SOLUTION - CORPORATE REPORTING STRATEGY MAY 2009 QUESTION 1 Rapid Limited Group Consolidated Profit & Loss Account

for the year ended 31st December, 2008 Sales Cost of sales Gross profit Selling, general and administrative expenses Share of profit of associate Profit before tax Tax expenses Non controlling interest Gain on sale of shares in subsidiary company Gain on acquisition of Quick ltd Net profit for year transferred to income surplus account GH 92,186,763 (66,009,988 ) 26,176,775 (14,967,500 ) (581,147 ) 11,209,275 (3,999,212 ) 7,791,210 (847,336 ) 6,943,874 179,653 463,038 7,586,565 Consolidated Income Surplus Account for the year ended 31st December, 2008 Balance brought forward Net profit for year transferred from profit & loss account Dividend paid Balance carried forward Consolidated Balance Sheet at 31st December, 2008 GH Assets Non current assets Properties, plant & equipment (nbv) Investment in Associate Current assets: Stocks Debtors GH 16,893,700 4,123,094 21,016,794 5,638,000 8,582,320 1 GH 3,121,600 7,586,565 (2,520,000) 8,188,165

Cash and bank balances Total assets

5,637,800 19,858,120 40,874,914

Equity & Liabilities Equity Parent equity Stated capital Income surplus Non controlling interest Current liabilities: Creditors Sundry creditors Total equity & liabilities Computation of Goodwill on Acquisition of Fast Ltd GH Stated capital 80%* GH4,800,000 Income surplus 80%* GH1,680,000 Net assets acquired Cost Goodwill Goodwill attributable to 50% of its holding sold: 50%* GH416,000 Computation of Goodwill on Acquisition of Quick Ltd GH Stated capital 70%* GH6,200,000 Pre acquisition profits: Income surplus @ 1st January, 2008 70%* GH2,700,000 Profits January to March 2008 70%*3/12* GH2,474,500

GH

15,000,000 8,188,165 23,188,165 3,039,750 26,227,915 5,432,000 9,215,000 14,647,000 40,874,915

GH 3,840,000 1,344,000 5,184,000 5,600,000 416,000 208,000

GH 4,340,000 1,890,000 433,038 2,323,038 2

Net assets acquired Cost Gain on acquisition of Quick Ltd

6,663,038 6,200,000 (463,038)

Computation of Gain to Rapid Ltd on Partial Disposal of Shareholding in Fast Ltd Sale proceeds Original cost 50%* GH5,600,000 Gain Tax @ 10% Net gain GH 3,400,000 (2,800,000) 600,000 (60,000) 540,000

Computation of Gain to Rapid Ltd Group on Partial Disposal of Shareholding in Fast Ltd GH Sale proceeds Share of net assets at date of disposal 50%**)%*{2,082,000 bf + 4,800,000 + (2,905,736*6/12 954,000)} Goodwill at acquisition Tax Net gain GH 3,400,000

(2,952,347) (208,000) 239,653 (60,.000) 179,653

Alternative Sale proceeds Original cost 3,400,000 (2,800,000) 600,000

Share of post acquisition profits 50%*80%* balance brought forward 50%*80%* (GH2,082,000 1,680,000) 50%*80%* current year profit 50%*80%* ((6/12*2,905,736 954,000) Tax Net gain

160,800 199,547 (360,347) 239,653 (60,000) 179,653

Consolidation scheme Consolidated Profit & Loss account year ended 31st December, 2008 Rapid Ltd GH Sales Cost of sales Gross profit Selling, general and administrative expenses Other income Profit before tax Groups share of Associates profit before tax (40%*6/12*GH4,277,800) Tax
Groups share of Associates tax 67,536,000 (51,363,000) 16,173,000 (9,800,000) 6,373,000 1,251,000 _________ 7,624,000

Quick Ltd GH

Fast Ltd GH

Adjustments

Cons. P & L

GH
(200,000) 200,000 (1,251,000) __________ (1,251,000)

GH
92,186,763 (66,009,988) 26,176,755 (14,967,500) 11,209,275 __________ 11,209,275

13,323,263 11,527,500 (8,158,388) (6,688,600) 5,164,875 4,838,900 (2,467,500) (2,700,000) 2,697,375 2,138,900 _________ _________ 2,697,375 2,138,900

__________ 7,624,000 (2,471,680) __________ 5,152,320

_________ 2,697,375 (841,500) ________ 1,855,875 (556,763)

_________ 2,138,900 (686,032) _________ 1,452,868 (290,574)

__________ (1,251,000) __________ (1,251,000)

855,560 12,064,835 (3,999,212) (274,413 7,791,210 (556,763 (290,574)

(40%*6/12*GH1,372,064) Profit after tax Non controlling interest 30%*GH1,855,875 20%*GH1,452,868 Gain on sale of shares in Subsidiary Company per: Parent company Group
Gain on acquisition of Quick Ltd Net profit for year transferred to income surplus account

540,000 __________ 5,692,320 _________ 1,299,113 _________ 1,162,294

(540,000) 179,653 463,038 __________ (1,148,310)

179,653 463,038 __________ 7,586,565

Consolidation Schedule Consolidated Income Surplus Account year ended 31 st December, 2008 Rapid Ltd GH Balance brought forward Fast Ltd 80% (2,082,000 1,680,000) Net profit for year transferred from profit & loss account 5,692,320 1,299,113 2,800,000 Quick Ltd GH 321,600 (1,148,310) Adjustments Cons. P & L GH GH 2,800,000 321,600 7,586,565 4

Dividend paid

(2,520,000) 5,972,320

________ __________ _ 1,148,310 1,299,11 3

(2,520,000) 8,188,16 5

Consolidation Schedule Consolidated Balance Sheet as at 31st December, 2008 Rapid Ltd GH Equipment, plant & machinery (nbv) Investment in Associate: Original cost 50%* 5,600,000 post acquisition profit 1/7/2008 31/12/2008 PBT 855,560 Tax 274,413 1/1/2008 30/6/2008 40%*6/12*2,905,736 Several years ago 31/12/2008 40%*(2,082,000 1,680,000) Goodwill Current assets: Stocks Debtors Proceeds from sale of shares Cash and bank balances 1,850,000 2,492,320 3,400,000 1,060,000 8,802,320 Total assets Current liabilities: Creditors Tax on sale of shares Sundry creditors Non controlling interest 30%*10,132,500 15,000,000 3,788,000 6,150,000 1,117,80 0 11,055,80 0 3,320,000 60,000 6,050,000 9,430,000 2,112,000 3,105,00 0 5,217,00 (6,200,000) 5 __________ (60,000) 60,000 _________ 12,600,000 ________ __________ _ 4,293,70 0 12,600,000 Quick Ltd GH 4,293,700 Adjustments Cons. B S GH GH 16,893,700 2,800,000

581,147 581,147 160,800 _________ 21,016,794

5,638,000 8,582,320 3,400,000 2,237,800 19,858,120 40,874,914

5,432,000 60,000 9,155,000 14,647,000 3,039,750

Stated capital Income surplus Total equity & liabilities

5,432,320 20,432,320

(9,364,820 ) (15,564,820 )

15,000,000 8,188,165 23,188,165 40,874,915

6,200,000 3,932,500 10,132,50 0

QUESTION 2

(a)

Realisation Account on Liquidation at 31/12/2008

Liquidation expenses Net book value of assets: Freehold land & buildings Plant & Machinery Fixtures & Fittings Motor vehicles Investments Stocks Debtors Development cost

GH 50,000 Sale proceeds: Freehold land & buildings 550,000 Plant & Machinery 380,600 Fixtures & fittings 400,000 Motor vehicles 950,000 Investments 90,500 Stocks 650,500 Debtors 850,800 250,000 Loss on realisation 4,172,400

GH 680,500 150,800 385,000 995,500 150,600 450,600 750,500 356,500 608,900 4,171,800

Sundry Members Account

Income surplus account Loss on realisation Bank

GH 860,900 Ordinary shares 609,700 849,200 Share deals account

GH 1,900,000 419,800 6

2,319,800

2,319,800

(b)

PAYA LTD

Distribution of the sale proceeds to the various stakeholders GH 580,000 680,500 GH

25% Debenture Proceeds of freehold land & buildings Balance available to unsecured creditors Add: Proceeds from sale of remaining assets (3,562,700 680,500) Cash on hand Liquidation expenses Preferential creditors PAYE tax and social security deductions Unsecured creditors: Bank overdrafts Debenture interest Trade creditors B/F 20% Cumulative Reference shareholders Ordinary shareholders

100,500

2,882,200 56,500 3,039,200 (50,000) 2,989,200 (150,000) 2,839,200 650,000 280,000 560,000

1,490,000) 1,349,200 (500,000) 849,200 (849,200) -

(c) PAYA LTD Computation of loss in the event of reconstruction GH 860,900 7

Income surplus account

Freehold land & buildings Plant & machinery Fixtures & Fittings Motor vehicles Stocks Debtors Investment Share Deals Total loss

(130,500) 200,000 9,400 (30,600) 59,900 85,080 (419,800) 634,380

In the event of liquidation all stakeholders except the ordinary shareholders will receive full payment. The whole of the loss should be borne by the ordinary shareholders. Suggestion for scheme reconstruction i. ii. Reduce ordinary share capital by GH634,380. If the company is liquidated it is only the ordinary shareholders who will lose portion of their investment The company requires additional working capital totaling GH1,215,000 Ordinary shareholder should contribute GH800,000 cash for additional ordinary shares. The 20% Cumulative Preference shareholders should bring in cash of GH415,000 for ordinary shares. The 20% Cumulative Reference shares should be converted to 22% cumulative Preference share iii. Management should renegotiate with the bank for rescheduling repayment of the overdraft balance. 50% of the overdraft balance should be paid now. The remaining balance is to be paid by two equal installments. (d) Balance Sheet of Paya Ltd immediately after the reconstruction. GH Non-current assets Freehold land & buildings Plant and machinery Fixtures & fittings Motor vehicles Investments GH 680,500 180,600 390,600 980,600 90,500 8

Development cost Current Assets Stocks Debtors (850,000 10% x 850,800) Bank balance (56,500 + 800,000 + 415,000 50% x 650,000) Total assets

250,000 2,572,800 590,600 765,720 946,500 2,302,820 4,875,620

GH Equity & Liabilities Equity Ordinary Share Capital (1,900,000 634,380 + 800,000 + 415,000) 22% Cumulative Preference Share Capital Liabilities 25% Debentures Current Liabilities Creditors Bank overdraft Total Equity & Liabilities

GH

2,480,62 500,000 2,980,620 580,000 990,000 325,000 1,315,000 4,875,620

QUESTION 3 (i) Net Assets Method

Under this method valuation is done by reference to the market/fair value of the assets after deducting all liabilities. GH 3,500,000 3,585,000 4,650,000 3,000,000 1,200,000 9

Goodwill Fixtures & fittings Land & buildings Motor vehicles Equipment

Stocks Debtors Bank & Cash Creditors Taxation Accrued charges Provision for bad debts Bonus Preference Shares Net Assets No. of Shares Value per share Price-earnings ratio

9,500,000 14,085,000 3,500,000 (5,250,000) (1,125,000) (5,085,000) (1,408,500) (850,000) 4,500,000 22,301,500 12,000,000 GH1.86

(ii)

The P/E ratio could also be used to value the shares of Kose. From data provided by the question, earnings available to equity shareholders can be computed as follows: MV = P/E x EPS GH 8,800,000 (1,408,500) (850,000) 6,541,500 1,635,375 4,906,125 450,000 4,456,125 12,000,000 GH0.37

Profit before tax as given Provision for bad debts Bonus Less Corporate Tax @ 25% Profit after tax Less preference Dividend Earnings available to equity shareholders No. of ordinary shares issued Earnings per share

This gives a EPS of GH0.37. The P/E ratio of Araba Limited, a similar company which is listed needs to be determined as follows: Market capitalization Number of shares GH24,990,000 8,500,000 10

Earnings per share Total earnings Price per share P/E = 24,990,000 8,500,000 = = 2.94 0.30 =

GH0.30 GH2,550,000 GH2.94 9.80

The P/E of 9.80 would be marked down by say 30% to allow for differences in earnings record, growth, asset backing and non-marketability of the shares of Kose which are not listed. Thus the price per share = 9.80 x 70% x 0.37 which is GH2.54 (iii) Dividend yield The Dividend yield approach could also be used. Under this method, price per share = required future dividend x (100/required dividend yield). Dividend per ordinary share of Kose Limited is: Number of shares Dividend Dividend per share 12,000,000 GH1,650,000 GH0.14 (2,100,000 450,000)

Dividend per share of Araba = 80% of GH0.30 = GH0.24. Dividend yield = 0.24 x 100 = 8.16% 2.94 Since Kose Limited is not listed, one may expect it to pay a slightly higher dividend than those of quoted companies. If the dividend yield of 8.16% is marked up by 30% to say 10.6%, then price per share = GH0.14 x (100/10.6) = GH32 (iv) Discounted cash flow PAT GH000 5,940 6,831 7,514 8,340 Dep. GH000 2,800 2,940 3,250 3,300 Interest charge GH000 1,250 1,550 2,200 2,200 NCF GH 9,990 11,321 12,964 13,840 Disc. Factor 30% 0.7692 0.5917 0.4551 0.3501 NPV GH000 7,684.31 6,698.64 5,899.92 4,845.38 11

Year

2009 2010 2011 2012

2013

9,174

3,350

2,250

14,774

0.2693

3,978.64 29,106.89 12,000,000 29,106,890 12,000,000 GH2.43

Present value Number of shares Price per share

= =

b. Summary: Net Asset Basis P/E ratio Dividend yield DCF GH2.07 giving a valuation of GH24,840,000 GH2.54 giving a valuation of GH30,480,000 GH1.32 giving a valuation of GH12,720,000 GH2.43 giving a valuation of GH29,106,890

The dividend yield approach resulted in the lowest valuation figure of GH12,720,000. This is far lower than Kose Limiteds existing equity interest of GH19,460,000. The other methods did not only produce higher valuation amounts but were also very close. The P/E ratio approach and the DCF virtually yielded the same results. The GH12,720,000 valuation posted by the dividend yield approach is as result of the low dividend paid to equity holders in 2008 which is a reflection of the companys earnings performance. In practice, the dividend will be adjusted to cater for future growth.

QUESTON 4 a) Characteristics of a hyperinflationary economy. i. ii. The general population prefers to keep its wealth in non-monetary assets or in a relatively stable foreign currency. The general population regards monetary accounts not in terms of the local currency but in terms of a relatively stable foreign currency and may indeed quote prices in that currency. 12

iii. iv. v. b) i)

Sales and purchases on credit take place at prices that compensate for the expected loss of purchasing power during the credit period. Interest rates, wages and prices are linked to a price index. The cumulative inflation rate over the years is approaching or exceeds 100%. Unrealised Gains/Loss on Stock Unrealized Gains at Year End 12,350 x 105 + 120 2 - 12350 112 12,405.13 12,350 Less Unrealised gains at start 11,290 x 105,120 + 2 - 11,290 112 11,340.40 - 11,290 Unrealised Gains in stock Comment GH 55.13

150.40 4.73

The unrealized gain of GH4.73 on stocks cannot be distributed to shareholders if the company wishes to maintain its operating capacity. It would be prudent to credit the gain to an undistributable account until it is realised. ii) Unrealised Holding gains on Motor Vehicles Initial Calculations Depreciation Cost Cost of Asset Depreciation every year Schedule of Depreciation Year 1, 2006 Cost Less Depreciation Year 2, 2007 Bal b/d Less Depreciation Year 3, 2008 bal b/d = = = GH19,500.00 GH19,500 x 20% = GH3,900.00 GH 19,500 3,900 15,600 3,900 11,700 3,900 7,800

Carrying Amount on 31/12/2008 Calculation of Unrealised Holding Gain Gain at Year End (GH7,800 x 22,500) - 7,800 19,500 Gain at start (GH11,700 x 19,800) = 11,700 19,500 Less: Element of Current cost Revaluation

GH 1,200

180 1,020 13

Written off as Depreciation during Year (3,900 x 22,500) - 3,900 19,500 Unrealised Holding Gain Comments

600 420

As with stocks, the production capacity of the company will be adversely affected if this gain of GH420 were to be distributed and so it should be held in an undistributable capital reserve.

iii.

Cost of Sales Adjustments HCA GH 11,290 118,900 (12,350) 117,840 Factor 120/105 120/112 120/112 CCA GH 12,902.86 127,392.86 (13,232.14) 127,063.58 117,840.10 9,223.48

Opening stock Purchases Closing stock HCA cost of sales Less HCA cost of sales COSA Comments

The COSA is the difference between the current cost of sales and the historic cost of sales and is charged to the historic cost profit and loss account as an adjustment inorder to arrive at the current cost profit. It should also be credited to a non-distributable reserves. iv The Monetary Working Capital Adjustment 2007 GH 12,320 12,080 240 GH MWC at End Less MWC at start Increase Due to Volume 14 2008 GH 15,230 14,580 650 GH 650 240 410

Debtors Less creditors Monetary Working Capital

MWC at End : 650 x 12 120 Les MWC at start 240 x 112 105 MWCA

607 256 351 59

Comments The MWCA represents the increase/decrease in finance necessary to provide an appropriate level of monetary working capital due to price changes rather than a change in volume of working capital. QUESTION 5 a) In advising Nana Oduro as to where to place his investment, we need to evaluate both qualitative and quantitative factors. Qualitative Factor (1) Gross Profit % = CT 27,350 x 100 115,200 23.7% CL 99,870 x 100 280,150 = 35.7%

Comment CL does better in managing its cost of sales than CT Ltd. (2) Net Profit % CT 11,720 x 100 115,200 = 10.2% CL 33,600 x 100 280,150 = 12.0%

Comments CL continuous to manage its selling, general and administration expenses better than CT Ltd. (3) ROCE CT 11,720 x 100 92,310 = 12.7% CL 33,600 x 100 109x230 = 30.8%

Comments CL Ltd yields a far higher returns on investment than CT Ltd thus displaying a higher efficiency in the management of assets placed at its disposal. (4) Current Ratio CT CL 15

78,950 42,600 = 1.85

117,030 58,000 = 2.08

Comments CL is much better in managing its current assets against its current liabilities than CT Ltd. (5) Quick Ratio CT 48,900 42,600 = 1.15 Comments On terms of acid test CT does better than CL Ltd. (6) Gearing Ratio CT Nil CL 20,000 x 100 109,230 = 18.3% Comments CT is zero-geared and is likely to apply its profits in paying dividends to its shareholders rather than paying it out as interest to lenders as in the case of CL Ltd. (7) Interest Cover CT Nil CL 44,400 2,400 = 18.5 times Comments Even though CL has a good interest cover for its medium-term loan, it is still less advantageous in relation to CT Ltd which has no interest payments. (8) Dividend Cover CT 11,720 4800 = 2.44 times Comments CT Ltd has adequate interest cover and in actually approving a dividend, it edges ahead of its competitor CL Ltd. Qualitative Factors (9) Shareholding structure CT 20,000 x 100 50,000 = 40% CL 45,000 x 100 50,000 = 90% 16 CL Nil CL 59,930 58,000 = 1.03

Comments CT Ltd has a better potential for raising additional capital in future to support its operations as a result of greater unissued shares than CL Ltd. (10) Statutory Debt % of creditors CT 10,320 x 100 42,600 = 24.2% = CL 51,460 x 100 58,000 88.7%

Comments The bulk of creditors in CL Ltd being statutory debt if deductions made on behalf of government are not paid over to government in good time. (11) Permanent employee % CT CL 280 x 100 503 x 100 400 530 = 70% = 94.9%

Comments A greater number of employees being permanent may or may not signal stability of operations but the high overhead cost of permanent employees in CL Ltd may diminish profits and therefore may not be the most preferred. (12) Employee Age Profile Analysis Years 25 44 45 55 56 59 Totals CT 168 84 28 280 % 60 30 10 100 CL 125 112 266 503 % 24.9 22.3 52.8 100.0

Comments CT has more youthful labour who will work longer in the company than CL Ltd whose concentration of over-aged labour will soon retire with their expertise. (13) Effective Use of Man-hours CT 93,184 x 100 100 116,480 CL 100,440 209,248 = 48.0% x

= 80% Comments CT makes more effective use of its labour force than CL Ltd. (14) Employee Performance Analysis Sick leave % CT 9,318 x 100 116,480

CL 41,850 x 100 209,248 17

= Industrial Accident % = Industrial Dispute % =

8% 8,154 x 100 116,480 7% 5,824 x 100 116,480 5%

20%

25,110 x 100 209,248 = 12% 41,848 x 100 209,248 = 20%

Comments The working environment in CL Ltd appears to be more hazardous than in CT Ltd thus leading to more sickness among the workforce, more industrial accidents and obviously more industrial disputes. (15) Cost of Overtime As a result of more lost hours in CL Ltd, it will incur much more overtime cost than CT Ltd and this will impact negatively on its income account. Labour Disputes Analysis Favourable Non- Favourable Pending Litigation Totals CT 5 2 7 % 71.4 28.6 100 CL 6 14 5 25 % 24.0 56.0 20.0 100.0

(16)

Comments Even if all pending cases are decided in favour of CL Ltd, it will still show that labour disputes are unduly safe and that this is not beneficial to the company. (17) Board of Directors Analysis In-Company Directors Out-Company Directors Totals CT 2 3 5 % 40 60 100 CL 7 2 9 % 77.8 56.0 22.2 100.0

Comments CT Ltd has a more qualitative Board which is likely to achieve results than CL Ltd which has merely packed the Board to rubber-stamp management decisions. (18) Advice: Nana Oduro should place his investment in CT Ltd because the company has a total of 13 out of 17 evaluation scores and is likely to yield the greater benefits.

b)

a)

Borrowing cost are interest and other cost incurred by an equity in connection with the borrowing of funds and may include interest on bank overdrafts and short term and long term borrowings, amortisation of discounts or premiums relating to borrowing, finance charges in respect of finance leases, etc. 18

b) Under the benchmark treatment, borrowing costs are recognised as an expense in the period in which they are incurred regardless of how the borrowings are applied. Under the allowed alternative treatment, borrowing costs that are directly attributable to the acquisition contribution or production of an asset are included in the cost of that asset. Such borrowing costs are capitalised as part of the cost of the asset when it is probable that they will result in future economic benefits to the entity and the cash can be measured reliably. c) Calculation of Avoidable Interest Cost Payment Date 30/6/2008 30/9/2008 31/12/2008 Weight 6/12 3/12 0/12 Payment 58,000 48,500 43,500 150,000 Weighted Ave. Exp. 29,000 12,125 41,125 GH 9,048 GH 33,000 150,000 9,048 159,048 = 6,532

Avoidable Interest Cost Weighted Average Expenses x Loan Interest 41,125 x 22% Interest Expense 150,000 x 22% The lower of the two is capitalised Carrying cost Total payment Add Avoidable cost Interest Expenses (33,000 9,048 17,420) d) Carrying Amount of Canteen Project Basic cost .. No. 1 2 3 58,000 48,500 43,500 150,000 GH

Borrowing Cost of Loan GH150,000 x 22 100 Investment Income Up to 30/6/2008: 150,000 x 16 x 6 100 12

33,000

12,000 19

Up to 30/9/2008 (150,000 58,000) = 92,000 x 16 x 3 100 12 Up to 31/12/2008 (150,000 106,500) = 43,500 x 16 x 3 100 12 Carry Amount Basic Cost Add: Borrowing Cost Less: Investment Income CARRYING AMOUNT

3,680

1,740 17,420 GH

150,000 33,000 (17,420) 165,580

20