School of Accountancy, Stellenbosch University

Risk and Information Management 784

BComHons (Management Accounting)

Test – 14 May 2021

Examiners: J Smeda
LP Steenkamp
A van Zyl

Internal moderator: R Goosen

External moderator: A Bester

Marks: 50
Duration: 1.5 hours
Number of questions: 1 (All questions must be answered)

INSTRUCTIONS:
1. You are allowed 90 minutes to answer this question paper.
2. You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned.
Question 1

APD: Background, organisational structure and financial controls

APD is one of the world’s largest manufacturers of energy saving products for use in construction.
The group specialises in the manufacture of timber framed sections and of insulated panels, both
being used in domestic and commercial construction. The insulated panels take the form of a
“sandwich” of outer layers of wooden board with a polystyrene core, and so APD is very dependent
on access to timber supplies for the manufacture of both of its products.

APD owns manufacturing plants and distribution centres in various locations around the world. The
group is largely based in Europe, and has its headquarters and Research and Development Unit in
Germany, as well as manufacturing sites in Germany, Scotland and Poland. The European
manufacturing operations are supported by distribution centres located in each of Germany, France
and Scotland. An additional manufacturing plant and two distribution centres are located in Canada,
to serve both the Canadian and US markets. APD sells to customers located in 15 different countries
in Europe and North America.

The control structure in APD is regionally rather than product based. Manufacturing and distribution
centres are managed in combination as regional profit centres, whilst the Research and Development
Unit is treated as a cost centre. For example, the Director of Operations for Western Europe is
responsible for a single profit centre that covers the German and Scottish manufacturing plants
together with the distribution centres in Germany, France and Scotland. Similarly, the Director of
Operations for North America is responsible for a profit centre that includes all of the Canadian
manufacturing and distribution centres. The Polish manufacturing plant is a separate profit centre
managed by a UK based Director.

Profit centre results are calculated before inclusion of the impact of any foreign exchange or interest
rate movements.

Product Development

The Board of Directors regards new product development as vital to the continued success of the
business, and 5% of group profit is allocated to Research and Development. All new products have
to obtain certification on their suitability for purpose and compliance with health and safety and building
regulations. Certification is granted by an internationally approved body such as the UK based Building
Research Establishment, but obtaining certification can take up to three years to complete.

Environmental Issues

APD’s timber based products appeal to customers because of the fact that timber is a renewable
building material. There is, however, growing consumer concern about illegal logging and global
depletion of major forestry resources.

In response to these concerns, APD’s strategic plan states that it aims, by 2022, to have 75% of timber
supplies sourced from sustainable woodland. The timber used for both the timber framed sections and
the insulated panels is primarily softwood which, in forestry terms, is fast growing. Trees reach the
necessary level of maturity in approximately 20 years. Reliable market forecasts suggest that demand
for sustainably produced timber is growing faster than its supply, and that severe competition for this
resource will emerge over the next five to eight years.

A number of international schemes have developed with the aim of providing customer assurance on
the sustainability of a timber source. APD uses suppliers which are registered under a number of
different such schemes including the Forestry Stewardship Council, Sustainable Forestry Initiative,
and the Canadian Standards Association. Consumers, however, appear to be poorly informed about
the different assurance systems and are unable to clearly distinguish between genuine and “rogue”
assurance schemes.

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Market Conditions

The business has expanded very rapidly since 2010 as a result of a growing awareness amongst
architects of the need to use environmentally friendly building systems, combined with the potential of
both product types to halve construction times.

In the 1990s and 2000s there was a degree of mistrust within the industry about the use of timber
frame construction techniques, and in Europe there were only a small number of contractors who were
knowledgeable and experienced in their use. In contrast, the Canadian market for the product has
been well established since the 1950s.

Insulated panels have also been in widespread use in North America for many years, but APD was
the first company to introduce this building system into Europe in 2010. Since then a number of
competitors have entered the European market, some of which provide customers with on site
installation services as well as acting purely as panel manufacturers. An important reason for the
market appeal of the panels lies in the fact that they offer very high levels of insulation, and the
European market has expanded hugely following the introduction of strict new regulations on the
energy efficiency of new buildings. The MD is aware of the impact of the 2020 pandemic and has
taken that into account when preparing the 2021/2022 budget by suggesting that there will be zero
sales growth.

The customer base for both timber framed sections and the insulated panels is highly concentrated.
For timber framed sections, 40% of global revenue is earned in Canada, whilst 80% of APD’s
substantial European revenue from the sale of the insulated panels comes from ten main construction
companies. Retention of key customers is pursued by APD through its policy of guaranteeing delivery,
anywhere in the world, of all orders in excess of €0·5 million, within six weeks of the order being
received. As a result, there are times when APD is manufacturing in Canada for delivery in Europe
and vice versa.

Sales Mix and Profit Margins

Year ended 30 June 2019 2020

Sales: €m €m
Global 350 420
North America 150 175
UK 45 65
France 10 10
Germany 60 70
Other countries 85 100
Global Ratio of timber frame to panel sales (by value) 60 : 40 52 : 48
Average profit margin on panels 9.5% 9.0%
Average profit margin on timber framed sections 12.5% 14.0%

Risk Management in APD

Overall responsibility for risk management systems within APD rests with a senior manager (ranked
immediately below Board level) who holds the title of Group Risk Controller. He was appointed five
years ago, after promotion following 20 years service as APD’s Head of Group Insurance. He works
closely with the Head of Internal Audit, although their respective roles are not clearly defined and
documented and they jointly report monthly to the Audit Committee and the Finance Director.

The Board of Directors’ approach to risk management is to either avoid risk or transfer it. One
consequence of this policy is that the insurance bill for the group is extremely high in comparison to
its peers. The existing risk averse culture also means that all overseas customers are billed in Euros,
and the Treasury unit is barred from using derivative financial instruments, even for hedging purposes,
because they are “too risky.”

The Group Risk Controller of APD is due to retire in December 2021, and in its most recent review of
internal controls within APD the Audit Committee recommended that the Board of Directors should

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work with the new appointee to undertake a major review of current risk management practice within
APD.

Required
(a) Discuss the extent to which each of the following aspects of the operational and business
environment of APD creates potential upside risks for the group’s shareholders:

(i) Product development

(ii) Environmental issues
(iii) Market conditions
(iv) Sales mix and profit margins
(v) Financial controls

(26 marks)

Romanian supplier
On an unannounced, but routine visit, to the manufacturing site in Poland, the CEO of APD noticed
trucks from Romania delivering wood. Upon further investigation it became clear that the Romanian
supplier was harvesting wood from a protected nature site and paid a bribe to all the managers at the
Poland site to look the other way. These managers have been with APD for many years and have
excellent reputations otherwise.

The director responsible for the Polish site is of the opinion that they should draw a line under this
matter and take no further action. The purchases from the Romanian supplier constituted only 3% of
purchases for the past six months.

Required
(b) Discuss the situation and advise the board of directors on the way forward.
(10 marks)

(c) Discuss changes to their risk management process that APD should consider to prevent a
similar situation from arising in the future.
(6 marks)

Diversification

APD is considering expanding the size of the company by following a strategy of backwards
integration.

Required
(d) Write a report to the shareholders and management explaining what backwards integration in
their context would mean and what the potential effect thereof would be on the company’s risk
profile.
(8 marks)
(Total marks = 50)

END OF PAPER

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