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

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

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:

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)

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

Stock

Cash

Capital Employed

Share Capital

Profit

£

4,200

4,000

(1,600)

(2,400)

1,800

£

1,600

4,200

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:

£’000

Ordinary shares of £1 each fully paid                   100

Retained Earnings                                             (216)

Net assets                                                             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%.