of opinion sought
This is a great checklist for the leader to monitor the performance of their team.
3.3.2 Dealing with conflict within the team

If there is conflict within the team will reduce its effectiveness and capability. Conflict
is a distraction and results in freeze, where progression slows.

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There are a range of responses to conflict from the leader of the team. They will not
all work in a given situation, so care needs to be taken on the response to make sure
it works.
(1) Denial - Ignoring the issue may work for a very small conflict but usually if the
underlying causes are not understood it is likely to get worse over time and
potentially be out of control eventually.
(2) Suppression - This involves dealing with the surface issue only. If there is a
‘crack’ this involves smoothing it over. However, it may be that the crack is too
large to achieve this.
(3) Dominance - Using power of command to achieve a solution. This may work,
though can lead to an underlying resentment from the person who has ‘lost’.
(4) Compromise - This is bound to happen in many teams, though it may be that
the compromise means that a good solution is not obtained and everyone
loses out.
(5) Integration/collaboration - The key focus point is the task or objective which
overrides personal issues. Individuals may have to concede their position in
order to help the team to achieve the team objective.
(6) Encouragement of cooperative behaviours - This involved group problems-

solving, so that all the team can follow the decisions.
It is best for the leader to consider which will make their team the most effective.
This involves weighing up the team members' personalities and focusing on the
best resolution for the conflict, in the interests of the team and achievement of
its task.
The best model is a 'win-win' model. If one or both parties in a dispute lose then one
or both parties will be dissatisfied and that is likely to be negative for the success of
the team.
The questions to be asked are:
° What do you want this for?
e What do you think will happen if you do not get it?
The aim is for the leader to get to the heart of what people really need and want,
rather than something that is on the surface, such as a temporary loss of face. It may
not be possible to get to a win-win situation but working towards it is key. There will
be more communication, better mutual respect and cooperation, and more effective
problem solving.

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5
, Activity 7
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o
You are leading a team and have come across an argument between two of your
team members. Both of the team members have been allocated to a new office
block and they are arguing about who gets the office in the corner of the building
near the lift.
Required
Suggest a solution that is:
(a) Awin-lose situation

(6) Acompromise
(c) Awin-win solution
3.3.3 Encouraging teamwork

Teamwork is the joint action ofa group, with the individual interests of group
members secondary to the goals of the group. It requires a common goal for the
team and commitment to work together towards that goal.
There are two fundamental approaches to organising teamwork:
(1) Multi-skilled teams: This is a team that have individuals that can perform any of
the team's tasks. These tasks can be shared out between the team members
flexibly, depending on who has the time and availability to do a specific job.
(2) Multi-disciplinary teams: This has team members with lots of different skills,
which can be added together for the benefit of the team. This increases team
members' awareness of their overall objectives and targets, boosts
communication and help bring different perspectives to problems.
A team leader may not have a choice in the type of team members they have, though
it is valuable to think which type it is in order to boost the team's effectiveness.
A self-managed team is a highly developed form of team working. The team members
will make all the key decisions in their work, from processes, tasks allocation, and
conflict management and so on. They save managerial costs, gain in productivity,
encourage individual responsiveness and boost overall efficiency. If they are possible,
they can produce a very effective team.
3.3.4 Coaching and mentoring

Coaching is bringing out the best in a person and improving his/her skills. Mentoring
is arelationship with a team member that can share their story and have guidance
and feedback provided.

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Coaching involves:
° First-hand experience of the workplace and what needs to be achieved
° Empowering attitudes and assumptions
° Strong rapport
° Excellent listening and questioning skills
In contrast a mentor is required to understand how the mentee thinks and functions.
Once this is understood, the mentor advises on how the mentee can do things better.
This is more general than a coach and requires a lot of patience, approachability and
perseverance.
Often the mentor is the team leader. The leader must have time to perform the
mentor role on top of their other responsibilities. It may be that a mentor may need
to be separate from the leader outside the team.
3.3.5 Evaluating and rewarding effective teams

The key aspect is to recognise team performance and reward that, rather than
individual performance. Rewarding individual performance above team performance
can act against good team performance, if team members are looked on as
individuals rather than as part of a team. For team rewards to be successful, the team
must have the following characteristics:
° Significant autonomy and influence over performance
e Distinct roles and targets
° Maturity and stability
° Cooperation
° Interdependence of team members
Suitable reward schemes for leaders to consider are:
1. Profit sharing schemes, based on a pool of money related to the profit made by
the team
2. | Employee share options schemes, where staff have the right to buy shares in
their company at an attractive price
3. Gainsharing, where the reward is based on achieving particular target, KPI or

other metric that is within the team's control. For example, a technology
company may give bonuses based on the number of new users of their tech
platform, especially if they are not making a profit yet.
A good reward scheme will help the leader get effective results from their team, due
to the underlying motivation to perform well and succeed.

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Key takeaway
In order to develop a high performing term, Leaders must be very responsive to
ensure each of the five methods which are effective in developing team capability are
embedded within regular team operations.
(1) Developing effective team characteristics
(2) Dealing with conflict within the team
(3) Encouraging teamwork
(4) Coaching and mentoring
(5) Evaluating and rewarding effective teams
3.4 Preparing teams for change

There are a series of issues for a leader involved with preparing a team for
change. If there is a new project that the organisation undertakes or a new threat
externally that has to be responded to, then that will impact on the team's
effectiveness. All the skills necessary for the change may not be present in the
team which can result in uncertainty, a fall in team moral ofa decrease in employee
performance.
First the critical success factors for change need to be identified and included in
the business case for change which is agreed by the board. The critical success
factors for change can be based on financial success, customer satisfaction, internal
business processes and learning and growth, as seen in the Balanced Scorecard in
Chapter 4 of this Capstone Study Guide.
Preparing teams for change involves:
° Knowing the extent of the change and how likely that is. Is the change a
revolution or an adaptation?
e Understanding the process for change. There are nine steps that Balogun
and Hope Hailey set for the process for change (see Chapter 10, Implementing
business solutions). These steps include determining the type of change
needed, identifying the critical change factors, designing and implementing the
changes and then managing and implementing the changes. This will help
prepare team members, so they are ready for change. It is also a systematic
approach for creating and implementing change.
° Overcoming resistance for change within the team. The team may have
some resistance to change, and this can be overcome by a variety of measures
given by Kotter and Schlesinger, which range from educating the team ,
supporting them, getting them involved through to manipulating them or

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even, in extreme cases, coercing them. This will help the leader sponsor
and integrate the change into a team or business. Some of the team members
may be well placed to deal with the change and will need a relatively small
amount of help whereas others will need a lot of help. Communication from
the leader will be necessary throughout, particularly for those employees
that need the most help to deal with the change. Hence, they will require
education, support and involvement. As seen above, coaching and mentoring
is important to help team members adapt and this should be used where
necessary.
Key takeaway
Dealing with the process of change and overcome resistance to change is a key role
for a leader to ensure employees and teams are open to necessary organisational
change. The details of the models for change are covered in Chapter 10,
Implementing Business Solutions of this Study Guide which covers the details of
change management.
Customer focused management

Key term
A customer-centric (or client-centric) strategy is based on putting your customer first,

and at the core of your business.
4.1 Value and benefits of being customer-centric

Customer centric businesses revolves around three activities:
° Understanding your customers.
° Designing the experience that they want
° Continuous feedback from customers to drive further improvement
The benefits of being a customer-centric organisation are as follows:
e Increase in customer loyalty and customer lifetime
° Reduction in customer churn. Churn is a measure of how many customers are

lost during a particular year.
° Increase in profits

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4.2 Customer focussed leadership/management

Leaders and managers have a crucial role in ensuring that everybody in the
organisation is focussed on customers. The following section looks at ways in which
leaders and managers can make their businesses customer focussed:
4.2.1 Demonstrate commitment from the top

Senior leaders must regularly communicate the importance placed on customer
service to staff. Such communication could take place using some of the following
communication channels:
° ‘Town hall’ meetings: these are meeting which include the whole organisation,
where the senior management talk about important topics, and give staff the
opportunity to ask questions. Such meetings may take place virtually if the
organisation is dispersed.
° Posting on the company's intranet or social media platform
° More personal meetings between staff and human resource or line managers,
at which staff are told of the important of customer satisfaction and their
contribution towards it
4.2.2 Empower employees

Research has shown that where employees are given the tools and responsibility to
solve customers' problems, they react positively to this. Employees find it fulfilling to
help customers (W. Earl Sasser Jr, quoted by Anne Field).
This leads to a virtual circle, as fulfilled employees are likely to remain with the
organisation, leading to lower staff turnover and therefore more experienced staff.
This leads to greater customer satisfaction, as customers will enjoy better service
from experienced and satisfied staff. Greater customer satisfaction leads to customer
loyalty and therefore increased revenues.
4.2.3 Show link between employees' actions and customer satisfaction

Employees must understand how what they do impacts on customer satisfaction. The
president of a car dealer in the US told his staff that the lifetime value of a customer
was on average $332,000. Staff should, therefore, remember that when they have any
contact with customers, and be aware that poor service can cost the company that
amount if the customer decides to take their business elsewhere.
4.2.4 Find out what customers really want

Many businesses focus on KPIs that they believe that customers will value, without
actually asking the customers what is actually important to them.
Many senior managers have little direct contact with customers. However,
procedures should be put in place where these managers are required to meet some

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customers (e.g., once a month), and to write monthly reports about these meetings
with and what they learned.
Alternatively, in some businesses, it might be possible for managers to visit the

business as customers (e.g., a restaurant chain might require its senior manager to
dine at the restaurant) in order to understand the customer experience.
4.2.5 Go beyond good services and products

Customer focussed management should focussing on the values that are shared with
customers (eg treating customers with courtesy).
4.2.6 Get it right first time

Have processes in place to ensure the customer gets what they want first time. If this
is the case, defects and complaints should be the exception rather than the rule. The
use of a service quality programme (see next section) should enable this.
ACR
Real life Illustration: Amazon
Jeff Bezos, the founder of Amazon stated that the success of Amazon was largely due
to providing customers with the fastest and most reliable service so they would only
need to contact customer service in those unusual situations where something has
gone wrong.
4.2.7 Reward employees for good customer service

Rewards schemes should be in place for employees who demonstrate a commitment
to good customer service. Rewards might include financial incentives such as
bonuses, but other types of reward can be equally effective. McDonalds has an
employee of the month award in all of its restaurants which recognises good
customer service. This motivates staff, as they feel their efforts have been recognised.
4.2.8 Establish communication channels
Communication channels must exist throughout the organisation, so that customer

feedback can be obtained, and passed on to frontline staff and managers, so
everybody in the organisation is aware of how well the business is satisfying its
customers.
Lo
Suggested online research
This paper on Customer-Focused Leadership by Harvard Management Update will
help to deepen understanding of the benefits of proactively leading on a strategy
which puts customers first.
https://hbr.org/2008/02/leadership-that-focuses-on-the-1.html

ya{0) Certified Public Accountants
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Real life Illustration: Meeting customer needs

fee Two contrasting approaches to meeting (or not meeting) customer needs in the car
industry are described in a book that describes the Toyota motor company's rise to
SUCCESS.
"Let's being by visiting a typical car dealer in almost any Western country [...] While it
may still be possible to special order some makes of car in North America, the sales
staff pushes the customer very hard to take a car already on the lot perhaps by
offering a better discount. Once a deal is struck after some intense haggling, the
customer, now the buyer is turned over to the financial staff to arrange payments
and then to the service staff to arrange delivery.
Selling of cars door to door is unique to Japan [...] here is how it works. Team
members draw up a profile on every household within the geographic area around
the dealership. Then periodically visit each one after first calling to make an
appointment. During their visits, the sales representative updates the household
profile: how many cars of what age does each family have? What is the make and
specifications? How much parking space is available? How many children in the
household and what use does the family make of its cars? When does the family think
it will need to replace its cars? The last response is particularly important to the
product planning process team members systematically feed this information back to
the development teams.
On the basis of the information they garnered and the knowledge of the Corolla
product range, the sales representative suggests the most appropriate specification
for a new vehicle to meet this particular customer's needs."
(Source: taken from Womack, Jones and Roos, "The Machine that Changed the
World," Simon& Schuster, London, New York, Sydney and Toronto, 2007)
Activity 8
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Hotel Asia runs a chain of smart, five star hotels throughout South East Asia. You have
recently been contacted by the senior management of the hotel after the company's
ratings fell in an online travel website, where travellers review hotels that they have
stayed in, and provide ratings (out of 5).
One of the reviewers complained that they called the Hotel's front desk to ask for the
dates of their booking to be changed. The customer was put on hold for 10 minutes
while the clerk tried to connect the customer to the reservations team. When the
customer arrived at the hotel, he was not happy with his room, as it faced onto a busy
highway and asked if he could move. Staff at reception advised him that such a move
could only be made with the permission of the rooms division manager who was not
at work, but the room could be changed following day.

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The management feel that the ratings only represent the views of a small minority
of their guests, but want to obtain better feedback about how the hotels are
performing. They also want to know what they can do to improve the experience of
guests such as the reviewer.
Required
(a) Suggest effective ways that senior managers could obtain more a more
representative picture of the customer experience at their hotels.
(b) Describe what improvements could be made to avoid customers having the
same bad experience as the reviewer.

Key takeaway
An important task for leaders is to ensure that the business is focussed on the
customer. Leaders must communicate the importance of this to all staff, and
empower staff to provide excellent service to customers.
4.3 Customer relationship management
Key term
Customer relationship management (CRM) consists of the activities that businesses
perform to manage their interactions with customers, throughout the customer
lifecycle.
Customer relationship management (CRM) aims to achieve the following:
° Attract new customers
° Improve customer retention
° Extension by improving sales to customers
° Identify changes in customer demand (e.g., new products)
e Lifetime value perspective
Many businesses also use CRM systems which support them in their CRM activities.

Ya Certified Public Accountants
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4.3.1 Attracting new customers

Attracting new customers involves advertising or contacting potential customers
directly. Typically this involves the use of technology such as:
e Search engine optimisation involves ensuring that a business's website is more

likely to appear at the top of the list when users enter a particular phrase.
° Having a presence on social networks and communicating with potential

customers on the network.
° E-mail marketing, offering products. It is important that any e-mail addresses

that the business holds have been obtained legally and ethically (eg from
partner websites where the individuals have agreed that the partner can pass
on the individual's email address).
° Traditional marketing approaches, such as sending targeted promotions to

individuals who fit the target segment.
4.3.2 Improve customer retention

The cost of winning new customers is high. It makes sense therefore to try to retain
customers once a business has gone to the trouble and expense of attracting the
customer in the first place. Customer retention involves making sure that customers
return for a second time.
Methods that can be used to retain customers include:
° Providing excellent customer service
° Giving customers a tailored service based on historic preferences
° Customer loyalty schemes
° Relationship marketing (see below)
Not all customers behave in the same way, and can be categorised as follows:
° Customers who appear for a single cash transaction and do not return
° Frequent customer who purchase regularly in large volumes
° Customers who purchase infrequently, but make high value transactions (such
as investors who acquire shares that they hold for the long term)
In terms of focussing effort at retaining the right customers, businesses would

usually wish to target customers who purchase regularly in large volumes.
Customer segmentation analysis can be used to identify these types of customers
to ensure that effort is not wasted on trying to retain customers would are not likely
to return.

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Real life Illustration: Loyalty schemes
Most major airlines operate air miles programmes, such as the Asia Mile program. If
customers join the programme, they earn mile, whenever they use the services of an
Asia Miles partner. These loyalty programmes are partly set up to persuade
customers to remain loyal, and use an Asia Miles partner whenever they travel. They
also allow the company to record information about the purchasing habits of its
members, which can be used to send targeted marketing messages to increase sales
of other services.
4.3.3 Extending customers

Extending customers means selling additional products or services to customers,
other than those they have bought to date. It is sometimes referred to as cross
selling. Extending customers means more revenue for the business, but it also makes
customers feel valued: they perceive that the business knows them, and is making
recommendations that will please them.
Real life Illustration: Extending customers

F122: |
The Amazon website offers its customers other products based on what they have
purchased before. This may be books on the same topic as books that customers
have bought before, or other products and services, such as Amazon Prime, the
company's streaming service.
4.3.4 Identifying changes in the customer

Customer relationship management (CRM) focusses on meeting the needs of
individual customers. This means that investment must be made to understand
individual customers' characteristics and preferences.
It involves building long-term relationships with customers so changes in their needs

are quickly identified and understood.
Under a customer relationship management approach, staff at all levels of the

organisation are encouraged to adopt a customer oriented service culture in all
activities, to enhance and strengthen the relationship with the customer.
CRM is appropriate in industries where there are high switching costs, which mean
that if a customer is lost, it is less likely that they will return. The opposite of customer
relationship marketing is transactional marketing, where the emphasis is on making a
single sale.

Va Certified Public Accountants
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4.3.5 Lifetime value perspective

Building relationships with customers whose lifetime value is highest makes most
sense. Lifetime value is the expected revenues and costs of servicing a customer over
the lifetime of the relationship.
The lifetime value can be calculated as (average annual revenue: costs to serve) x
(customer retention period).
Lifetime value may assume that customers’ profitability will change over time. If
customer lifetime value is potentially high, then it may be worth offering incentives
for new customers to switch.
Real life Illustration: Lifetime value
The market for virtual banks is booming in Hong Kong, with banks such as Revolut
and Monzo. Most of these offer free account opening to attract new customers. The
concept of Lifetime value is key to banks as it measures the lifetime value of each
customer to the bank. Based on this, banks may offer incentives to attract customers
away from competitors.
4.3.6 Customer relationship management (CRM) systems

CRM systems aim to support businesses in the customer relationship management.
Typically they enable all the different departments within an organisation (especially
sales and marketing) to share information about customers, to ensure that all
departments send the same message to the customer.
Database systems are an essential part of a customer relationship management

system. Customers' details can be stored on these, along with details of their
communications and preferences. This helps businesses to provide an individualised
service to customers.
Knowing your customer is highly valued. A key feature of a CRM system is keeping
detailed information about the customer and logging all interactions in one place, so
this information is there to refer to before each interaction.
Real life Illustration: Salesforce
Salesforce is recognised as being the market leader in CRM systems. The following
information from the company's website explains how the company's "Customer 360"
suite of apps supports CRM activities.
"Customer 360 offers apps that unite every team: marketing, sales, commerce,
service and IT: around a single shared view of customer data on an integrated
platform [...] this ultimately leads to more connected, personalized experiences for
your customers, building stronger relationships."

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Salesforce mentions the following ways (among others) that it can support the CRM
process:
° Tailoring marketing messages to specific customers
° Collecting customer data about prospective customers
° Using artificial intelligence to make better decisions about which customer
segments to target
° Supporting the sales process and ensuring it is consistent with the marketing
messages
° Managing customer service activities, including from contact centres and
automated chatbots powered by artificial intelligence
Key takeaway
In today's e-commerce led business world, it is almost impossible for large
organisations to effect effective customer relationship management without a CRM
system to capture customer data and all customer interactions. Many organisations
see investment in a CRM system to a critical success factor in itself.
4.4 Defining and measuring the drivers of client satisfaction

When monitoring the performance of a business, it is important that businesses
measure not only the results of good performance, but the underlying drivers.
Fitzgerald and Moon's Building Block model for measuring performance in service
based industries. That model suggests measuring performance under six
"dimensions". The first two dimensions are "results", which measure the outcomes of
decisions taken in the past. The remaining four are "determinants" which are forward
looking dimensions.
The six dimensions for measuring client satisfaction are:
(1) Financial performance - traditional measures such as return on capital
employed
(2) Competitiveness - measures such as market share and revenue growth
(3) Quality - refers to quality of service (measures might include customer ratings)
(4) Innovation - refers to the ability to develop new services
(5) Flexibility - customers expect tailored services rather than the same as
everyone else
(6) Resource utilisation - resource utilisation can be important in service industries
as services cannot be stored, so the business needs to have sufficient resources
to meet peak demand, but not be overstaffed.

a SRRHHAR
Key takeaway
Organisations can embed customer or client satisfaction measures within their suite
of key performance indicators (KPIs) to facilitate regular monitoring and review by
senior management and the Board of Directors.
Human resource management
Key term
Human resource management (HRM) is the process of evaluating an organisation's
knowledge and skills needs, finding people to fill those needs, and getting the best
performance from each employee by providing the supportive management,
incentives, appropriate working environment and the opportunity for learning and
development.
HRM is a people strategy as it has the overall objective of helping an organisation

achieve its strategic goals, by providing personnel, skills and knowledge to meet
market growth and changing activities. Therefore, HRM takes a strategic approach to
an organisation’s recruitment, training and development and performance appraisal
systems.
This section considers the objectives of HRM and three aspects of human resource
management which are:
(1) Recruitment and selection
(2) Training and development
(3) Performance appraisal
5.1 Main aspects of HRM

5.1.1 Objectives of HRM
The following objectives of HRM will help a human resource department to meet its
human resource (HR) strategy, which is aligned to and supports an organisations
overall strategic objectives.
(1) Define and implement the most effective organisational size and structure:
To structure an effective human component for the organisation that is ready
to deliver sustainable productivity and profitability in line with an organisations
strategic objectives. The ideal is having the optimal volume of employees who
are organised in an optimal way, using an optimal knowledge skills and
knowledge to perform and innovate.

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(2) Enabling strategic objectives to be met through the provision of knowledge,

skills and talent: To obtain and develop the human resources required by the
organisation and to use and motivate them effectively. This is done by
personnel learning and development and by external recruitment.
(3) Ensure organisational ethical and legal compliance: To meet the organisation's
social and legal responsibilities relating to its people requirements and embrace
wider societal and ethical developments as the evolve, such as implementing
policy for opportunity for career and personal development, sustainability,
diversity, inclusion and well-being.
(4) Effective co-ordination, communication and manage conflict: To ensure

interactions between people and functions is efficient and to communicate
effectively and timely on all personnel matters, especially during periods of
change. In doing so, HRM aims to create and maintain a co-operative culture
within the organisation and efficiently manage internal disputes as they arise.
5.1.2 Why is HRM important?
Effective HRM and employee development are strategically necessary as they

contribute to the success of the organisation.
The main benefits of HRM are:
° Increased productivity: Developing employee skills might make employees more

productive.
° Enhanced group learning: Employees work more and more in multi-skilled

teams. Each employee has to be competent at several tasks. Some employees
have to be trained to work together as a team.
° Reduced staff turnover: Training and developing staff often reduces turnover
rates. This increases the effectiveness of operations and profitability as staff
become more experienced.
° Encouragement of initiative: Organisations can gain significant advantage from

encouraging and exploiting the present and potential abilities of the people
within them.
Employees represent a scarce and critical resource which must be obtained, retained,
developed, mobilised and motivation for an organisation to be strategically
successful.
Armstrong (2003) defined HRM as ‘a strategic approach to the acquisition, motivation,

development and management of the organisation’s human resources’.
Bratton and Gold (1999) gave a more detailed definition of HRM. ‘HRM emphasises
that employees are crucial to achieving sustainable competitive advantage, that
human resources practices need to be integrated with the corporate strategy, and

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that human resource specialists help organisational controllers to meet both

efficiency and equity objectives.’
HRM should be integrated with strategic planning. The objectives of the human
resource (HR) function should be directly related to achieving the organisation's goals
for growth, competitive gain and improvement of ‘bottom line’‘performance.
It is therefore important to consider HRM to be a set of activities. Note, smaller

companies may not have a HR department to manage them but larger organisations
should. The concepts of HRM can be applied by small and medium organisations as
well as large ones.
5.1.3 Main HRM activities
The key activities in human resource management can be described as a cycle

consisting of four key activities: recruitment and selection, performance appraisal,
rewards and training and development.
(1) Employee selection (and recruitment) is important to ensure the organisation

obtains people with the qualities and skills required.
(2) Appraisal enables targets to be set that contribute to the achievement of the
overall strategic objectives of the organisation. It also identifies skills and
performance gaps and provides information relevant to reward levels. This links
to setting an appropriate rewards policy which should motivate and ensure
valued staff are retained.
(3) Training and development ensure skills remain up to date, relevant, and
comparable with (or better than) the best in the industry.
The performance of employees depends upon each of these components and how
HRM activities are co-ordinated.
5.2 Recruitment and selection

The success of an organisations depends on many factors. An important factor is the
commitment, aptitude, knowledge, skills, experience, talents such as innovation and
creativity of its workforce and importantly, the motivation to succeed. HRM can
search for these specific qualities during an internal selection process or external
recruitment process.
5.2.1 Key concepts in preparing for recruitment and selection
Before recruiting and selecting individuals to work for their organisation, HR

managers must understand what job vacancies there are, what the jobs consist of,
and what type of person should be selected to fill the job vacancy. This information
can be obtained be co-ordinating with directors and managers and completing job or
role analysis which describes the organisations needs, and provides selection criteria.

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Key term
Job analysis is to investigate a job and analyse the requirements of the job. From a job
analysis, a job description can be prepared, which can be used in the recruitment and
selection process.
The type of information that may be obtained in a job analysis is set out in the
following table.
Type of Co) an nat ales)

information
Purpose of This might seem obvious. However, an important starting point is to

the job establish the purpose of the job and why someone needs to do it.
Content of These are the tasks that the job holder is expected to do. They
the job should be recorded in detail. This is probably the biggest part of the
job description.
Responsibility | This sets out the importance of the job. What is the job holder
responsible for? Does the job holder have subordinates?
Accountability These are the results for which the job holder is responsible and
who the job holder reports to and is responsible to.
5.2.2 Role analysis and competency based selection
Key term
Role analysis establishes the competences that the job holder should have, in terms
of behavioural competences (soft skills, or behaviour expectations) and the technical
or functional competences (hard skills).
A person’s competence is a capacity that leads to behaviour that meets the job
demands within the parameters of the organisational environment and that, in turn,
brings about desired results.
° Behavioural competences are underlying personal characteristics and

behaviours required which are known to support successful performance. For
example, ‘ability to relate well to others’.
° Work-based, occupational competences are expectations of workplace

performance and the outputs and standards people in specific roles are
expected to obtain. For example, a competence for a senior financial
accountant in a company may be to produce financial statements and report
to management.

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Generic competences can apply to all people in an organisation, regardless of

their role. A selection of generic competences for managers are included in the
following table.
Intellectual ° Strategic perspective

° Analytical judgement
° Planning and organising
Interpersonal e Managing staff

e Persuasiveness
e Assertiveness and decisiveness
° Interpersonal sensitivity
° Oral communication
Adaptability ° Flexibility
° Coping with change
5.2.3 Reasons for ineffective recruitment and selection
A recruitment and selection process might be ineffective for the following reasons:
Not enough people apply for job vacancies (poor recruitment).
Unsuitable individuals are selected as a result of out of date, or ill-conceived

election criteria (poor selection).
The desired candidate refuses the job when it is offered to them.
Individuals do not stay in the job for long after their appointment.
There are several reasons for poor recruitment and selection procedures which
include inadequate recruitment messages and processes and poor selection criteria.
Inadequate recruitment messages and processes

There are several possible reasons for a failure to attract a sufficient number of
suitable applicants for a job.
The requirements of the job are not properly considered before the job is
advertised, so that the vacancy is advertised to individuals with unsuitable
skills.
The job itself is not attractive enough, or the pay is too low, so that few people
apply for the vacancy.
The job vacancies are advertised in an unsuitable way. The vacancy may not
come to the attention of people who might apply if they knew about it.

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Poor selection criteria
Possible reasons for poor selection criteria are as follows:
° A badly designed application form, so that applicants do not provide enough

relevant information about themselves. A candidate may therefore be offered
the job on the basis of insufficient information.
° The selection techniques are inappropriate. Tests may be used that do not
indicate the suitability of the candidate for the job.
° The individuals making the selection (for example, the individuals doing the
selection interviews) are not trained in selection, and do not have the necessary
skills to do the task well. For example, interviewers may not be skilled at
interviewing.
° The effectiveness of the selection process is not monitored and reviewed

regularly, so that management are unaware of the failures of selection in
the past.
As a result, the best job applicants are not selected, and in some cases unsuitable
candidates are offered the role.
5.3 Training and development

The success of an organisations depends on many factors. An important factor is the
commitment, aptitude, skills, experience and motivation to succeed. These qualities
can be developed through formal training and on the job training.
Key terms
Development is the growth or realisation of a person’s ability and potential through
the provision of learning and educational experiences.
Training is the planned and systematic modification of behaviour through learning

events, programmes and instruction which enable individuals to achieve the level of
knowledge, skills and competence to carry out their work effectively.
The overall purpose of training and development includes:
° Ensuring the organisation meets current and future performance objectives
Continuous improvement of the performance of individuals and teams
Maximising employee potential for growth (and promotion)

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5.3.1 Learning and development strategy
Organisations often have a learning and development strategy, based on the overall
strategy for the business. This can also be referred to as training.
A learning and development strategy can be described in three steps.
° Step 1: Identify the skills and competences needed by the business plan.
° Step 2: Draw up the development strategy to show how training and

development activities will assist in meeting the targets of the corporate plan.
° Step 3: Implement an enhanced learning and development strategy.
This three step approach to developing a learning and development strategy

approach produces learning and development with the following qualities.
° Problem based (i.e. corrects a real and current lack of skills in the organisation)
° Relevant to current roles in the organisation
° Action-oriented (i.e. employees learning by participating and doing)
° Relates directly to employee performance and therefore, rewards
5.3.2 Effective learning programmes
The following principles are key to implementing an effective learning and

development programme.
Participants Must have the ability, skills, knowledge and motivation to learn.
Overview An overview of what is to be learnt should be provided before

focusing on specific tasks.
Feedback Participants should receive accurate and timely feedback on

their progress.
Rewards Progress should be rewarded by positive re-enforcement such

as praise or tangible items such as certificates.
Active Successful learning involves taking part rather than listening or

involvement reading.
Learning curve _ Training must reflect the fact that some skills are picked up
quickly whereas some will take time to develop. Progress is not
always at the same pace.
Job specific Training should be as realistic as possible to the job concerned

to minimise problems of applying the new skill of knowledge.

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5.3.3 Benefits of learning and development for the organisation
The benefits for the organisation of learning and development programmes are
outlined in the following table.
Minimise external A learning and development programmes aims to upskill

recruitment costs existing employee across the entire organisation in the
short-term and long-term, so the organisation has the skills
its requires to deliver its business strategy.
Increased Upskilling employees provides the skills, knowledge and

productivity confidence to perform better which leads to improved
efficiency and productivity.
Improved safety Compliance with employment law and health and safety
at work regulations requires knowledge based training. Employees
can take employers to court if accidents occur or if unhealthy
work practices persist.
Less need for Training is an aspect of employee empowerment. If people

detailed are trained they can confidently get on with their job with the
supervision need for less support and supervision. This frees up
managers so they can concentrate on strategic planning and
delivery.
Flexibility Training ensures that people have the variety of skills

needed - multi-skilling is only possible if people are properly
trained.
Recruitment Learning and development attracts new recruits and ensures

and succession that the organisation has a supply of suitable managerial and
planning technical staff to take over when people retire.
Change Training helps organisations manage change by letting

management people know why the change is happening and giving them
the skills to cope with it.
Corporate culture Training programmes can be used to build the corporate

culture or to direct it in certain ways, by indicating that
certain values are espoused. Also, training programmes can
build relationships between staff and managers in different
areas of the business.
Motivation Training programmes can increase commitment to meeting

goals and objectives and increase loyalty to the organisation.

SRAHACR
5.3.4 Benefits of learning and development for the employee
Enhances Even if not specifically related to the current job, training can
employee be useful in other contexts, and the employee becomes more
portfolio of skills | attractive to employers and more promotable.
Psychological Investment in training can make employees feel reassured that

benefits they are of continuing value to the organisation.
Social benefit People’s social needs can be met by training courses and they
can also develop networks of contacts within the organisation.
Job satisfaction Training can help people do their job better, thereby increasing
job satisfaction.
5.3.5 Possible drawbacks of learning and development programmes
Many organisations acknowledge that learning and development has limits on what it
can achieve.
Learning and development is not always the answer to specific performance-

related issues.
Learning and development irrelevant to problems caused by faulty organisation,

layout, methods, equipment, employee selection and placement and so on.
Cost, time, inconvenience, apathy and unrealistic expectations of training in the

past may restrict its effectiveness.
Limitations imposed by intelligence, poor motivation and the psychological

restrictions of the learning process also restrict its effectiveness.
Learning and development may not deliver new required skillsets or quickly
enough. In which case, an external recruitment strategy may be faster and more
cost effective.
5.3.6 Analysing an organisations learning and development needs
Analysing learning and development needs cover three aspects, as follows.
1 Organisation’s current results Desired results, standards
2 Existing knowledge and skill Knowledge and skill needed
3 Individual performance Required standards

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The difference between the two columns is known as the knowledge and skills gap.
Learning and development programmes must then be designed to close the training
gap by improving individual knowledge, skills and performance.
Activity 9
The CEO of large and successful internationally based IT consultancy, which employs
over a thousand employees, said in a recent interview that he did not believe
investment in learning and development was value for money.
The HR Director does not agree and has asked you as operations manager to use
your leadership skills and help influence the CEO to appreciate the benefits of
investing in a formal programme of learning and development for its IT consultants.
Required
Draft a briefing paper for the HR Director to share with the CEO, for discussion at the
next board meeting. The briefing paper must cover the following:
° Discuss why the CEO may be reluctant to train its employees and the problems
the organisation may encounter in the future as a consequence.
° Make recommendations to influence the CEO to change their attitude to the
value a formal programme of learning and development for the IT consultants.

5.4 Performance appraisal

Performance management aims to get better results for the organisation and
evaluation of individual performance. This section considers the role of performance
appraisal in supporting organisational performance and success.
Performance appraisal involves:
1. Setting targets or standards of performance that each individual is expected to

achieve over a period of time (typically one year or less).
2. Reviewing the performance of the individual periodically (at least once each
year) and comparing what the individual has achieved with what was expected.
3. | Performance appraisals can be a part of the personal development of

individuals, although they can have other purposes too.

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5.4.1 Purpose of performance evaluation

Performance appraisals can be used to reward employees, identify potential and
identify areas for improvement and learning and development needs.
The general purpose of any appraisal system is to improve the efficiency of the
organisation by ensuring that the individuals within it are performing to the best of
their ability and developing their potential for improvement. However, performance
evaluation has a direct influence in the behaviour of employees which can lead to
negative behaviours if it is used overtly to blame employees for past mistakes.
An appraisal system has three main components, as follows:
1. Performance review. Evaluation can be used to identify training needs when
unsatisfactory performance indicates a weakness or deficiency in the skills or
knowledge of an individual.
2. Rewards review. Performance evaluation is used as a basis for deciding reward
allocations, such as bonus payments and increases in pay.
3. Potential review. Performance evaluation is an aid to planning career
development and succession, by attempting to predict the level and type of work
the individual will be capable of in the future. It is an important consideration in
decisions about promotion, transfer and termination of employment.
Performance evaluation also provides feedback to employees about how they
have been performing so they can reflect on how to adapt their working practises
and improve.
5.4.2 The process of performance appraisal
There are four basic requirements for a formal appraisal system.
1. Formulation of objectives, targets, standards or behaviours. These provide a
benchmark against which each employee will be assessed.
2. Recording assessments. There should be some way of recording the actual
performance of individuals against the required targets or standards.
Performance appraisal forms may be used for this purpose. The line manager of
the individual may make the assessment, but assessment of the individual by
subordinates or colleagues may also be part of the appraisal process.
3. Feedback. There should be formal feedback to the individual about their
performance. This may be done in an appraisal interview between the individual
and a more senior manager (for example, a line manager or someone from the
HR department).
4. Decisions. The appraisal process should result in a decision or agreement with
the individual about what should now be done. As suggested earlier, this may
be a decision about further training or development for the individual, or a
decision about how the individual should be rewarded. The appraisal may also
be used to assess the individual's abilities and suitability for promotion.

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5.4.3 Performance appraisal and motivation
The performance appraisal process can provide motivation to individuals to perform

well in their work. This is possible only if people perceive that putting more effort into
their work will lead to better performance, and that better performance will lead to
rewards (more pay, or promotion). This is the expectancy theory of motivation.
Appraisal systems will not be motivating if individuals cannot see a direct connection
between the appraisal system and how it bring benefits to themselves. This may mean
rewards or promotion, but individuals may also be interested in discussing their
learning and development needs, which is an important part of the appraisal process.
5.4.4 What performance is assessed?
Performance appraisal should compare what an individual has achieved compared

with what is expected from them. This may involve an appraisal of performance at
work or an assessment of behaviour and attitudes at work.
° Work performance and achieving targets. The performance of the individual at

work may be compared with targets or standards that were agreed in advance.
For senior managers, performance may be measured in terms of revenue
earned, keeping costs within budget or making profits for the organisation. For
project managers, targets may relate to the achievement of targets for the
completion of project work.
e Behaviour and attitudes. Employee performance may also be assessed in terms

of the way in which the individual has conducted themselves at work. Criteria
for assessment may include diligence at work (for example, completing tasks on
time), an ability to work without excessive supervision, getting on well with
other people at work, contribution to team efforts, showing a good attitude,
demonstrating confidence and proactivity.
5.4.5 Who should perform the evaluation/appraisal?
A manager or supervisor is directly responsible and accountable for the performance

of their subordinates team members. Therefore, it is usually the line manager or
supervisor who is involved in discussing performance with the individuals who work
under them.
In many appraisal systems, appraisals are conducted by the immediate supervisor, or

the person at the next level of seniority above that. However, the appraisee, their
peers, subordinates and other stakeholders can also have a role. These roles are each
explained further as follows.
° Immediate supervisor. Performance appraisal for individuals at lower and

middle management levels of the organisation are often conducted by the
employee's manager. Some supervisors may not have the necessary skills to
conduct a constructive appraisal. Other supervisors may be reluctant to

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appraise their staff for emotional reasons because they do not want to criticise
them or disappoint them in any way. Therefore, it is essential that those who
are appraising are trained to do so.
Peer review. Peer review involves the appraisal of individuals by their

colleagues. Performance evaluation undertaken by peers may be a reliable
method of appraisal because they are familiar with the individual's work from
daily interaction. Judgements are also supplied by several people, not just one.
Immediate subordinates (upward appraisal). An organisation may ask for

subordinates to make an appraisal of their supervisor/manager. This may
provide useful feedback about the performance of the individual as a leader.
The major weakness of this method of appraisal is the fear of reprisal from
bosses when the subordinate gives an unfavourable assessment.
Self-evaluation. Employees may be required to carry out an assessment of their

own performance. This can be a useful part of the overall appraisal process
because the self-appraisal by the interview can be compared with the appraisal
by the individual's boss, or peers or subordinates. This can provide a basis for
discussion at an appraisal interview.
360-degree appraisal. 360-degree appraisal is appraisal that combines

appraisals from ‘all directions‘or all sides - from the individual's supervisor or
manager, from peers, subordinates, customers and other people outside the
organisation with whom the individual has regular business dealings. The views
of all these different people are brought together and form the basis for an
appraisal interview with the individual.
5.4.6 Performance appraisal follow-up
After the appraisal interview, a manager will complete a report with an overall
assessment of employee performance against agreed objectives, an assessment of
learning and development needs and consideration of potential and advancement. It
should also include recommendations for follow-up actions.
Follow-up procedures typically include the following:
(a) Informing the employee of the results of the appraisal if this has not been
central to the review interview
(b) Carrying out agreed actions on training, promotion and so on
(c) Monitoring the appraisee’s progress and checking that they have carried out
agreed actions or improvements
(d) Taking necessary steps to help the appraisee attain improvement objectives, by
guidance, providing feedback, upgrading equipment, altering work methods and
so on

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5.4.7 Barriers to effective appraisal
The main barriers to an effective system of employee performance appraisal are

included in the following table.
Appraisal barrier Explanation
Appraisal as Many people dread appraisals or use them as a sort of

confrontation ‘show down’ with their manager. In this kind of situation:
e There is likely to be a lack of agreement on
performance levels and improvement needs.
e The feedback may be subjective or exaggerated.
e The feedback may be negatively delivered.
e The appraisal may focus on negative aspects, rather
than looking forward to potential for improvement
and development.
Appraisal as judgement The appraisal ‘is seen as a one-sided process in which

the manager acts as judge, jury and counsel for the
prosecution’. This puts the subordinate on the defensive.
Instead, the process of performance management
‘needs to be jointly operated in order to retain the
commitment and develop the self-awareness of the
individual’.
Appraisal as chat The appraisal is conducted as if it were a friendly chat

‘without [...] purpose or outcome [...] many managers,
embarrassed by the need to give feedback and set
stretching targets, reduce the appraisal to a few
mumbled “well dones!” and leave the interview with a
briefcase of unresolved issues.’
Appraisal as bureaucracy Appraisal is a form filling exercise, to satisfy the personnel

department. Its underlying purpose, improving individual
and organisational performance, is forgotten.
Appraisal as unfinished Appraisal should be part of a continuing future-focused

business process of performance management, not a way of
‘wrapping up'the past year's performance issues.
Appraisal as annual Many targets set at annual appraisal meetings become

event irrelevant or out of date. Feedback, goal adjustment and
improvement planning should be a continuous process.

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5.4.8 How effective is the appraisal scheme?
Like any organisational programme, it may not be wholly effective and could benefit
from change like any other aspect of the organisation. The effectiveness and cost-
effectiveness of appraisal should be periodically and systematically evaluated.
The appraisal scheme could be evaluated (and regularly re-assessed) according to the
following general criteria.
Relevance Does the system have a useful purpose, relevant to the needs of
the organisation and the individual?
Is the purpose clearly expressed and widely understood by all
concerned, both the individuals who are being evaluated and the
people conducting the appraisal?
Are the appraisal criteria relevant to the purposes of the system?
Fairness Is there reasonable standardisation of criteria and objectivity

throughout the organisation?
Is the process reasonably fair and objective?
Serious Are the managers concerned committed to the system, or is it

intent just something the personnel department thrusts upon them?
Who does the interviewing, and are they properly trained in
interviewing and assessment techniques?
Are reasonable time and attention given to the interviews, or is it
a question of ‘getting them over with’?
Is there a genuine demonstrable link between performance and
reward or opportunity for development?
Cooperation Is the appraisal a participative, problem-solving activity, or a tool

of management control?
Is the employee given time and encouragement to prepare for
the appraisal, so that they can make a constructive contribution?
Does a jointly agreed, concrete conclusion emerge from the
process?
Are appraisals held regularly?
Efficiency Does the system seem overly time consuming compared to the
value of its outcome?
Is it difficult and costly to administer?

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<= Activity 10
iz A small company has recently undergone a period of significant growth. The

managing director has recognised the need to restructure the organisation and
improve its human resource management processes. The company currently does
not have a formal performance appraisal system in place as the managing director
has relied on informal performance discussions with managers in the past.
The managing director would like to understand more about objectives of a formal
performance appraisal system and has requested a high-level overview as a starting
point for further discussions.
Required
Provide an explanation the most common objectives of a performance appraisal

system for the managing director.

Key takeaway
Performance Appraisal is part of the system of performance management, including
goal setting, performance monitoring, feedback and improvement planning. Appraisal
can be used to reward but also to identify potential. It is part of performance
management and can be used to establish areas for improvement and learning and
development needs.
Basic requirements of a formal appraisal system are: defining what is to be appraised,

recording assessments, providing feedback to the individual who is evaluated and
making decisions about what to do in the future. The appraisal interview is an
important stage in the process, as it can be used to encourage collaborative problem
solving and improvement planning.
5.5 HRM reports

There is no requirement by law, corporate governance or by HKExX listing rules to
include human resource management information in an organisation’s annual report,
or as a Separate report. However, some large or global organisations do so as part of
their corporate and social responsibility reports and in response to stakeholder
expectations.

YASY Certified Public Accountants
a SRRHHAR
An organisations HRM report may include a summary of people resources, human

resource policies, the employee turnover rate, details of the working environment, a
summary of salaries and other compensation, diversity and inclusion data.
Weblink
Review an examples of an HRM Report published by Deutsch Bank in 2021 which

provides a good example of HR statistics, policies and initiatives, particularly in the
areas of employee learning and development and welfare.
oe en T files/d |.
reports/2022/HR_Report_2021.pdf

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° Understand the role ofa leader and how it contrasts with a management role.
° Leadership traits and attributes theory is based on analysing the personality

characteristics or possession of specific qualities which successful leaders are
believed to demonstrate.
° Behavioural theory of leadership is based on analysing the behaviour of leaders

and managers (task vs people).
° Leadership styles are based on the view that leadership is an interpersonal

process and different styles of leadership behaviour influence people in
different ways. Styles include authoritarian, bureaucratic, democratic and
laissez-faire.
° Contingency theory of leadership is based on the view that there is no 'one best
way' of leading, but that the most effective style of leadership depends on
circumstances.
° Modern leadership theories focus on how leadership styles affect the behaviour
and morale of those around the leader or managed by them. This theory
emphasises the power of self-awareness and emotional intelligence to regulate
a leaders emotions, reactions, criticisms or judgements.
° Know your leadership styles and theories so you can analyse and spot evidence
of ineffective leadership at Capstone. Remember, leadership theory is not
conclusive and many people can be a leader!
° There are lots of ways to develop leadership capabilities. It is highly unlikely that
any individual will have the skills to be a leader in a wide range of differing
situations, so some skills will need to be developed.
° There are many different influences on the culture of an organisation and a

leader needs to understand these.
° The organisational structure will make a difference to the culture, whether there
is a focus on power, roles, tasks or persons.
° A cultural web is present for each organisation, and this should be assessed to
see if the assumptions that are made are reflected in the actual state of the
organisation. This will help leaders understand a need of cultural change.
° Leadership styles should vary under different organisational cultures and

situations. So it is important to understand the culture of the organisation and
adapt leadership styles to fit.

yay. CPA Certified Public Accountants
mae SHRHHOR
A team will go through four development stages, including forming, storming,

norming and performing.
There are various activities for a leader to know - how to select team members
for the roles available and to train team members for their roles.
Once the team is formed then the capabilities of the team should be developed
by the team leader who should also manage any teams conflict which occur.
A system for how teams are rewarded needs to be determined by an

organisation to make sure each team is motivated towards achieving set goals.
Inevitably a team will experience changes, from external or internal factors. The
process of change management needs to be followed though. This is covered in
detail in Chapter 10.
Leaders and management must ensure that an organisation is focussed on the

customer. This includes communicating the importance of the customer to all
staff and rewarding staff for demonstrating a commitment to good customer
service.
HRM is concerned with assessing the needs of the organisation for employees,
finding people to meet those needs and getting the best performance from
them.
The main elements in HRM are recruitment and selection, performance

appraisal and learning and development.
A starting point for the recruitment and selection process is job analysis and
competence analysis (role analysis). This leads to reparation of job descriptions
and personal specifications for each job for recruitment and performance
management.
The purpose of learning and development is to obtain a skilled work force, by

raising standards of competence of employees and improve their work
performance. It is also concerned with personal development, helping and
motivating employees to fulfil their potential.
Learning and development consists of specific transfer of knowledge to learn or

develop particular skills, such an interpersonal skills, problem-solving skills or
work related knowledge.
Performance appraisal can be used to reward but also to identify employee

potential as part of succession planning. It also identifies areas for improvement
and learning and development needs.

ae SRN OR
Activity 1 answers
Required
Consider who is the best leader you have had and what leadership attributes have
made them different to other leaders that you have known.
Solution
There is no one right answer to this as it will depend upon your personality as well as
the leader's. It may be that you were happy following someone who has strong
opinions and who wanted things to be done in a given way, that they decided.
Alternatively, you may have been put off following someone like this and decided that
you would rather follow someone who is more inclusive and democratic. You should
have identified attributes from the list which you recognise as factors why this person
is a good leader. Remember, there is no one leadership style that will impress all
followers.
Activity 2 answers
Scoring instructions
Score yourself assessment according to the following point values.
Question 1 Question 3
A. 4 A. 4
B. 3 B. 3
G, z2 G 2
D 1 D 1
A. 4 A. 4
B. 3 B. 3
Gc, Zz G 2
D 1 D 1

mae =SRRHHOR
A. 4 A. 4
B. 3 B. 3
Cc 2 Cc 2
D. 1 D. 1
A. 4 A. 4
B. 3 B. 3
Cc. 2 Cc 2
D. 1 D. 1
A. 4 A. 4
B. 3 B. 3
Cc 2 Cc. 2
D. 1 D. 1
Total point tally:
Score between 33-40: Your general leadership style is autocratic. You are a leader
which has control over all decisions made and uses your own ideas and judgments to
decide what the organisation should be doing.
Score between 26-32: Your general leadership style is bureaucratic. You are leader
which sets down a set of processes and procedures underneath an overall structure.
Score between 18-25: Your general leadership style is democratic. You are leader
who focuses on collaborative energy, delegation of responsibilities, and group-level
decision making which means there are far more possibilities for employees to
have a Say.
Score between 10-17: Your general style of leadership is laissez-faire. You are a
hands-off leader which ensures that employees are able to work more autonomously
to complete the work needed and you provide the resources needed to give
employees latitude to complete their duties.

ae SHRNGAR
Activity 3 answers
Required
Compare and contrast the democratic leadership style and the authoritarian
leadership style. In what circumstances would you prefer either of them?
Solution
A democratic leadership style is where a manager involves subordinates (or team

members) in the decision-making process. A leader with an authoritarian style takes
all the decisions themselves and do not allow subordinates to take decisions
themselves or even take part in the decision-making process.
Tannenbaum and Schmidt identified a continuum of leadership styles, each with a

different combination of authoritarian and democratic elements. They suggested
that, when subordinates are new to their job or inexperienced, an authoritarian style
may be necessary, but as team members become more experienced and
knowledgeable, a leader should adopt a more democratic style and trust the team
members to take some decisions themselves and share in the decision-making
process for the leader's own decisions.
Contingency theory suggests that the most suitable leadership style in any situation
depends on the circumstances (contingent factors). Fiedler, for example, made a
distinction between psychologically distant managers, who may adopt a more
authoritarian style, and psychologically close managers, who may adopt a more
participative/democratic style.
Fiedler suggested that a situation is favourable to the leader when the leader is liked
and trusted by the group, the tasks of the group are clearly defined and unambiguous
and the leader has the authority and power to reward and punish subordinates.
Fiedler went on to suggest that a psychologically distant style is most effective when
the situation is either favourable or unfavourable to the leader. A psychologically
close style is more effective when the situation is neither very favourable nor very
adverse.
You might find that an authoritarian style would be more appropriate in a situation
where you are responsible for an area of work that involves routine activities and
where your subordinates are inexperienced or unskilled. A participative style would
be preferable when the nature of the work is complex, and the subordinates have
skills and experience that they can use to contribute constructively to decision
making.

a HRRUNALR
Activity 4 answers
Look to see where you have ticked the most. It is likely that you have ticked in several
columns.
° If you have ticked most in Column 1 then you would be classified as Dominant
i.e., direct, positive, straightforward, and like to be in charge.
e If you have ticked most in Column 2, then you are an Influential person, very
people orientated. You probably define yourself by your relationships, as you
are generally interested in people.
° If you have ticked in Column 3, then you are most likely to be Steady. Often,
they struggle most with becoming a leader as they are most comfortable being
a 'behind the scenes' person.
° If you have ticked more in Column 4 then you are most likely to be a
Conscientious person. You are precise, systematic and like information.
This is an interesting exercise for you to see if you will be a leader, or how you may
need to change to give yourself a better chance of being so. Steady and Conscientious
people can learn from Dominant and Influential characteristics to see what aspects of
their personality and behaviour they need to develop. Similarly for Dominant and
Influential people they can think how they can change to improve how they perform.
Activity 5 answers
Required
Choose an organisation that you come into contact with regularly, say a chain of shops
or an online business, or which you are a member of, such as a social or sports club.
List the various cultural properties of the organisation - its underlying assumptions
and values, its stated beliefs and slogans and any visible signs and symbols.
Solution
The solution that you produce will depend on the organisation that you have chosen.
If itis a club, attending will be interesting to see if there are any issues that they are
not covering but which could improve them, such as a logo or a slogan. It is more
likely that a commercial business will have these.
In particular look out for:
1. The underlying attitudes that come from how the organisation operates and
manages itself. This will be affected by its aims and its leadership, so see what
you can learn about them.
2. For the underlying assumptions and values, see if there are any slogans, mottos
and, for a commercial business, any advertising messages that are used.
3. For the visible signs and symbols, how staff or members dressed are, is there a
uniform approach, are there logos, asset décor and so on.

ae SRN OR
Activity 6 answers
Required
Assess into which category each of the statements fits best i.e., forming, storming,
norming, performing or dorming.
Solution
The statements are most likely to fall in the following categories:

1. Norming
Forming
WN
Dorming
Storming
uF
Performing
Activity 7 answers
Required
Suggest a solution that is:
(a) A win-lose situation
(b) A compromise
(c) A win-win solution
Solution
(a) In a win-lose scenario one of the team members will get the corner office by the
lift and the other will not. The team member that did not get the office will
probably be upset and unhappy with the other team member and the leader.
(b) A compromise would be to have the two staff members rotate and have the
office for a set period of time, then swap. This is a messy solution if they have to
move in and out of the office regularly.
A win-win solution requires the leader to understand the views of both team
members so it can be agreed on who is best suited to the office. There will be
disadvantages, such as extra noise from the lift and the people using it. However,
one team member may have young children to collect and are worried about
getting out of the building quickly to achieve that. The other team member may
not have thought that the other office offered is closer to the canteen, or has a
better view, and may realise that the office by the lift is not such as good choice.
So, a win-win situation requires more work to explore the options and get a
better solution for both team members due to this. At the very least, both team's
members will have felt listened to and that their views have been considered in
order to make the best overall decision for both of the team members.

100) Certified Public Accountants
ew SHRNHOR
Activity 8 answers
Required
(a) Suggest effective ways that senior managers could obtain a more representative
picture of the customer experience at the hotels.
(b) Describe what improvements could be made to avoid customers having the
same bad experience as the reviewer.
Solution
(a) The problem with review websites is that only a small minority of guests would
ever leave a review on them, and often these will be guests who have a
complaint, which means that the review sites may not give a representative
picture of what the hotel is really like.
One approach would be for senior managers to visit the hotels, incognito, and
stay there as guests. This would give them the opportunity to experience the
hotels first hand, and to evaluate the service that is being provided. Managers
would also be given the opportunity to meet other guests at the hotels, where
they could obtain feedback from those guests.
Another approach would be for managers to call a sample of guests after their
visit and ask them for feedback.
Feedback forms could be given out to guests, but the problem with these
is that many guests would not complete them, or guests that do complete
them may tend not to be totally frank in their evaluation, for fear of offending
the staff.
(b) The reviewer complained about two incidents. First, they were put on hold when
they called the hotel to ask for their reservation to be changed. Secondly, the
Staff at the front desk were not able to change their room until the next day,
when the rooms division manager was back.
Both of these problems could be solved by empowerment. Giving staff at the

front desk the power to make decisions immediately, without having to get
approval from above. In the case of the reservation change, the front office
clerk could have been given access to the reservations system and given the
authority to change reservations (although this authority should be restricted,
so that big groups, for example, would still have to go through the reservations
department). Similarly, the front desk staff should have the authority to give
guests a different room if they are not happy with the one they were allocated.
This would enable staff to react immediately and improve the goodwill of
the guests.

ae SRN OR
Activity 9 answers
Draft a briefing paper for the HR Director to share with the CEO, for discussion at the
next board meeting. The briefing paper must cover the following:
° Discuss why the CEO may be reluctant to train its employees and the problems
the organisation may encounter in the future as a consequence.
° Make recommendations to influence the CEO to change their attitude to the

value a formal programme of learning and development for the IT consultants.
Solution
To: The HR Director
Subject: Evaluation of current learning and development strategy
Introduction
This briefing paper sets out possible reasons for the organisations preference for self-
development and recruit in skills rather than to invest in learning and development to
train its IT consultants and the evaluates the problems the organisation may encounter
as a consequence. Key recommendations will then follow.
Rationale for current learning and development strategy
There are several reasons why the organisation is currently reluctant to train its
employees.
Cost: An important reason is cost as formal training can be costly to deliver. External
training involves payment to colleges or other training providers. Training internally
uses up the time of experienced employees or staff in a training department. For this
reason, the organisation may decide to rely on the job training for new employees,
with relatively little supervision.
Considered unnecessary: The organisation has a successful history, which its

consultants have either self-learned based on need and their day to day
responsibilities create on-the-job training opportunities and the opportunity to learn
from colleagues and clients. The CEO believes learning and development is not
required as the organisation has been successful without it, however, it is gamble to
continue without it. A difficulty with this approach to learning and development is
training inconsistency, incompleteness, a lack of relevance and self-determined,
meaning the organisation has no transparency of its learning and development needs.
Upskill and leave concern: Companies may also be concerned that if they train
employees, then upskilled employees will leave soon afterwards to join a rival
organisation. This means that the organisation will have paid for the training of the
rival's staff. However, training is only one aspect of human resources Strategy and if an
organisation wants to obtain skilled staff, it must reward them sufficiently as well as
train them.

a HRRUNALR
Recruit skills which are required: An organisation may also believe that instead of
training staff, it can recruit already skilled staff in the jobs market, after they have
been trained by someone else, perhaps by 'poaching' them from a rival. This will save
costs but will also cause dissatisfaction among the organisation's existing staff, who
are not being given training or career development opportunities.
Consequences of existing learning and development strategy
Lack of strategic planning: The CEO is neglecting to train its IT consultants because
the organisation does not have a clear human resources strategy which means the
organisations has not made plans to deliver the skills that their employees will need
in the future.
Loss of competitiveness: In the fast changing world of IT consultancy, failure to

provide suitable training to staff means that their competences will not improve,
except through work experience; therefore the performance of employees may be
much lower than it should be. Over time the organisation may lose its
competitiveness against rival companies that do train their staff, or may even find it
is obsolete, as the organisation has failed to keep up with changes in technology.
Recruitment gap: The organisation may not be able to recruit sufficient staff with
the necessary IT consultancy skills that are needed to operate the business
efficiently or effectively, or without paying a significant premium. If this is the case,
the premium may be better invested in learning and development which develops
existing staff into competent employees who demonstrate loyalty to the
organisation.
Culture of dissatisfaction: There will be only limited internal career development

opportunities for staff as there is no formal programme of learning development
and new skills required by the organisation are generally recruited in. This may
be viewed as unfair by the current IT consultants which results in poor staff morale.
As a direct consequence, the organisation may suffer a higher rate of employee
turnover which would be disruptive to current business and increase recruitment
costs.
Recommendations
In an IT consultancy, the IT consultants are the most significant resource which

should be managed and protected. A failure to develop its own IT consultants
through formal training represents a major strategic failing by the organisation and is
likely to be a false economy. High employee turnover would be significant problem
for the CEO which investment in learning and development may reduce. This is likely
to be more costly than investing in a programme of learning and development. If
true, this will provide a business case for the CEO to invest in learning and
development.

ae SRN OR
Therefore, it is recommended that the organisation:
Complete a knowledge and skills gaps analysis and quantifies the cost of
learning and development to close this gap.
Undertake an employee survey to ask for their feedback in the current level of
learning and development provided by the organisations.
Analyse its IT consultant turnover rate and external recruitment expenditure and
consider the impact on its recruitment costs if knowledge and skills were internally
developed as an alternative as this option may be less expensive and less risky.
Activity 10 answers
Required
Describe the most common objectives of a performance appraisal system.
Solution
The general purpose of an appraisal is to improve the efficiency of the organisation

by ensuring individual employees are performing their role to acceptable standards
and to the best of their ability. The process also considers the employees ‘potential to
improve and to develop.
Objectives of a formal performance appraisal system include the following:
To enable a picture to be drawn up of overall staff levels and skills, strengths
and weaknesses. This will enable more effective HR planning to address skills
gaps and focus future learning and development.
To monitor a company’s employee selection procedures against the subsequent
performance of recruits. This will help to refine recruitment procedures, interview
questions and selection criteria which will improve recruitment outcomes.
To establish what the individual has to do in a job in order that the objectives for
the section or department are realised. This will help to improve the precision of
job descriptions and employee understanding of their responsibilities. This
should lead to greater ownership and improved performance.
To assess an individual's performance including strengths and any weaknesses.
This helps identify training needs. This will help the employee to understand
areas of focus and self-development and to identify the need for support and
learning and development.
To assess appropriate rewards (pay, bonuses etc). This should improve the
allocation of rewards based on merit and achievement. This encourage loyalty
and reduce staff turnover.
To assess employee potential. At the organisational level this will assist career
and succession planning. At the individual level it facilitates an individual
development plan.

HARUALR
Case Study Activity
©) Tutorial video: Chapter 6 Case Study Activity

-o—— This tutorial video provides a walkthrough of the following HKKBS Case Study activity.
Additional HKKBS Case Study Information
Cherry Pang, Director of Human Resources at HKKBS wishes to discuss the comments
made by Ben Wong in his exit interview (Exhibit 10) with the Jessica Chau, the chief
financial officer. Cherry has decided to have an appraisal interview with Jessica.
She believes that Ben's comments expose some areas for improvement in Jessica
Chau's leadership skills and wishes to discuss these further.
Required
Prepare an assessment of Jessica Chau's leadership style based on Ben's comments,

which will be used in Jessica's appraisal.

mae F4AateaARe
Case Study Activity - Answers
Assessment of Jessica Chau's leadership style
Jessica is always very clear about what needs to be done. She provides clear
instructions. These are clearly communicated to staff at the meetings on Monday
morning. The advantage of this is that staff will always be clear about what has to
be done, and this means that the tasks that Jessica identifies will be achieved.
Jessica is a very hands-on leader. Staff are likely to respect a leader who is seen to
be working alongside them and is aware of what is happening at a detailed level,
rather than just issuing instructions from above. While this allows for instructions to
be communicated quickly and clearly, Jessica will often bypass line managers and go
directly to staff to discuss their work with them. It was noted that although Ben's line
manager was David, Jessica often spoke directly with Ben rather than going through
David. This suggests an eagerness to achieve and possibly impatience although it
could be perceived as a lack of respect for organisational hierarchy and for David,
or his position. This could lead to conflict between Jessica and David or David
becoming demotivated.
While Jessica is very clear about what needs to be done, she tends to be a leader who
"tells" rather than "sells" and is not democratic in style. Ben mentions that Jessica
does not give staff an opportunity to make suggestions or does not appreciate it
when they do. She was dismissive of some of the ideas that Ben had.
An autocratic style of leadership can be appropriate when dealing with staff who have
little initiative or motivation, but in the context of a finance department, where the
staff are likely to be well educated and motivated, it brings problems. Firstly, Jessica
may not see all the issues that exist, and her staff might be able to make useful
contributions to the decision making if they were given the opportunity. Secondly,
staff may become demotivated. Ben has stated quite explicitly that he is leaving
because he has not been given the opportunity to participate as much as he could.
Jessica has demonstrated the following effective leadership traits:
° Power: Jessica is recognised in her role and employees respond to her

commands.
° Courage and resolution: Jessica is willing to tackle problems urgently to get

things done.
° Decisiveness: Jessica demonstrates clear and transparent decision making and

communicates this well.

me =SKGHHOR
° Self-confidence: Jessica projects self-confidence which fosters confidence in

others.
° Trustworthiness: Jessica is loyal and if she says she will do something, then she
is trusted to see it through.
e Need for achievement: Jessica is results driven, and this means she can be
dynamic force to effect and lead change.
The following are areas for development
° Influence: Jessica's default is a 'tell' leadership style, so she could aim to flex this
style to sell or consult more readily to bring staff members on Board.
° Emotional intelligence: Jessica does not realise the effect on others by bypassing
the cultural hierarchy and established roles, and how this is perceived by others
a disrespectful, regardless of the intention.
° Assertiveness: Care needs to be taken that tendencies toward over-

assertiveness does not cause friction.
° Creativity: Jessica does not always take the time to view a problem from multiple
angles before making a decision. Sometimes more creative approaches provide
a better solution.
In summary, Jessica is very well organised, and sets clear goals and instructions for
the team, and communicates with them well. However, she would benefit from being
more democratic, and listening to the ideas and suggestions of the staff in the finance
department, rather than simply telling them to do things the way she thinks that they
should be done.
Key takeaway
This analysis was performed for an appraisal with Jessica. It is important therefore
that it is written with a certain amount of tact and diplomacy, rather than simply
pointing out all of Jessica's weaknesses. For this reason, the analysis started by
focussing on Jessica's strengths before discussing areas for improvement. Note that
the word "weakness" was not used at all.

Certified Public Accountants S104
mem SAHA
Business
ethics and
professional
negligence
Topic list
1 Introduction to business ethics
and professional negligence
Ethical code for accountants
BR WN
Company's codes of ethics

Nm
Professional negligence
Addressing ethical dilemmas
Independent Commission
Against Corruption (ICAC)
Practice
End of chapter Case Study activity
Learning focus
Ethics is a core part of the way that accountants should act. We should assess
how we are behaving with an ethical focus but, also, be aware of any ethical
issues that may be arising in our work environment, whether that is in the
organisation that we work for or in the dealings with any stakeholders. Hong
Kong has been at the front of ethical behaviour in the world.
For Capstone, be aware of the potential for ethical issues. It is likely that there
will be at least one. Also, Know how to deal with ethical dilemmas, have the
HKICPA framework at your fingertips and apply it when needed.
7: Business ethics and professional negligence
Learning outcomes
Business ethics and professional negligence
Evaluate the appropriate course of action across 2

a wide range of ethical dilemmas
Appraise business situations using a questioning 3

mindset and through the application of ethical
frameworks
Recommend appropriate solutions to ethical 3

dilemmas in business
Advise clients on solutions in the context of the 3

IFAC Code of Ethics and the HKICPA Professional
Ethics and Conduct
Analyse the interrelationship of ethics and law 2
Consider the consequences of unethical 3

behaviour to the individual, the profession and
the society
Consider the long-term consequences of 3

unethical decisions
Consider the perspective of others and the 2

concept of social responsibility when reviewing
ethical issues
Explain how professional accountants should 1

exercise their care and skills when performing
their duties
Explain how professional accountants may be 1

exposed to professional negligence liabilities
and damages
Advise on how professional accountants can 3

manage professional negligence exposure
Hong Kong institute of

C PA Certified Public Accountants 309
mae SRR
Essential Reading Chapters

. Module 12: Business Finance, Chapter 15: Ethics in Financial Management
° Module 10: Business and Company Law and Chapter 13: Receivership,
Liquidation and Winding up, Section 13.2.1.1, Procedure
° Module 13: Assurance, Chapter 1: Ethical Standards, Legislation and

Professional Guidance

31 0 CPA Certified Public Accountants
mae SHANNA
Chapter Summary
Business ethics and

professional negligence
| |
Introduction to business ;
‘ : Ethical code for Company's codes
ethics and professional ;
: accountants of ethics
negligence
Change the culture of : | HKICPA Code of Ethics for | | Features

organisation | Professional Accountants i} Itisa formal document
¢ — Ethics is about ‘doing the right : ¢ Integrity: Straightforward and . It a specify oe clearly
thing’ ii honest in all business and tl proniiited business
e Professional negligence is when a fi professional relationships lj aa
professional fails to perform their: | « Objectivity: Do not allow bias, ; i ¢ Regulation of employee
responsibilities to the required i conflicts of interest or undue i behaviour is the main focus
; standard or breaches a duty of care i influence to override independence: : @ Responsibility for conduct
i canes hacsieiieeieih desis <add dileiesaiasieas uladinaiasiad hie ; * Professional competence and due i is shifted onto employees
: care: maintain professional ; : e Employees will be asked to
knowledge and skill at a level ; : sign the declaration
5» mmmiamacnccacce:
required
{jena
:
cn :
without proper or authority i i Reasons for a code
¢ Professional behaviour: avoid any of ethics
behaviour that discredits the
profession ° Helps to control board
ee ae i behaviour
Prer r r r tr irrrt iti tir) | POOR Nene en ene en ee neeneeneneeeeeee : ; e Provides statement of
Ethical safeguards for ii values to follow

directors i ° Helps to control employee
ae behaviour
e Separating the roles of Chair and ° Helps promote the
Chief-executive Officer (CEO),
company
e Limiting powers via internal ° Reassures stakeholders
controls and segregating their
duties
e Having non-executive directors on
the Board
e =Aninternal audit committee and
internal audit function
e An ethics committee and code of
ethics

me seersae
Independent
Professional Addressing ethical
Commission Against
negligence dilemmas
Corruption (ICAC)
oamanaaae a, enaaes : ee! enn ,

NOCLAR HKCIPA framework for The Independent
e Non-compliance with Laws and addressing ethical Commission Against
Regulations dilemmas Corruption (ICAC)
NOCLAR covers areas such as:
1 Identify the ethical dilemma e Established in 1974,
e Money laundering, terrorist
2 Identify the fundamental principle e ICAC embraces a three-pronged
financing and proceeds of crime
violated approach
e Fraud, bribery and corruption
3. Discover alternative solutions - 1 Law enforcement
e Securities markets and trading
Recommend a solution - 2 Prevention
e Banking and other products and - 3 Community education
5 Explain and justify your choice
services
e Data protection
e Tax and pension liabilities and
Tucker's Five Questions
payments
e Environmental protection Is it Profitable?
WN =
e¢ Health and safety Is it Legal?
e Employment Is it Fair?
Is it Right?
Fs
Is it Sustainable/environmentally
nO
sound?
312 CPAad
SRAHHAAR
Introduction to business ethics and professional

negligence
Ethics is about 'doing the right thing’.
This principle can be applied by following our duty as accountants as there are rules
and concepts that we will see in this chapter to help us know what to do.
Ethics may also be required where we are put into a challenging situation where we
have to make a judgement on the right thing to do and there isn't an immediate rule
that can be followed. This is known as an ethical dilemma. In this case, it is necessary
to look at what is the issue, the root cause of that issue and the result of actions,
i.e., who is affected and what happens to them, in order to suggest action which
will resolve it.
In a business the ethical principles that will be used are given to us as accountants
and we should follow those rules. There will be further rules, for example, for a listed
company, there will be stock market rules that should be respected. There are also
the wider laws in the country/countries that our organisation is operating in, many
of which will be consistent with the ethical principles. However, we should always be
cognisant of the end effect of what we are doing. HKICPA Code of Ethics for
Professional Accountants gives guidance on the correct course to follow.
If we are involved in an organisation that behaves unethically, cheating its customers

or preparing sets of accounts that are wrong, for example, then the effect on our
organisation will be severe. It is possible that such an organisation can go out of
business and its shareholders lose all their wealth and its employees lose their jobs.
Alternatively, an organisation that is seen to behave ethically can have a competitive
advantage. If a food company is sourcing ethical ingredients for its meat products,
then it is likely to attract more customers in comparison to a competitor that is
relying on mass breeding of animals that are kept in bad conditions.
Sometimes, it will not be clear what the right answer is to an ethical issue. Where
there are ethical dilemmas, we should follow the guidance of the HKCIPA and the
process that they recommend in order to come to a correct decision. This involves
taking into account the code of ethics in our profession.
Professional negligence is when a professional, an accountant or a lawyer, for

example, fails to perform their responsibilities to the required standard or breaches
a duty of care. This poor conduct subsequently results in a financial loss, physical
damage or injury of their client or customer. This will usually lead to a claim against
the professional. This claim will result in negative consequences if the professional's
behaviour fell short of what was expected of them in their capacity. This could result
in having to pay damages and even losing their job and place in their profession.

Certified Public Accountants Hs)
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In this chapter, we focus on legal and professional ethics. However, in practice

business ethics should also be considered. For example, a business may consider
setting up a manufacturing operation in a low labour cost location that has poor
standards of regulation and low-quality labour laws. It may mean that employees in
that location are treated in a way that would be deemed unacceptable elsewhere,
even though no laws or regulations are actually being broken. Treating the employees
badly in that location may be disapproved of by stakeholders and as such this activity
could affect the reputation and ultimately the commercial performance of the
business.
In this chapter, we will begin by considering the ethical code of accountants which is
binding on their work and also acts as a good guide for others to follow, albeit it is not
binding as such on non-accountants. We then consider the potential threats to those
ethical principles and safeguards that can be put in place.
We then move on to look at company codes of ethics - their typical contents and the
purpose of them - before moving on to look at professional negligence and the
international ethical standards board's 'NOCLAR' requirements (non-compliance with
laws and regulations.
Next, we look at examples of ethical dilemmas and the HKICPA framework for dealing
with ethical dilemmas as well as the Tucker's Five Questions framework.
We complete the chapter by looking at the Independent Commission Against

Corruption (ICAC) and its contribution internationally.
Weblink
Work Ethics Fitness Challenge | Hong Kong Business Ethics Development Centre
(icac.hk)
This short test is a short, fun test of your ethical fitness at work. It is not designed
specifically for accountants but provides a test of some ethical situations you may
face at work.
Key takeaway
Be aware of wrongdoing that you come across. Don't try to avoid taking some action,
even though that may be easiest.

Sar) Certified Public Accountants
a SRRHHAR
2 Ethical codes for accountants

The main International Code of Ethics for accountants is issued by the International
Federation of Accountants (IFAC). The principles in the Code are included in the
HKICPA Code of Ethics for Professional Accountants.
This HKICPA Code of Ethics for Professional Accountants is based on the following
principles:
° It is important that the public interest comes first. This means that an
accountant should not be thinking about themselves immediately when making
ethical decisions but taking a far wider view, to see who is affected by the
decision and what the consequences are.
e In order to assist an accountant with an ethical decision, IFAC has set down a
series of principles that an accountant should be guided by when making ethical
decisions. These are at a high level.
° There is also a conceptual framework. Accountants should first identify any

ethical threats. Once identified then the size of the threat should be evaluated.
Any threats to compliance should be identified and evaluated. Once evaluated,
there are safeguards that should be used to reduce or eliminate the threat.
Remember that the legal environment is likely to be consistent with the ethical
principles and the law will often need to be followed. However, there will be times
that ethical principles need to be considered, as the law won't cover every situation.
2.1 Ethical principles for accountants

There are five fundamental principles that accountants should follow to make the
best ethical decisions in the public interest. These are:
2.1.1 Integrity
Accountants should be straightforward and honest in all business and professional
relationships.
2.1.2 Objectivity
Accountants should not allow bias, conflicts of interest or undue influence of others
to override professional or business judgements.
2.1.3 Professional competence and due care

Accountants have a continuing duty to maintain professional knowledge and skill at a
level required to ensure that a client or employer receives competent professional
service based on current developments in practice, legislation and techniques.
Accountants should act diligently and in accordance with applicable technical and
professional standards when providing professional services.

Certified Public Accountants 31 boy
ae SHRNGAR
2.1.4 Confidentiality
Accountants should respect the confidentiality of information acquired as a result of
professional and business relationships and should not disclose any such information
to third parties without proper or specific authority, or unless there is a legal or
professional right or duty to disclose. Confidential information acquired as a result of
professional and business relationships should not be used for the personal
advantage of members or third parties.
2.1.5 Professional behaviour

Accountants should comply with relevant laws and regulations and should avoid any
behaviour that discredits the profession.
Activity 1
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For the following examples, think which of the fundamental principles are affected.
1. An accountant wrote to the Registrar of Companies making disclosures of their

audit work on the client's records following a dispute.
2. | An accountant advised their client to make an investment in a local company.

The accountant assured the client that they would deal with the tax issues. It
was found that the accountant had not invested the money for their client or
paid any tax to the tax authorities.
Required
Explain which of the fundamental principles have been breached.
Key takeaway
It would be a useful exercise to review Professional Module 13 Assurance Chapter 1
Ethical standards, legislation and professional guidance.
This will remind you the detail included in the HKICPA Code of Ethics for Professional
Accountants, and the ethical threats accounts face.
2.2 Ethical threats to independence

It would be hoped that accountants would follow the ethical principles that we have
seen. However, there are often corporate scandals that occur each year and there will
be accountants working for those companies.
The following five ethical threats are contained in the HKICPA Code of Ethics for
Professional Accountants.

a SRAHHLB
2.2.1 Self-interest
This is where financial or other interests of a professional accountant or of an
immediate family member inappropriately influence judgement or behaviour. It may
be difficult ifa large bonus has been promised to turn a blind eye to something
unethical. That said, the bonus should not be taken.
2.2.2 Self-review
Self-review happens when an accountant makes an evaluation ofa judgement by

themselves, or a member of the same organisation. Hence the decision is likely to
be biased.
2.2.3 Advocacy
This is where an accountant is promoting a position or opinion to the point where
objectivity may be compromised. There is likely to be some benefit to the accountant
of doing so.
2.2.4 Familiarity
Familiarity is where there is a close relationship that results in excessive trust in, or
sympathy for, someone else.
2.2.5 Intimidation
Intimidation involves an accountant not acting objectively because of an actual or
perceived pressures. This may come from employees that are higher up the
organisation that the accountant works in.
Activity 2
For the following examples, think which of the ethical threats are involved.
1. An accountant is starting an audit of a client but is aware that his sister works at
the client in a managerial role.
2. | An accountant has been told that she will lose her job if the accounts are not
signed off within the next week.
3. | An accountant has invested in a series of companies and has noticed that one of
the clients that he will be involved in is the company that he has the biggest
investment in.
4. | An accountant has been asked to perform an audit of financial statements
prepared by her own firm.
5. | An accountant has been championing his client's case in a lawsuit.
Required
Explain, for the five situations given above, which of the ethical threats they relate to.

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Real life Illustration
Hong Kong has had some corporate ethical scandals, which included the Sino-Forest
Corporation. This was a company that was involved in forestry plantation.
Its headquarters were based in Hong Kong, and it had made claims that it owned
a lot of timber in China. However, this was not the case; it was alleged that the
company was a form of fraud in which belief in the success of a non-existent enterprise
is fostered by the payment of quick returns to the first investors from money invested
by later investors. Once the allegations came out the company's shares plummeted.
A Canadian dollar settlement of C$117 million settlement was also found against Ernst
and Young, the auditors of the company, for failing to do its job.
Factbox: Hong Kong's Corporate Scandals (ibtimes.co.uk)
Weblink
The following is the full code of ethics published by HKICPA.
https://www.hkicpa.org.hk/-/media/HKICPA-Website/Members-
Handbook/volumel/COErevised.pdf
2.3 Ethical safeguards for accountants working in practice

The accountancy profession acknowledges that there will be ethical threats for
accountants, so it sets out how to protect accountants from these threats.
Similarly, there are safeguards set by professional firms that the accountants
work for to make sure that the accountants working for it don't succumb to threats
to their independence. Hence these safeguards, which include training, codes of
conduct and monitoring, should reduce the chances of an accountant falling for an
ethical threat.
2.3.1 Ethical safeguards by the accountancy profession

There are a number of ways that the accountancy profession and legislation set out
to guard the members of the accountancy profession. These include:
° Professional standards set by HKICPA
° Monitoring and disciplinary procedures by professional bodies
° Education and training to become a HKICPA member
e Continuing Professional Development (CPD) that is required for accountants to

remain as a qualified accountant
° Corporate governance regulations for accountants that are involved as directors

of a business

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2.3.2 Ethical safeguards by professional firms

There are a series of safeguards that most professional firms will have in place to
make sure that their staff behave ethically. These include:
The tone from the top:
° The importance of compliance stressed by the leaders of the firm
° Expectations that acting in the public interest will be complied with
The policies and procedure of the accountancy firm for:
° Identification and evaluation of ethical threats
° Identification and application of safeguards
° Quality control
° Policy documents covering independence, interest, relationships with clients,
compliance with fundamental principles
Staff management:
° Stopping non-team members from having any influence
° Appropriate training and education
° Setting senior management to oversee the quality control procedures in the firm
° Guidance on independence for their clients
° Disciplinary procedures
° Guiding staff to inform senior management of any ethical issues that may
become an issue
Specific accountancy work performed:
° Rotating senior personnel for clients
° Involving another accountancy firm to assist
° Consulting a professional regulatory body
2.4 Ethical safeguards for accountants working in a business

The ethical safeguards for accountants working in a business rather than an
accountancy practice are similar to those given above for accountancy practices. A
business should have the following ethical safeguards in place:
2.4.1 Safeguards in the workplace

The three main sources of safeguards in the workplace are:
(1) Leadership - stressing the importance of ethical behaviour, having good
oversight systems, policies created at the top of the business that are enforced
on the employees of the business in a timely manner, consultation with other
professional accountants

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(2) Recruitment and training - good recruitment procedures, training and

education of employees (initially and ongoing), ethics and conduct programmes
(3) Internal systems - an internal control system, appropriate disciplinary

procedures, whistleblowing procedures, policies encouraging good employee
behaviour
2.5 Ethical safeguards for directors and top management

Accountants in a business need to have guards in place for ethical threats but there
also needs to be set out ethical safeguards for other directors and management.
The level of the procedures will depend on the size of the business, so the following
list will work for larger organisations and be reduced for smaller ones.
2.5.1 Procedures for directors and management

These include:
(1) Separating the roles of Chair and Chief-executive Officer (CEO), so that the CEO
has someone that can challenge any potentially unethical actions that he/she
makes
(2) Limiting the power of any other powerful individuals via internal controls and
segregating their duties
(3) Having non-executive directors on the Board to provide balance and oversight
(4) Aninternal audit committee to make sure that the law is complied with, as well
as accounting standards and corporate governance codes. This is likely to be
supported by an internal audit department.
(5) An ethics committee to see if the company's code of ethics is being complied
with
2.6 Advantages and disadvantages of professional codes

Overall, it is clear that having professional codes is a positive thing overall. They are in
the public interest. However, there are also some potential disadvantages.
2.6.1 Advantages of professional codes

The advantages of professional codes are as follows:
° Minimum standards of behaviour to be expected are set down.
° International application is possible. They will apply in most locations.
° They are a clear statement of the need to act in the public interest.
° They are a benchmark that actions can be judged against.
° The public should have more confidence in accountants due to using these
ethical codes.

a HRRUNALR
e Active consideration of ethical issues is important, and accountants should seek

to comply all the time.
° They aren't based on a series of rules, which can be limited. However, some
explicit prohibitions are still possible.
2.6.2 Disadvantages of professional codes

The disadvantages of professional codes are:
° Some people treat codes as box-ticking exercises and don't treat them seriously
enough.
° Codes can over-complicate matters by dealing with so many situations.
° International variations in beliefs and practices.
° They may not be legally enforceable in all countries of the world.
° Having illustrative examples in a code may make users believe that the codes
are limited to those situations.
Overall, it seems clear that the advantages far outweigh the disadvantages, but it is
worth thinking them through as above. IFAC is clear that having a principles-based
approach is worthwhile for the following reasons:
2.7 Advantages and disadvantages of using principles in a code

of ethics
Principles are far broader than strict legislation or rules. Rules only cover a particular
situation whereas principles can be applied to a wide variety of issues as they are
more flexible and can adapt to new situations that occur.
2.7.1 Advantages of using principles

The advantages are:
° Accountants will have to actively think though a situation and weigh up the
issues involved, both positive and negative. This will lead to a conclusion on the
situation faced that the accountant will be able to demonstrate follows from the
principles involved.
° The ethical issues can't be avoided. This would be easier if there were a set of
rules or laws to follow. Principles encourage compliance with them, whereas
rules allow people to try to deceive the rules.
e Most situations are different, and the principles allow for this.
° In a fast-changing environment the principles can be adapted quickly, in

contrast to rules which will take time to adapt and be verified. The rules may
still be out of date once they are finally enacted if the environment has
changed again.

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2.7.2 Disadvantages of using principles

The disadvantages are:
° They require a lot of thought based on proper understanding of the underlying

principles. This can take a lot of time and effort.
e The codes of principles will often be voluntary and difficult to enforce due to
this.
Key takeaway
Learn the ethical principles and ethical threats. Know the ethical safeguards that are
in place to protect against the threats, both for accountants specifically and for
management and directors in business.
Company's code of ethics

Companies will often have a requirement to be seen to behave ethically, due to public
and other pressure. In order for the companies to show this, they will often publish
ethical codes, showing what they value and their responsibilities to the stakeholders
that they are involved with. There is usually a series of statements to show their
ethics values and how they behave towards their stakeholders.
3.1 Features of a company's code of ethics

The likely features of a company's code of ethics include:
° It is a formal document.
° It will specify the clearly prohibited business activities.
e Regulation of employee behaviour is the main focus.
° Responsibility is shifted to the staff that are on the operational part of the
company.
° There will be specific areas such as taking gifts, behaviour that is

anti-competitive and so on that is barred.
° Employees will be asked to sign the declaration, so that they have stated that
they will comply.
e They are developed from third party codes and may use third parties to monitor
them.

SYe Certified Public Accountants
ae SRRHHAR
3.2 Reasons for a company's code of ethics

A code of ethics has value for a company in various ways.
3.2.1 Control of staff
All staff will be made aware of the code of ethics and its importance for their
actions on behalf of the company. The employees will be aware that there will
be consequences of not following the code of ethics. If an issue arises then the
code will be referred to and used to judge the employee's behaviour. Any sanctions
in the code can be used.
3.2.2 Statement of values

The ethical code will mirror the company's mission and values statements. Hence,
they are connected to the company's underlying environment.
3.2.3 Helps to control employees

Once staff are trained up on the ethical code and have signed it off, then they will
be aware that they are required to meet the code. They will also know that it will be
used against them if there is any possible wrongdoing, and the ethical code needs to
be invoked.
3.2.4 Helps promote the company

If the company is taking an ethical stand in its business, then having an ethical code is
a good selling point for it. It will make the company's customers happier to be dealing
with it and will attract new customers that the ethical principles appeal to.
3.2.5 Encouragement of stakeholders

There will be a wider effect than just the company's customers. The other stakeholders
of the company will be made aware of what the company is expecting ethically and
hence will be aware that they should also follow the same code. For example, if the
company has parts of its code dealing with environmental issues, then a supplier of
the company that knows the code will be aware that they should also be taking care
of the environment. If the supplier is damaging the environment when it produces
or supplies goods to the company then that will have an impact on the company,
potentially meaning the company doesn't meet its code. This will require good
communication, honesty and transparency from the company as well as the supplier.
3.3 Example of a company's code of ethics

A code of ethics can contain many elements, dependent on the business that a
company is involved in. Some of the most common ones are as follows:
° The company and its staff are always expected to behave ethically.
e Employees are key to the company's ethical policy. Only employees that
are committed to the company's ethical policies will be employed; their

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behaviour will be monitored and there will be consequences for any breach
of the policy.
° The customers of the company are essential for the future success of the
company and will always be treated well. If there is a customer complaint,
then the company will listen carefully and respond when there has been an
ethical breach.
° The company and its employees will always follow the laws of the countries it
operates in and also the standards that are in place it its industry, from the
guidelines that the industry has put into place on ethical behaviour.
° The company is committed to treating its suppliers with respect in their
relationship. That will involve any contracts entered into with the supplier,
the pricing of the supplier's products, making sure that the supplier is paid on
time. The company will require suppliers to behave ethically with respect to
their staff and the environment as well as how they act towards the company.
° The company will make sure that it is behaving properly to any competitors
and the markets that it operates in. It will not gain competitive advantage by
entering into questionable payments or favours. The company believes in open
and fair markets.
° The company will do its best to protect the environment and help protect
against climate change and depletion of nature. It will try to be efficient in its
use of natural resources at all times. If there are opportunities to help the
environment the company will do so.
° The company will look more broadly at the direct stakeholders it has as well
as the wider population of the countries it trades in. As well as meeting
government requirements it will also try to help in raising education attainment,
health outcomes, safety in the wider community. It will do whatever it can to
encourage diversity and help level up poorer parts of the countries. It will try to
be a good corporate citizen, wherever possible giving charitable donations, and
contributing to education, culture and local affairs.
Weblink
https://nkbedc.icac.hk/en
The Hong Kong Business Ethics Development Centre is an excellent resource for
Hong Kong. It has helped businesses in Hong Kong boost the quality of ethical
decision-making over time and made Hong Kong one of the strongest parts of the
world for this. The site contains helpful videos and e-learning.
§ Key takeaway
Make sure that you know the features and benefits of a company's code of ethics.

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A Professional negligence
Key term
NOCLAR means non-compliance with laws and regulations.
Professional negligence may arise from an act or continuing conduct of a professional

which fails to meet the standards of the required care and skill, and results in
provable damage. However, negligence does not include the exercise of proper
professional judgment even where the results are detrimental to his or her client.
The International Ethical Standards Board issued NOCLAR - Responding to Non-
compliance with Laws and Regulations. This helps accountants deal with situations
where there is professional negligence relating to non-compliance with laws and
regulations, say at a client they are working for.
NOCLAR covers acts of omission or commission that are contrary to the laws and
regulations. The accountant that becomes aware of the situation has an ethical
responsibility not to ignore the situation and it is likely that the situation will be
difficult for the accountant as he/she must also comply with fundamental principle
of confidentiality.
In responding to a situation, the accountant should aim to comply with fundamental
principles of integrity and professional behaviour as well as taking into account the
public interest. The accountant should also aim for the problem to be corrected and
to prevent its occurrence in the future.
4.1 The scope of NOCLAR

The scope of NOCLAR covers any act (or suspected act) of non-compliance with laws
or regulations that the accountant either discovers or is made aware of.
4.1.1 Acts or suspected acts

The accountant should be looking out for acts or suspected acts carried out by:
° Employees of the entity
° The management of the entity
° Those charged with governance
° Third parties under the control of the entity
4.1.2 Laws or regulations

The most likely laws that will be affected cover areas such as:
° Money laundering, terrorist financing and proceeds of crime
° Fraud, bribery and corruption
° Securities markets and trading

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Banking and other products and services
Data protection
Tax and pension liabilities and payments
Environmental protection
Health and safety
Employment
4.2 Response to an allegation of non-compliance with laws

and regulations
When responding to an allegation of NOCLAR it depends on the situation that the
accountant is facing.
4.2.1 Audit work
There are a series of steps for an accountant to follow when dealing with an audit and
there is the possibility of professional negligence:
(1) Become aware. Do not seek out and spend lots of time seeking out non-
compliance. However, if it is discovered it should be followed up and dealt with.
It can't be ignored.
(2) Obtain an understanding of the matter. Understand the act and the
circumstances it was carried out in. This will involve having meetings with
directors and management. Legal advice is likely to be needed. Care should
be taken to make sure that the accountant doesn't get involved or even
colludes in the situation.
(3) Address the matter. Advice should be given to management of the client so that
the situation can be resolved. If there are legal issues then it may well have
to be reported to the legal authority, obviously so if there is a regulatory
requirement to do so. If there are matters in the public interest, then reporting
the issue may well be necessary.
(4) Communication with respect to groups. If there is a group of companies

involved, then the group audit partner should be informed.
(5) Determine whether further actions are needed. Has the client responded
correctly to the ethical issue, and in a timely manner? If not, further reaction
is likely to be necessary. This could include withdrawing from the audit,
particularly where it is the only possible option, and disclosing the matter
to the appropriate authority.

HARUALR
(6) Determine whether to disclose the matter to the appropriate authority.

This decision will be based on the nature and extent of actual or potential
harm which may be caused to investors, creditors, employees or the general
public.
(7) Documentation. The accountant must document the process of compliance with
the NOCLAR guidance. This must include the response of the entity, the courses
of action considerer, the judgments made, and the decisions taken.
4.2.2 Accountants in business
If the accountant is working for an organisation and becomes aware of NOCLAR, then
the first step is to look at the protocols in the organisation for dealing with the issue.
These involve:
If it fits the protocols, the accountant should inform their boss so that the
appropriate action can be taken.
If the immediate superior of the accountant is, or could be, involved in the
matter, then the accountant should inform the next higher level of authority
within the organisation.
In exceptional situations, it may be appropriate for the accountant to directly

disclose the matter to an appropriate authority though there are considerations
to take into account below.
The process of compliance with the professional negligence guidance should be

fully documented by the accountant.
4.2.3 Considerations to disclose to an authority

When considering whether to disclose to an authority, the accountant must take the
following factors into account:
1. The legal and regulatory framework
2 The urgency of the matter
3 The pervasiveness of the matter throughout the organisation
4. Whether there is confidence in the integrity of those charged with governance
5 Whether non-compliance is likely to recur
6 Actual or potential harm to the interest of the organisation, investors, creditors,

employees or the general public

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4.3 Managing professional negligence exposure

An accountant may have a claim against them for professional negligence. If
this is due to breaching one or more of the fundamental ethical principles,
then the accountant is likely to be sued and have to pay the person or client that is
suing them.
However, it could be that something has happened, perhaps due toa

misunderstanding as to the degree of responsibility which the accountant
was expected to assume in giving advice or expressing an opinion, and the
accountant is being sued due to the person or client believing they can gain
something from their accountant. In order to prevent this happening, the
accountant can take some steps in order to make it far less likely that a claim
will be made against them.
4.3.1 Steps
The steps that should be taken to lessen the chance of incurring a liability for
professional negligence include:
° Agreeing the exact duties with the client, including any significant matters to
be excluded, in advance and in writing, say in a letter of engagement. Any
additional duties required should also be defined in writing.
° If any 'snap' advice is given at the request of the client or based on incomplete
information, it should be made clear that the advice is subject to limitations,
and it may need to be revised once considered in depth.
° A clause disclaiming liability may be included when publishing documents.
° For any unaudited financial statements submitted to the client, the purpose
for which the financial statements have been prepared should be recorded
on their face and, where appropriate, there can be a clause recording that
the statements are confidential and prepared solely for the private use of
the client.
e For a situation that warrants it, due to the complexity, the accountant should
recommend the clients seeks specialist advice, from another accountant or
another profession where needed.
Each of the steps above are taking into account the possible legal ramifications of
the accountant's work and taking steps in advance to mitigate any liability. This is
the most sensible approach to avoid litigation.
R
Key takeaway
If there is a case of professional negligence, follow the procedures for addressing it.

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Addressing ethical dilemmas

Ethical dilemmas emerge when an issue arises which involves:
A breach of the law or regulation. For example, failure to disclose directors’

remuneration so shareholders are unable to fully evaluate the directors’
performance. Also, health and safety at work is an important issue for
employees and there is legislation that should be complied with.
A breach of a company's own ethical code. For example, a company states it will
treat all employees fairly, then denies a certain individual the opportunity to
apply for promotion. Also, if a company has a code mentioning diversity in the
workplace but doesn't follow the code.
Close personal relationships between the parties involved in an ethical issue.

For example, a director awards a supplier contract to the company of a family
member, foregoing company policy to follow supplier selection procedures.
Also, a politician that a director went to school with could be approached to
help a company get an advantage in the awarding of a government contract.
Actions cause harm to a stakeholder.
- Harm may be physical. For example, the release of toxic pollutants from a
manufacturing plant into the water supply and resulting in health issues
for local residents.
- Harm may be financial. For example, a very low pay below a living wage or
directors awarding themselves excessive rewards whilst reducing the
payment of dividends to shareholders.
- Harm may be to an individual mental wellbeing. For example,

discrimination targeted against particular individuals in the workplace.
Also, bullying in the workplace will have a negative effect on the individual
being bullied.
There is a lack of equality or fairness in a company's actions (e.g., a Company

fails to pay a supplier on time resulting in working capital issues for that
supplier). Another example could be that the company pays more to men than
women for doing the same job, or treats one stakeholder favourably compared
to another in the case of winding a company up.
Key takeaway
Remind yourself of the ethical issues surrounding the end of a company's life by
reviewing Professional Module 10 Business and Company Law, Chapter 13
Receivership, liquidation and winding up, Section 13.2.1.1 Procedure.

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° There is a breach of fiduciary duty by the directors to its shareholders. This

could be a lack of board meeting resulting in a failure to focus on strategy or
implement a sufficient system of internal control, or failure to identity and
control a specific business risk which has now occurred. Another example is
selling company assets below market value to repay debt, rather than make
efforts to find another solution to resolve this.
° There is a breach of business trust or integrity by individuals within an

organisation. For example, shareholders are provided with misleading
information in investor reports. Also, a company might manipulate its financial
reporting dates so that it can make each part of its business look better when
they come to produce their accounts.
5.1 HKCIPA framework for addressing ethical dilemmas

In Capstone, the following HKICPA core enabling competency framework for resolving
ethical dilemmas is used to analyse and recommend actions to resolve ethical
dilemmas.
(1) Identify the ethical dilemma
(2) Identify the fundamental principle violated
(3) Discover alternative solutions
(4) Recommend a solution
(5) Explain your choice
Looking at each in more detail:
5.1.1 Identify the ethical dilemma

There will be indications in the Capstone that something has happened. Consider the
effect on the stakeholders in the material. Remember that stakeholders are the
people that are involved with the organisation, internally or externally. Some
examples of the issue that may have arisen are:
° Manipulation - alteration to mislead or create a false impression to others
° Omission - deliberately missing out a key piece of information to distort the

picture
° Confidentiality - inappropriately disclosing privileged information such as

leaving confidential business information accidentally in a public place
° Conflict of interest - an additional situation to the one being considered that

causes apparent or actual bias to be introduced and objectivity to be impaired
The question that arises is whether it is necessary to raise the alarm to the
appropriate authority externally or within the organisation?

a HRRUNALR
There is also the question of fact versus speculation. Is there evidence confirming
unethical behaviours have taken place, or it is unconfirmed as it has been raised in a
letter to the company or discussed in a newspaper article or media report. In some
cases, it is necessary to advice that an organisation performs a full investigation to
confirm the facts and circumstances. However, it is important to note that any
unethical behaviour which the company has been accused of, must still be evaluated
using the HKCIPA Framework for Addressing Ethical Dilemmas.
5.1.2 Identify the fundamental principle violated

You should be familiar with the fundamental ethical principles of the HKICPA. These
are:
° Integrity
e Objectivity
° Professional competence and due care
° Confidentiality
° Professional behaviour
There may well be more than one principle that has been breached by the issue that
has arisen, though a single issue is enough to raise the alarm.
Make sure that you know the five fundamental ethical principles so that you can
apply them to the situation faced and use specific principles to explain why certain
behaviour is unethical and must be stopped or prevented.
5.1.3 Discover alternative solutions.
How is it possible to fix the situation that is being faced? Can the issue be defined in
financial terms? Is there likely to be a legal action taken or how can this be resolved?
There will usually be an eventual authority that can be used to
° Assess the severity of the dilemma
° Identify the legal issues
° Identify the parties affected
° Document the dilemma
° Take an outsider's view to see the dilemma differently
° Seek legal advice
° Inform the proper authorities
Again, learn the steps so that it can be seen that you have followed the right course of
action. You may have more than one possibility for the courses of action, trying to
sort it out internally in an organisation before taking it to an external body.

Certified Public Accountants Sey
ae SRN OR
5.1.4 Recommend a solution
What will help resolve the ethical dilemma so that those that have been adversely
affected by it are helped to mitigate or remove any impact?
Give a solution based on the facts of the Capstone though it is worth stating any next
steps if there are other possibilities if that solution doesn't work.
Also, think about a solution which:
(1) Stops the unethical behaviour, if currently happening, by taking clear and
decisive actions. Be clear actions should be immediate, where this is practical.
(2) It may be necessary to issue a press release which responds to negative

publicity or comments in the media regarding the unethical practices noted. It is
important in such a statement to acknowledge that a company will:
Fully investigate the circumstances and take full corrective action
Apologise to the general public and to the company's stakeholders for the
organisations behaviour falling short of their expectations in this instance
Reassure the public and stakeholders that this was an isolated occurrence
(where this is true)
(3) Aim to prevent future reoccurrence by:

Reviewing all other business activities for evidence of similar unethical
activities
Strengthening the internal controls environment and implement new

controls to address the specific unethical behaviours noted
Considering implementing or extending the organisation's own code of

ethics to specifically prohibit the unethical behaviour noted and to provide
further guidance to employees, so it is clear the unethical behaviour
evidence is unacceptable in this organisation
5.1.5 Explain your choice

Make sure that there is a logical explanation dealing with the issue that has occurred
and the people involved on both sides of the issue.
In doing so:
(1) Explain the negative impacts and consequence which will be avoided by
addressing the unethical behaviour.
(2) Explain the benefits to the company's stakeholders on the company's

reputation and sustainability by addressing unethical behaviours.
Bey. CPAa Hong Kong Institute of

HRRUNALR
Activity 3
TTT
4
ao
A company called Neil Wei Ltd has had its draft financial statements prepared for the
+t
43
latest year. Profits have dropped substantially, and this has a consequent effect on
the statement of cash flows.
The directors of Neil Wei Ltd are concerned about this and want to reduce the impact
that the knowledge of this will have on its investors. They believe the problem was
down to issues that one of its main customers was facing and that the economy in
general had suffered over the year, so hopefully this will be a short-term problem.
Results had picked up a bit in the last months of the financial year.
There are other consequences of the poor results that will be reported based on the
draft accounts. These include:
° Poor bonuses awarded to the directors
° A breach of the terms of the loan covenants that the company has on its main
loans
° A strong drop in market confidence, with negative consequences over time
Thence the directors have approached the chief financial accountant of the company
to tell her to adjust the financial statements by including some of the operating
expenses as extraordinary items in the financial statements, to mitigate the effect on
the reporting of the results by keeping the reported operating profit at a better level.
Required
Explain the ethical dilemma of the chief financial accountant of the company and her
actions that should result from this.

iG
Activity 4
[wil
Babylon Fitness Ltd (BFL) is a small private company operating in the fitness sector
in Hong Kong. It provides training space and equipment to its members through its
network of fitness centres and has two major revenue streams: monthly membership
fees and personal training fees from individually tailored fitness programmes
developed for members by personal trainers.
The business was founded 30 years ago to take advantage of the growing interest in
health and fitness at that time, which has grown ever since. The CEO is Wing Cai and
all four board members, including the CEO are HKICPA qualified accountants as they
met whilst undergoing training, and left public practice to set up the company.

me SearGoe
The building that houses its fitness centres is owned by BFL and is extremely popular
with local office workers, who visit the centre early in the morning, at lunchtimes and
after work. The Board of BFL have been aware for some time that this building (along
with other BFL centres) is in need of refurbishment and minor structural
improvements, but it has never been regarded as unsafe by the Board.
This centre has also had staffing problems. Its previous manager left BFL for a
competitor, and while a replacement manager was being sought the centre was being
managed by Wing Cai's daughter, Leia Cai. She was appointed by Wing Cai with very
little assessment of her suitability, as there was pressure to put an interim manager
in place.
Unfortunately, due to the pressures of her new role and having to deal with a backlog
of customer complaints, Leia Cai failed to tell BFL board that a neighbouring business
had informed her that there was a risk to the structure of the building in which the
fitness centre operated, following building works that took place next door.
Last year, a formal report on the matter was received at head office, advising of the
possible need to vacate the fitness centre until the building could be properly
investigated. The CEO decided not to take any action as Wing could see no evidence
of any building problems himself. The rest of the Board agreed, as the fitness centre
concerned had the highest number of visits per week of any of its branches, and so it
was important that it be kept open.
Last week, part of the ceiling collapsed in the centre, hurting one arm of a member
who was using a rowing machine who required minor hospital treatment. The
neighbouring business has used social media to point out that BFL was warned
previously . In response, Leia Cai has been told by her father, the CEO, not to make
any public comment for the time being.
Required
As HKICPA qualified CPAs, the CEO and the Board should demonstrate adherence to
HKICPA's five fundamental principles of ethics. The principles of integrity, objectivity,
professional competence and due care and professional behaviour are all relevant
here.
(a) Evaluate the situation using the HKICPA fundamental ethical principles.
(6) Discuss how to proceed using the HKICPA framework for addressing ethical
dilemmas.

©
—o—— This tutorial video provides a walkthrough of this activity.

yd SRRHHLR
5.2 Tucker's Five Questions model

A further model which can be useful to confirm that a decision made to address an
ethical dilemma is correct is Tucker's five-question model.
This approach is very helpful when it is unclear if an organisation's behaviour is

ethical or is not ethical. If there are questions about whether the behaviour is unfair,
unjust, not truthful or morally questionable, then it is likely that the organisation
should be applying the Tucker's five questions model even where behaviours are
within the law or regulatory guidelines.
Sometimes, organisation should act above the minimum requirements set out by law,
by regulations, or by other guidelines such as the code of corporate governance and
the listing rules.
Tuckers five questions to apply are as follows:
1. Profitable? Who is making money from the decision and is this a motivation for
an unethical decision?
2. Legal? Does the decision meet the requirements of the law or not?
3. Fair? How are the stakeholders involved affected? Are they being treated
properly in the situation?
4. — Right? Is it ethically right for the stakeholders or is there damage that is being
caused to them?
5. Sustainable or environmentally sound? How will this affect the organisation in

the future, will there be negative consequences of the decision going forward?
Will there be bigger effects on the environment?
This can be applied to general corporate decisions too as well as ethical decisions.
For example, if a company has the opportunity to buy a factory cheaply that produces
diesel fuel, a fuel that is seen as polluting the atmosphere, what is the result of
Tucker's Five Questions?
1. — Is it Profitable? - This could well be in the short term, as the factory is cheap. In
the long term, this may not be a good decision as diesel is a fuel that is seen as
heavily polluting so the factory may not be in use for many years.
2. Is it Legal? - There are no actions which have broken the law here.
3. Is it Fair? - This may save some redundancies, so is good for that. It may not
turn out to be a good investment, affecting the company's shareholders.
4. Is it Right? - Diesel is a polluting fuel, so this decision isn't right.
5. — Is it Sustainable/environmentally sound? -- Definitely not. It affects the

environment negatively and isn't sustainable over time.

ae SRN OR
——re Example: Tucker's five-question Model

El John Tse Building Limited is a construction company based in Hong Kong and run by
John Tse. The business has not been profitable in the last year, due to a recession as
well as problems with one of the business's main customers.
John has decided to contact all the creditors that the business has, to tell them that
they will only be paid 50% of the amount they are owed. The payment will probably
arise by the end of the financial year.
Evaluate if this decision is an ethical one, using Tucker's five-questions model.
Solution
Tucker's five-question model is a useful framework to help decide if the company's

actions are ethical.
Profitable? Not paying suppliers what they are due means that John Tse Building
Limited will retain more money, so there is a profit and cash motive driving this
decision.
Legal? This is not a legal decision, there is a legal obligation for an organisation to pay
its debts. Hence it can't be a legal decision to unilaterally decide not to pay suppliers.
There may be personal legal consequences on John Tse for doing so.
Fair? A company has an obligation to pay suppliers and it is not fair for them to
receive less than was promised to them. The suppliers may suffer due to this.
Right? John Tse is knowingly and wilfully intending to avoid the legal obligations he
has to the suppliers, without the suppliers agreeing in any way. Therefore, the
decision not to pay the suppliers is not right.
Sustainable or environmentally sound? This will have ramifications for John Tse
Building Limited for the future, as it will get a bad reputation with its suppliers, and
this will stretch to other contacts of the suppliers.
From the above, it is clear that the decision not to pay suppliers what they are due is
not ethical. There may well be legal consequences too if the suppliers decide to take
the company to court.
Key takeaway
Remember, Tucker's five-question model can be used in addition to the HKICPA
framework for addressing ethical dilemmas, as it provides an additional set of
questions to determine if an organisation's behaviour in a specific area is ethical
or not.

a SRRHHAB
Independent Commission Against Corruption (ICAC)

6.1 History of ICAC
The Independent Commission Against Corruption (ICAC) was established in 1974, and
during this time it has made enormous strides in combating corruption activity in
Hong Kong. To achieve this, ICAC embraces a three-pronged approach of (1) law
enforcement, (2) prevention and (3) community education to fight corruption.
However, ICAC acknowledges the fight against corruption is never ending. With the
rapid advancement of information technology and advent of globalisation, corruption
is now a crime which goes beyond borders and is an increasing global issue. This
means that international cooperation is more important than ever.
In recent years, the ICAC has been actively strengthening liaison with its international
counterparts and sharing Hong Kong's anti-corruption experience.
To emphasise the strength of Hong Kong's fight for ethical behaviour in business it is
recommended to review the website of Hong Kong's Independent Commission
Against Corruption (ICAC).
Weblink
The ICAC homepage can be found here.
https://www.icac.org.hk/en/home/index.htm|
Research into its landmark cases and anti-corruption resources amongst other useful
parts of the ICAC site.
The following ethical dilemma case was provided by ICAC for HKICPA Capstone
students to attempt as part of their studies.
Activity 5
[wil
You are the financial controller and company secretary of a listed biotechnology
company with business primarily in manufacturing pharmaceutical and medicinal
products for sale in mainland China and the Southeast Asia.
The company has benefited from the substantial economic growth of the mainland
and the rising concern on health care of its people, the company has undergone rapid
business growth in the past few years and therefore, can afford to distribute
handsome bonuses to its senior executives, including you. The favourable monetary
reward supports you and your family a comfortable lifestyle, including your
daughter's tuition fee at an international school.
In arecent meeting, the CFO briefed you on the latest strategic development initiative
of the Chair and Chief Executive, i.e., diversifying the company's business portfolio
through seeking out acquisition opportunities.

Certified Public Accountants Bey/
ae Seana
A mainland healthcare product company had been identified as the target, with the
proposed purchase price of CNY200 million. In fact, in the process of preparing
monthly management accounts, you understand that the double-digit growth rate
recorded in the past few years is unlikely to sustain through mere organic growth.
While you agree with the management's proposed direction, you are surprised that
your boss has asked you to hastily prepare a review report on the target company for
the upcoming board meeting held in two weeks' time.
You immediately express your concern about the insufficient time to conduct a
thorough due diligence check. The CFO told you not to worry and left you with a pile
of documents for generating a "positive" report.
A week has passed. You realize that it is impossible to meet the report submission
deadline because of the lack of certain due diligence data. You frankly presented the
fact to the CFO and, at the same time, queried that CNY200 million was substantially
overpriced according to your research. The CFO was irritated and asked you to fill in
the "gaps" using your professional knowledge. The response did not persuade you.
He then tried to give you a soothing assurance, saying that you need not to be
anxious about the prospect of the target company as it is owned by the Chair's family
and the CEO is fully in the picture.
He also says: "The Chair promises us a pay rise and a share option of $1 million for
exceptional performance in closing the deal."
He went on, "You have a good career prospect. I'll be retiring in a couple of years. If
you can show to the senior management that you are with them, you will surely have
a good path within the company. But if the contrary is shown, I'm not sure if you still
fit in this company."
Required
Analyse the ethical issues in this situation, and using an appropriate framework,
recommend and justify how to respond to the CFO's request.

6.2 Summary of approach to dealing with an ethical dilemma

When you approach an ethical dilemma, look out for the five aspects of interest -
self-interest, self-review, familiarity, advocacy and intimidation. When dealing with an
ethical dilemma, this involves examining who has been affected and by whom. Use the
HKICPA framework or Tucker's 5-question model for addressing the ethical dilemma.
The decision taken to correct the dilemma should consider the position of both sides,
especially those negatively affected, and ideally correct the situation for them.

yd SRAHHAR
° The HKICPA's Code of Ethics for Professional Accountants should be used to guide
your approach to ethical dilemmas.
° Learn the five fundamental ethical principles, they are key to knowing when an
action has breached them.
° Ethical threats are also worth knowing. They help understand what can go
wrong.
° There are safeguards in practice and also in business, learn the steps to follow.
° Professional codes are set by accountancy and other professional bodies, based
around ethical principles.
° Be aware of the usual contents ofa company's code of ethics.
° Be aware of the contents of the IESB's pronouncement 'Responding to non-

compliance with laws and regulations' NOCLAR to help you to understand how
to respond to acts or omissions that are contrary to laws or regulations.
° In situations of professional negligence there are approaches for audit work and
for other situations in business.
° There is a very useful series of steps to follow, set by the HKCIPA, for situations
where there is an ethical dilemma. Make sure you know and have practiced
using the following steps.
(3) Discover alternative solutions.
° Tucker's five-question model can also be used to determine if specific company

behaviour, actions or treatment is ethical or not ethical. The five questions ask,
is the company's behaviour:
(1) Profitable?
(2) Legal?
(3) ‘Fair?
(4) Right?
(5) Sustainable/environmentally
sound?

ae searwae
Activity 1 answers
Required
Which of the fundamental principles have been breached?
The solution is:
1. | Here the breach is concerning the principle of confidentiality. The accountant

has revealed information from their client to the Registrar of Companies in a
dispute. However, accountants should not reveal anything about their clients
without the express agreement of the client or due to an obligation of law.
Hence the accountant has breached the confidentiality principle
2. This breach concerns professional behaviour. An accountant should not

promise to invest money for a client and then not do so and they should not
promise any services, here with respect to taxation, and then not provide them.
It is also a breach of the principle of integrity.
In order to see these cases in more detail please follow this link to IFAC's website:
standards/discussion/case-studies-compliance-iesba-code-ethics
Activity 2 answers
Required
For the five situations given above, which of the ethical threats do they relate to?
The solution is:
Self-interest An accountant has invested in a series of companies and has noticed

that one of the clients that he will be involved in is the company that
he has the biggest investment in
Self-review An accountant has been asked to perform an audit of financial

statements prepared by her own firm
Advocacy An accountant has been championing his client's case in a lawsuit
Familiarity An accountant is starting an audit of a client but is aware that his

sister works at the client in a managerial role
Intimidation An accountant has been told that she will lose her job if the accounts
are not signed off within the next week

me FRRHHRAR
Activity 3 answers
To analyse the situation of Neil Wei Ltd and the ethical dilemma the chief financial
accountant faces the HKICPA framework for addressing ethical dilemmas should be
used. The steps are:
1. Identify the ethical dilemma
There is an undoubted manipulation of the company's accounts if the chief financial

accountant tries to make the accounts look better than they are. There is a conflict of
interest for the chief financial accountant as she will want to keep the directors happy
but will not want the financial accounts to be manipulated and be wrong. If she is
unable to persuade the directors that the financial results should be correctly
reported then she may eventually have to raise the alarm.
2. Identify the fundamental principle violated
If the financial accounts are manipulated then this means that there is a lack of
integrity, this fundamental concept will have been violated. There is also a problem
with objectivity as the chief financial accountant will have let bias, conflict of interest
or the influence of others override professional judgment. This is made worse if she
would benefit from the performance-related pay i.e., she would stand to gain from
the situation herself.
There would be a breach of professional behaviour if normal operating expenses are

categorised as extraordinary.
Hence there is a lot wrong with the course of action that the directors are suggesting
and this places a lot of pressure on the chief financial accountant.
3. Discover alternative solutions.
This is a Severe situation for an accountant, dishonesty in financial reporting is wrong.

There will be legal issues once the matter is revealed to the relevant authorities and
the chief financial accountant is under an ultimate obligation to do this.
She should document the dilemma and see if there is any other way to view it.
However, from the outside it is clear that this is a wrong act.
She should try to persuade the directors to do the right thing and explain that the
consequences of not doing so are likely to be far more severe for them and their
company, even threatening its existence in the end. Accounting standards exist to be
complied with.
She may need to seek legal advice, though her accountancy training should have
made it obvious that manipulation of financial accounts is wrong.

Certified Public Accountants Sr
ae SRN OR
4. Recommend a solution
The recommended solution is for the financial accounts not to breach the accounting
rules, that would be wrong. If the directors have a problem with this, then the
accountant would probably have to resign and also have to report the issue to the
company's auditors as well. Informing the relevant financial reporting body may well
be necessary if the directors continue with their approach.
5. Explain your choice
It is wrong to manipulate accounts. An accountant is under an obligation to make

sure financial accounts are correct and to report to others if not.
Activity 4 answers
(a) HKICPA fundamental ethical principles are used to evaluate the situation.
Integrity
The principle of integrity involves being straightforward and honest in all

professional and business relationships. Integrity also implies fair dealing and
truthfulness.
The Board were faced with a dilemma: should they be open and honest
about the issue, or should they suppress it? They have a responsibility to
be straightforward and honest with the information contained in the
report. By keeping the report private, they are keeping important
information out of the public domain, even though they believe that the
report is unfair in its depiction of BFL.
The CEO's behaviour in complying with the decision not to act upon
the information has also brought his integrity as a HKICPA qualified
accountant, and that of BFL, into question. He has also told his daughter
not to make any public comment on the situation. As the CEO is now
conducting an internal enquiry into what improvements are required
then this represents a more ethical course of action than suppressing
the report. However, the decision not to address this earlier or make any
public comments to address concerns, falls short of the integrity principle.
Objectivity
The principle of objectivity means that bias, conflict of interest or undue

influence should not be allowed to override professional or business judgment.
In addition, relationships that may impair objectivity should be avoided.
The CEO allowed bias and a conflict of interest to influence his behaviour
when he decided not to close the affected centre, and, along with his
daughter, to consider covering up the critical report.
ery. CPAa Hong Kong Institute of

HRRUNALR
° Also, the CEO contravened this principle by appointing his daughter as

interim manager when she was not qualified for the role. He continued to
show a certain level of bias in certain subsequent actions to cover-up the
situation (for example by asking his daughter not to make any public
comment).
Professional competence and due care
The principle of professional competence and due care implies the need to act
diligently and in accordance with professional standards.
e The CEO, Wing Cai, and the other board directors have contravened this
principle because he did not take appropriate action on the letter when it
was originally received, concerning possible damage to the building. It
could be argued that he failed to carry out his duties diligently, or to
exercise professional competence, even though there was no firm
evidence that there was a safety issue.
° The CEO and the Board have an obligation to act diligently on behalf of
employees, shareholders, customers and the general public. All board
members have a responsibility to conduct themselves in a manner
consistent with the reputation of BFL and the standards expected of a
HKICPA qualified accountant. It is clear that the Board have failed to
provide due care in protecting their members and general public from
concerns regarding the building's safety.
It is recommended that a full independent review of the building is undertaken

by an expert building surveyor and BFL's compliance with health and safety
regulations should be reviewed independently by an industry expert, as there
is no evidence the company's has a non-executive director.
Professional behaviour
This is the requirement to comply with laws and regulations and avoid action
that discredits the individual's profession.
By deciding to keep the report private, the Board could be covering up

negligence that has potentially been committed by staff of BFL in failing to act
upon information received. This may potentially result in court action, and it
would be up to the courts to decide. Given the ceiling has collapsed, then a
claim for damages should be expected. The Board are advised to provide for
legal expenses and take legal advice which results from their inaction to address
the issue.

ae SRN OR
(b) The HKIPCA framework for addressing ethical dilemmas is used to discuss how
to proceed:
Identify the ethical dilemma
A member was hurt and required hospital treatments following a partial

collapse of a ceiling in one of the gyms sites operated by the BHL. This event
could have been foreseen as the general manager, Leia Cai was pre-warned,
however, she was advised by her father, the CEO, to take no action. Her
inexperience and close personal connection prevented herself from taking
action and calling in a building expert to review the structural safety of the
building at that time.
Identify the fundamental principle violated
The company has failed in its duty of care to protect its gym members. BFL was
warned by a neighbouring business of potential structural issues, and the CEO
and board chose to ignore this in order to keep a popular site open. The CEO
relied on his own observation of the building and could see nothing wrong,
however, Wing Cai is not a building inspector and is not professionally
competent to make that judgement. As a result, members were put in physical
harm's way which is unethical.
Discover alternative solutions.
The ceiling collapse and harm to a member have happened, so the only solution
now is to prevent reoccurrence.
Recommend a solution
e BFL must perform a full structural building safety review at all BFL's sites
and undergo works, as soon as possible, for any defects noted.
e Where defects are noted, the correct action is to close the sites, as the BFL
has a duty to protect the safety of its members.
° BFL needs to consider providing compensation to the injured member,

and at the very least cover any medical bills.
Explain your choice
e Performing a review of every site for health and safety concerns is a

minimum action where the safety of its customers and employees is at stake.
° The Board must evaluate very carefully its decision not to close the
affected site which it was first informed of a potential problem, and take
measures to ensure this does not happen again, by agreeing ethical
principles which the Board agree to adhere to in the event of similar
events, which should be identified by completing a full business risk
analysis.

rv. CPA Certified Public Accountants
ew SHRNHOR
Activity 5 answers
Identify relevant facts:
The Chair needs your assistance to prepare a review report which guides board
members to support the proposed acquisition. As a financial controller and company
secretary, you should make sure that the documents prepared by you are clear and
not misleading, and not to hide material information.
Identify affected parties:
These include all the staff and board members of the company. Existing and potential
shareholders of the company may also be misled into trading the shares of the
company because of the distorted and incomprehensive information about the
acquisition. The reputation of the city's listed regime may also be tarnished.
Who should be involved in the resolution:
You should involve the audit committee in relation to the overpriced acquisition. If in
doubt, you should consult the ICAC on the legality of your final decision.
The following detailed answer points apply the fundamental ethical principles and the
CEC framework for addressing ethical dilemmas.
1. Identify the ethical dilemma:
The CFO has asked the controller to provide a favourable report on an

acquisition target, but accurate due diligence information is incomplete. Based
on the information available there is concern the acquisition target is overpriced
but it is owned by the Chair's family. The CFO promises financial and career
rewards if the controller provides a favourable report to facilitate the deal.
2. Identify the fundamental principle violated:
Integrity:
It would be dishonest for you to prepare a report you know to be inaccurate,

especially if doing so were for personal gain. The CFO is attempting to persuade
you to prepare misleading financial information for the Board meeting. The other
directors may be misled by the financial information and make a wrong decision.
Objectivity:
The fact that the acquisition target is owned by the Chair's family is a conflict of
interest. By concealing the fact that the acquisition is a connected transaction,
the Chair has put his own interests above those of the company. In fact, the
Chair owes fiduciary duties, including a duty to act in good faith and in the best
interest of his company. Obviously, he fails in discharging these duties. You also
risk being swayed by this personal connection. You have been also receiving a
handsome bonus from the company. You are also offered an inducement of pay

ae SRN OR
rise and a Share option for closing the deal—and you may lose your job if you
do not follow the CFO's instructions. The self-interest threat and intimidation
threat to objectivity are created.
Professional competence and due care:
Should the controller prepare a favourable report without considering all the
relevant information, s/he has failed to exercise due care. You cannot
demonstrate professional competence and due care in your role if you just fill in
the gaps in the report without conducting a thorough due-diligence check. In
fact, as a professional accountant in business, you have a guardian role to
ensure the due diligence report provides a fair evaluation on the target
company for the Board's thorough consideration.
Professional behaviour:
There is a potential non-compliance with the laws and regulations and hence a
breach of this key fundamental principle. As the target company is owned by
the Chair's family, the acquisition may be considered as a connected transaction
according to the Listing Rules of the Stock Exchange of Hong Kong and therefore
should be disclosed in an announcement to the public, circulars to the
shareholders and annual report, and conditional on shareholders' approval. If
you accept the pay rise and the share option from the Chair for facilitating the
acquisition against HKEx's requirements and/or give an unwarranted valuation
of the target company without the Board's approval, both you and the Chair
may breach S.9 of the Prevention of Bribery Ordinance (POBO). In addition, if
you submit to the company a review report which contains false and/or
misleading information with an intent to deceive the Board, you may also
breach S.9(3) of the POBO.
Discover alternative solutions:
It is important to stay open and identify as many solutions as possible, rather

than limiting yourself to past experience and obvious alternatives. Try to think
of as many alternative solutions as possible and identify the likely positive and
negative consequences and likelihood of impact of each. Look for reliable
resources that you can consult, including professional organisations, written
guidelines and standards.
As such, the following solutions may be considered:
° Involve other board members - Given the transaction involves the
personal interests of the Chair, it is important for you to firstly understand
the relationship of board members with the Chair. Careful tactics and
wordings should be used when consulting the Board members on the
case to identify whether they are connected with personal interests in
the case or not.

HARUALR
Consult lawyers for proper steps in handling the matter - Apart from ICAC,
consulting HKICPA or other related professional body may provide
valuable guidelines or resources, e.g., lawyers' contact, when needed.
Be prepared to resign - This is unfortunately a must-have mindset when

one comes across such situation, not only because your relationship with
the Chair, the CFO and others will likely be destroyed, but also because the
company itself may not provide a healthy environment for one to work on
if the situation cannot be resolved. Another important factor to consider is
association risk - the risk of being associated with a bad-practice company
with regard to your career standing and professionalism.
Recommend a solution:
You should not blindly follow the instructions of your CFO or succumb to
the ill-intended pressures imposed by your seniors and any board
members. As a professional accountant, you have a duty to make your
seniors aware of the difficulty, including the time limitation, in the course
of your work.
You should arrange a meeting with the presence of your CFO and CEO and
explain to them your unwillingness to prepare a review report which you
believe contains inaccurate information, as the principle of integrity
requires a professional accountant not to be associated with information
that he believes to be false or misleading.
If your seniors do not heed your advice, you should involve the audit
committee or those charged with the role of corporate governance, or
consult a relevant professional body or seek legal advice before taking a
further step.
To avoid being implicated, you should blow the whistle by reporting any
attempted bribery to the ICAC.
You should document, in detail, the steps that you have taken in resolving
your dilemma, in case your ethical judgment is challenged in the future.
Explain your choice:
This course of action escalates your concern and sounds the alarm at each level
of the company. Seeking legal advice can protect you and your family from
retaliation, such as being fired from your position. Documenting the steps you
have taken makes it clear that you took all necessary legal, and ethical steps to
resolve this dilemma. Reporting illegal behaviour to the Audit Committee,
governance entity and/or ICAC also ensures that the Board is not misled and
that stakeholders are not hurt by this unethical acquisition.

Certified Public Accountants Bry
ae SRN OR
Case study activity
6) Tutorial video: Chapter 7 Case Study Activity

-o—— This tutorial video provides a walkthrough of the following HKKBS Case Study activity.
Additional HKKBS Case Study information

Ken Law has been working in the accounts department of HKKBS for the last two
years at an accounting technician level. He will take his lower-level exams soon and
hopes to progress to take the HKICPA exams. He is attending the same accounting
teaching location as you are, so knows you through that.
He has become aware of two issues at HKKBS and seeks your advice on what to do.
1. | HKKBS sell an adhesive they use to install specific products in new kitchens and
bathrooms. The adhesive contains an active ingredient which can cause minor
irritation and burns to the skin, and therefore gloves must be worn when using
it. The adhesive is manufactured by a supplier in Vietnam. Instructions for using
the products are provided in English and Vietnamese only.
There have been some reports in the media that some users have had to seek
medical attention after using the product and that it is unsafe and should be
banned. However, this hasn't happened to any HKKBS customers yet, perhaps
as there is a list of trusted builders, joiners and plumbers that the customers
use for the installation. It is not illegal to use chemicals so long as they are
correctly labelled.
2. Ken has been reading an article on sustainability (see Exhibit 9 in Chapter 5)

and has seen that there seems to be advantages for businesses that are
sustainable. Ken's experience of HKKBS is that they have good aims that they
show to the public.
However, Ken believes that the Board of Directors 'talk a good story' about
their concerns for sustainability but actually do very little on this, sourcing
materials from cheap suppliers in other countries and importing the products
to Hong Kong using transport that affects the environment negatively. The
factories that produce the kitchens and bathrooms are still using the same
technologies from many years ago, including oil and gas that is detrimental
for the environment.

ey ts) CPA Certified Public Accountants
me SRRHHAR
Ken wants to persuade the directors of HKKBS that their current mode
of operation is not good for the planet but needs to know how to achieve
this. He Knows that a local newspaper has started investigating into the
difference between what some companies say they do on sustainability and
what actually happens and is worried that HHKKBS may be a target of that
investigation.
Ken believes that there are ethical issues with both situations but needs help on what
to do.
Required
Assess the two situations and give ethical advice for Ken to help him deal with the
dilemmas and justify the solution to the ethical dilemmas.

ae ShaaaR
Case Study Activity - answers
There are two ethical dilemmas to address, the use of the adhesive that is made in
Vietnam and the issue of sustainability. The best approach is to use the HKICPA
framework for addressing ethical dilemmas, which has five steps:
° Integrity
° Objectivity
° Professional competence and due care
° Confidentiality
e Professional behaviour
(3) Discover alternative solutions
To explain the choice in step 5 and check on the solution to the ethical dilemma,
Tucker's five-question approach can be used:
Is the ethical decision:
1. Profitable? Who is making money from the decision and is this a motivation for
an unethical decision?
2. Legal? Does the decision meet the requirements of the law or not?
3. Fair? How are the stakeholders involved affected? Are they being treated
properly in the situation?
4. Right? Is it ethically right for the stakeholders or is there damage that is being
caused to them?
5. Sustainable or environmentally sound? How will this affect the organisation in

the future, will there be negative consequences of the decision going forward?
Will there be bigger effects on the environment?
The first ethical situation is that HKKBS are selling an adhesive that appears it can
cause harm to its users, which could include HKKBS's customers. This should concern
Ken Law as an accountant as he should be trying to follow ethical guidelines in his
role. He may not be qualified yet, but the guidelines are still important.

350 Cc PA Certified Public Accountants
ae = fKanHAR
Using the HKICPA framework:

1. The ethical dilemma is whether it is correct to continue supplying adhesive that
may cause harm. The fact that the adhesive could be harmful hasn't been made
clear to the users of the adhesive other than via the instructions that tell the
users that they must wear gloves. These instructions are only given in English
and Vietnamese, meaning that there may be some Chinese users of the
adhesive that are at danger of becoming harmed due to not understanding the
risks. In which case the product is likely to be breaching regulations, and
company will have failed in duty to protect customers.
The fundamental principles violated if HKKBS doesn't make it clear about the
adhesive to all of the users include professional competence and due care - the
customers are not being looked after, if HKKBS doesn't tell all of its customers
about the dangers they are facing. There is also a problem with integrity if the
company isn't being open and honest.
The next step is to discover alternative solutions. Considering the issues Ken
knows that the chemical can cause physical harm if used incorrectly. It is the
duty of HKKBS to ensure the product is correct labelled. There should be a
check that the product is compliant with trading standards and safe to use in
HK. It would be very difficult for HKKBS to monitor usage of all customers as this
is not practical. HKKBS could recall all the products and relabel the stock so that
it covers more languages. Alternatively, it could try to find another adhesive that
has no danger of being harmful.
HKKBS should think what the best approach is to take. It may well be that the
best solution, particularly for the short term, is to recall all the existing stock
recently sent to users so that the immediate danger to its users goes away.
Once the stock has been recalled then the next step should be to relabel the
recalled stock and also any existing stocks, so the labelling is compliant.
Instructions should be given to the manufacturer to update labelling on any
new adhesive manufactured immediately, particularly to include Chinese and
any other important languages, rather than just English and Vietnamese. It may
be wise to consider financial provision and discuss with the HKKBS legal
department about any potential liability.
Tucker's 5-question model can be used to explain the decision made. This
decision will not be profitable in the short term but should help avoid a big
potential liability and will also demonstrate that HKKBS is considerate towards
its customers, which may boost its popularity. The decision is legal as the
adhesive can be used legally if the correct labelling and advice is used. The
decision is fair to the users of the adhesive, it treats them correctly. It is right
as it will minimize the risk to users of any damage. It is also a sustainable
decision and environmentally sound as it doesn't cause much damage to
the environment and the overall benefits of the decision will outweigh any
environmental costs of the recall and relabelling of the existing products.

ae SRN OR
The second ethical decision that Ken Law is concerned about is the sustainability of
the methods and processes that HKKBS is using. Using the same HKICPA framework:
1. The ethical dilemma is whether HKKBS should be doing more to help the
environment. It appears that its actions are not helping at all, given that it is
using suppliers that seem to be harming the environment. HKKBS is in danger
of being revealed by a local newspaper investigation and it may well be missing
out on being a leader in sustainability. The report from Drew and Farrel gives
various benefits of acting more sustainably, firstly as a means of differentiating
themselves. There are a large number of stakeholders, including customers,
employees and investors that value working with or for a company that puts
sustainability to the forefront of its mission and objectives.
It appears that HKKBS is not acting with due care for the environment. It also
may not be behaving professionally if it has some of its stated aims as behaving
well towards the environment whilst not actually doing this. Its reputation will
be harmed substantially if the local newspaper finds this out. Ken Law is making
a good point in saying that this is an issue HKKBS should address.
There are various solutions. It should change from any suppliers that are
polluting the environment and are sourcing materials to supply HKKBS at low
cost. It is likely that these suppliers will not be considering the effect on the
environment of their sourcing. New suppliers that source sustainably should be
sought. HKKBS should look at the rest of its value chain - could the company
source from suppliers that are local to it, who sources ethically sound materials,
in order to cut down any pollution due to transportation? HKKBS should also
analyse its value chain for any other changes it can make to its operations to
reduce environmental harm. Once changed, it could be worth contacting the
newspaper so that it can Sell its environmental credentials to it.
The key point is to change suppliers to cut down transportation costs and to
source better materials for the environment. That will at least get HKKBS on a
better track. Once achieved, it will give a marketing advantage to HKKBS.
Sustainability is becoming ever more important and HKKBS should be bringing
it to the forefront of its thinking. The change in suppliers is immediately
important, partly due to the interest from the newspaper but also as a Start
point in getting HKKBS to be a sustainable company. However, HKKBS could
gain from getting more customers, who would prefer to be buying a sustainable
kitchen or bathroom. So, using Tucker's 5-question model - this is initially not
a profitable decision as costs will increase but, in the long term, it may well be
if HKKBS obtains a competitive advantage. It is legal. Some of the suppliers
will suffer initially, so it won't be fair to them at the start but may encourage
them to operate more sustainably. It is the right thing to do and is obviously
sustainable/environmentally sound. Hence this is the correct decision to make.
Rie CPAa Hong Kong Institute of

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CP A Hong Kong Institute of

YUM tduacenaqcane tees

LEARNING AND PRACTICE

Hong Kong Institute of

CPA Hong Kong Institute of

2 HKICPA Core Enabling Competency Framework Cy,

4 Effective analysis 118

5 Analysing the Pre-seen Case Study 167

6 Leadership, teams and human resource management 209

a Business ethics and professional negligence 308

8 Raising finance 353

9 Formulate business decisions 396

10 Implement business solutions 442

11. Risk management 487

12 Corporate governance and regulation Sioy

13. Contemporary topics 640

14 Further Capstone activity practice 726

15. Preparing for the Capstone Final Examination 749

16 Capstone Final Examination Practice 763

cP A Hong Kong Institute of

The world is evolving rapidly, so is the business environment. The accounting

: Hong Kong institute of

About the Capstone

C PA Hong Kong Institute of

A key element in examination success at the Capstone is practice. It is important that,

In order to achieve the above, you should:

G Hong Kong Institute of

HKICPA Proficiency Levels and Taxonomy

° Level 1 is the foundation level, covering the skills of knowledge and

Skill Verb Definition

Knowledge: Define Give the accepted meaning of

Outline Give the main facts about something

State Accurately articulate established principles, concepts, terms

Comprehension: Describe Communicate the key features of something, present a

Interpret Make clear the meaning of something and its implications

Summarise Describe something concisely; bring together the main facts

CPA Hong Kong Institute of ee

Skill Verb Definition

situations by Apply Demonstrate knowledge, concepts or techniques; Use

Prepare Follow established procedures/methods to create a report

Solve To work out to a result or conclusion

Use Apply in a practical way

Analysis: Examine Analyse To examine methodically by separating into parts and

Justify Explain the reason for recommendation made, or

Prioritise / Determine the order for dealing with a series of items or

C P A Hong Kong Institute of

Skill Verb Definition

Integration: Construct To form an idea, a process, or procedure by bringing

solutions Formulate Devise and put a plan into words

Integrate Combine one aspect of learning with another to form a

Plan / Propose Formulate a detailed proposal for doing or achieving

Produce Draw together similar or disparate items to form a report

Evaluation: Advise Communicate appropriately the recommended course of

Consider Think carefully about something before making a decision,

Evaluate Assess and determine the value, importance or qualities

Recommend Select the best course of action or choice; Advocate a

cp A Hong Kong Institute of

The International Federation of Accountants. (2016). Framework for International