THE INSTITUTE OF CHARTERED ACCOUNTANTS
OF NIGERIA
NOVEMBER 2010 PROFESSIONAL EXAMINATION II
Question Papers
Suggested Solutions
Plus
Examiners‟ Reports
PATHFINDER
FOREWORD
This issue of the PATHFINDER is published principally, in response to a growing
demand for an aid to:
(i)
Candidates preparing to write future examinations of the Institute of Chartered
Accountants of Nigeria (ICAN);
(ii)
Unsuccessful candidates in the identification of those areas in which they lost
marks and need to improve their knowledge and presentation;
(iii)
Lecturers and students interested in acquisition of knowledge in the relevant
subjects contained herein; and
(iv)
The profession; in improving pre-examinations and screening processes, and
thus the professional performance of candidates.
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 altered slightly so that some principles or application of
them may be more clearly demonstrated.
It is hoped that the suggested answers will prove to be of tremendous assistance to
students and those who assist them in their preparations for the Institute‟s
Examinations.
NOTES
Although these suggested solutions have been published
under the Institute‟s name, they do not represent the views of
the Council of the Institute. The suggested solutions are
entirely the responsibility of their authors and the Institute
will not enter into any correspondence on them.
2
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
TABLE OF CONTENTS
SUBJECT
PAGES
FINANCIAL REPORTING AND ETHICS
4 – 27
STRATEGIC FINANCIAL MANAGEMENT
28 – 59
ADVANCED TAXATION
59 – 90
PUBLIC SECTOR ACCOUNING & FINANCE
60 - 91
MULTI-DISPINARY CASE STUDY
92 - 178
3
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
ICAN/102/Q/2
EXAMINATION NO...................................
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
FINANCIAL REPORTING AND ETHICS
SECTION A: Attempt All Questions
PART I
1.
2.
MULTIPLE- CHOICE QUESTIONS
Which of the following options is excluded from the class of rational agents, and
hence cannot be subjected to moral judgement?
(i)
(ii)
(iii)
Moral minors
The insane
The senile
A.
B.
C.
D.
E.
(i) and (ii) only
(ii) and (iii) only
(i) and (iii) only
(ii) only
(i), (ii) and (iii)
An action is good if only it promotes happiness for the greatest number of
people. This is an example of which ONE of these ethical theories?
A.
B.
C.
D.
E.
3.
(20 MARKS)
Contractarianism
Utilitarianism
Majoritarian Morality
Ethical Considerationism
Sympathetic Morality
Government grants available to an enterprise are considered for inclusion in the
accounts
A.
if the grant is not a financing device.
B.
C.
if it is to enable the government participate in the ownership.
if the grant is recognised as government assistance to the organization.
D.
where there is reasonable assurance that the enterprise will comply with
the conditions attached to them.
E.
where contingency related to a government grant is recognised.
4
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
4.
The amount of contract revenue may increase or decrease from one period to
the next in all of the following, EXCEPT
A.
a contractor and a customer may agree variations of claims in the period
subsequent to that which the contract was initially agreed.
B.
the amount of revenue agreed in a fixed price contract may increase as a
result of cost escalation clauses.
the amount of contract revenue may decrease as a result of penalties
arising from delay caused by the contractor.
when a fixed price contract involves a fixed price per unit of output,
contractor revenue increases as the number of units is increased.
C.
D.
E.
5.
6.
negotiations have reached an advanced stage such that the customer will
accept the claim.
Undisclosed assets revaluation surplus in the Financial Statements of a
company is known as
A.
B.
C.
revaluation reserve.
capital reserve.
secret/hidden reserve.
D.
asset revaluation reserve.
E.
contingency reserve.
All the following are forms of business combinations, EXCEPT
A.
B.
C.
D.
E.
merger.
acquisition.
amalgamation.
absorption.
joint Venture.
5
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
7.
8.
The theory that holds that it is morally acceptable for one to do what one feels
is in one‟s self-interest, is an example of which of these moral theories?
A.
B.
Selfish Immorality
Humanistic Morality
C.
D.
E.
Ethical Egoism
Ethical Altruism
Unethical Egoism
The claim that there is only one correct moral code or system of moral principle
which supplies the single correct answer to every moral question, is attributed
to which of these?
A.
B.
C.
D.
E.
9.
The statement that there is no such thing as correct or incorrect moral code for
human conduct, is ascribed to which of these?
A.
B.
C.
D.
E.
10.
Moral Subjectivism
Moral Objectivism
Moral Totality
Moral Globalization
Moral Uniqueness
Moral Relativism
Moral Universalism
Moral Non-Wrongness
Moral Nihilism
Moral Incorrigibility
Which of these moral theories that holds that human nature determines the
correct moral laws of nature that human beings should follow?
A.
B.
C.
D.
E.
Moral Fellowship
Natural Morality
Natural Law Theory
Natural Egoism
Ethical Naturalism
6
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
11.
12.
The following statements are true of a parent company, EXCEPT
A.
the financial statements of a group are presented as those of a single
economic entity.
B.
control is the power to govern the financial and operating policies of an
entity so as to obtain benefits from its activities.
C.
a group is a parent and all its subsidiaries.
D.
non-controlling interest is the equity in a subsidiary not attributable
directly or indirectly to a parent.
E.
a parent is an entity that must have at least three subsidiaries.
The following are the generally recognised potential problems of using ratios
for comparison purposes, EXCEPT
A.
B.
inconsistent definition of ratios.
financial statements that have been deliberately manipulated.
C.
D.
different companies may adopt different accounting policies.
different managerial policies e.g. different companies offer customers
different payment terms.
profit for the year may result in higher cash flow.
E.
13.
Potential users of financial reports do NOT include ONE of the following:
A.
B.
C.
D.
E.
14.
Equity investors
Educationists
Creditors
Suppliers
Employees
In using the accounting ratios, comparison is commonly made between all BUT
ONE of the following:
A.
B.
C.
Previous accounting periods
Other companies (mostly in the same type of business)
Budget and expectations
7
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
D.
E.
15.
The integration of social and ethical criteria into investors‟ investment decision
is known as
A.
B.
C.
D.
E.
16.
17.
Government statistics
Emolument of the chief executive
ethical Investing.
social Investing.
moral Investing.
socio-ethical Investing.
socio-moral Investing.
The use of ethical, social and environmental criteria in the selection and
management of investment, generally consisting of company shares is known as
A.
B.
C.
D.
ethical investment.
social investment.
moral investment.
socio-ethical investment.
E.
socio-moral investment.
One of the fundamental precepts of Corporate Social Responsibility which
requires business leaders to acknowledge and accept the legitimate claims,
rights and needs of other groups in society is known as
A.
B.
Voluntary Social Responsibility.
Involuntary Social Responsibility.
C.
D.
Unlimited Social Responsibility.
Limited Social Responsibility.
E.
Liberal Social Responsibility.
8
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
18.
19.
20.
The basic principles of a good corporate governance system include:
i.
ii.
iii.
iv.
Transparency
Competence
Integrity
Proper alignment of interests and allocation of responsibilities
A.
i and iv only
B.
C.
ii and iii only
i, ii and iii only
D.
E.
i, ii, iii and iv
ii, iii and iv only
The framework for ethical decision making that is useful for exploring ethical
dilemmas and identifying ethical courses of action does NOT include ONE of the
following:
A.
B.
C.
D.
Recognition of an ethical issue
Evaluation of alternative actions
Making a decision and testing it
Acting and reflecting on the outcome
E.
Engaging a professional person for consultation
Which of the following is ordinarily computed and reported as part of the
financial statements of a large organisation?
A.
B.
C.
D.
Current ratio
Return on assets
Book value per share
Earnings per share
E.
Price earnings ratio
9
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
PART II
1.
SHORT-ANSWER QUESTIONS
(20 MARKS)
Responsibility is divided into Retrospective Responsibility and ………..
Responsibility.
2.
The action that purports to benefit others primarily without any form of egoism
is ……………...
3.
A risk management technique that mixes a wide variety of investments within a
portfolio is called ..........................
4.
The duration between the purchase of a firm‟s inventory and the collection of
account receivable for a sale of that inventory is known as .........................
5.
Kabir Ventures Ltd. had sales last year of N530 million including cash sales of
N50 million. If its average collection period was 40 days, its ending account
receivable is closest to ..............................
6.
A scheme approved by the court in which the nominal value of a company‟s
paid up share capital is reduced is termed ......................
7.
8.
9.
10.
11.
12.
13.
The process through which a person learns the values and behaviour patterns
considered appropriate by an organisation or group is called …....…………..
The Utilitarian theory of justice ties the question of economic distribution to the
promotion of ………......……
An approach to Business Ethics that attempts to change economic concepts with
the aim of facilitating moral action is termed ....…………….
The Libertarian associates justice with ........………….
Payments made to a parent company by a subsidiary out of pre-acquisition
profits are known as ...........................
The Institute of Chartered Accountants of Nigeria (ICAN) requires that its
members who are in Public Practice take up insurance policy with reputable
insurance companies. What is the name of the insurance policy required?
A component of an entity that engages in business activities from which it may
earn revenue and incur expenses is described by IFRS 8 as ..........................
10
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
14.
15.
16.
17.
18.
19.
20.
The organisation which is empowered by law to incorporate, register and windup companies in Nigeria is called ....................................
Two features of a business entity are .......................... and .................................
The standards of behaviour that groups expect of their members is referred to as
................................
Ethics must be promoted and institutionalized in an organization in order to
build credibility and ...............................
The ethical challenge in companies is often triggered by .............................
A method of accounting whereby an interest in a jointly controlled entity is
initially recorded at cost and adjusted thereafter for the post-acquisition change
in the venture‟s share of net assets of the jointly controlled entity is called
..........
The bringing together of separate entities or businesses into one operating
entity is called ...............................
11
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
SECTION B – ATTEMPT QUESTION ONE AND ANY OTHER THREE
(60 MARKS)
QUESTION 1 –CASE STUDY
Topic: Variance Reporting
Characters: Olabisi, Director of Manufacturing and Computer Services
Tunde, Manager, Manufacturing Department 207
Bose, Supervisor, Manufacturing Department 201
Olabisi has been with Peace Auto Parts Manufacturing Company for 23 years. Recently,
he was appointed Director of Manufacturing and Computer Services. In just six weeks
in this new position, he has moved to reduce the amount of information provided to
manufacturing department managers by 60 percent. He argues that excess data is
distracting, expensive to provide and usually unused.
Tunde has been the Department Manager for 12 years. During a coffee break with
some of his department production supervisors, Tunde is quite vocal about the change.
“Who‟s this guy Olabisi to tell us what data we need? He needs to be out here for a few
weeks to find out what it‟s like. Keep it quiet, but I‟ve got a contact in Computer
Services who‟ll get me all the data analysis I want for just a N3,000 bill each month.
It‟s a good deal, and Olabisi will never know. How does he expect us to make good
decisions about those variances without enough data? This guy in Computer Services
can get any of you data, if you need it.”
Bose, overhearing Tunde, is shocked. “Is that ethical, Tunde? Do you really need that
extra data? Can‟t you get the information without going around Olabisi? I sure don‟t
want to pay for anything Mr. Olabisi doesn‟t want me to have.”
“Bose , you've only been a supervisor for six months,” Tunde replies. “It‟s just how the
firm operates. Try it, and you'll see it‟s worth the N3,000. You can't make good
decisions with the stuff Olabisi gives us now.” Bose doesn't respond, and the coffee
break ends with people returning to their jobs.
Later that evening, Bose begins to think about what Tunde said. She knows that he is a
good manager, but she does not want to have to buy information to do her job
correctly. Tomorrow, she is scheduled for a staff meeting with Mr. Olabisi. She is
uncertain about what to do or say, if anything.
12
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Required
(a) What are the relevant facts?
(3 marks)
(b) What are the ethical issues?
(2 marks)
(c) Applying the Kant‟s Categorical Imperative, advise Bose on the
action(s) she should take.
QUESTION 2
(10 marks)
(Total 15 marks)
a)
Explain briefly Ethical Issues in business.
b)
State TWO examples each of ethical issues relating to the following areas:
i.
ii.
iii.
iv.
v.
Society
Internal and industry practice
Marketing
Product
Supply chain
(5 marks)
(10 marks)
(Total 15 marks)
QUESTION 3
a) Explain the term “conflict of interest”.
(7 marks)
b) Situate conflict of interest within the accounting profession, especially as an
external auditor to a firm
(8 marks)
(Total 15 marks)
QUESTION 4
Why should an accountant get involved in the study of ethics, given that all human
beings, including accountants, have moral beliefs they follow?
.. (15 Marks)
13
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
QUESTION 5
a) State the meaning of the following terms as contained in IAS 27 - Consolidated and
Separate Financial Statements:
i.
Consolidated Financial Statements
ii.
Subsidiary
iii.
Non controlling interest
iv.
Control
(6 Marks)
b) Explain briefly THREE of the disclosure requirements in Consolidated Financial
Statements.
(9 marks)
(Total 15 Marks)
QUESTION 6
Identify and explain FIVE potential users of financial reports and their information
needs
(Total 15 marks)
14
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
SECTION A
PART I:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
SOLUTIONS TO MULTIPLE CHOICE QUESTIONS
E
B
D
E
C
E
C
B
D
C
E
E
B
E
A
B
A
D
E
D
EXAMINERS‟ REPORT
The questions test various aspects of the syllabus. The candidates demonstrated clear
understanding of them. This translated into good performance by most candidates.
PART II:
1.
2.
3.
4.
5.
6.
SOLUTIONS TO SHORT ANSWER QUESTIONS
Prospective
Altruism
Diversification
Cash conversion cycle or Cash operating cycle
N52.6million or N53million {(40/365 x (530-50) million}
Capital reduction
15
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
7.
8.
9.
Socialization or Societalisation
Social Well-being/Happiness
Prescriptive or Normative
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
Liberty or Individual right or Entitlement
Pre-acquisition dividends
Professional Indemnity Insurance Policy
Operating segment or Reportable segment
Corporate Affairs Commission (CAC)
Legal status, Ownership of assets and Profit oriented
Group norms or Code of Conduct or Professional Ethics
Public trust/Confidence
Financial problems
Equity method
Business combination.
(any two)
EXAMINERS‟ REPORT
The questions test most areas of the syllabus with particular emphasis on effective use
of terminologies in Ethics.
The performance of candidates was fair. Candidates are advised to make use of their
Study Packs and recommended texts on the subject to improve on their performance in
future.
SOLUTIONS TO SECTION B
QUESTION 1 – CASE STUDY
(a)
Relevant facts about the Case:
(i)
(ii)
(iii)
(iv)
Olabisi has reduced the amount of data on Reports sent to departments.
Tunde secretly buys data from someone in the Computer Services
Department to supplement the variance report he receives.
Bose knows of Tunde practice of buying data, thinks it is unethical, but
does not know what to do about it.
Olabisi, the Director of Manufacturing and Computer Services is a long
standing employee of the organisation for the past 23 years.
16
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(v)
Olabisi was recently appointed as the Director of Manufacturing and
Computer Services.
(vi) He has moved to reduce the amount of information provided to Managers
by 60%.
(vii) Tunde has been the Departmental Manager of the Organisation for 12
years, and he advised Bose to obtain information at a cost.
(viii) Bose is the Supervisor, Manufacturing Department, and she is in a
dilemma as to whether she should yield to Tunde‟s advice or not.
(b)
Ethical Issues Involved:
(i)
Should Tunde buy data for his use in managing his Department?
(ii)
Should Bose tell Olabisi (or any one else) what Tunde is doing?
(iii) Should Bose use the data source in Computer Services?
(iv) The appropriateness of disobeying a superior officer‟s instruction.
(v)
The superior‟s intention of obtaining the information without cost from
undisclosed source.
(c)
Emmanuel Kant made a major contribution to Ethics of duty. For him, the moral
values of actions, decisions and propositions are not dependent on a particular
situation or on the consequences of the action. Rather, morality was simply a
question of certain eternal, abstract and unchangeable principles that humans
should apply to all ethical problems.
To be moral, therefore, one must consciously act according to rules previously
calculated by „reason‟ to be right or just, and the motive for observing those
rules must be respected for duty alone. He, however, articulated the categorical
imperative as a theoretical framework to guide our commitment to duty. By this
he meant that this theoretical framework should be applied to every moral issue
regardless of who is involved, profits and who is harmed by the principles once
applied in specific situations.
The „categorical imperative‟ consists mainly of three formulations. We would
make use of the first two formulations in this case.
The first formulation states, “Act only according to that maxim by which you can
at the same time will that it should become a universal law.”
This means that for any action to be morally right, it must be capable of being
consistently universalisable. By implication, if any action is moral for me, it
must be moral for anyone else; everyone should be able to follow the same
underlying principle, it gives no room for any exceptions.
17
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
The second formulation otherwise referred to as the principle of humanity goes
thus: “Act so that you treat humanity, whether is your own person or in that of
another, always as an end and never as a means only.”
Kant‟s emphasis here is on the rational nature of humans as free, intelligent
and self directing beings. This nature of rationality is the basis for his/her value
as an end in itself. Because of this, “a rational being is worthwhile, has dignity
and is worthy of respect. Hence each person should be treated by every person
as an end, with respect and dignity …” This formulation forbids us to „use‟
people and manipulate them merely as means to our own ends.
Consider the different possible alternative actions that Bose can take, which
may include:
(i)
Telling Mr. Olabisi of the situation when she meets with him tomorrow.
(ii)
(iii)
(iv)
(v)
Asking Tunde to stop his data purchases.
Turning Tunde in to Mr. Olabisi‟s anonymously.
Buying information for herself if and when she needs it.
Do nothing.
Given the main tenets of Kant‟s Categorical Imperative, Bose has a duty to tell
the truth always, to uncover any unethical practice in her organisation not
minding who will be affected and to protect another person from any form of
manipulations for selfish interests.
The best option, therefore, would be for Bose to first confront Tunde and ask
him to stop his data purchases. The reason is that, a lot of frictions and crises
could be avoided if Tunde heeds to this advice.
But Bose should be smart enough to decipher and discern what Tunde‟s
reaction would likely be so that she would not have failed to prevent any harm
being done on Olabisi. By implication, she would have to tell Olabisi what
Tunde‟s is. Going by Kant‟s first formulation of the Categorical Imperative, this
would be a good option because if she were Olabisi, she would have wished
that someone exposes such unethical intent to her.
Finally, I will strongly advise Bose against turning Tunde in to Olabisi
anonymously. The reason being because, it would be difficult for her to remain
anonymous since she had earlier on kicked against Tunde‟s decisions.
18
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
EXAMINERS‟ REPORT
The question tests candidates‟ understanding of Kant‟s Categorical Imperative
principles in Ethics. It also tests candidates‟ ability to identify ethical issues in the Case
Study.
The overall performance of the candidates was poor.
The commonest pitfalls of the candidates include:
(i) Lack of awareness of Kant‟s Categorical Imperative and its application.
(ii) Inability to identify ethical issues in the Case Study.
It is important for candidates to appreciate that examiners would continue to examine
questions which require application of ethical principles; hence, they are advised to
make use of recommended texts and journals on ethics. These would expose them to
relevant ethical principles and how they can be applied within the context of the
accounting profession.
QUESTION 2
(a) Ethical issues are problems, situations, or opportunities that require a person or
organisation to choose among several actions that must be evaluated as right or
wrong. Most ethical issues relate to conflicts of interest, fairness and honesty,
communications, or organisational relationship both internal and external.
In general, businesses seem to be more concerned with ethical issues that could
hurt the firm through negative publicity, such as bribery, and issues related to
consumers and the general public, such as environmental impact. Scandals related
to bribes, deceptive communications, and ecological disasters have severely
damaged public trust in business institutions and have helped to focus attention on
activities that could do further harm.
Therefore, studying ethical issues helps to prepare us to identify potential problems
within an organisation and to understand alternatives and ethical solutions to the
problem.
19
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(b) Two examples each of ethical issues relating to the following areas:
(i) Society.
 Involvement in the Community/Obligation to protect, preserve & improve
the environment
 Honesty, truthfulness and fairness in marketing
 Use of animals in product testing
 The degree of safety built into product design
 Donation to good cause
 The extent to which a business accepts its alleged responsibilities for
mishaps, spillages and leakages
 The selling of addictive products e.g. tobacco
 Involvement in the arms trade
 Trading with repressive regimes.
(ii) Internal and industry practice.

Treatment of customers – e.g. honouring the spirit as well as the letter of
the law in respect to warranties and after sales service

The number and proportion of women and ethnic minority people in senior
positions

The organisation‟s loyalty to employees when it is in difficult economic
conditions

Employment of disabled people

Working conditions and treatment of workers


Bribes to secure contracts
Child labour in the developing world
(iii) Marketing.

Dumping – selling at loss to increase market share and destroy
competition in order to subsequently raise prices

Price fixing cartels

„Bait and switch‟ selling – attracting customers and then subjecting them
to high pressure selling techniques to switch to a more expensive
alternative

Counterfeit goods and brand piracy

Copying the style of packaging in an attempt to mislead consumers

Deceptive advertising

Unethical practices in market research and competitor intelligence
20
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(iv) Product.

Selling goods abroad which are banned at home

Omitting to provide information on side effect

Unsafe products

Built in obsolescence

Wasteful and unnecessary packaging

Deception on size and content

Inaccurate and incomplete testing of products

Treatment of animals in product testing.
(v) Supply chain.

The use of child labour and forced labour

Production in sweatshops

Violation of the basic rights of workers

Ignoring of health, safety and environmental standards.
EXAMINERS‟ REPORT
The question tests candidates‟ knowledge on ethical issues in business and it requires
specific examples of ethical issues in various areas of business.
The performance of candidates was good. Although, majority of the candidates were
able to explain ethical issues in business but some could not give specific examples in
various areas of business.
Candidates are advised to pay more attention to various forms of ethical issues in
business and how they can be addressed effectively.
QUESTION 3
(a)
Explaining the term “Conflict of Interest.”
(i)
(ii)
Conflict of interest exists when an individual must choose whether to
advance his or her own interest
It exists when there is a clash in one‟s moral conviction and another
person‟s proposal
21
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(iii) Such competing interest can make it difficult for a professional to fulfil
his or her duties impartially
(iv) A conflict of interest can create an appearance of impropriety that can
undermine confidence in the accountant, his professional activity, and
the profession
(v) To avoid conflict of interest, one must be able to separate his private
interest from the business dealings of his employer or client.
(b)
Identifying the conflict of interest within the accounting profession, especially
as an external auditor to a firm:
(i)
Acting for two competing clients.
Assurance firms are at liberty to have clients who are in competition
with each other. However, the firm should ensure that it is not the
subject of dispute between the clients. It must also manage its work so
that the interests of one client do not adversely affect the other. Where
acceptance or continuance of an engagement would, even with
safeguards, materially prejudice the interests of any client, the
appointment should not be accepted or continued.
(ii)
Provision of services other than audit for the same firm.
Auditors often give their clients business advice unrelated to audit. In
such a position, they may well become involved when clients are
involved in issues such as share issues and take-overs.
Neither situation is inherently wrong for an auditor to be in – With
regard to share issue, audit firms should not underwrite an issue of
shares to the public of a client they audit.
In a take-over situation, if the auditors are involved in the audit of
both predator and target company, they must take extra care. They
should not:
- be the principal advisor to either party
- issue reports assessing the accounts of either party other than
their audit report.
If they find they possess material confidential information, they
contact the appropriate body or regulator.
should
22
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(iii)
Self Interest Threat.
A conflict between members‟ and clients‟ interest might arise if
members compete directly with a client, or have a joint venture or
something similar with a company that is in competition with the client.
A professional public accountant (external auditor) has the moral
responsibility to protect the interest of the public by providing objective
and accurate financial reporting which will be released to the public by
the firm; the management of the company could request for
overstatement of profit in order to mislead the public and hence continue
in business without fear of losing out. The situation becomes worse when
the auditor has some pressing financial needs which will be taken care of
by the money that may accrue when the client produces fraudulent
financial report.
Here the auditor faces the dilemma of choosing to advance his selfish
interest by taking the bribe and solve his own pressing financial
problems or protecting public interest by declining.
EXAMINERS‟ REPORT
The question tests the application of ethics in accounting profession with special
emphasis on conflict of interest as it affects external auditors when carrying out their
duties as professional accountants.
Candidates are required to explain the term “Conflict of Interest” and also to give
instances where it may arise, most especially for audit firms in particular and
accounting profession in general.
The pitfalls noted include the following:
(i)
Inability to correctly explain the meaning of “Conflict of Interest”.
(ii) Discussing Auditor‟s Independence and factors that may impair Auditor‟s
Independence instead of “Conflict of Interest”.
(iii) Inability to give specific instances when conflict of interest may arise.
The candidates are advised to pay more attention to the application of ethical
principles, particularly as they affect Accountants, Auditors and other related
professionals. It is also important for candidates to be sufficiently familiar with the
23
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
basic ethical problems that can arise as they carry out their professional duties as
Accountants.
QUESTION 4
Accountants cannot afford not to study ethics for the following reasons:
(i)
Possibility of conflicting ethical principles:
Due to conflicting ethical principles it may be difficult to determine what to do
in certain circumstances. In this case, ethics can provide insights into how to
adjudicate between conflicting principles and show why certain courses of action
are more desirable than others.
(ii) Individual Accountant may hold some inadequate beliefs or cling to inadequate
values.
Subjecting those beliefs or values to ethical analysis may show their inadequacy.
It could be that at one time you thought some things were wrong but now you
think they are acceptable, or vice versa. For instance, some would claim that
while accounting firms operate within the letter of the law in attesting to the fact
that companies followed Generally Accepted Accounting Principles (GAAP), they
had an ethical obligation to encourage more realistic financial pictures. Also, at
one time accountants thought it unacceptable to advertise. Today, it seems a
justifiable practice. So, ethical reflection can make us more knowledgeable and
conscientious in moral matters.
(iii) Development of abilities needed to deal with ethical conflicts.
The study of ethics helps us to understand whether and why our opinions are
worth holding on to. As an Accountant, what do I do when I need to choose
between keeping a job and violating professional responsibilities? Ethics
provides the Accountant with the likely thing to do when his responsibility to his
family conflicts with his professional responsibility.
(iv) Recognition of issues in accounting that have ethical implications.
Some moral beliefs an individual accountant holds may be inadequate because
they are simple beliefs about complex issues. The study of ethics can help in
sorting out these complex issues, by seeing what principles operate in those
cases.
24
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(v)
Identification and application of basic ethical principles.
The final reason for studying ethics is to learn to identify the basic ethical
principles that can be applied to action. That should help develop the skill of
determining what should be done and an understanding of why it should be
done. When faced with trying to decide what to do in a difficult situation, it is
often helpful to have a checklist for basic questions or considerations that need to
be raised and applied to the situation to help determine what the outcome
should be. Just as one learns the principles of accounting in order to apply them
to specific situations, one also needs to learn the principles of ethics that govern
human behaviour in order to apply them when faced with difficult ethical
situations. The study of ethics makes us aware of the number and types of moral
principles that can be used in determining what should be done in a situation
involving ethical matters.
EXAMINERS‟ REPORT
The question tests the purpose of studying ethics by Accountants. It also tests the
importance of ethics to the accountancy profession in general.
Candidates are required to explain possibility of conflicting ethical principles, and also
to state the reasons why some Accountants may hold inadequate beliefs when faced
with issues in accounting that have ethical implications.
Most candidates demonstrated inadequate understanding of the question and
performance was generally poor.
The major pitfall was that candidates misinterpreted the question and they were
discussing ICAN Code of Conduct instead of answering the question.
Candidates are advised to study questions properly before answering them.
It is also important for candidates to appreciate that Ethics is an important aspect of
this paper; therefore, special attention must be paid to this part of the Syllabus for
better performance in future.
25
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
QUESTION 5
(a).
(i)
Consolidated Financial Statements are the financial statements of a
group presented as those of a single economic entity.
(ii)
A Subsidiary is an entity, including an unincorporated entity that is
controlled by another entity known as the parent.
(iii)
Non-controlling interest is the equity in the subsidiary not attributable
directly or indirectly to a parent.
(iv)
Control is the power to govern the financial and operating policies of
an entity so as to obtain benefits from its activities.
(b)
The following disclosures shall be made in Consolidated Financial Statements,
according to Schedule II paragraph 68 of CAMA:
(i)
The nature of the relationship between the parent and subsidiary when
the parent does not own, directly or indirectly through
subsidiaries, more
than half of the voting power.
(ii)
The reasons why the ownership, directly or indirectly through
subsidiaries, of more than half of the voting or potential voting power
of an investee does not constitute control.
(iii)
The end of the reporting period of the financial statements of a
subsidiary when such financial statements are used to prepare
consolidated financial statements and are as of a date or for a period
that is different from that of the parent‟s financial statements, and the
reason for using a different date or period.
(iv)
The nature and extent of any significant restrictions on the ability of
subsidiaries to transfer funds to the parent in the form of cash
dividends or to repay loans or advances.
26
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(v)
A schedule that shows the effects of any changes in a parent‟s
ownership interest in a subsidiary that does not result in a loss on the
equity attributable to owners of the parent.
(vi)
If control of a subsidiary is lost, the parent shall disclose the gain or
loss, if any.
(vii)
A list of investment in subsidiaries, jointly controlled entities and
associates including the name and country of incorporation.
(viii) Where separate financial statements are prepared by a jointly
controlled entity or an investor, in an associate, the reason for
preparing separate financial statements, the list of significant
investment and country of incorporation of the investee must be
disclosed.
EXAMINERS‟ REPORT
The question tests candidates‟ understanding of the requirements of IAS 27 on
Separate Financial Statements as well as disclosure requirements when preparing
Consolidated Financial Statements.
The performance of the candidates was fair.
Most candidates were able to define the basic terms in accordance with the
International Accounting Standard No. 27, but they displayed inadequate
understanding of the disclosure requirements.
Candidates are advised to pay more attention to Statements of Accounting Standards.
27
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
QUESTION 6
Financial reporting is not an end in itself. It is a means of communicating to the users
of the financial reports. Information is useful in making choices among alternative
uses of scarce resources, though, the objective stems largely from the needs and
interests of those users.
Potential users of financial reports and their information needs include:
(a)
Equity investors.
Equity investors in an entity are interested in the entity‟s ability to generate net
cash inflows because their decisions relate to the amounts, timing, and
uncertainties of those cash flows. To an equity investor, an entity is a source of
cash in the form of dividends (or other cash distributions) and increases in the
prices of shares or other ownership interests. Equity investors are directly
concerned with the ability of the entity to generate net cash inflows and with
how the perception of that ability affects the prices of its equity interests.
They are also interested in the ability of the company to issue scrip, which
will increase their shareholding and consequently increase their cash inflow.
(b)
Creditors, including purchasers of trade debt instruments.
These provide finance to an entity by lending cash (or other assets) to it.
Like investors, creditors are interested in the amounts, timing and uncertainty
of an entity‟s future cash flows. To a creditor, an entity is a source of cash in the
form of interest, repayments of borrowings and increase in the prices of debt
securities.
(c)
Suppliers.
They provide services rather than financial capital. They are interested in
assessing the likelihood that amounts an entity owes them will be paid as at
when due.
(d)
Employees.
They provide services to equity; employees and their representatives are
interested in evaluating the stability, profitability, and growth of their
employer. They are interested in information that helps them to assess the
entity‟s continuing ability to pay salaries and wages and to provide incentive
payments and retirement and other benefits.
28
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(e)
Customers.
To its customers, an entity is a source of goods and services. Customers are
interested in assessing the entity‟s ability to continue to provide those goods or
services, especially if they have a long-term involvement with, or are dependent
on the entity.
(f)
Governments and their agencies and regulatory bodies.
These are interested in the activities of an entity because they are in various
ways responsible for seeing that economic resources are allocated efficiently.
They also need information to help in regulating the activities of entities,
determining and applying taxation policies, preparing national income and
similar statistics.
(g)
Management.
This requires financial reports to obtain financial information among others to
effectively perform their function of planning and controlling the operation of
the enterprise.
(h)
Financial Analyst.
This like Accountants, Stockbrokers, etc. will need the financial information to
determine the performance of the entity in order to give constructive advice as
to whether their clients should invest in a particular company or not.
(i)
Competitors.
Competitors require the financial statements of companies in the same line of
business or the same industry for the purpose of comparison. This will make
them know their position and facilitate effective analysis of their strengths,
weaknesses, opportunities and threats within the industry. This will also enable
competing companies know how they are faring among their peers and make
them evolve appropriate policies and/or actions for improvement.
(j)
Researchers.
Researchers require financial information for inter-firm and inter-period
comparisons to guide students and consultants.
EXAMINERS‟ REPORT
The question tests candidates‟ knowledge on users of financial statements and their
individual information needs.
Majority of the candidates understood the question and the performance was good.
29
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
ICAN/
EXAMINATION NO...................................
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
STRATEGIC FINANCIAL MANAGEMENT
Time allowed – 3 hours
SECTION A: Attempt All Questions
PART 1
MULTIPLE-CHOICE QUESTIONS (20 Marks)
1.
Which of the following functions is NOT performed at a lower management level?
A.
B.
C.
D.
E.
2.
The following are the characteristics of strategic decision EXCEPT they
A.
B.
C.
D.
E.
3.
Supervision of cash receipts and payments.
Safeguarding cash balances
Record keeping and reporting
Custody and safeguarding securities and valuable papers
Planning and control of funds
are concerned with the scope of the organisation‟s activities.
match the organisation‟s activities to the environment in which it operates.
match an organisation‟s activities to its resource capability.
involve major decisions about the allocation or re-allocation of resources.
affect the short-term direction that the organisation takes.
Which of the following short-term investment opportunities is NOT available to
companies?
A.
B.
C.
D.
E.
Treasury bills
Commercial papers
Certificates of deposits
Bonds
Bank deposits
30
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
4.
Baumol‟s model on cash management is not based on ONE of the following
assumptions.
A.
B.
C.
D.
E.
5.
Which of the following simplifying assumptions is NOT commonly made in
examining the relationship between capital structure and cost of capital?
A.
B.
C.
D.
E.
6.
A firm is able to forecast its cash needs with certainty.
A firm‟s cash payments occur uniformly over a period of time.
The opportunity cost of holding cash is known and it does not change over
time.
The firm will incur the same transaction cost whenever it converts securities
to cash.
The net cashflow is normally distributed with a zero mean and standard
deviation.
There is no income tax
The firm pursues a policy of paying all its earnings as dividends
Investors have identical subjective probability distributions of operating
income
The operating income is expected to be static
A firm can change its capital structure almost instantaneously without
incurring transaction costs
Which of the following reasons for valuing securities is NOT correct?
A.
B.
C.
D.
E.
To determine the purchase consideration in an absorption or merger scheme
To ascertain the total amount of the estate of a deceased investor
To determine the fair price at which shares of a company could be
purchased
To meet the stock exchange requirements
To estimate the break-up value of a company in liquidation
31
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
7.
Given the following data in respect of Alariwo Plc, calculate the P/E ratio:
Share Price
N5.00; and
EPS
N0.82
A.
B.
C.
D.
E.
8.
Which of the following statements may NOT be a reason for issuing bonus shares?
A.
B.
C.
D.
E.
9.
4.10
6.10
6.12
6.14
6.22
Bonus shares tend to bring the market price per share within a more
popular range
Bonus shares increase the number of outstanding shares
The rate of dividend tends to increase
Issuing of bonus shares improves the prospects of raising additional funds
The share capital base increases and the company may achieve a more
respectable size in the eyes of the investing community
Which of the following is NOT one of the core decision areas in financial
management?
A.
B.
C.
D.
E.
Investment decision
Finance decision
Dividend decision
Liquidity decision
Credit management decision
10. The traditional approach to the valuation of a company assumes that
A.
B.
C.
D.
E.
the gearing of a company is changed immediately by issuing debts to
purchase equity or vice-versa.
all earnings are distributed in form of dividend.
business risk fluctuates regardless of how the company invests its funds.
taxation is ignored.
earnings are assumed to have zero growth into perpetuity.
32
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
11. An integrated approach to the strategy making process provides a framework
which consists of the following parts EXCEPT
A.
B.
C.
D.
E.
analysing the present internal and external conditions.
identifying and evaluating the present strategy.
searching for strengths and weaknesses within the present strategy and
environment.
considering changes in the existing strategy.
choosing the strategy that best satisfies the objectives.
12. Mr Adeyemi obtained a three-year loan of N10,000 @ 9% from his employer to
buy a motorcycle. The loan is expected to be repaid in three equal end-of-year
instalments. What is the annual instalment?
A.
B.
C.
D.
E.
N3,905
N3,921
N3,951
N3,975
N3,981.
13. An investor expects a perpetual sum of N500 annually from his investment. What
is the present value of this perpetuity if his interest rate is 10%?
A.
B.
C.
D.
E.
N5,000
N5,200
N5,300
N5,400
N5,500.
14. The following are relevant factors in taking a decision to raise money through
loan stock EXCEPT
A.
B.
C.
D.
E.
issue costs.
capital repayment.
control.
servicing costs.
interest repayment.
33
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
15.
Who has the overall responsibility for the attainment of corporate governance objectives
in an organisation?
A.
B.
C.
D.
E.
16.
Which of the following is an aspect of the intermediation functions in the Nigerian
financial system?
A.
B.
C.
D.
E.
17.
Denomination intermediation
Maturity intermediation
Risk Intermediation
Interest rate intermediation
Liquidity intermediation
Strategic planning serves the following purposes in an organisation EXCEPT
A.
B.
C.
D.
E.
18.
Top executive officer
Shareholders
Work force
Audit Committee
Board of Directors
clear definition of the purpose of the organisation and establishment of realistic
goals and objectives consistent with that mission in a definite time frame.
communication of those goals and objectives to the organisation‟s constituents.
development of a sense of ownership of the company‟s plan.
reflecting on how a specific function will contribute to the achievement of a
department‟s corporate priorities and defence tasks.
provision of a base from which progress can be measured and establishment of a
mechanism for informed change when needed.
Which of the following does NOT explain the essence of corporate planning?
A.
B.
C.
D.
E.
The probability of future outcome of events is unknown
Predictions are susceptible to errors
The future is unpredictable
Decision makers cannot be assertive on future events
Decision relating to corporate planning rests on hunches
34
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
19.
In relation to capital investment, a managerial option
A.
B.
C.
D.
E.
20.
applies only to new projects.
limits the flexibility of management‟s decision-making.
limits the downside risk of an investment project.
limits the profit potential of a proposed project.
extends the risk of executed projects.
Which of the following is NOT a limitation of capital rationing?
A.
B.
C.
D.
E.
The assumption that projects are infinitely divisible may not always be true in
practice
An investment policy outcome may be less than optimal
The risk associated with the different projects and managements attitude to risk
are not considered
The linearity relationship can be faulted
If there is capital rationing in more than one year and more than two projects are
involved, ranking by discounted profitability index is not adequate
35
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
PART II – SHORT-ANSWER QUESTIONS (20 Marks)
.
1.
Strategy formulation is ultimately the responsibility of............................
2.
The secondary goal of a corporate organisation is................................
3.
The two main theories relating to the effect of capital structure on the value of
the company are....................... and ..............................
4.
A schedule statement of projected cash inflows and cash outflows over some
period is known as........................
5.
What is the name given to an income received by the firm for goods and
services, to be supplied in future?
6.
A financial instrument which entitles an investor to buy new shares of a
company during a specified period in future, at a price determined now, is
called...............................
7.
Issue of shares of new companies are usually offered to the public for
subscription at........................value.
8.
The process of guaranteeing to buy new public or rights issues if the issues are
NOT fully subscribed by the public is called................................
9.
The development of financial strategy in an organization is the responsibility of
the...................................
10.
The process of policy formulation, establishment of goals and objectives and the
development of strategies is known as ...........................
11.
The level at which an order should be placed to replenish inventory is known
as...........................
12.
Offers to the existing shareholders to subscribe cash for additional shares in the
proportion of their existing shareholdings at a price which is appreciably below
the current market price are referred to as .......................
13.
The formula for determining the rate of return on a single asset is given
as...............................
36
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
14.
The technique used in determining the viability, time of completion, costs and
resources of rescheduling alternative strategies is called.............................
15.
The company‟s objective of maximising market price per share is synonymous
with …………………..
16.
When a listed company delays or fails to notify the Stock Exchange of any new
development which may substantially affect the price of its security, an investor
can out-perform the market thereby resulting in …………….. capital market.
17.
The process of developing and maintaining a strategic fit between the
organisation‟s goals and capabilities and its changing marketing opportunities
is the responsibility of the …………………..
18.
A continuous process whereby people make decisions about how outcomes are
to be accomplished, what products will be produced, how success is measured
and evaluated and how budgetary resources are allocated is known
as………………..
19.
Whenever there is a budget ceiling or a constraint on the amount of funds that
can be invested during a specific period, there will be need
for………………………
20.
The terminology used to describe the value of a project‟s asset when sold
externally is known as …………………….
37
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
SECTION B -ANSWER QUESTION ONE AND ANY OTHER THREE (60 Marks)
QUESTION 1 - CASE STUDY
LAPEKUN LIMITED
Lapekun Limited is considering the purchase of a locally manufactured machine for N3
million. In view of the fact that the shares of the company are not quoted, it finds it
difficult to raise money through the issue of shares. The purchase of this machine
becomes absolutely necessary if the sales target given to the sales manager is to be
achieved. In order to ensure that the machine is purchased, the domineering
proprietor of the company and the accountant met informally to decide on how to
source for funds.
Many finance options were considered and they eventually agreed to negotiate for a
loan from Microfinance Bank Ltd. The bank agreed to give the company a loan of N2.5
million, which means that the company will have to source for the balance of N0.5
million elsewhere. However, the company has no tangible collateral with which to
secure additional loan to cover the balance of the value of the machine. In view of this
difficulty, the finance officer offered to advance the shortfall. The proprietor graciously
accepted this offer.
The duration of the loan is 20 years with an interest rate of 12% per annum. The
annual interest charge is to be calculated on the balance outstanding at the beginning
of each year. Repayment is to be made in 20 equal annual instalments. Each
instalment will include both interest and capital. A working capital of N250,000 will
be required at the beginning of the year. The amount will be sourced internally. The
machine is expected to generate net cashflows of N540,000 per annum for FIVE
consecutive years from its predominantly local sales.
You are required to determine
(a)
the amount to be paid in each year on the loan;
(5 Marks)
(b)
the NPV of the machine and advise on its viability; and
(5 Marks)
(c)
identify FIVE features of small scale enterprises.
(5 Marks)
(Total 15 Marks)
38
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
QUESTION 2
(a)
(b)
(c)
Explain the term “rights issue”.
(2 Marks)
Differentiate between “rights issue” and “public issue”.
(3 Marks)
(i) Rapala Plc is about to make a one-for-three rights issue. Its current capital
structure is as follows:
 6 million Ordinary shares of N1 each (current market value is N6.20 per
share)

15% Debentures (Redeemable at par in 10 years time) – N6 million.
(ii) The money raised from the rights issue may be used to execute the
following;
 Buy back all the 15% debentures at their current market value. It is
expected that this investment will be priced to offer investors a yield of
9% which is the current market-yield on debenture loan.
 Finance a new project costing N1.6 million.
You are required to determine the
(i)
finance required to redeem the debentures and finance the new project.
(5 Marks)
issue price per share;
(1 Mark )
(ii)
(iii) theoretical ex-rights price; and
(iv) theoretical nil paid value of a right per share
(2 Marks)
(2 Marks)
NOTE:
The total finance required for (i) and (ii) should be rounded up to the next
N100,000 for the purpose of the rights issue.
(Total 15 Marks)
QUESTION 3
(a)
State the formula for calculating the rate of return on equity shares
(2 Marks)
(b)
Calculate the rate of return on equity share using the following information:
Price at the beginning of the year N60.00
39
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Dividend paid at the end of the year N2.40
Price at the end of the year N69.00
(3 Marks)
(c) Explain FIVE areas in which the financial management in a business
organisation can benefit from information and communication technology.
(10 Marks)
(Total 15 Marks)
QUESTION 4
Abija Plc‟s and Bayela Plc‟s balance sheet extracts are set out below. Abija Plc is
proposing to take over Bayela Plc by means of an issue of its own shares in exchange
for those of Bayela and has to decide on the terms of its offer.
Abija Plc
Bayela Plc
N‟000
N‟000
1,000,000
500,000
Preference Share Capital
200,000
-
Share Premium Account
-
20,000
Profit and Loss Account
380,000
40,000
10% Debentures
150,000
50,000
1,730,000
610,000
Ordinary Shares of N1 each
Other pieces of information concerning the two companies are as follows:
Abija Plc
Maintainable
annual
profits
after
attributable to equity
Bayela Plc
tax
N 240,000,000
N 150,000,000
Current market value of ordinary shares
2.40
2.70
Current EPS
0.24
0.30
10
9
125%
125%
P/E ratio
Current market price of debts
40
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Required:
Determine the offer which the directors of Abija Plc would make to the shareholders of
Bayela Plc on each of the following bases:
a)
Net Asset
(3 Marks)
b)
Earnings
(4 Marks)
c)
Market value
(2 Marks)
d)
Financial analysis
(6 Marks)
The company‟s income tax rate is 30%.
(Total 15 Marks)
QUESTION 5
BIROM PLc is considering investment in a computer-controlled machine which can be
replaced by an identical one when it gets to the end of its economic life. The machine
has a maximum life of four years but, as its productivity declines with age, it could be
replaced after either one, two, three or four years. The financial details of the machine
are as given below:
N‟000
Cost
6,000,000
Running cost:
Year
1
450,000
2
480,000
3
570,000
4
630,000
Scrap value after:
Year
1
4,500,000
2
3,900,000
3
3,000,000
4
2,100,000
The Board of Directors of BIROM Plc is concerned with deciding on its replacement
policy.
41
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
As the financial manager of the company, you are required to advise the board on the
optimal replacement policy of the machine assuming that the company‟s cost of
capital is 10%.
(15 Marks)
QUESTION 6
“The role of planning cannot be over emphasised in the attainment of corporate
objectives”:
(a)
In relation to the above statement, explain each of the following concepts:
(i) Operational planning;
(ii) Tactical planning; and
(iii) Strategic planning.
(6 Marks)
(b)
State Three functions of each of the following:
(i) Central Securities Clearing System (CSCS); and
(ii) Securities and Exchange Commission (SEC)
(9 Marks)
(Total 15 Marks)
42
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
SOLUTIONS TO SECTION A
PART 1: MULTIPLE-CHOICE QUESTIONS
1.
E
2.
E
3.
D
4.
E
5.
D
6.
D
7.
B
8.
C
9.
E
10.
C
11.
D
12.
C
13.
A
14.
C
15.
E
16.
D
17.
D
18.
A
19.
C
20.
E
43
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Tutorials
7.
12.
13.
N 5.00
N 0.82
= 6.098
= 6.10
N 10,000
= N 3,951
2.531(Cum DF)
DF = Discounting Factor
P = N 5.00
0.10
= N 5,000
EXAMINERS‟ REPORT
The questions test candidates‟ knowledge of various aspects of the syllabus. Virtually
all the candidates attempted the questions and performance was fair.
Candidates are advised to ensure adequate coverage of all sections of the syllabus for
better performance.
44
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
PART II SHORT-ANSWER QUESTIONS
1.
Board of Directors
2.
Profit maximisation
3.
Traditional view; Net operating income
4.
Cash budget
5.
Deferred income
6.
Warrant
7.
Par or Nominal
8.
Underwriting
9.
Head of Finance or Finance Officer
10.
Corporate planning
11.
Re-order level or Re-order point
12.
Rights issue
13.
Annual income + (ending price – beginning price) x 100 %
beginning price
1
OR
Capital Gain / Loss + dividend x 100 % ie di + (P1-P0) x 100
Price at Start of period
1
P0
1
OR
Income / Returns
x 100 %
Investment / Capital
1
14.
Program Evaluation Review Technique (PERT).
15.
Maximisation of shareholders‟ wealth
16.
Inefficient
17.
Top management
18.
Tactical planning
19.
Capital Rationing
20.
Abandonment value or scrap value
45
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
EXAMINERS‟ REPORT
The questions test candidates‟ knowledge of various aspects of the syllabus.
Candidates‟ performance was average.
Candidates are advised to study extensively and adequately to cover the syllabus
when preparing for the examinations of the Institute for better result.
46
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
SOLUTIONS TO SECTION B
QUESTION 1 - CASE STUDY
LAPEKUN LIMITED
(a)
Calculation of the annual repayment
A
=
[1-(1 + r)-n]
r
=
1 –( 1.12)-20
0.12
=
7.4694
: . Annual repayment
(b)
=
N2,500,000
7.4694
=
N 334,698.90
Calculation of the NPV of the machine
Year
NCF
(N)
DF@
12%
PV
(N)
0
(3,000,000)
1.0000
(3,000,000)
0
(250,000)
1.0000
(250,000)
540,000
3.6048
1,946,592
250
0.5674
141,850
1-5
5
NPV
-1,161,558
Advice:
The machine should not be bought, as its purchase would result in the
reduction of the shareholders‟ wealth by N1,161,558.
47
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(c)
Features of small-scale enterprises.
These include:
i.
The ownership of the firm and its control are not often separated, that is,
both are in most cases in the hands of a few closely related people,
probably within the same family.
ii.
The companies‟ shares are usually not quoted on the stock market;
iii.
The informal relationship among employees in the organization dominates
the formal relationship;
iv.
In most cases, their inputs are locally sourced;
v.
Management structure is uncomplicated, hence there is a speedy decisiontaking process;
vi.
They contribute to the domestic capital formation;
vii.
Low setup costs;
viii.
Accelerating rural development and contributing to stemming urban
immigration and problems of congestion in large cities through employment
generation;
ix.
Provide links between agriculture and industries; and
x.
Supplying parts and components to large scale industries.
EXAMINERS‟ REPORT
Part „a‟ of the question tests candidates‟ knowledge of annuity while part „b‟ tests
candidates‟ understanding of one of the techniques of investment appraisal. Part „c‟ of
the question, however, tests candidates‟ knowledge of the features of Small Scale
Enterprises (SMEs).
Over 80% of the candidates attempted the question and most of them did well in part
„b‟ but demonstrated lack of adequate understanding of parts „a‟ and „c‟, hence
performance was average.
Candidates‟ commonest pitfall in part „a‟ was their inability to remember the annuity
formula, hence they were unable to calculate the annual „loan repayment.
48
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Their pitfall in part „b‟ was their inability to compute the projects Net Present Value
(NPV) correctly owing to their failure to recognise the recovery of working capital at
the end of the project‟s life. However, in part „c‟, candidates focused on the features of
sole proprietorship instead of Small Scale Enterprises (SMEs).
Candidates are advised to read wide, understand and interprete questions
appropriately before attempting them. They should also make effort to remember key
formulae.
QUESTION 2
(a)
Rights Issue –This is an offer to the existing shareholders of securities listed in the
primary market to subscribe for additional shares in the proportion of their
existing shareholdings at a price lower than the current market price of the
shares. It is the most common method of raising capital by private and public
companies.
(b)
Differences between “rights issue” and “public issue”
(i)
Rights issue is usually more successful than public issue because it is made
to investors who are familiar with the operations of the company.
(ii)
A rights issue involves selling of ordinary shares to the existing shareholders
while a public issue involves raising of share capital directly from the
public.
(iii) The flotation costs of a rights issue are significantly lower than those of a
public issue because a rights issue is not underwritten.
(iv) A rights issue may be made by private companies as well as public
companies whereas a public issue can only be made by public companies.
(v)
A rights issue does not lead to dilution of control except the rights are not
fully taken up by the shareholders whereas a public issue can lead to
dilution of control.
49
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(b)
(i)
Finance required:
The finance required to redeem the debenture and finance the new project is
the addition of the current price of the debenture and the cost of the new
project. This is obtained as follows:
Calculation of the current value of the debenture
15% Redeemable debenture
Annual interest
Year
1 – 10
10
Item
Interest
Debt
redeemed
= N 6,000,000
= N 900,000
Cashflow
DCF @
PV
N
9%
(N)
900,000
6.4177
5,775,930
6,000,000
0.4224
2,534,400
Current value
8,310,330
Current value of the 15% redeemable debenture
Cost of the proposed project (given)
Therefore, the finance required is
=
=
=
N 8,310,330
N 1,600,000
N 9,910,330
= N10,000,000 approx.
(ii)
Calculation of issue price per share
Finance required
=
N 10,000,000 (c (i) above)
No of shares issued (6,000,000/3)
=
2,000,000 shares
Issue price
=
N10,000,000
2,000,000
=
N5.00
50
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(iii) Calculation of theoretical ex-rights price
N
3 shares at N6.20
18.60
1 share at N5.00
5.00
4 shares
23.60
Theoretical ex-rights price
=
N23.60/4
=
N5.90
(iv) Calculation of nil paid value of a right per share
Theoretical ex-rights price
=
Less: Issue price
N5.90
5.00
0.90
Nil paid value
=
0.90/3
=
N0.30
EXAMINERS‟ REPORT
The question tests candidates‟ understanding of „rights‟ and „public‟ issues under the
capital market operations.
Candidates‟ understanding of the „c‟ part of the question was very low while they had
a fair knowledge of the „a‟ and „b‟ parts. Many candidates attempted the question but
performance was poor especially in the „c‟ part which requires some calculations.
Unfortunately, this part carries the highest mark.
Candidates‟ commonest pitfall in part „c‟ of the question was their inability to
determine the present price of the debenture which would have helped in calculating
the finance required and assist in solving the remaining parts of the question under
part „c‟, that is, c (ii – iv).
Candidates are advised to always cover the Institute‟s syllabus adequately, and make
use of the Pathfinder and Study Packs.
51
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
QUESTION 3
(a)
The formula for calculating the rate of return on equity shares is
Annual income + (Ending price – Beginning price) X 100 %
Beginning price
1
OR
Capital Gain / Loss + dividend X 100 % ie di + (P1-P0) x 100 %
Price at start of period
1
P0
1
(b)
Calculation of the rate of return
Using the formula in (a) above, the rate of return works out as follows:
N2.40 + (N69.00 - N60,00) X 100%
N60.00
1
=
N11.40 X 100
60
1
=
(c)
19%
The areas in which the financial management of a business firm will benefit
from information and communication technology (ICT) include the following:
(i)
Financial Planning – this function of the financial manager can be
performed with greater ease through the use of spreadsheets and other
financial softwares to evaluate the present and projected financial
performance of a business. Through information and communication
technology, companies can determine the financing needs and analyse
alternative methods of financing more quickly and relatively easier.
Financial manager receives immense support from Decision Support
System (DSS) when he takes long-term financial planning decisions
involving many assumptions that jointly affect these decisions. Where for
instance, there is a need to test the effect of a change in any of the
assumptions on the result (sensitivity analysis), computerized financial
planning models can be programmed to carry this out instantaneously.
The specific areas of financial planning that receive this type of support
from DSS include the effect of different sales values, different selling
52
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
prices, and different input costs on the forecast figure in the projected
financial statements.
(ii)
Working Capital Management – On a real time or periodic basis, ICT
system can be used to collect information on all cash receipts and
payments within the company. ICT is applicable in the area of cashflow
forecasts and management. It makes it possible to spot future cash
deficits or surpluses.
In addition to cash management, it could also be used for inventory
management to determine the economic order quantity and optimum
level of inventory investment to maximize profitability.
(iii)
Capital Investment Appraisal – Spreadsheet models that incorporate
present value analysis of expected cash flows and probability analysis of
risk to determine optimal mix of capital projects are available for
evaluating the profitability and financial impact of proposed capital
expenditure. It also provides support in the areas of evaluation of the
effect of alternative discount rates on projects net present values where
cash flows that have to be estimated go into fairly distant future.
(iv)
Investment Management – System / Service helps financial managers to
make buying / selling or holding decisions for various types of securities
and for developing an optimal mix of securities, which minimizes risks
and maximizes investment income for the business.
(v)
Optimisation problems – The decision support system (DSS) model base
might have optimal models such as linear programming. These models
could be used to provide solutions to problems involving optimisation of
a given objective (profit maximisation or cost minimisation) in the face of
many (at least more than two) interacting variables and complex
relationships.
53
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
The limiting factors might be labour, machine hours, capital and others
which incidences jointly affect profit or cost.
(vi)
Financial and Profit Analysis - The ICT, through the use of DSS based
financial planning models, provide support where there is need to assess
different financing plans and their impact on the critical variables such
as earnings per share (EPS), debt equity ratio (gearing ratio), etc.
Financial managers are usually interested in every aspect of the financial
analysis since it is their overall responsibility to see that the resources of
the firm are used most effectively and efficiently and that the firm‟s
financial condition is sound.
EXAMINERS‟ REPORT
The „a‟ and „b‟ parts of the question test candidates‟ understanding of the formula for
the calculation of return on capital and its interpretation in relation to the market
value of equity shares. The „c‟ part tests candidates‟ knowledge of information
technology and its benefits to the financial manager.
Few candidates attempted the question and their performance was poor. Most
candidates did not understand the requirements of the question and therefore did not
attempt it.
Candidates‟ commonest pitfall in part „a‟ of the question was their inability to
remember the formula and this also affected their performance in the „b‟ part of the
question since the formula is expected to be used in solving it. In part „c‟, candidates
failed to interprete and note the specific requirements of the question hence they
failed to proffer correct solution to it.
Candidates‟ are advised to take time to read, understand and interprete questions
appropriately and note specific requirements before attempting them. They should
also make effort to remember key formulae.
54
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
QUESTION 4
Calculation of offer price by Abija Plc to shareholders of Bayela Plc based on :
(a)
Net asset basis
Net Asset Value (NAV)
=
NAV for Abija
=
=
NAV for Bayela
=
=
Value attributable to equity
No of ordinary shares
N 1,380,000,000
1,000,000,000
N1.38
N560,000,000
500,000,000
N1.12
Comment
Abija Plc is expected to issue 112 of its own shares in exchange for every 138 of
those in Bayela Plc, which it acquires
To acquire the whole of the issued share capital of Bayela Plc, Abija Plc should
issue.
500,000,000 x 112
138
(b)
=
405,797,101 new N1 shares
Earnings Basis
Earnings per share (EPS)
=
EPS for Abija Plc
=
=
EPS for Bayela plc
=
=
Total earnings attributable to equity
No. of shares
N240,000,000
1,000,000,000
N0.24
N150,000,000
500,000,000
N 0.30
Comment
55
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Abija Plc is expected to issue 30 new shares in exchange for 24 existing shares
in Bayela Plc. This leads to a total issue of
500,000,000 x 30
24
(c)
=
625,000,000 new N1 shares
Market value Basis
The current market price of Abija Plc share is N2.40 and that of Bayela Plc‟s
share is N2.70. To maintain the market value of the holdings, Abija Plc should
issue 9 new shares for each 8 of Bayela‟s shares (i.e 270 for 240). Therefore, the
total number of shares to be issued is
(d)
N500,000,000 x 9
8
Financial Analysis
=
562,500,000 new N1 shares
Abija Plc current cost of equity (assuming no expected growth) is:
Maintainable annual profit
Market value of equity
x 100%
1
=
=
Abija Plc cost of debt is:
N 240,000,000
N2,400,000,000
10% per annum
x 100%
1
Coupon rate x Nominal value
Market value
=
10% x 100
125
=
8%
The after tax cost of debt is therefore 8 (1-tax rate)
=
8 (0.7)
=
5.6% per annum
Abija Plc WACC is: (10 x N2,400,000,000) + [5.6 x (N150,000,000x1.25]
N2,587,500,000
=
9.68% per annum
56
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
The maximum price that Abija Plc would be prepared to pay to Bayela Plc for
this to be an acceptable “project” under conventional capital project appraisal
methods
is:
Earnings of Bayela Plc
Cost of capital of Abija Plc
=
N 150,000,000
0.0968
=
N1.549,586,777
This implies issuing
=
N 1,549,586,777
N2.40
645,661,157 new shares in Abija Plc for
the equity in Bayela Plc
This is an offer of about 129 new shares in Abija Plc for 100 shares in Bayela Plc
as follows:
645,661,157 =
1.29 : 1 or 129 : 100
500,000,000
EXAMINERS‟ REPORT
The question tests candidates‟ knowledge of the different methods of valuing business
units for share exchange under mergers and acquisitions.
Few candidates attempted the question and performance was poor. Many of the
candidates that attempted the question did not understand the concepts tested and
this led to their poor performance.
Candidates‟ commonest pitfalls were their inability to interprete the question correctly
and use of wrong figures in computing the number of shares to be offered to the
shareholders of the target company.
Candidates‟ are advised to always cover the syllabus adequately and give
considerations to all sections of the syllabus in their preparations for the Institute‟s
examinations. They should also improve their knowledge on mergers and acquisitions
for better result in future.
57
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
QUESTION 5
YEAR
DF (10%)
1
2
3
4
0
1.0000
(6,000,000) (6,000,000) (6,000,000) (6,000,000)
1
0.9091
(409,095)
2
0.8264
__
3
0.7513
__
4
0.6830
__
(409,095)
(409,095)
(409,095)
(396,672)
(396,672)
(396,672)
__
(428,241)
(428,241)
__
__
(430,290)
PV of Costs
(6,409,095) (6,805,767)
PV of Scrap value
4,090,950
3,222,960
2,253,900
1,434,300
(2,318,145)
(3,582,807)
(4,980,108)
(6,229,998)
1.7355
2.4868
3.1698
NPV
(7,234,008) (7,664,298)
Divide by Annuity factor
0.9091
Annual Equivalent Cost
(2,549,934) (2,064,424) (2,002,617) (1,965,423)
ADVICE
Year 4 has the least Annuity Equivalent Cost; hence the machine should be replaced
every four years.
58
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
EXAMINERS‟ REPORT
The question tests candidates‟ knowledge of replacement and abandonment decisions.
Many candidates attempted the question and performance was just fair. Most of the
candidates that attempted the question are familiar with the topic but they appear to
have poor understanding of the underlying principles involved in solving it.
Candidates‟ commonest pitfalls were their inability to calculate the Annual Equivalent
Cost (AEC) which is expected to form the basis for the advise. In addition, many
candidates had problems in the lay-out of their solutions and also failed to use the
correct present value.
Candidates are advised to practise with questions on similar topic during their
preparations for the Institute‟s examinations. They should also endeavour to prepare
adequately before sitting for the examinations. The pathfinder and the institute study
packs are strongly recommended for use by candidates.
QUESTION 6
(a)
(i)
Operational planning is concerned with how a specific function or
operation contributes to the achievement of the department‟s corporate
priorities and defence tasks. It is required of Senior Managers who are
tasked with a functional or horizontal responsibility to be well grounded
in operational planning.
(ii)
Tactical planning is a continuous process of decision making about the
accomplishment of outcomes such as what products will be produced,
how success is measured and evaluated and how budgetary resources
are allocated. It is a process of developing detailed short–term decision
about what is to be done, who is to do it and how it is to be done. It is a
Middle Level Management responsibility.
(iii)
Strategic planning is the process of developing and maintaining strategic
fit between the organization‟s goals and capabilities and its changing
market opportunities. It involves defining a clear company mission,
setting supporting objectives, designing a sound business portfolio, and
coordinating functional strategies. It is Top Level Management‟s
responsibility.
59
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(b)
(i)
(ii)
The functions of the Central Securities Clearing System (CSCS) Include:
 Serving as a central depository for share certificates of companies
quoted on the Nigerian Stock Exchange;

Serving as a sub-registry for all quoted securities in conjunction with
registrars of quoted companies;

Issuing Central Securities identification numbers to stockbrokers and
investors;

Clearing and settlement of stock market transactions; and

Safe keeping / custodian of local and foreign instruments.
Functions of the Securities and Exchange Commission (SEC) include:

Determining the amount, timing and pricing of securities to be issued
in the market;

Registering all securities to be traded in the capital market;

Promoting and protecting the integrity of the securities market
against abuses arising from insider trading practices;

Auditing the books of companies and other dealing institutions in the
stock exchange.

Registering all the stock exchange dealers; and

Determining the basis for allotment of securities in the public offer to
ensure a wide spread of ownership.
EXAMINERS‟ REPORT
Part „c‟ of the question tests candidates‟ knowledge of the differences between
strategic, tactical and operational planning under corporate strategy. The „b‟ part tests
candidates‟ knowledge of the functions of one of the key participants in the money
and capital markets. – Securities and Exchange Commission (SEC). In addition, it tests
60
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
candidates‟ knowledge of emerging issues in the stock market with particular
reference to the Central Securities Clearing System (CSCS).
Many candidates attempted the question and performance was average. Majority of
the candidates understood the „a‟ part of the question but the „b‟ part was not well
understood. Functions of the Securities and Exchange Commission (SEC) were confused
for the functions of the Central Securities Clearing Systems CSCS.
Candidates‟ commonest pitfalls were their inadequate knowledge of CSCS hence the
mix up in the functions of CSCS and SEC in the part „b‟ of the question. In addition,
some of the candidates did not understand the meaning of the three planning
concepts stated in the question and were therefore unable to give satisfactory
explanation of each.
Candidates are advised to read wide, and in depth for better result. They should not
limit themselves to reading only textbooks but extend their readings to include
business journals, magazines, newspapers and write-ups on the stock exchange and
also familiarize themselves with current development and terminologies for better
result.
61
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
ICAN/102/F/4
EXAMINATION NO.............................
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
ADVANCED TAXATION
Time allowed – 3 hours
SECTION A Attempt all questions
PART I MULTIPLE-CHOICE QUESTIONS (20 MARKS)
1.
Under the Personal Income Tax Acts CAP P8 LFN 2004, what is the period of
assessment for income tax purposes?
A.
B.
C.
D.
E.
2.
Which Government Agency is responsible for the administration of the Value
Added Tax in Nigeria?
A.
B.
C.
D.
E.
3.
12 months from 1 April
12 months from 1 January
12 months from 1 July
12 months from 30 September
12 months from 31 December
Federal Inland Revenue Service
Directorate of Value Added Tax
Federal Ministry of Finance
State Inland Revenue Service
Federal Ministry of Justice
How is the legislation currently regulating Company‟s Income Tax in Nigeria
captioned?
A.
B.
C.
D.
E.
Company‟s Income Tax Act 1990, as amended
Finance Miscellaneous Taxation Provisions
Federal Inland Revenue Board
Companies Income Tax Act CAP C21 LFN 2004
Personal Income Tax Act
62
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
4.
Who bears the cost of an appeal brought before the Tax Appeal Tribunal?
A.
B.
C.
D.
E.
5.
Which of the following statements is applicable to the grant of full
tax relief period(s) to a Pioneer Company?
A.
B.
C.
D.
E.
6.
Two periods of two years each
One period of two years followed by one period of one year
One period of three years followed by one period of two years
One period of two years followed by another period of two years
Two periods of one year each
What is the tax at specified rate on dividends, rents, royalties and interest
received as well as payments for contracts of supply executed called?
A.
B.
C.
D.
E.
7.
The Tax Auditors
The Legal Practitioners
Each Party to the Appeal
The Tax Authority
The Tax Consultants
Chargeable tax
Assessable tax
Adjusted tax
Withholding tax
Value Added tax
Which of the following is the correct assessable profit subjected to Education
Tax?
A.
B.
C.
D.
E.
Adjusted profit after giving effect to loss relief, balancing charge and
capital allowance
Adjusted profit before giving effect to loss relief, balancing charge but
after capital allowance
Adjusted profit before giving effect to loss relief, balancing charge and
capital allowance
Adjusted profit after giving effect to only loss relief
Adjusted profit after giving effect to only balancing allowance and loss
relief.
63
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
8.
The assessable profit of Praise Limited for the tax year 2009 was N7.5 Million,
with N10 million Loss Relief and N10 million balancing charge. What is the
education tax payable?
A.
B.
C.
D.
E.
9.
Which of these is an Indirect Tax?
A.
B.
C.
D.
E.
10.
Value Added Tax
Capital Gains Tax
Education Tax
Companies Income Tax
Personal Income Tax
Which of the following is an attribute of a good tax system?
A.
B.
C.
D.
E.
11.
N110,000
N130,000
N145,000
N150,000
N90,000
Universality
Directability
Indirectability
Effectability
Reversibility
Which of the following is NOT a Capital Allowance?
A.
B.
C.
D.
E.
Annual Allowance
Personal Allowance
Investment Allowance
Initial Allowance
Balancing Allowance
64
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
12
Which of the following is NOT a duty of the Joint Tax Board?
A.
B.
C.
D.
E.
13.
Which of the following is NOT a condition for granting capital allowances?
A.
B.
C.
D.
E.
14.
The claimant must have incurred qualifying capital expenditure
The claimant must remain the beneficial owner of the assets at the end of
the basis period
The qualifying capital expenditure must be in use mainly for the purpose
of business of the claimant
The qualifying capital expenditure must have been in use for at least two
years
The qualifying capital expenditure must have been in use during the
basis period
On which of the following is education tax computed in line with the provisions
of Income Tax Act Cap C21 LFN 2004?
A.
B.
C.
D.
E.
15.
To settle disputes among the States as regards tax matters
To enforce compliance with Federal Government Revenue matters
To promote uniformity both in the application and incidence of the
provision of tax laws on individuals throughout the country
To settle disputes among States with regards to residence and remittance
To advise the government on request in respect of double taxation
arrangement, rates of capital allowances and other tax matters
Chargeable income
Assessable profit
Adjusted profit
Earned income
Unearned income
Which of the following is an objective of taxation?
A.
B.
C.
D.
To raise money for Government officials
To raise money for Projects only
To exercise control on Individuals‟ expenses
To redistribute Income and Wealth of the Citizens
65
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
E.
16
Which of the following is NOT true for data entry in Excel when applying same
for tax computations?
A.
B.
C.
D.
E.
17
B.
C.
D.
E.
The Registrar General of the Corporate Affairs Commission or his
representative
The Auditor General of Nigeria or his representative
The Accountant General of Nigeria or his representative
The Secretary of the Joint Tax Board
A Director in the Federal Budget office
What is the due date for filing Annual Tax Returns to Federal Inland Revenue
Service by an ongoing business?
A.
B.
C.
D.
E.
19
Values may be calculated with the use of formulas
Data can be calculated accurately
Information is displayed visually
Cell can contain only values
Labels are text headings
Which of the following is a member of the Federal Inland Revenue Service
Board?
A.
18
To raise money for States and Federal Inland Revenue Service
Eighteen months from the company‟s accounting year end
Six months from the company‟s accounting year end
Five months from the company‟s accounting year end
Seven months from the company‟s accounting year end
31December of the year following the year of accounts
What is the Principal Place of Residence of a Partner for tax purposes?
A.
B.
C.
D.
E.
Where he sleeps regularly during the assessment year
His state of origin as at January of the assessment year
His employment address as at 1 January of the assessment year
His place of birth as at 1 January of the assessment year
The place in which he resides at 1 January of an assessment year
66
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
20.
Which of the following is true of withholding tax?
A.
B.
C.
D.
E.
It can be used as offset against education tax liability
It can be used as offset against back year liability
It is an advance payment of tax which is deducted at source
It is a tax on contract regarded as final tax
It is an amount paid to suppliers by Non-Governmental Organisations
PART II SHORT-ANSWER QUESTIONS (20 Marks)
1.
An allowable expense under Petroleum Profit Tax Act Cap P13 LFN 2004, which
is also a form of tax is called........................
2.
What is the tax imposed on companies that fail to commence business after six
months of incorporation?
3.
What is the percentage of tax payable available as rebate to a company which
filed a self assessment?
4.
Conscious refusal to pay tax by committing a criminal act such as making false
returns to the tax office is called ……………….
5.
What tax is due on gains made on the disposal of chargeable assets?
6.
Which body is charged with the responsibility for imposing and collecting
Petroleum Profit Tax in Nigeria?
7.
The day when a company‟s pioneer status is deemed to commence is called
…………….
8.
Under Capital Gains Tax CAP CI LFN 2004, what is claimable when the sales
proceeds have been fully re-invested in the replacement of assets for the
purpose of the company‟s business?
9.
When a new firm or business is exempted from the burden of income tax for a
period of time, such firm or business is said to be on …………………………
67
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
10.
An International Treaty set up by the United Nations to prevent fiscal evasion of
taxes on income and capital goods between countries is
called………………………….
11.
An advance payment on account to be applied as tax credit to settle the income
tax liability of the year to which the income that suffered the deduction relates,
is called………………………
12.
If a firm of tax consultants was paid an amount of N450,000 by a client, what
was the gross fee payable?
13.
Further to Question 12, what is the Withholding Tax deducted?
14.
Which principle of taxation provides that those with the same level of income
should pay the same amount of tax?
15.
The enabling Law for the Federal Inland Revenue Service Board (FIRSB) is
called …………………
16.
What is the punishment for an offence by any person who obstructs or hinders
an officer of the Federal Inland Revenue Service in the performance of his/her
duties?
17.
For a newly incorporated company, due date for filing its first tax returns is
………….. months after its accounting year end or ……………… months from
the date of incorporation, whichever is earlier.
18.
The two types of tax audit embarked upon by the Federal Inland Revenue
Service are …………. and …………...
19.
The tax payers‟ conscious efforts which involve anticipating a set of
circumstances and the identification of opportunities to minimize or defer tax
liabilities within the law is referred to as ………………..
20.
Under the Personal Income Tax Act, CAP P8, LFN 2004, any individual that does
not have a permanent principal place of residence in a year of assessment is
referred to as an ………………….
68
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
SECTION B - ATTEMPT QUESTION ONE AND ANY OTHER THREE (60 MARKS)
CASE STUDY
QUESTION 1
STAPLES LIMITED
Staples Limited is a company engaged in the manufacturing and importation of
certain raw materials. The finished products are sold to wholesalers and some to
designated large organizations.
During the course of the audit, it was discovered that the company did not register for
Value Added Tax (VAT). The Managing Director complained that an additional charge
of 5% on his company‟s products, will make them non competitive with similar
products in the market.
Most of his customers also deduct withholding tax from their invoiced values when
making payments.
Required:
As the tax consultant to the company, advise the Managing Director on:
a) The procedure for registration and penalties for non – compliance with the
provisions of Value Added Tax Cap V1 LFN 2004.
(7 Marks)
b) The differences between Withholding Tax and Value Added Tax.
(8 Marks)
(Total 15 marks)
QUESTION 2
(a)
(b)
(c)
In accordance with the provisions of Personal Income Tax Act, CAP P8, LFN
2004, who are the Members of:
(i)
Joint State Revenue Committee; and
(ii)
Local Government Revenue Committee?
(6 Marks)
State FIVE merits of the withholding tax system.
(5 Marks)
List the stages in a typical tax audit process.
(4 Marks)
(Total 15 Marks)
69
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
QUESTION 3
(a)
Mrs. Bestfeed has been on active employment as Secretary of a Company since
1978 and is now preparing for her retirement. Apart from her employment
emolument, Mrs. Bestfeed runs a private Cybercafé (an enterprise) on
weekends.
Her income from various sources in recent years are as follows:
2009
Annual Basic Salary
N
3,200,000
Annual Transport Allowance
320,000
Annual Housing Allowance
640,000
Annual Leave Bonus
740,000
Overtime
274,000
Benefits in kind (Airtime)
95,000
Annual Meal Subsidy
32,000
Entertainment & Utility allowance
64,000
Other Income
Net Interest on Deposits (2008)
162,000
Net Interest on Deposits (2009)
154,800
Net Rental Income (2008)
225,000
Net Rental Income (2009)
234,000
Adjusted Profit from Cybercafé in 2008 was N925,000 and Capital Allowances
computed for the business amounted to N716,000.
Mrs. Bestfeed is a widow with three children in Private Universities, with total
school fees payment of N1,250,500 per annum. She also maintains her two
aged brothers up to N155,000 per annum and pays N120,000 as annual
mortgage repayment on her personal building, plus an approved pension
70
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
contribution of 71/2% of her total annual basic salary, transport and housing
allowances.
Required:
Compute Mrs. Bestfeed Chargeable Income and Tax Payable for 2009 Year of
Assessment.
(11 Marks)
(b)
(i)
What is a Double Taxation Treaty?
(ii)
Explain the relief available to a Nigerian Company, which has paid tax
on a profit upon which Commonwealth Income Tax has been paid.
(2 Marks)
(Total 15 Marks)
QUESTION 4
(a)
(2 Marks)
Domboshawa Airlines and Logistics Limited, a Zimbabwean Company, was
duly registered in Hutinre after the country‟s independence in 1980. The
company is fully involved in the business of transporting passengers and
goods to and from Nigeria since 1997. It has the following operational
details for the year ended 31 October 2008.
N
Operating Income from passenger tickets from Lagos Airport 28,524,000
Operating Income from passenger tickets from Abuja Airport 17,293,000
Income from goods loaded into aircraft from Lagos
and Abuja Airports
26,460,000
Income from passenger tickets outside Nigeria
203,160,000
Income from goods loaded into aircraft outside Nigeria
74,110,000
1,500,000
The following expenses were debited to Profit
and Loss Account for the period:
Provision for depreciation
Administrative and marketing expenses
Operation Staff Salaries
Provision for bad debts (General)
Fines paid to Federal Airport Authorities
22,990,000
46,200,000
123,920,000
6,997,000
.3
71
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Required:
Using the information given above, compute;
(b)
(i)
The Adjusted Profit of Domboshawa Airlines and Logistics Limited for
the year ended 31 October 2008.
(5 marks)
(ii)
the Nigerian Income tax liability using the current Nigerian Tax rates
for the relevant year of assessment.
(5 marks)
Toluwalase Enterprises Limited had 31 May as its accounting date. The
company is contemplating on changing its Accounting year end to coincide with
the Government year end of 31 December.
You are required to state steps to be followed in determining the Assessable
Profits, if the change is eventually effected.
(5 marks)
(Total 15 Marks)
QUESTION 5
(a)
Mention any FIVE categories of Instruments that could become subject of Stamp
Duties under the Stamp Duties Act CAP S8 LFN 2004.
(5 marks)
(b)
MELTDOWN CONSTRUCTION LIMITED purchased a bulldozer on hire purchase on
1 February 2007 and paid a sum of N28,500,000 as a deposit on the purchase
price.
The cash price of the bulldozer at the time of purchase was N45,000,000, but
Meltdown Construction Limited was allowed to pay the balance in twenty
monthly instalments of N1,000,000 each with effect from 1 March 2007.
You are required to calculate the Capital Gains Tax for the relevant year of
assessment, assuming that the bulldozer was sold for:
(i)
N48,400,000 after the payment of instalment on 3 December,
2007.
(5 marks)
(ii)
N49,600,000 after the payment of instalment on 5 September,
2008.
(5 marks)
(Total 15 Marks)
72
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
QUESTION 6
Ofuobi Nigeria Plc, a large multinational entity, has four (4) subsidiaries which are
engaged in the following distinct businesses – Pharmaceuticals, Telecommunications,
Petroleum operations (Extraction) and Agricultural production.
The Group Managing Director has approached you to find a permanent solution to the
recurring problems which the organization is facing regarding tax compliance issues.
He is keen on having in place a system of monitoring regular/prompt compliance by
the Group.
You are aware that each of the subsidiaries has well staffed Finance Department but
not so for the Holding Company.
You believe that the solution to the Group Managing Director‟s problems rests in the
setting up of a Computer Department/Unit within the Group‟s Head Office.
Required:
What are the Key Data/Issues to be maintained by the Department/Units?
1. CAPITAL ALLOWANCES
TAX RATES
Office Equipment
Motor Vehicles
Office Building
Furniture & Fittings
Industrial Building
Non-Industrial Building
Plant and Machinery – Agricultural
Production
– Others
(15 Marks)
Initial %
50
50
15
25
15
15
Annual %
25
25
10
20
10
10
95
50
NIL
25
73
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
2.
INVESTMENT ALLOWANCE
3.
TAX – FREE ALLOWANCE:
10%
Maximum Per Year
N
150,000
20,000
10,000
5,000
6,000
10% of Annual Basic Salary
Rent
Transport
Utility
Meal Subsidy
Entertainment
Leave
4.
PERSONAL INCOME TAX RELIEFS / ALLOWANCES
(a) Personal Allowance
– N5,000 plus 20% of Earned Income
(b) Children Allowance – N2,500 per annum per unmarried child
subject to a maximum of four children.
(c) Dependent Relative –
(d) Disabled Persons –
(e) Life Assurance
5.
–
N2,000 each
N5,000 or 10% of Earned Income (which ever is
higher)
Actual Premium paid
RATES OF PERSONAL INCOME TAX:
Taxable Income
N
First
30,000
Next
30,000
Next
50,000
Next
50,000
Over
160,000
Rate of Tax
%
5
10
15
20
25
Note: Annual income of N30,000 and below is exempted from tax but a
minimum tax of 0.5% will be charged on the total income.
6.
7.
COMPANIES INCOME TAX RATE
EDUCATION TAX
30%
2%
74
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
8.
9.
10.
CAPITAL GAINS TAX
VALUE ADDED TAX
WITHHOLDING TAXES
Type of payment
Dividend, Interest, Rent
Royalties
Contract supplies
Building construction activities
Consultancy/Professional services
Management services
Commissions
Technical services
Directors fees
10%
5%
Rates
(Companies)
10%
15%
5%
5%
10%
10%
10%
10%
10%
Rates
(Non- corporate)
10%
15%
5%
5%
5%
5%
5%
5%
10%
75
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
SOLUTIONS TO SECTION A
PART I MULTIPLE-CHOICE QUESTIONS
1.
B
2.
A
3.
D
4.
C
5.
C
6.
D
7.
C
8.
D
9.
A
10.
A
11.
B
12.
B
13.
D
14.
B
15.
D
16.
D
17.
A
18.
B
19.
C
20.
C
76
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Tutorial
8. 2/100 x N7,500,000 = N150,000
NOTE:
The balancing charge and the loss relief are not relevant to the calculation.
EXAMINERS‟ REPORT
The questions test various areas of the syllabus.
Candidates‟ performance was generally above average.
Candidates are advised to continue to read all areas of the syllabus.
77
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
PART II
SHORT-ANSWER QUESTIONS
1.
education Tax.
2.
Pre-Operational levy.
3.
The rebate was 1% before the relevant section was repealed in 2007.
4.
tax evasion.
5.
Capital Gains Tax.
6.
Federal Inland Revenue Service.
7.
production day.
8.
Roll-over relief.
9.
Tax holiday.
10.
Double taxation agreement.
11.
Withholding tax.
12.
N450,000.
13.
N22,500.
14.
Canon of horizontal equity.
15.
The Federal Inland Revenue Service (Establishment) Act, 2007.
16.
A fine of N200,000 or an imprisonment of up to three years or both fine and
imprisonment.
17.
six; or within eighteen.
18.
Desk, field audits.
19.
tax planning.
20.
itinerant worker.
78
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Tutorials:
12.
The payment of N450,000 includes 5% VAT, hence 5% of N450,000 = N22,500.
The element of fee in the payment to the Consultants = N427,500. ie N450,000
– N22,500.
The client in paying the N427,500 must have deducted 5% withholding tax from
the fee.
Therefore
Then
13.
N427,500 = 95% of the fee
100% = 100/95 x N427,500
= N450,000
Since the element of fee in Q12 is N427,500, this must have suffered
withholding tax of 5%.
Therefore, Withholding Tax = N450,000 – N427,500 = N22,500.
EXAMINERS‟ REPORT
The questions test all areas of the syllabus.
All the candidates attempted the questions and performance was well above average.
The few candidates that performed poorly in this area are advised to study harder.
79
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
SOLUTION TO SECTION B
QUESTION 1
(a)
CASE STUDY
The Managing Director,
Staples Limited,
Ikeja
Dear Sir
Our review of your tax affairs revealed that your company is yet to register with the
Federal Inland Revenue Service (FIRS) for Value Added Tax purpose.
Please be informed that the provisions of the VAT Act Cap VI LFN 2004 requires taxable
persons to register for VAT purpose within six months of incorporating the business.
Find below the steps to be taken to register your company for VAT.
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
the company should write a letter of application for registration.
Obtain the Vat application form (VAT from 001) from the tax office.
complete the form by supplying the following information:
- The full name of your company;
- Registered/business address;
- Company incorporation number: and
- Date of incorporation.
commencement date, nature of business/services to be rendered.
signature and stamp (bearing the company‟s name) in the relevant sections of
the application form by the officers of the company.
file the application form together with photocopy of the certificate of
incorporation.
Obtain a Tax Identification Number (TIN) after the Federal Inland Revenue
Service official must have confirmed the receipt of the VAT application and
sighted the original Certificate of Incorporation.
As vatable person engaged in taxable supplies, you are required to quote the TIN on
all your correspondences with the Federal Inland Revenue Service (FIRS), on all your
invoices, charge VAT at rate of 5% and file monthly VAT returns within 21 days after
the end of every month
The penalties for not complying with Vat provisions include;
80
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(i)
a fine of N10,000.00 for the first month for not registering and N5,000.00 for
each month the failure continues.
(ii)
a fine of N5,000.00 for every month for not filing Vat returns.
(iii)
a fine of 150% plus 5% interest above the CBN rediscount rate for failure to
charge VAT on taxable supplies/services.
(b) DIFFERENCES BETWEEN WITHHOLDING TAX (WHT) AND VALUE ADDED TAX (VAT)
Withholding Tax (WHT) is an advance payment of Income Tax and the purpose is to
bring the tax payer to the tax net thereby widening the income tax base. In other
words, the WHT system is used to track down tax payers and their incomes, which
may otherwise not be reported by them.
When income on which WHT is deducted at source is finally brought to the notice of
the tax authority and the appropriate tax is computed, credit is given for WHT
deducted at source on the presentation of the original Withholding Tax receipts.
The tax payer will be required to pay only the balance of the tax due after the
determination of the final tax liability and the grant of credits for the WHT suffered at
source. Withholding Tax is nothing more than a collection machinery designed to
curb tax evasion. It is not a separate tax on its own.
Value Added Tax (VAT) on the other hand, is a consumption tax, payable on the goods
and services consumed by any person whether government agencies, business
organizations or individuals. The target of VAT is consumption of goods and services
and unless an item is specifically exempted by law, the consumer is liable to the tax.
With the above explanations coupled with the discussions we had in your office, we
believe you will have no hesitation in completing the forms attached to this letter.
We shall be in your office tomorrow to collect the completed forms to enable us file for
registration in the appropriate VAT office of the Federal Inland Revenue Service
(FIRS). You will please attach a copy of your Certificate of Incorporation. The Federal
Inland Revenue Service (FIRS) will, however, require to sight the original. Please
leave the original Certificate and the completed forms with your secretary. We shall
endeavour to return same before close of business.
81
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Should you require further clarifications, please do not hesitate to contact us.
Yours faithfully,
Akangba Jaje & Co.
Consultants.
EXAMINERS‟REPORT
The question tests Value Added Tax, Withholding Tax and Professional opinion.
Performance was below average.
The major pitfall was that the candidates did not understand the question as a
professional advice which requires a good knowledge of the provisions of VAT Act, and
Withholding Tax Act.
Candidates are advised to prepare adequately for the Institute‟s examinations and
understand the nitty gritty of the provisions of the various Acts, the professional duties
of consultants to the clients and ways of writing professional opinion.
QUESTION 2
(a)(i) Members of the Joint State Revenue Committee are:
- The Chairman of the State Internal Revenue Service who acts as
Chairman to the Committee;
- The Chairman of Local Government Revenue Committee;
- A Representative of the Bureau of Local Government Affairs, not below
the rank of Director;
- A Representative of the Revenue Mobilisation Allocation and Fiscal
Commission (as Observer);
- State Sector Commander of Federal Road Safety Commission (FRSC) as an
Observer; and
- Legal Adviser of the State Internal Revenue Service;
The Secretary to the Committee – a staff of the State Internal Revenue
Service. (The secretary is not a member of the committee).
(ii)
Members of the Local Government Revenue Committee are:
The Supervisor for Finance as the Chairman;
-
Three Local Government Councilors as Members; and
82
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
-
(b)
Merits of Withholding Tax System include;
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(c)
Two other persons experienced in Revenue matters to be
nominated by the Chairman of the Local Government on their
personal merits.
helping to broaden the tax base by bringing many people into the tax
net.
making tax payment less cumbersome to the tax payer who may not have
to border themselves going to the Revenue office to perform their civic
duty.
bringing obscure transactions to the notice of the tax authorities, thus
increasing tax yield.
reducing the incidence of tax evasion.
ensuring a regular inflow of tax revenue to coffers of the various
governments.
helping to educate the taxpayer as well as the collecting agents.
enhancing voluntary tax compliance.
Stages in Tax Audit Process include:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
(ix)
(x)
Selection of the taxpayer to be audited;
Preliminary review of the taxpayer‟s file;
Notification of taxpayer;
Pre-audit meeting;
Field work;
Post audit meeting;
Interim audit report;
Post audit review by regional/headquarter‟s audit unit;
Reconciliation meetings; and
Final Audit Report;
83
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
EXAMINERS‟ REPORT
The question tests candidates‟ knowledge of composition of Joint State Revenue
Committee and Local Government Revenue Committee, Withholding Tax and Tax Audit
Process.
Many candidates attempted the question and performance was below average.
It was evident that most candidates used residual knowledge by repeating all they
listed in one Committee in the other. Candidates exhibited scanty knowledge of Tax
Audit Process.
Candidates are advised to get good grips of what a question requires as repeating
points in different requirements will not earn them any mark.
QUESTION 3
(a)
MRS BESTFEED
INCOME TAX COMPUTATIONS
FOR 2009 YEAR OF ASSESSMENT
N
EARNED INCOME
Employment Income:
- Annual Basic Salary
- Annual Transport Allowance
- Annual Housing Allowance
- Annual Leave Bonus
- Overtime
- Benefit in kind (Airtime)
- Annual Meal Subsidy
- Entertainment & Utility Allowance
Trading Income (PYB)
- Profit from Cybercafé
Capital Allowances Restricted (W1)
3,200,000
320,000
640,000
740,000
274,000
95,000
32,000
64,000
5,365,000
925,000
(616,667)
TOTAL EARNED INCOME
UNEARNED INCOME
2009 Gross Interest on Deposits (W2)
2009 Gross Rental Income (W3)
N
308,333
5,673,333
172,000
260,000
84
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
TOTAL UNEARNED INCOME
TOTAL INCOME
General Charges and Non-Taxable
Payments
- Mortgage Payment
- Pension Contribution (W4)
- Housing Allowance
- Transport Allowance
- Meal Subsidy
- Utility Allowance
- Entertainment Allowance
- Leave Allowance (W5)
432,000
6,105,333
120,000
312,000
150,000
20,000
5,000
10,000
6,000
320,000
(943,000)
5,162,333
STATUTORY TOTAL INCOME
Reliefs
Personal Allowance
(N5,000 + 20% of N5,673,333)
Children Allowance (N2,500 x 3)
Dependant Relatives (N2,000 x 2)
1,139,667
7,500
4,000
CHARGEABLE INCOME
TAX DUE
First
Next
Next
Next
Next
N
30,000
30,000
50,000
50,000
3,851,166
4,011,166
=====
Net Tax Payable
N
1,500
3,000
7,500
10,000
962,792
984,792
@ 5%
@ 10%
@ 15%
@ 20%
@ 25%
Tax Suffered at source
On Dividend (W2)
On Rent
(W3)
(1,151,167)
4,011,166
18,000
25,000
(43,000)
941,792
85
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
WORKING NOTES
W1
W2
W3
W4
W5
(b)
Capital Allowances:
Capital Allowance available
C/A Restricted to 662/3 of N925,000
Unabsorbed C/A C/Fwd
N
716,000
(616,667)
99,333
2009 Gross Dividend = 100/90 x 162,000/1
W/Tax on Dividend = N180,000 – N162,000
=
=
2009 Gross Rental Income = 100/90 x 225,000/1
W/Tax on Rent
= N250,000 – N225,000
=
=
Pension Contribution:
N180,000
18,000
N250,000
N25,000
Annual Basic Salary
N
3,200,000
Annual Transport Allowance
Annual Housing Allowance
Gross Salary
Pension Contribution @ 7½%
320,000
640,000
4,160,000
N 312,000
Allowable Leave Bonus
Restricted to 10% of Annual Basic Salary
Of N3,200,000
=
=
/100 of N3,200,000
N320,000
10
(i)
Double Taxation Treaty:
A double taxation treaty is a bilateral agreement aimed at affording
relief from double taxation, by exempting certain classes of income from
one or other of the territories which are parties to such agreement.
(ii)
Commonwealth Relief to a Nigerian Company:
86
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Where a Nigerian Company (Resident Taxpayer) has paid tax on a profit,
upon which Commonwealth Income Tax has been paid; such company
will be entitled to relief as follows:
 If the Commonwealth Rate of Tax (CRT) does not exceed one half of the
Nigerian Rate of Tax (NRT), the rate at which relief is to be given shall be
the Commonwealth Rate of Tax (CRT).
That is:
If CRT < ½ NRT; Relief = CRT.
 In any other case, the rate at which relief is to be given shall be one half
of Nigerian Rate of Tax (NRT).
That is:
If CRT > ½ NRT; Relief = ½ NRT
EXAMINERS‟ REPORT
The question tests knowledge of Personal Income Tax, with regards to earned Income,
unearned Income, disallowable expenses, reliefs, grossing up of Interest Income and
calculation of Tax Due.
Many candidates attempted the question but performance was average.
Candidates could not segregate earned Income from unearned Income, and statutory
total income. Candidates‟ knowledge of Double Taxation Treaty and Commonwealth
Reliefs was scanty.
Candidates are advised to work harder before sitting for the Institute‟s examinations,
especially a question that deals on practical daily occurrences of Personal Income Tax
should be a point of interest to them.
87
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
QUESTION 4
(a) (i)
DOMBOSHAWA AIRLINE AND LOGISTICS LIMITED
COMPUTATIONS OF ADJUSTED PROFIT
FOR THE YEAR ENDED 31 OCTOBER, 2008
NIGERIAN INCOME
N
Operating Income from
Lagos Passengers tickets
28,524,000
Operating Income from
Abuja Passengers tickets
17,293,000
Income from Goods on Lagos
and Abuja rate
26,460,000
INCOME FROM OTHER ROUTE
Income from Passengers tickets
outside Nigeria
Income from Goods loaded
outside Nigeria
ADJUSTED PROFIT
72,277,000
203,160,000
74,110,000
GLOBAL INCOME
Allowable Expenses
Administrative & Marketing
Operation Staff Salaries
N
46,200,000
123,920,000
277,270,000
349,547,000
(170,120,000)
179,427,000
88
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(ii)
DOMBOSHAWA AIRLINE AND LOGISTICS LIMITED
INCOME TAX LIABILITY
FOR 2009 ASSESSMENT
 Adjusted Profit Ratio
=
=
 Depreciation Ratio
=
=
=
 Capital Allowance
=
=
=
=
Adjusted Profit x 100
Global Income
179,427,000 x 100
349,547,000
51.33%
Depreciation x 100
Global Income
22,990,000 x 100
349,547,000
6.58%
Depreciation Rate x Nigerian Income
N6.58% x 72,277,000
N4,755,827
Nigerian Adjusted Profit
N
N
72,277,000.00
Capital Allowances
For the year
4,755,827.00
Relieved
(Restricted to 66.67% of N72,277,000)
= 48,184,667
limited to
Taxable Profit
67,521,173.00
Income Tax Liability thereon @ 30%
20,256,352.00
(4,755,827.00)
WORKING NOTES
The following expenses are disallowed for tax purpose under CITA, CAP C18, LFN 2004:
 Depreciation of N22,990,000
 General Bad Debts Provision of N6,997,000
89
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
 Fines paid to Federal Airport Authorities N1,500,000.
Note:
Only specific bad debts are allowable for tax purpose.
(b)
Steps to be followed in determining Assessable Profit for Change of Accounting
Date
(i)
Determine the year in which the change occurs. The year of change is
that which the company fails to make up its accounts based on the old
date.
(ii)
Determine the first three discretionary years commencing from the first
year determined in (i) above.
(iii) Calculate the assessable profits for the three discretionary years on the
old accounting date basis.
(iv) Calculate the assessable profit for the three discretionary years on the
new accounting date basis.
(v)
It is the practice of the Federal Inland Revenue Service to choose the
higher of (iii) and (iv) above.
EXAMINERS‟ REPORT
The „a‟ part of the question tests candidates‟ knowledge of Taxation on foreign air
operation with respect to transportation of passengers and goods to and from Nigeria,
while the „b‟ part tests candidates‟ knowledge of change of accounting date.
Less than 75% of the candidates attempted this question and performance was below
average.
Candidates did not understand the calculation of adjusted Profit ratio, the
depreciation ratio and the use of depreciation ratio in calculating capital allowances.
Candidates are advised not to relegate any part of the syllabus to the background.
They need to have adequate knowledge of all parts of the syllabus.
QUESTION 5
(a) Categories of Instruments subject to Stamp Duties under the Stamp Duties Act,
CAP S8, LFN 2004 include:
1.
Agreements;
2.
Appraisement;
3.
Bank Notes, Bills of Exchange and Promissory Notes;
4.
Bills of Exchange;
90
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(b)
5.
Bills of Lading;
6.
Contract Notes;
7.
Conveyances on sale and other conveyances;
8.
Duplicates and Counterparts;
9.
Exchange, Partition or Division;
10.
Leases;
11.
Letters or Power of Attorney and Voting Powers;
12.
Marketable Securities;
13.
Mortgages;
14.
Notarial Acts;
15.
Policies of Insurance;
16.
Receipts;
17.
Settlements;
18.
Share Warrants;
19.
Warrants for Good; and
20.
Share Capital of Companies.
21.
Documents requiring postage stamp: and
22.
Transactions in the Capital Market.
(i)
MELTDOWN CONSTRUCTION LIMITED
COMPUTATIONS OF CAPITAL GAINS TAX
FOR 2007 YEAR OF ASSESSMENT
N
N
Sales Proceed of Bulldozer
N
48,400,000
Cost of Bulldozer
Deposit Paid
28,500,000
91
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Instalments Paid
(10 months @ N1,000,000 each) 10,000,000
Interest Portion paid (W2)
(1,750,000)
8,250,000
(36,750,000)
Chargeable Gains
Capital Gains Tax thereon @ 10%
(ii)
11,650,000
1,165,000
MELTDOWN CONSTRUCTION LIMITED
COMPUTATIONS OF CAPITAL GAINS TAX
FOR 2008 YEAR OF ASSESSMENT
N
N
N
Sales Proceed of Bulldozer
49,600,000
Cost of Bulldozer
Deposit Paid
Instalments Paid
(19 months @ N1m each)
Less Interest Portion paid (W3)
28,500,000
19,000,000
(3,325,000)
Chargeable Gains
Capital Gains Tax thereon @ 10%
15,675,000
(44,175,000)
5,425,000
542,500
WORKING NOTES
(W1) Calculation of Hire Purchase Interest
Hire Purchase Price:
Deposit (1/2/2007)
20 Instalments Payable
N
28,500,000
92
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(March 2007 to October 2008)
@ N1,000,000 per month
20,000,000
48,500,000
Cash Price
45,000,000)
Hire Purchase Interest for 20 months
3,500,000
(W2) Calculation of Hire Purchase Interest up to 1/12/2007
Hire Purchase Interest Payable
N3,500,000
Hire Purchase Interest at the time
of Disposal – 3/12/2007
N3,500,000
20
x
10
N1,750,000
(W3) Calculation of Hire Purchase Interest up to 1/10/2008
Hire Purchase Interest for 19 months
at the time of Disposal (i.e. 5/9/2008)
=
N175,000 x 19months
N3,325,000
EXAMINERS‟ REPORT
The question tests candidates‟ knowledge of instruments subject to Stamp Duties and
Hire Purchase installments in Capital Gain Tax.
Many candidates attempted the question, but performance was very poor.
Majority of the candidates did more of guess work in listing the instruments that could
become subject of Stamp Duties in the „a‟ part of the question. The „b‟ part was
completely misunderstood by majority of the candidates.
Candidates are advised to study adequately with the aim of having basic knowledge of
these areas of the syllabus.
93
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
QUESTION 6
KEY DATA AND ISSUES INVOLVED IN INSTALLING A GOOD COMPUTERISED TAX
COMPLIANCE MONITORING SYSTEM IN THE GROUP‟S HEAD OFFICE
In view of the desire of the Group Managing Director in finding a permanent solution
to the problems encountered in monitoring regular and prompt compliance with tax
issues by the Group, it is recommended as follows:
HARDWARE
An Information Technology (IT) consultant and other members of the steering
committee should be appointed to supervise the selection and purchase of appropriate
computer hardware for installation.
SOFTWARE
Compatible software should also be purchased that will network all modules for ease
of preparation of monthly report and meeting all recurrent obligations including Tax
matters.
ISSUES
(a)
The new process will provide data of what constitutes income for tax purposes
for each subsidiary. When correctly done, VAT resulting from turnover will be
ascertained,
(b)
Detailed records of all purchases especially to capture input VAT incurred on
purchases,
(c)
Details of Fixed Assets and calculation of monthly depreciation.
(d)
Details of allowances and reliefs claimable for Agricultural and Petroleum
Operations. Also, other details of allowable expenses in all the various
departments in accordance with the Companies Income Tax Act Cap C21 LFN
2004 and Value Added Tax Cap VI LFN 2004 should be contained in the system.
(e)
Due dates for filing annual tax returns, monthly Value Added Tax Returns and
monthly Pay As You Earn (PAYE) returns.
94
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(f)
Schedule of deduction and payment of Withholding Tax.
(g)
Tax Identification Number (TIN) of each of the companies within the group.
(h)
All the tax computations for all relevant years of assessment, capital allowance
and taxes paid.
(i)
Monitoring of status of tax compliance by both the Holding Company and the
Subsidiaries
(j)
Adequate training and workshops for staff members concerned.
EXAMINERS‟ REPORT
This question tests candidates‟ knowledge of the use of Information Technology in
taxation.
Few candidates attempted the question and performance was poor.
Candidates‟ knowledge of this area of the syllabus appeared to be grossly inadequate.
Candidates are advised to have basic knowledge of Information Technology as it
relates to taxation.
95
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
ICAN/
EXAMINATION NO..............................
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA
PROFESSIONAL EXAMINATION ll - NOVEMBER 2010
PUBLIC SECTOR ACCOUNTS AND FINANCE
Time allowed – 3 hours
SECTION A: Attempt All Questions
PART I
1.
MULTIPLE-CHOICE QUESTIONS (20 Marks)
Which of the following is the biggest revenue source in recent times in Nigeria?
A.
B.
C.
D.
E.
2.
Which of the following is NOT an example of “financing activities” in the
preparation of government accounting cash flow statement?
A.
B.
C.
D.
E.
3.
Companies Income Tax.
Education Tax.
Capital Gains Tax.
Petroleum Profits Tax.
Import/Excise Duties.
Proceeds from loans.
Proceeds from the sale of assets.
Proceeds from bank overdraft.
Dividends received.
Repayment of loans.
Into which account are the proceeds of the PAYE of the Armed Forces, Police
Forces, Foreign Service officers and Residents of the Federal Capital Territory
paid?
A.
B.
C.
D.
E.
Special Fund Account.
Development Fund Account.
Contingency Fund Account.
Federation Account.
Consolidated Revenue Fund Account.
96
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
4.
Which Warrant is expected to be in operation for a maximum of six months or
until the budget has been approved?
A.
B.
C.
D.
E.
5.
For which of the following will corporations NOT obtain the approval of the
Supervising Ministry?
A.
B.
C.
D.
E.
6.
provide adequate welfare.
stabilize balance of trade.
increase its expenditure.
reduce its income.
determine supply.
Which of the following statutory officers does NOT have his salaries and
consolidated allowances chargeable directly to the Consolidated Revenue Fund?
A.
B.
C.
D.
E.
8.
The budget.
Signing of foreign agreement.
Payment of staff monthly salaries.
The bye laws.
Increasing the price of its goods and services.
The main objective of government is to
A.
B.
C.
D.
E.
7.
Supplementary (Contingency) Warrant.
Annual General Warrant.
Provisional General Warrant.
Supplementary General Warrant.
Supplementary (Statutory Expenditure) Warrant.
Commissioner of the Police Service Commission.
Accountant – General of the Federation.
Chairman Code of Conduct Bureau.
Chief Judge of the Federal Court of Appeal.
Chairman Federal Character Commission.
Which of the following standards sets out the requirements for financial
reporting by governments and other related public sector organizations?
A.
B.
C.
International Government Accounting Standards.
International Accounting Standards.
International Public Sector Accounting Standards.
97
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
D.
E.
9.
To which of the following can any officer found guilty of the contravention of
any of the provisions of the Code of Conduct Tribunal appeal?
A.
B.
C.
D.
E.
10.
Trading and Profit and Loss Account.
Balance Sheet.
Value Added Statement.
Cash Flow Statement.
Income and Expenditure Account.
Which of the following ratios does not indicate the working capital of a
parastatal?
A.
B.
C.
D.
E.
12.
Magistrate Court.
Court of Appeal.
Supreme Court.
Federal High Court.
State High Court.
Which of the following is a „not-for-profit‟ entity expected to prepare?
A.
B.
C.
D.
E.
11.
International Financial Reporting Standards.
Government Accounting, Auditing and Financial Reporting Standards.
Current ratio.
Quick ratio.
Gearing ratio.
Debtors‟ payment period.
Creditors‟ payment period.
Which of the following is a disadvantage of payback period method of
investment appraisal?
A.
B.
C.
D.
E.
It is a measure of liquidity.
It is used as a safeguard against risk.
It is not difficult to calculate and understand.
It does not consider the time value of money.
It serves as a useful screen to evaluate projects.
98
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
13.
Which of the
Government?
A.
B.
C.
D.
E.
14.
NOT
a
Memorandum
Accounts
Book
in
Departmental Vote Expenditure Allocation Book.
Dishonoured Cheques Register.
Paper Money Register.
Cash Book.
Cheque Summary Register.
Debit Materials Account, Credit Goods Account
Debit Cash Account, Credit Goods Account
Debit Materials Account, Credit cash Account
Debit Cash Account, Credit Purchases Account
Debit Materials Account, Credit Stock Account.
What is the budgeting technique which requires every item of
expenditure to be justified as if the activity or programme is taking
off for the first time?
A.
B.
C.
D.
E.
16.
is
Which of the following entries records the purchase of sodium chloride, for cash,
by Atuma State Water Corporation?
A.
B.
C.
D.
E.
15.
following
Incremental budgeting.
Line item budgeting.
„Zero-base‟ budgeting.
Planning, programming and budgeting system.
Performance budgeting.
What is the revenue allocation principle which requires that the States from
which the bulk of revenue is generated should receive an extra share above
other States?
A.
B.
C.
D.
E.
Derivation.
Generation.
Even development.
National interest.
Independent revenue.
99
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
17.
Which of the following fiscal policy measures can help to protect infant
industries?
A.
B.
C.
D.
E.
18.
Which of the following is NOT an instrument of government‟s domestic
borrowing?
A.
B.
C.
D.
E.
19.
Treasury Bills.
Treasury Certificates.
Bill of exchange.
Government Development Stocks.
Revenue Bonds.
Which of the following international financial institutions grants balance of
payments support facilities to countries in need?
A.
B.
C.
D.
E.
20.
Increase in Value-Added Tax rate
Increase in import duties.
Increase in export duties.
Increase in excise duties.
Reduction in subsidies.
London Club of Creditors.
Paris Club of Creditors.
The World Bank.
International Monetary Fund.
African Development Bank.
Which of the following is an instrument of fiscal policy?
A.
B.
C.
D.
E.
Discount rate.
Open Market Operation.
Reserve requirements.
Government expenditure.
Selective credit control.
100
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
PART I SHORT-ANSWER QUESTIONS (20 Marks)
1.
The sourcing of the cash requirements of a public sector organization and the
effective application of same in such manner that projects are executed
unhindered is known as_______________________
2.
A summary of total receipts and payments as posted in the cash book of a selfaccounting unit is called______________________
3.
A debt for which no fund has been set up and whose maturity period is short is
known as________________________
4.
The supervision of the activities of a government entity with the authority and
responsibility to control or exercise significant influence over the financial and
operating decisions of the organization is called_____________________
5.
The method adopted where the implementation of a project is to be accelerated
is known as_____________________
6.
Evidence that a contractor or supplier has performed its obligation under a
procurement contract up to a level stipulated but not implying completion is
called___________________
7.
Under the Fiscal Responsibility Act of 2007, the projected amount expected to
be utilized in granting tax reliefs, tax holidays and tax concessions
is_____________
8.
Not later than ninety days following the end of each year, the distribution from
the Federation Account shall be rendered to both Houses of National Assembly
by the _____________________
9.
The sharing of revenue among the States of the Federation is called
____________
10.
A non-statutory discretional assistance from the Federal Government to a State
which is not tied to a particular project is a ____________
11.
The use of taxation and public expenditure by the government to influence
aggregate economic activities is called ____________
101
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
12.
In taxation, the object being taxed, such as income or property, is the
____________
13.
The spill-over effects of the production and consumption activities of economic
units such as pollution on others are called ____________
14.
A National Plan which is adjusted yearly in keeping with the requirement of the
economy is called ____________
15.
The independent body charged with the responsibility of sharing revenue
among the three levels of government in Nigeria is the ________________.
16.
The economic system which encourages private ownership of resources is
called_________________
17.
State any two criteria of revenue allocation in Nigeria.
18.
The tax structure that tends to bridge the income gap between the rich and poor
is the ________________.
19.
A public debt for which no provision is made for its repayment is known
as________________.
20.
Taxes levied on goods and services are classified as ___________________
SECTION B: ATTEMPT QUESTION 1 AND ANY OTHER THREE (60 Marks)
QUESTION 1
CASE STUDY – WORN OUT CONTROLS
GETWELL Specialist Hospital was hurriedly commissioned when there was an outbreak
of cholera epidemic in Baraje town, by the EMMONY State Government in January,
2006.
The first external auditor had been qualifying his report annually because
“everything” on internal control was virtually upside down, except the regular
provisions of the health care to the patients. The external auditor clamoured for the
102
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
establishment of an Internal Audit Department as a panacea to curb, correct and arrest
the collapse of the “internal control.”
The unit was eventually established in December, 2008. In addition to the normal
routine assignments of the unit, it was mandated as a matter of urgency, to review the
financial statements of the hospital for the period, 1 January to 31 December, 2008,
which the external auditor will work upon in April, 2009.
The Internal Audit unit submitted a comprehensive interim report covering the
operations in the following departments: Finance/Accounts, Stores, Pharmacy and
General Out-patients. The report was catalogue of woes, disaster, colossal losses,
misappropriations, etc. Extracts from the report are highlighted below:
(i)
The losses and shortages in all the units visited were colossal because of the
obvious “worn out controls” in the hospital;
(ii)
The records in all the stores, especially the Main/Central Store were
inadequately and wrongly prepared. Records were kept in arrears of five to six
months. More than 80% of the physical items identified in the stores had no
bearing to their store records;
(iii)
The only attempt at “stock taking” ever done was in mid – 2008 by the stores
personnel and there were no acceptable records of the exercise;
(iv)
Items received into the Main/Central store for which payments were made had
their “invoices” and “goods received notes” not processed in the store;
(v)
Issues from the stores were not rightly executed; nearly every issue was done in
hurry and for emergency sake;
(vi)
Fixed assets, particularly/motor vehicles, accident vehicles, generators,
intensive care equipment, X-ray equipment etc, could not be ascertained with
accuracy. There was no fixed assets register.
(vii)
Cash count at the Treasury and all cash points were non-existent. There were
bank reconciliation statements on four out of the eleven operated. These bank
reconciliation statements were haphazardly prepared, hence they were
misleading;
(viii) Less than 60% of the cash takings in the hospital in the last three months had
been banked and the balance had been used to grant advances and pay staff
salary/wage. Cash records were in arrears for over four months and three of the
103
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
seven cashiers had absconded with the hospital‟s fund and a principal officer in
the Treasury is missing; and
(ix)
There was a long list of unsettled cash advances and cheque exchange, most of
which were not properly authorized. Despite the seriousness of this action,
management did not take appropriate disciplinary action against the cashiers.
The internal audit department was worried over the situation and had advised
the management of the hospital to call for a “Board of Enquiry” or “Losses
Committee” to ascertain and recover the colossal losses and shortages.
You are required to:
(a)
(b)
(c )
(d)
(e)
State the TWO types of losses incurred in this hospital.
(2 marks)
State any FOUR major likely causes of the colossal losses in this hospital.
(4 marks)
In line with the provisions of the Financial Regulations, 2006, is the „Losses
Committee‟ the more appropriate in this situation then the „Board of Enquiry‟?
(2marks)
State any FIVE issues to be considered before setting up a „Board of Inquiry‟.
(5marks)
Give any TWO reasons why cheque exchange and/or cash advance is considered
a serious offence.
(2 marks)
(Total 15 marks)
QUESTION 2
Ireakari Local Government is considering projects A and B which have the following
cash flows:
Year
Cash flows
A (N)
B (N)
0
1,300
1,200
1
250
400
2
750
500
3
400
600
4
150
600
5
100
300
Required:
(a)
Use the table above to compute the Net Present Value (NPV) of the two projects,
given that the cost of capital is 15%. All calculations to 2 decimal places.
(11 Marks)
104
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(b)
Advise the government on which of the projects to undertake and give reasons
for your answer.
(4 Marks)
(Total 15 Marks)
QUESTION 3
Confluence Local Government is considering embarking on an investment and has
been presented with the following three alternatives:
Initial Cash Outlay
Residual Value
Yr 1
Yr 2
Yr 3
Yr 4
EL
N‟000
15,000
1,000
EM
N‟000
20,000
1,000
EN
N‟000
20,000
1,000
EL
N‟000
6,000
7,000
8,000
9,000
EM
N‟000
10,000
10,000
1,000
1,000
EN
N‟000
1,000
6,000
10,000
20,000
Assume that the projects are mutually exclusive.
You are required to advise the Council on the most viable project, using
(a)
(b)
Payback period; and
Accounting Rate of Return, methods.
(5marks)
(10 marks)
(Total 15 Marks)
QUESTION 4
The following transactions were anticipated by the office of the Accountant-General of
Falcun Federation for the year ended 31 December 2009:
N(million)
Revenue Anticipated:
Import duties
Export duties
Excise duties-Local companies
35,000
118,000
1,875,000
105
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Petroleum profit tax
625,500
Capital gains tax
87,000
Royalty on oil
900,000
Crude oil sales proceeds
750,000
Companies income tax
75,000
Personal income tax:
Military personnel
70,000
Officers of the Foreign Affairs Ministry
35,000
Residents of Federal Capital Territory
45,350
Quarrying licenses
42,900
Medical fees
Visa Fees
Repayment of loan by Local Govt.
Rent of Government Land
Overpayment Recoverable
N(million)
96,540
65,500
730,000
225,000
95,000
The following expenditure items were also anticipated:
a.
b.
c.
d.
Establishment cost
Personnel cost
Special expenditure
Transfer to Development Fund
N(million)
807,500
1,267,500
312,500
425,000
During the year, the following transactions took place:
(i)
Balance on the Consolidated Revenue Fund as at 1 January, 2009 was N850,
725 million;
(ii)
There was a problem in Bayana State which gave rise to N1,750 million
being withdrawn from the Contingency Fund. However, N1,365
million was transferred back before 31 December, 2009;
(iii)
Due to incessant political crisis in the Federation, only 80 per cent of the
budgeted revenue was realized. Similarly, the expenditure incurred was limited
to 75% of the estimated figures; and
106
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(iv)
The balance in the Federation Account as at 31 December, 2008 was N1,800
billion.
You are required to:
(a)
Prepare the Federation Account Statement as at 31 December, 2009 and
distribute same, based on the existing revenue sharing formula, viz:
Federal
States
Local Governments
Special Fund
48.6 per cent
24.0 per cent
20.0 per cent
7.5 per cent
(5 ½ marks)
(b)
Prepare the Consolidated Revenue Fund for Falcun Federation for the period
under review, in accordance with the provisions of the Finance (Control and
Management) Act 1958 (as Amended)
(9 ½ marks)
(Total 15 marks)
QUESTION 5
(a)
We have various users of Public Sector Accounting information. State any THREE
internal users and any THREE external users of the information.
(6 Marks)
(b)
State six differences between Government Accounting and Private Sector
Accounting.
(9 Marks)
(Total 15 Marks)
QUESTION 6
RIVER BASIN AUTHORITY, OLUOKUN STATE
INCOME AND EXPENDITURE ACCOUNTS FOR THE YEAR ENDED 31 DECEMBER, 2009
N
N
Gross Income
41, 100, 000
Costs incurred
Salaries and Pension
Purchase of weed control chemical
Depreciation (tractors, etc)
Lubricants and Oil
15,000,000
3,600,000
2,000,000
1,600,100
107
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Purchase of stationery
Utility (water, light, etc)
1,100,100
500,000
(23,800,200)
17,299,800
Interest due
Bank loan
Agric bank loan
Surplus realized on
Ordinary operations
Surplus for last year b/f
Surplus carried forward
1,040,000
2,960,000
(4,000,000)
13,299,800
9,500,200
22,800,000
You are required to:
(a)
(b)
Prepare the Value Added Statement for the year ended 31 December, 2009;
(10 marks)
Briefly differentiate between “Value-Added” and
“Value Added Statement.”
(5 marks)
(Total 15 marks)
SOLUTIONS TO SECTION A
PART l MULTIPLE CHOICE QUESTIONS
1.
D
2.
B
3.
E
4.
C
5.
D
6.
A
7.
B
8.
C
9.
B
10.
E
11.
C
12.
D
13.
C
14.
C
15.
A
108
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
16.
17.
18.
19.
20.
B
C
D
D
D
EXAMINERS‟ REPORT
The questions have a good spread and adequately cover the two aspects of the
syllabus – the public sector accounts and public finance. The candidates performed
creditably well.
PART II SHORT-ANSWER QUESTIONS
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
Cash control.
Transcript.
Floating debt.
Oversight.
Selective or Limited Tender procedure.
Interim Performance Certificate.
Tax Expenditure Projections.
Accountant-General.
Horizontal Revenue Allocation/Horizontal Distribution.
General or Non-matching grant.
Fiscal policy.
Tax base.
Externalities.
14.
15.
16.
Rolling plan
Revenue Mobilization Allocation and Fiscal Commission (RMAFC).
Capitalism/Capitalist Economy/Free Enterprise/Market Economy/System/Liassezfaire.
Derivation, Even development, Need, National interest, Equality of
states, Independent Revenue, Population
Progressive.
Unfunded.
Indirect.
17.
18.
19.
20.
109
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
EXAMINERS‟ REPORT
The short answer questions test the various aspects of the syllabus. Candidates‟
performance was generally above average, an indication that they were generally
exposed to the various aspects of the syllabus. Candidates can still improve by
familiarizing themselves with new principles, concepts and technical terms related to
this subject.
SOLUTIONS TO SECTION B
QUESTION 1
CASE STUDY
Two types of losses in the hospital are:
(a)
(i)
(ii)
(b)
Likely major causes of losses include:
i)
ii)
iii)
iv)
v)
vi)
vii)
viii)
ix)
Loss of stores; and
Loss or shortages of funds.
Poor or weak internal control.
Inadequate record keeping of essential books.
Lack of sound stores control and management.
Obvious non-existence of cash and bank operation control.
Non-existence of the required controls on fixed assets.
Poor staffing, putting a “square peg in a round hole” and no standard
organizational set up.
Delayed introduction of the Internal Audit Department;
The hospital was hurriedly commissioned without any plan, rules and
regulations to guide its operations; and
Non-adequate consideration of the external auditors‟ recommendations.
(c)
The “Board of Enquiry” is more appropriate/applicable here
(d)
The Board of Enquiry should be set up If
i)
ii)
iii)
fraud is probable;
the loss is substantial;
several officers are involved;
110
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
iv)
v)
vi)
the responsibility of officers is not clearly defined;
the loss took place over a period of time; and
collution is suspected.
(e) Cheque exchange and/or cash advance is considered a serious offence because it
i)
ii)
iii)
iv)
v)
is a veritable tool for fraud;
could be used to conceal the true position of case on hand;
is a good example of „teeming and lading;
may impair the liquidity position of the hospital; and
deprives an organization the use of its resources.
EXAMINERS‟ REPORT
The question tests candidates‟ understanding of some aspects of treasury procedures
on loss of funds and stores, and internal control system in a public institution.
Candidates are expected to demonstrate familiarity with the provisions of the Financial
Regulations (2006).
All the candidates attempted the question. The general performance was average.
There was a clear indication that candidates did not have proper understanding of the
Financial Regulations relating to the issues that were tested in the question.
Candidates are advised to always take some time to understand case studies before
attempting the questions. It is also necessary for candidates to familiarize themselves
with Financial Regulations and other relevant publications.
QUESTION 2
(a)
IREAKARI LOCAL GOVERNMENT PROJECTS EVALUATION
PROJECT
A
Year
15%dD
0.87
0.76
YearDiCash
Discounting
flows Values
Factor
(N)
(N)
15%
0
1.00 (1
(1,300)
(
0.87
1
0.87
250
0.76
2
1.76
750
(N)
(1,300)
217.50
570.00
PROJECT B
Cash flows
(N)
Values
(1,200)
400
500
(1,200)
348.00
380.00
(N)
111
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
0.66
0.57
0.50
0.66
3
0.57
4
0.50
5
1.66
1.57
1.50 100
400
150
85.50
100
50.00
264.00
85.50
50.00
(113.00)
600
600
300
396.00
342.00
150.00
416.00
Formula:
NPV
where
A
−
r
−
C
−
t
−
cash flow
cost of capital (15%)
initial outlay
time
NPVA =
N (− 1,300 + 1,187)
NPVB =
N (− 1,200 + 1,616) = N 416.00
(b)
= N − 113.00
Based on the above calculations, Ireakari local government should embark on
project B because it gives a positive Net Present Value (NPV) of N416.00. This
means that project B is more viable as its investment value obtained is higher
than its outlay.
DISCOUNT TABLE
DISCOUNT
Year
0
1
2
3
4
5
TABLE
DF 15%
1.000
0.8696
0.7561
0.6575
0.5718
0.4972
EXAMINERS‟ REPORT
This is a straightforward question on public project appraisal. It requires candidates‟
ability to calculate the Net Present Value (NPV) and determine the viability or
otherwise of a project, based on expected cash flows.
112
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Majority of the candidates attempted the questions and the performance was quite
impressive. However, a few of the candidates approximated their calculations to more
than two decimal places, contrary to the requirements of the question and they lost
valuable marks.
Candidates are advised to follow strictly the requirements of questions as given.
QUESTION 3
CONFLUENCE LOCAL GOVERNMENT
(i)
Payback period
EL
N „000
15,000
EM
N „000
20,000
EN
N „000
20,000
Less: Yr 1 inflow
6,000
9,000
10,000
10,000
1,000
19,000
Less: Yr 2 inflow
7,000
2,000
10,000
-
6,000
13,000
Less: Yr 3 inflow
8,000
-
-
10,000
3,000
Less: Yr 4 inflow
-
-
20,000
-
Initial Cash Outlay
Payback Period for EL is 2 years + (2000/8000*12) = 2 years, 3 months.
Payback Period for EM is 2years.
Payback Period for EN is 3 years + (3000/20000*12) = 3 years, 2 months.
113
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
ADVICE
From the above, Project EM should be chosen because it has the shortest payback
period.
(ii) Accounting Rate of Return
EL
N(000)
EM
N(000)
EN
N 000)
6,000
7,000
8,000
9,000
30,000
4
N 7,500
10,000
10,000
1,000
1,000
22,000
4
N 5,500
1,000
6,000
10,000
20,000
37,000
4
N 9,250
Annual Profit
Yr 1
Yr 2
Yr 3
Yr 4
Total profit
No of yrs
Average Annual
Accounting Profit
Average Investment =
EL
N(000)
15,000
1,000
16,000
2
N8,000
Cash Outflow
Residual Value
Total
Average
inve
stm
ent
EM
N(000)
20,000
1,000
21,000
2
N10,500
EN
N(000)
20,000
1,000
21,000
2
N10,500
ARR =
=
=
Q
7,500
5,500
9,250
8,000
10,500
10,500
0.937
0.523
0.881
94%
52%
88%
114
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
ADVICE
From the above, Project EL should be selected as it yields the highest accounting
rate of return of 94%.
EXAMINERS‟ REPORT
This is a question on investment criteria applied to public sector projects. It tests
candidates understanding of the criteria of payback and accounting rate of return
methods in project evaluation. Using these criteria, candidates are expected to
appraise economic viability of the three projects and advise the Council accordingly.
The question was very popular as over four-fifths of the candidates demonstrated good
understanding of the appraisal methods.
QUESTION 4
FALCON FEDERATION
Federation Account Statement As At December 31, 2009
N million
Balance b/f – 1/1/2009
Import duties
28,000
Export duties
94,400
Excise duties – Local
1,500,000
Petroleum Profit Tax
500,400
Capital Gains Tax
69,600
Royalty on oil
720,000
Crude oil sales
600,000
Companies income tax
60,000
Sharing:
Federal
States
Local Governments
Special fund
N million
1,800,000
3,572,400
5,372,400
%
48.5
N million
2,605,614
24.0
20.0
7.5
1,289,376
1,074,480
402,930
5,400
5,372,400
115
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
b). FALCON FEDERATION
Consolidated Revenue Fund as at 31 December, 2009
N million
Balance b/f – 1/1/2009
Issues from contingency
1,750
Transfer to contingency
(1,365)
Revenue (1/1/09-W(i)
3,729,846
Expenditure
(1/1/091,790,625
31/12/09) W (ii)
Transfer to development
Fund
Balance
as
at
31.12.2009
N million
850,725
385
1,939,221
(318,750)
2,471,581
Notes/Workings:
i)
These are the revenues items accruing to Falcun State alone, viz
Personal income tax:
Military
Foreign Affairs Ministry
Residents of FCT
Quarrying licenses
Medical fees
Visa fees
Repayment of loan by local
governments
Rent on government land
Overpayment recoverable
Federation Account -Allocation
To Consolidated Revenue Fund
N million
56,000
28,000
36,280
34,320
77,232
52,400
584,000
180,000
76,000
2,605,614
3,729,846
ii) The summary of overhead costs anticipated, limited to 75%:
Establishment cost
Personnel cost
N million
605,625
950,625
116
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Special expenditure
To Consolidated Revenue Fund
234,375
1,790,625
EXAMINER‟S REPORT
The question tests candidates‟ knowledge of the preparation of the Federation Account
Statement and the Consolidated Revenue Fund (CRF) Account.
The performance, however, was below average. The candidates did not have proper
understanding of the question. Most of them did apply the operating condition of 80%
of budgeted revenue realizable and 75% of expenditure incurable as stated in the
question. Another common pitfall was the expression of naira value in „thousands‟ or
ordinary naira value, instead of Naira value in Millions.
Candidates are advised to always take note of instructions in questions and be mindful
of correct interpretation of same. They should also avail themselves of valuable and
relevant materials contained in Study Packs and Pathfinders of the Institute.
QUESTION 5
(a)
The following are the internal users of government accounting information and
their uses:
Internal
a.
The trade union
b.
The employee
c.
The Administrator in the ministry
d.
The Management in the Ministry
e.
The subordinates who are given with control
External Users
These are those who use Government Financial information that are not prepare within
their Department, e.g.
a.
Members of the legislature and selected committees of the houses.
117
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
b.
c.
d.
e.
f.
g.
h.
Government other than the reporting government e.g. State and Local
Governments.
Researchers and representative of the media.
The general public.
Sectional groups in the population e.g. Political Parties, Human Right
Groups etc.
Foreign interest like Paris Club, London Club etc.
Regional Organization e.g. EU, ECOWAS, etc.
Rating Agencies e.g. Flitch.
Tutorials on Internal Users
a.
b.
c.
d.
e.
They use it to agitate for better welfare of staff increase in salary.
They use it to argue or agitate for increase in salary.
They use it for planning and control.
They use it for planning and control.
They use it to execute government.
(b)
Comparison Of Government Accounting And Private Sector Accounting
S/NO
I
Differences
Objectives
ii
Accounting Basis
iii
Income/Revenue
iv
Treatment of cost of
Fixed Assets
v.
Accountability
/Responsibility
Public
Provision of adequate
welfare services at
reasonable cost.
The government records
its financial transactions
on cash basis.
Revenue is from members
of the public in form of
taxation, custom duties,
etc.
Written off immediately
after
purchase
and
payment.
The
government
primarily responsible
the citizenry.
is
to
Private
To maximise profit.
The
private
sector
records are shown on
accrual basis.
Income is from the
sales of goods and
services.
The costs are spread
over the estimated
useful life of the fixed
assets.
Business/private entity
is responsible to the
shareholders.
118
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
vi.
Exclusion principle
on provision of
goods and services
vii.
Formation
viii
Auditing
Ix
Accounting
x
Efficiency
Xi
Treatment of
Dividend
Xii
AGM
Benefit does not match
contribution. Services are
rendered irrespective of
the contributions of those
benefitting from them.
Comes in various forms.
Ministries,
parastatals;
they have their Enabling
Acts.
Accounts are audited by
the
AuditorGeneral
through the approved
External Auditors.
Fund
accounting
is
adopted.
Measured by services
rendered.
Dividends
are
not
paid/declared
to
shareholders.
No AGM of stakeholders
Goods and services
depend on how much
is paid.
Incorporated
companies
are
controlled by CAMA
1990 and regulated by
CAC.
Accounts are audited
by approved External
Auditors.
Proprietary approach
is preferred.
Measured by profits,
capital appreciation,
etc.
Dividends are often
declared/paid to
shareholders.
AGM
is
held
in
conformity with CAMA
(as amended).
EXAMINERS‟ REPORT
The question is on the uses of public sector accounting information and also tests
candidates‟ knowledge of the differences between Government Accounting and Private
Sector Accounting.
Majority of the candidates attempted the question and the overall performance was
above average. The candidates demonstrated fair understanding of the question. A
major pitfall was the inability of candidates to identify what constitutes the major
technical differences between the two forms of accounting. Those issues identified by
the candidates in most cases did not bring out the differences so clearly.
119
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Candidates should endeavour to read wide and desist from resorting to residual
knowledge in answering examination questions. Study packs and Pathfinder of the
Institute should be consulted for better understanding and performance.
120
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
QUESTION 6
(a)
RIVER BASIN AUTHORITY, OLUOKUN STATE
VALUE ADDED STATEMENT FOR THE YEAR ENDED 31 DEC, 2009
Turnover
Less: Budget in goods and
services
Value
Added
from
Operations
and
Other
Income
Add Other Income
Less Other Expenses
Total Value Added
Applied as follows:
Employees
Government (Tax)
Providers of Capital
Provision for growth and
expansion
TOTAL VALUE DISTRIBUTED
Notes to the Account
Bought-in-goods and
services
Purchase of weed control
chemical
Lubricant and oil
Purchase of Stationery
Utility (Water, light, etc)
Providers of Capital
Interest on Bank Loan
Interest on Agric. Bank Loan
N‟000
41,100,000
6,800,200
%
34,299,800
34,299,800
100.00
15,000,000
4,000,000
15,299,800
43.73
11.66
44.61
34,299,800
100.00
3,600,000
1,600,100
1,100,100
500,000
6,800,200
1,040,000
2,960,000
4,000,000
Provision for Growth and
121
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Expansion
Depreciation Charges
Surplus realized on ordinary
operation
2,000,000
13,299,800
15,299,800
Employees
Salaries & Pension
(b).
15,000,000
Value Added is the wealth created by the combined efforts of both the
organization and
its employees. It is the amount by which the sales value of
production was enhanced by the effort of the organization and its employees.
“Value Added Statement” is the information format prepared to show how the
excess of turnover over bought-in-materials and services, has been applied; to
items such as provisions for depreciation, employees, government and providers
of capital.
EXAMINERS‟ REPORT
The focus of the question is on “Value-Added” and “Value-Added Statement”.
Candidates are expected to differentiate between them. They are also to
demonstrate ability to prepare the Value-Added Statement from income and
expenditure account information.
Over 90% of the candidates attempted the question and the overall performance
was very good. Students demonstrated that they were familiar with published
financial statements of companies as they applied suitable different formats for
the statement. However, the definition of “Value-Added” and “Value-Added
Statement” posed a great challenge to some of the candidates.
Candidates are advised to be familiar with technical terms of the subject by
studying relevant current text books, study packs and Pathfinder of the
Institute.
122
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
ICAN/102/z/4
EXAMINATION NO.............................
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA
PROFESSIONAL EXAMINATION III – NOVEMBER 2010
MULTI-DISCIPLINARY CASE STUDY
Time allowed – 3 hours
PROSPECT GROUP
PROSPECT PLC was founded in 1970, immediately after the Nigerian civil war as
Prospect Nig Enterprises. Later in 1990, to reflect the company‟s several acquisitions
and diversifications, the company‟s name was changed to Prospect Limited.
DECISION TO GO PUBLIC
By 2005, it was apparent to the company‟s management that further expansion would
only be possible with larger scale of operations which could be achieved by either
raising capital from a public issue of shares or acquisitions or some kind of merger.
At the April 2005 management retreat, the senior management of Prospect Limited
discussed taking the company to the capital market for several reasons. The company
so formed would be a legal entity, its shares would be transferable. It would have
perpetual succession; that is, continuity despite changes among members. It would
have its own management and its memorandum and articles of association which,
among other matters may limit its capacity to enter into binding contracts. Its affairs
will be regulated in considerable detail by the Companies and Allied Matters Acts 1990
(CAMA) and other statutory and non-statutory regulations.
Management had no liquidity for its holdings and no market for its shares, therefore,
there was a desire to create liquidity for its shares and allow management to diversify
some of its wealth. The management team, with an average age of less than fifty,
viewed going public as presenting challenges and additional experience.
In August 2005, Prospect Limited invited six Investment banks, that had expressed
interest in the offering to a „bake-off‟ (a competition where investment bankers
attempt to sell their services to management). After their presentations, Detonic Bank
was chosen as the lead underwriter for PROSPECT Limited‟s offer. In October 2005, the
123
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
prospectus and the underwriting agreement were issued. In the initial filings, the
nominal value of the shares was fifty kobo per share, but the price was forecast to be
between two and three naira per share. Detonic advised PROSPECT Ltd to reduce the
price to between one naira fifty kobo and two naira per share. The management
refused and maintained that it should be at least two naira fifty kobo per share and
the original nominal value remained. A “road show” was arranged for the
underwriters and PROSPECT Ltd`s management to sell the issue to institutional
investors. After the closing of the share offer, the allotment was made as follows:
management of old PROSPECT owned twenty seven percent, former owners of
PROSPECT PLC twenty percent and the balance of fifty three percent was owned by the
public and before the multicity road show was completed, the offer was
oversubscribed three times. At the end of November 2005, the share was finally priced
at three naira. Even though Prospect was officially a public company at that point, its
shares were not officially traded until the deal was closed on 15 December 2005. The
shares began trading above the offering price and seemed to reach a barrier at seven
naira per share and took one dip to four naira, but by early February 2006 had
reached a high of nine naira before falling back to six naira fifty kobo at end of April
2006.
NEW MANAGEMENT
In 2008 sales and profits of the group continued to decline, a trend that had been on
since 2006 and Chief Alatise Gbenga, the Group Chairman could no longer avoid the
issue. He concluded that the best option was to go outside the company and bring in a
professional manager with no direct ties with any of the directors or division and
management staff of PROSPECT PLC. In Chief Alatise‟s view, a housecleaning was in
order and special management talent was needed.
In November 2008, Mr. Kola Ikumawoyi joined PROSPECT Plc as Managing Director,
Chief Alatise continued as Chairman of the Board. Mr Ikumawoyi was recruited from a
major competitor in the industrial distribution industry where he had served as
Executive Director. In view of the challenges facing PROSPECT Plc, Kola seemed to be
the ideal choice. In addition to his strong industry and marketing background, he also
had a warm and outstanding personality and a very high level of energy and
optimism. As one student who interviewed him remarked, “His openness and candor
catches you off guard. You don‟t usually expect a Managing Director to be so open and
honest about issues”.
Kola faced the additional challenge of attempting to correct PROSPECT PLC`S
problems while still faced with the same old directors on the Board. Even though Chief
124
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Alatise was able to recruit Kola, the Managing Director did not always have a full
support of the Board, many of whom viewed him with skepticism. Kola promised that
he would be restructuring PROSPECT PLC`S top management by recruiting
outstanding individuals to provide a new leadership and a professional team to lead
PROSPECT PLC`S turnaround.
Mallam Iwalesin Oladele was hired in January 2009 as Executive Director
(Administration and Operations). Iwalesin was recruited from Coca-Cola Plc. In March,
Ms Chika Ike was brought in as Executive Director (Marketing and Corporate
Development), Chika was in the consulting business and had served as Manager in
Steakhouse Ltd and as Director in Kokumo Limited.
Richard Popoola joined the company in June from Ronky Communications, a Lagos
based advertising and public relations firm, to fill the position of Executive Director
(Marketing Communications and Field Marketing Services) and Personal Assistant to
the Managing Director. Jerry Gbenga was brought in as manager in July, he had been
an Area Sales Manager for Toyota Motors and previously served as manager at
Thermocool Limited.
With the majority of the new management team in place during 2009, Kola began to
embark on the quest to turn the company around and build comprehensive group. The
major problems facing the new management team were:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
The company was not making any profit;
Divisions within the group were losing money and were overstaffed;
No unit growth – divisions were declining;
No management strategies, goals or plans in place
No advertising
Image was old and faded;
Directors/managers were bottom line oriented with nothing being re-invested in
business.
To turn the organization around, Kola and his management team embarked on a
strategy that encompassed three points:
(a)
(b)
(c)
attack problems concerning divisions and PROSPECT PLC`S image
improve marketing, inventory management and replace obsolete plant, and
improve communications.
125
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
The key to attacking attitude problem centred on marketing and to be successful, any
plan depended on three critical issues
(1)
(2)
(3)
The corporate and division owners are to “buy in” to it;
The plan had to be simple enough to be executed, and
It had to provide visible evidence of working by improving profit for the
division and group owners.
INTEGRATION/EXPANSION
Sola Nigeria Limited was engaged in electrical and fluid (mostly pumps) equipment
maintenance and sales for mid-market size companies. In this regard, it was
relatively capital intensive. Its most recent year-end financial statement reflects
revenue of one hundred and twelve million Naira (N112m), operating income of
Twenty eight million Naira (N28m), depreciation of Seven million Naira (N7m), net
income after taxes of twelve million Naira (N12m), total assets of seventeen million
Naira (N17m), interest-bearing debt of fifty four million Naira (N54m) and
shareholders‟ equity of forty million Naira (N40m).
Its cash position was negligible. The company has five million and six hundred
thousand Naira (N5.6m) shares outstanding and its current share price is sixteen
Naira.
The company has attracted the attention of Prospect Group, which was considering
acquiring Sola Nigeria Limited. Prospect Group and its investment banker believed
that by offering a premium of fifty per cent (50%), Sola Nigeria Limited could be
acquired. At present, Sola Nigeria Limited‟s free cash flow (excluding interest on debt)
is shown in appendix I.
Prospect Group believed that with synergy, it could grow its earnings before interest
and taxes by twenty per cent (20%) for three years and then by twelve per cent (12%)
for the next three years. At the same time, it believed it could hold capital expenditure
and working capital additions to a combined increase (from the present eleven million
Naira (N11m) of only two million Naira (N2m) per year. At the end of six years,
Prospect Group assumed that free cash flow would grow at five per cent (5%) per
annum into perpetuity. It also assumes that the cost of capital for such investment
was fifteen per cent (15%). Comparable recently acquired companies had the medium
valuation ratios shown in appendix II.
126
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
In 2010, the management of Prospect is considering the closure of its internal printing
department. If the proposal sailed through the approval of next meeting of the Board
of Directors, the staff of the department were to be redeployed to other departments
within the group. The department prints all the company‟s publicity materials and it
also carries out other printing jobs as required. An external firm offered to produce all
the company‟s printing requirements for a total cost of eighteen thousand Naira
(N18,000) per month.
The internal printing department‟s cost includes the following: a total of one hundred
and sixty thousand (160,000) sheets of customized paper were used each month, at a
cost of one hundred Naira (N100) per two thousand (2000) sheets. The contract for
supply of the paper required three months‟ notice of cancellation. The company did
not hold inventory of the best paper but any excess could be sold for the net price of
forty Naira (N40) per two thousand (2,000) sheets, a total of four hundred (400) litres
of fluorescent ink are used each month, at a cost of three Naira sixty kobo (N3.60) per
litre. The contract for supply of this ink requires one month‟s notice of cancellation.
No inventory of ink was held but any excess could be sold for one Naira net per litre.
Other paper and material costs amount to five thousand, seven hundred Naira
(N5,700) per month, the printing machinery was rented for nine thousand Naira
(N9,000) per month. It was operated for one hundred and twenty hours (120 hours)
each month. The rental contract could be cancelled with two months‟ notice.
The two employees in the department were each paid twenty thousand Naira
(N20,000) per month. The company had a no-redundancy policy which meant that the
employees were guaranteed employment even if the department closed. Overhead
cost for the printing department was as follows: Variable overheads were eight Naira
per machine hour. The variable overheads vary in direct proportion to the machine
hours operated. Fixed overhead represents an apportionment of central overheads
which would not alter as a result of the printing department‟s closure.
ORGANISATION
The corporation was organized into six product groups (Appendix III & IV, Appendix III
describes the organization chart and Appendix 2 describes the groups major products).
All of the products benefited from well-known product trademarks and most of their
products were leaders in their market segments.
Prospect Plc was operated in a highly decentralized fashion. The product groups were
allowed considerable discretion in establishing and implementing the strategies
127
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
appropriate to their areas of business. The primary central mechanisms employed by
headquarters were annual and quarterly reviews of budgets submitted from each of
the divisions.
Each of the three divisions was headed by a General Manager, who were told that they
were expected to act as if they were the Managing Director of independent companies.
Each division was regarded by Head Office as a profit centre and the performance of
each divisional manager was evaluated on the basis of his profit performance.
PROSPECT Plc did not have a single unified accounting system that was used in all its
operating units. This was due to the fact that PROSPECT Plc had acquired many
companies over the years and the acquired companies were allowed to continue with
most of the elements of their accounting systems, even after they became part of
PROSPECT Plc. The accounting policies set at corporate Head Office tended to describe
minimum reporting requirements and every general accounting policy rather than
detailed instructions that had to be followed, for example, the accounting policy
manual specified that the operating units were to follow the full absorption method of
accounting „whereby most fixed and variable costs are recognized in inventory and
cost of sales accounting‟ but it did not provide further description as to how the full
absorption method was to be accomplished.
In specific terms, each division was expected to achieve a net return on sales of at
least six percent. Operations were planned on an annual basis, linked to a financial
year end of December 31. Prior to the beginning of each financial year, divisional
managers were required to submit budgets showing the net profit, in excess of the six
per cent sales revenue, that they expect to earn. At this stage, adjustments were often
made to the budget as a result of consultation and negotiation between divisional
managers and Head Office. Once agreed, the budget formed the basis for evaluating
performance in the ensuing year.
However, the Head Office required each division to maintain an elaborate budget and
control system. The following points summarize the budget and control system in each
division:
First, one, three, and five year budgets were prepared each year. Second, the
Executive Director overseeing the division looked for three and five years‟ budgets that
stretched the division‟s capabilities, that is, divisions were pushed to devise programs
that increased value. Three, these budgets were developed and approved first at the
divisional level, then by the Executive Director at the Head Office assigned to the
128
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
division and then by Corporate Head Office. Four, every three months, the division
must reconcile actual performance to budget and write detailed reports on the
corporate actions taken.
Five, each Executive Director assigned to the division visited each division quarterly
for three days of meetings that involved extensive reviews of the budgets and
operating results. These meetings involved all the senior managers in the division. Six,
divisional senior managers are neither compensated nor rewarded for meeting budget
targets. Rather, they were evaluated on their ability to develop new markets, solve
short-run problems, add value to their organization and to PROSPECT PLC, manage
and motivate their subordinates. These performance evaluation criteria were quite
subjective, but the corporate Executive Director assigned to the division had a great
deal of in-depth personal contact with each of the senior people in his or her division
and were able to arrive at suitable performance evaluations.
Preparing for these meetings with the corporate Executive Directors and developing
the budgets requires the involvement of all the senior managers in the division, one
manager remarked “I‟d hate to see how much money we could be making if we didn‟t
have to spend so much time in budget and financial review meetings”.
It turned out that PROSPECT PLC was not unique in the amount of senior management
time spent on budgeting and financial reviews. A survey of large publicly quoted
companies in Nigeria supports the PROSPECT PLC system. Researchers found that
innovative firms in complex environments characterized by high uncertainty and
change used much more elaborate formal financial control (budgeting systems than
did firms in more stable, mature industries) innovative companies seemed to employ
more financial controls than less innovative companies.
CAPITAL INVESTMENT PROCEDURES AND FINANCING
Like most companies, Prospect Group had layered levels of approval with the largest
being approved only by the Board of Directors, each division was charged with
preparing capital budgeting requests, item by item. Routine types of expenditure
could be lumped together. However, any major expenditure had to be documented as
to expected cash flow, payback, internal rate of return and a qualitative assessment of
the risk involved. These proposals were reviewed by the corporate analysis and
control office headed by Mrs. Lalupon Adedeogun while neither she nor her boss Mr.
Phillip Azika had final authority, they made recommendations on each of the larger
projects.
129
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Projects fell into one of two categories: profit adding and profit sustaining. The profit
adding projects were those where the cash flows could be estimated and discounted
cash flow methods employed. The profit sustaining projects were those that did not
provide a measurable return. Rather, they were projects necessary to keep the
business going. For example, environment and health control certain corporate assets.
Approximately twenty per cent of the projects proposed and accepted in Naira volume
were profit sustaining in nature. For profit-adding projects, the fifteen per cent (15%)
required rate of return was used as the hurdle rate.
Projects that fell below this return simply were not sent forward. The use of the
discount rate was supplemented by the financial goal of achieving growth in sales and
earnings per share without undue diminution in the quality of the earnings streams.
This objective was sufficiently “fuzzy” that most did not take cognizance of it in the
capital budgeting process. Rather, the fifteen per cent return was key variable. It was
simply assumed that if projects provided return in excess of this figure, they would
have given the company a continuing growth in “quality” earnings per share.
Overall, the company has a total debt-to-equity ratio of one point four five (1.45).
However, much of the total debt is represented by accounts payable and accruals. All
borrowings are controlled at the corporate level, and there is no formal allocation of
debt or equity funds to the individual divisions. Everything is captured in the
minimum hurdle rate of fifteen per cent (15%). However, some of the divisions are
characterized by having to undertake a number of lease contracts in order to expand
their division and departments within the division.
While the required rate of return of the company once represented a blending of debt
and equity financing, this no longer was the case. In recent years, it has been
adjusted on a subjective basis, in keeping with returns earned by competitors in the
industry, Prospect Group has little difficulty financing itself; it enjoyed a high
investment rating by many financial institutions in Nigeria. It also has ample lines of
credit with prominent financial institutions.
Mr. Phillip Azika‟s office was charged with determining what would happen if the
company moved from a single required rate of return to multiple hurdle rates. His
group focused in using external market valuations for the required rate of return of the
various divisions. For debt capital, it proposed using the company‟s overall rate of
interest on bonds. In early 2009, the rate was approximately ten per cent. The
company fixed a tax rate of approximately forty per cent (40%).
130
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
For the required return on equity capital, the study group used the capital asset
pricing model (CAPM). In this context, the measure of risk in beta, the co-variability of
a stock‟s return with that of the overall market as represented by Nigerian Stock
Exchange stock index.
The return on equity is simply
Rs
=
Ri
(Rm – Rf) βj
Where: Rs = Return of the equity, Ri = Return on Security,
Rm = Return on the market portfolio
Rf is the risk free rate and βj is the beta of security j.
In early 2009, three month Treasury Bills yielded approximately three point one per
cent (3.1%), three year treasury bills yielded approximately four point six per cent
(4.6%) and long term treasury bills of five years yielded approximately five point four
per cent (5.4%). Mr. Azika‟s group proposed using five year Treasury rate as the riskfree rate in their calculations. Estimates by various Mortgage banks of the required
return on the overall market portfolio of ordinary shares average eleven per cent in
early 2009.
Mr. Azika and his staff proposed the use of proxy or “pure play” companies, that is,
companies that were closely identified with the business of the division, but that had
publicly traded her shares. After extensive study, Mr. Azika and his staff proposed the
list of companies shown in appendix V. For industry products for division, there were
a reasonable number of proxy companies. This was not the case for mining division or
the automotive division. Unfortunately, for the automotive division, some of the larger
companies were divisions of multi-division companies. In particular, Jacet Limited
was part of Jacet International and could not be differentiated from the mining
division. Some of the largest mining companies are either government owned or
privately owned, so that they do not appear in the sample. However, the study group
felt that the proxy companies were representatives and that the summary information
was useful. For the betas, the group proposed using a simple average for each
category of proxy companies. This meant a beta of zero point nine eight (0.98) for
mining products, zero point eight two (0.82) for automotive and one point two seven
(1.27) for industrial products.
Concerning debts employed to get blended costs of capital, Prospect Group recently
established a target long-term liabilities to capitalization ratio of forty per cent (40%).
Capitalization consisted of all long-term liabilities (including the current portion of
long term debt), plus shareholders‟ equity. The target of forty per cent (40%) was
131
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
somewhat higher than existing ratio. For capital expenditure purposes, the recent
financing vehicles were felt to be long-term liabilities and equity, not short-term debt,
payables and accruals.
The mining division and the automotive divisions did not need that much in debt
funds, as their internal cash flows were sufficient to finance most capital expenditure
(the mining division uses short-term debt to carry inventories). Originally, Mr. Azika
proposed that for calculation purposes, these two divisions have long-term liability to
capitalization ratio of zero point three five (0.35). Given the growth rate in demands
of the industrial product division, he proposed that this division have a ratio of zero
point four five (0.45). The representative of the industrial products division objected
to this percentage, claiming that it should be higher. When Mr. Azogwu, the Director of
the industrial products division learned of this, he went directly to Mr. Azika and Mrs.
Adedoyin. He claimed that if the industrial division were to stand alone, it could
command a ratio of at least zero point six zero (0.60) based on its real estate value, in
order to have a debt-ratio consistent with the main aggressive companies in the
industry.
Mr. Azogwu threatened to take the matter directly to Mr. Kola Ikumawoyi, the Group
Managing Director, unless he got his way. Eventually, Mr. Azogwu and Mr. Azika
struck a compromise and agreed to a long-term liability to capitalization ratio of zero
point five zero (0.50) for the industrial products division. To accommodate this change
within the overall capital structure objectives of the group, Mr. Azika cut the mining
division ratios to zero point three zero (0.30).
In order to allow for profit-sustaining projects, Mr. Azika proposed grossing up the
divisional required returns with twenty per cent (20%) of the projects on average being
profit-sustaining which were presumed to have a zero per cent expected return, the
“gross up” multiplier was one point two five (1.25), that is, if a division were found to
have an overall after-tax required return of nine point six per cent (9.6%), it would be
grossed up to be twelve per cent (12%) i.e. 9.6% (1.25) = 12%.
As profit-sustaining projects were a cost of doing business, profit-adding projects had
to earn enough to carry them. The simple gross-up was easiest to apply, and Mr. Azika
proposed that it be the same for all the divisions.
When Hajia Lemu Awawu, Deputy Group Managing Director and Financial Controller,
Prospect Group, was talking with Mr. Azika, she reminded him that the question of
simple versus simple required return was not resolved yet, therefore it would be useful
132
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
to calculate a required return for the overall Group in the same manner as was due for
the divisions. The beta for Prospect Group in early 2009 was one point zero five (1.05)
and it had been relatively static in recent years. It was felt that a target long-term
liabilities-to-capitalization ratio of zero point four zero (0.40) should be employed.
As the required return reports would be completed shortly, Mr. Philip Azika, needed to
arrange a meeting among himself, other members of Senior management and the
Executive Directors of the three divisions. He asked Mrs. Adedoyin to present the
report to management.
The meeting would be an important one because the decisions reached would
determine the method by which capital would be allocated to the various divisions
both now and in the future; it also would establish the standard for judging return-onasset performance. Mr. Ikumawoyi was anxious to get the matter resolved so that
management would be on a solid footing when it went to the Board of Directors in
March 2010 for capital allocation, while Mr. Asogwu, the Director of the Industrial
Products division, was familiar with the report, the other Directors of the other two
divisions were not. Mr. Asogwu made it known to Mr. Ikumawoyi that although he
could live with the system proposed in the report, he felt it would be simpler to have a
single required rate of return for all the divisions. “If your objective is competitive
advantage and growth, fundamentals of the business, these financial whizzes do not
produce value for the shareholders – we do. Don‟t shackle us with too many
constraints” was a statement he made in passing to Mr. Ikumawoyi.
Also, Prospect Group wished to use equipment that cost one million (N1.0m) and that
will have a zero residual value at the end of five years to beef up its industrial
products. Management was satisfied that the equipment would represent an
attractive project with a positive net present value. The company approached a lessor
with regards to a financial lease and the Lessor agreed to lease the equipment at an
annual rental of three hundred thousand Naira (N300,000) over five years, with each
payment to be made in advance. Alternatively, the company could finance the
purchase of the equipment by borrowing the one million Naira (N1m) at an internal
rate of twenty per cent (20%) per annum.
133
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
INDUSTRIAL PRODUCTS DIVISION
In 2009, the court approved the scheme of reconstruction and recapitalization brought
to it by PROSPECT PLC relating to its industrial products distribution division. The
scheme was to take effect in January 2010. The draft balance sheet of the division is
set out in Appendix VI.
Particulars of the re-organization were as follows: The ordinary shares were to be
written down to fifty kobo each; the preference dividend was three years in arrears,
the preference shareholders were to waive their rights to these dividends and in return
were to choose whether they wish to convert their holdings to a new issue of nine per
cent cumulative preference shares or ordinary shares of fifty kobo each on a four to
one basis. Fifty percent of the preference shareholders have elected to take this latter
alternative.
The debentures were secured on the freehold buildings, the entire debenture being
held by Trans Bank Plc. Arrears of debenture interest were to be paid at once. Trans
Bank Plc agreed to conversion of the existing issue of debentures to a new issue with
an interest rate of ten per cent and to take up a further ten million naira (10,000,000)
of these debentures in view of the increased value of the collateral. The bank overdraft
would be repaid in full and amounts totaling twenty million naira (N20,000,000)
would be paid to the trade creditors once.
The Directors would waive half of the loans owed to them while the balance would be
met by the issue to them of ordinary shares of fifty kobo each. Goodwill, deferred
development expenditure and the balance on the profit and loss account would be
written off in full. Whilst plant would be revalued at eighteen million eight hundred
and eleven thousand naira (N18,811,000). The land and buildings would be revalued
at fifty million naira (N50,000,000) and trade investment is to be sold for fifty million
naira (N50,000,000). Sixteen million naira (N16,000,000) would be written off the
stocks and provision of ten percent for doubtful debts would be made.
Globalization embodied integration of international markets for goods, services,
technology, finance and to some extent labour, improves on the process of structural
change, underpinned by transformation from an agricultural to an industrial economy,
with critical implication for growth, equity and poverty. In this context, structural
adjustment or liberalization policies, symbolizing measures to stimulate structural
change by re-organising production, focus on shifting emphasis from national to the
global market and forging closer interaction between the national (domestic) and the
134
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
global economy.
In fact, shrinking global economic frontiers have created
opportunities and opened new markets.
Dramatic reforms and remarkable economic recovery and growth in some developing
countries particularly in Latin America, South and East Africa have kindled foreign
interest and confidence, encouraging new investments and enabling domestic
companies to access international equity capital directly as well as seeking listing on
foreign stock markets. The 1990s was a decade of widespread policy reforms in many
emerging economies, a trend which has continued into the 2000s. Such policies, trade
liberalization, deregulation etc were common place.
The progress made by some emerging economies particularly in Africa has shown that
good and consistent macro-economic policies impacted positively on investment flows
and the capital market. In essence, economic policy fundamentals must be right and
stable to strengthen investors‟ confidence and stimulate participation in the economy.
Indeed, good and stable macro-economic policies aimed at reducing inflations to a
tolerable level, strengthening the local currency and bringing down public sector
deficit among others are beneficial, as foreign investors are usually concerned about
high rates of inflation which reduce investment value while depreciating local
currency rate, thereby reducing foreign currency value of domestic investments.
Economic reforms in Nigeria and some African countries incorporated policies which
were specifically aimed at improving the foreign investment climate. These include
the elimination of policies which discriminated against foreigners, simplification of
investment and remittance procedures, as well as the provision of special incentives
for foreign investors. To enhance the attractiveness of the local market many countries
including Nigeria also abolished capital gains taxes while withholding taxes were
reduced and in a few cases abolished.
The adequacy and efficiency of social and economic infrastructure such as electricity,
roads, water, communication facilities, transport, health care etc., are crucial to
domestic and foreign direct investment. Countries with these facilities have therefore
tended to attract more direct foreign investments than countries with inefficient
infrastructural facilities.
One fundamental issue which was addressed by emerging economies in the quest for
foreign investment was the establishment of appropriate legal and regulatory
frameworks to achieve the most effective system of investor protection. The system of
protection has to be such that ensures fairness, efficiency, transparency and to
135
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
minimize abuses. Improvement in the quality of information about many emerging
economies enhanced their transparency and stimulated foreign interest in them.
Political stability is one of the most crucial factors in ensuring economic and securities
market development. Investors both domestic and foreign, understandably consider
the safety of their funds in deciding whether or not to invest or retain their
investments in any country. Political instability exposes investment to high risks and
encourages capital flight and inhibits economic growth. Evidently, many emerging
economies instituted economic reforms alongside political reform in the 2000s and are
today important recipients of foreign investment capital.
It is well known that the foreign investment climate in Nigeria in the recent past has
not been conducive leading to a spate of divestments even by the nation‟s traditional
and long standing investors, who have perhaps moved to more favourable
environments. Although, more measures are desirable and are already being
considered by government to “win the hearts” of foreign investors into Nigeria, the
repeal of the Exchange Control Act 1962 and the Nigerian Enterprises Promotion Act
1989 are laudable and should be seen as the first step towards setting up a conducive
investment environment. There is no doubt that with the right economic and political
climate, Nigeria with its size, huge resources and vantage position in Africa, stands a
good chance of attracting significant resource inflows and even serving as a “feeder”
to less developed countries in the sub-region.
By the repeal of both Acts, the major restrictions to easy flow of foreign investments
have been removed. Foreign investors can now access the Nigerian market fully and
freely without having to seek the approval of the Minister and without requiring a
local partner to do so. In effect, no distinction now exists between local and foreign
entrepreneurs in respect of investments in the country as both classes of investors are
now treated equally.
With these and other restrictions removed, the country should ultimately witness an
impressive flow of direct and portfolio investments.
Under sound and stable economic environment, foreign investments could flow in via
the following avenues:
(i)
foreign firms establishing wholly owned subsidiaries or entering into joint
ventures/partnerships with Nigerians firms;
136
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
(ii)
return of some traditional investors who have exited the Nigerian market;
(iii)
commitment of new funds by existing foreign investors into enterprises
domiciled in Nigeria
(iv)
Investment in the Nigerian Stock Market, and
(v)
domestic companies sourcing funds in the global capital market.
If the economic environment improves reasonably well, Nigeria‟s country risk rating
should improve, which could in turn stimulate new capital inflows as confidence is
rekindled.
Prospect Group used these challenges to its advantage by consolidating its presence in
the Western sub-region. Today, the company is looking globally, not merely into
exports but also for establishing manufacturing bases. The company is to commit
corporate resources in areas where it is or can become leaders. In the current
financial year, the company aims to make inroads into new markets, both
independently and through strategic business alliances. Ghana and Angola units
would be operational in the current financial year. Cameroun, Sao Tome and Liberia
are some of the areas that the company will be focusing on in the future. Like in the
past, in the coming years too, the company will launch new products, strengthen and
consolidate existing markets.
Alongside this marketing thrust is a constant upgrading of manufacturing technology
and a commitment to research technology and development. It is however important
to sustain these catalysts of growth through dedicated manpower. To this, Prospect
Group attracts professionals of high caliber while constantly upgrading the skills and
knowledge of existing employees. It is this optimum utilization of corporate resources
at all levels that is sustaining the company‟s leadership profile.
The second phase of expansion and modernization has been completed successfully
during the year. Manufacturing capacity, and expansion of projects have also been
completed for products like reagents, chemicals, sprayers and DSM Agro. Total
investments in machines and land and buildings were N25.87 million and N11.65
million respectively. In Ikeja Industrial Estate, the second unit for manufacturing of a
popular brand of the products has also been set up and production has commenced in
the current year.
137
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
A new plant in Ikeja Industrial Estate is under construction for food processing to meet
the requirements of growing demand for popular fruit juices. An integrated facility
has also been designed at Ilesa for the housewives range which was found to be very
popular and encouraging among consumers. At the same site, in Ilesa, a joint venture
along with Andex Nigeria Limited is being commissioned to extend the different range
of natural gum into profitable speciality products. Besides this, the company has
successfully launched many new products. These products have been well received in
the market.
Prospect Finance Limited, a subsidiary of the company has recorded an impressive
growth of 168% in the profits during 2007-2008 and is actively pursuing the activities
of leasing, hire purchase and investments. The company‟s industrial products division
had successfully launched its new range of products in 2006 and the products have
shown encouraging response from the market.
Growth in the demand of the products of the company in the Nigerian market is
satisfactory, particularly, with the sale of chemical reagents among the range of
products. The turnover of the division recorded an impressive growth of 25%.
The company has an ambitious plan to extend their range of consumer products to
include domestic products like shaving foam, hair creams, shampoos, variants of
herbal toothpaste. By adding these new products, the company hopes to achieve a
35% growth in export to other West African countries. In this context, it may be
pointed out that the Prospect Group has floated two companies: a manufacturing unit
in Sierra Leone in the name of Prospect Limited and another company Prospect
International Limited in Liberia.
In Sierra Leone, Prospect Group has taken seventy six per cent (76%) equity and the
balance of twenty four per cent (24%) has already been contributed by Healey Limited,
London.
The land for the manufacturing activity has been procured, the company has
appointed legal and liaison consultants and the construction of the factory building is
in progress. The expected date of commencement of commercial production is April
2011. The other company, Prospect International Limited is appraising the possibility
of setting up a pharmaceutical and bulk drug plant overseas either on its own or with
a collaborator. The company has successfully developed an anti cancer drug, namely,
Lactuxel. The response to the drug in Nigeria and abroad is very encouraging. The
company therefore plans to set up a manufacturing facility for the product in Canada
to cater for the US market. In this context, the company, entered into a joint venture
138
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
agreement with Lawry International Limited, an affiliate of Lawry Incorporation, USA.
The joint venture company will be named as Prosivough Incorporated with fifty per
cent (50%) equity holding by each collaborator. The commercial production at
Prosivough Incorporated is expected to commence in April 2011.
During the years 2008 and 2009, the sales at the West African sub-region markets has
been satisfactory. New markets were established in Sao Tome, Cameroun and Ghana.
Further entry is planned for South Africa and Angola. The company has set up a
trading office in Algeria with the necessary permission from the Government of the
Federal Republic of Nigeria.
Prospect Gabon Limited, a joint venture subsidiary company set up in Gabon, in its
second year of commercial production has completed the installation of the plant for
the extraction of the Texas baccatta leaves and will commence production shortly. The
company is in the process of implementing an expansion programme for
manufacturing of herbal toothpaste, shampoo and shaving cream.
The company has been promoting research and development activities through the
efforts of Prospect Foundation. The Prospect Foundation is gaining more and more
recognition because of the research work and successful completion of the research
projects which have helped in providing the necessary research and development
inputs in the area of company‟s business both in health care and in consumer non
durables. Successful completion of the clinical trials and other product. Development
works were done on many new herbals and Ayurvedic products in 2008-2009. The
company launched new products like TOLAC, TADEN and TIKARA. A high fibre, sugar
free nature care variant has also been developed which is currently undergoing a
market research and is likely to be introduced in the current financial year. A number
of cosmetic products are under development both for domestic and export markets.
Many of these products are in their final stages of approval and are likely to be
commercialized next year.
The company has been able to successfully complete the clinical trials on human
volunteers of the novel anti-cancer drug Lactuxel. Two more bulk drug technologies
were developed, scaled up and commercial production of these products, “vix
Flucanozole” (anti-fungal, anti-biotic) and “citizen dihydrochloride” (a second
generagion anti-histamine) were started.
Active management of business and disciplined execution of growth strategies by the
company have delivered seven consecutive years of earnings growth and excellent
return to shareholders.
139
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Mr. Popoola Ajayi, the Executive Director in the industrial products division expects
that the 2010 net sales for the division should be four hundred and forty five million
Naira (N445m) and believes that the division will continue to market aggressively its
products as it has done in the past. Before making these sales forecasts for 2010,
Popoola analyzed the impact of high interest costs on the firm‟s debt. He began with
the firm‟s 2009 and 2008 balance sheet of the division as prepared by the finance
department. He did not ask for a pro forma income statement because he was likely to
prepare it himself. In addition to knowing the forecasted sales figure, Popoola knew
that the firm is to budget three relatively stable items for 2010. Office and marketing
salaries, fifteen million Naira (N15m), sales expenses and promotion, twenty one
million Naira (N21m) and miscellaneous overheads is ten million Naira (N10m).
Popoola knew that if the firm did not borrow any additional funds, the industrial
division would be incurring an annual interest of twelve million Naira (N12m) in 2010.
Having gathered this data, Popoola had a look at collection costs and bad debt losses
that were included in the general and administrative expenses above, he decided to
forecast these items using data from the division‟s risk class category that was
reviewed on a regular basis. The finance manager normally prepared an estimate of
the collection costs and bad debt losses to be allocated to each category of customers.
These estimates were compared against actual data at the end of each year and for the
last five years, the estimates proved to be fairly accurate. The bad debts losses were
based on actual losses over the past seven years and collection costs well allocated
based on the routine expenses and special collection efforts required for each category
of customers. Appendix VII shows the result from this process.
Popoola decided to have a meeting with A. J. Aaron, the division‟s finance manager,
after receiving this data on industrial product division. Aaron supported four months
back that the Company should change its credit policy from 2/10 net 30 to 2/10 net 60.
He argued the new policy would increase receivables, collection costs and bad debt
losses but would provide additional sales and profits to the group. Aaron estimated
that though selling expenses would rise but the level of receivables would also
increase. If the additional profits were high enough, it would make sense to borrow
money at fifteen per cent (15%) to finance these receivables. Popoola asked Aaron to
check out the changing terms of trade to 2/10 net 15. This would reduce receivables
and allow the firm to pay off a portion of the fifteen per cent (15%) notes, Aaron
indicated that selling expenses would probably drop by one point two five (1.25), but
this savings would probably be more than offset by the loss of sales and profits. From
this discussion, it appeared that Aaron was willing to make another appraisal of both
140
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
alternatives and he indicated that he could get back to Popoola with the effect of each
alternative on sales.
Aaron submitted his forecast for 2010 sales with each alternative to Popoola, he
pointed out that during the period 2005 – 2009, industrial products sold on terms 2/10
net 30. With these terms in 2010, the division could expect eighty million Naira
(N80m) of sales to category one customers, one hundred and five million Naira
(N105m) of sales to category two customers, sixty million Naira (N60m) of sales to
category three customers and five million Naira (N5m) of sales to category five
customers. Based on past data, thirty per cent (30%) of the total customers would take
the two per cent (2%) discount while the others would pay in thirty five (35) to forty
(40) days.
A quick check of Aaron‟s calculation indicated to Popoola that they were in agreement
that the 2/10 net alternatives could be relied on. Popoola knew that the cost of goods
sold would be approximately seventy five per cent (75%) at four hundred and forty five
million (N445m) of sales and he estimated that they could run eighty per cent (80%) at
two hundred and two million five hundred thousand Naira (N202.5m) of sales and
seventy per cent (70%) at three hundred million Naira (N300m). The general and
administrative expenses, with the exception of the collection costs, bad debts losses
and selling expenses were in effect, fixed for 2010. Using these assumptions, Popoola
was prepared to develop the data and reach a decision on the optimal credit policy for
industrial products division of Prospect Group. He decided that they would not change
policies in future unless the new policy gives either an increase in sales of twenty five
per cent (25%) or an increase in profit of fifteen per cent (15%) or more.
AUTOMATION DIVISION
PROSPECT PLC is contemplating repackaging its products in the automation division,
the introduction of the products would enhance e-banking. A new equipment costing
ten million naira (N10,000,000) would have to be bought to manufacture the machine,
but PROSPECT PLC could accommodate all other aspects of the new equipment for
example, the requirements for factory and warehouse space within the company‟s
existing facilities. The equipment has an annual capacity of ten thousand units of the
machines and could be used for four to five years before being scrapped at zero value.
PROSPECT PLC sets selling prices for its product on the basis of cost-plus calculations.
Its current Chief Accountant has prepared the following standard cost figures
(Appendix V) to enable a target selling price to be set.
141
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
The standard has been based on the capacity of the equipment i.e. ten thousand
(10,000) units per annum. The marketing department, in conjunction with the
industrial products distribution division has signed a five year contract to take all the
budgeted production at a price of three thousand, five hundred naira (N3,500). The
industrial product distributors would pay the Automation division for the machine
annually in arrears i.e. first payment would be made in one year and one day after the
start of production. The automation division holds one month‟s stock of materials, and
on average, pays suppliers one month nine days after delivery.
A trainee accountant, attached to the division, has been asked to prepare a cashflow
and Net Present Value (NPV) calculations for the five years during which the machine
might be produced. Additional information provided to aid his calculations are that
the equipment is to be financed by a loan at the going interest rate of ten percent per
annum, the company will thus pay annual interest charges of two hundred thousand
(N200,000) on the loan; the division allocated fixed overheads on the basis of direct
labour hours. The general overheads present allocations of the division‟s existing fixed
overheads to produce the machine. The specific overhead charge is an allocation, on a
straight line basis of the depreciation of the new equipment over its useful life of five
years.
Skilled labour is in short supply. During the first year of the machine production,
skilled labour would have to be diverted from existing product lines. Currently, the
average cash contribution generated per skilled labour hour is fifty naira. Skilled
labour could be made available for the remaining three years of the machines
production by carrying out a recruitment and training during the first year. This
programme would entail a one-off cost of one million and five hundred thousand naira
(N1,500,000) and if undertaken, would enable the diverted labour to return to its
usual work after one year of manufacturing the machine.
The current rates of company tax are forty percent on taxable profits over seven million
and five hundred thousand (N7,500,000) and a sliding scale for profits is between
these levels. The plant attracts a written – down allowance of twenty five per cent at
cost or a written–down allowance of twenty five per cent at cost or written-down
value. The figures and notes produced by the trainee accountant are contained in
Appendix IX.
The automotive division is considering investing in the production of an electronic
security device and the manufacturing of lazer printer AZ2000Q. The finance and the
marketing departments have undertaken an analysis of the proposed projects.
142
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
The financial implication and market survey which showed the expected market life of
the electronic device for the first five years of production have been submitted for the
approval of the Board of Directors of Prospect Group. The main features of the analysis
is as shown in appendix X. The committee that works on the feasibility of the
electronic security device has recommended that the project should not be undertaken
because the estimated annual accounting rate of return is only twelve point three per
cent (12.3%).
The notes attached to the feasibility study indicated that the figures in appendix VII
relating to cash flow and profit estimates have been prepared in terms of present day
costs and prices, because the committee assumed that the sales price could be
increased to compensate for any increase in costs. However, other information
indicates that the selling prices, working capital requirements and overhead expenses
are expected to increase by five per cent annually; material costs and labour costs are
expected to increase by ten per cent every year, while capital allowances (tax
depreciation) are allowable for taxation purposes against profits at twenty five per
cent (25%) per year on a reducing balance basis, the machinery for the production of
the electronic device has no expected salvage value at the end of the five years. For
the purpose of this project, the automotive divisions real after-tax weighted average
cost of capital is estimated to be eight per cent (8%) per year, and the nominal aftertax weighted average cost of capital is fifteen per cent (15%) per year.
On the manufacture of AZ2000Q printer, the Director of Marketing was concerned as
the division reviewed for the costs of the printer, which she is planning to launch next
month. The AZ2000Q is a new commercial printer that Prospect designed for mediumsized direct mail businesses. The basic system price was set at seventy five thousand
Naira (N75,000), the unit manufacturing cost of the AZ2000Q is forty seven thousand
Naira (N47,000) and selling and administrative cost is budgeted at thirty three per
cent (33%) of the selling price. The maintenance price she planned to announce was
eighty five Naira (N85) per hour of Prospect technician time. While the seventy five
thousand Naira (N75,000) base price is competitive, eighty five Naira (N85) per hour
is a bit higher than the industry average of eighty two Naira (N82) per hour.
However, Monisola Makinwa, the Director of Marketing in the automotive division
believed she could live with the eighty five Naira (N85) price. She is concerned,
because she has just received a memo from the Field Service department of the
division stating that they were increasing their projected hourly charge for service of
thirty five Naira (N35) to thirty eight Naira (N38).
143
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
The eighty five Naira price Mrs. Makinwa was prepared to charge for service was
based on last year‟s thirty five Naira. The Service Manager thought that using last
year‟s cost was conservative since field service had been downsizing and she expected
the cost to go down not up. The thirty five Naira cost still did not yield the sixty per
cent (60%) margin on service that was the standard for other Prospect‟s divisions.
Makinwa had difficulty justifying the higher costs without significantly reducing sales.
Given the higher cost of the division, field technicians and the prices charged for
maintenance by the competitors, she will not be able to make the profit target in her
plan. The lazer printers being introduced by Prospect is an innovation over existing
lazer printers by the competitors. In particular, they have specialized paper transfer
mechanism to handle the customized heavier paper, varying paper sizes and high
speed paper flow rates. With such high paper flow rates, printers require regular
adjustments to prevent paper jams and misalignments. Prospect‟s nationwide field
service department for its automotive decision, has about 300 employees who
maintain these printers and other related products.
The standard automotive division sales contract contains two parts: the purchase price
of the equipment and maintenance contract for the equipment. All automotive
division printers are maintained by the Field Service personnel, and the maintenance
contract specifies the price per hour that was charged for routine and unscheduled
maintenance.
Most of the profit in the automotive division comes from printer
maintenance. Printers have about five to ten per cent mark-up over manufacturing
and selling costs, but the mark-up on maintenance has historically averaged about
sixty per cent.
The printers manufactured by Prospect‟s Automative division have substantial amount
of built-in-intelligence to control the printing and for self-diagnostics. Each printer
has its own microcomputer with memory to hold the data to be printed. These internal
micro-computers also keep track of printing statistics and can alert operator to
impending problems (low toner, paper alignment problems, form breaks). When
customers change their operating system or computer, this often necessitates a
Prospect service call to ensure that the new system is compatible with the printer. The
standard service contract calls for normal maintenance after a fixed number of
impression (pages) for example AZ2000Q requires service after every five hundred
thousand pages are printed. Its micro-computer is programmed to call Prospect Plc`s
central computer to schedule maintenance whenever the machine has produced three
hundred and seventy five thousand (375,000) pages since the last servicing.
144
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
The Automotive division is organized into engineering, manufacturing, marketing,
field service and administrative departments. Engineering designs the new printers
and provides consulting services to marketing and field service regarding system
installation and maintenance. Engineering department is evaluated as a cost centre.
Manufacturing department produces the printers, which are assembled from
purchased parts and sub-assemblies. Prospect Plc`s comparative advantage is quality
control and design. Manufacturing also provides parts for field service maintenance.
Manufacturing is treated as a cost centre and evaluated based on meeting cost targets
and delivery schedules. Manufacturing‟s unit cost is charged to marketing for each
printer sold.
Marketing department is responsible for designing the marketing campaign, pricing
the printers and managing the Field sales staff. The Automotive division sells six
different printers, each has a separate Marketing Program Manager.
The sixth
Marketing Manager thought that using last year‟s cost was conservative since Field
Service had been downsizing and she expected the cost to go down not up. The thirty
five Naira cost still did not yield the sixty per cent (60%) margin on service that was
the standard for other Prospect‟s divisions. Makinwa had difficulty justifying a higher
cost without significantly reducing sales. Given the higher cost of the division field
technicians and the prices charged for maintenance by the competitors, she will not be
able to make the profit target in her plan.
Field sales is organized around four regional managers responsible for the sales office
of their region. Each of the sales offices has a direct sales force that contacts potential
customers and sells the six programs. Sales people receive a salary and a commission
depending on the printer and option sold. The sales person continues to receive
commissions from ongoing revenues paid by the account for service. Since ongoing
maintenance forms a significant amount of a printer‟s total profit, the sales people
have an incentive to keep the customers with Prospect Plc.
Field service contains the technical people who install and maintain the printers
headed by Ayobami Gbenga, a General Manager. Field service is a cost centre and its
direct and indirect costs are charged to programs when the printers are serviced. The
price charged is based on the budgeted rate set at the beginning of the year. Any
difference between the actual amount charged to the programs and the total cost
incurred by the Field service group is charged to the division overhead account and
not to the marketing programs.
145
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Administration manages human resources, finance, accounting and field leases. It
handles customer billings and collections, payroll and negotiating office space for the
field service people. Administration is evaluated as a cost centre while local office
space is managed by administration, the cost of the office space is allocated to the
field service and service group and included in their budgets and monthly operating
statements.
Each Prospect Plc`s printer sold requires a service contract. The AZ2000Q‟s service
contract calls for normal maintenance every five hundred thousand (500,000) pages at
a price of fifty kobo per one thousand pages. Normal maintenance requires three
hours, the typical AZ2000Q prints twelve million pages per year. Besides normal
maintenance, (sometimes called preventive maintenance) unscheduled maintenance
occurs due to improper operator set ups, paper jams, system upgrades and harsh
usage of the equipment. Past statistical studies shows that each normal maintenance
hour generates zero point five zero (0.50) unscheduled maintenance hours.
Unscheduled maintenance is billed to the customer at the service contract rate of
eighty five Naira (N85) per hour.
When maintenance is performed on a particular machine, the service revenues less
field service costs are credited to the Marketing Manager for that program. All the
programs actual service profits are compared with the plan, they form part of MM‟s
performance evaluation. The field sales person receives a commission based on the
total service revenue generated by the account. In evaluating each new printer
program, Prospect Plc uses the following procedures: profits from service are expected
to create an annuity that will last for five years at 18% interest; to evaluate a proposed
new printer, the one-year maintenance profit is multiplied by 3.127 to reflect the
present value of the future service profits each printer is expected to generate over its
life (about five years).
Any parts used during service are charged directly to the customer and do not flow
through field service budgets or operational statements.
Automotive division
purchases most of the printers‟ parts from outside suppliers and the customer pays
only a token mark-up. Marketing department does not receive any revenue nor is it
charged any costs when customers use parts in the service process. The reason for not
charging customers a larger mark-up on parts stems from an antitrust case filed
against Prospect Plc and other printer companies six years ago. A third-party service
company, Salawu Limited sued the printers manufacturers for restraint of trade
claiming they prevented Salawu Limited from maintaining the printers by only selling
replacement parts at very high prices. To prevent other such claims, Prospect sells
146
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
parts at a small mark-up over costs, yet Salawu Limited and other third party service
firms have never been able to penetrate Prospect Plc service markets, because their
lazer printing technology changes rapidly and an outside company cannot keep a
workforce trained to fix the latest products. Besides, each printer usually has at least
two engineering modifications each year to fix problems or upgrade the printer or its
microcomputer hardware and/or software. An outside service company cannot learn of
these changes and provide the same level of service as Prospect Plc.
The automotive division of Prospect Group had two types of technicians, Tech 1s and
Tech 2s. Both were trained to repair electromechanical problems but Tech 2s had
more training in electronics and computers to work on the latest, most sophisticated
printers.
Field service had been trying to reduce the size of the service workforce in the last few
years through voluntary retirements and attrition. As the printers became more
sophisticated, they became more reliable, the newer systems had self diagonising
software that allowed a service technician to call up a customer‟s printer and run a
diagnostic program. Often, the problem was solved over the phone line having a
Prospect technician handling the repair in the software. If a mechanical problem was
detected, the technician dispatched a repair person (often a tech 1s) with the right
part. Also, past customers replaced their older printers with newer ones that required
less maintenance. The result was excess capacity in the field staff.
The voluntary retirements over the past few years did not produce the reductions
necessary to eliminate the excess capacity. In 2009, field service went through a very
large involuntary reduction of its workforce through attrition, early retirements and
terminations. Prospect Group reduced the number of technicians in the automotive
division by 75% in 2010. The company simultaneously improved the skill level of its
remaining field force substantially.
Makinwa‟s 2010 sales plan for the AZ2000Q calls for 120 placements that year and a
programmed profit projection of about N2.5 million based on capitalizing the service
income using the 3.127 annuity factor. If she were to raise the service price much
above N0.51 per 1,000 pages, they would lose sales, which are already ambitious. She
called Ayobami and raised “phil,” she began, “explain to me how you downsized your
field personnel, cut some office allocations, consolidated inventories and reduced
other fixed costs yet the price I‟m being charged for service increased from N35 to
N38. I thought the whole purpose of the field service reorganization was to streamline
147
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
and make us more cost competitive. You know that our service costs were out of line
without competitors.
We were planning to charge N85 an hour for the AZ2000Q maintenance contract.
Even at N85 per hour I would be violating the corporate policy of maintaining a 60%
mark up on service rule, I would have to charge N87.63 per hour if you had kept your
cost to me at N35.05. But with your cost of N38.25 and my price of N85 the margin
falls to 55%. I already had to get special permission to lower the margin to 59% with
the N35.05.”
Ayobami replied, “well, there are a number of issues that you have just raised. Let me
respond to a few over the phone now and suggest that we meet to discuss this more
fully when I‟m back in the office. In the meantime, I‟ll send you our budget for next
year that derived the N38.35 rate.
Regarding the key question as to how our hourly rate could go up after downsizing it
is really quite simple. We had a lot of idle time being built into the numbers with
people just pretending to be busy. Had we not downsized, the hourly charge would
have gone up even more than it did. For example, on the AZ2000Q that you
mentioned, we would have used 3.25 hours per normal servicing had we kept our
labour force mix of Tech 1s and 2s, the same as in 2009 and our variable costs for Tech
1s and 2s would have increased to the 2010 amounts because of wage increase and
inflation. Let me get you our numbers, so you can see for yourself how much progress
we have been making.” That afternoon, Mrs. Makinwa received a fax from Ayobami
(see appendix XI).
MINING DIVISION
PROSPECT PLC is also thinking whether to purchase or lease an automatic casting
machine in its mining division. The machine will cost one million and five hundred
thousand Naira (N1,500,000) and for tax purposes, will be depreciated towards a zero
salvage value over a five-year period to 2013. However, at the end of the fifth year,
the machine actually has an expected salvage value of two hundred and ten thousand
naira (N210,000), since the machine is depreciated toward a zero book value at the
end of the five years. The salvage value is fully taxable at the firm‟s marginal tax rate
of forty percent (40%); hence, the after-tax salvage is only one hundred and five
thousand naira (N105,000). PROSPECT PLC utilized the straight line depreciation
method to the one million and five hundred thousand naira (N1,500,000) toward a
zero salvage value. Furthermore, the project is expected to generate annual cash
148
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
revenues of five hundred thousand naira (N500,000) per annum over the next five
years (net of cash operating expenses but before depreciation and taxes). PROSPECT
PLC has a target debt ratio of forty percent for projects of this type which is imposed on
its after-tax cost of capital of twelve percent (12%). Also PROSPECT can borrow funds at
a cost before tax rate of ten percent. The operating expenses associated with the asset
that will be paid by the lessor, if PROSPECT PLC leases generally consist of certain
maintenance expenses and insurance. PROSPECT PLC estimates them to be one
hundred thousand naira (N100,000) per year over the life of the project. The annual
lease payments are given and equal to four hundred and twenty thousand Naira
(N420,000).
HUMAN RESOURCES, ACCOUNTING AND INFORMATION SYSTEMS
Underlying PROSPECT PLC‟s operational capabilities is an employee relations
philosophy aimed at closely linking each employee with the company‟s short-andlong-term goals. It‟s management feels that mission-oriented employees are more
productive. Employees are asked to put out more effort in return for higher pay, yet
their efforts go beyond a straight work-harder-for-more-money arrangement. Their
efficiency and commitment allow PROSPECT PLC to hold down overall costs while
paying higher wages.
PROSPECT PLC looks for special people to fill its vacant positions. “We draft great
attitudes”, according to the Managing Director, Mr Kola Ikumapayi, “If you don‟t have
a good attitude, we don‟t want you no matter how skilled you are. We can change skill
levels through training, we can‟t change attitudes. We are fanatics about hiring the
right people. We want to give them latitude to be individuals on their job. We want
them to be good-natured and have a good-humoured approach to life and have fun
doing their job”.
Unlike many of its competitors, PROSPECT PLC`S employees are unionized. By
maintaining a favourable relationship with the unions, management has been able to
negotiate flexible work rules for its employees. Relationships throughout the company
are cooperative, and people take pride in their organization. Even though PROSPECT
PLC`S workforce is ninety percent unionized, its employees own ten per cent of the
company, the highest in the industry. Annual employee turnover was a mere seven per
cent (the industry‟s lowest) and eighty per cent of promotions came from within. In
2009, five thousand people applied for jobs in PROSPECT PLC, only two hundred were
hired, based on their ability, among other things, to work hard, to have fun, and to be
a part of the company‟s extended family.
149
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
The finance, information systems, and human resources divisions report to the
Managing Director‟s office. The reporting requirements for the company has been
recently streamlined by implementation of an IBM AS400 computer system in January
2009. This new system allowed for a reduction of five people in administrative office.
The new staff and system have resulted in streamlined financial reporting and
extended reporting to the field sales force and to PROSPECT PLC`S customers.
Improved order and cost tracking, as well as the automating of many previously
manual reports have also resulted. PROSPECT PLC recently awarded the contract for
the computerization of its wages, billing, shipping and accounts receivable. The
computer company sent the following information about the system installation to
PROSPECT PLC (see appendix XII).
After the installation, the new system was test run to ensure it works effectively and
meets the expectation of the company, there was a parallel running of the old system
with the new one. In 2009 financial year audit exercise, Mr Oshinbolu Rotimi, who is
the partner in charge of the audit of PROSPECT PLC during the interim work assigned
an audit assistant, Mr. Arowele Ojo to review the accounting system and the internal
control. The assistant determined the following information concerning the new IT
system and the processing and control of shipping notices and customer invoices.
Each of the major computerized functions – wages, shipping, billing, accounts
receivable and so on – is permanently assigned to a specific computer operator, who is
responsible for making program changes, running the program, and reconciling the
computer log. Responsibility for the custody and control of the magnetic tapes and
system documentation is randomly rotated among the computer operators monthly to
prevent any one person from having access to the tapes and documentation at all
times. Each computer programmer and operator has access to the computer room via a
magnetic card and a digital code that is different for each card. The systems analyst
and the supervisor of the computer operators do not have access to the computer
room.
The system‟s documentation consists of the following items: program listing, error
listing, logs, and record layout. To increase efficiency, batch totals and processing
controls are omitted from the system. PROSPECT PLC ships products directly from two
warehouses, which forward shipping notices to its General Accounting department.
The billing clerk enters the price of the item and accounts for the numerical sequence
of shipping notices and also prepares daily adding machine tapes of the units shipped
150
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
and sales amounts. Shipping notices and adding machines tapes are forwarded to the
IT department for processing. The computer output consists of
(a)
A three-copy invoice which is forwarded to the billing clerk.
(b)
A daily sales register showing the aggregate totals of units shipped and sales
amounts that the computer operator compares with the adding machine tapes.
The billing clerk mails two copies of each invoice to the customer and retains the third
copy in an open invoice file that serves as a detailed accounts receivable record.
LIST OF APPENDICES
APPENDIX I:
Sola Nigeria Limited Cash Flow Statement Extract
APPENDIX II:
Comparative Ratio Analysis of recently acquired companies
APPENDIX III:
Organisation Chart of Prospect Group
APPENDIX IV:
Prospect Group: Products lines, sales and operating income
APPENDIX V:
Prospect Group Financial Information on Proxy Companies
APPENDIX VI:
Prospect Group Industrial Products Limited Draft Balance Sheet
APPENDIX VII:
Industrial Products Division Bad Debts Losses & Collection costs by
category of customers
APPENDIX VIII:
Prospect Group – Proposed Investment in production of E-Banking
machine
APPENDIX IX:
Standard cost for the manufacturing
automation/electrical division
APPENDIX X:
Proposed electrical security device project at Automotive/Electrical
division
APPENDIX XI:
Automotive/Electrical division field service budgeted hourly rates
for 2010
of
machine
151
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
at
PATHFINDER
APPENDIX XII:
Prospect Group: Table of Activity for the computerization of
accounting system
APPENDIX I
SOLA NIGERIA LIMITED
CASH FLOW (EXCLUDING INTEREST ON DEBT)
N‟m
Operating profit after tax
Depreciation
17
7
Total
24
Less: Capital expenditures
8
Working capital additions
3
Free cash flow
13
APPENDIX II
COMPARATIVE RATIO ANALYSIS OF RECENTLY ACQUIRED COMPANIES
Equity value-to book
2.9x
Enterprise value-to sales
1.4x
Equity value to earnings
15.3x
Enterprise value to EBIT
7.8x
152
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
APPENDIX III: ORGANISATION CHART: PROSPECT GROUP
BOARD OF DIRECTORS
CHAIRMAN
GROUP
MANAGING DIRECTOR
EXECUTIVE
EXECUTIVE
EXECUTIVE EXECUTIVE
DIRECTOR
DIRECTOR
DIRECTOR
DIRECTOR
MARKETING
INDUSTRIAL PRODUCTS
MINING
FINANCE
INDUSTRIAL
HOUSE
SECURITY
QUARRY
HAULAGE
FINANCE
FASTENERS
EXECUTIVE
DIRECTOR
AUTOMOTIVE PRODUCTS
AUTOMATION
PRODUCTS
AUTOMOTIVES APPAREL
WARES
CONTROLLER
153
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
APPENDIX IV: PROSPECT GROUP: PRODUCTS LINES, SALES AND OPERATING INCOME
(Nm)
GROUP
Industrial Products
MAJOR PRODUCT LINES
Reagents, Chemicals, DSM Agro,
Sprayers, Footwears, DSM
Energy
Security Products
Lock sets, Padlocks, Door
closures, Electronic locking
system
Housewares
Blenders, Food processors,
Irons, Coffee makers, Electric
knives
Apparel/fasteners
Snap fasteners, rivets, burrs
brass zippers
Automation/Electrical Pneumatic valves, Cylinders,
regulators, tyre valves, printing
machines
Mining
Laterite, Bridge stones, Pellets
SALES
2009
200.5
OPERATING INCOME 2009
112.6
12.3
149.3
4.4
149.1
21.7
123.2
12.0
83.2
4.3
31.8
154
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
APPENDIX V
PROSPECT GROUP
FINANCIAL INFORMATION IN PROXY COMPANIES
BETA
LONG TERM
LIABILITIES TO
CAPITALISATION
Apopo Plc
0.90
0.45
Toyed Plc
1.05
0.30
Bosco Plc
0.76
0.42
Dendo Plc
1.20
0.51
0.98
0.42
Vauve Plc
0.85
0.38
Aloyd Plc
0.75
0.46
Ponco Plc
0.85
0.31
0.82
0.38
1.10
0.55
Howeg Plc
1.35
0.48
Atuka Plc
1.24
0.15
Chenco Plc
1.35
0.48
Pecaco Plc
1.10
0.30
Average
1.23
0.39
A. Industrial products
Average
B. Housewives
Average
Automation/Automatives
C. Gee Plc
155
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
APPENDIX VI: PROSPECT GROUP: INDUSTRIAL PRODUCTS LTD
Draft Balance Sheet, as at 31 December 2005
Fixed assets
Tangible assets:
Land and Buildings
Plant
Fixtures and Fittings
N‟000
Cost
N‟000
Dep.
N‟000
40,000
36,315
3,855
19,284
1,225
40,000
17,031
2,630
80,170
20,509
59,661
Intangible assets:
Goodwill
Investment: trade investment(at cost)
Current assets
Stock
Debtors
Deferred Development Expenditure
20,000
45,000
40,166
35,802
15,000
90,968
Current liabilities
Bank Overdraft
Trade Creditors
Director‟s Loans
Working Capital
Long term liabilities
7% Debentures
Accrued Interest
15,209
63,420
10,000
(88,629)
30,000
4,200
2,339
127,000
(34,200)
156
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
92,800
Capital and Reserves
Authorized share capital
50,000,000 ordinary shares @ N2.
40,000,000 7% cumulative preference
Shares @ N1.
100,000
40,000
140,000
Allotted share capital
40,000,000 ordinary shares @ N2
40,000,000 7% cumulative preference
Shares @ N1
80,000
40,000
120,000
Profit and loss account
(27,200)
92,800
APPENDIX VII
INDUSTRIAL PRODUCTS DIVISION
BAD DEBTS LOSSES AND COLLECTION COSTS BY CATEGORY OF CUSTOMERS
Risk
Category
1
2
3
Annual Bad debt
losses as a
percentage of sales
0.5
1.0
2.0
Collection cost as a
percentage of sales
1.0
1.5
4.0
APPENDIX VII
PROSPECT PLC – PROPOSED INVESTMENT IN PRODUCTION OF E-BANKING MACHINE
157
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
NOTES:
1. Skilled labour.
(a)
This is the scarce resource of the company. If labour is to be moved from one
area of production to another, it is necessary to ensure that the contribution
earned on the new production is at least equal to that which would have been
earned elsewhere. Accordingly, the contribution forgone by switching skilled
labour to the production of the machine has been included as a cost of the
machine.
(b) The option to recruit and train new labour has been rejected on the ground that
the cost of recruitment and training exceeds the discounted value of the
expected benefits. See calculation below:
Cashflow
N
Year
1. Training cost
2. Additional cash contribution
10 x 1000 x N50
1,500,000
3. 10 x 1000 x N50
500,000
4. 10 x 1000 x N50
500,000
Net Present Value
Discount
factor
Present Value
N
0.9091
(1,363,650)
2.261
1,130,500
500,000
(233,150)
2. Taxation: This has been ignored because of the difficulty in establishing the rate of
tax applicable to PROSPECT. Over the last decade, PROSPECT has sometimes paid
tax at the small company rate. Sometimes at the marginal rate, and at times has
had no taxable profit.
3. General fixed overheads. These have been excluded from cost of production, as
they are not related to the manufacturing of the machine, and will be incurred
whether or not the machine is produced.
158
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Calculation of Net Present Value
Annual Cash Outflow:
Unit cost of production per standard cost
less general fixed overhead (see note 1)
Unit cost directly attributable to the machine
N2,800
150
2,650
Total annual production cost
N2,650 x 1000
plus: opportunity cost of using skilled labour (note 2)
10 x 1000 x N50
Interest payment on loan
Total annual cash outflow (years 1 -4)
N2,650,000
500,000
200,000
3,350,000
Other cash flows
Purchase of equipment (year o)
Annual cash inflow: Payment from
Distributor in arrears
(years 2 – 5) 1000 x N3,500
1,000,000
3,500,000
Calculation of Net Present Value
Year Cash
Cash
Outflow
Inflow
0
(1,000,000)
1
(3,350,000)
2
(3,350,000)
3,500,000
3
(3,500,000)
3,500,000
4
(3,500,000)
3,500,000
5
3,500,000
D.F.
P.V.
1.0
0.9091
0.8264
0.7513
0.6830
0.6209
(1,000,000)
(3,045,485)
123,960
112,695
102,450
2,173,150
Net Present Value (NPV)
(1,533,230)
Recommendation by the trainee Accountant: Do not purchase the equipment to
manufacture the e-banking machine.
APPENDIX IX
STANDARD COST FOR THE MANUFACTURING OF MACHINE AT ELECTRICAL DIVISION
159
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
N
Materials
N
1,000
Labour:
Skilled: 10hrs @ N60 per hour
Semi-skilled: 10 hours @ N50 per hour
Prime cost
600
500
2,100
Overheads:
Variable: 20 hours @ N20 per hour
Fixed:
Specific: 20 hours @ N7.50 per hour
General: 20 hours @ N7.50 per hour
Total Cost
Profit Margin 25%
Selling Price per machine
400
150
150
700
2,800
700
3,500
APPENDIX X
PROPOSED ELECTRONIC SECURITY DEVICE PROJECT AT AUTOMATIVE/ELECTRICAL
DIVISION
Year 0
(N‟000)
depreciable
4,500
Year 1
(N‟000)
Year 2
(N‟000)
Year 3
(N‟000)
Year 4
(N‟000)
Year 5
(N‟000)
300
400
3,500
500
1,065
200
576
900
3,241
659
264
395
500
4,900
650
1,120
200
576
900
3,446
1,954
782
1,172
600
5,320
900
1,620
200
576
900
4,196
1,724
690
1,034
700
5,740
1,000
1,720
200
576
900
4,396
2,044
818
1,226
700
5,320
950
1,720
200
576
900
4,346
1,674
670
1,004
Investment
fixed assets
Cumulative investment
Working capital
Sales
Materials
Labour
Overhead
Interest
Depreciation
Taxable profit
Taxation
Profit after tax
160
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Total initial investment is N4,831,000. Average annual after tax profit is N966,200.
APPENDIX XI
AUTOMATIVE DIVISION
FIELD SERVICE PROJECTED HOURLY RATE FOR 2010
Variable costs
Technician grade
Salary & benefits
Number
Total direct cost of technician grade 1
Technician grade 2
Salary & benefits
Number
Total direct cost of technician grade 2
Total variable cost
Fixed costs
Supervision
Occupancy costs
Utilities
Insurance
Other
Total fixed cost
Total cost
Number of technician grade 1
Number of technician grade 2
Total technicians
Number of man months
Average number of billable hours per month per technician
Projected number of billable hours
Cost per hour projected for 2010
Note: Cost per hour 2009
N
x
N
42,800
105
4,494,000
54,800
x 195
10,686,000
15,180,000
1,200,000
1,100,000
320,000
50,000
50,000
105
195
300
3,000
130
2,720,000
17,900,000
468,000
N38.25
35.05
APPENDIX XII
PROSPECT GROUP: TABLE OF ACTIVITY FOR COMPUTERIZATION OF
161
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
ACCOUNTING SYSTEM
Activity
Activity Description
Immediate
Predecessor
Time
Most
Most
optimistic likely
Most
pessimistic
A
Select the computer model
-
4
6
8
B
Design input/output system
A
5
7
15
C
Design Monitoring System
A
4
8
12
D
Assemble computer Hardware
B
15
20
25
E
Develop the main programs
B
10
18
26
F
Dev. Input/output routines
C
8
9
16
G
Create data base
E
4
8
12
H
Install the system
D,F
1
2
3
I
Test and implement
G,H
6
7
8
PART I:
ATTEMPT ALL QUESTIONS
MULTIPLE-CHOICE QUESTIONS
(10 Marks)
1. Which ONE of the following best describes Gross National Product (GNP)?
A.
The total value of all goods and services produced in the country during the
year less taxation
B. The total value of all goods and services produced in the country during the
year plus net income from abroad
C. The total of all consumption in the country during the year
D. The total of all incomes earned in the country during the year
E. Gross National Income at factor cost less capital consumption.
2. The main classes of digital computers include all EXCEPT
162
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
A.
B.
C.
D.
E.
Hybrid
Mini
Super
Mainframe
Micro.
3. On cessation of a business or a trade, a gap occurring in the basis period for the
penultimate and ultimate years for the purpose of initial allowances is deemed to form part
of
A.
B.
C.
D.
E.
Penultimate year
Ultimate year
Pre-penultimate year
Preceeding year
None of the above.
4. Which ONE of the statements below does NOT describe the term “Degree of
Leverage?”
A.
B.
C.
D.
E.
The elasticity of earnings to change in debt
The level of retained earnings to debenture
The level of current assets to fixed assets
The sensitivity of earnings to change in capital structure
The impact of capital structure on company performance.
5. A supplier who is able to segregate the market for his goods and charge differential
prices between the poor and the rich is called
A.
B.
C.
D.
E.
Price dictator
Monopsony
Price monopolist
Discriminating monopolist
Dominating monopolist.
6. The Federal Government policies that attempt to reduce the volatility of export
prices are called
163
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
A.
B.
C.
D.
E.
Export prices volatility policies
Export substitution policies
Commodity stabilization policies
Commodity price monitoring policies
Export monitoring policies.
7. A mathematical technique used in scarce resource allocation with a view to
optimizing the decision process in a multifarious objective environment subject to
certain constraints is known as
A.
B.
C.
D.
E.
Mathematical programming model
Pareto optimality model
Sensitivity Analysis model
Goal programming model
Critical path analysis model.
8. A situation where a company gains control over another company by successive
purchases of shares over a period of time is known as
A.
B.
C.
D.
E.
Merger
Backward integration
Piece-meal acquisition
Sub-subsidiary control
Associated company.
9. A sampling method which involves the selection of the nth item/subject from serially listed
population, where n is any number usually determined by dividing the population by the
required sample size is known as
A.
B.
C.
D.
E.
Random sampling
Cluster sampling
Systematic sampling
Stratified sampling
Purposeful sampling.
164
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
10. Monthly demand for a company‟s product is 800 units, ordering cost per order is
N250, purchase cost per unit is N5 and carrying cost of 20% per annum. The EOQ is
A.
B.
C.
D.
E.
2,490 units
1,550 units
1,480 units
3,020 units
1,986 units.
PART II
SHORT-ANSWER QUESTIONS (30 Marks)
1.
A company in distress but whose economic worth as an operating entity is
greater than its liquidation value should opt for ……………..
2.
A method by which the number of outstanding shares is increased through a
proportional reduction in the par value of the share is called ……………….
3.
Risk capital invested in a new or young company for research and development
and/or growth is referred to as ………………….
4.
The dividend valuation model where annual dividend growth is expected is
given by Ke = ………………..
5.
Public sector audit is principally divided into ………….. and ………….
6.
A lease which runs for considerably less than the useful life of the assets
concerned is ………………….
7.
Tax attributable to timing difference is known as ………………….
8.
The Institute of Chartered Accountants of Nigeria Disciplinary Tribunal has the
powers of a Federal High Court and appeal against its verdicts can only go to
the …………..
9.
Tangible assets are depreciated over time while wasting assets …………… and
intangible assets ………………..
165
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
10.
Under PPTA, tax and royalty on gas transferred from the natural gas liquid to
gas-to-liquids facilities are ………..% and ………..% respectively.
11.
A method of comparing one company‟s financial ratio with another within the
same industry is referred to as ……………
12.
The time limit for a claim of tax credit under a double taxation agreement is
………………..
13.
The name of the meeting that a public company must hold within a period of six
(6) months from the date of its incorporation is ………………..
14.
The right of the insurer, having paid the insured to take over any right that the
insured has against the person who caused the loss is called ………….
System implementation is not complete without ……………..
A computer security system where list of authorized users of a company`s
network are established and maintained is …………………….
15.
16.
17.
The authority that is explicitly given by the principal in which the agreement
sets out the obligations of the agent and the precise powers, he has to carry out
those obligation is called …………………
18.
The accounting principle that makes distinction between the receipt of cash and
the right to receive cash, the payment of cash and the legal obligation to pay
cash is known as ……………….
19.
Transactions occurring subsequent to balance sheet date that lend insight to
amount and information disclosed in the financial statement are known as
……………..
20.
Communication approach involving patterns, movements and creativity as
propounded by Clampit (1991) is the …………….
21.
The managerial theory that situate leadership style on maturity of subordinates
is called……………..
22.
In how many ways can 5 passengers sit in a compartment having 16 vacant
seats?
23.
In queuing theory, the rate of arrival over the service rate is known as ………….
166
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
24.
Given the following functions:
TR
=
10Q, TC
=
50 + 5Q,
Sa = 20. If BEP is represented
by Sb, Sb is ………….. and margin of safety is ………….
25.
A tax assessment where there has been a valid objection is termed ……………..
26.
Portfolio that offers the lowest risk (standard deviation) for its expected return
and the highest expected return for its level of risk is called ………………
27.
NEEDS is the acronym for …………………
28.
The act of examining underlying documents in support of transactions or event
is known as ……………………
29.
A measure of variation or dispersion among the items in a population is called
…………………
30.
The software that provides individual authentication and identification
called …………………
is
SECTION B
QUESTION 1
(a)
With reference to Appendix III and other relevant information in the case,
prepare reduction and reconstruction accounts of the Industrial product division
of PROSPECT GROUP.
(6 Marks)
(b)
Prepare the Balance Sheet of the Industrial product division of PROSPECT
GROUP as at January 1,2006 after the recapitalization.
(3 Marks)
(c)
With the aid of three ratios, comment briefly on changes in the financial
position of PROSPECT GROUP consequent upon the reorganization.
(3 Marks)
(Total 12 Marks)
167
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
QUESTION 2
(a)
Prepare a revised cashflow forecast and Net Present Value (NPV) for the
proposed e-banking machine by the Automation division.
(6 Marks)
(b)
List the strengths and weaknesses of the budgeting and control system at
PROSPECT GROUP.
(2 Marks)
(c)
Apart from cashflow, what other factors should PROSPECT GROUP management
take into consideration in appraising the e-banking machine?
(2 Marks)
(Total 10 Marks)
QUESTION 3
(a)
Using Appendix VI, construct a flowchart for the programme of computerization
of some parts of the accounting system.
(4 Marks)
(b)
Determine the critical path and compute the expected project completion time.
(3 Marks)
(c)
Taking into consideration the financial condition of PROSPECT GROUP, advise
the management on whether to purchase or lease the equipment for the
Automation Division.
(7 Marks)
(Total 14 Marks)
QUESTION 4
(a)
In the context of the case study, define attitude and identify its components
attitude.
(2 Marks)
(b)
Identify the weaknesses of the internal control in the new computerized system
and inefficiency in the procedures for processing and controlling shipping
notices and customer invoices in PROSPECT GROUP.
(5 Marks)
(Total 7 Marks)
168
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
QUESTION 5
(a)
If you are engaged as the management consultant for the management audit of
PROSPECT GROUP. List and explain briefly any SIX specific steps you would take
to carry out the assignment.
(6 Marks)
(b)
Outline four contents of management Audit Report.
QUESTION 6
(2 Marks)
(Total 8 Marks)
(a)
When data can be input on-line through a computer terminal, there is a
possibility of unauthorized input. Discuss the various security control
components that PROSPECT GROUP should put in place to prevent such
unauthorized access.
(5 Marks)
(b)
Evaluate the human capital management of PROSPECT GROUP by outlining key
motivating factors in the group.
(2 Marks)
(c)
State four reasons why company capital may be restructured.
MULTI-DISCIPLINARY CASE STUDY
(2 Marks)
(Total 8 Marks)
SOLUTIONS TO MULTIPLE CHOICE QUESTIONS
1.
A
2.
A
3.
A
4.
C
5.
D
6.
C
7.
D
169
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
8.
C
9.
D
10.
B
MULTI-DISCIPLINARY CASE STUDY
SOLUTIONS TO SHORT-ANSWER QUESTIONS
1.
Corporate or Capital Restructuring
2.
Stock split
3.
Venture capital
do(1  g )
Ke =
g
Mve
Where do = dividend in year 1
G = growth rate.
MVe = Market Value of Equity per share.
4.
5.
Pre-audit and post-audit
6.
Operating
7.
Deferred
8.
Court of Appeal
9.
Depleted and amortized
10.
0% and 0% - S.10 (A) of PPTA
11.
Comparative Trend Analysis
12.
2 years after Year of Assessment
13.
Statutory meeting
14.
Doctrine of subrogation
15.
Pilot testing
16.
Firewalls
17.
Delegation
170
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
18.
Accrual principle
19.
Post Balance sheet
20.
Dance approach
21.
22.
23.
The situational or Contingency theory
524,160 - This question is on arrangement of passengers where the order of
arrangement is important and it is therefore a permutation problem. i.e.
16!
16.15.14.13.12
16!
16P5=
!
=
=
= 524,160
11!
11!
(16 - 5)
Traffic Intensity
24.
10 and 10
At BEP, TR = TC i.e. 100 = 50 + 5
5Q = 50
Q = 10.
Margin of Safety = Sa – Sb
= 20
– 10
=10
25.
Revised assessment
26.
Optimal
27.
National Economic Empowerment Development Strategy
28.
Vouching
29.
Standard deviation/variance
30.
Password.
EXAMINER‟S REPORT
The question in Part (a) and (b) was on Critical Path Analysis while part (c) was on
Lease or Buy Option. Only few candidates had an idea of Critical Path analysis and
the few were unable to draw the chart accurately. Consequently, they failed to
identify the path and compute the project completion time.
171
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
In Part (c), most candidates could not calculate the Cash Flows required for evaluating
the Lease or Buy decision.
As a result of the above, candidates‟ performance was very poor.
Once again, candidates are enjoined to always remember that they need the
knowledge of previous subjects they have passed earlier to properly answer questions
in Multi Disciplinary Case Study.
MULTI-DISCIPLINARY CASE STUDY
SOLUTION 1
(a)
REDUCTION AND RECONSTRUCTION ACCOUNT
N‟000
Ordinary share
Capital (written down to 50k) 20,000
Ordinary share capital
(issued to 50% preference
shareholders)
9% cumulative Preference
shares
Capital (issued to 50%
preference shareholders)
10% Debenture
Ordinary share capital (to
Directors)
Goodwill
Dev. Exp.
P & L bal.
20,000
15,000
27,200
20,000
Ordinary share capital
Preference shares
7% Debenture
Cash – 10% Debenture
Directors‟ loan
Revaluation of plant
Revaluation of land and
buildings
Profit on sale of trade
investments
N‟000
80,000
40,000
30,000
10,000
10,000
1,780
10,000
5,000
20,000
40,000
5,000
Written off
172
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Stock written down 16,000
Doubtful debts
3,580
62,200
19,580
186,780
(b)
186,780
BALANCE SHEET AS AT 1 JANUARY 2006
Fixed Assets
Land and Buildings at valuation
Plant at valuation
Fixtures and fittings (at written down value)
Current assets
Stocks
Debtors (N35,802 – N3,580)
Bank (see workings)
Current liabilities:
Trade creditors
Working capital
N‟000
24,166
32,222
20,591
76,979
(43,420)
33,559
105,000
Long term liability
10% Debenture (secured)
Represented by:
Authorized share capital:
200,000,000 Ordinary shares @ 50k
40,000,000 9% Pref. shares @ N1
N‟000
50,000
18,811
2,630
71,441
(40,000)
65,000
100,000
40,000
140,000
Issued share capital
90,000,000 ord. shares @ 50k
20,000,000 9% cum. Pref. shares @ N1
45,000
20,000
65,000
173
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Workings
Bank Account
Issued of Debenture
Sale of trade investment
N‟000
10,000
50,000
Balance b/f
Creditors
Debenture interest
Balance c/f
60,000
N‟000
15,209
20,000
4,200
20,591
60,000
(c)(i) The company‟s liquidity has improved from a potentially dangerous situation to
one of relative comfort. Using the quick ratio (acid-test ratio) the position
before and after reorganization can be compared:
Before
35,802:88,629 or 0.4:1
After
52,813:43,420 or 1.2:1
Sufficient quick assets now exist with which to meet the claims of creditors
should they demand payment simultaneously. Also, after re-organisation, the
company has funds to finance running expenses.
(ii)
(iii)
The company‟s working capital ratio shows a marked improvement. Since the
company now places less emphasis on finance from outsiders for its working
capital, greater security may now be offered to potential creditors (and it may
be possible to negotiate more favourable terms with suppliers). The relevant
ratios, before and after reorganization are :
Before
90,968:88,629 or 1.03:1
After
76,979:43,420 or 1.77:1
The company‟s gearing becomes higher after reorganization. The amount
required to service the preference share dividend and debenture interest has
risen by N900,000 per annum and the higher gearing will tend to make the
ordinary shares more speculative. The reduction in the amount of equity capital
may also result in a higher earnings per share (EPS) and possibly a higher
dividend than was potentially possible before reorganization. The relevant
ratios, before and after reorganization are:
174
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
Before
After
80,000:70,000 or 1.4:1
45,000:65,000 or 0.69:1
EXAMINERS‟ REPORT
The question tests candidates‟ knowledge of capital reduction and reconstruction.
About 90% of the students attempted the question but their performance was very
poor.
The commonest pitfall, was candidates‟ failure to arrange the figures in the Balance
Sheet orderly and inability to compute ratios correctly.
Candidates should be aware of the need to read wide, most especially, areas they have
covered in the previous examinations in preparation for this subject such as
acceptable presentation of accounts and ratio analysis.
MULTI-DISCIPLINARY CASE STUDY
SOLUTION 2
(a)
Annual cash outflow
N
2,800
150
150
2,500
1,000
Unit cost of production per standard cost
Less: Specific fixed overhead
General fixed overhead
Annual production
Total annual cash outflow
1-4
Other cash outflows
Purchase of equipment year 1
Investment in recruitment training year 1
Opportunity cost of using skilled labour year 1
Payment by distributor
N
2,500,000
1,000,000
1,500,000
1,500,000
3,500,000
Calculation of NPV
Year
Cash outflow
Cash inflow
DF
Present value
175
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
0
1
2
3
4
(1,000,000)
(4,500,000)
(2,500,000)
(2,500,000)
(2,500,000)
3,500,000
3,500,000
3,500,000
3,500,000
1.0
0.9091
0.8264
0.7515
0.6830
Decision: The company should purchase the equipment.
(1,000,000)
(909,100)
826,400
751,300
683,000
351,600
(b)(i) STRENGTHS
-
autonomy of the managers to set budgets
performance evaluation based on profit performance
division of the budget into short and long term
the stages of the budget approval: bottom to top promote goal
congruence
revision and monitoring of the budget on quarterly basis.
-
(ii)
WEAKNESSES
-
decentralization may weaken Head office
the 3, 5 year budget forecast may be a wasteful exercise because of
environmental uncertainties.
time and money is being wasted on budget monitoring
managers are not compensated on budget attainment.
(c)
Other factors that should be considered include the following:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(v)
activities of competitors
quality of the product
potential life cycle of the product
acceptability of the product
continual demand for the product
availability of other components
availability of raw materials.
176
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
EXAMINER‟S REPORT
The question tests candidates‟ knowledge of Capital Budgeting. The general
performance of candidates was extremely poor. The candidates lacked adequate
understanding of the question and parts thereof because they seemed to have
forgotten the technicalities and theoretical background behind Capital Budgeting.
The candidates failed to identify the required figures for the computation of Cash Flow
forecast to calculate the Net Present Value. In part (b), they failed to identify the
strengths and weaknesses in the company‟s budgeting process as revealed in the
case. Most candidates also failed to identify other factors to be taken into
consideration in project selection apart from Cash Flow as asked for in part (c).
Candidates need to realize that Capital Budgeting is an important area in
management and a good understanding of this is required of a competent accountant.
Therefore candidates must ensure adequate knowledge of this topic in the future.
SOLUTION 3
(b)
Calculation of Expected Time Activity
Activity
A
B
C
D
E
F
G
H
I
where tei
Time
1–2
2–3
2–4
3–6
3–5
4–6
5–7
6–7
7–8
=
a
4
5
4
15
10
8
4
1
6
m
6
7
8
20
18
9
8
2
7
b
8
15
12
25
26
16
12
3
6
tei
6
8
8
20
18
10
8
2
7
a + 4m + b
6
177
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
0
A
6
B
8
1
C
E
2 18
5G
D
20
8
6
4
3 10
F
8
2
H
7
I
Paths
Durations
A – B –E – G – I
A–C–F–H–I
A – B – D –H – I
6+ 8 + 18 + 8 + 7 = 47
6 + 8 + 10 + 2 + 7= 33
6 + 8 + 20 + 2 + 7= 43
Therefore, the critical path is A – B – E – G – I
and expected time the Project would be completed is 47 days.
178
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
7
PATHFINDER
(c)
Step 1: Computation of NPV – should the equipment be purchased.
COMPUTATION OF PROJECT ANNUAL AFTER TAX
CASH FLOW ASSOCIATED WITH EQUIPMENT PURCHASE
YEAR
1
2
3
4
5
N000
N000
N000
N000
N000
N000
N000
N000
N000
N000
Book
profit
500
Cash
flow
500
Book
profit
500
Cash
flow
500
Book
profit
500
Cash
flow
500
Book
profit
500
Cash
flow
500
Book
profit
500
Cash
flow
500
Less depreciation
300
-
300
-
300
-
300
-
300
-
Net revenue before taxes
200
500
200
500
200
500
200
500
200
500
Less taxes 50%
100
100
100
100
100
100
100
100
100
100
Annual cash revenues
Annual after tax cash flow
400
400
400
400
179
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
400
COMPUTATION OF NET PRESENT VALUE
Year
0
1
2
3
4
5
5 Salvage
Annual
cash flow
1,500,000
400,000
400,000
400,000
400,000
400,000
105,000
D. F.
Present
value
(1,500,000)
357,040
318,880
284,720
254,200
226,960
59,577
1,377
1.0
0.8926
0.7972
0.7118
0.6355
0.5674
0.5674
Net present value
COMPUTATION OF THE NET ADVANTAGE OF LEASE
Year
1
2
3
4
5
After-tax
operating
expenses paid
by lessor
50,000
50,000
50,000
50,000
50,000
Year
1
2
3
4
5
Salvage value 105,000
Initial outlay
(Net advantage of lease)
After-tax
rental
expenses
Tax shield
interest
Tax shield on
dep.
Total
210,000
210,000
210,000
210,000
210,000
75,000
62,716
49,204
34,341
17,991
150,000
150,000
150,000
150,000
150,000
(385,000)
(372,716)
(359,204)
(344,341)
(327,991)
Total
D. F.
(385,000)
(372,716)
(359,204)
(344,341)
(327,991)
0.9091
0.8264
0.7513
0.6830
0.6209
105,000
0.5674
Present
value
350,004
308,013
269,870
235,185
203,650
(1,366,722)
59,577
1,500,000
73,701
PROFESSIONAL EXAMINATION II – NOVEMBER 2010
PATHFINDER
AMORTISATION SCHEDULE
Year
0
1
2
3
4
5
Instalment
payment
395,673.96
395,673.96
395,673.96
395,673.96
395,673.96
Annual instalment payment
Interest
150,000.00
125,432.60
98,408.47
68,681.92
35,982.72
Principal
repayment
245,673.96
270,241.36
297,265.49
326,992.04
359,691.24
=
1,500,000
1  (1  r )  n
=
i
1,500,000
3.791
N395,673.96
=
Balance
1,500,000.00
1,254,326.04
984,084.68
686,819.19
359,827.15
135.91
Decision criteria: First the project‟s NPV of purchase of N1,377 indicating that the
asset should be purchased. However, the net advantage to leasing, it was found
that the financial lease was the preferred method of financing the acquisition of
the equipment.
EXAMINER‟S REPORT
The question tests candidates‟ knowledge of Leasing and Critical Path analysis.
The question in Part (a) and (b) was on Critical Path Analysis while part (c) was on
Lease or Buy Option. Only few candidates had an idea of Critical Path analysis and
the few were unable to draw the chart accurately. Consequently, they failed to
identify the path and compute the project completion time.
In Part (c), most candidates could not calculate the Cash Flows required for
evaluating the Lease or Buy decision.
As a result of the above, candidates‟ performance was very poor.
Once again, candidates are enjoined to always remember that they need the
knowledge of previous subjects they have passed earlier to properly answer
questions in Multi Disciplinary Case Study.
181
P. E. I EXAMINATION – NOVEMBER 2010
PATHFINDER
SOLUTION 4
(a)
Attitude can be defined as a predisposition or readiness to respond in a
certain way to a person, object, idea or situation.
The three components of attitudes are: cognition, affect and behavior.
The cognition component is beliefs and perceived knowledge about the subject of
the attitude.
The affective component includes the feelings associated with the subject, often
conveying likes and dislikes.
The behavioural component stems from the perceptions and feelings as an
intention to act in a certain way.
(b)
Weakness in the internal control of the new computerised system:
(i)
The major computerized function is permanently assigned to a
specific computer operator.
(ii)
A single computer operator is responsible for program changes,
running the program and recruiting the computer log.
(iii)
The system analyst and supervisor of the computer operators do not
have access to the computer room.
(iv)
Responsibility for the custody and control of the magnetic tapes and
documentation is solely with the computer operators.
(v)
Inconsistent policies.
Weakness in the processing and controlling shipping notices and customer
invoices:
(i)
The billing clerk enters the price as well as prepares daily adding
machine tapes of units shipped without anybody checking his work.
(ii)
Omission of batch totals and processing controls from the system.
(iii)
The shipping notice goes only to the General Accounting, not to
inventory or purchasing department or other relevant units.
(iv)
The daily sales show only the aggregate total of units shipped.
(v)
The distribution of the invoices.
182
P. E. I EXAMINATION – NOVEMBER 2010
PATHFINDER
EXAMINERS‟ REPORT
The question tests students‟ knowledge of management theory of attitude and
internal control system in auditing.
Part (a) of the question asked for the definition of attitude and its components in
the context of the case while part (b) asked the candidates to identity the
weaknesses in the Internal Control. Many candidates understood the question but
found it difficult to properly define attitude and its components. Also candidates
found it difficult to identify the internal control weaknesses and inefficiency in the
procedures for processing and controlling shipping notices to aid customer
invoices.
Candidates should learn how to sift through procedures and identify weaknesses
inherent in a procedure.
SOLUTION 5
(a)
Before commencing a management audit engagement, it is pertinent for the
auditor to plan and outline briefly and concisely an audit programme as it
relates to the areas being studied. The following steps represent the real
crux of an efficient management audit programme.
Step 1: Organisation structure. The auditor should study the organization and
compare the existing structure with that shown in the company‟s organization chart
(if any).
Step 2: Policies and practices. The auditor should carry out a study to find out
what action must be taken to improve the effectiveness of the policies and
procedures.
Step 3: Regulations. Determine whether or not due regard has been given by the
company for full compliance with all local, state and federal regulations.
Step 4: Systems and procedures. Study the systems and procedures for possible
defects or irregularities in the elements examined and seek out methods to bring
about possible improvements.
Step 5: Operations. Evaluate operations to ascertain what is necessary for income
effective controls and efficient results.
Step 6: Personnel. Study the general personnel requirements and their application
to the work in the area under appraisal.
183
P. E. I EXAMINATION – NOVEMBER 2010
PATHFINDER
Step 7: Layout and physical equipment. Determine whether or not improvement
could be made in the layout and in better or greater use of physical equipment.
Step 8: Report. Prepare a report of findings with suggested recommendations for
improvement.
(b)
The contents of management audit report (in outline form).
(i)
(ii)
(iii)
(iv)
(v)
(vi)
Purpose and scope of engagement.
Facts of major importance.
Matters discussed with supervisors/managers.
Details of current practices.
Recommandation.
Appendices/exhibits.
EXAMINERS‟ REPORT
The question tests the steps to follow in carrying out a management audit.
Ordinarily, the question should not pose any problem for any serious candidate.
However, majority of the candidates lacked proper and in-depth understanding of
the topic and as such most of those who attempted the question peformed poorly.
Candidates are advised to study widely in the course of preparation for future
examinations.
SOLUTION 6
(a)
There are various ways of protecting computer systems from unauthorized
assessment which include the following:
1.
Operations Security:
(i)
to prevent unauthorized users to access or use data.
(ii)
to prevent authorized users from misusing the data or
damaging it through ignorance
2.
Preventive and Proactive measures. These measures include:
(i)
precautionary measures to safeguard the system from external
threats and unauthorized persons e.g. use of passwords
184
P. E. I EXAMINATION – NOVEMBER 2010
PATHFINDER
(ii)
(b)
3.
Detective measures which include:
(i)
measure to sense and report unauthorized operations
(ii)
measure to discover and identify illegal operations and
intruders.
4.
Physical security. This includes the following controls:
(i)
physical access control
(ii)
fire prevention and detection equipment
(iii) storage of working media in fireproof stations.
The key motivating factors at PROSPECT GROUP include the following:
(i)
(ii)
(iii)
(vi)
(v)
(vi)
(vii)
(viii)
(c)
measures to obstruct, protect and defend the system from
illegal operations e.g. use of operators permissions, restriction
to certain functions.
Reward for hardwork through higher pay.
Cooperative attitude encouraged by management.
Openness, commitment and sincerity of top management.
Maintenance of favourable relationship with unions.
Part ownership of the company by employees.
Boost of morale of employees by installation of computer system.
Provision of conducive work environment.
Low employee turnover due to flexible rules for its employees.
A company‟s capital may be restructured for the following reasons:
(i)
(ii)
As a possible alternative to liquidation.
To tidy up a balance sheet which might otherwise show large number
of different reserves.
(iii) A capital re-organisation scheme may be used to effect a change in
the relative rights of different classes of shareholders.
(iv) When operating losses are being incurred continuously.
(v)
The book value of the ordinary share capital is overstated.
(vi) The company is unable to meet its obligations as and when due.
(vii) There is rapid labour turnover particularly loss of skilled labour.
(viii) The fixed assets of the company are too weak or old to put the
company into the path of success and growth.
185
P. E. I EXAMINATION – NOVEMBER 2010
PATHFINDER
EXAMINERS‟ REPORT
The question tests candidates‟ knowledge of computer system, human capital
management and the reason why a company‟s capital may be restructured.
This question was in three parts, which are direct and should have been easy for
candidates with fair knowledge of computer system, management theory and
financial management.
Candidates‟ understanding of each part of the question is shallow. Part (a) on
Computer system which should have been a cheap source of marks was wrongly
approached. They only control most candidates mentioned is the use of Password
while others are not mentioned. Part (b) on Human Capital Management has all
the answers in the case but only a few candidates could identify them. Also, most
of the candidates failed to identify four reasons why a Company‟s capital may be
restructured as required in part (c) of the question.
Inadequate preparation and lack of understanding are the undoing of most
candidates. There is a need for adequate preparation on the part of the candidates
for future examinations.
186
P. E. I EXAMINATION – NOVEMBER 2010