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AUDITING 202 TEST 3 MEMORANDUM

Question One

1. A
2. C

3. D

4. B

5. D

6. C

7. D

8. B

9. D

10.A

11.A

12.D

13.D

14.C

15.C

16.C

17.B

18.B

19.A

20.D
(20)
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QUESTION TWO SUGGESTED SOLUTION (25 MARKS)

(a) The existing Board does not comply with the recommendations of the King IV Code in the
following respects :

1. John Cape should not be both Chairman and Chief Executive Officer; it is recommended
that the position of Chairperson be held by an independent non-executive director. ✓

2. In the case where the two roles are held by the same person, (there must be an acceptable
reason and the reason must be explained in the integrated report) the board should appoint
a lead independent non-executive director (LID) to act as chairman when any situation of
conflict of interest arises for the chairman. In these cases the chairman should recuse
himself from the meeting and should not vote on the matter. Capestorm Ltd currently does
not have any independent non-executive directors. ✓

3. The Board does not comprise a balance of executive and non-executive directors; there is
only one non-executive director to five executive directors. There should be a majority of
non-executive directors and the majority of the non-executives should be independent. ✓

4. The Board is not in anyway representative of the demographics of the country; no females,
five white males, one black male (judging by names!). There should be a diversity of race
and gender (and other aspects) to conduct the business of the board and make it effective.
✓

5. There are no independent non-executive directors : David Brown represents a shareholder

who owns 28% of the company and will have his uncle’s interests as his prime
consideration, that is why he is there. ✓
(5)

(b) Advice I would give to John Cape.

1. The company should appoint five new non-executive directors, ensuring that each
candidate is ethically suitable, competent and not disqualified or under probation. ✓
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1.1 There is already one non-executive director and the appointment of another five
would provide “a balance of executive and non-executive directors, with a majority
of non-executive directors”. ✓

1.2 At least four of the newly appointed non-executive directors should be

independent non-executive directors to ensure that all stakeholder interests can be
protected, and that the majority of non-executive directors are independent. ✓

2. In appointing the non-executive directors, the Board should look for

2.1 individuals of calibre and credibility who have the necessary skill and experience
to “bring independent judgement to bear on issues of strategy, performance,
transformation, standards of conduct etc.” ✓

2.2 individuals that would improve the diversity of the Board as suggested by King IV
(academic qualifications, age, race, gender, industry knowledge, etc). ✓

3. A number of those up for consideration cannot be considered for a position as independent non-
executive directors.
3.1 Andy Storm – he is an immediate family member of Roddy Storm the financial
director (related). ✓

3.2 Peter Obden – he is the company’s longtime legal advisor. ✓

3.3 Reg Gumede – Capestorm Ltd is his major customer, the survival of his business
depends on the executive directors of Capestorm Ltd and he may find it very
difficult to disagree with them where necessary on important Board issues. ✓

3.4 Mary Masters – employed by Capestorm Ltd within the last three years in an
executive position. ✓

4. In addition Eric Redfern cannot be appointed as a director of Capestorm Ltd as he is a

partner in its audit firm; Companies Act 2008 Sec 90. The fact that he is not the designated
partner does not override this prohibition. ✓

5. This means that the four independent non-executive directors to be appointed should be:

5.1 Moss Mda – business experience and sound corporate responsibility values. ✓

5.2 Carter Brown – experienced in Capestorm Ltd’s business, (not engaged on a

regular basis in the past). ✓

5.3 Raksha Vather – also experienced in Capestorm Ltd’s line of business and
independent of the company. ✓

5.4 Titus Sexwale – business experience, leadership and involved in the wider business
community. ✓
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6. I would advise that the appointment of the fifth non-executive director (does not have to be
an independent non-executive director) be either

6.1 Mary Masters: experienced in the business or✓

6.2 Reg Gumede : as there are 10 small businesses which form part of the company’s
social and business development plans, a representation from them on the Board
enhances the credibility of the initiative and may help to expand it. Reflects good
corporate citizenship. ✓

7. Once the appointments have been made (and hopefully accepted) John Cape should
relinquish his post as Chairman. ✓

7.1 The Board as a whole should then elect a chairman from the four independent non-
executive directors. ✓

8. As an interim measure (this will be an inexperienced Board) John Cape could retain both
positions but request that a lead independent non-executive director be appointed from the
four independent non-executive directors. ✓

[19 marks + 1 point for good presentation = 20] (20)

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QUESTION THREE SOLUTION (42 MARKS)

(a) and (b)

1. Operational risk. ✓ This is a risk which is inherent from operating ocean-going tankers and
container ships. ✓

Response : Transferring the risk to a third party by taking out adequate insurance to
cover the loss of the vessel, its cargo and any other potential losses such as
business interruption cover. ✓

: Reducing/mitigating the risk by ensuring that high maintenance standards

(sea-worthiness) are complied with and shipping personnel are well trained
and competent. ✓

2. Market risk. ✓ This is a risk which affects the market in which Logistics Ltd operates and has
a direct effect on its “sales”. ✓

Response : Reducing the risk, continually assessing the market, e.g. looking for new
markets, working with existing customers etc. ✓

: Exploiting the risk by diversifying into other forms of shipping and/or the
transport of other products. ✓

3. Operational risk. ✓ This is a risk which appears to have become part and parcel of international
shipping.

Response: Avoid the risk by ceasing to send ships on routes which are at risk of piracy. ✓

: Transferring the risk (of loss) by taking out adequate insurance. ✓

: Taking (legal) measures to physically protect ships and crew. ✓

: Reducing the risk by joining industry organizations fighting piracy. ✓

(any 2)

4. Organisational risk✓. The information system is integrated and therefore likely to affect the
organization as a whole, not only say, financial systems, or operational
systems. ✓
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Response : Reducing the risk by investing in upgrading and maintaining to quality

computer hardware and software and✓

: Having a reliable and comprehensive disaster recovery plan. ✓

: Transferring the risk by outsourcing to a virtual private network. ✓

(any 2)

5. Financial risk. ✓ Inability of customers to pay will directly affect cash flow and liquidity. ✓

Response : Reducing the risk (there is always going to be risk of bad debts) by having
strong internal controls which include thorough credit approval and credit
management procedures including✓

✓ * comprehensive creditworthiness checks

✓ * setting of appropriate credit terms and limits

✓ * ongoing follow up of collection of outstanding amounts, and debtors

reviews by management

✓ * use of credit guarantee insurance (transference).

(any 2)

6. Financial risk✓. Failure to comply with covenants could result in the immediate call up of
loans. This affects the financing of the company and may place pressure on
liquidity (and solvency). ✓

Response : Reducing the risk by integrating the review of loan covenant status (and
reporting on it) to the board on a monthly basis; the control procedure to be
delegated to a specific individual such as the company secretary. ✓

(Whilst it would be desirable to avoid the risk by negotiating loans without

covenants, this is extremely unlikely in practice). ✓

7. Financial risk. ✓ Interest and foreign currency exchange rate directly affects how Logistics
Ltd will finance many of its transactions. These fluctuations have a direct
bearing on costs, and profits. ✓
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Response : Mitigate the risk by careful and constant scrutiny of foreign currency markets
and hedging by, for example, taking forward cover. ✓

: Reducing the risk by ongoing review by the board and management of the
company’s exposure to interest and foreign exchange fluctuations. ✓

8. Legal risk. ✓ Self explanatory.

Response : Reducing the risk by reliance on service providers e.g. shipping/marine

lawyers and shipping trade associations to keep the company informed of
shipping legislation and changes thereto. ✓

: Reducing the risk by continual training of shipping management, operational

staff, e.g. courses, seminars, annual updates. ✓

9. Strategic risk✓ : Failing to keep up with advances in a company’s line of business will result
in the risk of making poor strategic decisions. ✓

Response : Mitigating (reducing) the risk by employing staff and appointing a board that
understands the shipping market sectorially, geographically and in global
terms. ✓

: Appointing a CEO who is innovative and proactive. ✓

: Establishing a support expertise which includes, financiers, insurers, agents

and technical shipping experts. ✓

10. Operational risk✓ : Security and safekeeping of containers are part of the operational

(reputational risk) responsibilities of the company.

: If theft becomes endemic, LogisticsLtd’s reputation will suffer.

Response : Transferring the risk exposure by taking out insurance✓

: Treating the risk by implementing sound physical and cargo handling

controls whilst containers are at sea, properly secured and sealed, and on
land. ✓
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11. Organisational risk✓ : A situation which threatens the organization as a whole. ✓

Response : Reducing the risk by ensuring competitive remuneration packages and long-
term incentives, a progressive work environment, career growth and
succession planning. ✓

12. Reputational risk/✓ : This type of activity is viewed in a very poor light by✓

Operational risk/ environmental groups, some governments and the public. It presents
Legal risk operational risks (safety of employees, pollution of the environment) as well
as potential exposure to legal action being taken against the company. (It
may also be regarded as a strategic risk if the company intends to pursue the
transfer of toxic waste as a company strategy). ✓

Response : These risks should be avoided (or terminated) by not accepting offers to
transport toxic waste. Risks too high for a company with a good reputation.
✓ {plus additional 1 pt =2}

MARKING SCHEME FOR Q3:

Identification of risk: 1 pt = 12

Explanation : .5 pt = 6

18

Response: 2pts 24

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