CASE ANALYSIS: Hue Incorporated

Hue Incorporated designs and manufactures personalized shirts and jackets. The company employs 2,500

staff, and its shares are held by 15 individuals, most of them from the same family. The maximum shareholding

is 15% of the share capital.

The executive directors are drawn mainly from the shareholders. There are no executive directors primarily

drawn from the shareholders. There are no non-executive directors because the company legislation in Hue

Incorporated's jurisdiction does not require any. The executive directors are very successful in running Hue

Incorporated, partly from their training in production and management techniques, and partly from their

'hands-on' approach motivating employees.

The Board is considering a significant expansion of the company. However, the company's bankers are

concerned with the standard of financial reporting as the financial director (FD) has recently left Hue

Incorporated. The Board is delaying the provision of additional financial information until a new FD is

appointed. Hue Incorporated does have an internal audit department. However, the chief internal auditor

frequently comments that the Board of Hue Incorporated does not understand his reports or provide sufficient

support for his department or the internal control systems within Hue Incorporated.

The Board of Hue Incorporated concurs with this view. Rivera & Co, the external auditors, have also expressed

concern in this area and the fact that the internal audit department focuses work on control systems, not

financial reporting. Rivera & Co are appointed by and report to the Board of Hue Incorporated. The Board of

Hue Incorporated is considering a proposal from the chief internal auditor to establish an audit committee.

The committee would consist of one executive director, the chief internal auditor as well as three (3) new

appointees. One (1) appointee would have a non-executive seat on the Board of directors.

Required:

Answer the following (3 items x 5 points):

a. What do you think is the main cause why Hue Incorporated's Board does not understand the report

given by the Chief Internal Auditor?

b. How can you solve the problem identified in letter (a)?

c. How can you ensure the independence of the external auditor?