September 2015 Professional Examination
Paper 2.1: Question & Solutions
Financial Accounting and Financial Statement Analysis
Economics and Financial Markets
Quantitative Analysis and Statistics
Level 2
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SECTION B:
Question 2 - Financial Accounting and Financial Statement Analysis –
Explain how each of the items below would affect the statutory published earnings per share
figure for a manufacturing company:
(3 marks)
2a)
The impairment of an intangible asset.
2b)
Recognition of significant contingent liabilities in the financial statement.
2c)
A profit on the sale of a property.
Solution to Question 2
2a) The impairment of an intangible asset.
Impairment of intangible asset results in an immediate write off (impairment charge). This
in turn results in a reduction in net income and subsequently a reduction in the published
Earnings Per Share (EPS).
2b) Recognition of significant contingent liabilities in the financial statement.
This depends on the situation.
i.
ii.
2c)
If the contingent liability is both probable and the amount can be estimated, then the
contingent liability and the related contingent loss are recorded in the books of
account. This will result in a reduction in net income and published earnings per
share.
If the contingent liability is only possible (not probable), or if the amount cannot be
estimated, only a disclosure is required. This will not impact the published earnings
per share.
A profit on the sale of a property.
Profit on the sale of property is recognized in the income statement. This increases net income
as well as earnings per share.
Question 3 - Economics and Financial Markets
You are told that the market price of milk has increased and less milk is being purchased in the
market. What change in supply for milk will result for the market to clear?
(3 marks)
Solution to Question 3
There must have been a decrease in the supply of milk for there to be market-clearing in the
milk market, as shown in the following diagram
Price
D
S1
E2
P2
P1O
S
E1
Quantity
D
S
q2
q1
Quantity
(3 marks)
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Question 4 - Quantitative Analysis and Statistics
Find the values of x and y for the matrix
A=
x+y
x–y
0
1
to be the identity matrix of order 2
(4 marks)
Solution to Question 4:
The identity matrix is
I=
Thus if x + y = 1 and
x – y = 0 then A will be the identity matrix
x+y=1⇒x=1–y
x–y=0⇒x=y
⇒x=y=½
(4 marks)
SECTION C:
Question 5 - Financial Accounting and Financial Statement Analysis
You are given below the condensed balance sheet and statement of income according to IFRS
of Road Master Ltd, a sports car manufacturer, as at December 31, 2014 (figures in N’000).
Balance sheet of RoadMaster as of December 31, 2014
Cash and cash equivalents
10,000 Current liabilities
159,000
Other current assets
120,000 Noncurrent liabilities 220,000
Noncurrent assets
325,000 Shareholders' Equity
76,000
Total
455,000 Total
455,000
Statement of income of RoadMaster for year 2014
EBIT
13,000
Financial expense
-5,000
Income before taxes
8,000
Income taxes
-2,400
Net income
5,600
5(a)
Compute the current ratio, total gearing ratio and ROCE of RoadMaster Ltd. Given
the industry average ratios below, briefly comment on your result and the
performance of the company.
Ratio
Current
Gearing (D/D+E)
ROCE
Industry Average
1.1
50%
11%
(5 marks)
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5b)
Assume RoadMaster Ltd issues a bonus of one additional share for every existing
share to all its shareholders. What impact (if any) will this have on each of the ratios
computed above?
(2 marks)
On December 31, 2014 RoadMaster Ltd acquired a 60 per cent interest in Runners Ltd for
N35,000,000 in cash. The acquisition enabled RoadMaster to govern the financial and operating
policies of Runners Ltd. Condensed balance sheets and statements of income according to IFRS
of Runners Ltd before the business combination is shown below (figures in N’000).
Balance sheet of Runners Ltd as at December 31, 2014
Cash and cash equivalents
3,000 Current liabilities
44,500
Other current assets
42,000 Noncurrent liabilities
78,000
Noncurrent assets
109,000 Shareholders' Equity
31,500
Total
154,000 Total
154,000
Statement of income of Runners Ltd for year 2014
EBIT
2,800
Financial expense
-800
Income before taxes
2,000
Income taxes
-600
Net income
1,400
5(c)
Calculate the amount of goodwill that RoadMaster Ltd paid as part of its acquisition of
60% of Runners Ltd. To answer this question, use the following assumption:
The assets of Runners Ltd as of December 31, 2014 include hidden reserves of
N20,000,000. (Ignore Taxation)
(3 marks)
5(d) Explain briefly the two methods that are available for the evaluation of non-controlling
interests according to IFRS 3 ‘Business Combinations’ (these methods are sometimes called the
"full goodwill" method and the "partial goodwill" method).
(3 marks)
5(e)
Calculate the consolidated net income for the fiscal year 2014, assuming that the net
income of RoadMaster and Runners Ltd does not include any profit or loss from
intragroup transactions (provide a brief explanation in support of your calculations).
(3 marks)
5(f)
Prepare the consolidated balance sheet of the RoadMaster group as at December 31,
2014.
State any assumption you make.
(4marks)
Solution to Question 5
5(a)
Compute the current ratio, total gearing ratio and ROCE of RoadMaster Ltd. Given
the industry average ratios below, briefly comment on your result and the
performance of the company.
Ratio
Current
Gearing (D/D+E)
ROCE
i.
Industry Average
1.1
50%
11%
Current ratio = CA/CL = 130,000/159,000 = 0.82: 1
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ii.
Gearing ratio = 220,000/(220,000+76,000) = 74.31%
iii.
ROCE = 13,000/296,000 = 4.39%
Note:
Return is defined as EBIT while Capital Employed is defined as Total asset less current
Liability
(5 marks)
COMMENTS

The liquidity position of RoadMaster Ltd is below par when compared with industry Average.
With a ration of 0.82;1, the company is appears to be at risk of potentially not beign able to
meet its obligations to creditoe as and when due even though the liquidity requirement of
the industry as a whole appears fairly low at 1.1:1

As regards gearing, the company employs a higher level of debt financing in its capital
structure than an average company in the industry. This means a higher level of financial
risk. However, this could be of advantage in times of rising income and profitability as
RoadMaster will likely record higher levels of earning per share as a result of benefits of the
tax effects of debt financing.

As measured by ROCE, RoadMaster Ltd’s profitability performance is below industry average
at 4.39% compared to 11%. Further assessment using Dupont analysis needs to be used to
identify the factor responsible for this, which could be profit margin, leverage factor or asset
turnover.
5b)

A bonus issue of 1:1 will not impact on any of the ratios since bonus issuance is simply
capitalization of existing reserves.
(2 marks)
Explanations
i.
For current ratio, a bonus does not affect current asset and current liabilities
ii.
For gearing ratio and ROCE, there is equally no impact as the shareholders fund remain
the same after a bonus issue
5c)
The Goodwill acquired by RoadMaster amounts to N4,100,000.
Calculation:
Purchase price
Proportionate book value of shareholders‘ equity
(60% of N31,500,000)
Proportionate hidden reserves (60% of N20,000,000)
-18,900,000
-12,000,000
=
N4,100,000
Acquired goodwill
N
35,000,000
5d)
 According to the revised IFRS 3, the acquisition method for the accounting of business
combinations gives entities the option to either measure non-controlling interests at the fair
value of their proportion of identifiable assets and liabilities or at full fair value.

Using the first method (partial goodwill method), goodwill is measured as the difference
between the consideration paid and the purchaser’s share of identifiable net assets acquired.
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The second method (full goodwill method) means that goodwill is recognised for the
controlling interest as well as for the non-controlling interests.

5e)
The consolidated net income for the year 2014 amounts to 5,600 (That is the net income
of RoadMaster only).
The net income of Runners Ltd for the fiscal year 2014 has been generated before the
combination and therefore cannot be consolidated.
5f)
RoadMaster Group
Consolidated Balance Sheet
N
N
Cash and Cash equivalent
(10,000+3,000)
13,000
Other current assets
(120,000+ 42,000-35,000)
127,000
Non current Assets
(325,000+109,000+
20,000)
Goodwill (wk 1)
Current liabilities
(159,000 + 44,500)
203,500
Non current liabilities
(220,000+ 78,000)
298,000
Shareholders equity
76,000
454,000
4,100
Minority interest (wk 2)
598,100
20,600
598,100
Workings
1) Computation of Goodwill (‘000)
35,000 – 60% (31,500 +20,000) = N 4,100
2) Minority Interest (‘000)
40% (31,500 +20,000) = N20,600
Question 6 - Economics and Financial Markets
“Since the Great Depression, most economists believe that economic policy can smooth out
the volatile fluctuations of the business cycle”
6(a1) Provide a profile of a business cycle to show its characteristic features.
(8 marks)
6(a2) Identify and explain what kind of economic policy would be necessary to moderate or
eliminate the fluctuations associated with the business cycle.
(6 marks)
6(b)
Suppose the consumption, investment and government expenditure functions of an
economy is given as follows:
C
I
G
T
=
=
=
=
500 + 0.75(Y – T)
50
200
50
Calculate the equilibrium national income
(4 marks)
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Solution to Question 6(a1)
(i) The business cycle depicts the fluctuations in the level of economic activity (i.e., Gross
National Product), alternating between the periods of depression and boom conditions.
Potential GNP
Level of
economic
activity
boom recession
actual GNP
recovery
depression
Business cycle, fluctuations in the level of economic
(2marks)
(ii) (ii.) As shown in the figure, the business cycle is characterized by four phases: depression,
recovery, boom and recession.
(2marks)
(iii) Depression is a period of rapidly falling aggregate demand accompanied by very low levels of
output and heavy unemployment, which eventually reaches the bottom of the trough.
(2marks)
(iv) Recovery, a period of upturn in aggregate demand accompanied by rising output and a
reduction in unemployment.
(2marks)
(v) Boom: a period of aggregate demand reaching and then exceeding sustainable output levels
as the peak of the cycle is reached. Full employment is reached and the emergence of excess
demand causes the general price level to increase (inflation)
(2marks)
(vi) Recession: this follows the period of boom in the business cycle. It is a period characterized
by falling aggregate demand, bringing with it modest falls in output and employment. As
demand continues to contract, it eliminates in the onset of depression.
(2marks)
2 marks each for any 4 points = 8 marks
Solution to Question 6(a2)
(i)
The Volatile fluctuations in the business cycle usually call for countercyclical policy, a
demand management or stabilisation policy.
(ii)
The demand management policy involves the control of the level of aggregate demand in
an economy, using fiscal policy and monetary policy to moderate or eliminate fluctuation
in the level of economic activity associated with the business cycle.
(iii)
The general objective of demand management is to “fine-tune” aggregate demand so
that it is neither deficient relative to potential gross national product (thereby avoiding a
loss of output and unemployment) nor overfull (thereby avoiding inflation).
(iv)
Ideally, the government would wish to manage aggregate demand so that it grows
exactly in line with the underlying growth of potential gross national product, offsetting
the amplitude of troughs and peaks of the business cycle.
(v)
If the authorities can get the timing and magnitudes correct, then they should be able to
counterbalance the effects of recession/ depression and follow the path of potential gross
national product. Reducing the intensity of the recession in this way requires authorities
to forecast accurately the onset of recession some time ahead, perhaps while the
economy is still buoyant (i.e. boom).
2 marks each for any 3 points = 6 marks
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Solution to Question 6(b)
Y
=C+ I+G
Y
= [500 + 0.75 (Y – T)] + 50 + 200
Y
= 500 + 0.75Y – 0.75(50) + 50 + 200
Y
= 500 + 0.75Y – 37.50 + 250
Y
= 712.50 + 0.75Y
Y – 0.75Y = 712.50
0.25Y = 712.5
Y = 2850
The equilibrium national income is 2,850
(4 marks)
Question 7 - Quantitative Analysis and Statistics
The statistics department of a manufacturing company came up with the daily cost and
revenue functions for two of their flagship products as shown below:
Product A:
TCA=4QA
QA= 10-PA
Product B:
TCB= 13QB
QB= 15- PB
where TC = Total Cost, Q = Quality and P = Price
Currently, 5 units of product A and 3 units of product B are produced daily.
Required:
7(a) How many units of products A and B should be produced in order to maximize profit?
(4 marks)
7(b)
How much should the company sell each unit of products A and B?
7(c)
What is the maximum profit achievable from the production of both commodities?
(3 marks)
The production manager is also concerned about a perceived high cost of production
especially for product A. What is the estimated cost savings from your recommendation
for product A?
(3 marks)
7(d)
(2 marks)
Solution to Question 7(a)
Units of products A and B to be produced in order to maximize profit
Product A:
TCA=4QA
QA= 10-PA
PA =10-QA
TRA=P*Q=10QA-QA2
MRA=DTR/DQ=10-2QA
MCA=DTCA/DQA=4
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To maximize profit, set MCA=MRA (or equate the derivative of the profit function to
zero(0))
(½ mark)
10-2QA=4
2QA=10-4
2QA=6
QA=6/2=3
(½ mark)
Product B
Each unit of products A and B:
TCB= 13QB
QB= 15- PB
PB=15-QB
TRB=P*Q=15QB-QB2
MRB=DTR/DQ=15-2QB
MCB=DTCB/DQB=13
(1 mark)
To maximize profit, set MCB=MRB (or equate the derivative of the profit function to
zero(0))
(½ mark)
15-2QB=13
2QB=2
QB=1.
(½ mark)
Solution to Question 7(b)
Each units of Product A and B
Solve for PA
PA =10-QA
PA =10-3
PA =7
(1 mark)
Solve for PB
PB=15-QB
PB=15-1
PB=14
(1 mark)
Product A should be sold at N7 while product B should be sold at N14.
(2 marks)
Solution to Question 7(c)
7(c)
The maximum profit achievable from the production of both commodities
Solution:
Total revenue from A
TRA=P*Q=10QA-QA2
QA=3
TRA=P*Q=10(3)-32
TRA=21
Total cost from A
TCA=4QA=4(3)=12
Profit from product A = TRA-TCA=21-12=9.
(1½ mark)
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Total Revenue from B
TRB=P*Q=15QB-QB2
QB=3
TRB=P*Q=15(1)-12
TRB=14
Total cost from B
TCB= 13QB
TCB= 13(1)
TCB= 13
Profit from B
TRB- TCB=14-13=1
(1½ mark)
Maximum profit achievable from both products = N(9+1) = N10
Solution to Question 7(d)
7(d)
The production manager is also concerned about a perceived high cost of production
especially for product A. What is the estimated cost savings from the recommendation for
product A.
Solution:
Current cost of Product A
= 4QA = 4Q(5) = N20
Cost at maximum profit of production for Product A
= 4QA = 4(3)= N12
Recommended estimated cost saving for Product A
= 20 – 12 = N8
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FORMULAE
Regression Analysis:
Y = a+bx
b= n∑xy-∑x∑y
n∑x2-(∑x)2
a= ∑y _ b∑x
n
n
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