Subject: CORPORATE REPORTING

Search 500 + past questions and counting.
Professional Bodies Filter
Program Filters
Subject Filters
More
Tags Filter
More
Check Box – Levels
Series Filter
More
Topics Filter
More
  • 20 Marks

FR – May 2018 – L2 – Q4 – Financial Statement Analysis

Calculate financial ratios for Obiya Ltd based on its financial statements for the year ended 30 September 2017.

Obiya Ltd assembles computer equipment from bought-in components and distributes them to various wholesalers and retailers. It has recently subscribed to an inter-firm comparison service. Members submit accounting ratios as specified by the operator of the service, and in return, members receive the average figures for each of the specified ratios taken from all of the companies in the same sector that subscribe to the service. The specified ratios and the average figures for Obiya’s sector are shown below:

Ratios of sector companies for the period to 30 September 2017

Ratio Sector Average
Return on capital employed 22.1%
Net asset turnover 1.8 times
Gross profit margin 30%
Net profit (before tax) margin 12.50%
Current ratio 1.6:1
Quick ratio 0.9:1
Inventory holding period 46 days
Accounts receivable collection period 45 days
Accounts payable payment period 55 days
Debt to equity 40%
Dividend yield 6%
Dividend cover 3 times

Obiya Ltd’s financial statements for the year to 30 September 2017 are set out below:

Statement of profit or loss for the year ended 30 September 2017

Description GH¢’000
Revenue 2,425
Cost of sales (1,870)
Gross profit 555
Other operating expenses (215)
Operating profit 340
Finance costs (34)
Exceptional item (note ii) (120)
Profit before tax 186
Income tax (90)
Profit for the period 96

Statement of changes in equity (extract)
For the year ended 30 September 2017

Description GH¢’000
Retained earnings – 1 October 2016 179
Net profit for the period 96
Dividends paid (Interim GH¢60,000; final GH¢30,000) (90)
Retained earnings – 30 September 2017 185

Statement of financial position as at 30 September 2017

Description GH¢’000
Non-current assets
Property, plant, equipment 540
Current assets
Inventory 275
Accounts receivable 320
Bank –
Total current assets 595
Total assets 1,135
Equity
Ordinary shares (25 pesewas each) 150
Retained earnings 185
Total equity 335
Non-current liabilities
8% loan notes 300
Current liabilities
Bank overdraft 65
Trade accounts payable 350
Taxation 85
Total current liabilities 500
Total equity and liabilities 1,135

Notes:

i) The details of the non-current assets are:

Description Cost (GH¢’000) Accumulated depreciation (GH¢’000) Net book value (GH¢’000)
At 30 September 2017 3,600 3,060 540

ii) The exceptional item relates to losses on the sale of a batch of computers that had become worthless due to improvements in microchip design.

iii) The market price of Obiya’s shares throughout the year averaged GH¢6.00 each.

Required:
a) Calculate the ratios for Obiya equivalent to those provided by the inter-firm comparison service.

(5 marks)

b) Write a report analyzing the operational performance, gearing, investment, and liquidity of Obiya Ltd based on a comparison with the sector averages. (10 marks)

Ratios for Obiya Ltd for the period to 30 September 2017:

Description Obiya Ltd
Return on capital employed (186 + 34 loan interest ÷ (335 + 300)) 34.6%
Net asset turnover (2,425 ÷ (335 + 300)) 3.8 times
Gross profit margin (555 ÷ 2,425 × 100) 22.9%
Net profit margin (186 ÷ 2,425 × 100) 7.7%
Current ratio (595 ÷ 500) 1.19:1
Quick ratio (320 ÷ 500) 0.64:1
Inventory holding period (275 ÷ 1,870 × 365) 54 days
Accounts receivable collection period (320 ÷ 2,425 × 365) 48 days
Accounts payable payment period (350 ÷ 1,870 × 365) 68 days
Debt to equity (300 ÷ 335 × 100) 90%
Dividend yield (15p ÷ GH¢6 × 100) 2.5%
Dividend cover (96 ÷ 90) 1.07 times

(5 marks evenly spread)

b)

Report on Financial Performance of Obiya Ltd
To: Management of Obiya Ltd
From: Financial Analyst
Subject: Analysis of Financial Performance, Gearing, Investment, and Liquidity Compared to Sector Averages

1. Operational Performance:

  • Return on Capital Employed (ROCE):
    Obiya’s ROCE of 34.6% is significantly higher than the sector average of 22.1%. This indicates that Obiya is more efficient in generating profits from its capital employed. The high ROCE is largely driven by a higher Net Asset Turnover of 3.8 times compared to the sector’s 1.8 times. However, this high turnover may be partly due to the relatively old and fully depreciated non-current assets, which could require replacement soon.
  • Gross Profit Margin:
    Obiya’s gross profit margin of 22.9% is lower than the sector average of 30%. This suggests that Obiya may be facing higher cost pressures or competitive pricing challenges.
  • Net Profit Margin:
    The net profit margin of 7.7% is also below the sector average of 12.5%. The impact of the exceptional item (GH¢120,000 loss on inventory) worsens the profit margin, indicating potential issues with inventory management and technological obsolescence. Excluding this, Obiya’s profitability would improve but still remain below the sector.

2. Liquidity:

  • Current Ratio:
    Obiya’s current ratio of 1.19:1 is below the sector average of 1.6:1, indicating that the company may struggle to cover its short-term liabilities.
  • Quick Ratio:
    The quick ratio of 0.64:1 is also lower than the sector average of 0.9:1, highlighting liquidity challenges, especially if inventory becomes difficult to liquidate quickly.
  • Accounts Payable and Receivable:
    Obiya’s accounts payable payment period is 68 days, significantly higher than the sector average of 55 days, which may suggest that Obiya is taking longer to pay its suppliers. This could damage supplier relationships. The accounts receivable collection period is 48 days, which is close to the sector average of 45 days.

3. Gearing:

  • Debt to Equity:
    Obiya’s debt to equity ratio of 90% is more than double the sector average of 40%. The company is highly leveraged, which poses financial risk, especially given its lower liquidity ratios. Although the company benefits from low-interest payments (8%), the high gearing could become problematic if profitability declines further or if it struggles to meet debt obligations.

4. Investment:

  • Dividend Yield and Cover:
    Obiya’s dividend yield of 2.5% is considerably lower than the sector average of 6%. Additionally, the dividend cover of 1.07 times (compared to the sector’s 3 times) indicates that almost all the company’s earnings are being paid out as dividends, leaving little room for reinvestment or to cushion against financial difficulties. This might not be sustainable in the long run.

Conclusion:

While Obiya Ltd demonstrates strong operational efficiency in terms of asset turnover, its profitability margins are weaker compared to the sector, and it faces significant liquidity and gearing challenges. Additionally, its investment return for shareholders is below sector expectations, and the company’s dividend policy appears unsustainable. Immediate attention should be given to improving liquidity, addressing high debt levels, and managing inventory more effectively to avoid future losses.

(10 marks evenly spread)

  • 6 Marks

CR – May 2019 – L3 – Q5c – Regulatory framework and ethics

The question asks for four reasons why the IASB found it necessary to revise the conceptual framework, as part of its effort to improve financial reporting.

The Framework for the Preparation and Presentation of Financial Statements was originally issued in 1989. In 2004, the IASB and the FASB decided to review and revise the conceptual framework. However, this decision changed priorities and the slow progress in the project led to the project being abandoned in 2010. This was after only Phase A of the original joint project was finalized and introduced into the existing framework as Chapters 1 and 3 in September 2010.
The current form of the conceptual framework as at May 2018 provides a revised and complete version of the framework.

Required:
Explain FOUR (4) primary reasons why the IASB believed it was necessary to revise its conceptual framework. (4 marks)

Four Primary Reasons Why the IASB Revised the Conceptual Framework:

  1. Gaps and Outdated Concepts in the Original Framework:
    The original conceptual framework, issued in 1989, was incomplete in several areas, and many of its concepts were outdated. The revised framework was necessary to fill these gaps, ensure consistency, and address new developments in financial reporting, such as emerging issues related to fair value accounting, measurement uncertainties, and more complex financial instruments.
  2. Need for Clearer Guidance on Key Areas:
    There was a growing demand from users of financial statements, preparers, and standard-setters for clearer and more comprehensive guidance on fundamental areas like the definition of assets and liabilities, recognition criteria, and measurement bases. The revised framework aimed to clarify these key elements, which are crucial for the consistent application of financial reporting standards.
  3. Improving Consistency Across Standards:
    The IASB recognized that certain inconsistencies had emerged between the conceptual framework and some IFRS standards. The revision sought to ensure that the framework is consistent with existing and future standards, thus helping to avoid conflicts and provide a solid foundation for developing new standards and interpreting existing ones.
  4. Enhancing Decision-Usefulness for Users of Financial Statements:
    The primary objective of financial reporting is to provide information that is useful to investors, creditors, and other users in making decisions. The revision of the framework aimed to strengthen the focus on decision-usefulness by refining the qualitative characteristics of useful financial information (such as relevance and faithful representation) and ensuring the framework remains aligned with the evolving needs of financial statement users.
  • 10 Marks

CR – May 2019 – L3 – Q5b – Regulatory framework and ethics

The question requires identifying and discussing the ethical issues arising from conflicts of interest, board dynamics, and related party transactions within Bolgatanga Ltd and how to address them appropriately.

Bolgatanga Ltd (Bolgatanga), currently operating in the biotechnology research and healthcare sector, is a Ghanaian listed company which prepares financial statements in accordance with International Financial Reporting Standards (IFRS) up to 31 December each year. On 1 January 2015, Bolgatanga acquired 80% interest in Wa Ltd (Wa). You are a newly qualified accountant at Bolgatanga and report directly to Mr. Dominic Atubiga, the Financial Controller (FC). Early 2017, Bolgatanga acquired Sissala Ltd (Sissala), a private company, and has recently had an application for additional funds rejected from its current bankers on the basis that there are insufficient assets to offer security.

You have been reviewing the minutes of Bolgatanga’s last board meeting, dated 28 December 2017. The minutes indicate that the sales director resigned on 1 December 2017. In her resignation letter to the board, the sales director states that she can no longer work with Dominic Atubiga, who is dominating the board and allowing a close friendship with, and advice from, Salifu Adams (Managing Director of Sissala) to compromise his judgement.

The Human Resources department is currently in the process of recruiting a new sales director. Dominic Atubiga tells the board that, in the interim, the marketing department will just have to cope until a replacement sales director is appointed. Speaking to other staff in Bolgatanga, you have become aware that the wife of the Managing Director of Bolgatanga is a partner in Brother and Co., a firm of solicitors which the company uses to provide legal advice in relation to the market development activities of Wa. However, Brother and Co. has confirmed that the FC’s wife works in a different division and that she has no involvement in the services provided. It is your understanding that legal fees of GH¢500,000 (included in administration expenses) were paid by Bolgatanga to Brother and Co. during the year ended 31 December 2017.

Required:
Discuss the ethical issues arising from the information provided, and the appropriate steps to address them.

Ethical Issues Arising:

  1. Conflict of Interest (Friendship Influence on Board Decisions):
    The relationship between the Financial Controller, Dominic Atubiga, and Salifu Adams, the Managing Director of Sissala Ltd, raises a potential conflict of interest. The sales director’s resignation letter suggests that Atubiga’s judgment may be compromised due to his close friendship with Adams. The conflict arises because decisions regarding Sissala might be influenced by personal relationships rather than what is best for Bolgatanga Ltd.

    Step to Address:

    • The board should review the governance structure to ensure decisions are made objectively, free from personal biases. A formal policy on conflicts of interest should be implemented or strengthened, requiring disclosure of personal relationships that may affect decision-making.
  2. Leadership and Board Governance Issues:
    The resignation of the sales director indicates governance issues, particularly with how Dominic Atubiga’s leadership is perceived. His statement that the marketing department will have to “cope” until a new sales director is appointed suggests a lack of strategic leadership and disregard for potential operational risks due to the vacancy.

    Step to Address:

    • The board needs to ensure that leadership changes are handled strategically to avoid operational disruption. An interim plan for marketing leadership should be devised until the position is filled, with clear responsibilities assigned to maintain smooth operations.
  3. Related Party Transactions (Legal Services Provided by Brother and Co.):
    The legal fees paid by Bolgatanga to Brother and Co., where the wife of Bolgatanga’s Managing Director is a partner, constitutes a related party transaction. Although the FC’s wife works in a different division of the firm, the relationship still creates a perception of bias or undue influence, which should be addressed to ensure transparency and fairness.

    Step to Address:

    • The related party transaction must be disclosed in accordance with IAS 24 to ensure transparency in financial reporting. The company should ensure that all related party transactions are conducted at arm’s length and are fully disclosed in the financial statements.
  4. Corporate Governance and Professional Ethics (Board Dominance):
    The dominance of the Financial Controller, as mentioned in the sales director’s resignation letter, suggests poor governance practices where one individual exerts too much control over board decisions. This undermines the principle of collective decision-making and could lead to poor judgment or biased decisions, which is against good corporate governance practices.

    Step to Address:

    • The board should ensure that its governance structures promote balanced decision-making. Implementing formal governance guidelines and independent oversight would help distribute power and prevent any one individual from dominating decisions. An audit or governance review could help identify weaknesses in the board’s operation.
  5. Lack of Clear Strategic Response to Bank Rejection:
    Bolgatanga Ltd had its request for additional funds rejected due to insufficient assets to offer as security. This could indicate underlying financial issues or poor asset management, suggesting that the company may not have a strong financial position.

    Step to Address:

    • The company should re-evaluate its financial strategy, including exploring other financing options or improving asset management. Additionally, clearer communication with stakeholders, including the banks, might help in securing future funding. Strategic financial planning should be prioritized to address asset management concerns.

Conclusion:

The ethical issues identified relate to conflicts of interest, board governance, leadership, and related party transactions. To address these, Bolgatanga Ltd should implement formal governance structures, disclose related party transactions transparently, and ensure that leadership changes and financial strategies are aligned with ethical standards and good corporate governance practices.

  • 9 Marks

CR – May 2019 – L3 – Q5a – Beyond financial reporting

The question asks for the factors motivating companies to disclose environmental and social information and the challenges in recognizing and measuring financial effects of environmental matters.

The directors of Kibi Ltd, a bauxite mining company in East Akim Municipal Assembly, after reviewing their published financial statements, are of the view that their financial statements have limited environmental information and do not address a broad enough range of users’ needs.

Despite the difficulties in recognizing and measuring the financial effects of environmental matters in financial statements, Kibi Ltd discloses the following environmental information in its financial statements:

  • Release of minerals and other naturally occurring impurities including heavy metals;
  • Loss of natural fishing and recreational places;
  • Soil erosion and sedimentation, noise, and dust.

Required:
i) Explain THREE (3) factors which motivate companies to disclose social and environmental information in their financial statements. (3 marks)

ii) Identify FOUR (4) specific difficulties in recognizing and measuring the financial effects of environmental matters. (4 marks)

i) Factors Motivating Companies to Disclose Social and Environmental Information (3 marks)

  1. Stakeholder Pressure:
    Companies are increasingly motivated to disclose environmental information due to pressure from stakeholders such as investors, regulators, customers, and non-governmental organizations (NGOs) who demand transparency regarding the company’s environmental impact. Companies recognize that failure to meet stakeholder expectations can harm their reputation and relationships.
  2. Legal and Regulatory Requirements:
    Governments and regulatory bodies have begun to enforce laws requiring environmental disclosures, particularly in industries with significant environmental impacts, such as mining. Kibi Ltd, being in the bauxite mining sector, would be particularly sensitive to these requirements to avoid legal penalties.
  3. Corporate Social Responsibility (CSR) and Reputation Management:
    Disclosing social and environmental information is part of demonstrating corporate social responsibility. Companies like Kibi Ltd may use these disclosures to enhance their reputation, showing that they are responsible corporate citizens, which could lead to better relations with local communities, improved customer loyalty, and potential investor interest.

ii) Difficulties in Recognizing and Measuring the Financial Effects of Environmental Matters (4 marks)

  1. Uncertainty of Environmental Costs:
    It is often difficult to accurately estimate the financial impact of environmental issues because future costs, such as the clean-up of environmental damage, are uncertain and dependent on factors such as government regulations and future environmental standards.
  2. Lack of Clear Guidance:
    The accounting standards do not always provide clear guidelines for recognizing and measuring environmental liabilities. For example, there is no universally accepted way to quantify certain environmental impacts, such as biodiversity loss or damage to natural habitats.
  3. Difficulty in Estimating the Useful Life of Environmental Assets:
    Estimating the useful life and depreciation of environmental assets, such as reclamation projects or pollution control equipment, can be challenging. This makes it difficult to match environmental expenses with revenues in a reliable manner.
  4. Problems with Attributing Costs to Specific Accounting Periods:
    Environmental costs may span multiple accounting periods, making it hard to determine in which period the costs should be recognized. For example, the cost of restoring a mining site may occur several years after the site was initially exploited, complicating the recognition of liabilities.
  • 15 Marks

CR – May 2019 – L3 – Q4 – Analysis and interpretation of financial statements

The question requires calculation of financial ratios and analysis of the financial performance and cash position of Madina Ltd for the year ended 30 September 2018.

Below are the recently issued financial statements of Madina Ltd, a listed company, for the year ended 30 September 2018, together with comparatives for 2017.

Statement of Profit or Loss for the year ended 30 September:

Details 2018 (GH¢’000) 2017 (GH¢’000)
Revenue 125,000 90,000
Cost of Sales (100,000) (75,000)
Gross Profit 25,000 15,000
Operating Expenses (13,000) (11,000)
Finance Costs (4,000) –
Profit before Tax 8,000 4,000
Tax (at 25%) (2,000) (1,000)
Profit for the year 6,000 3,000

Statement of Financial Position as at 30 September:

Details 2018 (GH¢’000) 2017 (GH¢’000)
Non-Current Assets
Property, Plant, and Equipment 105,000 45,000
Goodwill 5,000 –
Total Non-Current Assets 110,000 45,000
Current Assets
Inventory 12,500 7,500
Receivables 6,500 4,000
Bank – 7,000
Total Current Assets 19,000 18,500
Total Assets 129,000 63,500
Equity and Liabilities
Equity
Share Capital 50,000 50,000
Retained Earnings 7,000 6,000
Total Equity 57,000 56,000
Non-Current Liabilities
8% Loan Notes 50,000 –
Current Liabilities
Bank Overdraft 8,500 –
Trade Payables 11,500 6,500
Current Tax Payable 2,000 1,000
Total Current Liabilities 22,000 7,500
Total Equity and Liabilities 129,000 63,500

Additional Information:

  • On 1 October 2017, Madina Ltd acquired 100% of the net assets of Aboabu Ltd for GH¢50 million. In order to finance this transaction, Madina Ltd issued GH¢50 million 8% loan notes on the acquisition date.
    Aboabu Ltd’s results for the year ended 30 September 2018 are shown below:

Aboabu Ltd’s Statement of Profit or Loss for the year ended 30 September:

Details GH¢’000
Revenue 35,000
Cost of Sales (20,000)
Gross Profit 15,000
Operating Expenses (4,000)
Profit before Tax 11,000
Tax (at 25%) (2,750)
Profit for the year 8,250
  • Aboabu Ltd has not paid any dividend during the year, but Madina Ltd paid a dividend of GH¢0.05 per share.
  • The following ratios have been calculated for Madina Ltd for the year ended 30 September 2017:
    • Return on capital employed: 7.1%
    • Gross profit margin: 16.7%
    • Net profit (before tax) margin: 4.4%

Required:

a) Calculate the equivalent ratios for Madina Ltd for 2018:
i) Including the results of Aboabu Ltd acquired during the year. (3 marks)
ii) Excluding all effects of the purchase of Aboabu Ltd. (3 marks)

b) Analyse the performance of Madina Ltd for the year ended 30 September 2018. (5 marks)

c) Analyse the cash position of Madina Ltd as at 30 September 2018. (4 marks)

a)

Madina Ltd

Equivalent ratios
i) Including Aboabu Ltd:

ii) Excluding the effects of Aboabu Ltd:

 

Candidates are to be mindful that the financial statements of Madina Ltd for the year
ended 30 September 2018 includes the results of Aboabu Ltd acquired during the year.
It is useful to re-draft a statement of profit or loss without the effects of Aboabu Ltd.

Statement of profit or loss

Note: Capital employed will be made up of share capital and retained earnings, as no
loan notes will exist without the purchase of Aboabu Ltd. Retained earnings without
Aboabu Ltd will actually be GH¢1.75 million. This can be calculated in two ways:

Closing retained earnings of GH¢7 million less GH¢8.25 million from Aboabu Ltd’s
profit, plus GH¢3 million increase in profit after tax relating to the interest on the loan
notes (GH¢4 million interest saved less GH¢3 million tax relief at 25%).

An alternative calculation of retained earnings would be GH¢6 million in 2017 plus
GH¢0.75 million from Madina Ltd’s profit excluding Aboabu Ltd less GH¢5 million
dividend (GH¢0.05 per share), which would also give GH¢1.75 million.

A final alternative calculation of retained earnings would be closing retained earnings
of GH¢7 million less the original profit of GH¢6 million plus the GH¢0.75 million
profit excluding Aboabu Ltd, to give GH¢1.75 million.

 

Part (b) Performance Analysis

The acquisition of Aboabu Ltd has significantly improved the overall financial performance of Madina Ltd. Key observations include:

  • Revenue Growth: Including Aboabu Ltd, revenue increased by GH¢35 million (from GH¢90 million in 2017 to GH¢125 million in 2018, and an additional GH¢35 million from Aboabu Ltd).
  • Profitability: The gross profit margin increased from 16.7% in 2017 to 25% in 2018 (including Aboabu Ltd). Without Aboabu Ltd, the gross profit margin would still have improved to 20%.
  • Efficiency: The return on capital employed (ROCE) shows a substantial improvement, rising from 7.1% in 2017 to 21.5% in 2018 when including Aboabu Ltd. Without the acquisition, ROCE would still show an improvement at 11.2%.
  • The acquisition positively impacted profitability and capital efficiency, contributing to the overall growth of the company.

Part (c) Cash Position Analysis

  • Bank Overdraft: The company has moved from a cash surplus position in 2017 (GH¢7 million) to a significant bank overdraft of GH¢8.5 million in 2018. This indicates a potential liquidity issue.
  • Current Liabilities: The increase in trade payables (from GH¢6.5 million to GH¢11.5 million) suggests the company is relying more on credit from suppliers to finance operations.
  • Acquisition Financing: The acquisition of Aboabu Ltd was financed by issuing GH¢50 million 8% loan notes. This increased non-current liabilities but also resulted in higher finance costs (GH¢4 million).
  • Working Capital Management: Despite the acquisition, the current ratio has deteriorated. In 2017, current assets of GH¢18.5 million exceeded current liabilities of GH¢7.5 million, whereas in 2018, current assets of GH¢19 million are lower than current liabilities of GH¢22 million. This indicates potential liquidity risks and a strain on short-term cash flow.

 

  • 15 Marks

CR – May 2019 – L3 – Q3 – Business valuations

The question involves redrafting financial statements of PFC based on additional information provided and calculating a range of possible issue prices for an IPO using Net Assets Method and Earnings Yield/Price Earnings Ratio Method.

The Board of Pogas Furniture Ltd (PFC), after a few years of incorporation, has decided to get the company listed on the Ghana Stock Exchange. The Board has contacted you to assist in determining the true value of the business as at 31 December 2018 and to provide a range of possible issue prices based on the Net Assets Method and the Earnings Yield Method. Oliso Ltd, a listed company and a competitor of PFC, current results show a price-earnings ratio of 5 and earnings yield of 20%. The summarised unaudited financial statements of PFC are as follows:

Statement of Profit or Loss for the year ended 31 December 2018

GH¢’000
Sales Revenue (note i) 150,000
Cost of Sales (72,000)
Gross Profit 78,000
Operational Expenses (34,800)
Finance Costs (Interest on debenture stocks) (1,200)
Net Profit 42,000
Taxation (@ 25%) (10,500)
Profit for the period 31,500

Statement of Financial Position as at 31 December 2018

GH¢’000
Non-current assets
Property at Valuation (Land GH¢3 million; buildings GH¢27 million) 30,000
Plant and Equipment 24,000
Intangible Asset – Patent Right 3,000
Financial Asset (fair valued through profit or loss at 1/1/2018) 7,500
Total Non-current Assets 64,500
Current Assets 30,000
Total Assets 94,500
Equity and Liabilities
Stated Capital (4 million shares issued at GH¢3.00 per share) 12,000
Retained Earnings 57,960
Total Equity 69,960
Non-current liabilities
20% Debenture Stocks (2018-2020) 6,000
Deferred Tax provision (1 January 2018) 4,500
Total Non-current Liabilities 10,500
Current Liabilities
Trade Payables 3,540
Current Tax liability 10,500
Total Current Liabilities 14,040
Total Equity and Liabilities 94,500

Additional Information:

i) The sales revenue includes GH¢24 million of revenue for credit sales made on a ‘sale or return’ basis. At 31 December 2018, customers who had not paid for the goods had the right to return GH¢7.8 million of them. PFC applied a markup on cost of 30% on all these sales. In the past, PFC’s customers have sometimes returned goods under this type of agreement.

ii) The depreciable non-current assets have not been depreciated for the year ended 31 December 2018.

  • PFC has a policy of revaluing its land and buildings at the end of each accounting year. The values in the above statement of financial position are as at 1 January 2018 when the buildings had a remaining life of 18 years. A qualified surveyor has valued the land and buildings at 31 December 2018 at GH¢33 million.
  • Plant and equipment are depreciated at 12.5% per annum on the reducing balance basis. As at 31 December 2018, the value in use and the fair value less cost to sell were assessed at GH¢21.3 million and GH¢20.25 million respectively.
  • The patent right was acquired in January 2018 at a cost of GH¢3 million. It is expected to be used for five years after which the right of usage would have to be renewed in January 2023.

iii) The financial assets at fair value through profit or loss are held in a fund whose value changes directly in proportion to a specified market index. At 1 January 2018, the relevant index was 240.0, and at 31 December 2018, the index was 259.2.

iv) In late December 2018, the directors of PFC discovered a material fraud perpetrated by the company’s credit controller. Investigations revealed that a total of GH¢9 million of the trade receivables (included in current assets) as shown in the statement of financial position at 31 December 2018 had in fact been paid and the money had been stolen by the credit controller. An analysis revealed that GH¢3 million had been stolen in the year to 31 December 2017, with the rest being stolen in the current year. PFC is not insured for this loss and it cannot be recovered from the credit controller since his whereabouts are unknown.

v) As at 31 December 2018, the company’s taxable temporary differences had increased to GH¢24 million. The deferred tax relating to the increase in the temporary differences should be taken to profit or loss. The applicable corporate tax rate is 25%. The above figures do not include the estimated provision for current income tax on the profit for the year ended 31 December 2018. After allowing for any adjustments required in items (i) to (iv), the directors have estimated the provision of current tax liability for 2018 at 25% of adjusted profit. (This is in addition to the deferred tax effects of item (v)).

Required:

a) Redraft the financial statements above (taking into consideration the additional information (i) – (v) above). (11 marks)

b) Based on the revised financial statements, provide a range of possible issue prices per share using the Net Assets Method and the Earnings Yield/Price Earnings Ratio Method. (4 marks)

Part (a) Redrafted Financial Statements

Statement of Profit or Loss for the year ended 31 December 2018 (Revised)

Details GH¢’000
Sales Revenue (150,000 – 7,800) 142,200
Cost of Sales (72,000 – 6,000) (W1) (66,000)
Gross Profit 76,200
Operational Expenses (34,800)
Depreciation/Amortization (W2) (5,100)
Bad Debts (W3) (6,000)
Fair Value Gain on Financial Asset (W4) 600
Finance Costs (1,200)
Net Profit 29,700
Current Taxation (@ 25%) (7,425)
Deferred Taxation (1,500)
Net Profit for the Period 20,775
Other Comprehensive Income 4,500
Total Comprehensive Income 25,275

Statement of Financial Position as at 31 December 2018 (Revised)

Assets GH¢’000
Non-current assets
Property at Valuation 33,000
Plant and Equipment (24,000 – 3,000) 21,000
Intangible Asset – Patent Right 2,400
Financial Asset (fair valued through profit or loss) 8,100
Total Non-current Assets 64,500
Current Assets
Trade Receivables (30,000 – 7,800 – 9,000) 13,200
Total Current Assets 19,200
Total Assets 83,700
Equity and Liabilities
Equity
Stated Capital 12,000
Retained Earnings 44,235
Revaluation Surplus 4,500
Total Equity 60,735
Non-current liabilities
20% Debenture Stocks 6,000
Deferred Tax Provision 6,000
Total Non-current Liabilities 12,000
Current Liabilities
Trade Payables 3,540
Current Tax Liability 7,425
Total Current Liabilities 10,965
Total Equity and Liabilities 83,700

Workings:

  • W1: Cost of Sales Adjustment:
    Sales on a sale or return basis were GH¢7.8 million. PFC applies a 30% markup, so the cost of these sales is GH¢6 million.
    Adjustment:

    • Debit: Cost of Sales = GH¢6 million
    • Credit: Sales Revenue = GH¢7.8 million
  • W2: Depreciation:
    • Buildings = GH¢27 million ÷ 18 years = GH¢1.5 million
    • Plant and Equipment = 12.5% reducing balance (12.5% × GH¢24 million) = GH¢3 million
    • Amortization of Patent = GH¢3 million ÷ 5 years = GH¢600,000
    • Total Depreciation/Amortization: GH¢5.1 million
  • W3: Bad Debts Adjustment:
    Fraud loss = GH¢9 million; GH¢3 million for 2017, GH¢6 million for 2018.

    • Debit: Bad debts = GH¢6 million
    • Credit: Receivables = GH¢9 million
  • W4: Fair Value Adjustment for Financial Asset:
    Index increased from 240 to 259.2, resulting in an increase in value of the financial asset.
    Adjustment:

    • New Value = (259.2 ÷ 240) × GH¢7.5 million = GH¢8.1 million
    • Fair Value Gain = GH¢600,000

Part (b): Share Valuation

  1. Net Assets Basis:
    • Net assets = Total Equity = GH¢60,735,000
    • Number of shares = 4 million shares
    • Issue Price (Net Assets Basis) = GH¢60,735,000 ÷ 4,000,000 shares = GH¢15.18 per share
  2. Earnings Yield/Price-Earnings Ratio Method:
    • Earnings = GH¢20,775,000
    • Number of shares = 4 million
    • Earnings per Share (EPS) = GH¢20,775,000 ÷ 4 million = GH¢5.19 per share
    • Using a 20% Earnings Yield:
      • Issue Price (Earnings Yield Method) = GH¢5.19 ÷ 0.20 = GH¢25.95 per share
    • Using a Price-Earnings (P/E) Ratio of 5:
      • Issue Price (P/E Ratio Method) = 5 × GH¢5.19 = GH¢25.95 per share

Range of Possible Share Issue Prices:

  • Net Assets Basis: GH¢15.18 per share
  • Earnings Yield/P-E Ratio Method: GH¢25.95 per share
  • 5 Marks

CR – May 2018 – L3 – Q5c – Accounting and reporting concepts

Identify and explain two different approaches to defining a reporting entity for financial reporting purposes.

In May 2008, the International Accounting Standards Board (IASB) issued the discussion paper Preliminary Views on an Improved Conceptual Framework for Financial Reporting – The Reporting Entity. The objective of the Reporting Entity phase is to determine what constitutes a reporting entity for the purposes of financial reporting.

Required:
Identify and explain TWO different approaches to determining what a “reporting entity” should be for financial reporting purposes.

 

Two different approaches to determining a “reporting entity” for financial reporting purposes are:

  1. Legal Form Approach:
    • Explanation:
      Under the legal form approach, a reporting entity is determined based on its legal structure. In this approach, the entity is defined by its legal registration, such as a corporation, limited liability company, or partnership. This means that a legally incorporated entity is considered a reporting entity, and its financial statements should reflect the financial activities of that legal entity. This approach is commonly used because it aligns with legal and regulatory frameworks.
    • Advantages:
      The legal form approach provides clear boundaries for what constitutes a reporting entity, making it straightforward to prepare financial statements. It ensures that the financial reporting is aligned with the legal responsibilities of the entity, such as its tax and regulatory obligations.
    • Limitations:
      The legal form approach may not capture the full economic activities of a business, particularly if the entity is involved in a complex group structure with subsidiaries, associates, or joint ventures. As such, legal boundaries may not always reflect the economic reality of how resources are controlled or managed.
  2. Control Approach:
    • Explanation:
      The control approach defines a reporting entity based on the concept of control, as outlined in IFRS 10 Consolidated Financial Statements. In this approach, any entity over which another entity has control is considered part of the reporting entity. Control is established when an entity has the power to direct the relevant activities of another entity and can derive benefits from its operations. This approach is used to consolidate financial statements, where a parent company includes all subsidiaries that it controls.
    • Advantages:
      The control approach better reflects the economic reality of a business by including all entities that are controlled by a parent entity, even if they are legally distinct. It ensures that financial reporting provides a holistic view of the financial performance and position of a group of entities under common control.
    • Limitations:
      This approach may be more complex to implement, particularly for large groups with multiple layers of ownership. Additionally, determining control can sometimes be subjective, especially in cases where control is not based solely on ownership percentage but rather on contractual agreements or potential voting rights.
  • 10 Marks

CR – May 2018 – L3 – Q5b – Regulatory Framework and Ethics

Identify the ethical issue related to inventory adjustment and explain the Finance Manager’s course of action.

The Finance Manager of Integrity Sports, a Takoradi-based manufacturer and retailer of sporting goods, prepares quarterly accounts for his boss, the Finance Director. At the end of the first quarter of 2017, the Finance Manager identified that net assets were below the level required by a bank covenant that the company had entered into with Unique Bank. He therefore alerted the Finance Director to this. The following week, the Finance Manager identified that amended quarterly accounts had been sent to the bank by the Finance Director, in which the inventory figure had been increased. The same issue arose at the end of the second quarter of 2017, and again the Finance Manager noted that the accounts sent to the bank included a different inventory figure from those that he had prepared the previous week. The Finance Manager is sure that cut-off procedures and valuation were correctly adhered to and this was done under his supervision. He therefore asked the Finance Director why the figures had changed, and the Finance Director responded:

“The adjustment is just for some goods held at one of our customer’s retail premises – we missed it out from the stock count. Don’t worry, I’ve got it all in hand!”

The Finance Manager then reviewed the contract with the customer in question and noted that it clearly states that the customer will be supplied with goods as ordered and has no right of return in the case of unsold goods. He also noted that Integrity Sports has sold goods to this customer for a number of years on the same terms, and no adjustment has ever been made before. Both the Finance Manager and Finance Director are Chartered Accountants.

Required:
i) Explain why the inventory adjustment suggests an ethical issue. (6 marks)
ii) Explain FOUR courses of action that the Finance Manager should take in respect of the issue that he has identified. (4 marks)

i) Ethical Issue in Inventory Adjustment:
The inventory adjustment made by the Finance Director raises a significant ethical concern because it appears to violate accounting principles and ethical standards. Here’s why:

  1. Violation of Revenue Recognition Principles:
    Under IAS 18, revenue is recognized when the significant risks and rewards of ownership are transferred to the buyer, which in this case, happens when the goods are delivered. The Finance Manager reviewed the contract and found that the customer had no right of return on unsold goods. This implies that the goods had been sold, and any inventory adjustment is inappropriate since it would inflate the closing inventory figure and reduce the cost of sales. This misrepresentation results in an artificially increased profit.
  2. Breach of Bank Covenant:
    The inventory adjustment seems to have been made deliberately to meet the net asset requirement of the bank covenant. Inflating inventory to avoid breaching the covenant is a form of financial manipulation and misrepresentation, which is unethical and could lead to legal consequences if discovered.
  3. Professional Integrity and Objectivity:
    As both the Finance Director and Finance Manager are Chartered Accountants, they are bound by the Code of Ethics for Professional Accountants (issued by IFAC), which requires accountants to act with integrity and objectivity. Manipulating inventory values to meet external covenants compromises the integrity of financial reporting and misleads stakeholders, including the bank, shareholders, and regulators.
  4. Potential Personal Gain:
    The Finance Director may be attempting to manipulate the financial statements to present a healthier financial position for personal or corporate gain, such as avoiding penalties from the bank or preserving the company’s credit facilities. This type of action is in direct conflict with ethical standards and fiduciary responsibilities.

(6 marks for explaining the ethical issues)

ii) Courses of Action for the Finance Manager:
As a qualified Chartered Accountant, the Finance Manager is obligated to act ethically and professionally. Here are four courses of action he should take:

  1. Gather All Relevant Facts:
    The Finance Manager should first ensure that he has all the facts regarding the inventory adjustment. This may involve reviewing contracts, invoices, and the original stock count to confirm that the adjustment is indeed improper. It is essential to have a clear understanding before taking further steps.
  2. Discuss the Issue with the Finance Director:
    The Finance Manager should have a direct conversation with the Finance Director to express his concerns about the ethical and financial reporting implications of the inventory adjustment. This discussion should emphasize the professional and legal consequences of manipulating financial statements, including potential breaches of accounting standards and bank covenants.
  3. Escalate the Issue to a Higher Authority:
    If the Finance Director does not respond appropriately, the Finance Manager should escalate the issue to a higher authority within the company, such as the Board of Directors or the Audit Committee. These parties have oversight responsibilities and can intervene to ensure that the financial statements are prepared in accordance with ethical standards and accounting principles.
  4. Consult External Auditors or Regulatory Bodies:
    If internal escalation fails to resolve the issue, the Finance Manager should consider informing the company’s external auditors or relevant regulatory bodies. External auditors have a duty to ensure that financial statements are fairly presented and may take corrective action if they discover financial manipulation. In extreme cases, regulatory bodies may need to be informed of the unethical practices.
  • 10 Marks

CR – May 2018 – L3 – Q5a – Beyond financial reporting

Explain how integrated reporting merges sustainability reporting and financial reporting.

“Integrated reporting advances the proposition that sustainability reporting and financial reporting are inherently linked and thus would benefit from merging.” – Bob Massie, co-founder of the Global Reporting Initiative.

Required:
Explain how integrated reporting merges sustainability reporting and financial reporting.

Explanation of Integrated Reporting:
Integrated reporting combines sustainability reporting and financial reporting into a single, cohesive framework. This allows companies to provide a comprehensive picture of how they create value over time, considering both financial and non-financial factors. Here are the key ways in which integrated reporting merges sustainability and financial reporting:

  1. Linking Financial Performance with Sustainability:
    Traditional financial reporting focuses on profitability, revenues, and expenses, while sustainability reporting looks at environmental, social, and governance (ESG) issues. Integrated reporting brings these together, showing how sustainability initiatives (e.g., reducing carbon emissions or improving labor practices) directly impact the company’s financial performance and long-term value creation. For example, cost savings from energy efficiency improvements can enhance profitability.
  2. Capitals in Integrated Reporting:
    The integrated reporting framework focuses on multiple “capitals,” which are resources and relationships that organizations use to create value. These include:

    • Financial Capital: Traditional financial resources such as equity and debt.
    • Manufactured Capital: Physical assets like plants and machinery.
    • Intellectual Capital: Knowledge-based assets such as patents and proprietary technology.
    • Human Capital: Employee skills, well-being, and motivation.
    • Social and Relationship Capital: Relationships with stakeholders, including customers and communities.
    • Natural Capital: Environmental resources, including water, air, and biodiversity.

    The inclusion of non-financial capitals (e.g., social and environmental factors) alongside financial capital helps to demonstrate the full range of factors that contribute to the company’s success.

  3. Holistic View of Performance:
    Integrated reporting provides a holistic view of a company’s performance by combining both financial and non-financial information. This approach ensures that stakeholders understand how the company’s operations, strategy, and governance are aligned with its sustainability goals and financial objectives.
  4. Future-Oriented Reporting:
    Integrated reporting emphasizes the future, focusing on how a company’s strategy and sustainability practices will impact its ability to create value over the long term. This is in contrast to traditional financial reports, which tend to focus on historical financial performance. Integrated reporting allows companies to communicate their long-term sustainability initiatives and how these initiatives will enhance future profitability and resilience.
  5. Guiding Principles:
    Integrated reporting is based on guiding principles such as materiality, stakeholder inclusiveness, and reliability. This ensures that both financial and non-financial data are relevant and meaningful to stakeholders, promoting transparency and accountability. Stakeholder relationships, risks, and opportunities are reported in a way that links sustainability with financial outcomes.
  6. Strategic Alignment:
    Integrated reporting encourages companies to align their business strategy with sustainability objectives, leading to better decision-making. This alignment helps companies manage risks and capitalize on opportunities related to ESG factors, ultimately improving financial performance.
  7. Improved Communication with Stakeholders:
    By merging sustainability and financial reporting, integrated reports provide a more comprehensive view for stakeholders, including investors, customers, employees, and regulators. It allows stakeholders to understand not only the company’s financial performance but also its broader social, environmental, and governance impacts, helping them make informed decisions.

Conclusion:
Integrated reporting merges sustainability and financial reporting by providing a more complete, future-oriented, and stakeholder-inclusive view of how a company creates value. It emphasizes the interconnectedness of financial performance and sustainability initiatives, demonstrating that long-term success depends on both.

  • 8 Marks

CR – May 2018 – L3 – Q4c – Analysis and Interpretation of Financial Statements

Analyze and compare the financial performance of two companies in terms of operating performance, liquidity, gearing, and investment ratios.

Fordland Ltd and Fiatland Ltd are two companies in the garment industry. The following are financial ratios computed by the Research Department of ICAG as part of analyzing companies’ performance industry by industry:

Ratios Fordland Ltd Fiatland Ltd
Return on Capital Employed (ROCE) 24.10% 30%
Net Assets Turnover 1.9 times 2.5 times
Gross Profit Margin 35% 20%
Net Profit Margin 10.50% 38%
Current Ratio 1.0:1 2.0:1
Quick Ratio 0.8:1 1.0:1
Inventory Holding Period 60 days 90 days
Receivables Collection Period 58 days 60 days
Payables Payment Period 50 days 50 days
Debt to Equity Ratio 50% 30%
Dividend Yield 3% 2%
Dividend Cover 2 times 1.5 times

Required:
Write a report analyzing and comparing the financial performance of Fordland Ltd and Fiatland Ltd. The report should cover operating performance, liquidity, gearing, and investment ratios. (8 marks)

Report
From: Financial Analyst
To: ICAG Research Department
Date: May 2018
Subject: Financial Performance Comparison of Fordland Ltd and Fiatland Ltd

Introduction
This report provides a comparative analysis of the financial performance of Fordland Ltd and Fiatland Ltd in the garment industry. The analysis focuses on operating performance, liquidity, gearing, and investment ratios based on the data provided.

1. Operating Performance

  • Return on Capital Employed (ROCE):
    Fiatland Ltd outperforms Fordland Ltd with a ROCE of 30%, compared to Fordland’s 24.10%. This indicates that Fiatland is generating higher returns from its capital investments.
  • Net Asset Turnover:
    Fiatland’s asset turnover ratio of 2.5 times is better than Fordland’s 1.9 times, suggesting that Fiatland is more efficient in utilizing its assets to generate revenue.
  • Gross Profit Margin:
    Fordland has a higher gross profit margin (35%) compared to Fiatland (20%), which indicates that Fordland is better at controlling its cost of sales relative to revenue.
  • Net Profit Margin:
    Fiatland’s net profit margin (38%) is significantly higher than Fordland’s (10.50%), implying that Fiatland is more efficient at converting revenue into profit after all expenses.

2. Liquidity

  • Current Ratio:
    Fiatland has a current ratio of 2.0:1, which is stronger than Fordland’s 1.0:1. This indicates that Fiatland is in a better position to cover its short-term liabilities with its current assets.
  • Quick Ratio:
    Similarly, Fiatland’s quick ratio (1.0:1) is higher than Fordland’s (0.8:1), suggesting that Fiatland has a better ability to meet its short-term obligations without relying on inventory sales.
  • Efficiency in Working Capital Management:
    Both companies have similar receivables collection periods (58 days for Fordland and 60 days for Fiatland). However, Fiatland has a longer inventory holding period (90 days vs 60 days), which may indicate slower inventory turnover. Both companies have the same payables payment period (50 days), showing consistency in their credit management policies.

3. Gearing

  • Debt to Equity Ratio:
    Fordland is more leveraged with a debt to equity ratio of 50% compared to Fiatland’s 30%. This indicates that Fordland has a higher financial risk due to its greater reliance on debt financing.

4. Investment Ratios

  • Dividend Yield:
    Fordland has a higher dividend yield of 3% compared to Fiatland’s 2%. This suggests that Fordland is offering a better return on dividends to its shareholders.
  • Dividend Cover:
    Fordland’s dividend cover (2 times) is stronger than Fiatland’s (1.5 times), indicating that Fordland has a better ability to sustain its dividend payments from its earnings.

Conclusion
In summary, Fiatland Ltd outperforms Fordland Ltd in terms of return on capital employed, asset turnover, and net profit margin, suggesting better overall efficiency. However, Fordland Ltd has stronger gross profit margins and better dividend returns, which could appeal to income-focused investors. Additionally, Fordland’s higher debt levels indicate greater financial risk compared to Fiatland’s more conservative capital structure. Fiatland’s higher liquidity ratios reflect better short-term financial stability.

Signature
Financial Analyst

Take control of your business data with insight and in-depth understanding by taking this course. 

Services

Contact Info

  • +233203701923
    +233543919232
  • info@noohrabusiness.com

Get In Touch

Follow us on our social media and get daily updates.

Facebook-f Twitter Linkedin-in Envelope