Series: MAY 2020

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  • 20 Marks

CR – May 2020 – L3 – Q1 – Consolidated Statement of Financial Position

Prepare the consolidated statement of financial position for Phato Ltd and its subsidiaries as at 30 September 2019, including relevant calculations for goodwill, non-controlling interest, and asset impairments.

Phato Ltd, is a Public Limited Liability Company which operates in the service sector in Ghana. Phato Ltd has a business relationship with two other Ghanaian companies, Sakara Ltd and Saadi Ltd, which are public limited liability companies too. The draft statements of financial position of these three companies are as below as at 30 September 2019.

Phato Ltd GH¢ million Sakara Ltd GH¢ million Saadi Ltd GH¢ million
Assets:
Non-current assets
Property, plant, and equipment 460.0 150.0
Investment in subsidiaries
Sakara Ltd 365.0
Saadi Ltd 160.0
Investment in Azuri Ltd 24.0
Intangible assets 99.0 15.0
Total Non-current assets 948.0 325.0
Current assets 447.5 240.0
Total assets 1,395.5 565.0
Equity and liabilities:
Equity:
Share capital 460.0 200.0
Other components of equity 36.5 18.5
Retained earnings 447.5 221.0
Total equity 944.0 439.5
Non-current liabilities 247.5 61.5
Current liabilities 204.0 64.0
Total liabilities 451.5 125.5
Total equity and liabilities 1,395.5 565.0

Additional relevant information:

  1. Phato Ltd, on 1 October 2017, acquired 60% of the equity interests of Sakara Ltd. The cost of the investment comprised cash of GH¢360 million. At acquisition, the fair value of the non-controlling interest in Sakara Ltd was estimated at GH¢146 million. The fair value of the identifiable net assets acquired totaled GH¢417.5 million, including retained earnings of GH¢159.5 million and other components of equity at GH¢13.5 million. The excess in fair value results from non-depreciable land.
  2. Sakara Ltd, on 1 October 2018, acquired 70% of Saadi Ltd for GH¢160 million. The fair value of non-controlling interest was estimated at GH¢36 million. The fair value of the identifiable net assets of Saadi Ltd at acquisition was GH¢181 million, retained earnings GH¢53 million, and other components of equity GH¢10 million.
  3. Phato Ltd acquired a 14% interest in Azuri Ltd for GH¢9 million on 1 October 2017. On 1 April 2019, Phato Ltd acquired an additional 16% interest in Azuri Ltd for GH¢13.5 million, achieving significant influence.
  4. Phato Ltd purchased patents for GH¢5 million and incurred other development costs for product development.
  5. Impairment tests were conducted on Sakara Ltd and Saadi Ltd.

Required:
Prepare the consolidated statement of financial position for the Phato Ltd Group as at 30 September 2019.

Phato Ltd Group
Consolidated Statement of Financial Position as at 30 September 2019

Assets GH¢ million
Non-current assets
Property, plant, and equipment (460 + 150 + 155 + 44.5 + 18) 827.5
Goodwill (W3) 93.5
Intangible assets (99 + 15 + 17.5 – 4.5 -13.5) 113.5
Investment in Azuri (W7) 25.25
Total non-current assets 1,059.75
Current assets 812.5
Total assets 1,872.25
Equity and Liabilities GH¢ million
Equity attributable to owners of parent
Share capital 460
Retained earnings (W5) 489.41
Other components of equity (W5) 38.05
Total Equity attributable to owners 987.46
Non-controlling interest (W4) 192.29
Total Equity 1,179.75
Non-current liabilities 355.5
Current liabilities 337.0
Total Liabilities 692.5
Total Equity and Liabilities 1,872.25

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  • 20 Marks

CR – May 2020 – L3 – Q1 – Consolidated Statement of Financial Position

Prepare the consolidated statement of financial position for Phato Ltd and its subsidiaries as at 30 September 2019, including relevant calculations for goodwill, non-controlling interest, and asset impairments.

Phato Ltd, is a Public Limited Liability Company which operates in the service sector in Ghana. Phato Ltd has a business relationship with two other Ghanaian companies, Sakara Ltd and Saadi Ltd, which are public limited liability companies too. The draft statements of financial position of these three companies are as below as at 30 September 2019.

Phato Ltd GH¢ million Sakara Ltd GH¢ million Saadi Ltd GH¢ million
Assets:
Non-current assets
Property, plant, and equipment 460.0 150.0
Investment in subsidiaries
Sakara Ltd 365.0
Saadi Ltd 160.0
Investment in Azuri Ltd 24.0
Intangible assets 99.0 15.0
Total Non-current assets 948.0 325.0
Current assets 447.5 240.0
Total assets 1,395.5 565.0
Equity and liabilities:
Equity:
Share capital 460.0 200.0
Other components of equity 36.5 18.5
Retained earnings 447.5 221.0
Total equity 944.0 439.5
Non-current liabilities 247.5 61.5
Current liabilities 204.0 64.0
Total liabilities 451.5 125.5
Total equity and liabilities 1,395.5 565.0

Additional relevant information:

  1. Phato Ltd, on 1 October 2017, acquired 60% of the equity interests of Sakara Ltd. The cost of the investment comprised cash of GH¢360 million. At acquisition, the fair value of the non-controlling interest in Sakara Ltd was estimated at GH¢146 million. The fair value of the identifiable net assets acquired totaled GH¢417.5 million, including retained earnings of GH¢159.5 million and other components of equity at GH¢13.5 million. The excess in fair value results from non-depreciable land.
  2. Sakara Ltd, on 1 October 2018, acquired 70% of Saadi Ltd for GH¢160 million. The fair value of non-controlling interest was estimated at GH¢36 million. The fair value of the identifiable net assets of Saadi Ltd at acquisition was GH¢181 million, retained earnings GH¢53 million, and other components of equity GH¢10 million.
  3. Phato Ltd acquired a 14% interest in Azuri Ltd for GH¢9 million on 1 October 2017. On 1 April 2019, Phato Ltd acquired an additional 16% interest in Azuri Ltd for GH¢13.5 million, achieving significant influence.
  4. Phato Ltd purchased patents for GH¢5 million and incurred other development costs for product development.
  5. Impairment tests were conducted on Sakara Ltd and Saadi Ltd.

Required:
Prepare the consolidated statement of financial position for the Phato Ltd Group as at 30 September 2019.

Phato Ltd Group
Consolidated Statement of Financial Position as at 30 September 2019

Assets GH¢ million
Non-current assets
Property, plant, and equipment (460 + 150 + 155 + 44.5 + 18) 827.5
Goodwill (W3) 93.5
Intangible assets (99 + 15 + 17.5 – 4.5 -13.5) 113.5
Investment in Azuri (W7) 25.25
Total non-current assets 1,059.75
Current assets 812.5
Total assets 1,872.25
Equity and Liabilities GH¢ million
Equity attributable to owners of parent
Share capital 460
Retained earnings (W5) 489.41
Other components of equity (W5) 38.05
Total Equity attributable to owners 987.46
Non-controlling interest (W4) 192.29
Total Equity 1,179.75
Non-current liabilities 355.5
Current liabilities 337.0
Total Liabilities 692.5
Total Equity and Liabilities 1,872.25

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  • 9 Marks

CR – May 2020 – L3 – Q2a – Government Grants for Factory Construction

Discuss the accounting treatment for a government grant received for the construction of a factory, showing calculations and relevant entries.

On 1 January 2018, Asankragua Ltd (Asankragua) applied to a government agency for a grant to assist with the construction of a factory in Enchi. The proposed construction cost of the factory was GH¢52 million and the company projected that 350 people would be employed after completion. The land was already owned by Asankragua.

On 1 March 2018, the government agency offered to grant a sum amounting to 25% of the factory’s construction cost to a maximum of GH¢13 million. The grant aid was to be advanced on completion and would be repayable on demand if total employment at the factory fell below 300 people within 5 years of completion.

At the financial year end, 31 March 2018, Asankragua had accepted the offer of grant aid and had signed contracts for the construction of the factory at a total cost of GH¢52 million. Construction work was due to commence on 1 April 2018.

By 31 March 2019, the factory had been completed on budget, 400 people were employed ready to commence manufacturing activities, and the government agency agreed that the conditions necessary for the drawdown of the grant had been met.

On 1 April 2019, the factory was brought into use. It was estimated that it would have a ten-year useful economic life. On 1 June 2019, the government agency paid over the agreed GH¢13 million. In addition, the company sought and was paid an employment grant of GH¢1.2 million as employment exceeded original projections. This is expected to be payable annually for 5 years in total, at a rate of GH¢12,000 per additional person employed over 300 in each year. There are no repayment provisions attached to the employment grant.

The directors of Asankragua expect employment levels to exceed 350 people for at least 4 further years from 31 March 2020.

Required:
Demonstrate, showing calculations and relevant entries, how Asankragua Ltd should record the above transactions and events in its financial statements for years ended 31 March 2018, 2019, and 2020.

Year ended 31 March 2018:
No accounting entry is made in this financial year, as no transaction has yet been entered into. A capital commitment exists and should be disclosed in the notes. The grant approval should be disclosed also.

Year ended 31 March 2019:
At this date, the factory should be recorded at its cost of GH¢52 million. As all conditions for the payment of the grant have been met, recognition should be made of this amount receivable also. As the factory has not yet been brought into use, no depreciation will be charged for the year. Similarly, no amortisation of the grant will take place in the period.

Recognition of factory:
Dr Property, plant & equipment: GH¢52 million
Cr Cash: GH¢52 million (New factory constructed at a cost of GH¢52 million)

Recognition of grant:
Option 1:
Dr Government grant receivable (current asset): GH¢13 million
Cr Property, plant & equipment: GH¢13 million (Government grant approved, not received yet)

Option 2:
Dr Government grant receivable (current asset): GH¢13 million
Cr Deferred income – current liability: GH¢1.3 million
Cr Deferred income – non-current liability: GH¢11.7 million (Government grant approved, not received yet)

Year ended 31 March 2020:
There are several transactions to record based on the new factory. These are (1) depreciation and (2) amortisation of the grant. In addition, the cash was received from the government agency.

Receipt of grant:
Dr Cash: GH¢13 million
Cr Government grant receivable: GH¢13 million (Receipt of cash grant from government agency)

Option 1 (Depreciation of factory):
Dr Profit or loss: GH¢3.9 million
Cr Accumulated Depreciation – PPE: GH¢3.9 million (Depreciation of the cost of factory net of grant over 10 years)

Option 2 (Depreciation of factory):
Dr Profit or loss: GH¢5.2 million
Cr Accumulated Depreciation – PPE: GH¢5.2 million (Depreciation of gross factory cost over 10 years)

Amortisation of grant:
Dr Deferred income: GH¢1.3 million
Cr Profit or loss: GH¢1.3 million (Amortization of grant over 10 years, reflecting the proportional expensing of the factory to which the grant relates)

The employment grant relates entirely to the cost of employing staff in that year. Hence it should be entirely recognized as income in the year ended 31 March 2020.

Recognition of employment grant:
Dr Cash: GH¢1.2 million
Cr Profit or loss: GH¢1.2 million (Recognition of employment grant as income as received)

Initial recognition of the factory in 2019: 1 mark
Page 19 of 28
Recognition of the grant in 2019: 2 marks
Treatment of receipt of grant in 2020: 2 marks
Depreciation of factory in 2020: 1 mark
Treatment of amortization of grant: 1.5 marks
Recognition of employment grant: 1.5 marks

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  • 9 Marks

CR – May 2020 – L3 – Q2a – Government Grants for Factory Construction

Discuss the accounting treatment for a government grant received for the construction of a factory, showing calculations and relevant entries.

On 1 January 2018, Asankragua Ltd (Asankragua) applied to a government agency for a grant to assist with the construction of a factory in Enchi. The proposed construction cost of the factory was GH¢52 million and the company projected that 350 people would be employed after completion. The land was already owned by Asankragua.

On 1 March 2018, the government agency offered to grant a sum amounting to 25% of the factory’s construction cost to a maximum of GH¢13 million. The grant aid was to be advanced on completion and would be repayable on demand if total employment at the factory fell below 300 people within 5 years of completion.

At the financial year end, 31 March 2018, Asankragua had accepted the offer of grant aid and had signed contracts for the construction of the factory at a total cost of GH¢52 million. Construction work was due to commence on 1 April 2018.

By 31 March 2019, the factory had been completed on budget, 400 people were employed ready to commence manufacturing activities, and the government agency agreed that the conditions necessary for the drawdown of the grant had been met.

On 1 April 2019, the factory was brought into use. It was estimated that it would have a ten-year useful economic life. On 1 June 2019, the government agency paid over the agreed GH¢13 million. In addition, the company sought and was paid an employment grant of GH¢1.2 million as employment exceeded original projections. This is expected to be payable annually for 5 years in total, at a rate of GH¢12,000 per additional person employed over 300 in each year. There are no repayment provisions attached to the employment grant.

The directors of Asankragua expect employment levels to exceed 350 people for at least 4 further years from 31 March 2020.

Required:
Demonstrate, showing calculations and relevant entries, how Asankragua Ltd should record the above transactions and events in its financial statements for years ended 31 March 2018, 2019, and 2020.

Year ended 31 March 2018:
No accounting entry is made in this financial year, as no transaction has yet been entered into. A capital commitment exists and should be disclosed in the notes. The grant approval should be disclosed also.

Year ended 31 March 2019:
At this date, the factory should be recorded at its cost of GH¢52 million. As all conditions for the payment of the grant have been met, recognition should be made of this amount receivable also. As the factory has not yet been brought into use, no depreciation will be charged for the year. Similarly, no amortisation of the grant will take place in the period.

Recognition of factory:
Dr Property, plant & equipment: GH¢52 million
Cr Cash: GH¢52 million (New factory constructed at a cost of GH¢52 million)

Recognition of grant:
Option 1:
Dr Government grant receivable (current asset): GH¢13 million
Cr Property, plant & equipment: GH¢13 million (Government grant approved, not received yet)

Option 2:
Dr Government grant receivable (current asset): GH¢13 million
Cr Deferred income – current liability: GH¢1.3 million
Cr Deferred income – non-current liability: GH¢11.7 million (Government grant approved, not received yet)

Year ended 31 March 2020:
There are several transactions to record based on the new factory. These are (1) depreciation and (2) amortisation of the grant. In addition, the cash was received from the government agency.

Receipt of grant:
Dr Cash: GH¢13 million
Cr Government grant receivable: GH¢13 million (Receipt of cash grant from government agency)

Option 1 (Depreciation of factory):
Dr Profit or loss: GH¢3.9 million
Cr Accumulated Depreciation – PPE: GH¢3.9 million (Depreciation of the cost of factory net of grant over 10 years)

Option 2 (Depreciation of factory):
Dr Profit or loss: GH¢5.2 million
Cr Accumulated Depreciation – PPE: GH¢5.2 million (Depreciation of gross factory cost over 10 years)

Amortisation of grant:
Dr Deferred income: GH¢1.3 million
Cr Profit or loss: GH¢1.3 million (Amortization of grant over 10 years, reflecting the proportional expensing of the factory to which the grant relates)

The employment grant relates entirely to the cost of employing staff in that year. Hence it should be entirely recognized as income in the year ended 31 March 2020.

Recognition of employment grant:
Dr Cash: GH¢1.2 million
Cr Profit or loss: GH¢1.2 million (Recognition of employment grant as income as received)

Initial recognition of the factory in 2019: 1 mark
Page 19 of 28
Recognition of the grant in 2019: 2 marks
Treatment of receipt of grant in 2020: 2 marks
Depreciation of factory in 2020: 1 mark
Treatment of amortization of grant: 1.5 marks
Recognition of employment grant: 1.5 marks

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  • 5 Marks

CR – May 2020 – L3 – Q2b – Capitalization of Borrowing Costs

Dompoase Ltd incurred the following borrowing costs during the financial year 2018:

GH¢’000
Overdraft interest 12
Foreign currency loan interest (correctly translated into GH¢) 84
Foreign currency loan exchange differences on capital 140

In addition, a three-year fixed-rate GH¢2 million loan was taken out on 1 January 2018 at 6.5%. A loan set-up fee was charged at GH¢20,000. This increased the effective interest rate on the loan to 6.88%.

Required:
Determine the maximum amount that could potentially be capitalized as borrowing costs during the period (assuming an asset was being financed using all available finance).

 

 

GH¢’000
Overdraft 12
Foreign currency loan interest 84
Foreign currency loan exchange differences on capital –
Effective interest on loan ((2,000 – 20) x 6.88%) 136.2

The maximum amount to capitalize is GH¢232.2k.

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  • 5 Marks

CR – May 2020 – L3 – Q2b – Capitalization of Borrowing Costs

Dompoase Ltd incurred the following borrowing costs during the financial year 2018:

GH¢’000
Overdraft interest 12
Foreign currency loan interest (correctly translated into GH¢) 84
Foreign currency loan exchange differences on capital 140

In addition, a three-year fixed-rate GH¢2 million loan was taken out on 1 January 2018 at 6.5%. A loan set-up fee was charged at GH¢20,000. This increased the effective interest rate on the loan to 6.88%.

Required:
Determine the maximum amount that could potentially be capitalized as borrowing costs during the period (assuming an asset was being financed using all available finance).

 

 

GH¢’000
Overdraft 12
Foreign currency loan interest 84
Foreign currency loan exchange differences on capital –
Effective interest on loan ((2,000 – 20) x 6.88%) 136.2

The maximum amount to capitalize is GH¢232.2k.

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  • 20 Marks

CR – May 2020 – L3 – Q2c – Defined Benefit Pension Plan

Recommend the accounting treatment for a defined benefit pension plan with supporting calculations.

Nzema prepares its financial statements in accordance with International Financial Reporting Standards (IFRS) with a financial year end of 31 December 2018. On 1 January 2018, Nzema commenced a defined benefit pension plan for a number of head office employees. Under the pension scheme, Nzema has an obligation to provide these staff with agreed post-employment benefits. Nzema carries the actuarial and investment risk associated with the pension scheme.

The following information has been compiled from workings by Nzema’s accounting staff and actuarial reports for the 2018 financial year:

GH¢
Interest income on plan assets 16,500
Employer contributions to plan 550,000
Current service cost 600,000
Interest on plan liability 18,000
Fair value of plan assets at 31/12/2018 580,000
Present value of plan obligation at 31/12/2018 620,000

The Accountant was not sure which accounting standard to apply when accounting for the pension scheme. The only adjustment made to account for the scheme was to expense the company’s contributions of GH¢550,000 for the 2018 financial year in the Statement of Profit or Loss and Other Comprehensive Income and to credit the ‘Cash’ account.

Required:
Recommend, with appropriate calculations, the necessary accounting treatment for this accounting issue.

The applicable accounting standard is IAS 19: Employee Benefits. Nzema’s pension plan is a defined benefit plan since Nzema has an obligation to provide agreed post-employment benefits and carries the actuarial and investment risk.

The employer contributions were accounted for incorrectly. Under IAS 19, a defined benefit liability (or asset) is recognized on the balance sheet as the present value of the defined benefit obligation minus the fair value of plan assets.

Workings – Calculation of Actuarial Gain/Loss:

Pension Asset:

Description GH¢
Opening balance 0
Return on assets 16,500
Employer contributions 550,000
Remeasurement – Actuarial Gain 13,500
Closing balance (31/12/2018) 580,000

Pension Liability:

Description GH¢
Opening balance 0
Interest Cost 18,000
Current Service Cost 600,000
Remeasurement – Actuarial Loss 2,000
Closing balance (31/12/2018) 620,000

Net Actuarial Gain:
GH¢13,500 (gain on pension assets) – GH¢2,000 (loss on pension liabilities) = GH¢11,500

Journal Entries:

  1. Net Interest Expense (Profit or Loss):
    Dr Net Interest Expense (Profit or Loss) GH¢1,500
    Cr Pension Liability GH¢1,500
    (Net interest expense: 18,000 – 16,500)
  2. Current Service Cost (Profit or Loss):
    Dr Current Service Cost GH¢600,000
    Cr Pension Liability GH¢600,000
    (Recognition of current service cost)
  3. Actuarial Gain (Other Comprehensive Income):
    Dr Pension Liability GH¢11,500
    Cr Remeasurement – Actuarial Gain (Other Comprehensive Income) GH¢11,500
    (Recognition of actuarial gain)
  4. Correction of Previous Accounting Treatment:
    Dr Pension Liability GH¢550,000
    Cr Pension Contribution Expense (Profit or Loss) GH¢550,000
    (Correcting previous entry where contributions were expensed)
  5. Identification of the appropriate standard to be applied: 1 mark
    Net interest expense to Profit or Loss: 1 mark
    Actuarial gain on pension asset: 1 mark
    Actuarial loss on pension liability: 1 mark
    Net actuarial gain to OCI: 1 mark
    Currents service cost: 1 mark
    (Total: 20 marks)

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  • 20 Marks

CR – May 2020 – L3 – Q2c – Defined Benefit Pension Plan

Recommend the accounting treatment for a defined benefit pension plan with supporting calculations.

Nzema prepares its financial statements in accordance with International Financial Reporting Standards (IFRS) with a financial year end of 31 December 2018. On 1 January 2018, Nzema commenced a defined benefit pension plan for a number of head office employees. Under the pension scheme, Nzema has an obligation to provide these staff with agreed post-employment benefits. Nzema carries the actuarial and investment risk associated with the pension scheme.

The following information has been compiled from workings by Nzema’s accounting staff and actuarial reports for the 2018 financial year:

GH¢
Interest income on plan assets 16,500
Employer contributions to plan 550,000
Current service cost 600,000
Interest on plan liability 18,000
Fair value of plan assets at 31/12/2018 580,000
Present value of plan obligation at 31/12/2018 620,000

The Accountant was not sure which accounting standard to apply when accounting for the pension scheme. The only adjustment made to account for the scheme was to expense the company’s contributions of GH¢550,000 for the 2018 financial year in the Statement of Profit or Loss and Other Comprehensive Income and to credit the ‘Cash’ account.

Required:
Recommend, with appropriate calculations, the necessary accounting treatment for this accounting issue.

The applicable accounting standard is IAS 19: Employee Benefits. Nzema’s pension plan is a defined benefit plan since Nzema has an obligation to provide agreed post-employment benefits and carries the actuarial and investment risk.

The employer contributions were accounted for incorrectly. Under IAS 19, a defined benefit liability (or asset) is recognized on the balance sheet as the present value of the defined benefit obligation minus the fair value of plan assets.

Workings – Calculation of Actuarial Gain/Loss:

Pension Asset:

Description GH¢
Opening balance 0
Return on assets 16,500
Employer contributions 550,000
Remeasurement – Actuarial Gain 13,500
Closing balance (31/12/2018) 580,000

Pension Liability:

Description GH¢
Opening balance 0
Interest Cost 18,000
Current Service Cost 600,000
Remeasurement – Actuarial Loss 2,000
Closing balance (31/12/2018) 620,000

Net Actuarial Gain:
GH¢13,500 (gain on pension assets) – GH¢2,000 (loss on pension liabilities) = GH¢11,500

Journal Entries:

  1. Net Interest Expense (Profit or Loss):
    Dr Net Interest Expense (Profit or Loss) GH¢1,500
    Cr Pension Liability GH¢1,500
    (Net interest expense: 18,000 – 16,500)
  2. Current Service Cost (Profit or Loss):
    Dr Current Service Cost GH¢600,000
    Cr Pension Liability GH¢600,000
    (Recognition of current service cost)
  3. Actuarial Gain (Other Comprehensive Income):
    Dr Pension Liability GH¢11,500
    Cr Remeasurement – Actuarial Gain (Other Comprehensive Income) GH¢11,500
    (Recognition of actuarial gain)
  4. Correction of Previous Accounting Treatment:
    Dr Pension Liability GH¢550,000
    Cr Pension Contribution Expense (Profit or Loss) GH¢550,000
    (Correcting previous entry where contributions were expensed)
  5. Identification of the appropriate standard to be applied: 1 mark
    Net interest expense to Profit or Loss: 1 mark
    Actuarial gain on pension asset: 1 mark
    Actuarial loss on pension liability: 1 mark
    Net actuarial gain to OCI: 1 mark
    Currents service cost: 1 mark
    (Total: 20 marks)

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  • 10 Marks

CR – May 2020 – L3 – Q3a – Foreign Currency Transactions

Foreign currency transactions related to purchases, sales, and investment property with exchange rate variations and reporting implications.

Medina Power Ltd has carried out certain transactions denominated in foreign currency during its financial year ended 31 October 2019 and has also conducted foreign operations through a foreign entity. Medina Power Ltd.’s functional and presentation currency is the cedi.

On 31 July 2019, Medina Power Ltd purchased goods from a foreign supplier for 16 million dinars. At 31 October 2019, the supplier had not yet been paid and the goods were still held in inventory by Medina Power Ltd.

On 31 July, Medina Power Ltd sold goods to a foreign customer for 8 million dinars, and it received payment for the goods in dinars on 31 October 2019.

Medina Power Ltd had also purchased an investment property on 1 November 2018 for 56 million dinars. At 31 October 2019, the investment property had a fair value of 48 million dinars. The company uses the fair value model in accounting for investment properties.

Medina Power Ltd wants advice on how to treat these transactions in the financial statements for the year ended 31 October 2019.

question table

Required:
Discuss the accounting treatment of the above transactions in accordance with the advice required by the directors. (You should show detailed workings as well as a discussion of the accounting treatment used.)

 

Inventory and payable

  • The inventory and trade payable would be recorded initially at GH¢10 million (16 million dinars x GH¢0.6250).
  • At the year-end on 31 October 2019, the amount payable is still outstanding. It should be re-translated at the closing rate to GH¢12.3 million (16 million dinars x GH¢0.7692).
  • This creates an exchange loss of GH¢2.3 million (12.3 – 10) which should be recognized in profit or loss.
  • Unless it has been impaired, the inventory (a non-monetary asset) should be recorded at GH¢10 million at the year-end.

Sale of goods

  • The sale of goods should be recorded at GH¢5 million (8 million dinars x GH¢0.6250) as revenue and as a trade receivable.
  • Payment in dinars was received on 31 October 2019 and the actual cedi value of the dinars received was GH¢6.2 million (8 million dinars x GH¢0.7692).
  • This creates a gain on exchange of GH¢1.2 million (6.2 – 5) which should be recognized in profit or loss.

Investment property

  • The investment property should be recognized on 1 November 2018 at GH¢40 million (56 million dinars x GH¢0.7143).
  • At the year-end on 31 October 2019, the property should be recognized at its fair value of GH¢36.9 million (48 million dinars x GH¢0.7692).
  • The fall in fair value (40 – 36.9 = 3.1) should be recognized in profit and loss as a loss on investment property.
  • The property is a non-monetary asset and when a gain or loss on a non-monetary item is recognized in profit or loss, the element of the gain or loss relating to exchange rates is also recognized in profit or loss.

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  • 10 Marks

CR – May 2020 – L3 – Q3a – Foreign Currency Transactions

Foreign currency transactions related to purchases, sales, and investment property with exchange rate variations and reporting implications.

Medina Power Ltd has carried out certain transactions denominated in foreign currency during its financial year ended 31 October 2019 and has also conducted foreign operations through a foreign entity. Medina Power Ltd.’s functional and presentation currency is the cedi.

On 31 July 2019, Medina Power Ltd purchased goods from a foreign supplier for 16 million dinars. At 31 October 2019, the supplier had not yet been paid and the goods were still held in inventory by Medina Power Ltd.

On 31 July, Medina Power Ltd sold goods to a foreign customer for 8 million dinars, and it received payment for the goods in dinars on 31 October 2019.

Medina Power Ltd had also purchased an investment property on 1 November 2018 for 56 million dinars. At 31 October 2019, the investment property had a fair value of 48 million dinars. The company uses the fair value model in accounting for investment properties.

Medina Power Ltd wants advice on how to treat these transactions in the financial statements for the year ended 31 October 2019.

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Required:
Discuss the accounting treatment of the above transactions in accordance with the advice required by the directors. (You should show detailed workings as well as a discussion of the accounting treatment used.)

 

Inventory and payable

  • The inventory and trade payable would be recorded initially at GH¢10 million (16 million dinars x GH¢0.6250).
  • At the year-end on 31 October 2019, the amount payable is still outstanding. It should be re-translated at the closing rate to GH¢12.3 million (16 million dinars x GH¢0.7692).
  • This creates an exchange loss of GH¢2.3 million (12.3 – 10) which should be recognized in profit or loss.
  • Unless it has been impaired, the inventory (a non-monetary asset) should be recorded at GH¢10 million at the year-end.

Sale of goods

  • The sale of goods should be recorded at GH¢5 million (8 million dinars x GH¢0.6250) as revenue and as a trade receivable.
  • Payment in dinars was received on 31 October 2019 and the actual cedi value of the dinars received was GH¢6.2 million (8 million dinars x GH¢0.7692).
  • This creates a gain on exchange of GH¢1.2 million (6.2 – 5) which should be recognized in profit or loss.

Investment property

  • The investment property should be recognized on 1 November 2018 at GH¢40 million (56 million dinars x GH¢0.7143).
  • At the year-end on 31 October 2019, the property should be recognized at its fair value of GH¢36.9 million (48 million dinars x GH¢0.7692).
  • The fall in fair value (40 – 36.9 = 3.1) should be recognized in profit and loss as a loss on investment property.
  • The property is a non-monetary asset and when a gain or loss on a non-monetary item is recognized in profit or loss, the element of the gain or loss relating to exchange rates is also recognized in profit or loss.

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  • 5 Marks

CR – May 2020 – Q3b(i) – Ethical Issues in Contract Bidding

This question requires a discussion on the ethical issues related to conflict of interest, confidentiality, and professional behavior in a contract bidding scenario.

You have just obtained your full membership with the Institute of Chartered Accountants (Ghana). Following this successful achievement, you have been appointed as the Head of Finance at Asasiyemedeh Company Limited, a Ghanaian company, which provides catering services. Your former employer, Akwaba Limited, is a large public sector organization operating in Accra, where, as the Financial Accountant, you had the opportunity to work on areas relating to financial accounting, procurement, contracts, and bids. One of Asasiyemedeh Company Limited’s major contracts is with Akwaba Limited, your former employer. The contract is now due for renewal, and Asasiyemedeh Company Limited is preparing a competitive bid for this contract.

You have been tasked to lead the team responsible for bidding for this contract, but you are concerned as a professional that you might breach confidentiality if you accept this role. You also suspect that your knowledge and experience of Akwaba Limited were seen as good reasons for appointing you to the position of Head of Finance at Asasiyemedeh Company Limited. You do not in any way want to let your new employer down as you are aware that the loss of such a major contract would have a significant effect on the financial performance of Asasiyemedeh Company Limited, and its performance-related bonus scheme for management members.

Required:
Discuss the ethical issues raised in the above scenario.

The ethical issues raised in the scenario include:

  1. Objectivity:
    There is a self-interest threat that arises due to the impact that losing Akwaba Limited’s contract would have on Asasiyemedeh Company Limited’s financial performance and reward policy. There is also an intimidation threat because other employees in the company may be affected by the financial implications of the contract not being renewed. Additionally, you may feel a strong desire to impress your new employer by helping to secure the renewal of the contract. The key question is whether you can safeguard against the self-interest threat posed by Asasiyemedeh Company Limited’s performance-related bonus scheme.
  2. Confidentiality:
    Clearly, there is a confidentiality threat here as you have worked with Akwaba Ltd in the past. Your previous employment with Akwaba Ltd has provided you with information which may be of value to Asasiyemedeh Company Limited. The principle of confidentiality prohibits the use of confidential information acquired as a result of your previous employment for your advantage or that of your current employer. While you have a responsibility to advance the legitimate aims of your employing organization, this should not extend to a breach of confidentiality. In this case, you (because of Asasiyemedeh Company Limited’s performance-related bonus) and Asasiyemedeh Company Limited stand to benefit from the confidential information about how bids are assessed at Akwaba Ltd. The principle would not be breached if you were in possession of information that was in the public domain, or if you were simply to use experience gained in your previous employment, so long as you do not use confidential knowledge that you acquired as a result of that employment.                           If you accept this role, can you ensure that you do not use confidential information relating to your former employer to your advantage or to the advantage of your current employer? You must be careful and professional as winning that contracts may leads to confidential breaches against you or your current employers perhaps from those bidders of the same contracts who might lose the bids
  3. Professional Behavior:
    You must demonstrate professionalism here. For example, what can you do to safeguard your reputation as a professional, the reputation of your employer, and the accountancy profession to which you belong? You must consider the Institute of Chartered Accountants (Ghana) code of ethics, applicable laws (procurement Act 914), and regulations, your current and previous contracts of employment, and your employer’s policies and procedures.

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  • 5 Marks

CR – May 2020 – Q3b(i) – Ethical Issues in Contract Bidding

This question requires a discussion on the ethical issues related to conflict of interest, confidentiality, and professional behavior in a contract bidding scenario.

You have just obtained your full membership with the Institute of Chartered Accountants (Ghana). Following this successful achievement, you have been appointed as the Head of Finance at Asasiyemedeh Company Limited, a Ghanaian company, which provides catering services. Your former employer, Akwaba Limited, is a large public sector organization operating in Accra, where, as the Financial Accountant, you had the opportunity to work on areas relating to financial accounting, procurement, contracts, and bids. One of Asasiyemedeh Company Limited’s major contracts is with Akwaba Limited, your former employer. The contract is now due for renewal, and Asasiyemedeh Company Limited is preparing a competitive bid for this contract.

You have been tasked to lead the team responsible for bidding for this contract, but you are concerned as a professional that you might breach confidentiality if you accept this role. You also suspect that your knowledge and experience of Akwaba Limited were seen as good reasons for appointing you to the position of Head of Finance at Asasiyemedeh Company Limited. You do not in any way want to let your new employer down as you are aware that the loss of such a major contract would have a significant effect on the financial performance of Asasiyemedeh Company Limited, and its performance-related bonus scheme for management members.

Required:
Discuss the ethical issues raised in the above scenario.

The ethical issues raised in the scenario include:

  1. Objectivity:
    There is a self-interest threat that arises due to the impact that losing Akwaba Limited’s contract would have on Asasiyemedeh Company Limited’s financial performance and reward policy. There is also an intimidation threat because other employees in the company may be affected by the financial implications of the contract not being renewed. Additionally, you may feel a strong desire to impress your new employer by helping to secure the renewal of the contract. The key question is whether you can safeguard against the self-interest threat posed by Asasiyemedeh Company Limited’s performance-related bonus scheme.
  2. Confidentiality:
    Clearly, there is a confidentiality threat here as you have worked with Akwaba Ltd in the past. Your previous employment with Akwaba Ltd has provided you with information which may be of value to Asasiyemedeh Company Limited. The principle of confidentiality prohibits the use of confidential information acquired as a result of your previous employment for your advantage or that of your current employer. While you have a responsibility to advance the legitimate aims of your employing organization, this should not extend to a breach of confidentiality. In this case, you (because of Asasiyemedeh Company Limited’s performance-related bonus) and Asasiyemedeh Company Limited stand to benefit from the confidential information about how bids are assessed at Akwaba Ltd. The principle would not be breached if you were in possession of information that was in the public domain, or if you were simply to use experience gained in your previous employment, so long as you do not use confidential knowledge that you acquired as a result of that employment.                           If you accept this role, can you ensure that you do not use confidential information relating to your former employer to your advantage or to the advantage of your current employer? You must be careful and professional as winning that contracts may leads to confidential breaches against you or your current employers perhaps from those bidders of the same contracts who might lose the bids
  3. Professional Behavior:
    You must demonstrate professionalism here. For example, what can you do to safeguard your reputation as a professional, the reputation of your employer, and the accountancy profession to which you belong? You must consider the Institute of Chartered Accountants (Ghana) code of ethics, applicable laws (procurement Act 914), and regulations, your current and previous contracts of employment, and your employer’s policies and procedures.

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  • 5 Marks

CR – May 2020 – Q3b(ii) – Ethical Actions in Contract Bidding

This question requires recommendations for maintaining ethical standards in a contract bidding situation involving a conflict of interest.

Recommend the possible courses of action that you will take in order to be ethically responsible as expected from a Professional Accountant.

 

Possible courses of action

  • You should discuss the situation and your obligations with your managing director in the first place and, ask for your involvement in the preparation of the contract bid to be limited. For example, you may be able to contribute to aspects of the bid that do not in any way require you to refer to confidential knowledge about your previous employment with Akwaba Ltd.
  • If the managing director fails to understand the conflict that you are facing, probably he is not in your profession, you should request that you both discuss the matter with the board chairman or another member of staff. During these discussions, you should refer to the company’s ethical code, if it has one, as well as that of the Institute of Chartered Accountants (Ghana).
  • If there are no other formal channels available, you should make the entire board aware of your dilemma by writing formally to them. If necessary, you must refuse to take part in the bid without necessary safeguards being implemented.
  • Ultimately, disassociating yourself from Asasiyemedeh Company Limited may be the only solution. However, before taking such a step, you should seek legal advice on your employment.
  • Rights and responsibilities (subject to the rules and guidance of the Institute of Chartered Accountants, (Ghana)).
  • You should document, in detail, the steps that you take in resolving your dilemma, in case your ethical judgment is challenged in future periods.
  • Looking at this issue from Asasiyemedeh Company Limited’s perspective, it may be appropriate to suggest to the managing director or the board of your employer that a policy on conflicts of interest be developed and that the remuneration and bonus policy be reviewed in light of this contract bid with Akwaba Ltd.

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  • 5 Marks

CR – May 2020 – Q3b(ii) – Ethical Actions in Contract Bidding

This question requires recommendations for maintaining ethical standards in a contract bidding situation involving a conflict of interest.

Recommend the possible courses of action that you will take in order to be ethically responsible as expected from a Professional Accountant.

 

Possible courses of action

  • You should discuss the situation and your obligations with your managing director in the first place and, ask for your involvement in the preparation of the contract bid to be limited. For example, you may be able to contribute to aspects of the bid that do not in any way require you to refer to confidential knowledge about your previous employment with Akwaba Ltd.
  • If the managing director fails to understand the conflict that you are facing, probably he is not in your profession, you should request that you both discuss the matter with the board chairman or another member of staff. During these discussions, you should refer to the company’s ethical code, if it has one, as well as that of the Institute of Chartered Accountants (Ghana).
  • If there are no other formal channels available, you should make the entire board aware of your dilemma by writing formally to them. If necessary, you must refuse to take part in the bid without necessary safeguards being implemented.
  • Ultimately, disassociating yourself from Asasiyemedeh Company Limited may be the only solution. However, before taking such a step, you should seek legal advice on your employment.
  • Rights and responsibilities (subject to the rules and guidance of the Institute of Chartered Accountants, (Ghana)).
  • You should document, in detail, the steps that you take in resolving your dilemma, in case your ethical judgment is challenged in future periods.
  • Looking at this issue from Asasiyemedeh Company Limited’s perspective, it may be appropriate to suggest to the managing director or the board of your employer that a policy on conflicts of interest be developed and that the remuneration and bonus policy be reviewed in light of this contract bid with Akwaba Ltd.

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  • 6 Marks

CR – May 2020 – Q4a – Capital Reduction Account

This question requires the preparation of a Capital Reduction Account for Sasasila Ltd following a reorganization.

Sasasila Ltd has been operating profitably for a number of years. However, in recent times, the company has been making losses. Below is the statement of financial position as at 30 June 2019:

Assets GH¢000
Non-Current Assets
Patents and copyrights 75,000
Land and buildings (net) 200,000
Plant and machinery (net) 150,000
Current Assets
Inventories 125,000
Trade receivables 125,000
Bank 37,500
Investments (cost) 100,000
Total Assets 812,500
Equity and liabilities:
Equity
Ordinary share capital (issued at GH¢10 each) 375,000
20% cumulative preference shares (issued at GH¢10 each) 175,000
Retained earnings (75,000)
Non-current Liabilities
15% Debentures 125,000
Current Liabilities
Interest on debentures 18,750
Trade payables 93,750
Provision for business restructuring 50,000
Provision for legal damages & claims 12,500
Provision for warranties 37,500
Total Equity and Liabilities 812,500

Additional relevant information: The following scheme of reconstruction was approved by all parties as well as the High Court with the exception of only one ordinary shareholder:

  1. The ordinary shares were to be reduced to GH¢5 per share.
  2. The preference shares were to be reduced to GH¢7.5 per share and arrears in dividends for three years were to be canceled from the company’s books.
  3. The fair values of the assets were agreed at the following values:
    • Patents and copyrights: Nil
    • Land and buildings: GH¢225,000
    • Plant and machinery: GH¢75,000
    • Investments: GH¢75,000
    • Inventories: GH¢105,000
    • Trade receivables: GH¢70,000
  4. The balance on retained earnings is to be eliminated in full.
  5. The liability for legal damages and claims was to be settled for GH¢10 million, and the provision for warranties reduced to GH¢27.5 million.
  6. The accrued debenture interest was to be paid in cash.
  7. Investments with a carrying amount of GH¢52.5 million were to be sold for cash at that value to strengthen the working capital position.
  8. The amount set aside for business restructuring was to be eliminated as well.
  9. The High Court directed a payment of GH¢0.2 million to a member who opposed the scheme for 50 ordinary shares held by him.

Prepare the Capital Reduction Account as at 30 June 2019.

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  • 6 Marks

CR – May 2020 – Q4a – Capital Reduction Account

This question requires the preparation of a Capital Reduction Account for Sasasila Ltd following a reorganization.

Sasasila Ltd has been operating profitably for a number of years. However, in recent times, the company has been making losses. Below is the statement of financial position as at 30 June 2019:

Assets GH¢000
Non-Current Assets
Patents and copyrights 75,000
Land and buildings (net) 200,000
Plant and machinery (net) 150,000
Current Assets
Inventories 125,000
Trade receivables 125,000
Bank 37,500
Investments (cost) 100,000
Total Assets 812,500
Equity and liabilities:
Equity
Ordinary share capital (issued at GH¢10 each) 375,000
20% cumulative preference shares (issued at GH¢10 each) 175,000
Retained earnings (75,000)
Non-current Liabilities
15% Debentures 125,000
Current Liabilities
Interest on debentures 18,750
Trade payables 93,750
Provision for business restructuring 50,000
Provision for legal damages & claims 12,500
Provision for warranties 37,500
Total Equity and Liabilities 812,500

Additional relevant information: The following scheme of reconstruction was approved by all parties as well as the High Court with the exception of only one ordinary shareholder:

  1. The ordinary shares were to be reduced to GH¢5 per share.
  2. The preference shares were to be reduced to GH¢7.5 per share and arrears in dividends for three years were to be canceled from the company’s books.
  3. The fair values of the assets were agreed at the following values:
    • Patents and copyrights: Nil
    • Land and buildings: GH¢225,000
    • Plant and machinery: GH¢75,000
    • Investments: GH¢75,000
    • Inventories: GH¢105,000
    • Trade receivables: GH¢70,000
  4. The balance on retained earnings is to be eliminated in full.
  5. The liability for legal damages and claims was to be settled for GH¢10 million, and the provision for warranties reduced to GH¢27.5 million.
  6. The accrued debenture interest was to be paid in cash.
  7. Investments with a carrying amount of GH¢52.5 million were to be sold for cash at that value to strengthen the working capital position.
  8. The amount set aside for business restructuring was to be eliminated as well.
  9. The High Court directed a payment of GH¢0.2 million to a member who opposed the scheme for 50 ordinary shares held by him.

Prepare the Capital Reduction Account as at 30 June 2019.

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  • 14 Marks

CR – May 2020 – Q4b – Statement of Financial Position for Sasasila Ltd

This question requires the preparation of a statement of financial position for Sasasila Ltd following its restructuring.

Prepare the statement of financial position as at 31 December 2019 for Sasasila Ltd.

 

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  • 14 Marks

CR – May 2020 – Q4b – Statement of Financial Position for Sasasila Ltd

This question requires the preparation of a statement of financial position for Sasasila Ltd following its restructuring.

Prepare the statement of financial position as at 31 December 2019 for Sasasila Ltd.

 

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  • 20 Marks

CR – May 2020 – Q5 – Financial Performance and Position of Bossman Ltd

This question involves analyzing the financial performance and position of Bossman Ltd over three years using ratio analysis.

To: Managing Director, Gamashie Ltd
From: An Accountant
Date: 01/01/19
Subject: The Financial Position and Performance of Bossman Ltd

Introduction:

This report is based on the financial statements of Bossman Ltd for the years 2016, 2017, and 2018. It includes an analysis of the financial performance and position, with attention to key financial ratios calculated from the attached statements.

Financial Performance:

  • Revenue Growth: Bossman Ltd has experienced consistent revenue growth at approximately 5% per annum from GH¢18,000,000 in 2016 to GH¢19,845,000 in 2018.
  • Gross Profit Margin: The gross profit margin improved in 2017 but fell in 2018, indicating fluctuations in cost management. The margins were:
    • 2016: 42%
    • 2017: 45%
    • 2018: 40%
  • Operating Profit: Operating profit as a percentage of sales showed a similar trend to the gross profit margin. It increased from 25.5% in 2016 to 28.5% in 2017, before falling back to 25% in 2018. The decline in 2018 needs to be investigated to understand the reasons for the reduction.
  • Profit Before Tax (PBT): PBT decreased from GH¢3,882,000 in 2017 to GH¢3,909,000 in 2018, primarily due to increased finance costs. This indicates an increase in borrowing costs, which requires further investigation.

Financial Position:

  • Liquidity:
    • Current Ratio: The current ratio improved from 0.78 in 2016 to 1.05 in 2018, indicating better liquidity. However, it was below 1 in 2016 and 2017, suggesting that the company may have struggled to meet its short-term obligations during those years.
    • Quick Ratio: The quick ratio remained below 0.5 across all three years, highlighting potential issues with converting current assets (excluding inventory) into liquid assets. This indicates the company may be heavily reliant on inventory for liquidity.
  • Solvency:
    • Debt Ratio: The debt ratio increased steadily over the three years from 38.9% in 2016 to 43.2% in 2018, suggesting the company’s reliance on debt financing is increasing. This should be monitored, as it may impact the company’s financial flexibility.
  • Efficiency:
    • Receivables Collection Period: The collection period increased from 29.2 days in 2016 to 58.2 days in 2018. This could indicate deteriorating credit control or extended payment terms.
    • Inventory Turnover: Inventory turnover worsened, increasing from 62 days in 2016 to 122.6 days in 2018. This may indicate overstocking or slow-moving inventory, which ties up working capital.

Conclusion:

Bossman Ltd has shown consistent revenue growth but declining profitability. Liquidity has improved, but the quick ratio is concerning. The company’s growing reliance on debt and the extended receivables and inventory turnover periods should be investigated further to identify potential risks to financial stability.

Appendix – Ratio Analysis:

Ratios 2016 2017 2018
Gross Profit Margin 42% 45% 40%
Operating Profit Margin 25.5% 28.5% 25%
Return on Capital Employed 23.6% 27% 24.1%
Debt Ratio 38.9% 41.4% 43.2%
Current Ratio 0.78 0.86 1.05
Quick Ratio 0.36 0.40 0.47
Receivables Collection Period (days) 29.2 43.6 58.2
Inventory Turnover Period (days) 62 94 122.6

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  • 20 Marks

CR – May 2020 – Q5 – Financial Performance and Position of Bossman Ltd

This question involves analyzing the financial performance and position of Bossman Ltd over three years using ratio analysis.

To: Managing Director, Gamashie Ltd
From: An Accountant
Date: 01/01/19
Subject: The Financial Position and Performance of Bossman Ltd

Introduction:

This report is based on the financial statements of Bossman Ltd for the years 2016, 2017, and 2018. It includes an analysis of the financial performance and position, with attention to key financial ratios calculated from the attached statements.

Financial Performance:

  • Revenue Growth: Bossman Ltd has experienced consistent revenue growth at approximately 5% per annum from GH¢18,000,000 in 2016 to GH¢19,845,000 in 2018.
  • Gross Profit Margin: The gross profit margin improved in 2017 but fell in 2018, indicating fluctuations in cost management. The margins were:
    • 2016: 42%
    • 2017: 45%
    • 2018: 40%
  • Operating Profit: Operating profit as a percentage of sales showed a similar trend to the gross profit margin. It increased from 25.5% in 2016 to 28.5% in 2017, before falling back to 25% in 2018. The decline in 2018 needs to be investigated to understand the reasons for the reduction.
  • Profit Before Tax (PBT): PBT decreased from GH¢3,882,000 in 2017 to GH¢3,909,000 in 2018, primarily due to increased finance costs. This indicates an increase in borrowing costs, which requires further investigation.

Financial Position:

  • Liquidity:
    • Current Ratio: The current ratio improved from 0.78 in 2016 to 1.05 in 2018, indicating better liquidity. However, it was below 1 in 2016 and 2017, suggesting that the company may have struggled to meet its short-term obligations during those years.
    • Quick Ratio: The quick ratio remained below 0.5 across all three years, highlighting potential issues with converting current assets (excluding inventory) into liquid assets. This indicates the company may be heavily reliant on inventory for liquidity.
  • Solvency:
    • Debt Ratio: The debt ratio increased steadily over the three years from 38.9% in 2016 to 43.2% in 2018, suggesting the company’s reliance on debt financing is increasing. This should be monitored, as it may impact the company’s financial flexibility.
  • Efficiency:
    • Receivables Collection Period: The collection period increased from 29.2 days in 2016 to 58.2 days in 2018. This could indicate deteriorating credit control or extended payment terms.
    • Inventory Turnover: Inventory turnover worsened, increasing from 62 days in 2016 to 122.6 days in 2018. This may indicate overstocking or slow-moving inventory, which ties up working capital.

Conclusion:

Bossman Ltd has shown consistent revenue growth but declining profitability. Liquidity has improved, but the quick ratio is concerning. The company’s growing reliance on debt and the extended receivables and inventory turnover periods should be investigated further to identify potential risks to financial stability.

Appendix – Ratio Analysis:

Ratios 2016 2017 2018
Gross Profit Margin 42% 45% 40%
Operating Profit Margin 25.5% 28.5% 25%
Return on Capital Employed 23.6% 27% 24.1%
Debt Ratio 38.9% 41.4% 43.2%
Current Ratio 0.78 0.86 1.05
Quick Ratio 0.36 0.40 0.47
Receivables Collection Period (days) 29.2 43.6 58.2
Inventory Turnover Period (days) 62 94 122.6

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  • 4 Marks

FM – May 2020 – L2 – Q5c – Foreign exchange risk and currency risk management

Explain the differences between a foreign currency swap and an interest rate swap.

Explain FOUR (4) differences between a foreign currency swap and an interest rate swap.

A foreign currency swap and an interest rate swap are both financial derivatives used to manage risk, but they differ in the following ways:

  1. Nature of the Exchange:
    • Foreign Currency Swap: Involves exchanging principal and interest payments in one currency for equivalent principal and interest payments in another currency.
    • Interest Rate Swap: Involves exchanging interest payments on an agreed notional amount in the same currency. Typically, one party pays a fixed interest rate, while the other pays a floating interest rate.
  2. Purpose:
    • Foreign Currency Swap: Used to hedge or manage exposure to exchange rate fluctuations when dealing with multiple currencies.
    • Interest Rate Swap: Used to manage or hedge against interest rate risk, particularly the risk of changes in interest rates over time.
  3. Underlying Asset:
    • Foreign Currency Swap: The underlying asset is a currency.
    • Interest Rate Swap: The underlying asset is an interest rate, often tied to a benchmark like LIBOR.
  4. Usage:
    • Foreign Currency Swap: Commonly used by multinational companies with operations in different countries to manage currency exposure.
    • Interest Rate Swap: Commonly used by companies or financial institutions to stabilize interest payments and manage cash flow volatility.

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  • 4 Marks

FM – May 2020 – L2 – Q5c – Foreign exchange risk and currency risk management

Explain the differences between a foreign currency swap and an interest rate swap.

Explain FOUR (4) differences between a foreign currency swap and an interest rate swap.

A foreign currency swap and an interest rate swap are both financial derivatives used to manage risk, but they differ in the following ways:

  1. Nature of the Exchange:
    • Foreign Currency Swap: Involves exchanging principal and interest payments in one currency for equivalent principal and interest payments in another currency.
    • Interest Rate Swap: Involves exchanging interest payments on an agreed notional amount in the same currency. Typically, one party pays a fixed interest rate, while the other pays a floating interest rate.
  2. Purpose:
    • Foreign Currency Swap: Used to hedge or manage exposure to exchange rate fluctuations when dealing with multiple currencies.
    • Interest Rate Swap: Used to manage or hedge against interest rate risk, particularly the risk of changes in interest rates over time.
  3. Underlying Asset:
    • Foreign Currency Swap: The underlying asset is a currency.
    • Interest Rate Swap: The underlying asset is an interest rate, often tied to a benchmark like LIBOR.
  4. Usage:
    • Foreign Currency Swap: Commonly used by multinational companies with operations in different countries to manage currency exposure.
    • Interest Rate Swap: Commonly used by companies or financial institutions to stabilize interest payments and manage cash flow volatility.

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  • 13 Marks

FM – May 2020 – L2 – Q5b – Working Capital Management

Evaluate the impact of introducing credit sales on total profit before tax for a company and provide management advice.

Innovate Ghana Ltd is a dealer in household consumables in Ghana. It currently sells on a cash-only basis. The company’s current annual sales are GH¢10 million. The operating cost structure is as follows:

  • Cost of sales: 55% of sales
  • Staff cost: 10% of sales
  • Marketing and distribution cost: 15% of sales

Management in a meeting concluded that introducing credit sales will help boost sales in the light of the current tightness in liquidity in the market, the drive by other competitors, and pressure from the sales team.

It is projected that total sales will grow by 50% solely from the credit sales. The customers are offered 1-month credit, and a new credit department is set up to assess and monitor these credit sales. The monthly cost of running this credit department is GH¢20,000, and bad debts are expected to be 4% of the credit sales.

To finance this credit, Innovate Ghana Ltd will borrow at an interest rate of 25% per annum.

Required:

i) Calculate the total profit before tax before the introduction of the new policy.
(4 marks)

ii) Calculate the total profit before tax after the introduction of the new policy.
(6 marks)

iii) Advise management whether the initiative should be undertaken.
(3 marks)

i) Total Profit Before Tax Before the Introduction of the New Policy

Description Amount (GH¢)
Sales 10,000,000
Cost of Sales (55% of sales) (5,500,000)
Gross Profit 4,500,000
Staff Cost (10% of sales) (1,000,000)
Marketing & Distribution (1,500,000)
Net Profit Before Tax 2,000,000

(4 marks)

ii) Total Profit Before Tax After the Introduction of the New Policy

Description Amount (GH¢)
Sales (150% of 10 million) 15,000,000
Cost of Sales (55% of sales) (8,250,000)
Gross Profit 6,750,000
Staff Cost (10% of sales) (1,500,000)
Marketing & Distribution (2,250,000)
Credit Admin Cost (20,000 x 12) (240,000)
Bad Debts (4% of credit sales) (200,000)
Interest or Financing Cost (104,167)
Net Profit Before Tax 2,455,833

(6 marks)

iii) Management Advice

Profit before tax after the policy: GH¢2,455,833
Less: Profit before tax before the policy: GH¢2,000,000
Increase in Profit: GH¢455,833

The introduction of the credit sales policy has resulted in an incremental profit of GH¢455,833. Therefore, the initiative should be undertaken as it leads to higher profitability.

(3 marks)

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  • 13 Marks

FM – May 2020 – L2 – Q5b – Working Capital Management

Evaluate the impact of introducing credit sales on total profit before tax for a company and provide management advice.

Innovate Ghana Ltd is a dealer in household consumables in Ghana. It currently sells on a cash-only basis. The company’s current annual sales are GH¢10 million. The operating cost structure is as follows:

  • Cost of sales: 55% of sales
  • Staff cost: 10% of sales
  • Marketing and distribution cost: 15% of sales

Management in a meeting concluded that introducing credit sales will help boost sales in the light of the current tightness in liquidity in the market, the drive by other competitors, and pressure from the sales team.

It is projected that total sales will grow by 50% solely from the credit sales. The customers are offered 1-month credit, and a new credit department is set up to assess and monitor these credit sales. The monthly cost of running this credit department is GH¢20,000, and bad debts are expected to be 4% of the credit sales.

To finance this credit, Innovate Ghana Ltd will borrow at an interest rate of 25% per annum.

Required:

i) Calculate the total profit before tax before the introduction of the new policy.
(4 marks)

ii) Calculate the total profit before tax after the introduction of the new policy.
(6 marks)

iii) Advise management whether the initiative should be undertaken.
(3 marks)

i) Total Profit Before Tax Before the Introduction of the New Policy

Description Amount (GH¢)
Sales 10,000,000
Cost of Sales (55% of sales) (5,500,000)
Gross Profit 4,500,000
Staff Cost (10% of sales) (1,000,000)
Marketing & Distribution (1,500,000)
Net Profit Before Tax 2,000,000

(4 marks)

ii) Total Profit Before Tax After the Introduction of the New Policy

Description Amount (GH¢)
Sales (150% of 10 million) 15,000,000
Cost of Sales (55% of sales) (8,250,000)
Gross Profit 6,750,000
Staff Cost (10% of sales) (1,500,000)
Marketing & Distribution (2,250,000)
Credit Admin Cost (20,000 x 12) (240,000)
Bad Debts (4% of credit sales) (200,000)
Interest or Financing Cost (104,167)
Net Profit Before Tax 2,455,833

(6 marks)

iii) Management Advice

Profit before tax after the policy: GH¢2,455,833
Less: Profit before tax before the policy: GH¢2,000,000
Increase in Profit: GH¢455,833

The introduction of the credit sales policy has resulted in an incremental profit of GH¢455,833. Therefore, the initiative should be undertaken as it leads to higher profitability.

(3 marks)

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  • 3 Marks

FM – May 2020 – L2 – Q5a – Cash management

Explain three motives for holding cash.

Explain THREE (3) motives for holding cash.

Cash is held for various reasons. The three motives for holding cash are as follows:

  1. Transactionary Motive:
    This motive refers to holding cash to balance short-term cash needs for inflows and outflows. It ensures that the company can meet its day-to-day operations, such as paying suppliers, wages, and other operational expenses.
  2. Precautionary Motive:
    This motive refers to holding cash to meet contingent or unexpected cash needs as and when they occur. It acts as a buffer against unforeseen circumstances, such as emergencies or unexpected financial demands.
  3. Speculative Motive:
    This motive refers to holding cash to take advantage of investment opportunities as and when they arise. Companies may hold cash to invest in profitable ventures that may present themselves in the market.

(3 points explained for 3 marks)

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  • 3 Marks

FM – May 2020 – L2 – Q5a – Cash management

Explain three motives for holding cash.

Explain THREE (3) motives for holding cash.

Cash is held for various reasons. The three motives for holding cash are as follows:

  1. Transactionary Motive:
    This motive refers to holding cash to balance short-term cash needs for inflows and outflows. It ensures that the company can meet its day-to-day operations, such as paying suppliers, wages, and other operational expenses.
  2. Precautionary Motive:
    This motive refers to holding cash to meet contingent or unexpected cash needs as and when they occur. It acts as a buffer against unforeseen circumstances, such as emergencies or unexpected financial demands.
  3. Speculative Motive:
    This motive refers to holding cash to take advantage of investment opportunities as and when they arise. Companies may hold cash to invest in profitable ventures that may present themselves in the market.

(3 points explained for 3 marks)

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  • 20 Marks

FM – May 2020 – L2 – Q4 – Discounted cash flow | Introduction to Investment Appraisal

Calculate the NPV and payback periods for a project, and explain concepts related to market volatility and bull/bear markets.

Sabir Company is considering whether to invest in a project whose details are as follows.
The project will involve the purchase of equipment costing GH¢2,000,000. The equipment will be used to produce a range of products for which the following estimates have been made.

Incremental fixed costs are GH¢1,200,000 per annum. The sales prices allow for expected price increases over the period. However, cost estimates are based on current costs and do not allow for expected inflation in costs. Inflation is expected to be 3% per year for variable costs and 4% per year for fixed costs. The incremental fixed costs are all cash expenditure items. Tax on profits is at the rate of 30%, and tax is payable in the same year in which the liability arises.

Sabir Company uses a four-year project appraisal period, but it is expected that the equipment will continue to be operational and in use for several years after the end of the first four-year period.

The company’s cost of capital for investment appraisal purposes is 10%. Capital projects are expected to pay back within two years on a non-discounted basis and within three years on a discounted basis. Tax allowable depreciation will be available on the equipment at the rate of 25% per year on a reducing balance basis. Any balancing allowance or balancing charge is not attributed to a project unless the asset is actually disposed of at the end of the project period.

Required:

a) Calculate the net present value (NPV) of the project.
(11 marks)

b) To the nearest month, calculate the non-discounted payback period and the discounted payback period.
(4 marks)

c) Explain the meaning of market volatility in financial markets.
(3 marks)

d) Explain the difference between a bull and bear market.
(2 marks)

a) Workings
Year Written down value


Total Present Value of Net Cash Flows: GH¢2,786,000
Year 0 Capital Outlay: GH¢2,000,000
Project Four-Year NPV: GH¢786,000

b) Payback and Discounted Payback

Year Cash Flow (GH¢’000) Cumulative Cash Flow (GH¢’000) Discounted Cash Flow (GH¢’000) Cumulative Discounted Cash Flow (GH¢’000)
0 (2,000) (2,000) (2,000) (2,000)
1 279 (1,721) 254 (1,746)
2 974 (826) 805 (1,007)
3 1,546 720 1,161 154
4 828 1,548 566 720

Non-discounted Payback Period: 2 years + [(826/1,546) × 12] = 2 years 6 months
(2 marks)

Discounted Payback Period: 2 years + [(1,007/1,161) × 12] = 2 years 10 months
(2 marks)

c) Market Volatility Explanation:

Market volatility in financial markets is a measure of the extent to which the price of a financial security (such as a share’s market price), or a market as a whole, or an interest rate, or a currency, or a commodity changes over time. High volatility means rapid and large changes in a price or rate over a short period of time. Low volatility means smaller and less frequent price changes.

Volatility refers to price movements in both directions, up and down. If prices move over time always in the same direction (either up or down, but not both), this does not mean high volatility. Volatility implies uncertainty about the way that prices will move next, and by how much. High volatility creates high financial risk. Investors will want higher returns to invest in financial instruments where price volatility is high.
(3 marks)

d) Bull and Bear Markets Explanation:

In a bull market, prices on the whole move upwards continually over time. For example, in a bull stock market, share prices on the whole continue to rise over time.

In a bear market, prices on the whole move downwards continually over time. For example, in a bear stock market, share prices on the whole continue to fall over time.
(2 marks)

 

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  • 20 Marks

FM – May 2020 – L2 – Q4 – Discounted cash flow | Introduction to Investment Appraisal

Calculate the NPV and payback periods for a project, and explain concepts related to market volatility and bull/bear markets.

Sabir Company is considering whether to invest in a project whose details are as follows.
The project will involve the purchase of equipment costing GH¢2,000,000. The equipment will be used to produce a range of products for which the following estimates have been made.

Incremental fixed costs are GH¢1,200,000 per annum. The sales prices allow for expected price increases over the period. However, cost estimates are based on current costs and do not allow for expected inflation in costs. Inflation is expected to be 3% per year for variable costs and 4% per year for fixed costs. The incremental fixed costs are all cash expenditure items. Tax on profits is at the rate of 30%, and tax is payable in the same year in which the liability arises.

Sabir Company uses a four-year project appraisal period, but it is expected that the equipment will continue to be operational and in use for several years after the end of the first four-year period.

The company’s cost of capital for investment appraisal purposes is 10%. Capital projects are expected to pay back within two years on a non-discounted basis and within three years on a discounted basis. Tax allowable depreciation will be available on the equipment at the rate of 25% per year on a reducing balance basis. Any balancing allowance or balancing charge is not attributed to a project unless the asset is actually disposed of at the end of the project period.

Required:

a) Calculate the net present value (NPV) of the project.
(11 marks)

b) To the nearest month, calculate the non-discounted payback period and the discounted payback period.
(4 marks)

c) Explain the meaning of market volatility in financial markets.
(3 marks)

d) Explain the difference between a bull and bear market.
(2 marks)

a) Workings
Year Written down value


Total Present Value of Net Cash Flows: GH¢2,786,000
Year 0 Capital Outlay: GH¢2,000,000
Project Four-Year NPV: GH¢786,000

b) Payback and Discounted Payback

Year Cash Flow (GH¢’000) Cumulative Cash Flow (GH¢’000) Discounted Cash Flow (GH¢’000) Cumulative Discounted Cash Flow (GH¢’000)
0 (2,000) (2,000) (2,000) (2,000)
1 279 (1,721) 254 (1,746)
2 974 (826) 805 (1,007)
3 1,546 720 1,161 154
4 828 1,548 566 720

Non-discounted Payback Period: 2 years + [(826/1,546) × 12] = 2 years 6 months
(2 marks)

Discounted Payback Period: 2 years + [(1,007/1,161) × 12] = 2 years 10 months
(2 marks)

c) Market Volatility Explanation:

Market volatility in financial markets is a measure of the extent to which the price of a financial security (such as a share’s market price), or a market as a whole, or an interest rate, or a currency, or a commodity changes over time. High volatility means rapid and large changes in a price or rate over a short period of time. Low volatility means smaller and less frequent price changes.

Volatility refers to price movements in both directions, up and down. If prices move over time always in the same direction (either up or down, but not both), this does not mean high volatility. Volatility implies uncertainty about the way that prices will move next, and by how much. High volatility creates high financial risk. Investors will want higher returns to invest in financial instruments where price volatility is high.
(3 marks)

d) Bull and Bear Markets Explanation:

In a bull market, prices on the whole move upwards continually over time. For example, in a bull stock market, share prices on the whole continue to rise over time.

In a bear market, prices on the whole move downwards continually over time. For example, in a bear stock market, share prices on the whole continue to fall over time.
(2 marks)

 

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  • 10 Marks

FM – May 2020 – L2 – Q3b – Hedging with options

Calculate the variable and fixed interest payments under an interest rate swap agreement and determine if the strategy is an effective hedge.

Asanka Ghana Ltd is a medium-sized business in Ghana that is currently borrowing GH¢1,000,000 from North East Bank at a floating or variable interest rate basis at Ghana Reference Rate (GRR) plus 3% margin which is market determined on a monthly basis. This makes their monthly interest payment volatile depending on where GRR is at the end of the month. They are rather interested in fixed interest payment at the end of the month to manage this volatility.

OTI Bank Ghana Ltd has agreed to do an Interest rate Swap with Asanka where OTI Bank Ghana Ltd pays the variable rate to Asanka but Asanka pays them a fixed rate of 21% per annum paid monthly.

The table below shows the GRR for the last 6 months:

Month GRR (%) Variable Interest (C) Fixed Rate (D) Fixed Interest (E) Net Settlement (F)
1 16% 21%
2 18% 21%
3 20% 21%
4 19% 21%
5 18% 21%
6 17% 21%

Required:

i) Calculate the variable interest, fixed interest, and net settlement under columns (C), (E), and (F) in the table above.
(8 marks)

ii) Will you describe this strategy as an interest rate hedge? Explain.
(2 marks)

i) Calculation of Variable Interest, Fixed Interest, and Net Settlement:

ii) Interest Rate Hedge Explanation:

Yes, this strategy can be described as an interest rate hedge. The variable rate that Asanka will receive under the swap agreement compensates for the variable rate it has to pay to its original lender, North East Bank. This effectively leaves Asanka with a fixed interest payment of 21%, thereby removing the uncertainty and volatility in its monthly interest payments.
(2 marks)

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  • 10 Marks

FM – May 2020 – L2 – Q3b – Hedging with options

Calculate the variable and fixed interest payments under an interest rate swap agreement and determine if the strategy is an effective hedge.

Asanka Ghana Ltd is a medium-sized business in Ghana that is currently borrowing GH¢1,000,000 from North East Bank at a floating or variable interest rate basis at Ghana Reference Rate (GRR) plus 3% margin which is market determined on a monthly basis. This makes their monthly interest payment volatile depending on where GRR is at the end of the month. They are rather interested in fixed interest payment at the end of the month to manage this volatility.

OTI Bank Ghana Ltd has agreed to do an Interest rate Swap with Asanka where OTI Bank Ghana Ltd pays the variable rate to Asanka but Asanka pays them a fixed rate of 21% per annum paid monthly.

The table below shows the GRR for the last 6 months:

Month GRR (%) Variable Interest (C) Fixed Rate (D) Fixed Interest (E) Net Settlement (F)
1 16% 21%
2 18% 21%
3 20% 21%
4 19% 21%
5 18% 21%
6 17% 21%

Required:

i) Calculate the variable interest, fixed interest, and net settlement under columns (C), (E), and (F) in the table above.
(8 marks)

ii) Will you describe this strategy as an interest rate hedge? Explain.
(2 marks)

i) Calculation of Variable Interest, Fixed Interest, and Net Settlement:

ii) Interest Rate Hedge Explanation:

Yes, this strategy can be described as an interest rate hedge. The variable rate that Asanka will receive under the swap agreement compensates for the variable rate it has to pay to its original lender, North East Bank. This effectively leaves Asanka with a fixed interest payment of 21%, thereby removing the uncertainty and volatility in its monthly interest payments.
(2 marks)

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  • 10 Marks

FM – May 2020 – L2 – Q3a – Simple interest and compound interest

Calculate the quarterly loan installment and prepare an amortization schedule for a loan with compound interest and equal quarterly payments.

Odapagyan Foods Ltd is borrowing GH¢500,000 to finance a project involving an expansion of its existing factory. It has obtained an offer from Sika Bank. The terms of the loan facility are as follows:

  • Annual interest rate: 22%
  • Duration: 2 years
  • Interest method: compound interest with quarterly compounding
  • Payment plan: equal installments at the end of each quarter

Required:

i) Compute the quarterly installment.
(3 marks)

ii) Prepare a loan amortization schedule to show the periodic interest charges, installment payments, principal payments, and balance of the loan at the end of each quarter.
(7 marks)

i) Calculation of Quarterly Installment:
The present value of the payments, PVAn = Loan principal = GH¢500,000
Annual interest, i = 22%
Frequency, m = 4
Term (in years), t = 2
Number of periods, n = Term x Frequency = 2 x 4 = 8
The formula for the present value of an annuity (PVA) is:
Plugging in the values:

Thus, the quarterly installment is GH¢78,932.01.
(3 marks)

ii) Amortization Schedule:

Period Interest (GH¢) Installment (GH¢) Principal Repayment (GH¢) Outstanding Balance (GH¢)
0 – – – 500,000.00
1 27,500.00 78,932.01 51,432.01 448,567.99
2 24,671.24 78,932.01 54,260.77 394,307.23
3 21,686.90 78,932.01 57,245.11 337,062.12
4 18,538.42 78,932.01 60,393.59 276,668.53
5 15,216.77 78,932.01 63,715.24 212,953.29
6 11,712.43 78,932.01 67,219.57 145,733.72
7 8,015.35 78,932.01 70,916.65 74,817.07
8 4,114.94 78,932.01 74,817.07 –

(7 marks)

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  • 10 Marks

FM – May 2020 – L2 – Q3a – Simple interest and compound interest

Calculate the quarterly loan installment and prepare an amortization schedule for a loan with compound interest and equal quarterly payments.

Odapagyan Foods Ltd is borrowing GH¢500,000 to finance a project involving an expansion of its existing factory. It has obtained an offer from Sika Bank. The terms of the loan facility are as follows:

  • Annual interest rate: 22%
  • Duration: 2 years
  • Interest method: compound interest with quarterly compounding
  • Payment plan: equal installments at the end of each quarter

Required:

i) Compute the quarterly installment.
(3 marks)

ii) Prepare a loan amortization schedule to show the periodic interest charges, installment payments, principal payments, and balance of the loan at the end of each quarter.
(7 marks)

i) Calculation of Quarterly Installment:
The present value of the payments, PVAn = Loan principal = GH¢500,000
Annual interest, i = 22%
Frequency, m = 4
Term (in years), t = 2
Number of periods, n = Term x Frequency = 2 x 4 = 8
The formula for the present value of an annuity (PVA) is:
Plugging in the values:

Thus, the quarterly installment is GH¢78,932.01.
(3 marks)

ii) Amortization Schedule:

Period Interest (GH¢) Installment (GH¢) Principal Repayment (GH¢) Outstanding Balance (GH¢)
0 – – – 500,000.00
1 27,500.00 78,932.01 51,432.01 448,567.99
2 24,671.24 78,932.01 54,260.77 394,307.23
3 21,686.90 78,932.01 57,245.11 337,062.12
4 18,538.42 78,932.01 60,393.59 276,668.53
5 15,216.77 78,932.01 63,715.24 212,953.29
6 11,712.43 78,932.01 67,219.57 145,733.72
7 8,015.35 78,932.01 70,916.65 74,817.07
8 4,114.94 78,932.01 74,817.07 –

(7 marks)

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  • 20 Marks

FM – May 2020 – L2 – Q2 – Business valuations | Mergers and acquisitions

Value Staygood Ltd using the Price/Earnings ratio, Gordon growth model, and Discounted cash flow methods for a potential takeover by Restwell Ltd.

Restwell Ltd (Restwell), a hotel and leisure company, is currently considering taking over a smaller private limited liability company, Staygood Ltd (Staygood). The board of Restwell is in the process of making a bid for Staygood but first needs to place a value on the company. Restwell has gathered the following data:

Restwell:

  • Weighted average cost of capital: 12%
  • P/E ratio: 12
  • Shareholders’ required rate of return: 15%

Staygood:

  • Current dividend payment (GH¢): 0.27
  • Past five years’ dividend payments (GH¢): 0.15, 0.17, 0.18, 0.21, 0.23
  • Current EPS: 0.37
  • Number of ordinary shares issued: 5 million

The required rate of return of the shareholders of Staygood is 20% higher than that of Restwell due to the higher level of risk associated with Staygood. Restwell estimates that cash flows at the end of the first year will be GH¢2.5 million and these will grow at an annual rate of 5%. Restwell also expects to raise GH¢5 million in two years’ time by selling off hotels of Staygood that are surplus to its needs.

Required:

Estimate values for Staygood using the following valuation methods:

i) Price/earnings ratio valuation. (6 marks)

ii) Gordon growth model. (8 marks)

iii) Discounted cash flow valuation. (6 marks)

i) Calculation of the value of Staygood using P/E ratios:

Staygood’s share price = 12 x 37p = GH¢4.44
(3 marks)
Note:
Any candidate who uses an adjusted P/E ratio in a 30% range should be given full credit.
We will assume that the market will expect Restwell to achieve a level of return on Staygood comparable to that which it makes on its own assets. Hence:
Total market value = 5m x GH¢4.44 = GH¢22.2m
(3 marks)

ii) To use the Gordon growth model we must find g and kₑ
Here g is given by:

Kₑ for Staygood is 20% higher than Restwell, therefore:

Therefore:

Total market value = 5m x GH¢5.49 = GH¢27.46m

iii) Using future cash flows and discounting these to infinity using Restwell’s WACC as a discount rate:

Present value =

 

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  • 20 Marks

FM – May 2020 – L2 – Q2 – Business valuations | Mergers and acquisitions

Value Staygood Ltd using the Price/Earnings ratio, Gordon growth model, and Discounted cash flow methods for a potential takeover by Restwell Ltd.

Restwell Ltd (Restwell), a hotel and leisure company, is currently considering taking over a smaller private limited liability company, Staygood Ltd (Staygood). The board of Restwell is in the process of making a bid for Staygood but first needs to place a value on the company. Restwell has gathered the following data:

Restwell:

  • Weighted average cost of capital: 12%
  • P/E ratio: 12
  • Shareholders’ required rate of return: 15%

Staygood:

  • Current dividend payment (GH¢): 0.27
  • Past five years’ dividend payments (GH¢): 0.15, 0.17, 0.18, 0.21, 0.23
  • Current EPS: 0.37
  • Number of ordinary shares issued: 5 million

The required rate of return of the shareholders of Staygood is 20% higher than that of Restwell due to the higher level of risk associated with Staygood. Restwell estimates that cash flows at the end of the first year will be GH¢2.5 million and these will grow at an annual rate of 5%. Restwell also expects to raise GH¢5 million in two years’ time by selling off hotels of Staygood that are surplus to its needs.

Required:

Estimate values for Staygood using the following valuation methods:

i) Price/earnings ratio valuation. (6 marks)

ii) Gordon growth model. (8 marks)

iii) Discounted cash flow valuation. (6 marks)

i) Calculation of the value of Staygood using P/E ratios:

Staygood’s share price = 12 x 37p = GH¢4.44
(3 marks)
Note:
Any candidate who uses an adjusted P/E ratio in a 30% range should be given full credit.
We will assume that the market will expect Restwell to achieve a level of return on Staygood comparable to that which it makes on its own assets. Hence:
Total market value = 5m x GH¢4.44 = GH¢22.2m
(3 marks)

ii) To use the Gordon growth model we must find g and kₑ
Here g is given by:

Kₑ for Staygood is 20% higher than Restwell, therefore:

Therefore:

Total market value = 5m x GH¢5.49 = GH¢27.46m

iii) Using future cash flows and discounting these to infinity using Restwell’s WACC as a discount rate:

Present value =

 

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  • 10 Marks

FM – May 2020 – L2 – Q1b – Capital structure | Portfolio theory and the capital asset pricing model (CAPM)

Analyze the degree of operating and financial leverage for two subsidiary companies to determine the implications for their capital structure.

Firm A and Firm B are both subsidiary companies of Groupe Trojan Electronics. The directors of Groupe Trojan Electronics are reviewing the capital structure of the two subsidiary companies. You have been engaged to advise the directors on the appropriate capital structure for the subsidiaries.

You have obtained extracts from the financial results of the two companies for the past financial year and projection of the annual results for the current year, which is in its first quarter.

Required:

i) Compute the degree of operating leverage for each of the two companies. Based on the degree of operating leverage you obtain, advise the directors on the relative level of business risk associated with the two subsidiaries and the implication of that for capital structure design. (5 marks)

ii) Compute the degree of financial leverage for each of the two companies. Based on the degree of financial leverage you obtain, advise the directors on the relative level of financial risk associated with the two subsidiaries and the implication of that for capital structure design. (5 marks)

i) The degree of operating leverage (DOL)
The DOL of Firm A is 1.26, and that of Firm B is 1.76:

Implication:
The DOL assesses the volatility in operating profit due to changes in revenue. Firm B, with a higher DOL, presents a higher business risk to Groupe Trojan than Firm A. The implication for the capital structure decision is that Firm A, which has a lower DOL, could sustain higher debt in its capital structure than Firm B.

ii) The degree of financial leverage (DFL)
The DFL of Firm A is 1.3 and Firm B is 2.84:

Implication:
The DFL indicates the level of financial risk. Firm B, with a higher DFL, presents a higher financial risk to Groupe Trojan than Firm A. The implication for the capital structure decision is that Firm A, with a lower DFL, could sustain higher debt in its capital structure than Firm B.

 

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  • 10 Marks

FM – May 2020 – L2 – Q1b – Capital structure | Portfolio theory and the capital asset pricing model (CAPM)

Analyze the degree of operating and financial leverage for two subsidiary companies to determine the implications for their capital structure.

Firm A and Firm B are both subsidiary companies of Groupe Trojan Electronics. The directors of Groupe Trojan Electronics are reviewing the capital structure of the two subsidiary companies. You have been engaged to advise the directors on the appropriate capital structure for the subsidiaries.

You have obtained extracts from the financial results of the two companies for the past financial year and projection of the annual results for the current year, which is in its first quarter.

Required:

i) Compute the degree of operating leverage for each of the two companies. Based on the degree of operating leverage you obtain, advise the directors on the relative level of business risk associated with the two subsidiaries and the implication of that for capital structure design. (5 marks)

ii) Compute the degree of financial leverage for each of the two companies. Based on the degree of financial leverage you obtain, advise the directors on the relative level of financial risk associated with the two subsidiaries and the implication of that for capital structure design. (5 marks)

i) The degree of operating leverage (DOL)
The DOL of Firm A is 1.26, and that of Firm B is 1.76:

Implication:
The DOL assesses the volatility in operating profit due to changes in revenue. Firm B, with a higher DOL, presents a higher business risk to Groupe Trojan than Firm A. The implication for the capital structure decision is that Firm A, which has a lower DOL, could sustain higher debt in its capital structure than Firm B.

ii) The degree of financial leverage (DFL)
The DFL of Firm A is 1.3 and Firm B is 2.84:

Implication:
The DFL indicates the level of financial risk. Firm B, with a higher DFL, presents a higher financial risk to Groupe Trojan than Firm A. The implication for the capital structure decision is that Firm A, with a lower DFL, could sustain higher debt in its capital structure than Firm B.

 

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  • 10 Marks

FM – May 2020 – L2 – Q1a – Introduction to Financial Management

Brief the board of directors on the objectives and factors affecting investment, financing, and dividend decisions.

K-Force Ltd, a newly established security company, has constituted its first board of directors. The directors are expected, among others, to take financial decisions in the areas of investment, financing, and dividend payment. A consultancy firm has been engaged to run an orientation program for the directors in the coming week.

You work with the consultancy firm that has been engaged to run the orientation program for the new directors. You have been asked by your boss to prepare briefing notes on the specific roles the directors are expected to play in the three fundamental decision areas and the constraints that government policies might impose on them.

Required:
Prepare a briefing note on the nature of the three fundamental decision areas. Specifically, the briefing notes should cover the objective of each class of decision; TWO (2) specific decisions the directors are expected to take in each class of financial decisions; and TWO (2) factors in the external environment they should consider when making financial decisions.

Investing decisions
Investing decisions relate to the acquisition and disposition of assets that would generate cash flows for the firm. The objective is to achieve optimal allocation of limited resources to investment opportunities. Directors are expected to make decisions such as:

  • Deciding on growth strategy, whether to employ internal or external growth strategies.
  • Deciding on the proportion of the components of assets needed to achieve the firm’s objectives.

Financing decisions
Financing decisions are related to the mix of the various types of finance the firm should use. The objective is to minimize the risk and cost of finance. Directors are expected to make decisions such as:

  • Deciding on the blend of equity and debt in the financing structure.
  • Deciding on the method of issuing new securities.

Dividend decisions
Dividend decisions are related to the payment of dividends and retention of earnings for reinvestment. The objective is to achieve a balance between meeting shareholders’ expectations of current dividends and reinvesting enough earnings to achieve targeted growth. Directors are expected to make decisions such as:

  • Deciding on whether to recommend payment of dividends or reinvestment of earnings.
  • Deciding on the amount of dividend to recommend.

Relevant factors in the external environment
Directors should consider the following external factors when making financial decisions:

  • Laws and regulations
  • Economic factors

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  • 10 Marks

FM – May 2020 – L2 – Q1a – Introduction to Financial Management

Brief the board of directors on the objectives and factors affecting investment, financing, and dividend decisions.

K-Force Ltd, a newly established security company, has constituted its first board of directors. The directors are expected, among others, to take financial decisions in the areas of investment, financing, and dividend payment. A consultancy firm has been engaged to run an orientation program for the directors in the coming week.

You work with the consultancy firm that has been engaged to run the orientation program for the new directors. You have been asked by your boss to prepare briefing notes on the specific roles the directors are expected to play in the three fundamental decision areas and the constraints that government policies might impose on them.

Required:
Prepare a briefing note on the nature of the three fundamental decision areas. Specifically, the briefing notes should cover the objective of each class of decision; TWO (2) specific decisions the directors are expected to take in each class of financial decisions; and TWO (2) factors in the external environment they should consider when making financial decisions.

Investing decisions
Investing decisions relate to the acquisition and disposition of assets that would generate cash flows for the firm. The objective is to achieve optimal allocation of limited resources to investment opportunities. Directors are expected to make decisions such as:

  • Deciding on growth strategy, whether to employ internal or external growth strategies.
  • Deciding on the proportion of the components of assets needed to achieve the firm’s objectives.

Financing decisions
Financing decisions are related to the mix of the various types of finance the firm should use. The objective is to minimize the risk and cost of finance. Directors are expected to make decisions such as:

  • Deciding on the blend of equity and debt in the financing structure.
  • Deciding on the method of issuing new securities.

Dividend decisions
Dividend decisions are related to the payment of dividends and retention of earnings for reinvestment. The objective is to achieve a balance between meeting shareholders’ expectations of current dividends and reinvesting enough earnings to achieve targeted growth. Directors are expected to make decisions such as:

  • Deciding on whether to recommend payment of dividends or reinvestment of earnings.
  • Deciding on the amount of dividend to recommend.

Relevant factors in the external environment
Directors should consider the following external factors when making financial decisions:

  • Laws and regulations
  • Economic factors

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  • 20 Marks

FA – May 2020 – L1 – Q5 – Interpretation of financial statements (Financial Ratios)

This question involves calculating financial ratios and providing commentary on the company’s performance based on those ratios.

The following are extracts from the financial statements of Sky Ltd:

Required:

a) Prepare the following ratio analysis for 2018 financial year.
i) Current ratio
ii) Acid test ratio
iii) Net Profit Margin
iv) Return on capital employed
v) Receivables day
vi) Payables day
vii) Inventory turnover

(10 marks)

b) Comment on FIVE (5) of the ratios you have calculated.
Note: The following industry averages are provided to enable you to write your comment:

  • Current ratio: 1.9:1
  • Acid test ratio: 0.9:1
  • Net profit margin: 6%
  • Return on Capital Employed (ROCE): 25%
  • Receivable days: 45 days
  • Payable days: 38 days
  • Inventory turnover: 4.4 times

(10 marks)

a)

b) Commentary on Financial Ratios

  1. Liquidity Ratios (Current Ratio and Acid Test Ratio):
  • The Current Ratio of 2.41:1 is above the industry average of 1.9:1, indicating that Sky Ltd has a comfortable liquidity position, meaning it can cover its short-term liabilities with its current assets. However, a ratio above 2:1 might indicate excessive cash tied up in inventory or receivables.
  • The Acid Test Ratio of 1.11:1 is also above the industry average of 0.9:1, which suggests that the company has enough liquid assets to cover its immediate liabilities without relying on inventory.
  1. Profitability Ratios (Net Profit Margin and ROCE):
  • The Net Profit Margin of 8% is higher than the industry average of 6%, indicating that Sky Ltd is efficient in converting its revenue into profit. However, the drop in net profit margin from the previous year should be addressed.
  • The ROCE of 3% is significantly below the industry average of 25%, indicating that the company is not generating sufficient returns on its capital employed. This is a concern for investors and indicates inefficient use of the company’s capital resources.
  1. Receivables Days:
  • The Receivables Days of 27 days is better than the industry average of 45 days, indicating that Sky Ltd is effective in collecting its receivables quickly. This improves cash flow but should be monitored to ensure credit terms are not too strict, potentially losing sales.
  1. Payables Days:
  • The Payables Days of 28 days is close to the industry average of 38 days. This suggests that Sky Ltd is paying its suppliers in a timely manner, possibly even earlier than the average, which might allow the company to take advantage of early payment discounts.
  1. Inventory Turnover:
  • The Inventory Turnover of 5.8 times is higher than the industry average of 4.4 times, indicating that Sky Ltd is efficient in managing its inventory, selling goods at a quicker pace, and reducing the risk of obsolescence. This is a positive sign for operational efficiency.

(10 marks evenly spread using ticks)

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  • 20 Marks

FA – May 2020 – L1 – Q5 – Interpretation of financial statements (Financial Ratios)

This question involves calculating financial ratios and providing commentary on the company’s performance based on those ratios.

The following are extracts from the financial statements of Sky Ltd:

Required:

a) Prepare the following ratio analysis for 2018 financial year.
i) Current ratio
ii) Acid test ratio
iii) Net Profit Margin
iv) Return on capital employed
v) Receivables day
vi) Payables day
vii) Inventory turnover

(10 marks)

b) Comment on FIVE (5) of the ratios you have calculated.
Note: The following industry averages are provided to enable you to write your comment:

  • Current ratio: 1.9:1
  • Acid test ratio: 0.9:1
  • Net profit margin: 6%
  • Return on Capital Employed (ROCE): 25%
  • Receivable days: 45 days
  • Payable days: 38 days
  • Inventory turnover: 4.4 times

(10 marks)

a)

b) Commentary on Financial Ratios

  1. Liquidity Ratios (Current Ratio and Acid Test Ratio):
  • The Current Ratio of 2.41:1 is above the industry average of 1.9:1, indicating that Sky Ltd has a comfortable liquidity position, meaning it can cover its short-term liabilities with its current assets. However, a ratio above 2:1 might indicate excessive cash tied up in inventory or receivables.
  • The Acid Test Ratio of 1.11:1 is also above the industry average of 0.9:1, which suggests that the company has enough liquid assets to cover its immediate liabilities without relying on inventory.
  1. Profitability Ratios (Net Profit Margin and ROCE):
  • The Net Profit Margin of 8% is higher than the industry average of 6%, indicating that Sky Ltd is efficient in converting its revenue into profit. However, the drop in net profit margin from the previous year should be addressed.
  • The ROCE of 3% is significantly below the industry average of 25%, indicating that the company is not generating sufficient returns on its capital employed. This is a concern for investors and indicates inefficient use of the company’s capital resources.
  1. Receivables Days:
  • The Receivables Days of 27 days is better than the industry average of 45 days, indicating that Sky Ltd is effective in collecting its receivables quickly. This improves cash flow but should be monitored to ensure credit terms are not too strict, potentially losing sales.
  1. Payables Days:
  • The Payables Days of 28 days is close to the industry average of 38 days. This suggests that Sky Ltd is paying its suppliers in a timely manner, possibly even earlier than the average, which might allow the company to take advantage of early payment discounts.
  1. Inventory Turnover:
  • The Inventory Turnover of 5.8 times is higher than the industry average of 4.4 times, indicating that Sky Ltd is efficient in managing its inventory, selling goods at a quicker pace, and reducing the risk of obsolescence. This is a positive sign for operational efficiency.

(10 marks evenly spread using ticks)

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