acct1511 final version

SURNAME OF CANDIDATE:

FIRST NAME OF CANDIDATE:

STUDENT ID:

SIGNATURE:

SCHOOL OF ACCOUNTING

ACCT 1511: Accounting and Financial Management 1B

FINAL EXAMINATION

June 2007 Time Allowed: 3 Hours Reading Time: 10 minutes Total Number of Questions: 6

Answer ALL questions. The questions are NOT of equal value. • Answers to Questions 1 to 5 must be written in ink in spaces provided in

this Booklet. • Question 6 must be answered on the separate Generalised Answer Sheet

provided using a 2B pencil.

This paper is NOT to be retained by the candidate.

DO NOT OPEN THIS PAPER UNTIL INSTRUCTED BY THE EXAM SUPERVISOR

Official Use Only

Q Mark

1

2

3

4

5

Total (/80)

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QUESTION 1 (10 MARKS): CASH FLOW STATEMENTS Brickman Corporation is a medium-sized wholesaler of building materials in the state of NSW. Its shareholders have been paid a total of $1 million in cash dividends for the last 8 consecutive years. The policy of the Board of Directors requires that in order for this dividend to be declared, net cash provided by operating activities in Brickman’s current year’s Statement of Cash Flows must be in excess of $1 million. CEO Phil Lucky’s job is secure so long as he produces annual operating cash flows to support the usual dividend. At the end of the current year, financial controller Jack Black presents CEO Lucky with some disappointing news: the net cash provided by operating activities is calculated to be only $970,000. The CEO says to Jack, “We must get that amount above $1 million. Aren’t there some ways to increase operating cash flows by another $30,000?” Jack answers, “These figures were prepared by my assistant. I’ll go back to my office and see what I can do.” The CEO replies, “I know you won’t let me down, Jack.” After scrutinising the Statement of Cash Flows, Jack concludes that he can get the operating cash flows above $1 million by including a $60,000, 2-year Notes borrowed during the current year as part of the company’s Accrued Expenses account, rather than as part of the Notes Payable account. He returns to the CEO saying, “You can tell the Board to declare their usual dividend. Our net cash flow provided by operating activities is now $1,030,000.” “Good man, Jack! I knew I could count on you,” exults the CEO. Required: (a) Explain why Jack thinks the reclassification of the $60,000, 2-year Notes Payable

as Accrued Expenses can increase the net cash flow from operating activities. Use the concepts underlying: (i) the indirect method, and (ii) the direct method of calculating cash inflows and outflows from operating activities to support your answer.

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(i) Indirect method (2 marks)

DO NOT WRITE BEYOND THIS LINE (ii) Direct method (2 marks)

DO NOT WRITE BEYOND THIS LINE

(b) Assuming that the usual $1 million cash dividends can be declared and paid at the end of the current year, what would be the subsequent impact of this reclassification on the company’s (i) operating, (ii) investing, (iii) financing, and (iv) total cash flows? State both the direction and size of the impact (4 marks).

(i) Operating: (ii) Investing: (iii) Financing: (iv) Total cash flows:


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(c) Based on your answers above, do you agree with Jack’s suggestion to reclassify

$60,000, 2-year Notes? (2 marks).


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QUESTION 2 (15 MARKS): FINANCIAL STATEMENT ANALYSIS You have recently graduated from UNSW with a BCom degree (with a double major in Accounting and Finance) and have been hired by McDonald Bank, one of the most prestigious investment banks in Asia-Pacific region, to work as an equity investment analyst. Your first project is to help with the process of reviewing and analysing the financial results of Coles Ltd for the financial year ended on 30 July 2006. You have been provided with the company’s concise financial statements (see pages 5 and 6) and nearly-completed worksheet on its key financial information (see page 7). You have also been provided with the relevant corresponding financial information about the company’s major competitor, Woolworths Ltd. Note: Use the following formulae for ratio calculations if required. Key Ratio Formulae: Return on Equity (ROE) = Net Profit After Tax / Shareholders’ Equity Return on Assets (ROA) = Earnings before Interest & Tax (EBIT) / Total Assets Profit Margin = Net Profit After Tax / Sales Revenue Gross Margin = Gross Profit / Sales Revenue Asset Turnover = Sales Revenue / Total Assets Inventory Turnover = COGS / Average Inventory Days Inventory on Hand = 365 / Inventory Turnover Debtors (receivables) Turnover = Credit Sales / Average Trade Debtors Days in Debtors = 365 / Debtors turnover Creditors Turnover = Purchases (or COGS) / Average Accounts Payable Days in Creditors = 365 / Creditors Turnover Cash Flow Cycle = Days in Inventory + Days in Receivables – Days in Creditors Current Ratio = Current Assets / Current Liabilities Quick Ratio = (Current Assets – Inventories) / Current Liabilities Interest Coverage = EBIT / Interest Expense (net) Debt to Equity Ratio = Total Liabilities / Total Equity Debt to Assets = Total Liabilities / Total Assets Leverage = Total Assets / Shareholders’ Equity

QUESTION 2 CONTINUES ON PAGE 7

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Footnotes:

(1) The Income Statement for the year ended 31 July 2005 has not been restated as permitted by AASB 132 Financial Instruments: Disclosure and Presentation and AASB 139 Financial Instruments: Recognition and Measurement which have been adopted from 1 August 2005. (2) The profit for the year ended 30 July 2006 was $1,163.6 million. After adjusting for the gain on disposal of Myer of $583.7 million and strategic initiative costs of $207.4 million, the profit for the year would have been $787.3 million.

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QUESTION 2 CONTINUED: Required: (a) Using the information from Coles’ 2006 concise financial statements, calculate

the missing 2006 figures in the worksheet below on key financial information. State your answers in the boxes provided. Note that ratio formulae are provided on page 4 (6 marks).

Coles Woolworths

2006 2005 2006 2005 Income Statement Revenue from sale of goods 34,212.0 33,018.0 37,849.7 31,481.2

EBIT 1,027.2 1,722.2 1,302.1

Profit from continuing operations 536.4 686.1 1,014.6 817.2 Profit for the year 1,163.6 637.9 816.2 [see Note 2 of Income Statement] Balance Sheet Total Current Assets 3,881.3 4,259.6 3,064.5 Total Assets 9,135.3 9,223.8 13,346.4 8,775.2 Total Current Liabilities 3,962.8 3,962.9 3,780.7 Total Equity 3,598.0 3,415.0 4,027.8 2,002.2 Basic EPS (cents) 63.2 51.8 90.89 79.19 As at the financial year-end date Closing share price $14.61 $10.20 $19.93 $16.67 Price Earnings (PE) Ratio 23.12 19.69 21.93 21.05 Trend analysis

Sales growth 2.33% 20.23% 12.70%

Profit growth (from continuing operations) 11.29% 24.16% 11.78% Liquidity Ratios

Current Ratio 1.07 0.81

Financial Structure Ratios

Leverage 2.70 3.31 4.38

Interest Coverage 18.61 6.90 8.67

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(b) Comment on the “Sales growth” of Coles Ltd from 2005 to 2006 compared to the sales growth of Woolworths Ltd over the same period (1 mark).

DO NOT WRITE BEYOND THIS LINE (c) Comment on the “Profit growth (from continuing operations)” with reference to

the changes in the “Profit for the year” from 2005 to 2006 for Coles Ltd (2 marks).

DO NOT WRITE BEYOND THIS LINE (d) What do you think of the decision by the Coles’ management to report $1,163.6m

as the “Profit for the year” in the Income Statement? Explain your answer by referring to the footnote 2 of the Income Statement on page 5 (2 marks).



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This page has intentionally been left blank. You can use this page for workings.

Please note that any writing on this page will not be marked.

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(e) With references to a rule of thumb, discuss the change in the Current Ratios of Coles Ltd over the last 2 years, and whether it gives rise to any cause for concern (2 marks).

DO NOT WRITE BEYOND THIS LINE (f) The management wishes to make a presentation to analysts in order to inform

them of the company’s 2006 financial results. In the presentation, the management is expected to provide guidance that Coles Ltd’s Basic EPS would be 90 cents for the year 2007. Assuming that the PE Ratio stays constant as at the financial year-end of 2006, what do you expect the share price to be at the end of the year 2007? (2 marks).

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QUESTION 3 (20 MARKS): ACCOUNTING POLICY CHOICE, CORPORATE GOVERNANCE AND PROFESSIONAL ETHICS Part A (10 marks): ET FoneHome Ltd (“ETF” or “The Company”) is a mobile phone company listed on the Australian Stock Exchange (ASX). The Company is considering issuing new shares to finance the acquisition of mobile telephone spectrum licenses. The management prepared the following Income Statement for the period ending 31st December 2007, to be submitted to the Board of Directors for its approval:

ET FoneHome Ltd Income Statement

For the period ending 31st December 2007 $m $m 2007 2006 Sales revenue 678.2 330.9 Expenses (908.6) 305.7 Earnings Before Interest, Tax, Depreciation & Amortisation (EBITDA) (230.4) 25.2 Depreciation & amortisation (35.3) (12.3) Net interest (expense)/ revenue 3.3 (1.6) Net profit/ (loss) before income tax (262.4) 11.3 Income tax expense (30%) (3.4) Net profit/ (loss) after income tax (262.4) 7.9 After reviewing the draft 2007 Income Statement, the Chief Executive Officer (CEO) is concerned that, by reporting a loss for 2007, it may cause the Company’s share price to drop and make it difficult to raise further funds from a share issue. The CEO therefore asks the Chief Financial Officer (CFO) for suggestions regarding the figures. The CFO suggests that the $450 million spent on marketing costs on 1st January 2007 and currently treated as an expense, should be capitalised and amortised over 3 years instead.

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Required: (a) Re-calculate and prepare a new 2007 Income Statement to reflect the proposed

change in the accounting policy for marketing costs. Use 1-decimal point in every step of the calculations as well as for the answer (4 marks).

New Old 2007 2007 2006

Sales revenue 678.2 330.9

Expenses (908.6) 305.7

EBITDA (230.4) 25.2

Depreciation & amortisation (35.3) (12.3)

Net interest (expense)/ revenue 3.3 (1.6)

Net profit/ (loss) before income tax (262.4) 11.3

Income tax expense (30%) (3.4)

Net profit/ (loss) after income tax (262.4) 7.9

(b) According to the AASB Framework, what is the appropriate treatment for

marketing costs in 2007? Apply the relevant definition and recognition criteria in your answer (3 marks).


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(c) Discuss the cash flow implications (directional and size effects, if any) of the proposed accounting policy change for 2007 and 2008 (3 marks).


QUESTION 3 CONTINUES ON THE NEXT PAGE

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Part B (5 marks): The CFO is concerned that the Board of Directors may not approve the new Income Statement prepared in Part A. The CEO, who is also the Board Chairperson and the Chairperson of the company’s Audit Committee, however, is not as concerned about the Board approval. The CEO believes that he will be able to persuade other Board directors (including members of the Audit Committee who are also his golfing partners and have little accounting expertise), and obtain approval for the revised Income Statement. (a) Discuss how good corporate governance regarding the roles of the Board

Chairperson and CEO could potentially have avoided the above situation from arising (2 marks).

DO NOT WRITE BEYOND THIS LINE (b) Discuss how good corporate governance in the role and composition of the Audit

Committee may assist in having the Revised Income Statement for 2007 being rejected (3 marks).



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Part C (5 marks): NOT relevant in Session 2 2009 The CFO has been considering buying a property in Coogee with great sea views. He is concerned that the value of the Company shares he owns will fall if the original Income Statement is released, and consequently, will not be able to buy the property. He has been reminded that the final version of the Company’s Income Statement must be submitted to the Board within the next few days. The CEO has left the CFO to decide upon which Income Statement (old or new) should be submitted for Board approval. What should the CFO do? Apply the Code of Ethics for Professional Accountants to identify threats, evaluate significance and respond to this situation. Identify threats: Evaluate significance: Respond:


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QUESTION 4 (15 MARKS): COST CONCEPTS Black Swan Ltd produces “Snooze Sheep” dolls which have become very popular with the trendy university students. The company has two production departments, Assembly and Packaging departments. The following balances were recorded on 1 March 2007 for the Assembly Department: Inventory as at 1st March 2007: Raw Materials $3,600 Work-In-Process $11,000 Finished Goods $26,000 Required: The following transactions have occurred during the month of March 2007 in the Assembly Department of Black Swan Ltd. Write appropriate journal entries for each of the transactions. (a) Purchased $28,400 of raw materials on account (1 mark).

(b) Incurred $48,000 of direct labour, not yet paid (1 mark).

(c) Raw materials were issued for production. Raw materials balance on 31st March 2007 was $20,000 (2 marks).

(d) Applied overhead at the rate of $18 per machine hour. Machine hours incurred for the Assembly Department was 2000 hours (1 mark).

(e) Actual manufacturing overhead for March 2007 comprised indirect labour, $22,000 and depreciation expense, $12,000 (3 marks).

(f) Black Swan Ltd treats any overhead variance to be immaterial (1 mark).

(g) Work-In-Process balance on 31st March was $35,000 (2 marks).

(h) Finished Goods balance on 31st March was $10,000 and “Snooze Sheep” dolls were sold on an account with a 20% mark-up on the same day (4 marks).

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(a) (b) (c) (d) (e)

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(f) (g) (h)

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QUESTION 5 (20 MARKS): BUDGETING FOR PLANNING AND CONTROL Part A (5 marks): One of the many benefits of budgets is that they can be used as a motivational tool for employees. List two (2) essential aspects of budgets which must be present in order for the budget to be effective and explain how they can motivate employees to perform better.


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Part B (15 marks): Blackjack Ltd. is a retail company specialising in state-of-the-art surgical instruments for medical practitioners. Information about the company’s operations is given below:

• Sales in November were $400,000 and are budgeted at $440,000 for December, $300,000 for January, and $280,000 for February.

• Cash collections are expected to be 60 per cent in the month of sale and 38 per cent in the month following the sale. 2 per cent of sales each month are expected to be uncollectible (that is, they are expected to be written off straight away).

• The company’s gross margin is 25 per cent of its sales revenue.

• Each month, the company’s inventory purchase is to be 80 per cent of the following month’s sales requirement. Payments for the merchandise are expected to be paid in the month following the purchase.

• Expenses are paid in the month they incur. Variable operating expenses (excluding bad debts) are expected to amount to 4 per cent of sales. Fixed monthly expenses (excluding depreciation) are budgeted at $25,200.

• Annual straight-line depreciation expenses are estimated to be $432,000.

• Tax rate is 30%.

Blackjack Ltd Balance Sheet

As at 30 November 2007 Assets Cash $ 44,000 Accounts receivable $ 152,000 Inventory $ 264,000 Property, plant and equipment $3,100,000 Accumulated depreciation ($1,360,000)

Total Assets $2,200,000 Liabilities and Owners’ Equity Accounts payable $ 324,000 Share capital $1,600,000 Retained earnings $ 276,000

Total liabilities and owners’ equity $2,200,000

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Required: (a) Calculate the budgeted cash collections for December 2007 (3 marks).

(b) Calculate the budgeted cash payments for December 2007 (2 marks).

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(c) Prepare the budgeted Income Statement for December 2007 (5 marks).

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(d) Calculate the projected balance in Accounts Receivable on 31 December 2007

using a T-account. Identify clearly each item in the T-account (5 marks).

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SOLUTIONS TO QUESTION 1 PART A (i) Under the indirect method, increases in non-debt current liabilities are added back

to net profit to derive the CFO. Thus CFO is higher by the amount of the reclassification. (ii) Under the direct method, we have to reconstruct balance sheet accounts to back

out the amount of cash paid or received. The reclassification would result in an increase in the closing balance of the Other

Payables account. Other things equal, this translates into a corresponding decrease in the amount

calculated for cash paid for Other Payables. The increase in CFO is reflected in the reduction in the cash paid for Other

Payables. PART B (i) Operating cash flows increased by $60,000 (ii) Investing cash flows remained unchanged (iii) Financing cash flows decreased by $1,060,000 (iv) Total cash flows decreased by $1,000,000 PART C See tutors during consultation times SOLUTIONS TO QUESTION 2 (a) EBIT 850.9 Sales growth 3.62% Profit growth continuing operations -21.82% Current Ratio 0.98 Leverage 2.54 Interest Coverage 8.60 (b) – (e) See tutors during consultation times (f) Share price in 2008 = $0.90 x 23.12 = $20.81

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SOLUTIONS TO QUESTION 3 Part A (a) Sales revenue 678.2

Expenses (458.6)

EBITDA 219.6

Depreciation & amortisation (185.3)

Net interest (expense)/ revenue 3.3

Net profit/ (loss) before income tax 37.6

Income tax expense (30%) (11.3)

Net profit/ (loss) after income tax 26.3

(b) See tutors during consultation times (c) 2007 Accounting policy choices have no cash flow implications. 2008 There is an net profit before tax of $37.6 million in 2007 so there is a tax cash outflow impact of $11.3 million. Part B See tutors during consultation times.

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SOLUTIONS TO QUESTION 4 (a) Dr Raw Materials 28,400 Cr Accounts Payable 28,400 (b) Dr WIP 48,000 Cr Wages Payable 48,000 (c) Dr WIP 12,000 Cr Raw Materials 12,000 (d) Dr WIP 36,000 Cr Overhead Control 36,000 (e) Dr Overhead Control 34,000 Cr Wages Payable 22,000 Cr Accumulated Depreciation 12,000 (f) Dr Overhead Control 2,000 Cr COGS 2,000 (g) Dr Finished Goods 72,000 Cr WIP 72,000 (h) Dr COGS 88,000 Cr Finished Goods 88,000

Dr Accounts Receivable 105,600 Cr Sales Revenue 105,600 SOLUTIONS TO QUESTION 5 Part A See tutors during consultation times. Part B (a) Cash collection in December

Month of sale Sales December November $400,000 $152,000 December $440,000 $264,000 $347,200

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(b) Cash payment in December 0.75 x 440,000 = $330,000 0.8 x 330,000 = $264,000 Operating expenses: 0.04 x 440,000 = $17,600 Fixed expenses: $25,200 Cash payment: $306,800 (c) Income Statement for December

December Sales revenue $440,000 Less: Cost of goods sold (75% of sales) $330,000 Gross margin (25% of sales) $110,000 Less: Operating expenses: Variable operating expenses 4% of sales) $17,600 Bad debts expense (2% of sales) $8,800 Depreciation ($432,000/12) $36,000 Other expenses $25,200 Total operating expenses $87,600 Income before taxes $22,400 Tax expense $6,720 Net profit after tax $15,680

(d) Balance in Accounts Receivable (5 marks)

Accounts Receivable o/b 152,000

Sales 440,000 c/b 167,200

Cash (sales November) 152,000 Cash (sales December) 264,000 Bad debts written off 8,800

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acct1511 final version