Question one

a$)$ Explain what is meant by 'corporate governance' and why it is important. $(2$ marks$)$

b$)$ Merideth Company has been trading for over $30$ years and obtained a listing on a stock exchange seven years ago. Merideth Company manufactures and sells a range of microchips for use in the aviation industry.

Merideth Company's board comprises five directors; there are four executives who were there when the company set up and one non$-$executive director who joined Merideth Company just before the company's listing in the securities exchange. Each director has a specific area of responsibility and it is only the finance director who reviews the financial statements and budgets.

After the listing on the securities exchange, the chief executive officer, Peter Njenga, set up the audit committee and he sits on this sub$-$committee along with the finance director and the non$-$executive director. The board is relatively small, and in order to save costs, Peter Njenga recently took on the role of chairman of the board of directors. It is the finance director and the chairman who make decisions on the appointment and remuneration of the external auditors. Again, in order to save costs, no internal audit department has been set up to monitor internal controls.

The remuneration of the executive directors is proposed by the finance director and approved by the chairman. They are also paid a monthly salary as well as a year$-$end generous annual bonus which is calculated as a percentage of the revenue generated by the company.

All the board of directors' members have remained the same $($unchanged$)$ since the listing of the company at the securities exchange and none of them has been subjected to re$-$election by shareholders in any annual general meeting.

The Capital Markets $($Public Offers, Listings, and Disclosures$)$ Regulations, $2023$ require all companies to comply with the code of Corporate Governance Practices for any listed company, and the directors of Merideth Company feel fairly confident that they are following best practice in relation to this.

$1$

However, they have recently received notifications from a number of shareholders, who are concerned that Merideth Company does not comply with corporate governance principles.

Required:

Identify and explain six weaknesses of corporate governance faced by Merideth Company and provide recommendations to address each weakness, to ensure the company complies with the Capital Markets corporate governance regulations. $(18$ marks$)$

$20$ marks

Question two

Electra Company $($Electra$),$ is a company listed in the Nairobi Securities Exchange. The audit engagement partner has undertaken external audit work for Electra for eight years and his daughter has been employed by Electra as the sales manager. This role as a member of the management team entitles her to shares in Electra as part of her remuneration package.

Electra's board of directors have held a meeting and consider the establishment of an internal audit department as a priority. However, the finance director does not believe that it is necessary since the company's financial statements are audited by the external auditor. He has engaged the audit firm, Otieno & Associates to explain the differences between internal audit and external audit.

The board of directors have decided to establish the internal audit department. The board of directors of Electra is split on whether Otieno & Associates be appointed to act as both the internal and external auditors for Electra. After a vote, it has been decided that Otieno & Associates will be appointed to act as both the internal and external auditors for Electra. The board of directors of Electra have further suggested that the external audit fee should be $20\%$ of the earnings after tax of Electra Company.

Required:

a$)$ Using the information above, identify and describe the ethical threats which may affect the independence of Otieno & Associates in respect of the audit of Electra Company and for each threat explain how it might be managed to an acceptable level. $(6$ marks$)$

b$)$ Distinguish between internal and external audit. $(4$ marks$)$

$10$ marks