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BMAN21020 Page 1 of 8 Original Duration 2 Hours 30 Minutes THE UNIVERSITY OF MANCHESTER FINANCIAL REPORTING AND ACCOUNTABILITY 4th June 2021, 11:00AM Answer TWO questions in total: Answer Question 1 from SECTION A (COMPULSORY) and Answer ONE question from SECTION B ___________________________________________________________________ You have 2 hours and 30 minutes to complete this examination. You must type answers in Word. You should type your workings, but it is permissible to include images of your handwritten and/or excel workings. It is your responsibility to ensure that these are of high quality, and appropriately located and integrated into a single word document. However, it may save time to type your workings where necessary. Answers must be typed using Times New Roman Font type, size 12 with double spacing and only in black ink for clear visibility. Each question shows a required word limit which includes calculations. You must not exceed the specified word limit (+10% does not apply). Anything beyond the word limit will not be marked. You can check your word count for each question, as you type: highlight the words to your answer and the word count should be displayed at the bottom left of the Word screen. You will not be penalised for answers that are shorter than the limit; answers will be given credit for being comprehensive, rather than for being a certain length. As this is an open book exam, you should not directly quote from lecture materials, internet sources or other material. Every answer must be written in your own words to avoid plagiarism. ___________________________________________________________________ Electronic calculators may be used in accordance with the University regulations. ___________________________________________________________________ The University of Manchester, 2021 PTO BMAN21020 Page 2 of 8 SECTION A (COMPULSORY) Answer ALL parts of Question 1 Maximum word count for Q1: 1,500 words Question 1 Helena Products plc is a manufacturer of office furniture. In January 2019 the company carried out a strategic review and decided to target as customers people working from home. In order to achieve this strategy the company acquired a building with a showroom and a warehouse and invested on new delivery vehicles. This expansion has been financed by loans and the bank overdraft facility has been fully utilised. Financial information concerning the business is given below. Draft Income statement (extract) for the years ended 30 November 2020 2019 ￡’000 ￡’000 Revenue 5,683 5,241 Cost of sales (4,376) (4,124) Gross Profit 1,307 1,117 Operating expenses (786) (660) Operating profit 521 457 Interest charges (41) (11) Profit before taxation 480 446 Taxation (193) (179) Profit for the year 288 267 Draft Statements of Financial Position as at 30 November 2020 2019 ￡’000 ￡’000 Non-current assets Property plant and equipment (net book value) 3,680 2,620 Premises (net book value) 2,029 1,188 5,709 3,808 Current assets Inventories 2,710 1,193 Trade receivables 1,140 1,270 3,850 2,463 Total assets 9,559 6,271 Equity Share capital (￡1 nominal value) 1,000 1,000 Retained Earnings 4,134 3,907 5,134 4,907 Non-current liabilities Borrowing ± loans 1,838 610 Current liabilities Trade payables 1,122 578 Taxation 97 90 Short-term borrowing (all bank overdraft) 1,368 86 2,587 754 Total equity and liabilities 9,559 6,271 Question 1 continued overleaf BMAN21020 Page 3 of 8 Question 1 continued a) Calculate for Helena Products plc the following ratios for both 2019 and 2020 using the available information: i. Operating profit margin ii. Gross profit margin iii. Net profit margin (after taxation) iv. (Net) Asset Turnover ratio v. Return on capital employed (ROCE) vi. Current ratio vii. Receivables Collection period (days) viii. Stock turnover period (days) ix. Gearing ratio (debt to capital employed) (9 marks) b) You are working as an investment advisor for a large pension fund which is considering investing on Helena plc. +HOHQDSOF VSULFHSHUVKDUHZDV RQ 30 November 2020 and ￡1.29 on 30 November 2019. Using the ratios calculated in part (a), and any other ratios or information you consider relevant, provide an investment recommendation to your employer commenting on the performance of the company and on the new strategy. In your answer you should also reflect on the impact of COVID-RQWKHILUP VSHUIRUPDQFHLQDQGJRLQJIRUZDUG (25 marks) c) For the 2020 financial year, the CEO of Helena Products PLC received an annual salary of ￡100,000. Her executive pay contract also includes an annual bonus which can amount up to 200% of the salary (i.e., ￡200,000). The bonus becomes payable based on a number of criteria, as described in the following table: Desciption of Annual Bonus Plan for Financial year 2020 Performance Measure Weighting Minimum Threshold (20% of award) Target (50% of award) Stretch (100% of award) Performance Achieved Resulting Level (% or amount of bonus payable) ROCE 50% 7.60% 8.40% 9.20% Net Profit Margin 50% 3.95% 4.95% 5.95% Complete the blanks in the above table for 2020. How much is the bonus that the CEO will receive for her performance Show your workings and use two decimal points in your calculations. (8 marks) d) On 1 December 2019 Helena Products issued a loan of ￡1.625 million spanning a three-year term, with a coupon rate of interest of 2%. It received ￡1.3 million (face value less a 20% discount). Finance charges of ￡32,500 (2% of the ￡1.625m) are payable annually in arrears on 30 November, and the principal sum of ￡1.625 million is repayable on 30 November 2022. The implicit interest rate relating to this loan agreement is 10.0%. Helena Products has recorded the ￡32,500 payment made on 30 November 2020 as interest in their draft income statement for the year ended 30 November 2020. Question 1 continued overleaf BMAN21020 Page 4 of 8 Question 1 continued Explain how the loan should have been accounted for according to IAS 32, and calculate the impact of any correction on the net profit margin (ignoring tax). (10 marks) e) Define the Bonus Plan Hypothesis from Positive Accounting Theory. Briefly describe and explain its predictions on the choices of accounting policies by firm managers. Also, reflect on how the Bonus Plan Hypothesis could help us explain the accounting treatment of the loan as descibed in part (d). (8 marks) (Total for Q1: 60 marks) PTO BMAN21020 Page 5 of 8 SECTION B Answer ONE question Maximum word count for Q2/Q3: 1,000 words Question 2 a) Employee Benefits On 30 April 2020, actuaries valued the defined benefit pension scheme of Bitz plc and estimated that the scheme had assets of ￡30 million and obligations of ￡35 million (using the valuation methods prescribed in IAS 19). The actuaries made assumptions in their valuation that the plan assets would grow by 9% (their expected return) over the coming year to 30 April 2021, and that the obligations were discounted using an appropriate corporate bond rate of 6%. The actuaries estimated the current service cost for the year would be ￡1.1 million and informed the company that pensions paid to retired directors from the fund would be ￡1.6 million during the year, and the company should contribute ￡2.3 million to the scheme. At 30 April 2021, the actuaries revalued the pension fund and estimated the assets to be worth ￡29 million, and the obligations of the fund to be ￡31.6 million. Assume that contributions and benefits are paid on the last day of the year. Prepare two summaries showing the movements on pension plan assets and pension plan obligations in the year and use your summaries to calculate the net actuarial gain or loss on the pension fund in the year. Explain why adjustments relating to actuarial gains and losses are likely to arise. (18 marks) b) Judgement in financial reporting The accounting for a defined benefit pension scheme under IAS 19 involves the application of judgement under conditions of uncertainty. Describe two other examples where judgement is required in financial reporting and whether you believe that the uncertainty relating to the judgement is justified in providing the user of the financial statements with more useful information. (6 marks) Question 2 continued overleaf BMAN21020 Page 6 of 8 Question 2 continued c) Capital Maintenance On 1 April 2020 Arc Ltd began trading in specialist equipment made with components that are in short supply. Capital of ￡4,000 was introduced and used immediately to purchase 10 units of inventory at a cost of ￡400 each. On 1 October 2020, 6 units of the inventory was sold for ￡700 cash, when the replacement cost of each unit had risen to ￡450. No further transactions took place, and by the year-end of 31 March 2021, the replacement cost per unit had risen to ￡500. Summarised financial statements for the year ended 31 March 2021, based on the Historic cost convention (and ignoring tax), are shown below: Income Statement for the year ended 31 March 2021: ￡ ￡ Sales [6 units at ￡700 each] 4,200 Purchases [10 units at ￡400 each] 4,000 Closing stock [4 units at ￡400 each] (1,600) Cost of sales: (2,400) Profit 1,800 Statement of Financial Position at 31 March 2021 ￡ Stock 1,600 Cash 4,200 Capital Employed 5,800 Share Capital 4,000 Profit 1,800 5,800 The owners of Arc are keen to receive all distributable profits, however the directors DUH FRQFHUQHG WKDW GRLQJ VRPD HURGH WKH FRPSDQ V FDSLWDO JLYHQ LQFUHDVHV LQ replacement cost throughout the year as summarised below: Date: Replacement cost 1 April 2020 ￡400 1 October 2020 ￡450 31 March 2021 ￡500 Using the above information, prepare a summary income statement and statement of financial position in line with current cost accounting (Replacement Cost) basis (CCA). Explain to the directors why a distribution of ￡1,800 would not ensure capital is PDLQWDLQHGLQ3SKVLFDO′WHUPVDQGVXJJHVWDQDSSURSULDWHdividend to pay to maintain capital under the current cost accounting. (16 marks) (Total for Q2: 40 marks) PTO BMAN21020 Page 7 of 8 Question 3 a) Capital Reconstruction Dunstable Ltd has a statement of financial position with significant retained losses and no cash (it holds a bank overdraft of ￡66,000). Its net assets stand at ￡84,000 and are represented by the following capital and reserves: Preference shares of ￡1 each fully paid 200 Ordinary shares of ￡1 each fully paid 100 Retained Earnings (216) Net assets 84 Dunstable has succeeded in creating a new product that its directors anticipate will yield profits of ￡50,000 each year for at least the next five years, although this will require additional funds. The following capital restructuring scheme has been approved and authorised by its creditors: 1. 40% of the ordinary shares are to be surrendered. 2. The preference shares are to be surrendered and cancelled and the holder of every 50 preference shares will pay Dunstable ￡30 cash, and will be issued: One 7% loan note of ￡40 each, and 10 fully paid ordinary shares of ￡1 (redistributing the shares surrendered). 3. The freehold property is to be revalued upwards by ￡60,000. 4. The negative balance on retained earnings will be written off, and equipment will be impaired by ￡4,000. (i) Discuss the challenges that Dunstable would face in raising finance to fund its new product given its current capital and reserves presentation. Explain how Dunstable may be able to persuade both ordinary and preference shareholders ± and its creditors ± to the restructuring scheme that is described above. (12 marks) (ii) Prepare the journals that would account for each of the adjustments (1) to (4) outlined above and present a T-account of the Capital Reduction and Reorganisation (CR&R) account that should clear to zero as a result of the adjustments. (12 marks) b) Taxation Wang plc is a pharmaceutical company. Due to the length of time the company has to spend developing new medicines before they can be sold the company has accrued significant losses and has calculated a total deferred tax asset of ￡2,400,000 in relation to those losses for the year end 31 March 2021. On 1 April 2021, the company is due to start selling the medicines and taxable profits are estimated at ￡480,000 for the year ended 31 March 2022. However, due to competition in the market and other market uncertainties no profits can be anticipated for the year ended 31 March 2023 and beyond. The current tax rate is currently 20%. Question 3 continued overleaf BMAN21020 Page 8 of 8 Question 3 continued For year ended 31 March 2021 discuss the requirements for a tax asset to be recognised and calculate the amount to be included in the financial statements as a deferred tax asset. State any assumptions made in coming to your calculation. (8 marks) c) External Audit Discuss the stages that are involved in the external audit process, and whether you believe that an external audit adds value to the users of the financial statements. (8 marks) (Total for Q3: 40 marks) END OF EXAMINATION PAPER