BMAN21020 FINANCIAL REPORTING AND ACCOUNTABILITY 2021
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BMAN21020
FINANCIAL REPORTING AND ACCOUNTABILITY
2021
SECTION A (COMPULSORY)
Answer ALL parts of Question 1
Maximum word count for Q1: 1,500 words
Question 1
Helena Products plc is a manufacturer of office furniture. In January 2019 the company carried out a strategic review and decided to target as customers people working from home. In order to achieve this strategy the company acquired a building with a showroom and a warehouse and invested on new delivery vehicles. This expansion has been financed by loans and the bank overdraft facility has been fully utilised. Financial information concerning the business is given below.
Draft Income statement (extract) for the years
ended 30 November
Revenue
2020
£'000
5,683
2019
£'000
5,241
Cost of sales
Gross Profit
Operating expenses
Operating profit
Interest charges
Profit before taxation
Taxation
Profit for the year
Draft Statements of Financial Position as at 30 November
Non-current assets
Property plant and equipment (net book value) Premises (net book value)
Current assets
Inventories
Trade receivables
Total assets
Equity
Share capital (£1 nominal value)
Retained Earnings
Non-current liabilities
Borrowing – loans
Current liabilities
Trade payables
Taxation
Short-term borrowing (all bank overdraft)
Total equity and liabilities
(4,124)
1,117
(660)
457
(11)
446
(179)
267
2019
£'000
2,620
1,188
5,709 3,808
1,193
1,270
2,463
9,559 6,271
1,000
3,907
5,134 4,907
1,838 610
578
90
86
2,587 754
6,271
a) Calculate for Helena Products plc the following ratios for both 2019 and 2020 using the available information:
i. Operating profit margin
ii. Gross profit margin
iii. Net profit margin (after taxation)
iv. (Net) Asset Turnover ratio
v. Return on capital employed (ROCE)
vi. Current ratio
vii. Receivables Collection period (days)
viii. Stock turnover period (days)
ix. Gearing ratio (debt to capital employed)
(9 marks)
b) You are working as an investment advisor for a large pension fund which is considering investing on Helena plc. Helena plc’s price per share was £1.64 on
30 November 2020 and £1.29 on 30 November 2019. Using the ratios calculated in part (a), and any other ratios or information you consider relevant, provide an investment recommendation to your employer commenting on the performance of the company and on the new strategy. In your answer you should also reflect on the impact of COVID- 19 on the firm’s performance in 2020 and going forward.
(25 marks)
c) For the 2020 financial year, the CEO of Helena Products PLC received an annual salary of £100,000. Her executive pay contract also includes an annual bonus which can amount up to 200% of the salary (i.e., £200,000). The bonus becomes payable based on a number of criteria, as described in the following table:
Desciption of Annual Bonus Plan for Financial year 2020 |
||||||
Performance Measure |
Weighting |
Minimum Threshold (20% of award) |
Target (50% of award) |
Stretch (100% of award) |
Performance Achieved |
Resulting Level (% or amount of bonus payable) |
ROCE |
50% |
7.60% |
8.40% |
9.20% |
|
|
Net Profit Margin |
50% |
3.95% |
4.95% |
5.95% |
|
|
Complete the blanks in the above table for 2020. How much is the bonus that the CEO will receive for her performance? Show your workings and use two
decimal points in your calculations. (8 marks)
d) On 1 December 2019 Helena Products issued a loan of £1.625 million spanning a three-year term, with a coupon rate of interest of 2%. It received £1.3 million (face value less a 20% discount). Finance charges of £32,500 (2% of the £1.625m) are payable annually in arrears on 30 November, and the principal sum of £1.625 million is repayable on 30 November 2022. The implicit interest rate relating to this loan agreement is 10.0%. Helena Products has recorded the £32,500 payment made on 30 November 2020 as interest in their draft income statement for the year ended 30 November 2020.
Explain how the loan should have been accounted for according to IAS 32, and
calculate the impact of any correction on the net profit margin (ignoring tax). (10 marks)
e) Define the Bonus Plan Hypothesis from Positive Accounting Theory. Briefly describe and explain its predictions on the choices of accounting policies by firm managers. Also, reflect on how the Bonus Plan Hypothesis could help us explain the accounting treatment of the loan as descibed in part (d).
(8 marks) (Total for Q1: 60 marks)
SECTION B
Answer ONE question
Maximum word count for Q2/Q3: 1,000 words
Question 2
a) Employee Benefits
On 30 April 2020, actuaries valued the defined benefit pension scheme of Bitz plc and estimated that the scheme had assets of £30 million and obligations of £35 million (using the valuation methods prescribed in IAS 19). The actuaries made assumptions in their valuation that the plan assets would grow by 9% (their expected return) over the coming year to 30 April 2021, and that the obligations were discounted using an appropriate corporate bond rate of 6%. The actuaries estimated the current service cost for the year would be £1.1 million and informed the company that pensions paid to retired directors from the fund would be £1.6 million during the year, and the company should contribute £2.3 million to the scheme.
At 30 April 2021, the actuaries revalued the pension fund and estimated the assets to be worth £29 million, and the obligations of the fund to be £31.6 million.
Assume that contributions and benefits are paid on the last day of the year.
Prepare two summaries showing the movements on pension plan assets and pension plan obligations in the year and use your summaries to calculate the net actuarial gain or loss on the pension fund in the year. Explain why adjustments relating to actuarial
gains and losses are likely to arise. (18 marks)
b) Judgement in financial reporting
The accounting for a defined benefit pension scheme under IAS 19 involves the application of judgement under conditions of uncertainty.
Describe two other examples where judgement is required in financial reporting and whether you believe that the uncertainty relating to the judgement is justified in providing the user of the financial statements with more useful information.
(6 marks)
c) Capital Maintenance
On 1 April 2020 Arc Ltd began trading in specialist equipment made with components that are in short supply. Capital of £4,000 was introduced and used immediately to purchase 10 units of inventory at a cost of £400 each. On 1 October 2020, 6 units of the inventory was sold for £700 cash, when the replacement cost of each unit had risen to £450. No further transactions took place, and by the year-end of 31 March 2021, the replacement cost per unit had risen to £500. Summarised financial statements for the year ended 31 March 2021, based on the Historic cost convention (and ignoring tax), are shown below:
Income Statement for the year ended 31 March 2021:
Sales [6 units at £700 each]
Purchases [10 units at £400 each]
Closing stock [4 units at £400 each]
Cost of sales:
Profit
Statement of Financial Position at 31 March 2021
£ £
4,200
4,000
(1,600)
(2,400)
1,800
£
Stock
Cash
Capital Employed
Share Capital
Profit
1,600
4,200
5,800 |
4,000 1,800 |
5,800 |
The owners of Arc are keen to receive all distributable profits, however the directors
are concerned that doing so may erode the company’s capital, given increases in replacement cost throughout the year as summarised below:
Replacement
Date: cost
1 April 2020 £400
1 October 2020 £450
31 March 2021 £500
Using the above information, prepare a summary income statement and statement of financial position in line with current cost accounting (Replacement Cost) basis (CCA). Explain to the directors why a distribution of £1,800 would not ensure capital is maintained in “physical” terms and suggest an appropriate dividend to pay to maintain
capital under the current cost accounting . (16 marks)
(Total for Q2: 40 marks)
Question 3
a) Capital Reconstruction
Dunstable Ltd has a statement of financial position with significant retained losses and no cash (it holds a bank overdraft of £66,000) . Its net assets stand at £84,000 and are represented by the following capital and reserves:
Preference shares of £1 each fully paid Ordinary shares of £1 each fully paid Retained Earnings
Net assets
£’000
200
100
(216)
84
Dunstable has succeeded in creating a new product that its directors anticipate will yield profits of £50,000 each year for at least the next five years, although this will require additional funds. The following capital restructuring scheme has been approved and authorised by its creditors:
1. 40% of the ordinary shares are to be surrendered.
2. The preference shares are to be surrendered and cancelled and the holder of every
50 preference shares will pay Dunstable £30 cash, and will be issued:
One 7% loan note of £40 each, and
10 fully paid ordinary shares of £1 (redistributing the shares surrendered).
3. The freehold property is to be revalued upwards by £60,000.
4. The negative balance on retained earnings will be written off, and equipment will be impaired by £4,000.
(i) Discuss the challenges that Dunstable would face in raising finance to fund its new product given its current capital and reserves presentation. Explain how Dunstable may be able to persuade both ordinary and preference shareholders – and its creditors – to the restructuring scheme that is described above. (12 marks)
(ii) Prepare the journals that would account for each of the adjustments (1) to (4) outlined above and present a T-account of the Capital Reduction and Reorganisation (CR&R) account that should clear to zero as a result of the
adjustments. (12 marks)
b) Taxation
Wang plc is a pharmaceutical company. Due to the length of time the company has to spend developing new medicines before they can be sold the company has accrued significant losses and has calculated a total deferred tax asset of £2,400,000 in relation to those losses for the year end 31 March 2021. On 1 April 2021, the company is due to start selling the medicines and taxable profits are estimated at £480,000 for the year ended 31 March 2022. However, due to competition in the market and other market uncertainties no profits can be anticipated for the year ended 31 March 2023 and beyond. The current tax rate is currently 20%.
For year ended 31 March 2021 discuss the requirements for a tax asset to be recognised and calculate the amount to be included in the financial statements as a deferred tax asset. State any assumptions made in coming to your calculation.
(8 marks)
c) External Audit
Discuss the stages that are involved in the external audit process, and whether you believe that an external audit adds value to the users of the financial statements.
(8 marks) (Total for Q3: 40 marks)
2022-05-09