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GRE811S- CORPORATE GOVERNANCE RISK AND ETHICS- 2ND OPP- JUNE 2023 |
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nAmlBIA unlVERSITY
OFSCIEnCE Ano TECHn OLOGY
FACULTY OF COMMERCE, HUMAN SCIENCESAND EDUCATION
DEPARTMENT OF ECONOMICS, ACCOUNTING & FINANCE
QUALIFICATION: BACHELOR OF ACCOUNTING (HONOURS)
QUALIFICATION CODE: 0SBOAH
COURSE CODE: GRE811S
LEVEL: 8
COURSE NAME: CORPORATE GOVERNANCE,
RISK AND ETHICS
SESSION: JULY 2023
DURATION: 3 HOURS
PAPER: THEORY AND APPLICATION
MARKS: 100
SECOND OPPORTUNITY EXAMINATION QUESTION PAPER
EXAMINERS:
Kuhepa Tjondu
MODERATOR: Mr. M. Tondota
INSTRUCTIONS
• This question paper is made up of FOUR(4) questions.
• Answer All the questions and in blue or black ink.
• Show all your working in the answer sheet.
• Start each question on a new page in your answer booklet and show all your workings.
• Questions relating to this paper may be raised in the initial 30 minutes after the start of
the paper. Thereafter, candidates must use their initiative to deal with any perceived error
or ambiguities and any assumption made by the candidate should be clearly stated.
PERMISSIBLE MATERIALS
Non-programmable calculator/financial calculator
THIS QUESTION PAPER CONSISTS OF 6 PAGES (Including this front page)
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QUESTION 1
[25 MARKS]
KK is a large listed company. When a non-executive directorship of KK Limited
became available, Johny Samora was nominated to fill the vacancy. Johny is the
brother-in-law of KK's chief executive Kennedy Kavena. Johny is also the CEO of
Samora Supplies Ltd, KK's largest single supplier and is, therefore, very familiar with
KK and its industry. He has sold goods to KK for over 20 years and is on friendly terms
with all of the senior officers in the company. In fact last year, Samora Supplies
appointed KK's finance director, Susana Shaningwa, to a non-executive directorship
on its board. The executive directors of KK all know and like Johny and so plan to ask
the nominations committee to appoint him before the next AGM.
KK has recently undergone a period of rapid growth and has recently entered several
new overseas markets, some of which, according to the finance director, are riskier
than the domestic market. Kennedy Kavena, being the dominant person on the KK
board, has increased the risk exposure of the company according to some investors.
They say that because most of the executive directors are less experienced, they
rarely question his overseas expansion strategy. This expansion has also created a
growth in employee numbers and an increase in the number of executive directors,
mainly to manage the increasingly complex operations of the company. It was thought
by some that the company lacked experience and knowledge of international markets
as it expanded and that this increased the risk of the strategy's failure. Some
shareholders believed that the aggressive strategy, led by Kennedy Kavena, has been
careless as it has exposed KK Limited to some losses on overseas direct investments
made before all necessary information on the investment was obtained.
As a large listed company, the governance of KK is important to its shareholders. Fin
Brun is one of KK's largest shareholders and holds a large portfolio of shares including
8% of the shares in KK. At the last AGM he complained to KK's chief executive,
Kennedy Kavena, that he needed more information on directors' performance. Fin said
that he didn't know how to vote on board reappointments because he had no
information on how they had performed in their jobs. Mr Kavena said that the board
intended to include a corporate governance section in future annual reports to address
this and to provide other information that shareholders had asked for. He added,
however, that he would not be able to publish information on the performance of
individual executive directors as this was too complicated and actually not the concern
of shareholders. It was, he said, the performance of the board as a whole that was
important and he (Mr Kavena) would manage the performance targets of individual
directors.
Required:
(a) Explain the term 'conflict of interest' in the context of non-executive directors and
discuss the potential conflicts of interest relating to KK and Samora Supplies if Johny
Samora were to become a non-executive director of KK Limited.
(8 marks)
(b) Assess the advantages of appointing experienced and effective non-executive
directors to the KK board during the period in which the company was growing rapidly.
(7 marks)
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{c) Explain the typical contents of a 'best practice' corporate governance report within
an annual report and how its contents could help meet the information needs of Fin
Brun.
(10 marks)
QUESTION 2
[25 MARKS]
B Bank is a large international bank. It employs 6,000 staff in 250 branches and has
approximately 500,000 borrowers and over 1,500,000 savers. The bank, which was
founded in 1856, has an excellent reputation for good customer service. The bank's
share price has increased, on average, by 12% in each of the last ten years.
There has been much adverse media coverage in many countries, including B Bank's
home country, about the alleged excessive bonuses received by the directors of
banks. A meeting of central bank governors from many nations failed to reach
agreement on how to limit the size of directors' bonuses. The governor of the central
bank in B Bank's home country is particularly concerned about this issue, and
consequently put forward the following proposal:
'Directors of banks will be asked to pay a fee to the bank for the privilege of being a
director. This fee will be set by the remuneration committee of each bank. Directors
will be paid a bonus based solely on appropriate profit and growth indicators. The more
the bank succeeds, the higher will be the bonus. This proposal directly links
performance of the bank to directors' pay. I see this as a more realistic option than
simply limiting salaries or bonuses by statute as proposed at the recent central bank
governors' conference.'
The constitution of the board of B Bank is in accordance with the internationally agreed
code of corporate governance.
Overall board strategy has been to set targets based on previous (profitable)
experience, with increased emphasis on those areas where higher potential profits
can be made such as mortgage lending (this is discussed below). The bank's
executive information systems are able to compute relative product profitability, which
supports this strategy. This strategy generated substantial profits in recent years. The
last major strategy review took place four years ago. Up until the last couple of years,
non-executive directors have not queried the decisions of the executive directors.
However government help for other banks in the last couple of years has led to some
of B Bank's non-executive directors questioning the bank's approach to managing its
risks, and whether it ought to focus more on lower-risk activities and introduce stronger
control systems.
One of the major sources of revenue for the bank is interest obtained on lending money
against securities such as houses (termed a 'mortgage' in many countries) with
repayments being due over periods varying between 15 and 25 years. Partly as a
result of intense competition in the mortgage market, the values of the mortgages
advanced by B Bank regularly exceed the value of the properties, for example B Bank
has made advances of up to 125% of a property's value. Internal reports to the board
estimate that property prices will reverse recent trends and will rise by 7% per annum
for at least the next ten years, with general and wage inflation at 2%. B Bank intends
to continue
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to obtain finance to support new mortgages with loans from the short-term money-
markets.
Required:
(a) Evaluate the proposal made by the governor of the central bank.
(8 marks)
(b) Assess the risk management strategy in B Bank (except for consideration of
directors' remuneration). Your assessment should include recommendations for
changes that will lower the bank's exposure to risk.
(12 marks)
(c) Analyse the impact of B Bank adopting a more risk-averse approach towards
managing the risks relating to the activities it undertakes and the controls it operates
to manage these risks.
(5 marks)
QUESTION 3
[25 MARKS]
Susana Paulus was recently appointed as a non-executive member of the internal
audit committee of Fluck and Grootman, a public listed company producing complex
engineering products. Barney Chester, the executive finance director who chairs the
committee, has always viewed the purpose of internal audit as primarily financial in
nature and as long as financial controls are seen to be fully in place, he is less
concerned with other aspects of internal control. When Susana asked about
operational controls in the production facility Barney said that these were not the
concern of the internal audit committee. This, he said, was because as long as the
accounting systems and financial controls were fully functional, all other systems may
be assumed to be working correctly.
Susana, however, was concerned with the operational and quality controls in the
production facility. She spoke to production director Aaron Hangero, and asked if he
would be prepared to produce regular reports for the internal audit committee on levels
of specification compliance and other control issues. Mr Hangero said that the internal
audit committee had always trusted him because his reputation as a manager was
very good. He said that he had never been asked to provide compliance evidence to
the internal audit committee and saw no reason as to why he should start doing so
now.
At board level, the non-executive chairman, George Allejandra, said that he only
instituted the internal audit committee in the first place in order to be seen to be in
compliance with the stock market's requirement that Fluck and Grootman should have
one. He believed that internal audit committees didn't add materially to the company.
They were, he believed, one of those 'outrageous demands' that regulatory authorities
made without considering the consequences in smaller companies nor the individual
needs of different companies. He also complained about the need to have an internal
auditor. He said that Fluck and Grootman used to have a full time internal auditor but
when he left a year ago, he wasn't replaced. The audit committee didn't feel it needed
an internal auditor because Barney Chester believed that only financial control
information was important and he could get that information from his management
accountant.
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Susana asked Mr Allejandra if he recognised that the company was exposing itself to
increased market risks by failing to have an effective audit committee. Mr Allejandra
said he didn't know what a market risk was.
Internal control and audit are considered to be important parts of sound corporate
governance.
Required:
(a) (i) Describe five general objectives of internal control.
(5 marks)
(ii) Explain the organisational factors that determine the need for internal audit in public
listed companies.
(5 marks)
(b) Criticise the internal control and internal audit arrangements at Fluck and
Grootman as described in the case scenario.
(10 marks)
(c) Define 'market risk' for Mr Allejandra and explain why Fluck and Grootman's market
risk exposure is increased by failing to have an effective audit committee. (5 marks)
QUESTION 4
[25 MARKS]
It was the final day of a two-week-long audit of Van Buren Company, a longstanding
client of Fillmore Pierce Auditors. In the afternoon, Anne Hayes, a recently qualified
accountant and member of the audit team, was following an audit trail on some cash
payments when she discovered what she described to the audit partner, Zachary
Lincoln, as an 'irregularity'. A large and material cash payment had been recorded with
no recipient named. The corresponding invoice was handwritten on a scrap of paper
and the signature was illegible.
Zachary, the audit partner, was under pressure to finish the audit that afternoon. He
advised Anne to seek an explanation from Frank Monroe, the client's finance director.
Zachary told her that Van Buren was a longstanding client of Fillmore Pierce and he
would be surprised if there was anything unethical or illegal about the payment. He
said that he had personally been involved in the Van Buren audit for the last eight
years and that it had always been without incident. He also said that Frank Monroe
was an old friend of his from university days and that he was certain that he wouldn't
approve anything unethical or illegal. Zachary said that Fillmore Pierce had also done
some consultancy for Van Buren so it was a very important client that he didn't want
Anne to upset with unwelcome and uncomfortable questioning.
When Anne sought an explanation from Mr Monroe, she was told that nobody could
remember what the payment was for but that she had to recognise that 'real' audits
were sometimes a bit messy and that not all audit trails would end as she might like
them to. He also reminded her that it was the final day and both he and the audit firm
were under time pressure to conclude business and get the audit signed off.
When Anne told Zachary what Frank had said, Zachary agreed not to get the audit
signed off without Anne's support, but warned her that she should be very certain that
the irregularity was worth delaying the signoff for. It was therefore now Anne's decision
whether to extend the audit or have it signed off by the end of Friday afternoon.
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Required:
(a) Explain why 'auditor independence' is necessary in auditor-client relationships and
describe three threats to auditor independence in the case.
(9 marks)
Anne is experiencing some tension due to the conflict between her duties and
responsibilities as an employee of Fillmore Pierce and as a qualified professional
accountant.
(b) (i) Compare and contrast her duties and responsibilities in the two roles of
employee and professional accountant.
(6 marks)
(ii) Explain the ethical tensions between these roles that Anne is now experiencing.
(4 marks)
(c) Explain how absolutist (dogmatic) and relativist (pragmatic) ethical assumptions
would affect the outcome of Anne's decision.
(6 marks)
THE END
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