Diploma in Financial Management

Paper DA1 Incorporating subject areas: Interpretation of Financial Statements Performance Management
Monday 1 June 2009

Time allowed Reading and planning: Writing:

15 minutes 3 hours

This paper is divided into three sections: Section A Section B and Section C ALL 20 questions are compulsory and MUST be attempted THREE questions in total to be attempted Candidates MUST attempt ONE question from Section B, ONE question from Section C and ONE further question from either Section B or Section C

Do NOT open this paper until instructed by the supervisor. During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor. This question paper must not be removed from the examination hall.

The Association of Chartered Certified Accountants

Module A

Section A ALL 20 questions are compulsory and MUST be attempted Please use the Candidate Registration Sheet provided to indicate your chosen answer to each multiple choice question. Each question in this section is worth 2 marks. 1 The basic accounting equation states that assets liabilities = capital. Which of the following is correct? A B C D if assets increase, capital must also increase if capital is reduced, liabilities must have increased profit arises when the increase in liabilities exceeds the increase in assets a loss arises when the increase in liabilities exceeds the increase in assets

In the year to 31 May 2007 Ordov Co recognised an increase of $125,000 in the value of land and buildings. In the year to 31 May 2008, a further increase of $12,000 was recognised. During the year to 31 May 2009, the land and buildings suffered an impairment of $30,000. Based on the above information, what are the changes in value of retained profits and shareholders funds over the three years? A B C D Retained profits an increase of $107,000 an increase of $137,000 an increase of $107,000 no change Shareholders funds an increase of $107,000 an increase of $107,000 no change an increase of $107,000

Silur Co buys and restores items of exclusive vintage jewellery. At 31 May 2009, the company had three items in inventory. Details of the items were: $ Purchase cost Expected selling price Restoration costs to date Further costs before sale Necklace 12,000 25,000 6,000 2,000 Bracelet 31,000 38,000 5,000 3,000 Pendant 45,000 53,000 2,000 1,000

What was the total value of Silurs inventory at 31 May 2009? A B C D $88,000 $100,000 $106,000 $107,000

A customer of Pern Co claims that, on 22 March 2009, a fault in a product sold by Pern caused damage to its production line. The customer is seeking damages of $85,000. Pern has accepted liability and offered to pay $40,000 to repair the damage. The customer has refused this offer. The matter will be settled in a court case which is scheduled for July 2010. Perns legal representative has indicated that the court is almost certain to accept the customers claim for $85,000. How should this matter be dealt with in Perns financial statements for the year to 30 April 2009? A B C D as as as as a a a a current liability of $40,000 non-current liability of $40,000 current liability of $85,000 non-current liability of $85,000

On 6 May 2009, there was a fire in a factory owned by Triass Co. The cost of repairing the damage was $125,000. As the company had insurance cover, the balance of $125,000 was reported as a receivable in the draft financial statements for the year to 30 April 2009. In May 2009, the insurance company reported that due to non-compliance with the terms of the insurance contract, only $12,500 would be paid to Triass. What is the correct treatment of this matter in the financial statements for the year to 30 April 2009? A B C D only a charge of $112,500 should be reported only a receivable for $12,500 should be reported both a charge of $112,500 and a receivable for $12,500 should be reported only a disclosure note is required

Historical cost and current cost are possible measurement bases which could be used when preparing financial statements. Which of the following statements is correct? A B C D Historical cost is the most appropriate basis for inter-company comparisons of performance Current cost values are not related to cash values A statement of financial position prepared on the historical cost basis values all assets at the amount of cash paid Current cost values will always be higher than historical cost values

The Statements of financial position of Jurric Co at 30 April 2008 and 2009 include the following: 2008 $ 164,843 87,996 2009 $ 193,885 62,887

Inventory Payables

How should the changes in these values be reflected in the Statement of cash flows for the year to 30 April 2009? A B C D Change in inventory as a . . . cash inflow of $29,042 cash outflow of $29,042 cash inflow of $29,042 cash outflow of $29,042 Change in payables as a . . . cash inflow of $25,109 cash outflow of $25,109 cash outflow of $25,109 cash inflow of $25,109

Based on the current assets value of $172,793 reported in the draft financial statements of Palene, the companys current ratio at 31 May 2009 is 134. Since the draft financial statements were prepared, the chief accountant has calculated that the liability for current tax should be increased from $85,000 to $95,399. What is the current ratio following the increase in the current tax balance? A B C D 124 126 142 146

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The debt/equity ratio of Cretac Co at 31 May 2009 is higher than the debt/equity ratio at 31 May 2008. Which of the following would be a reason for the increase? A B C D a loan due for repayment in 2010 has been replaced by a loan due over the three years to 2012 the terms of a fixed rate loan have been renegotiated and the interest rate will increase from June 2009 in February 2009 the company reduced the number of shares in issue by buying back a number of shares in March 2009 the shareholders agreed to an increase in the amount the company can borrow to finance expansion

10 Consider the following statements about the Framework for the Preparation and Presentation of Financial Statements (the framework): (i) as it sets out underlying concepts, the framework will not be changed (ii) the framework is intended to assist users to interpret financial statements (iii) the framework is an International Accounting Standard Which of the above statements is/are correct? A B C D (i) only (ii) only (iii) only (i) (ii) and (iii)

11 The sales budget of Cambri Co includes the following sales volumes for one of the companys products: July August September 150,900 units 144,800 units 164,800 units

The sales director estimates that 10% of customers will pay in the month of sale, with 70% paying in the following month. The remaining customers will take a further months credit. All sales will be at $550 per unit, with customers paying in the month of sale obtaining a 10% settlement discount. What is the budgeted value of cash received from customers in September for sales of this product? A B C D $758,362 $749,298 $805,046 $814,110

12 Devin Co sells a single product at a selling price of $85. Direct costs are $38 per unit and overheads are $24 per unit. 60% of overheads represent the recovery of fixed costs. Both sales and production are budgeted to be 50,000 units. How many units are sold at the breakeven point (to the nearest unit)? A B C D 14,724 19,251 25,532 31,304

13 The directors of Carifer Co wish to use the maximin decision rule to select which one of four mutually exclusive projects to accept. The following payoff table has been calculated in $000: Demand Project A Project B Project C Project D Low 129 143 115 138 Medium 155 181 139 164 High 182 188 166 191

Using the maximin decision rule, which project should be selected? A B C D Project Project Project Project A B C D

14 Which of the following comments about sales pricing is correct? A B C D market penetration will normally be achieved by a low price on initial entry to the market market skimming will lead to a constant price throughout the products life cost plus pricing will lead to profit being maximised a target cost price will generate profit immediately following market entry

15 Which of the following statements about transfer pricing is correct? A B C D head office managers should never be involved in transfer pricing decisions the market price will always be the most appropriate transfer price the transfer price will not affect divisional profits the transfer price should promote goal congruence

16 Which of the following statements about divisionalisation is/are correct? (i) divisionalisation leads to head office managers having reduced control over operational decisions in an operating unit (ii) achieving corporate goals will be the only factor considered by divisional managers when they are making decisions (iii) divisionalisation allows operating decisions to reflect the local conditions of an operating unit A B C D (i) and (ii) only (ii) and (iii) only (i) and (iii) only (i), (ii) and (iii)

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17 The budgeted overheads of Nambro for the next year have been analysed as follows: Purchase order processing costs Production run set up costs Machine running costs $000 450 180 640

In the next year, it is anticipated that machines will run for 32,000 hours, 6,000 purchase orders will be processed and there will be 450 production runs. One of the companys products is produced in batches of 500. Each batch requires a separate production run, 30 purchase orders and 750 machine hours. Using Activity Based Costing, what is the overhead cost per unit of the product? A B C D $099 $159 $3530 $49500

18 At 30 April 2009, the book value of the net assets of Emor was $125 million, and the economic value was $17825 million. The net operating profit after tax for the year was $3,428,554. The budgeted return on investment for the year was 165%, and the cost of capital is estimated to be 12%. What is the companys economic value added (EVA) for the year? A B C D $487,429 $1,289,554 $1,366,054 $1,928,554

19 Which of the following statements about just-in-time is correct? A B C D introducing just-in-time production will always increase capacity utilisation just-in-time purchasing will lead to an increase in the number of suppliers receiving raw materials in large batches is a key feature of just-in-time purchasing a just-in-time approach seeks to eliminate non-value-added costs

20 A hospital management team assess performance using value for money. The following performance measures are reported by surgical departments: (i) the number of patients who need to be re-admitted following surgery (ii) the staff cost of each surgical procedure Which element of value for money is assessed by each measure? A B C D (i) economy efficiency effectiveness effectiveness (ii) efficiency effectiveness efficiency economy

(40 marks)

This is a blank page. Section B begins on page 8.

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Section B Candidates MUST attempt ONE question from Section B, ONE question from Section C and ONE further question from either Section B or Section C. 1 Adage is an advertising agency which is a limited liability company and is privately owned by the three founding directors, who each hold 1/3 of the companys shares and oversee the main activities, which are: (i) artistic development (ii) campaign production (iii) finance and administration. The director of artistic development is planning to retire and the remaining directors intend to buy his share of the business for $1,500,000, funding the purchase with a bank loan for the full purchase price. The directors wish to secure the loan on the assets of the company. You are a lending advisor at the bank which the directors have approached for funding. You are due to meet with the directors to discuss their proposal. The summary financial statements for the last two years are shown below: Adage Summarised Income statements for years ended 30 April 2008 2009 $000 $000 Revenue 3,255 3,482 Costs: Production costs 1,275 1,387 Administration expenses 944 1,048 Other expenses 538 636 2,757 3,071 Profit for year 498 411

Adage Summarised Statements of financial position at 30 April 2008 2009 $000 $000 Non-current assets 1,463 1,848 Current assets Receivables Prepayments Cash 352 27 40 419 1,882 348 1,089 1,437 430 15 445 1,882 462 31 21 514 2,362 348 1,500 1,848 497 17 514 2,362

Total assets Equity Share capital ($1 shares) Retained profit

Current liabilities Payables Accruals

Total liabilities and capital

You have also obtained the following information: (i) The net book values (NBV) and potential market values (MV) of non-current assets at 30 April 2009 were: NBV $000 946 644 258 MV $000 1,200 390 204

Property Equipment Vehicles

(ii) Receivables includes two disputed balances. One of these ($58,000) is the fee for a campaign which was not well received. The client claims that their reputation was damaged as a result of the campaign. As well as refusing to pay the outstanding balance, the client is threatening to commence legal proceedings for compensation if Adage does not write the balance off. The directors are unsure what the outcome of proceedings will be, but estimate that damages could be as high as $100,000 if the decision is in favour of the client. The other balance ($28,000) is due from a client who has been experiencing trading difficulties and may cease to trade. (iii) All other assets and liabilities are likely to be settled at their book value. Your objectives for the meeting with the directors are: to demonstrate to them that their objectives for the loan arrangement will be different to the objectives of the bank; and to obtain additional information to assist your decision making.

Required: (a) (i) Explain the differences between the objectives of the owners and the objectives of the bank with regard to the loan. (8 marks) (4 marks)

(ii) Identify the additional information that you will request.

(b) It is the banks policy to consider the worst possible outcome which might arise before agreeing any loan. This is done by considering the proceeds which would result from a realisation of the companys assets and liabilities. Loans are only agreed in those cases where the resulting funds are forecast to be sufficient to repay the loan. You have been asked to assess Adages application on this basis, using the statement of financial position at 30 April 2009 and the other information which is currently available. Required: Using the statement of financial position at 30 April 2009, together with the other information which is currently available, assess Adages loan application, based on the banks policy of considering the worst possible outcome. (8 marks) (20 marks)

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You are employed as a training consultant with a firm which provides training for non-executive directors of quoted companies. You are currently preparing material for a course dealing with the treatment of research and development expenditure. You plan to differentiate between research expenditure and development expenditure; explain the generally accepted accounting practice (GAAP) for such expenditure; and illustrate how key accounting ratios are affected by research and development expenditure, using return on capital employed and earnings per share as examples. The examples of expenditure which you plan to use are: (i) $15 million on a project to investigate improvements in the production process; (ii) $2 million on re-designing tools. It is expected that this re-design will improve the production process; and (iii) $12 million on assessing the characteristics of materials which are not currently used in the production process To demonstrate the impact of the expenditure on key accounting ratios, you plan to use the following data taken from an assumed company with a year end of 31 May 2009: Retained profit for the year Total non-current assets Current assets Current liabilities Non-current liabilities Shareholders funds Note (i) $000 75,700 293,800 95,890 69,800 104,000 215,890 note (i) note (ii)

note (iii)

This represents the profit for the year, after the following: $000 Taxation 8,650 Interest 822 Dividend 6,800 The total expenditure to be used in your example ($47 million) has been included in this value. This includes 50 million ordinary shares of $1 each. Of these, 10 million were issued on incorporation. The remainder is the result of two bonus issues. In each of these, 20 million shares were issued. The first bonus issue took place in February 2007, and the second bonus issue took place on 1 January 2009. The remainder of the value of shareholders funds represents retained profits.

Note (ii) Note (iii)

Required: (a) Explain the difference between research expenditure and development expenditure. (4 marks)

(b) Outline the generally accepted accounting practice with regard to research and development expenditure. (6 marks) (c) Indicate how each of the three items of expenditure should be treated. (3 marks)

(d) Calculate the values for return on capital employed and earnings per share following any adjustments which are needed to comply with generally accepted accounting practice. (7 marks) (20 marks)

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This is a blank page. Question 3 begins on page 12.

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(a) On 1 June 2007, Herbie Co acquired 160,000 shares in Sumber Co, at a price of $375 per share. At that date, the book value of the net assets of Sumber was $506,000. The fair value of all of the assets and liabilities was equivalent to book value, with the exception of land which was valued at $60,000 above the book value. In the period since the acquisition, the land has increased in value by a further $15,000. The terms of the acquisition are such that Sumber is to be treated as a subsidiary of Herbie. The directors of Herbie estimate that at 31 May 2009, the goodwill attributable to the group had been impaired by $30,000. At 31 May 2009, the statements of financial position of Herbie and Sumber were: ASSETS Non-current assets Property, plant and equipment Investment in subsidiary Note Herbie $000 4,375 600 4,975 1 124 237 53 7 421 5,396 2,500 750 1,204 4,454 750 144 19 29 192 5,396 Sumber $000 545 Nil 545 30 45 12 3 90 635 200 100 263 563 25 29 8 10 47 635

Current assets Inventories Trade receivables Other current assets Cash and cash equivalents

Total assets EQUITY AND LIABILITIES Share capital Share premium Retained earnings Total equity Non-current liabilities Long-term borrowings Current liabilities Trade and other payables Short-term borrowings Other current liabilities Total current liabilities Total equity and liabilities

Notes 1 During the year, Sumber sold goods to Herbie for $60,000. Sumber obtained a profit margin of 15% on the sale of these goods. At 31 May 2009, 1/3 of the goods were unsold. 2 The issued share capital of both companies comprises shares with a nominal value of $1. 3 No fair value adjustments have been recognised in the statements of financial position. Required: Calculate the value of: (i) the goodwill on acquisition attributable to both the group and non controlling interest; and (5 marks) (7 marks)

(ii) consolidated reserves at 31 May 2009.

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(b) The directors of Header Co are considering making an investment in Slo Co, one of their materials suppliers. The directors wish to clarify how any investment will be treated for financial reporting purposes. They are aware that it will be necessary to prepare consolidated financial statements, and that, depending on a number of factors, the investee will be treated as either a subsidiary or an associate. However, they are not sure what factors govern the classification of an investment as either a subsidiary or an associate, or the difference in accounting treatment in the consolidated financial statements. Required: Explain: (i) the factors which govern whether an investee is treated as an associate or a subsidiary in the consolidated financial statements; and (5 marks)

(ii) the difference in accounting treatment of an associate and a subsidiary in the consolidated financial statements. (3 marks) (20 marks)

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Section C Candidates MUST attempt ONE question from Section B, ONE question from Section C and ONE further question from either Section B or Section C. 4 Domeng Co is a company which carries out servicing of, and repairs to, a range of domestic appliances, such as central heating boilers, washing machines and air conditioning units. The company is structured into two divisions servicing and repairs. Each of these is subdivided into operating units for each type of appliance. The operating units are managed as cost centres. Cost variances are reported on a monthly basis. The variance report for May 2009 for one of the operating units is shown below: Materials usage Materials price Labour efficiency Labour rate Variable overhead expenditure Variable overhead volume Fixed overhead expenditure Fixed overhead volume $3,105 $4,296 $4,842 $2,550 $2,554 $1,846 $433 $984 Adverse Favourable Adverse Adverse Favourable Adverse Favourable Adverse

In your role of section manager, you have been asked to prepare a report for the attention of the divisional operations manager, explaining the reasons for the variances. To prepare your report, you have noted the following points which may be relevant: (i) (ii) (iii) (iv) (v) customers are charged a standard price per service. Therefore the divisional profit is improved when engineers complete services in less than standard time. a service consists of a set range of tasks, including replacing specified parts. These parts are included in a standard service pack which can be obtained from a number of suppliers. for each service completed in less than standard time allowed, engineers are paid a $30 bonus. the standard time for each service includes an allowance for travel time to the customers premises; if a service pack is subsequently found to have included parts which are faulty, all parts in the pack will be replaced at no cost to the customer. As the customer cannot be expected to pay a further fee, this is not regarded (or reported) as an additional service. all divisions are required to achieve planned cost savings on an ongoing basis. Statistics for May were: Budgeted volume of services 500 Actual volume of services 433 Replacement packs issued 90 Services completed in less than standard time 85

(vi) (vii)

Required: Prepare a report for the attention of the divisional operations manager which: (a) identifies possible causes for the variances which have been reported; and (b) suggests actions which should be considered to reduce the overall adverse variance. (12 marks) (8 marks) (20 marks)

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Birndan Co is structured into two divisions Albirn (A) and Boldan (B). The performance of the divisions is assessed on the basis of the divisional return on investment (ROI). ROI is calculated using the average of the opening and closing asset values. If divisional ROI is greater than 16%, the divisional managers are paid a bonus of 10% of the amount by which actual profit exceeds the target ROI of 16%. The following forecast data is available for the two divisions for the next year: Division Net book value of non-current assets: at start of year at end of year Average book value of working capital Profit for year A $6,230,000 $5,032,000 $511,200 $1,195,376 B $19,409,800 $16,756,600 $2,324,000 $3,411,856

The data above does not take into account the following proposed projects which are currently under consideration: Division Investment required: Initial investment in non-current assets Average investment in working capital Profit in first year Useful life A $1,650,000 $100,000 $278,844 5 years B $964,000 $55,000 $124,964 4 years

One of the head office managers has suggested that the calculation of the bonus should be revised so that it is based on residual income (RI). She has noted that ROI can sometimes lead to managers rejecting proposals which are beneficial to the company. She has suggested that the bonus should be a percentage of residual income. Her argument is that if the percentage was set at a level which would result in the same bonus being paid for the forecast results before investment in any additional projects, any projects which produce a residual income would be accepted. This would encourage goal congruence as the company would benefit, and managers would also benefit as they would receive a higher bonus. The companys cost of capital is estimated to be 12%. Required: (a) Based on the forecast data excluding the proposed projects: (i) calculate the forecast ROI of each division; and (3 marks)

(ii) based on the head office managers suggestion, calculate the percentage of RI which should be used in each division so that the bonus amounts are the same as would be paid under the current bonus arrangement; (5 marks) (b) Assuming that ROI continues to be used as the basis of the bonus calculations, calculate the increase or decrease in the bonuses if the proposed projects are accepted. (7 marks) (c) Indicate, with reasons, whether it is likely that divisional managers would accept the proposed projects if bonuses are based on RI rather than ROI. (5 marks) (20 marks)

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Remdev Co manufactures hand-held remote controllers for a range of domestic electronic products. A major retailer has requested Remdev to quote a fixed contract price for the supply of a batch of 10,000 controllers. The retailer has specified that the order must be completed within eight weeks of the contract being signed. Failure to meet this delivery deadline would lead to significant penalty payments. The sales director believes that the retailer will pay no more than $14 per controller. Each batch of 100 controllers will require 34 hours of direct labour. Remdevs standard labour cost is $55 per hour. Production capacity is 5,000 man-hours per week, and the current level of activity is 92% of operating capacity. An overtime premium of 30% is incurred when production exceeds full operating capacity. One of each of the following components will be required for each controller: casing; transmitter; diode; battery holder; and button sensor unit. The production manager had advised that the casing, battery holder and button sensor unit needed to be re-designed. The re-design work has already been completed so that production can commence immediately the contract is signed, and the design director has reported that re-designing these components required 12 man-hours. Design work is normally charged to contracts at a rate of $82 per man-hour. Because of the deadline for completing the design, it will be necessary to transfer some staff from another project. This will cause a delay of one week in completing the other project. As a result of this delay, Remdev will incur a penalty of $8,500. The purchasing manager has estimated that the following prices will apply for the supply of 10,000 of each of the following items: Casing Battery holder Button sensor unit $7,000 $6,200 $4,500

The standard transmitter used in all products can be used for the contract. There are currently 1,500 transmitters in inventory. These had cost $115 each. The current market price of transmitters is $160 each. Due to the reduction in demand for a previous product, Remdev has an inventory of 3,500 diodes which could be used for the contract. These were part of an order of 10,000 diodes, obtained at a cost of $21,500. The purchasing manager has found a supplier who will supply a batch of 8,000 diodes at a total cost of $14,200. Remdev has no alternative use for the diodes currently in inventory. The full batch of 8,000 of the additional diodes must be purchased in total, and could not be used in any of Remdevs other products. Overheads are normally charged to contracts on the basis of labour hours at a rate of $63 per hour. This comprises a charge of $47 per hour for fixed overheads, based on a normal activity level of 90% of capacity. The balance of the charge is the estimated cost of variable overheads. Required: (a) Calculate the minimum selling price per controller which Remdev should quote for the contract, clearly explaining the basis of each cost included in your calculation. (14 marks) (b) Identify which factors other than cost and selling price managers should consider before proceeding with the contract. (6 marks) (20 marks)

End of Question Paper

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