Pathfinder November 2016 Professional
Pathfinder November 2016 Professional
Pathfinder November 2016 Professional
ACCOUNTANTS OF NIGERIA
PATHFINDER
NOVEMBER 2016 DIET
PROFESSIONAL LEVEL EXAMINATIONS
Question Papers
Suggested Solutions
Marking Guides
Plus
Examiner’s Reports
(ii) Unsuccessful candidates in the identification of those areas in which they lost
marks and need to improve their knowledge and presentation;
The answers provided in this publication do not exhaust all possible alternative
approaches to solving these questions. Efforts had been made to use the methods,
which will save much of the scarce examination time. Also, in order to facilitate
teaching, questions may be edited so that some principles or their application may be
more clearly demonstrated.
NOTES
SUBJECT PAGE
QUESTION 1
a. Bata Plc, which operates in the manufacturing sector, has been surviving the
challenges operating in the Nigeria economic environment. The draft Statements
of Financial Position of Bata Plc and its subsidiaries as at October 31, 2016 are as
follows:
Bata Jewe Gaba
N’million N’million N’million
Non-current assets
Property, plant and equipment 4,320 360 420
Investments in subsidiaries 1,110 600 -
Financial assets 500 - -
5,930 960 420
Current assets 1,050 570 540
Total assets 6, 980 1,530 960
Equity
Share capital - N1 ordinary shares 2,400 600 300
Retained earnings 3,410 540 390
Other components of equity 450 - -
Total equity 6,260 1,140 690
(iii) At the respective dates of acquisitions, the fair value of the net assets of Jewe Plc
was N930million and for Gaba Plc N660million. The difference in the fair value
and book value of the net assets at acquisition dates relates to non-depreciable
land. The fair value of the non-controlling interest in Jewe Plc at the date of
acquisition was estimated at N390million and for Gaba Plc, N330million. Bata Plc
adopts the full goodwill method under IFRS 3 Business Combinations to account
for non-controlling interest.
(iv) Given the economic environment in the country, impairment test was carried out
for the subsidiaries and it was discovered that whereas Gaba Plc suffered no
impairment loss due to its line of business, Jewe Plc had suffered an impairment
loss of N60million.
(v) During the year ended October 31, 2016, Bata Plc had sold inventory to both
Jewe Plc and Gaba Plc. The invoiced prices of the inventories were N480million
and N360million respectively. Bata Plc invoices goods to achieve a mark-up of
25% on cost to all third parties including group companies. At the year-end, half
of the inventory sold to Jewe Plc remained unsold but the entire inventory sold to
Gaba Plc had been sold to third parties.
(vi) Bata Plc purchased a deep discount bond, an innovative financial instrument in
the Nigerian Capital Market for N500million on November 1, 2015 switching from
its equity holdings in that market where equities had suffered huge losses. The
bonds will be redeemed in 3 years time for N740.75million and are carried at
amortised cost in line with IAS 39 Financial Instruments – Recognition and
Measurement. The Accountant is not clear as to the correct treatment of
amortised cost and as such has not passed the correct entry to give effect to
amortised cost valuation at year end in the financial statements.
As such the financial asset is shown at N500million.
Required:
Prepare a Consolidated Statement of Financial Position for Bata Plc. and its
subsidiaries as at October 31, 2016.
(25Marks)
b. As a result of the challenges in the foreign exchange market since the advent of
the current administration which has made it difficult to source foreign exchange
to import raw materials, the Directors of Bata Plc are now considering acquiring
a foreign subsidiary which may facilitate access to such foreign exchanges that
may be needed. They are not fully aware of the requirements of IAS 21 ‘The
Effects of Changes in Foreign Exchange Rates in relation to translating the
financial statement of a foreign subsidiary.’
Required:
Briefly explain to the directors of Bata Plc how the assets, liabilities, income and
expenses of a foreign subsidiary including the resulting goodwill are translated
for consolidation purposes and the treatment of exchange difference arising from
the translation. (5 Marks)
(Total 30 Marks)
SECTION B: YOU ARE REQUIRED TO ANSWER ANY TWO OUT OF THREE QUESTIONS IN
THIS SECTION (40 MARKS)
QUESTION 2
The objective of IAS 33 - Earnings Per Share is to improve the comparability of the
performance of different entities in the same period and of the same entity in different
accounting periods. This is done by prescribing the methods for determining the
numbers of shares to be included in the calculation of earnings per share. The
management of Soar Plc had sought for your professional advice on the application of
IAS 33.
b. The directors of Soar Plc have decided to replace most of the existing plant and
machinery which are now obsolete during the year ended September 30, 2015 in
order to enhance earnings. The costs of removing existing plant and acquiring
and installing new plant have been estimated at N750,000.
In order to improve liquidity, the directors decided to make a new issue of
800,000 ordinary shares at N2 per share fully paid on January 1, 2015 and a
further N600,000 4% convertible loan notes on June 1, 2015. The terms of issue
would provide for conversion into ordinary shares as stated below:
On September 30 Number of shares per
N100 of loan stock
2015 120
2016 125
2017 118
2018 122
The ordinary shares issued would rank for dividend in the current year. The
following relates to the company for the period ended September 30, 2015:
Profit before interest and tax is N850,000.
Effective rate of company tax on profit is 30% and the basic EPS for the
year ended September 30, 2014 was 48kobo.
The company had issued as at September 30, 2014 the following:
2,000,000 ordinary shares of 50 kobo each fully paid
400,000 12% irredeemable preference shares of N1 each fully paid
300,000 10% redeemable preference shares of N1 each fully paid.
N700,000 8% redeemable debenture (non-convertible)
Required:
Calculate for Soar Plc for the year ended September 30, 2015:
i. Basic earnings per share (5 marks)
ii. Fully diluted earnings per share (5 marks)
(Total 20 marks)
QUESTION 4
(a) Prior to the advent of IFRS 13, many standards such as IAS 16, IAS 38, IAS 40 and
IAS 39 among others require the use of fair value. These various requirements
have been harmonised with the introduction of IFRS 13 Fair Value Measurement.
Required:
Define fair value in accordance with IFRS 13 (2 Marks)
(b) One of the companies formally operating in Nigeria that had recently relocated
its operation to Ghana as a result of the challenging business environment in
Nigeria has access to both Lagos and Accra market for its product. The product
sells at slightly different prices (in naira) in the two active markets. An entity
enters into transactions in both markets and can access the price in those
markets for the product at the measurement date as follows:
Lagos Accra
Market Market
N’000 N’000
Sale price 260 250
Transaction cost (30) (10)
Transport cost (20) (20)
Net price received 210 220
Required
i. Briefly explain the principal market of an asset in accordance with IFRS 13
and determine what fair value would be used to measure the sale of the
above product if the Lagos market were the principal market?
(4 Marks)
ii. How is fair value determined in the absence of a principal market and what
fair value would be used to measure the sale of the above product if no
principal market could be identified? (4 Marks)
SECTION C: YOU ARE REQUIRED TO ANSWER ANY TWO OUT OF THREE QUESTIONS
IN THIS SECTION (30 MARKS)
QUESTION 5
Manipulation of reporting entities book’s and records have been termed in many
quarters as “Creative Accounting” and “Window Dressing”. The Management of
Wastage Plc requires clarification of these two concepts.
QUESTION 6
QUESTION 7
a. ABC Plc, in accordance with the regulations of the Nigerian Stock Exchange on
transition to IFRS, prepared its first IFRS Financial Statement in 2012. The
Financial Statement was contained in a voluminous document of 155 pages.
Some of the stakeholders found it difficult to understand the essence of the
voluminous document.
a.
BATA AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT OCTOBER 31, 2016
N’m N’m
Non-current assets
Property, plant and equipment (wk2) 5,280.00
Goodwill (wk3) 540.00
Financial Asset (wk5) 570.00
Current Assets (wk4) 2,112.00
Total Assets 8,502.00
WORKINGS
(1) Group Structure
Bata
60%
Jewe 10%
70%
Gaba
Direct 10%
Indirect 60% x 70% 42%
52%
Working 2
Property, Plant and equipment
N’m N’m
Property, plant and equipments:
- Bata 4,320
- Jewe 360
-Garba 420
5,100
Fair Value land
- Jewe 60
-Garba 120 180
5,280
The cost of investment paid by Jewe in Gaba belongs to Bata 60% x N600 million ie
N360 million.
(3) GOODWILL
Jewe Gaba
N’m N’m N’m N’m
Purchase Consideration: Bata 852 258
Jewe 60% x 600 360
NCI (Note 1) at fair value 390 330
1,242 948
Net asset at acquisition
Share capital 600 300 300
Retained earnings 270 240 240
Fair value land 60 930 120 (660)
Goodwill 312 288
Impairment (60) ------
Goodwill to SOFP 252 288
Total Goodwill on Consolidation (252 + 288) = 540
(b)
From: Financial Controller
To: The Directors,
Bata Plc
I. Dee
Financial Controller
EXAMINER’S REPORT
The question tests preparation and presentation of consolidated financial statement of a mixed
group structure.
All the candidates attempted the question and the performance was average.
The commonest pitfall is their inability to calculate the deep discount bond.
This aspect of the syllabus has been examined on regular basis, therefore, candidates are
advised to study and understand the principles guiding various aspects of group financial
statements.
(a)
The Managing Director/CEO
Soar Plc
Dear Sir,
EARNINGS PER SHARE
In response to our recent discussion on the above subject matter, below is the
significance and shortcomings of earnings per share:
Yours faithfully,
Financial Accountant
No. of shares
Existing number of shares (2,000,000 x 12/12) = 2,000,000
New issue at 1/1/2015 (800,000 x 9/12) = 600,000
BASIC 2,600,000
% # , . # ,
= = 2.24 kobo
[ , / ( ÷ )] ,,
Since the incremental EPS is less than the BASIC EPS, the convertible stock should be
included in the calculation of DILUTED EPS
(# , # , )
Diluted EPS for 2015 = =17.08 kobo
, , ,
MARKING GUIDE
Marks
a. i. Significance of Earnings Per Share 5
ii. Shortcomings of Earnings Per Share 5
Examiner’s Report
The question tests candidates’ knowledge of Earnings Per Share.
About 85% of the candidates attempted the question and performance was above average.
Majority of the candidates understood the requirements of part ‘a’ of the question whilst there
was poor understanding of requirements of ‘b’. Also some candidates were unable to compute
the test for dilution
Total Revenues 110,419 82,566 192,985 2,375 2,535 4,910 197,895 100.00 97.52 2.48
Interest And
Similar Expenses -25,398 -34,049 -59,447 -271 -263 -534 -59,981 30.31 99.11 0.89
Operating Income 85,021 48,517 133,538 2,104 2,272 4,376 137,914 69.69 96.83 3.17
Total Income 86,871 49,469 136,340 2,104 2,272 4,376 140,716 71.11 96.89 3.11
Operating
Expenses -75,507 -88,429 -163,936 -1,530 -1,468 -2,998 -166,934 -84.35 98.20 1.80
Net Impairment
Loss On Financial
Assets -2772 -69,525 -72,297 -106 -3 -109 -72,406 -36.59 99.85 0.15
(Loss)/ Profit
Before Taxation 8,592 -108,485 -99,893 468 801 1,269 -98,624 -49.84 101.29 -1.29
Income Tax
Expense -1,572 25,346 23,774 -113 -213 -326 23,448 11.85 101.39 -1.39
(Loss)/ Profit After
Taxation 7,020 -83,139 -76,119 355 588 943 -75,176 -37.99 101.25 -1.25
Total Assets 954,165 899,434 1,853,599 78,882 155,300 234,182 2,087,781 100.00 88.78 11.22
Total Liabilities 781,019 711,678 1,492,697 57,630 143,684 201,314 1,694,011 81.14 88.12 11.83
Net Assets 173,146 187,756 360,902 21,252 11,616 32,868 393,770 18.86 91.65 8.35
Income statement
The Nigerian region contributed 97.52% of the entire revenue of the group. With
interest and similar expenses being 30.31% of the entire revenue of which Nigeria
contributed 99.11% leaving an operating income which is 69.69% of the group
revenue.
The operating expenses net impairment was more than the operating income of which
the contribution from Nigeria was a major component.
Tutorial Note
Vertical analysis is the proportional analysis of a financial statement, whereby each
line item on a financial statement is listed as a percentage of another item within a
single period. Vertical analysis between the segments requires a comparison of
segment’s figure with the group figure i.e. expressing contribution of the segment as a
proportion of the group total.
Examiner’s Report
The question tests performance evaluation of a group of Companies using vertical financial
analysis.
About 25% of the candidates attempted the question and the performance was poor.
The pitfall was that candidates could not understand the requirements of the question by
confusing financial appraisal with segment information.
Candidates are advised to understand the requirements of the question for better performance
in future examination.
(a) Fair value is “the price that would be received to sell an asset or paid to transfer
a liability in an orderly transaction between market participants at the
measurement date.”
According to IFRS 13 the principal market is the market with the greatest
volume and level of activity for the asset or liability. The price in the principal
market used to measure the fair value of the asset (liability) is not adjusted for
transaction costs.
(b)
i. If Lagos market is the principal market for the product, its fair value
would be measured using the price that would be received in that
market, after taking into account transport costs at N240, 000.
N’000
Sale price 260
Transport cost (20)
Fair value 240
ii. If no principal market could be identified, the fair value of the product
would be measured using the price in the most advantageous market.
The most advantageous market is the market that maximises the amount
that would be received to sell the asset, after taking into account
transaction costs and transport costs (i.e. comparing the net amount that
would be received in the respective markets).
This is the Accra market where the net amount that would be received for
the product would be N220,000, given the fact that transaction costs is
not considered in the determination of fair value. The fair value of the
asset is determined as:
N’000
Sale price 250
Transport cost (20)
Fair value 230
(c) IFRS 13 requires the fair value of a non-financial asset to be measured based on
its highest and best use from a market participant’s perspective. This
requirement does not apply to financial instruments, liabilities or equity. The
highest and best use takes into account the use of the asset which is physically
possible, legally permissible and financially feasible. The highest and best use of
a non-financial asset is determined by reference to its use and not its
If used for residential purposes, the value should include all costs associated with
changing the land to the market participant’s intended use. In addition,
demolition and other costs associated with preparing the land for a different use
should be included in the valuation. These costs would include the uncertainty
related to whether the approval needed for changing the usage would be
obtained, because market participants would take that into account when pricing
value of the land if it had a different use. Thus the fair value of the land if used
for residential purposes would be:
N’000
Fair Value 148
Legal cost (4)
Viability Analysis Cost (6)
Cost of demolition (2)
136
Discounted at 80%(80% of 136) 108.8
In this situation, the presumption that the current use is the highest and best use
of the land has been overridden by the market factors which indicate that
residential development is the highest and best use.
A use of an asset need not be legal at the measurement date, but it must not be
legally prohibited in the jurisdiction.
EXAMINER’S REPORT
The question tests the provisions and application of IFRS 13, Fair Value measurement.
More than 50% of the candidates attempted the question and some of them do not have clear
understanding of the requirement.
The commonest pitfall was the inability of the candidates to understand IFRS 13 requirements,
that the highest and best use of a non-financial asset is determined from the prospective of
market participant. As such they were unable to distinguish fair value of land if used for
commercial and residential purposes.
Candidates should endeavour to cover all relevant IFRS and IAS in the professional level of the
examination of the Institute.
a.
Creative Accounting
Creative accounting can be defined as the presentation of information in a manner
that is inconsistent with the underlying facts. It can also be the application of
accounting policies to structure particular transactions in such a way that the
financial statements will portray a picture of financial health that is in line with
what the directors would like users to see rather than the true financial
performance and position of the business. The main purpose of creative
accounting is to inflate profit figure though some companies may also reduce
report profits in good years either to smooth results or depending on what the
directors want to achieve. Assets and Liabilities may also be manipulated either to
remain within limit such as debt covenants or to hide problems.
Window dressing
The term, “window dressing” is strategy used to create a superficial or misleading
presentation of financial performance in an illegal and unethical manner. The
manipulation of investment portfolio performance numbers is window dressing
and creative accounting.
In a nutshell, the objective of window dressing and creative accounting are the
same, but the ways of achieving their results differs in the sense that creative
accounting involves taking the advantage of the loopholes in the accounting laws
and standards but window dressing does not necessarily take advantage of the
loopholes but sometimes intentionally go against the provision of the accounting
laws and standards.
Off-balance-sheet financing
This involves a firm’s debt being omitted from its statement of financial
position. This was the main creative accounting technique employed by Enron,
prior to its bankruptcy in 2001.
Revenue recognition
This is a technique to recognize revenue before it is earned. One of such
practice, known as ‘channel stuffing’, involves a distributor supplying more
goods to retail outlets than can be sold to customers.
Overstating assets
This involves the failure by a firm to record impairments relating to the value of
assets such as machinery, property, inventory, investments and receivables.
Inappropriate and constant changes in accounting policies with the main aim of
improving profitability performance.
i. Financial regulation
Legislation provides the basic weaponry in the war against creative
accounting. In prescribing the statutory regulations that must be
compiled with the relevant statutory and regulatory requirements which
establish a solid platform for the prevention of creative accounting.
viii. Ensuring that the substance of transactions as against its legal form is
reflected in the financial statements.
Yours faithfully
Financial Controller
Five (5) examples of window dressing and Creative Accounting at 1 mark each 5
Examiner’s Report
The question tests the knowledge and understanding of the creative accounting and
window dressing.
About 90% of the Candidates attempted the question and the performance was
average.
The commonest pitfall is the inability of the candidate to clearly distinguish between
Window dressing and Creative accounting.
Candidates are required to understand every aspect of the syllabus for better
performance in future.
(a) In accordance with the requirement of IFRS 5- Non-current assets held for sale
and Discontinued Operations, Maranathan Plc transactions would be treated as
follows:
i. The property would be classified as held for sale from 1st Oct, 2013
It is assumed that the directors have made a decision to sell the property
from 1st Oct, 2013 and that active steps to locate a buyer and the
property is being marketed at a reasonable price.
ii. The property would be removed from Non-current assets and presented
separately under current assets in the statement of financial position.
iii. The property will no longer be depreciated from the date of
classification(i.e from 1st Oct 2013) as held for sale, hence, it will only be
depreciated for the first four months before classification as held for sale
(i.e from 1/6/2013 – 1/10/2013).
iv. The property would be measured at the lower of carrying amount and
fair value less costs to sell.
v. Impairment must be considered both at the time of classification as held
for sale and subsequently as follows:
- Any impairment loss is recognized on profit or loss unless the assets
had been revalued before in which case the impairment is treated as a
revaluation decrease.
- A gain from any subsequent increase in fair value less costs to sell of
an asset is recognized in the profit or loss to the extent that it is not in
excess of the cumulative impairment loss already recognized in line
with IFRS 5.
(b)
i. At the time of classification as held for sale, depreciation needs to be
charged for the four months to 1 October 2013. This will be based upon
the year end value at 31 May 2013 of N2·65 million. The property has 10
years life remaining based upon the depreciation to date and assuming a
zero residual value, the depreciation for the four months will be
approximately N0·883 million. Thus, at the time of classification as held
for sale, after charging depreciation for the four months of N0·883million,
the carrying amount is N2·561 million (N4m – N 1 – N 0·883 m – N
0·35m) and fair value less costs to sell is assessed at N2·4 million. Thus,
the initial write-down on classification as held for sale is N161,667 and
the property is carried at N2·4 million.
MARKING GUIDE
Marks Marks
EXAMINER’S REPORT
The question tests candidates ability to apply the provisions and the requirements of IFRS 5 –
Criteria to classify a non-current assets as held for sale and discontinued operations and IAS
10 – Events after the reporting date.
The percentage attempt was about 40% and most candidates that attempted the question
demonstrated very poor understanding and performance was below average.
The commonest pitfall was that there were poor evaluation/ presentation of solution by
majority of the Candidates.
Professional level candidates are required to understand the provisions and applications of
IFRS at this level of the Institute’s examination.
a.
Introduction:
International Financial Reporting Standards (IFRS) are a set of accounting standards
developed by the International Accounting Standards Board (IASB) that is becoming
the global standard for the preparation of public company financial statements.
Convergence of accounting standards refers to the goal of establishing a single set of
accounting standards that will be used internationally. This is also described as the
international harmonisation of accounting standards.
Yours faithfully
Financial Controller
EXAMINER’S REPORT
The question tests the essence, merits and challenges of IFRS adoption in Nigeria.
The candidates demonstrated a fairly satisfactory understanding of the question. About 50%
of the Candidates attempted the question but did not perform well in Part b.
Commonest pitfall was the inability of the candidate to recognise the statements of Accounting
Standards still solely applicable to Nigerian environment after the adoption of IFRS.
Candidates should endeavour to familiarise themselves with ICAN Study Texts for Institute’s
future examinations.
ADVANCED TAXATION
INSTRUCTION: YOU ARE REQUIRED TO ANSWER FIVE OUT OF SEVEN QUESTIONS IN THIS PAPER
QUESTION 1
Zezee Nigeria Limited was incorporated on September 7, 2012, but it did not
commence business until July 1, 2013. Based on the Memorandum and Articles of
Association, the company was incorporated to carry on the business of distributorship
and general contracting.
Extracts of the Company’s Statements of Profit or Loss and Other Comprehensive
Income are as given below:
6 Months Year Ended Year ended
ended December December 31,
December 31, 2014 2015
31, 2013
N N N
Revenue 5,430,000 12,600,000 18,400,000
Direct Cost (890,000) (1,345,000) (1,910,000)
Gross Profit 4,540,000 11,255,000 16,490,000
Other Income 45,000 458,150 201,000
Distribution cost (386,000) (820,000) (1,060,500)
Administrative expenses (4,810,550) (6,510,440) (8,240,600)
Other expenses (41,000) (113,240) (145,100)
Net (Loss)/Profit (652,550) 4,269,470 7,244,800
You were recently appointed the Tax Consultant to the company. The directors sought
your advice on whether or not to exercise the company’s right of election for the
relevant years of assessment.
For all the relevant years of assessment, you are required to:
SECTION B: YOU ARE REQUIRED TO ANSWER ANY TWO OUT OF THREE QUESTIONS IN
THIS SECTION (40 MARKS)
QUESTION 2
b. State the importance of an Oil Mining Lease and an Oil Prospecting Lease.
(2 Marks)
On his own, he carried out some research using the internet. He presented you
with the following financial extracts of Joji Petroleum Company Limited, which he
obtained from the internet:
N’000
Current year capital allowances 6,080
Previous years’ capital allowances b/f 8,901
Custom duty 125
Royalties not included in the accounts 1,638
Loss brought forward 6,250
Petroleum Profits Tax payable 1,336
QUESTION 3
Obioma and Sons Limited, a company based in Emene – Enugu, has been producing
vegetable oil since 2015. It has been a leading name in the production of a popular
brand of household vegetable oil known as “Abop” which is in high demand.
Given the fact that the company is doing very well, it secured funds from its bankers
and bought additional Plant and Machinery in excess of its immediate needs on June
1, 2013 for N24,600,000.
However, the issue of the tax implications of these transactions is worrisome to the
Managing Director, who is visibly disturbed that the Federal Inland Revenue Service
(FIRS) might come after the company.
QUESTION 4
The Adjusted profits where the change is to December 31, each year, are as
follows:
N’000
Year ended March 31, 2011 50,000
Year ended March 31, 2012 60,000
Period ended December 31, 2013 (21 months) 180,000
Year ended December 31, 2014 70,000
SECTION C: YOU ARE REQUIRED TO ANSWER ANY TWO OUT OF THREE QUESTIONS
IN THIS SECTION (30 MARKS)
QUESTION 5
QUESTION 6
a. The administration of the Petroleum Profits Tax Act is under the charge and
management of the Federal Inland Revenue Service with respect to Petroleum
Profits Tax Act Cap P13 LFN 2004.
You are required to explain:
i. Associated Gas (2 Marks)
ii. Downstream Activities (2 Marks)
You were invited as the Chairman of a Tax Summit at Ikeja, Lagos State. The topics for
discussion were as follows:
(i) Tax Planning, an Effective Method of Tax Avoidance;
(ii) Tax Evasion in a Growing Economy;
(iii) Double Taxation – The Provisions and the Impact; and
(iv) Jurisdiction for Investment – Non-Tax Factors.
As the Chairman, you had the opportunity to summarise the papers presented by the
four paper presenters in just ten minutes.
After the relief allowance and exemption had been granted, the balance of
income shall be taxed as specified in the tax table above.
(a)
ZEZEE NIGERIA LIMITED
COMPUTATION OF ADJUSTED PROFIT OR LOSS
6 Months
Year Ended Year ended
ended
December 31, December 31,
December 31,
2014 2015
2013
N N N
Net (Loss) /Profit per accounts (652,550) 4,269,470 7,244,800
Add disallowable expenses:
Depreciation 160,000 320,000 440,000
Preliminary and formation expenses 216,000 0 0
Penalties and fines 0 0 65,000
General provision for bad debts 110,000 180,000 240,000
(166,550) 4,769,470 7,989,800
b)
ZEZEE NIGERIA LIMITED
COMPUTATION OF ASSESSABLE PROFITS
Normal Basis Actual Basis (Option)
Assessment Basis Period Assessable Profit/(Loss) Basis Period Assessable
Year Profit/(Loss)
N N N
2013 1/7/13 – 31/12/13 (211,550) 1/7/13 – 31/12/13 (211,550)
2014 1/7/13 – 30/6/14
(12 months)
1/7/13 – 31/12/13 (211,550)
1/1/14 – 30/6/14 2,184,160 1,972,610 1/1/14 – 31/12/14 4,368,320
2015 1/1/14 – 31/12/14
(Preceding Year) 4,368,320 1/1/15 – 31/12/15 7,788,800
Total Assessable profit
2nd & 3rd Years of
Assessment 6,340,930 12,157,120
2016 1/1/15 – 31/12/15
(Preceding Year) 7,788,800 1/1/15 – 31/12/15 7,788,800
c)
ZEZEE NIGERIA LIMITED
COMPUTATION OF CAPITAL ALLOWANCES FOR ASSESSMENT YEARS 2013 TO 2016
Furniture
Motor Office
and
vehicles equipment
Fittings
Initial allowance (%) 25 50 50
Annual allowance (%) 20 25 25
Total
Assessment Year 2013 N N N N
(6 Months)
Cost 980,000 2,400,000 1,200,000 4,580,000
Initial allowance (245,000) (1,200,000) (600,000) (2,045,000)
Annual allowance (73,500) (150,000) (75,000) (298,500)
W.D.V c/f to A.Y. 2014 661,500 1,050,000 525,000 2,236,500
Note:
Minimum Tax computation does not apply as the company is not up to 48 calendar months in
business.
MARKING GUIDE
Marks Marks
(a) Heading 1
Net (Loss) / Profit per accounts – ½ mark for each year (3) 1½
Depreciation – ½ mark for each year (3) 1½
Preliminary and formation expenses ½
Penalties and fines ½
General provision for bad debts - ½ mark for each year (3) 1½
Interest received on Treasury Bills - ½ mark for each year (2) 1
Interest on foreign Domiciliary Account - ½ mark for each year (3) 1½ 9
b) Heading ½
A.Y. 2013 Assessable Loss – ½ mark for each basis (2) 1
A.Y. 2014 Assessable Profit – ½ mark for each point (3) 1½
A.Y. 2015 Assessable Profit – ½ mark for each basis (2) 1
A.Y. 2016 Assessable Profit – ½ mark for each basis (2) 1
Comments 1 6
c) Heading ¼
A.Y. 2013:
Initial allowance ¾
Annual allowance ¾
A.Y.2014 – Annual allowance ¾
A.Y. 2015 – Annual allowance ¾
A.Y. 2016:
Initial allowance ¼
Annual allowance 1 4½
EXAMINER’S REPORT
It was attempted by all the candidates. Candidates’ performance was poor. The
commonest pitfalls was the candidates inability to distinguish between allowable and
disallowable expenses, incorrect basis period and incorrect years of assessment for
calculating capital allowances.
Candidates are advised to prepare better for future examinations using the ICAN Study
Texts and other suitable materials in order to improve performance.
(a) The Nigerian National Petroleum Corporation (NNPC) through one of its
subsidiaries - The Nigerian Petroleum Development Company (NPDC) carries out
the following activities:
vi. NPDC has joint partners e.g. Shell Petroleum Development Company and
Chevron Nigeria Limited (SPDC and CNL) and Service Contract Partners.
(b) An Oil Mining Lease is the lease granted to a company under the Minerals Act for
the purpose of winning petroleum or any assignment of such a lease. Its
importance rests on the fact that it is the legal approval to commence mining
operations.
iii. The significance of Chargeable Tax is that it is the tax that will be paid for the
year of assessment to which it relates.
MARKING GUIDE
Marks
(a) Identify activities of NPDC (1 mark each for any correct one) 5
(b) Identifying what Oil Prospecting Licence/Oil Mining Lease are
(1/2 mark for each correct one) 1
Stressing their significance (1/2 mark for each correct one) 1
(c) Identifying the disallowable deductions 4
Identifying parameters to determine capital allowance to use 1½
Identifying Tax offsets 2
Calculation of Assessable tax 2
Calculation of chargeable tax 2
Significance of each of the computations (1/2 Mark each for 3 points) 1½
20
EXAMINER’S REPORT
The question tests the candidates’ knowledge of the regulatory role of the NNPC in the
Oil and Gas Sector of the Nigerian economy and the significance of the Oil Mining
Lease and Oil Prospecting Lease. Candidates are also expected to compute chargeable
profits, Adjusted Profit, Chargeable Tax and explain their significance under Petroleum
Profits Taxation.
Over 60% of the candidates attempted the question.
Major pitfall is the poor understanding of the question.
Candidates are advised to use ICAN Study Texts and other suitable reading materials
in their preparation for the examination.
N
Sale proceeds of Plant and Machinery 37,925,000
Workings:
Where;
, ,
=
, , , ,
24,600,000
= N17,503,846
Marks
Chargeable assets ( /2 mark each for any four points)
1
2
Conditions for grant of Roll-over relief (2 marks each for 4 correct answers) 8
Sale proceeds of plant & machinery 1
/2
Incidental expenses 1
/2
Net sale proceeds 1
/2
Cost attributable to part disposed of 2
Chargeable Gains
4
Capital gains tax payable 1
15
EXAMINER’S REPORT
The question tests candidates’ understanding of various aspects of Capital Gains Tax covering
identification of chargeable assets; conditions governing the grant of Roll-Over Relief;
computation of chargeable gains and Capital Gains Tax.
Most all the candidates attempted the question. Majority of them displayed a good
understanding of the question and performance was above average.
The commonest pitfalls were the inability of some candidates to state the conditions for the
grant of Roll-Over Relief and calculate correctly the cost of the remaining asset.
Candidates are advised to use ICAN Study Texts and other suitable reading materials for future
examinations. This will enhance their performance in future examinations.
(a) Tax planning involves making conscious efforts to consider the tax that will be payable
by a taxpayer at a future date and how such tax can be minimized. This is the element
of the anticipatory nature of tax planning.
The ability to minimize the tax payable presupposes a deep knowledge of tax laws. You
are as good as your knowledge of tax laws in planning future tax liability if you have
some knowledge about dates and timing of such tax payments on due dates. It is to
this extent that both skills are critical in tax planning.
Tax planning requires a well thought out methodology in achieving set objectives. The
use of a Tax Planning Checklist is a sine qua non for adoption of methodologies that
will aid tax planning. These include:
Scenario 2
(Based on December 31)
2013 1/1/2011 – 31/12/2012
3
/12 x N33,000 + 9/21 x N180,000
N8,200 + 77,142.85 85,392.85 25,618.85
MARKING GUIDE
Marks
Five matters for Tax Planning 5
Correct identification of basis period Scenario I & II
1 mark each for each 6 points 6
Correct Assessment Year (Scenario I & II)
¼ mark each for the six points 1½
Correct Assessment profit (Scenario I & II)
1 mark each for the six points 6
Correct Tax Liability (Scenario I & II)
¼ mark each for the six points 1½
15
20
(b)
AJANAKU NIGERIA LIMITED
COMPUTAION OF ADJUSTED PROFITS/(LOSSES)
6 Months Year to Year to Six Months
31/12/11 31/12/12 31/12/13 30/6/14
N’000 N’000 N’000 N’000
(Loss)/Profits (3,750) (4,800) 2,250 4,500
Add Back
Depreciation 2,800 2,500 1,700 1,000
AJANAKU NIGERIA LIMITED will not pay any tax for the 2012, 2013 and 2014 Years of
Assessment – as a result of its Pioneer status. Tax holiday covers the years in question.
Dividends declared and payable out of Profits made during the Pioneer years do not attract
Withholding Tax, thus the shareholders will not suffer Withholding tax on the dividends
declared.
MARKING GUIDE
Marks
Heading 1
Identification of each of four products ( ½ mark each for any 4) 2
Correct identification of period (½ mark each for each basis period) 2
Correct computation of Adjusted Profit (1 mark each for each basis period) 4
Correct computation of Income Tax payable(1 mark for each basis period) 3
Summary of tax due for Ajanaku Nigeria Ltd. 11/2
Remarks on Withholding Tax 11/2
15
EXAMINER’S REPORT
The question tests candidates’ understanding of industries that qualify for the grant of “Pioneer
Status” under the Industrial Development (Income Tax Relief) Act 1971 and ability to compute the
tax liabilities relating to the Pioneer period of a company. They were also required to deal with
issues relating to withholding tax on dividends.
About 50% of the candidates’ attempted the question and performance was below average.
The commonest pitfalls include candidates’ inability to identify industries that qualify as “pioneer
industries” reliefs available to pioneer industries and determination of the relevant basis periods.
Candidates are advised to use ICAN Study texts and other suitable materials in their preparation
for future.
(a)
i. Associated Gas
Associated Gas is a form of natural gas which is found in deposits of
Petroleum either dissolved in the oil or as a free ‘gas cap’ above the oil in
the reservoir. This may be a stranded gas reservoir due to the remote
location of the oil field. It is produced in the course of Crude oil production
and is flared by most of the Oil producing companies in Nigeria.
Capital Allowances:
The lower of
(a) Capital Allowance for the year plus 253,750,000
Petroleum Investment Allowance 173,000,000
426,750,000
OR
(b) 85% of Assessable Profit (85% of N880,882,353) 748,750,000
Less: 170% of Petroleum Investment Allowance:
(170% of N173,000,000) (294,100,000)
454,650,000
(426,750,000)
Chargeable Profit 454,132,353
MARKING GUIDE
Total Marks
15
EXAMINER’S REPORT
The question tests candidates understanding of technical terms relevant to the Petroleum
Industry such as Associated gas downstream activities and how to determine Assessable Profit,
Assessable Tax and Chargeable Tax.
The question was generally well understood by the candidates. About 90% of them attempted
it and Performance was fair, notwithstanding that they could have done better.
The commonest pitfalls include incorrect computation of capital allowances, tertiary education
tax, assessable tax, chargeable tax as well as the mix-up of downstream activities with
upstream activities.
Candidates are advised to prepare better, by using ICAN Study Texts along with other relevant
study materials. Working through computational examples will also enhance confidence in
attempting questions since the subject involves some calculations.
It should be noted that tax evasion is a criminal offence which can lead to
imprisonment if convicted.
MARKING GUIDE
Total Marks
(a) Explanation of Tax Planning 1
Advantages of deductions, exemptions, incentives, concessions,
benefits and allowances 1
Definition of Tax Avoidance ½ mark
Anti-avoidance measures put in place (any two) 1/4 each 1
3
INSTRUCTION: YOU ARE REQUIRED TO ANSWER FIVE OUT OF SEVEN QUESTIONS IN THIS PAPER
QUESTION 1
Tinko Plc (TP) repairs and maintains heavy duty trucks, with workshops all over Nigeria and a
number of countries in Africa.
Below are extracts from the most recent Statement of Financial Position of TP:
₦’million
Share capital (50kobo/share) 200
Reserves 320
Non-current liabilities 760
Current liabilities 60
1,340
TP’s Free Cash Flows to Equity (FCFE) is currently estimated at ₦153million and this is
expected to grow at 2.5% per annum to infinity. The equity shareholders require a return of
11%.
The company’s non-current liabilities consist entirely of ₦1,000 nominal value of bonds which
are redeemable in four years at par, with a coupon rate of interest of 5.4%. The debt is rated
BB and the credit spread on BB rated debt is 80 basis points above the risk-free rate of return.
The government recently launched its “Graduates Back To Land (GBTL)” programme in which
graduates are being encouraged to take on highly mechanised farming. The programme will
involve massive importation of heavy duty agricultural machines like tractors, harvesters,
driers, etc. for distribution to “Graduate Agric Clubs” all over the country. However, there is a
growing concern, within the country about the possibility of effective maintenance of these
machines. TP is therefore considering entering this market through a four-year project. The
project will cease after four years because of increasing competition.
The initial cost of the project is expected to be ₦84million and it is expected to generate the
following after-tax cash flows over its four-year life:
The above figures are based on the GBTL programme growing as expected. However, it is
estimated that there is 25% probability that the GBTL programme will not grow as expected in
the first year. If this happens, then the present value of the project’s cash flows will be 50% of
the original estimates over its four-year life.
It is also estimated that if the GBTL programme grows as expected in the first year, there is still
a 20% probability that the expected rate of growth will slow down in the second and
subsequent years, and the present value of the project’s cash flows would then be 40% of the
original estimates in each of these years.
Feedwell Limited (FL) has offered ₦100million to buy the project from TP at the start of the
second year. TP is considering whether having this choice would add to the value of the
project.
Although, there is no beta for companies offering maintenance services for only agricultural
machines and equipment in the country, Abako Plc (AP), a listed company, offers maintenance
and related services for construction, minning, and agricultural equipment. About 15% of its
business is in the equipment maintenance services in the agricultural sector. AP has an equity
beta of 1.6. It is estimated that the asset beta of non-agricultural maintenance sectors is 0.80.
AP’s shares are currently trading at ₦4.50 per share and its debt is currently trading at ₦1,050
per ₦1,000. It has 80 million shares in issue and the book value of its debt is ₦340million. The
debt beta is estimated to be zero.
The income tax rate applicable to all companies is 20%. The risk-free rate is estimated to be 4%
and the market risk premium is estimated to be 6%.
Required:
a. Calculate the current total market value of TP’s:
i. Equity (3 Marks)
ii. Bonds (4 Marks)
b. Calculate the risk-adjusted cost of capital required for the new project.
(Round your final answer to the nearest %). (10 Marks)
c. Estimate the value of the project with and without the offer from FL
(10 Marks)
d. State the assumptions made in your calculations. (3 Marks)
(Total 30 Marks)
QUESTION 2
Honey Comb Plc, has issued 10% convertible loan stock which is due for redemption in
10 years’ time i.e. December 31, 2025. The option to convert is open only for another
two years. If conversion does not take place by December 31, 2017, the option will
lapse. The issue was sold to the public at a price of N920 for N1000 of convertible loan
stock. The conversion rate at January 1, 2016 was 250 equity shares for N1000 of
stock. Non-convertible loan stock in a similar risk class is presently yielding 12%. The
market price of Honey Comb Plc. equity shares has been increasing steadily over time
reflecting the performance of the company. The shares currently pay a dividend of
N0.30 per share. The current price of the convertible security is N960 and each share is
currently valued at N3.00. A holder of the convertible loan stock is considering
whether to sell his holdings or continue to hold the stock. Ignore taxation, while
answering the questions.
Required:
a. What is the value of the security as simple unconvertible loan stock?
(5 Marks)
b. What is the expected minimum annual rate of growth in the equity share price
that is required to justify the holder of convertible loan stock holding on to the
security before the option expires? (12 Marks)
c. What recommendation would you make to the holder of the security and why?
(3 Marks)
(Total 20 Marks)
QUESTION 3
Jack Limited is a family-owned business which has grown strongly in the last 50 years.
The key objective of the company is to maximise the family’s wealth through their
shareholdings.
Recently, the directors introduced value-based management, using Economic Value Added
(EVA) as the index for measuring performance.
₦’million
Operating profit 340.0
Finance charges (115.0)
Profit before tax 225.0
Tax at 25% (56.3)
Profit after tax 168.7
b. Irrespective of your answer in (a) above, assume the company’s current EVA is
₦120million and that this will decline annually by 2% for the next ten years and then
increase by 4% per annum in perpetuity. Assume the following for this part only:
Cost of equity 14%
WACC 10%
Calculate the market value added (MVA) by the company.
Show all workings (5 Marks)
(Total 20 Marks)
QUESTION 4
Gugi Plc. is now considering whether to establish a factory in the foreign country and stop
export from Nigeria to the country. The project is expected to cost F$1 billion, including
F$200million for working capital.
A suitable existing factory has been located and production could commence immediately. A
payment of F$950million would be required immediately with the remainder payable at the
end of year one. The following additional information is available:
Assume that the above cash items will remain constant throughout the expected life of
the project of 4 years. At the end of year 4, it is estimated that the net realisable value
of the non-current assets will be F$1.40billion.
It is the policy of the company to remit the maximum funds possible to the parent (i.e. Gugi
Plc.) at the end of each year. Assume that there are no legal complications to prevent this.
Production in Nigeria is at full capacity and there are no plans for further capacity expansion.
Tax on the company’s profits is at a rate of 40% in both countries, payable one year in arrears.
A double taxation agreement exists between Nigeria and the foreign country and no double
taxation is expected to arise. No withholding tax is levied on royalties payable from the foreign
country to Nigeria.
Tax allowable “depreciation” is at a rate of 25% on a straight line basis on all non-current
assets.
The Directors of Gugi Plc. believe that the appropriate risk-adjusted cost of capital of the
project is 13%.
Annual inflation rates in Nigeria and the foreign country are currently 5.6% and 10%
respectively. These rates are expected to remain constant in the foreseeable future. The current
spot exchange rate is F$1.60 = N1. You may assume that exchange rate reflects the
purchasing power parity theorem.
Required:
a. Evaluate the proposed investment from the view point of Gugi Plc.
Notes
i. Show all workings and all calculations to the nearest million.
ii. State all reasonable assumptions. (18 Marks)
b. State TWO further information and analysis that might be useful in the
evaluation of this project? (2 Marks)
(Total 20 Marks)
SECTION C: YOU ARE REQUIRED TO ANSWER ANY TWO OUT OF THREE QUESTIONS IN
THIS SECTION (30 MARKS)
QUESTION 5
You are required to show which of the companies is/are overvalued. (9 Marks)
(Total 15 Marks)
QUESTION 6
Osamco Limited, manufacturer of wire and cables, was bought from its conglomerate
parent company in a management buyout deal in August, 2010. Six years after, the
managers are considering the possibility of listing the company’s shares on the
Nigerian Stock Exchange.
The following information is made available:
OSAMCO LIMITED
INCOME STATEMENT FOR THE YEAR ENDED JUNE 30, 2016
N’million
Turnover 91.25
Cost of sales (79.00)
Profit before interest and taxation 12.25
Interest (3.25)
Profit before taxation 9.00
Taxation (1.25)
Profit attributable to ordinary shareholders 7.75
Dividend (0.75)
Retained profit 7.00
One of the means by which companies expand is through mergers and acquisition.
However, there are other means of expansion aside these methods.
Inkline Plc. is one of your client companies intending to expand its business by means
of merger or acquisition.
Your firm of management consultants has been asked to advise the management of
the company on what steps to take, while considering the merger and acquisition
methods, and whether it should go ahead with the expansion programme or
otherwise.
Required:
Asset Beta
(1 − )
= +
( + (1 − )) ( + (1 − ))
Equity Beta
= +( − ) (1 − )
Growing Annuity
1+
= 1−
− 1+
= (1 + ) − 1
r
Where r = discount rate
n = number of periods
(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0·901 0·893 0·885 0·877 0·870 0·862 0·855 0·847 0·840 0·833 1
2 1·713 1·690 1·668 1·647 1·626 1·605 1·585 1·566 1·547 1·528 2
3 2.444 2.402 2·361 2·322 2·283 2·246 2·210 2·174 2·140 2·106 3
4 3·102 3·037 2·974 2·914 2·855 2·798 2·743 2.690 2·639 2.589 4
5 3·696 3·605 3·517 3·433 3·352 3·274 3·199 3·127 3·058 2·991 5
6 4·231 4·111 3·998 3·889 3·784 3·685 3·589 3.498 3.410 3·326 6
7 4·712 4·564 4.423 4·288 4·160 4·039 3·922 3·812 3·706 3·605 7
8 5·146 4·968 4.799 4·639 4.487 4·344 4·207 4·078 3·954 3·837 8
9 5·537 5·328 5·132 4·946 4·772 4·607 4.451 4·303 4·163 4·031 9
10 5·889 5·650 5.426 5·216 5·019 4·833 4·659 4.494 4·339 4·192 10
11 6·207 5·938 5·687 5.453 5·234 5·029 4·836 4·656 4.486 4·327 11
12 6·492 6·194 5·918 5·660 5·421 5·197 4·988 4·793 4·611 4.439 12
13 6·750 6.424 6·122 5·842 5·583 5·342 5·118 4·910 4·715 4·533 13
14 6·982 6·628 6·302 6·002 5·724 5.468 5·229 5·008 4·802 4·611 14
15 7·191 6·811 6.462 6·142 5·847 5·575 5·324 5·092 4·876 4·675 15
This table can be used to calculate N(d) the cumulative normal distribution
0 (1 ) 153(1.025) 156.825
= = = = ₦1,845million
0.11 0.025 0.085
ii) ● Cost of the bond = Risk-free rate of return plus the credit spread
= 4% + 0.80% = 4.80%
= 54 + 54 + 54 + 1054 = ₦1,021.37
. . . .
The cost of capital should reflect the systematic business risk of the project. This should be
calculated from the information given about AP.
1.6 × 360
= = 0.89
360 (357×0.8)
= 1.4
i) Value of the project without the offer from Feedwell Limited (FL)
Year 1 2 3 4
Cash flow (₦’000) 6,555.20 32,268.6 73,009.4 71,367.20
Present value at 12% 5,852.90 25,724.3 51,966.6 45,355.10
ii) Expected value of the project with the offer from Feedwell Limited (FL)
If the Graduate Back To Land (GBTL) does not grow as expected in the first year, then
it is more beneficial for Tinko Plc. to exercise the offer made by FL, given that FL’s
offer of ₦89.27 million (PV of ₦100 million) is greater than the PV of years two to four
cash flows, that is, 50% × ₦(25.72m + 51.97m + 45.36m) = ₦61.53m for that
possible outcome.
This figure is then incorporated into the expected net present value calculations. Thus,
for possible outcome B:
₦
Year 1: 50% × ₦5,852,900 2,926,000
2: PV of ₦100million 89,286,000
92,212,000
Year 1 Year 2 - 4
d) Key assumptions
It is assumed that the capital structure of the company will not change substantially
when the new project is taken on. Since the initial cost of the project is significantly
smaller than the value of TP itself, it is not an unreasonable assumption.
There may be more possible outcomes in practice than the ones given and financial
impact of the outcomes may not be known with such certainty. The Black-Scholes
Option Pricing Model may provide an alternative and more accurate way of assessing
the value of the project.
It is assumed that TP can rely on FL paying the ₦100m at the beginning of year two
with certainty.
It is assumed that all the figures relating to the beta, growth rates, risk adjusted cost of
capital and probabilities are accurate.
EXAMINER’S REPORT
The question tests candidates’ knowledge of valuation of equity and bond, calculation of risk-
adjusted cost of capital and evaluation of capital project involving risk and uncertainty.
Being a compulsory question, almost all the candidates attempted the question. However, it is
highly disappointing that most of them did not understand the concepts being tested as they
could not generate the required solutions to parts ‘b’ and ‘c’ of the question, hence
performance was poor.
Candidates’ commonest pitfalls were their inability to calculate the equity beta needed for the
project and their failure to sort out its cash flows.
Candidates are advised to cover the syllabus adequately, work on past questions in the
Institute’s Study Texts, Pathfinders and other relevant text books for better results in future
examination.
(a) The value of the security as a simple unconvertible loan stock is the present value of
the future interest (years 1 – 10) and the present value of the face value due in year 10.
(b) For the holder to convert, the current market value of the convertible must at
least equal the present value of interest for the next two years and the present
value of the conversion value. The conversion value:
= Po (1 + g)n x R,
Where:
Po = current VPS = N3
g = growth rate in share price to be determined
n = years to expiration of the option to convert = 2 years
R = conversion ratio = 250 shares
Thus:
Correct Market Value = The Present Value Interest for the next two years + Present
Value of the conversion value.
3(1 g)2 X 250
i.e 960 = 100
(1.12)
100
+ (1.12)2 + (1.12)2
750(1 g)2
960 = 169 +
(1.12)2
MARKING GUIDE
MARKS MARKS
(a) Calculation of value as an unconvertible bond 5
EXAMINER’S REPORT
The question tests candidates’ knowledge of convertible bonds, Part ‘a’ of the question tests
candidates’ knowledge of bond valuation, while part ‘b’ tests analysis of convertibles.
About 40 percent of the candidates attempted the question and performance was generally
poor. A few of the candidates that attempted the question displayed good understanding
while some had problems in providing appropriate solutions hence poor performance.
Candidates’ commonest pitfalls were their inability to recognize the requirements of the
question in part ‘a’ which was simply the valuation of bonds and their failure to work out the
growth rate in part ‘b’.
Candidates are advised to read, understand and interpret questions appropriately and note
their specific requirements before attempting them.
a)
₦m ₦m
Operating profit 340.00
Add back:
Non-cash items 35.00
Accounting depreciation 295.00
Doubtful debts 10.00
Research and development 60.00
Marketing expenses 50.00 450.00
Less
Economic depreciation 415.00
Tax cash paid (45 – 2.5) 42.50
Loss tax relief on interest 28.75 (486.25)
(25% of N115m)
NOPAT 303.75
₦m ₦m
Per 2014 Statement of Financial Position 6,185.00
Add back:
Provision for doubtful debt at the end of 2014
(22.50 – 10) 12.50
Other non-cash expenses (2014) 30.00
Marketing expenses (2014) 45.00 87.50
Adjusted opening capital employed (AOCE) 6,272.50
The company is currently destroying value as it is failing to meet the economic cost of
its own capital. This is an unsustainable position in the long term and will lead to
shareholders’ dissatisfaction.
First 10 years when g= –2%. It is faster to work with growing annuity in this
case.
1 1
PV = 1−
1
1 0.02 10
120(1 0.02) 1
1.10
= = ₦671.28m
0.10 0.02
Years 11 to infinity
101.97 10
PV = × (1.10) = ₦655.23m
0.10 0.04
MARKING GUIDE
MARKS MARKS
(a)i. Adjusted NOPAT 5
ii. Adjusted opening capital employed 5
iii. Calculation of WACC 1
iv. Calculation of EVA 1
v. Comments and recommendations 3
15
(b) Calculation of MVA 5
TOTAL 20
About 50% of the candidates attempted the question but most of them did not have a clear
and accurate understanding of both parts of the question hence their performance was poor.
Candidates’ commonest pitfalls were their inability to carry out the accounting adjustments
required to determine the Net Operating Profit After Tax (NOPAT) and the Opening Capital
Employed (OCE).
Candidates are advised to make use of the Institute’s Study Texts in their preparation for the
Institute’s examinations.
Year 0 1 2 3 4 5
Receipts from foreign project (W4) (594) 99 118 112 957 (289)
Royalty received in Nigeria - 33 33 33 33 -
Related tax in Nigeria (at 40%) - (13) (13) (13) (13)
Net cash flow (594) 132 138 132 977 (302)
PVF at 13% 1 0.885 0.783 0.693 0.613 0.543
PV (594) 117 108 91 599 (164)
Note: The loss of exports to the foreign country is not a relevant cash flow since it will be
replaced by equivalent exports to North Africa.
Working Notes
1. Exchange rate
The rate of change of the value of the foreign currency is given as:
− 1, here
MARKING GUIDE
HEADING MARKS MARKS
(a)i Calculation of exchange rates 3
ii. Conversion of royalty to F$ 1
iii. Computation of profit after tax F$ 4
iv. Projects’ cash flows in N 5
v. Computation of NPV and conclusion 5
18
(b) 1 mark per point, max 2 2
TOTAL 20
EXAMINER’S REPORT
The question tests candidates’ knowledge of the analysis of foreign projects under International
Investment decisions aspect of the syllabus.
About 80 percent of the candidates attempted the question. They however demonstrated
insufficient knowledge of this area of the syllabus hence performance was very poor.
Candidates’ commonest pitfalls include their inability to:
(a) calculate the appropriate exchange rates to use;
(b) sort out the appropriate cash flows;
(c) remove working capital from the initial investment before computing tax depreciation;
(d) convert the royalty paid in Naira to the F$ for the purpose of computing the foreign tax;
(e) account for tax on the resale value of the investment even when the asset has been fully
depreciated for tax purposes;
(f) account for Nigerian tax on royalty collected in Nigeria.
Candidates are advised to always cover the syllabus adequately and make use of the Institute’s
Pathfinders, Study Texts and other relevant text books in their preparations for the Institute’s future
examinations. They should also endeavour to pay attention to and improve their knowledge on
International Investment decisions aspect of the syllabus. However, it is extremely important for
candidates to note that future examination questions will continue to be set to cover all areas of the
syllabus.
(a). Assumptions of Capital Asset Pricing Model (CAPM) include the following:
i. Investors only need to know the expected returns, the variances, and the co-
variances of returns to determine which portfolios are optimal for them;
ii. Investors have identical views about risky assets’ mean returns,
variances of returns, and correlations;
iii. Investors can buy and sell assets in any quantity without affecting price; all
assets are marketable (can be traded);
iv. Investors can borrow and lend at the risk-free rate without limit, and they can
sell short any asset in any quantity;
v. Investors pay no taxes on return;
vi. Investors pay no transaction costs on trades;
vii. All investors’ decisions are based on a single time period.
( . )( )
Akira (A) = = 1.30
( . )( . )
Bombadia (B) = = 0.80
( . )( )
Courage (C) = = 1.11
.
Divine (D) = = 1.70
= + i
( - )
Conclusion
Securities with positive alpha are undervalued and securities with negative
alpha are overvalued and should be sold.
MARKING GUIDE
MARKS MARKS
(a) Any 6 points at 1 mark each 6
EXAMINER’S REPORT
The question tests candidates’ knowledge on Capital Asset Pricing Model (CAPM).
About 25 percent of the candidates attempted the question. The few that attempted it showed
a good understanding of ‘part b’ of the question but others had problems in providing
appropriate solutions hence performance was average.
Candidates’ commonest pitfalls were their mix up of the assumptions of Capital Asset Pricing
Model (CAPM) with those of capital market generally in part ‘a’ of the question and their
failure to apply the appropriate formula to calculate beta factor in part ‘b’.
Candidates are advised to read, understand and interpret questions appropriately and note
their specific requirements before attempting them.
(a). The performance and financial health of Osamco Limited in relation to that of
the industry sector as a whole can be evaluated by comparing its financial
ratios with the industry averages, as follows:
Returns On Equity
Profit attributable to ordinary shareholders: Equity
₦7.75m : ₦31m 25% 16%
Current Ratio
Current assets : Current Liabilities
₦25.25m : ₦22.5m 1.12:1 1.6:1
Gearing Ratio
Debt : Equity
(₦5m + ₦5.5): ₦31m 33.9% 24%
Dividend Cover
Profit attributable to equity: Dividend
₦7.75m : ₦0.75 10.3 times 4.0 times
Interest Cover
Profit before interest and tax (PBIT): Interest
₦12.25m : ₦3.25 3.77 times 4.5 times
Osamco Limited’s return on capital employed, return on equity and operating profit
margin are all significantly above the industry averages. Although, the first two
measures could be inflated due to asset being shown at book values, the profit margin
indicates that OSAMCO LTD is managing to make good profit which could be due to
successful marketing, a low cost base or to its occupation of a particularly profitable
niche in the market.
Liquidity
Both the current and the quick (acid test) ratios are well below the industry averages.
This suggests that Osamco Limited is either short of liquid resources or is managing its
working capital poorly.
However, the three key working capital ratios modify this impression as follows:
.
Receivable days : = 47 days
.
.
Inventory Turnover days: = 51 days
.
.
Payment Period days = 81 days
.
Although, the industry averages are not given, these ratios appear to be good by
general standards.
Financial Stability
Gearing ratio is high in comparison with the rest of the industry and 48% of the debt is
in the form of overdraft which is generally repayable on demand. This is therefore a
risky form of debt to use in large amounts. The debenture is repayable in two years
and will need to be refinanced since Osamco Limited cannot redeem it out of existing
resources. Interest cover is also poor, and this together with the poor liquidity
probably account for the low payment ratio (the inverse of the dividend cover).
In summary, profit performance is strong, but there are significant weaknesses in both
the liquidity and financial stability. These problems need to be addressed if Osamco
Limited is to be able to maintain its record of strong and consistent growth.
MARKING GUIDE
MARKS MARKS
(a)i. Calculation of the given ratios 6
ii. Interpretation 4
10
(b) 1¼ per point (for any four points) 5
TOTAL 15
EXAMINER’S REPORT
The question tests candidates’ ability to calculate and interpret basic financial ratios.
About 90% of the candidates attempted the question and performance was average. Some of
the candidates displayed good understanding of the question while some had problems in
providing appropriate solutions.
Candidates’ commonest pitfalls were their failure to calculate some of the ratios correctly and
their inability to provide appropriate interpretations of the computed ratios.
Candidates are advised to ensure adequate coverage of all sections of the syllabus.
The Directors
Inkline Plc
34, Ojodu Street
Ikeja, Lagos
Dear Sirs,
We have gone through your request asking us to offer advice on your proposed
expansion via merger and acquisition, we advise as follows:
a. (i) The benefits derivable from the proposed method of expansion include:
Your company will experience faster growth than when the internal
development is pursued.
If your company’s expansion is made through acquisition of another
company, there is greater likelihood that your company may inherit new
products, new markets and new/additional customers from the acquired
company which may be difficult to obtain through internal development.
Your mode of expansion will enable your company enter a new market
and set up a new business which would have been difficult because of
high entry barriers.
Your acquisition of a competitor will prevent it from acquiring yours.
Your company may save cost and earn higher profits from synergy effects
EXAMINER’S REPORT
The question tests candidates’ knowledge of Mergers and Acquisitions with specific emphasis
on candidates’ ability to identify advantages and disadvantages of growth by mergers and
acquisition and its alternative means of growth.
About 90% of the candidates attempted the question and performance was good. However,
some of the candidates lost some marks for their failure to present their solution in a report
format.
Candidates are advised to always ensure that they read, understand, interpret questions
correctly and note their specific requirements before attempting them to avoid loss of marks.
QUESTION 1
Havana Bank Plc was listed on the Nigerian Stock Exchange in February 2015. There
was an initial public offer in the same period with proceeds of N5billion. Part of the
proceeds was expected to be utilised to strengthen the bank’s internet banking facility.
In November of the same year the Managing Director/Chief Executive Officer (MD/CEO)
proceeded on a three-week vacation to the United Kingdom but did not return at the
time of concluding the audit of the 2015 financial statements early in 2016. It was
observed that the MD/CEO had absconded with documents relating to the public offer.
It was also noted that he kept drawing cash whilst in the United Kingdom amounting
to N922 million.
The Bank closed its Gambian operations in June 2015 because it had made losses for
two consecutive years. Prior to the 2 years before the closure, the operations in Gambia
had grown into a network of five branches, contributing 15 percent of the gross
income and 9.5 percent of the net profits of the group. The closure was not disclosed in
the financial statements but reference was made to the closure in the directors’ report.
As the Audit Manager in the firm of Chartered Accountants that audits Havana Bank
Plc, you are required to:
a. Identify and explain the significant audit matters you will consider in forming an
opinion in relation to the missing documents and the cash drawings by the
absconded MD/CEO. (10 Marks)
b. Analyse and evaluate your views on the non-inclusion of the discontinued
Gambian operations in the financial statements. (10 Marks)
c. Explain FIVE duties, as an auditor in relation to the bank’s internet banking.
(10 Marks)
(Total 30 Marks)
QUESTION 2
As an Audit Manager in a big audit firm in Nigeria, you were opportuned to attend a
conference on Professional Ethics and Anti-Money Laundering in New York. On your
return, one of the audit seniors went through the presentations and asked questions
on some of the statements she noted in the presentations.
QUESTION 3
You are the Audit Manager in charge of the audit of Mix Biz, a company which runs a
chain of snack bars operating in a number of strategic locations in Lagos. Your firm
has been the auditor for a number of years and has always had to substantively test
cash sales because of lack of control over the recording of takings. The audit reports to
date have been unmodified.
You have recently been informed that the company has employed a newly qualified
Chartered Accountant as Chief Internal Auditor and a partly qualified Assistant
Internal Auditor. Since their appointment half way through the year ended December
31, 2015, they have spent most of their time carrying out substantive tests on cash
sales.
The Directors are hopeful that your audit fee this year will decrease because you will
be able to rely on the work carried out by the Internal Auditors.
Required
a. Explain the issues that will be relevant to your firm in deciding:
i. whether you can rely on the work performed by the Internal Auditors
(8 Marks)
QUESTION 4
a. You have been appointed as the Auditor of a company whose accounting
transactions are processed using computer. You have decided to use Computer-
Assisted Audit Techniques (CAAT) to generate evidence for the audit assignment.
Required
i. State FOUR advantages and THREE disadvantages of using test data in
compliance testing of application controls. (7 Marks)
ii. List FOUR activities for which audit software may be used to perform
substantive tests by the auditor. (4 Marks)
iii. List TWO advantages and TWO disadvantages of the use of audit software.
(4 Marks)
b. The availability of Computer-Assisted Audit Techniques should be considered by
the Auditor when planning the nature, extent and timing of tests in an audit.
The Auditor must determine his testing strategies which will depend on his
choice of either using a Manual Testing Method or Computer-Assisted Method.
Required
Identify FIVE solutions to loss of audit trail. (5 Marks)
(Total 20 Marks)
QUESTION 5
In compliance with ISA 250 “Consideration of Laws and Regulations in an Audit of
Financial Statements”, the auditor shall conduct the audit in a manner that gives him
confidence that the client has met all legal requirements of the country in which it
operates.
As the Audit Partner in charge of APB Manufacturing Plc, you are required to:
a. Identify and clarify SIX steps that ISA 250 requires of you in ascertaining that the
company complies with all applicable laws and regulations.
(9 Marks)
b. State and explain FOUR procedural actions you will take in the event that the
company failed to comply, in material areas, with applicable laws and
regulations.
(6 Marks)
(Total 15 Marks)
QUESTION 6
Allhope Publications Limited is an old established publishing company owned by two
brothers. Over the years, the company had made consistent progress both in sales and
profitability.
Due to the quality of their work, the patronage of the company has grown to the extent
that its working capital cannot accommodate the work on hand.
The Directors have approached their bankers, Owopo Bank Plc for a facility of N500m
to procure essentially modern machineries and printing materials and also for running
expenses, particularly salaries.
In support of its application for the bank facility, the company has prepared a profit
forecast which is being presented to your firm for review.
Required:
As contained in ISAE 3400: “The Examination of Prospective Financial Information
(PFI)”.
a. What will you take into consideration before accepting this assurance
engagement? (5 Marks)
QUESTION 7
Iyanuoluwa Pharmaceutical Industries Limited has been in existence for some years
and it has been audited by a firm of Chartered Accountants up to December 31, 2014.
Your firm, Blueberry & Co. (Chartered Accountants) has just been appointed to act as
auditors for the financial year January 1, 2015 to December 31, 2015 which has been
accepted.
Required:
(a) The significant audit matters relevant to the formation of opinion in relation to
the missing documents and the cash drawings by the absconded MD/CEO
include:
i. The accounting records for the sale of shares are missing.
ii. The accounting records are missing because the MD/CEO absconded with
them. There must be reasons why he took the accounting records: fraud
is a possible reason especially as he kept withdrawing cash while in
United Kingdom and also for failing to return at the end of his vacation.
iii. There is an indication in the manner the MD/CEO has taken the
accounting records and withdrawn cash that there may have been a
fraud. It is therefore probable that the auditors will have to modify the
opinion even if they are able to reconstruct the financial records, while it
will not be possible to gain sufficient appropriate evidence about the
possible fraud.
iv. The Bank may have been concealing ailing financial position by
manipulation for some years, and probably to make up for this, it went
public to raise cash.
v. There is constraint in obtaining sufficient appropriate audit evidence
(limitation on scope) for the year ended 31 December, 2015. The audit
opinion should be modified.
vi. The effectiveness of the internal control relating to the custody of
documents and cash withdrawal needs to be evaluated.
vii. Consider the utilization of the funds and cash realised from the public
offer.
viii. The possible impact of the cash withdrawal in other areas of the audit
and the overall assessment of audit risk.
EXAMINERS’ REPORT
The question tests candidates understanding of (a) significant audit matters to be considered
in forming an opinion, (b) the requirements of IFRS 5, 8 and IAS 7; and (c) auditors’ duties in
relation to internet banking.
Being a compulsory question, almost all the candidates attempted it, but performance was
poor.
The commonest pitfall of the candidates was their inability to interpret the question properly.
Candidates are enjoined to read the ICAN Study Text thoroughly.
(b) Money laundering is the process by which criminals attempt to conceal the true
origin and ownership of the proceeds from their criminal activities (e.g. drug
trafficking, terrorism, theft, tax evasion and other types of fraud), allowing them
to maintain control over the proceeds and, ultimately, providing a legitimate
cover for their sources of income. The term is widely defined to include
possessing, in any way dealing with, or concealing the proceeds of any crime.
Professionals, including accountants, have professional duty of confidentiality
to their clients, in which case they are not allowed to disclose their clients’
information to others unless where they have legal or professional duty or right
to disclose. However, the accountant’s professional duty of confidentiality is not
an adequate defence where money laundering is involved. The accountant has
a legal duty to report suspicions of money laundering to the appropriate
authorities as required by law, i.e. National Financial Intelligence Unit (NFIU)
or Economic and Financial Crimes Commission (EFCC). Under the Money
i. Putting into place systems, controls and procedures to ensure that the
firm is not used for money laundering purposes.
iii. Establishing and enhancing the record-keeping systems (a) for all
transactions, which must be kept for at least five years, with controls to
ensure that they are not inadvertently destroyed and (b) for verifying the
identity of clients by obtaining official documents, such as – for an
individual – passport or driving license, supported by recent utilities bills,
and – for a company – certificate of incorporation.
iv. Establishing procedures within the firm for reporting any suspicion of
money laundering by client companies.
A firm might act for two clients that are in direct competition with each other.
The firm has a professional duty of confidentiality, and so will not disclose
confidential information about one client company to its competitor. Again, the
test is whether a “reasonable and informed third party” would consider the
conflict of interest as likely to affect the judgement of the firm. The approach
that the accounting firm should take will be a matter of judgement and should
reflect the circumstances of the case. Where the acceptance or continuance of
an engagement would materially prejudice the interests of any client, the
appointment should not be accepted or continued.
In such cases, acceptable safeguards should be put in place. These include the
following:
EXAMINERS’ REPORT
The question tests candidates understanding of Professional Ethics and Anti-Money Laundering
activities.
About 85% of the candidates attempted the question, but performance was poor.
The commonest pitfall of the candidates was poor application of theoretical knowledge and
misinterpretation of the question.
Candidates are advised to cover the syllabus properly and learn to apply their knowledge in
practical ways.
a)
i. Sufficiency of organizational status of the internal audit, its objectivity
and operational independence of management structure. In particular,
whether or not the chief internal auditor reports to an ‘independent’
senior person or body within the entity, such as the audit committee
rather than the finance director.
ii. The scope of the internal audit work and any restrictions placed by the
senior management on the scope of their work and whether or not
management acts on the internal audit recommendations or undermines
them. External auditor will have less confidence on the internal audit
work if their recommendations are not acted upon by management.
iii. The technical competence and due professional care of the internal
auditors. The external auditors will assess the qualifications, technical
training and experience of the internal auditors. For Mix Biz, the chief
internal auditor is newly qualified and the second staff is partly
qualified, which suggests inadequate experience. The external auditor
will also assess to what extent the internal auditors take professional
approach towards their work.
MARKING GUIDE
Marks Marks
ai Placing reliance on the work of the internal auditor
- Explanation of the relevance of ISA 610 – “Using the Work of
an Internal Auditor” 2
Other considerations
- Status of the internal audit unit in the organisation
- Scope of its work
- Technical competence
- Quality control by the internal auditor
- Adequacy of resources
- Line of reporting
- Documented procedural guide
1 Mark each for any 6 points 6 8
ii. How much reliance can be placed on the internal auditor’s work
Evaluating the internal audit work performed to determine
reliability, risk assessment, transaction level 2
Other areas to consider include:
- Whether or not the work was properly performed
- Qualification of internal audit team
- Experience of team
- Whether or not sufficient and appropriate audit evidence was
obtained
- Whether or not reports prepared were consistent with the
work performed
- Whether or not management acted on recommendations and
findings of audit
- How exception matters were resolved
1 Mark each for any 5 points 5 7
EXAMINERS’ REPORT
The question tests candidates’ knowledge of External Auditor’s reliance on the work of Internal
Auditors and other specialists or experts.
About 85% of the candidates attempted the question, but performance was poor.
The commonest pitfall of the candidates was that, they were focusing on the newly appointed
officers rather than the technicalities involved and also repetition of answers.
Candidates should endeavour to read and understand the question properly before attempting
it.
(a)
(i) Advantages of test data include:
helps to confirm that exception reports are correctly produced
provides a positive assurance of the correct functioning of the
program controls actually tested;
can be used on a continuing basis until the programs are changed;
Once set up, running costs from year to year are low;
requires less detailed knowledge of data processing; and
are cheap to install and easy to implement as their contents are
variable at will.
Can be used to verify effectiveness
Disadvantages
The problem of data files corruption where ‘live’ test data is used
It is time consuming
Where ‘dead’ test data is used, the auditor requires a reasonable
assurance that the programs being used are those in normal
processing
It cannot provide assurance that the system and its controls
operate effectively at any other time.
(ii) Activities for which audit software may be used during substantive tests
by the auditor include:
(i) Re-performing calculations;
(ii) Selecting individual transactions for subsequent manual substantive
tests;
(iii) Extracting list of exceptional items;
(iv) Obtaining information relevant to analytical review;
(v) Used to scrutinize large volume of data.
(vi) Matching the contents of two or more computer files and selecting
any unmatched items for further audit work.
MARKING GUIDE
Marks Marks
ai Advantages of using test data in compliance testing of application
controls:
- Helps to confirm that exception reports are correctly produced
- They provide positive assurance of the correct functioning of
the program control
- Can be used on continuing basis
- Running cost low once it is set up
- Requires less detailed knowledge of data processing
- Can be used to verify effectiveness
- Cheap to install
1 Mark each for any four points 4
Disadvantages:
- Problem of data file corruption
- Time consuming
- It cannot provide assurance that the system and its controls
operate effectively at any other time
- Where dead test data is used, the auditor requires a reasonable
assurance that the programs being used are those in normal
process
1 Mark each for any three points 3
EXAMINERS’ REPORT
About 25% of the candidates attempted the question and performance was poor.
Candidates’ commonest pitfalls were lack of knowledge in this area. Candidates should learn
to cover the syllabus adequately.
MARKING GUIDE
Marks Marks
(a) ISA 250 requirements include:
- Obtaining general understanding of applicable legal and
regulatory framework and how entity is complying
- Getting appropriate audit evidence in respect of compliance
- Enquiring of management as regards compliance
- Inspecting correspondence
- Obtaining written representation
- Documenting all identified or suspected instances of non-
compliance
- Being alert during audit for instances that may bring about
non-compliance
1 /2 Marks each for any six points
1
9
EXAMINERS’ REPORT
The question tests candidates’ knowledge of the requirements of ISA 250 “Consideration of
Laws and Regulations in an Audit of Financial Statements”.
About 70% of the candidates attempted the question and performance was poor. It was
apparent that candidates did not cover this area of the syllabus. Candidates are advised to
cover all aspects of the syllabus before embarking on registering for the examination.
EXAMINERS’ REPORT
The question tests candidates understanding of the requirements of ISAE 3400 “The
Examination of Prospective Financial Information”.
About 70% of the candidates attempted the question and performance was poor. It appears
that candidates did not cover this area of the syllabus.
Candidates are advised to cover all aspects of the syllabus before registering for examinations.
EXAMINERS’ REPORT
The question tests candidates understanding of the requirements of ISA 510 “Initial Audit
Engagements”.
About 90% of the candidates attempted the question but performance was poor.
The commonest pitfall of the candidates was their misinterprestion of the question by taking it
to mean new audit engagement.
Candidates are advised to read and understand the requirements of a question before
attempting to answer it.
CASE STUDY
INSTRUCTION: YOU ARE TO USE THE CASE STUDY ANSWER BOOKLET FOR THIS PAPER
Requirement:
You are Marian Garuba, a recently qualified Chartered Accountant. You are employed
by Tees Financial Services, a consulting firm specialising in corporate restructuring,
financial and accounting services, as a Trainee Consultant.
Your managing partner, Fidelis Aihomu, has requested that you draft a report to be
submitted to Jide Adeolu, the Chief Executive Officer (CEO) of Jullys Engineering
Company Plc., one of your firm’s major clients, as set out in his email to you. (Exhibit
1)
Reading 1 hour
Exhibit Description
2 Letter from Dr. Jide Adeolu, the CEO of Jullys Engineering Company Plc to
Fidelis Aihomu.
Exhibit 1
Following our discussion on the above subject at the Monday Review meeting, I will
like you to peruse the attached documents (Exhibits 2 – 5) from Jullys Engineering
Company Plc., one of our major clients and let me have your recommendations in the
form of a report for my review before sending to our client next week.
Jullys Engineering is one of the oldest engineering companies in the country and has
grown from sole proprietorship to a limited liability company. It was quoted on the
Nigerian Stock Exchange (NSE) five years ago. The company has been performing well
until last two years when it started accumulating losses as a result of stiff competition
from new companies that have encroached into its core business with better
technology, manufacturing and management processes.
The board of the company has recently agreed with the shareholders to carry out a
major restructuring of the company’s business operational processes and this will
include capital reconstruction and reduction, if necessary. The board is optimistic that
it will obtain the cooperation of the company’s secured and unsecured creditors,
including the preferential shareholders.
The board is also of the opinion that the company will return to profitability after this
restructuring and will be able to pay handsome dividends to its shareholders and
adequately compensate the creditors.
During my recent telephone conversation with Dr. Jide Adeolu, the CEO of the
company, he informed me that although the board is not envisaging any loss of jobs to
its employees, but where this occurs, the board and management of the company have
good rapport with the house unions and it is not likely that they will pose any major
threat to the restructuring exercise.
To further strengthen the company’s ability to deliver after the restructuring, the board
also decided to benchmark three key areas of its operational processes with the best in
the industry and possibly with the best global practice. These areas are:
I will therefore, like you to cover the following areas in your report:
Suggestions on a capital reconstruction scheme that will be equitable and fair
to the company’s shareholders and creditors. Your report should include the
necessary steps the company will need to take to carry through the exercise;
and
The major steps the company should take in benchmarking the areas identified
by the board, the type of benchmarking that would be required, possible
advantages of the exercise to the company and any limitations you may
envisage.
We have to finalise this report by early next week, so I would like you to deal with it
with utmost dispatch, but without compromising the needed attention to details. Once
again, I must reiterate that your recommendations for capital reconstruction and
reduction should be fair to all the stakeholders of the company. I hope I can get this
draft report before close of work on Tuesday next week.
Regards
Fidelis Aihomu
Managing Partner
Tees Financial Services.
Required:
Use the attached information to draft a report to Dr. Jide Adeolu, the CEO of Jullys
Engineering Company Plc.
Your report should comprise of:
1. Recommendations on how to reconstruct the company’s capital, including capital
reduction, if necessary, so as to bring the company’s capital in line with the fair
value of the company’s assets. You should also outline the steps the board would
take to successfully carry out the exercise;
2. A brief discussion on benchmarking as a strategic tool to improve corporate
performance, types of benchmarking and which type the company should adopt,
the steps necessary to carry out a successful benchmarking, the benefits the
company is likely to derive from the exercise and the possible limitations.
Further to our telephone conversations this morning on our desire to carry out a
restructuring of the company, we shall be grateful if your firm can give us professional
advice on two key areas of this exercise, that is:
As you are well aware, Jullys Engineering Company Plc. has operated successfully over
the years and has metamorphosed from a one man business to what it is today. The
success story of the company is well known to you since your firm has been rendering
professional services to our company from inception. However, since the past two
years the story has changed for the worse as a result of incursion of two new
engineering companies into the core areas of our business as well as the present
economic recession in the country. The company has accumulated losses that are now
threatening its corporate existence.
From the summarised financial position of the company attached herewith, you will
notice that the company’s retained earnings is now a negative of N4.6million while
the net assets is N3.9million out of which we have obligations of N3.0million to our
debenture holders. Despite a bank overdraft of N6.0million, the company currently
has a negative working capital of N4.7million.
In our last annual general meeting, the company’s shareholders gave approval to the
board and mandated it to do everything possible to restructure the company,
including capital reduction, if necessary, to bring the company back into profitability.
They also expressed their preparedness to subscribe to new shares if called upon.
Capital restructuring and reduction to bring the company’s capital in line with
the fair values of the assets;
Benchmarking of three key areas of the company’s operational processes with
the best in the industry and global best practices.
The company will also need to invest in new technology to be able to compete
effectively with our new competitors. We are of the opinion that after this capital
reconstruction, we shall be able to raise additional funds from our shareholders and
creditors to finance the new machinery.
I need not to reiterate the urgency of this assignment, but I shall be grateful if I can
have your recommendations in form of a report latest by Friday next week.
Yours faithfully,
For: Jullys Engineering Company Plc.
Long-term Liabilities:
10% Secured debenture 4 2,500
Equity:
5% Cumulative preference shares 5 2,000
Ordinary shares 6 4,000
Retained earnings (4,600) (600)
3,900
2. Inventories:
The net realisable value of the inventories is estimated to be N1.875million.
3. Receivables:
The amount recoverable from the receivables is estimated to be N1.7million.
4. 10% Debenture:
The debenture is secured on the office premises. Two years interest is however
outstanding on the debenture.
5. 5% preference shares:
Two million authorised, issued and fully paid at N1.00 per share. The preference
shareholders have not been paid any dividend in the past two years.
6. Ordinary shares:
Four million authorised, issued and fully paid ordinary shares of N1.00 per share.
From the preliminary meetings of the company’s directors with shareholders and
creditors, the following additional information has been provided:
SUPERVISOR CHECKER
SIGNATURE SIGNATURE
Changes made?
Uses information provided in Exhibit 1 Considers the need to get the scheme
approved by the shareholders of the
company through a special resolution.
Uses information provided in Exhibit 2 Considers the need to get the scheme
approved by 75% of the secured
creditors
Uses information provided in the notes Considers the company's ability to return
to the summarised financial position to profitability after the scheme is
(exhibit 4). completed.
V NC BC CA SA V NC BC CA SA
Recognises need to secure approval from Considers why the complete financial
regulatory agencies such as Nigerian Stock statement for 2015 was not sent. Can
Exchange, Corporate Affairs Commission, this be requested for?
Securities and Exchange Commission, etc.
Considers whether the Articles of the Evaluates the basis of the profit
company allows for capital reconstruction projection by the company's board after
and reduction. restructuring.
V NC BC CA SA V NC BC CA SA
Determines the total amount to be written Evaluates the possibility of the company
off from the assets of the company. to be able to raise funds to meet the
costs of reconstruction.
Determines the position of the shareholders Considers whether the supplier and the
and creditors after reconstruction. cost of the proposed new plant and
machinery have been determined.
V NC BC CA SA V NC BC CA SA
V NC BC CA SA
RECOMMENDATIONS (commercial /
relevant)
V NC BC CA SA
Uses information from the letter of Jullys' Considers the possibility of the company to
CEO (exhibit 2) benchmark's willingness to make available
useful data
Uses information from the summarised Considers other methods of repositioning the
statement of financial position (exhibit company, e.g, developing the company's core
3) competence to gain competitive advantage.
Identifies wider issues Identifies the need to carry along the company's
management and staff in the exercise.
V NC BC CA SA V NC BC CA SA
Identifies the steps necessary for a Considers availability of data that are needed
successful benchmarking. for the exercise.
Identifies the likely constraints the Considers availability of funds needed to carry
company may have in carrying out the out the exercise.
proposed benchmarking
Identifies need to consider what makes Identifies need to break down the three
the organisation the best. areas to be benchmarked into specifics.
Identifies the need to close the gap Identifies actions that are necessary after
discovered in the KPIs benchmarking to integrate the findings
into the company's operational processes.
V NC BC CA SA V NC BC CA SA
CONCLUSIONS
(Draws distinct conclusions under a
heading)
Concludes on the type of benchmarking
appropriate for the company.
V NC BC CA SA
RECOMMENDATIONS
(commercial/relevant)
V NC BC CA SA
N’000
7,630
6,930
N’000 N’000
Office building
1,800
Less payable to debenture holders 1,800 -
Other land and buildings 4,500
Plant and machinery 1,500
Inventories 1,875
Receivables 1,700
9,575
Less cost of liquidation 2,000
Available for unsecured creditors 7,575
UNSECURED CREDITORS:
Bank overdraft
6,000
Debenture holders: capital 2,500
Interest 500
3,000
Less paid out to secured debenture holders as above 1,800 1,200
Payable to trade creditors 2,500
9,700
Note:
There is no indication of any preferential creditors in the summarised statement of
financial position and the accompany notes.
Since there is only N7.575m to meet the claim of unsecured creditors of N9.7m,
including the debenture holders to the extent that they are unsecured, each would
therefore receive N0.7809 in N1.00.
The various parties would therefore receive the following amounts on liquidation of
the company:
1,952
Preference shareholders 0
Ordinary shareholders 0
9,375
The above shows that all parties would lose on liquidation and there is
incentive to agree to a suitable reconstruction scheme. However, the greatest
burden of the loss will be borne by the shareholders.
REDUCTION
N’000
6,930
N’000 N’000
Non current assets:
Properties, plant and equipment 7,800
Current Assets:
Inventories 1,875
Receivables 1,700
Cash 1,295
4,870
Current Liabilities:
Bank overdraft (secured) 6,000
Payables
2,500
8,500
Net Current assets
(3,630)
Net Assets 4,170
Shareholders’ Equity:
2,170,000 ordinary shares of N1.00 each 2,170
4,170
Note:
b. Meeting of all classes of creditors where the scheme will be approved by at least
¾ of the various classes of creditors;
d. Filing of the following documents with the Securities and Exchange Commission:
o Extract of the Shareholders’ Resolution at the Annual General Meeting
authorizing the share capital reconstruction.
o Extract of Board Resolution authorizing the share capital reconstruction
o Memorandum and Articles of Association (including amendment thereto) of
the Company recently certified by the CAC
o Form CAC 2 – (Statement of Share Capital and Return of Allotment) certified
by the CAC
o Form SEC 6 (duly completed)
o Form CAC 7 (Particulars of Directors) certified by the CAC
o Audited Accounts for the preceding five years or such number of years the
company has been in operation if less than 5 years
o A copy of Certificate of Incorporation of the Company certified by the CAC or
Company Secretary
o The most recent copy of Certificate of Increase in Share Capital certified by
the Company Secretary (where applicable).
o Copy of the Court Order where the reconstruction entails a reduction of
share capital
o Explanatory memorandum on the factors necessitating the reconstruction
o Evidence of payment of filing fees
APPENDIX TO REQUIREMENT 2
OPTION 1
OPTION 2
Note:
Candidates can use any other method to explain the steps but such methods must
contain the essential steps as shown above.
BENEFITS OF BENCHMARKING
Activity Expected
Days
1 Identify what is to be benchmarked 5days
2 Create the benchmarking team in the organization 2 – 10
Executives & team 2days
3 Identify the organization(s) you want to benchmark against 5days
4 Determine the indicators and the data collection method 5days
5 Collect data 10days
6 Determine current performance levels and identify gaps 3days
7 Determine future performance levels; forecast the expected
improvements 3days
8 Communicate the benchmark findings 2days
9 Develop an action / improvement plan based on the strategy
developed 5days
TOTAL 40days
The case is on capital reconstruction and benchmarking as a strategic tool for performance
improvement.
Candidates were expected to prepare the following data in order to properly address
requirement 1 in the report:
a. Total amount of capital reduction required, based on the fair values of the assets and
to write off the negative balance on retained earnings;
b. Distribution of realizable values of the assets of the company, if liquidated, i.e if the
capital reconstruction is not carried out;
c. The proposed reconstruction scheme based on the information supplied on exhibit 5,
preliminary agreement with stakeholders; and
d. The expected statement of financial position after the capital reconstruction exercise.
All these will form the appendices for requirement 1 together with the procedures the
Company should follow in effecting the capital reconstruction scheme.
Also, for requirement 2, candidates were not expected to carry out a benchmarking but
to discuss the types of benchmarking and recommend the one that will be suitable for the
company, based on the scenario.
Candidates were also expected to show in the appendice to requirement 2 the following:
a. Steps to be followed for the benchmarking exercise;
b. Benefits the company could derive from benchmarking;
c. Limitations or pitfalls to beware of in benchmarking; and
d. Proposed timetable for the benchmarking
Candidates need to remember that case study examination is a test of professional competence
and it involves the ability of the candidates to make use of the knowledge and technical skills
they have acquired in all the other papers of the Institute’s examination. They are also
expected to bring to bear the experience they have gained in practical terms. Therefore, to
succeed in case study examination, candidates must refresh their knowledge of other papers in
the Institute’s examination, develop their analytical and report writing skills. They must
familiarise themselves with current situations in the economy as most case study papers
considers the economic situation to build a scenario to be examined.
In approaching any Case Study paper in the future, candidates should take note of the following
steps:
a. Read and understand the case in the light of the requirements of the examiner, stated in
the case;
b. Determine and carry out detail financial and data analysis that will help candidates give
a sound advice in their report: All these will form the appendices.
c. Determine the appropriate strategic model that is appropriate for the type of business
analysis required in the case, where the examiner do not ask candidates to use a
particular model;
d. Carry out the detail business analysis and put this as an appendice to their report;
e. Understand the elements of a good report with appropriate headings, sub-headings and
disclaimer where it is required;
f. Practice with the cases examined in previous examinations in their preparation.
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