THE INSTITUTE OF CHARTERED ACCOUNTANTS OF …icanig.org/documents/PATHFINDER-PEII-NOV2010.pdf · · 2012-05-25pathfinder 4 professional examination ii – november 2010 ican/102/q/2

THE INSTITUTE OF CHARTERED ACCOUNTANTS

OF NIGERIA

NOVEMBER 2010 PROFESSIONAL EXAMINATION II

Question Papers

Suggested Solutions

Plus

Examiners‟ Reports

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PROFESSIONAL EXAMINATION II – NOVEMBER 2010

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.

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TABLE OF CONTENTS

SUBJECT PAGES

FINANCIAL REPORTING AND ETHICS 4 – 27

STRATEGIC FINANCIAL MANAGEMENT 28 – 59

ADVANCED TAXATION

PUBLIC SECTOR ACCOUNING & FINANCE

59 – 90

60 - 91

MULTI-DISPINARY CASE STUDY 92 - 178

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ICAN/102/Q/2 EXAMINATION NO...................................

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA


FINANCIAL REPORTING AND ETHICS

SECTION A: Attempt All Questions

PART I MULTIPLE- CHOICE QUESTIONS (20 MARKS)

1. Which of the following options is excluded from the class of rational agents, and

hence cannot be subjected to moral judgement?

(i) Moral minors

(ii) The insane

(iii) The senile

A. (i) and (ii) only

B. (ii) and (iii) only

C. (i) and (iii) only

D. (ii) only

E. (i), (ii) and (iii)

2. 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. Contractarianism

B. Utilitarianism

C. Majoritarian Morality

D. Ethical Considerationism

E. Sympathetic Morality

3. Government grants available to an enterprise are considered for inclusion in the

accounts

A. if the grant is not a financing device.

B. if it is to enable the government participate in the ownership.

C. 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.

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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.

C. the amount of contract revenue may decrease as a result of penalties

arising from delay caused by the contractor.

D. when a fixed price contract involves a fixed price per unit of output,

contractor revenue increases as the number of units is increased.

E. negotiations have reached an advanced stage such that the customer will

accept the claim.

5. Undisclosed assets revaluation surplus in the Financial Statements of a

company is known as

A. revaluation reserve.

B. capital reserve.

C. secret/hidden reserve.

D. asset revaluation reserve.

E. contingency reserve.

6. All the following are forms of business combinations, EXCEPT

A. merger.

B. acquisition.

C. amalgamation.

D. absorption.

E. joint Venture.

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7. 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. Selfish Immorality

B. Humanistic Morality

C. Ethical Egoism

D. Ethical Altruism

E. Unethical Egoism

8. 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. Moral Subjectivism

B. Moral Objectivism

C. Moral Totality

D. Moral Globalization

E. Moral Uniqueness

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. Moral Relativism

B. Moral Universalism

C. Moral Non-Wrongness

D. Moral Nihilism

E. Moral Incorrigibility

10. Which of these moral theories that holds that human nature determines the

correct moral laws of nature that human beings should follow?

A. Moral Fellowship

B. Natural Morality

C. Natural Law Theory

D. Natural Egoism

E. Ethical Naturalism

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11. 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.

12. The following are the generally recognised potential problems of using ratios

for comparison purposes, EXCEPT

A. inconsistent definition of ratios.

B. financial statements that have been deliberately manipulated.

C. different companies may adopt different accounting policies.

D. different managerial policies e.g. different companies offer customers

different payment terms.

E. profit for the year may result in higher cash flow.

13. Potential users of financial reports do NOT include ONE of the following:

A. Equity investors

B. Educationists

C. Creditors

D. Suppliers

E. Employees

14. In using the accounting ratios, comparison is commonly made between all BUT

ONE of the following:

A. Previous accounting periods

B. Other companies (mostly in the same type of business)

C. Budget and expectations

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D. Government statistics

E. Emolument of the chief executive

15. The integration of social and ethical criteria into investors‟ investment decision

is known as

A. ethical Investing.

B. social Investing.

C. moral Investing.

D. socio-ethical Investing.

E. socio-moral Investing.

16. The use of ethical, social and environmental criteria in the selection and

management of investment, generally consisting of company shares is known as

A. ethical investment.

B. social investment.

C. moral investment.

D. socio-ethical investment.

E. socio-moral investment.

17. 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. Voluntary Social Responsibility.

B. Involuntary Social Responsibility.

C. Unlimited Social Responsibility.

D. Limited Social Responsibility.

E. Liberal Social Responsibility.

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18. The basic principles of a good corporate governance system include:

i. Transparency

ii. Competence

iii. Integrity

iv. Proper alignment of interests and allocation of responsibilities

A. i and iv only

B. ii and iii only

C. i, ii and iii only

D. i, ii, iii and iv

E. ii, iii and iv only

19. 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. Recognition of an ethical issue

B. Evaluation of alternative actions

C. Making a decision and testing it

D. Acting and reflecting on the outcome

E. Engaging a professional person for consultation

20. Which of the following is ordinarily computed and reported as part of the

financial statements of a large organisation?

A. Current ratio

B. Return on assets

C. Book value per share

D. Earnings per share

E. Price earnings ratio

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PART II SHORT-ANSWER QUESTIONS (20 MARKS)

1. 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. The process through which a person learns the values and behaviour patterns

considered appropriate by an organisation or group is called …....…………..

8. The Utilitarian theory of justice ties the question of economic distribution to the

promotion of ………......……

9. An approach to Business Ethics that attempts to change economic concepts with

the aim of facilitating moral action is termed ....…………….

10. The Libertarian associates justice with ........………….

11. Payments made to a parent company by a subsidiary out of pre-acquisition

profits are known as ...........................

12. 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?

13. 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 ..........................

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14. The organisation which is empowered by law to incorporate, register and wind-

up companies in Nigeria is called ....................................

15. Two features of a business entity are .......................... and .................................

16. The standards of behaviour that groups expect of their members is referred to as

................................

17. Ethics must be promoted and institutionalized in an organization in order to

build credibility and ...............................

18. The ethical challenge in companies is often triggered by .............................

19. 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

..........

20. The bringing together of separate entities or businesses into one operating

entity is called ...............................

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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.

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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. (10 marks)

(Total 15 marks)

QUESTION 2

a) Explain briefly Ethical Issues in business. (5 marks)

b) State TWO examples each of ethical issues relating to the following areas:

i. Society

ii. Internal and industry practice

iii. Marketing

iv. Product

v. Supply chain (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)

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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)

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SECTION A

PART I: SOLUTIONS TO MULTIPLE CHOICE QUESTIONS

1. E

2. B

3. D

4. E

5. C

6. E

7. C

8. B

9. D

10. C

11. E

12. E

13. B

14. E

15. A

16. B

17. A

18. D

19. E

20. 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: SOLUTIONS TO SHORT ANSWER QUESTIONS

1. Prospective

2. Altruism

3. Diversification

4. Cash conversion cycle or Cash operating cycle

5. N52.6million or N53million {(40/365 x (530-50) million}

6. Capital reduction

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7. Socialization or Societalisation

8. Social Well-being/Happiness

9. Prescriptive or Normative

10. Liberty or Individual right or Entitlement

11. Pre-acquisition dividends

12. Professional Indemnity Insurance Policy

13. Operating segment or Reportable segment

14. Corporate Affairs Commission (CAC)

15. Legal status, Ownership of assets and Profit oriented (any two)

16. Group norms or Code of Conduct or Professional Ethics

17. Public trust/Confidence

18. Financial problems

19. Equity method

20. Business combination.

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) Olabisi has reduced the amount of data on Reports sent to departments.

(ii) Tunde secretly buys data from someone in the Computer Services

Department to supplement the variance report he receives.

(iii) Bose knows of Tunde practice of buying data, thinks it is unethical, but

does not know what to do about it.

(iv) Olabisi, the Director of Manufacturing and Computer Services is a long

standing employee of the organisation for the past 23 years.

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(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.

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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) Asking Tunde to stop his data purchases.

(iii) Turning Tunde in to Mr. Olabisi‟s anonymously.

(iv) Buying information for herself if and when she needs it.

(v) 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.

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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.

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(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

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(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) Conflict of interest exists when an individual must choose whether to

advance his or her own interest

(ii) It exists when there is a clash in one‟s moral conviction and another

person‟s proposal

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(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 should

contact the appropriate body or regulator.

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(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

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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.

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(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.

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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.

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(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.

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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.

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(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.

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ICAN/ EXAMINATION NO...................................



STRATEGIC FINANCIAL MANAGEMENT

Time allowed – 3 hours


PART 1 MULTIPLE-CHOICE QUESTIONS (20 Marks)

1. Which of the following functions is NOT performed at a lower management level?

A. Supervision of cash receipts and payments.

B. Safeguarding cash balances

C. Record keeping and reporting

D. Custody and safeguarding securities and valuable papers

E. Planning and control of funds

2. The following are the characteristics of strategic decision EXCEPT they

A. are concerned with the scope of the organisation‟s activities.

B. match the organisation‟s activities to the environment in which it operates.

C. match an organisation‟s activities to its resource capability.

D. involve major decisions about the allocation or re-allocation of resources.

E. affect the short-term direction that the organisation takes.

3. Which of the following short-term investment opportunities is NOT available to

companies?

A. Treasury bills

B. Commercial papers

C. Certificates of deposits

D. Bonds

E. Bank deposits

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4. Baumol‟s model on cash management is not based on ONE of the following

assumptions.

A. A firm is able to forecast its cash needs with certainty.

B. A firm‟s cash payments occur uniformly over a period of time.

C. The opportunity cost of holding cash is known and it does not change over

time.

D. The firm will incur the same transaction cost whenever it converts securities

to cash.

E. The net cashflow is normally distributed with a zero mean and standard

deviation.

5. Which of the following simplifying assumptions is NOT commonly made in

examining the relationship between capital structure and cost of capital?

A. There is no income tax

B. The firm pursues a policy of paying all its earnings as dividends

C. Investors have identical subjective probability distributions of operating

income

D. The operating income is expected to be static

E. A firm can change its capital structure almost instantaneously without

incurring transaction costs

6. Which of the following reasons for valuing securities is NOT correct?

A. To determine the purchase consideration in an absorption or merger scheme

B. To ascertain the total amount of the estate of a deceased investor

C. To determine the fair price at which shares of a company could be

purchased

D. To meet the stock exchange requirements

E. To estimate the break-up value of a company in liquidation

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7. Given the following data in respect of Alariwo Plc, calculate the P/E ratio:

Share Price N5.00; and

EPS N0.82

A. 4.10

B. 6.10

C. 6.12

D. 6.14

E. 6.22

8. Which of the following statements may NOT be a reason for issuing bonus shares?

A. Bonus shares tend to bring the market price per share within a more

popular range

B. Bonus shares increase the number of outstanding shares

C. The rate of dividend tends to increase

D. Issuing of bonus shares improves the prospects of raising additional funds

E. The share capital base increases and the company may achieve a more

respectable size in the eyes of the investing community

9. Which of the following is NOT one of the core decision areas in financial

management?

A. Investment decision

B. Finance decision

C. Dividend decision

D. Liquidity decision

E. Credit management decision

10. The traditional approach to the valuation of a company assumes that

A. the gearing of a company is changed immediately by issuing debts to

purchase equity or vice-versa.

B. all earnings are distributed in form of dividend.

C. business risk fluctuates regardless of how the company invests its funds.

D. taxation is ignored.

E. earnings are assumed to have zero growth into perpetuity.

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11. An integrated approach to the strategy making process provides a framework

which consists of the following parts EXCEPT

A. analysing the present internal and external conditions.

B. identifying and evaluating the present strategy.

C. searching for strengths and weaknesses within the present strategy and

environment.

D. considering changes in the existing strategy.

E. 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. N3,905

B. N3,921

C. N3,951

D. N3,975

E. 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. N5,000

B. N5,200

C. N5,300

D. N5,400

E. N5,500.

14. The following are relevant factors in taking a decision to raise money through

loan stock EXCEPT

A. issue costs.

B. capital repayment.

C. control.

D. servicing costs.

E. interest repayment.

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15. Who has the overall responsibility for the attainment of corporate governance objectives

in an organisation?

A. Top executive officer

B. Shareholders

C. Work force

D. Audit Committee

E. Board of Directors

16. Which of the following is an aspect of the intermediation functions in the Nigerian

financial system?

A. Denomination intermediation

B. Maturity intermediation

C. Risk Intermediation

D. Interest rate intermediation

E. Liquidity intermediation

17. Strategic planning serves the following purposes in an organisation EXCEPT

A. clear definition of the purpose of the organisation and establishment of realistic

goals and objectives consistent with that mission in a definite time frame.

B. communication of those goals and objectives to the organisation‟s constituents.

C. development of a sense of ownership of the company‟s plan.

D. reflecting on how a specific function will contribute to the achievement of a

department‟s corporate priorities and defence tasks.

E. provision of a base from which progress can be measured and establishment of a

mechanism for informed change when needed.

18. Which of the following does NOT explain the essence of corporate planning?

A. The probability of future outcome of events is unknown

B. Predictions are susceptible to errors

C. The future is unpredictable

D. Decision makers cannot be assertive on future events

E. Decision relating to corporate planning rests on hunches

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19. In relation to capital investment, a managerial option

A. applies only to new projects.

B. limits the flexibility of management‟s decision-making.

C. limits the downside risk of an investment project.

D. limits the profit potential of a proposed project.

E. extends the risk of executed projects.

20. Which of the following is NOT a limitation of capital rationing?

A. The assumption that projects are infinitely divisible may not always be true in

practice

B. An investment policy outcome may be less than optimal

C. The risk associated with the different projects and managements attitude to risk

are not considered

D. The linearity relationship can be faulted

E. 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

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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...............................

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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 …………………….

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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)

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QUESTION 2

(a) Explain the term “rights issue”. (2 Marks)

(b) Differentiate between “rights issue” and “public issue”. (3 Marks)

(c) (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)

(ii) issue price per share; (1 Mark )

(iii) theoretical ex-rights price; and (2 Marks)

(iv) theoretical nil paid value of a right per share (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

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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

N‟000

Bayela Plc

N‟000

Ordinary Shares of N1 each

Preference Share Capital

Share Premium Account

Profit and Loss Account

10% Debentures

1,000,000

200,000

-

380,000

150,000

1,730,000

500,000

-

20,000

40,000

50,000

610,000

Other pieces of information concerning the two companies are as follows:

Abija Plc Bayela Plc

Maintainable annual profits after tax

attributable to equity

Current market value of ordinary shares

Current EPS

P/E ratio

Current market price of debts

N 240,000,000

2.40

0.24

10

125%

N 150,000,000

2.70

0.30

9

125%

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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.

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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)

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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

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Tutorials

7. N 5.00 = 6.098

N 0.82

= 6.10

12. N 10,000 = N 3,951

2.531(Cum DF)

DF = Discounting Factor

13. P = N 5.00 = N 5,000

0.10

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.

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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 + (P

1-P

0) 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

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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.

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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 = N2,500,000

7.4694

= N 334,698.90

(b) 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)

1-5 540,000 3.6048 1,946,592

5 250 0.5674 141,850

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.

mailto:DF@10%25

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(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 decision-

taking 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.

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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.

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(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 = N 6,000,000

Annual interest = N 900,000

Year Item Cashflow

N

DCF @

9%

PV

(N)

1 – 10 Interest 900,000 6.4177 5,775,930

10 Debt

redeemed

6,000,000 0.4224 2,534,400

Current value 8,310,330

Current value of the 15% redeemable debenture = N 8,310,330

Cost of the proposed project (given) = N 1,600,000

Therefore, the finance required is = 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

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(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 = N5.90

Less: Issue price 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.

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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 + (P

1-P

0) 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

= 19%

(c) 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

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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.

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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.

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QUESTION 4

Calculation of offer price by Abija Plc to shareholders of Bayela Plc based on :

(a) Net asset basis

Net Asset Value (NAV) = Value attributable to equity

No of ordinary shares

NAV for Abija = N 1,380,000,000

1,000,000,000

= N1.38

NAV for Bayela = 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 = 405,797,101 new N1 shares

138

(b) Earnings Basis

Earnings per share (EPS) = Total earnings attributable to equity

No. of shares

EPS for Abija Plc = N240,000,000

1,000,000,000

= N0.24

EPS for Bayela plc = N150,000,000

500,000,000

= N 0.30

Comment

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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 = 625,000,000 new N1 shares

24

(c) 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

N500,000,000 x 9 = 562,500,000 new N1 shares

8

(d) Financial Analysis

Abija Plc current cost of equity (assuming no expected growth) is:

Maintainable annual profit x 100%

Market value of equity 1

= N 240,000,000 x 100%

N2,400,000,000 1

= 10% per annum

Abija Plc cost of debt is: 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

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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.

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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) (409,095) (409,095) (409,095)

2 0.8264 __ (396,672) (396,672) (396,672)

3 0.7513 __ __ (428,241) (428,241)

4 0.6830 __ __ __ (430,290)

PV of Costs (6,409,095) (6,805,767) (7,234,008) (7,664,298)

PV of Scrap value 4,090,950 3,222,960 2,253,900 1,434,300

NPV (2,318,145) (3,582,807) (4,980,108) (6,229,998)

Divide by Annuity factor 0.9091 1.7355 2.4868 3.1698

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.

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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.

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(b) (i) 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.

(ii) 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

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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.

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ICAN/102/F/4 EXAMINATION NO.............................



ADVANCED TAXATION


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. 12 months from 1 April

B. 12 months from 1 January

C. 12 months from 1 July

D. 12 months from 30 September

E. 12 months from 31 December

2. Which Government Agency is responsible for the administration of the Value

Added Tax in Nigeria?

A. Federal Inland Revenue Service

B. Directorate of Value Added Tax

C. Federal Ministry of Finance

D. State Inland Revenue Service

E. Federal Ministry of Justice

3. How is the legislation currently regulating Company‟s Income Tax in Nigeria

captioned?

A. Company‟s Income Tax Act 1990, as amended

B. Finance Miscellaneous Taxation Provisions

C. Federal Inland Revenue Board

D. Companies Income Tax Act CAP C21 LFN 2004

E. Personal Income Tax Act

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4. Who bears the cost of an appeal brought before the Tax Appeal Tribunal?

A. The Tax Auditors

B. The Legal Practitioners

C. Each Party to the Appeal

D. The Tax Authority

E. The Tax Consultants

5. Which of the following statements is applicable to the grant of full

tax relief period(s) to a Pioneer Company?

A. Two periods of two years each

B. One period of two years followed by one period of one year

C. One period of three years followed by one period of two years

D. One period of two years followed by another period of two years

E. Two periods of one year each

6. 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. Chargeable tax

B. Assessable tax

C. Adjusted tax

D. Withholding tax

E. Value Added tax

7. Which of the following is the correct assessable profit subjected to Education

Tax?

A. Adjusted profit after giving effect to loss relief, balancing charge and

capital allowance

B. Adjusted profit before giving effect to loss relief, balancing charge but

after capital allowance

C. Adjusted profit before giving effect to loss relief, balancing charge and

capital allowance

D. Adjusted profit after giving effect to only loss relief

E. Adjusted profit after giving effect to only balancing allowance and loss

relief.

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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. N110,000

B. N130,000

C. N145,000

D. N150,000

E. N90,000

9. Which of these is an Indirect Tax?

A. Value Added Tax

B. Capital Gains Tax

C. Education Tax

D. Companies Income Tax

E. Personal Income Tax

10. Which of the following is an attribute of a good tax system?

A. Universality

B. Directability

C. Indirectability

D. Effectability

E. Reversibility

11. Which of the following is NOT a Capital Allowance?

A. Annual Allowance

B. Personal Allowance

C. Investment Allowance

D. Initial Allowance

E. Balancing Allowance

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12 Which of the following is NOT a duty of the Joint Tax Board?

A. To settle disputes among the States as regards tax matters

B. To enforce compliance with Federal Government Revenue matters

C. To promote uniformity both in the application and incidence of the

provision of tax laws on individuals throughout the country

D. To settle disputes among States with regards to residence and remittance

E. To advise the government on request in respect of double taxation

arrangement, rates of capital allowances and other tax matters

13. Which of the following is NOT a condition for granting capital allowances?

A. The claimant must have incurred qualifying capital expenditure

B. The claimant must remain the beneficial owner of the assets at the end of

the basis period

C. The qualifying capital expenditure must be in use mainly for the purpose

of business of the claimant

D. The qualifying capital expenditure must have been in use for at least two

years

E. The qualifying capital expenditure must have been in use during the

basis period

14. On which of the following is education tax computed in line with the provisions

of Income Tax Act Cap C21 LFN 2004?

A. Chargeable income

B. Assessable profit

C. Adjusted profit

D. Earned income

E. Unearned income

15. Which of the following is an objective of taxation?

A. To raise money for Government officials

B. To raise money for Projects only

C. To exercise control on Individuals‟ expenses

D. To redistribute Income and Wealth of the Citizens

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E. To raise money for States and Federal Inland Revenue Service

16 Which of the following is NOT true for data entry in Excel when applying same

for tax computations?

A. Values may be calculated with the use of formulas

B. Data can be calculated accurately

C. Information is displayed visually

D. Cell can contain only values

E. Labels are text headings

17 Which of the following is a member of the Federal Inland Revenue Service

Board?

A. The Registrar General of the Corporate Affairs Commission or his

representative

B. The Auditor General of Nigeria or his representative

C. The Accountant General of Nigeria or his representative

D. The Secretary of the Joint Tax Board

E. A Director in the Federal Budget office

18 What is the due date for filing Annual Tax Returns to Federal Inland Revenue

Service by an ongoing business?

A. Eighteen months from the company‟s accounting year end

B. Six months from the company‟s accounting year end

C. Five months from the company‟s accounting year end

D. Seven months from the company‟s accounting year end

E. 31December of the year following the year of accounts

19 What is the Principal Place of Residence of a Partner for tax purposes?

A. Where he sleeps regularly during the assessment year

B. His state of origin as at January of the assessment year

C. His employment address as at 1 January of the assessment year

D. His place of birth as at 1 January of the assessment year

E. The place in which he resides at 1 January of an assessment year

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20. Which of the following is true of withholding tax?

A. It can be used as offset against education tax liability

B. It can be used as offset against back year liability

C. It is an advance payment of tax which is deducted at source

D. It is a tax on contract regarded as final tax

E. 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 …………………………

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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 ………………….

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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) 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)

(b) State FIVE merits of the withholding tax system. (5 Marks)

(c) List the stages in a typical tax audit process. (4 Marks)

(Total 15 Marks)

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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

N

Annual Basic Salary 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

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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? (2 Marks)

(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) 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

The following expenses were debited to Profit

and Loss Account for the period:

- Provision for depreciation 22,990,000

- Administrative and marketing expenses 46,200,000

- Operation Staff Salaries 123,920,000

- Provision for bad debts (General) 6,997,000

- Fines paid to Federal Airport Authorities .3

1,500,000

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Required:

Using the information given above, compute;

(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)

(b) 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)

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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?

(15 Marks)

TAX RATES

1. CAPITAL ALLOWANCES

Initial % Annual %

Office Equipment 50 25

Motor Vehicles 50 25

Office Building 15 10

Furniture & Fittings 25 20

Industrial Building 15 10

Non-Industrial Building 15 10

Plant and Machinery – Agricultural

Production 95 NIL

– Others 50 25

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2. INVESTMENT ALLOWANCE 10%

3. TAX – FREE ALLOWANCE:

Maximum Per Year

N

Rent 150,000

Transport 20,000

Utility 10,000

Meal Subsidy 5,000

Entertainment 6,000

Leave 10% of Annual Basic Salary

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 – N2,000 each

(d) Disabled Persons – N5,000 or 10% of Earned Income (which ever is

higher)

(e) Life Assurance – Actual Premium paid

5. RATES OF PERSONAL INCOME TAX:

Taxable Income Rate of Tax

N %

First 30,000 5

Next 30,000 10

Next 50,000 15

Next 50,000 20

Over 160,000 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. COMPANIES INCOME TAX RATE 30%

7. EDUCATION TAX 2%

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8. CAPITAL GAINS TAX 10%

9. VALUE ADDED TAX 5%

10. WITHHOLDING TAXES

Type of payment Rates Rates

(Companies) (Non- corporate)

Dividend, Interest, Rent 10% 10%

Royalties 15% 15%

Contract supplies 5% 5%

Building construction activities 5% 5%

Consultancy/Professional services 10% 5%

Management services 10% 5%

Commissions 10% 5%

Technical services 10% 5%

Directors fees 10% 10%

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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

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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.

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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.

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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 N427,500 = 95% of the fee

Then 100% = 100/95 x N427,500

= N450,000

13. 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.

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SOLUTION TO SECTION B

QUESTION 1 CASE STUDY

(a) 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) the company should write a letter of application for registration.

(ii) Obtain the Vat application form (VAT from 001) from the tax office.

(iii) complete the form by supplying the following information:

- The full name of your company;

- Registered/business address;

- Company incorporation number: and

- Date of incorporation.

(iv) commencement date, nature of business/services to be rendered.

(v) signature and stamp (bearing the company‟s name) in the relevant sections of

the application form by the officers of the company.

(vi) file the application form together with photocopy of the certificate of

incorporation.

(vii) 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;

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(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.

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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

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- Two other persons experienced in Revenue matters to be

nominated by the Chairman of the Local Government on their

personal merits.

(b) Merits of Withholding Tax System include;

(i) helping to broaden the tax base by bringing many people into the tax

net.

(ii) 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.

(iii) bringing obscure transactions to the notice of the tax authorities, thus

increasing tax yield.

(iv) reducing the incidence of tax evasion.

(v) ensuring a regular inflow of tax revenue to coffers of the various

governments.

(vi) helping to educate the taxpayer as well as the collecting agents.

(vii) enhancing voluntary tax compliance.

(c) Stages in Tax Audit Process include:

(i) Selection of the taxpayer to be audited;

(ii) Preliminary review of the taxpayer‟s file;

(iii) Notification of taxpayer;

(iv) Pre-audit meeting;

(v) Field work;

(vi) Post audit meeting;

(vii) Interim audit report;

(viii) Post audit review by regional/headquarter‟s audit unit;

(ix) Reconciliation meetings; and

(x) Final Audit Report;

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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 N

EARNED INCOME

Employment Income:

- Annual Basic Salary 3,200,000

- Annual Transport Allowance 320,000

- Annual Housing Allowance 640,000

- Annual Leave Bonus 740,000

- Overtime 274,000

- Benefit in kind (Airtime) 95,000

- Annual Meal Subsidy 32,000

- Entertainment & Utility Allowance 64,000

5,365,000

Trading Income (PYB)

- Profit from Cybercafé 925,000

Capital Allowances Restricted (W1) (616,667)

308,333

TOTAL EARNED INCOME 5,673,333

UNEARNED INCOME

2009 Gross Interest on Deposits (W2) 172,000

2009 Gross Rental Income (W3) 260,000

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TOTAL UNEARNED INCOME 432,000

TOTAL INCOME 6,105,333

General Charges and Non-Taxable

Payments

- Mortgage Payment 120,000

- Pension Contribution (W4) 312,000

- Housing Allowance 150,000

- Transport Allowance 20,000

- Meal Subsidy 5,000

- Utility Allowance 10,000

- Entertainment Allowance 6,000

- Leave Allowance (W5) 320,000

(943,000)

STATUTORY TOTAL INCOME 5,162,333

Reliefs

Personal Allowance

(N5,000 + 20% of N5,673,333) 1,139,667

Children Allowance (N2,500 x 3) 7,500

Dependant Relatives (N2,000 x 2) 4,000

(1,151,167)

CHARGEABLE INCOME 4,011,166

TAX DUE

N N

First 30,000 @ 5% 1,500

Next 30,000 @ 10% 3,000

Next 50,000 @ 15% 7,500

Next 50,000 @ 20% 10,000

Next 3,851,166 @ 25% 962,792

4,011,166 984,792

=====

Tax Suffered at source

On Dividend (W2) 18,000

On Rent (W3) 25,000

(43,000)

Net Tax Payable 941,792

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WORKING NOTES

W1 Capital Allowances: N

Capital Allowance available 716,000

C/A Restricted to 662

/3 of N925,000 (616,667)

Unabsorbed C/A C/Fwd 99,333

W2

2009 Gross Dividend = 100

/90

x 162,000

/1 = N180,000

W/Tax on Dividend = N180,000 – N162,000 = 18,000

W3

2009 Gross Rental Income = 100

/90

x 225,000

/1 = N250,000

W/Tax on Rent = N250,000 – N225,000 = N25,000

W4 Pension Contribution:

N

Annual Basic Salary 3,200,000

Annual Transport Allowance 320,000

Annual Housing Allowance 640,000

Gross Salary 4,160,000

Pension Contribution @ 7½% N 312,000

W5 Allowable Leave Bonus

Restricted to 10% of Annual Basic Salary

Of N3,200,000 = 10

/100

of N3,200,000

= N320,000

(b)

(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:

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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.

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QUESTION 4

(a) (i)

DOMBOSHAWA AIRLINE AND LOGISTICS LIMITED

COMPUTATIONS OF ADJUSTED PROFIT

FOR THE YEAR ENDED 31 OCTOBER, 2008

N N

NIGERIAN INCOME

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

72,277,000

INCOME FROM OTHER ROUTE

Income from Passengers tickets

outside Nigeria 203,160,000

Income from Goods loaded

outside Nigeria 74,110,000

277,270,000

GLOBAL INCOME 349,547,000

Allowable Expenses

Administrative & Marketing 46,200,000

Operation Staff Salaries 123,920,000

(170,120,000)

ADJUSTED PROFIT 179,427,000

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(ii) DOMBOSHAWA AIRLINE AND LOGISTICS LIMITED

INCOME TAX LIABILITY

FOR 2009 ASSESSMENT

Adjusted Profit Ratio

= Adjusted Profit x 100

Global Income

= 179,427,000 x 100

349,547,000

= 51.33%

Depreciation Ratio

= Depreciation x 100

Global Income

= 22,990,000 x 100

349,547,000

= 6.58%

Capital Allowance

= Depreciation Rate x Nigerian Income

= N6.58% x 72,277,000

= N4,755,827

N N

Nigerian Adjusted Profit 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 (4,755,827.00)

-

Taxable Profit 67,521,173.00

Income Tax Liability thereon @ 30% 20,256,352.00

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

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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;

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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.

(b) (i) MELTDOWN CONSTRUCTION LIMITED

COMPUTATIONS OF CAPITAL GAINS TAX


N N N

Sales Proceed of Bulldozer 48,400,000

Cost of Bulldozer

Deposit Paid 28,500,000

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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 11,650,000

Capital Gains Tax thereon @ 10% 1,165,000

(ii)

MELTDOWN CONSTRUCTION LIMITED

COMPUTATIONS OF CAPITAL GAINS TAX


N N N

Sales Proceed of Bulldozer 49,600,000

Cost of Bulldozer

Deposit Paid 28,500,000

Instalments Paid

(19 months @ N1m each) 19,000,000

Less Interest Portion paid (W3) (3,325,000)

15,675,000

(44,175,000)

Chargeable Gains 5,425,000

Capital Gains Tax thereon @ 10% 542,500

WORKING NOTES

(W1) Calculation of Hire Purchase Interest

N

Hire Purchase Price:

- Deposit (1/2/2007) 28,500,000

- 20 Instalments Payable

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(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 x 10

20 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.

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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.

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(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.

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ICAN/ EXAMINATION NO..............................


PROFESSIONAL EXAMINATION ll - NOVEMBER 2010

PUBLIC SECTOR ACCOUNTS AND FINANCE



PART I MULTIPLE-CHOICE QUESTIONS (20 Marks)

1. Which of the following is the biggest revenue source in recent times in Nigeria?

A. Companies Income Tax.

B. Education Tax.

C. Capital Gains Tax.

D. Petroleum Profits Tax.

E. Import/Excise Duties.

2. Which of the following is NOT an example of “financing activities” in the

preparation of government accounting cash flow statement?

A. Proceeds from loans.

B. Proceeds from the sale of assets.

C. Proceeds from bank overdraft.

D. Dividends received.

E. Repayment of loans.

3. 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. Special Fund Account.

B. Development Fund Account.

C. Contingency Fund Account.

D. Federation Account.

E. Consolidated Revenue Fund Account.

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4. Which Warrant is expected to be in operation for a maximum of six months or

until the budget has been approved?

A. Supplementary (Contingency) Warrant.

B. Annual General Warrant.

C. Provisional General Warrant.

D. Supplementary General Warrant.

E. Supplementary (Statutory Expenditure) Warrant.

5. For which of the following will corporations NOT obtain the approval of the

Supervising Ministry?

A. The budget.

B. Signing of foreign agreement.

C. Payment of staff monthly salaries.

D. The bye laws.

E. Increasing the price of its goods and services.

6. The main objective of government is to

A. provide adequate welfare.

B. stabilize balance of trade.

C. increase its expenditure.

D. reduce its income.

E. determine supply.

7. Which of the following statutory officers does NOT have his salaries and

consolidated allowances chargeable directly to the Consolidated Revenue Fund?

A. Commissioner of the Police Service Commission.

B. Accountant – General of the Federation.

C. Chairman Code of Conduct Bureau.

D. Chief Judge of the Federal Court of Appeal.

E. Chairman Federal Character Commission.

8. Which of the following standards sets out the requirements for financial

reporting by governments and other related public sector organizations?

A. International Government Accounting Standards.

B. International Accounting Standards.

C. International Public Sector Accounting Standards.

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D. International Financial Reporting Standards.

E. Government Accounting, Auditing and Financial Reporting Standards.

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. Magistrate Court.

B. Court of Appeal.

C. Supreme Court.

D. Federal High Court.

E. State High Court.

10. Which of the following is a „not-for-profit‟ entity expected to prepare?

A. Trading and Profit and Loss Account.

B. Balance Sheet.

C. Value Added Statement.

D. Cash Flow Statement.

E. Income and Expenditure Account.

11. Which of the following ratios does not indicate the working capital of a

parastatal?

A. Current ratio.

B. Quick ratio.

C. Gearing ratio.

D. Debtors‟ payment period.

E. Creditors‟ payment period.

12. Which of the following is a disadvantage of payback period method of

investment appraisal?

A. It is a measure of liquidity.

B. It is used as a safeguard against risk.

C. It is not difficult to calculate and understand.

D. It does not consider the time value of money.

E. It serves as a useful screen to evaluate projects.

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13. Which of the following is NOT a Memorandum Accounts Book in

Government?

A. Departmental Vote Expenditure Allocation Book.

B. Dishonoured Cheques Register.

C. Paper Money Register.

D. Cash Book.

E. Cheque Summary Register.

14. Which of the following entries records the purchase of sodium chloride, for cash,

by Atuma State Water Corporation?

A. Debit Materials Account, Credit Goods Account

B. Debit Cash Account, Credit Goods Account

C. Debit Materials Account, Credit cash Account

D. Debit Cash Account, Credit Purchases Account

E. Debit Materials Account, Credit Stock Account.

15. 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. Incremental budgeting.

B. Line item budgeting.

C. „Zero-base‟ budgeting.

D. Planning, programming and budgeting system.

E. Performance budgeting.

16. 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. Derivation.

B. Generation.

C. Even development.

D. National interest.

E. Independent revenue.

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17. Which of the following fiscal policy measures can help to protect infant

industries?

A. Increase in Value-Added Tax rate

B. Increase in import duties.

C. Increase in export duties.

D. Increase in excise duties.

E. Reduction in subsidies.

18. Which of the following is NOT an instrument of government‟s domestic

borrowing?

A. Treasury Bills.

B. Treasury Certificates.

C. Bill of exchange.

D. Government Development Stocks.

E. Revenue Bonds.

19. Which of the following international financial institutions grants balance of

payments support facilities to countries in need?

A. London Club of Creditors.

B. Paris Club of Creditors.

C. The World Bank.

D. International Monetary Fund.

E. African Development Bank.

20. Which of the following is an instrument of fiscal policy?

A. Discount rate.

B. Open Market Operation.

C. Reserve requirements.

D. Government expenditure.

E. Selective credit control.

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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 self-

accounting 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 ____________

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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

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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

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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) State the TWO types of losses incurred in this hospital.

(2 marks)

(b) State any FOUR major likely causes of the colossal losses in this hospital.

(4 marks)

(c ) 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)

(d) State any FIVE issues to be considered before setting up a „Board of Inquiry‟.

(5marks)

(e) 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 0 1 2 3 4 5

Cash flows A (N) 1,300 250 750 400 150 100

B (N) 1,200 400 500 600 600 300

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)

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(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:

EL EM EN

N‟000 N‟000 N‟000

Initial Cash Outlay

Residual Value

15,000

1,000

20,000

1,000

20,000

1,000

EL E

M E

N

N‟000 N‟000 N‟000

Yr 1 6,000 10,000 1,000

Yr 2 7,000 10,000 6,000

Yr 3 8,000 1,000 10,000

Yr 4 9,000 1,000 20,000

Assume that the projects are mutually exclusive.

You are required to advise the Council on the most viable project, using

(a) Payback period; and (5marks)

(b) Accounting Rate of Return, methods. (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 35,000

Export duties 118,000

Excise duties-Local companies 1,875,000

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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

N(million)

Medical fees 96,540

Visa Fees 65,500

Repayment of loan by Local Govt. 730,000

Rent of Government Land 225,000

Overpayment Recoverable 95,000

The following expenditure items were also anticipated:

N(million)

a. Establishment cost 807,500

b. Personnel cost 1,267,500

c. Special expenditure 312,500

d. Transfer to Development Fund 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

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(iv) The balance in the Federation Account as at 31 December, 2008 was N1,800

billion.


(a) Prepare the Federation Account Statement as at 31 December, 2009 and

distribute same, based on the existing revenue sharing formula, viz:

Federal 48.6 per cent

States 24.0 per cent

Local Governments 20.0 per cent

Special Fund 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

15,000,000

Purchase of weed control chemical

3,600,000

Depreciation (tractors, etc) 2,000,000

Lubricants and Oil 1,600,100

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Purchase of stationery 1,100,100

Utility (water, light, etc) 500,000 (23,800,200)

17,299,800

Interest due

Bank loan

1,040,000

Agric bank loan 2,960,000 (4,000,000)

Surplus realized on

Ordinary operations 13,299,800

Surplus for last year b/f 9,500,200

Surplus carried forward 22,800,000


(a) Prepare the Value Added Statement for the year ended 31 December, 2009;

(10 marks)

(b) Briefly differentiate between “Value-Added” and

“Value Added Statement.” (5 marks)

(Total 15 marks)


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

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16. B

17. C

18. D

19. D

20. 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.


1. Cash control.

2. Transcript.

3. Floating debt.

4. Oversight.

5. Selective or Limited Tender procedure.

6. Interim Performance Certificate.

7. Tax Expenditure Projections.

8. Accountant-General.

9. Horizontal Revenue Allocation/Horizontal Distribution.

10. General or Non-matching grant.

11. Fiscal policy.

12. Tax base.

13. Externalities.

14. Rolling plan

15. Revenue Mobilization Allocation and Fiscal Commission (RMAFC).

16. Capitalism/Capitalist Economy/Free Enterprise/Market Economy/System/Liassez-

faire.

17. Derivation, Even development, Need, National interest, Equality of

states, Independent Revenue, Population

18. Progressive.

19. Unfunded.

20. Indirect.

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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.


QUESTION 1

CASE STUDY

Two types of losses in the hospital are:

(a) (i) Loss of stores; and

(ii) Loss or shortages of funds.

(b) Likely major causes of losses include:

i) Poor or weak internal control.

ii) Inadequate record keeping of essential books.

iii) Lack of sound stores control and management.

iv) Obvious non-existence of cash and bank operation control.

v) Non-existence of the required controls on fixed assets.

vi) Poor staffing, putting a “square peg in a round hole” and no standard

organizational set up.

vii) Delayed introduction of the Internal Audit Department;

viii) The hospital was hurriedly commissioned without any plan, rules and

regulations to guide its operations; and

ix) 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) fraud is probable;

ii) the loss is substantial;

iii) several officers are involved;

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iv) the responsibility of officers is not clearly defined;

v) the loss took place over a period of time; and

vi) collution is suspected.

(e) Cheque exchange and/or cash advance is considered a serious offence because it

i) is a veritable tool for fraud;

ii) could be used to conceal the true position of case on hand;

iii) is a good example of „teeming and lading;

iv) may impair the liquidity position of the hospital; and

v) 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

PROJECT B

Year Year Di Discounting

Factor

15%dD

Cash flows

(N)

Values

(N) (N)

Cash flows

(N)

Values

(N)

15%

0 1.00 (1 (1,300) ( (1,300) (1,200) (1,200)

0.87 1 0.87 0.87 250 217.50 400 348.00

0.76 2 0.76 1.76 750 570.00 500 380.00

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0.66 3 0.66 1.66 400 264.00 600 396.00

0.57 4 0.57 1.57 150 85.50 85.50 600 342.00

0.50 5 0.50 1.50 100 100 50.00 50.00 300 150.00

(113.00) 416.00

Formula:

NPV

where

A − cash flow

r − cost of capital (15%)

C − initial outlay

t − time

NPVA = N (− 1,300 + 1,187) = N − 113.00

NPVB = N (− 1,200 + 1,616) = N 416.00

(b) 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 TABLE

Year DF 15%

0 1.000

1 0.8696

2 0.7561

3 0.6575

4 0.5718

5 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.

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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

EM

EN

N „000 N „000 N „000

Initial Cash Outlay 15,000 20,000 20,000

Less: Yr 1 inflow 6,000 10,000 1,000

9,000 10,000 19,000

Less: Yr 2 inflow 7,000 10,000 6,000

2,000 - 13,000

Less: Yr 3 inflow 8,000 - 10,000

- - 3,000

Less: Yr 4 inflow - - 20,000

- - -

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.

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ADVICE

From the above, Project EM should be chosen because it has the shortest payback

period.

(ii) Accounting Rate of Return

EL E

M E

N

N(000) N(000) N 000)

Annual Profit

Yr 1 6,000 10,000 1,000

Yr 2 7,000 10,000 6,000

Yr 3 8,000 1,000 10,000

Yr 4 9,000 1,000 20,000

Total profit 30,000 22,000 37,000

No of yrs 4 4 4

Average Annual N 7,500 N 5,500 N 9,250

Accounting Profit

Average Investment =

EL E

M E

N

N(000) N(000) N(000)

Cash Outflow 15,000 20,000 20,000

Residual Value 1,000 1,000 1,000

Total 16,000 21,000 21,000

2 2 2

Average

inve

stm

ent

N8,000 N10,500 N10,500

ARR =

=

7,500 5,500 9,250

8,000 10,500 10,500

=

0.937 0.523 0.881

Q 94% 52% 88%

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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 N million

Balance b/f – 1/1/2009 1,800,000

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 3,572,400

5,372,400

Sharing: % N million

Federal

48.5 2,605,614

States 24.0 1,289,376

Local Governments 20.0 1,074,480

Special fund 7.5 402,930

5,400 5,372,400

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b). FALCON FEDERATION

Consolidated Revenue Fund as at 31 December, 2009

N million N million

Balance b/f – 1/1/2009 850,725

Issues from contingency 1,750

Transfer to contingency (1,365) 385

Revenue (1/1/09-W(i) 3,729,846

Expenditure (1/1/09-

31/12/09) W (ii)

1,790,625 1,939,221

Transfer to development

Fund

(318,750)

Balance as at

31.12.2009

2,471,581

Notes/Workings:

i) These are the revenues items accruing to Falcun State alone, viz

N million

Personal income tax:

Military 56,000

Foreign Affairs Ministry 28,000

Residents of FCT 36,280

Quarrying licenses 34,320

Medical fees 77,232

Visa fees 52,400

Repayment of loan by local

governments

584,000

Rent on government land 180,000

Overpayment recoverable 76,000

Federation Account -Allocation 2,605,614

To Consolidated Revenue Fund 3,729,846

ii) The summary of overhead costs anticipated, limited to 75%:

N million

Establishment cost 605,625

Personnel cost 950,625

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Special expenditure 234,375

To Consolidated Revenue Fund

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.

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b. Government other than the reporting government e.g. State and Local

Governments.

c. Researchers and representative of the media.

d. The general public.

e. Sectional groups in the population e.g. Political Parties, Human Right

Groups etc.

f. Foreign interest like Paris Club, London Club etc.

g. Regional Organization e.g. EU, ECOWAS, etc.

h. Rating Agencies e.g. Flitch.

Tutorials on Internal Users

a. They use it to agitate for better welfare of staff increase in salary.

b. They use it to argue or agitate for increase in salary.

c. They use it for planning and control.

d. They use it for planning and control.

e. They use it to execute government.

(b) Comparison Of Government Accounting And Private Sector Accounting

S/NO Differences Public Private

I Objectives Provision of adequate

welfare services at

reasonable cost.

To maximise profit.

ii Accounting Basis The government records

its financial transactions

on cash basis.

The private sector

records are shown on

accrual basis.

iii Income/Revenue Revenue is from members

of the public in form of

taxation, custom duties,

etc.

Income is from the

sales of goods and

services.

iv Treatment of cost of

Fixed Assets

Written off immediately

after purchase and

payment.

The costs are spread

over the estimated

useful life of the fixed

assets.

v. Accountability

/Responsibility

The government is

primarily responsible to

the citizenry.

Business/private entity

is responsible to the

shareholders.

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vi. Exclusion principle

on provision of

goods and services

Benefit does not match

contribution. Services are

rendered irrespective of

the contributions of those

benefitting from them.

Goods and services

depend on how much

is paid.

vii. Formation Comes in various forms.

Ministries, parastatals;

they have their Enabling

Acts.

Incorporated

companies are

controlled by CAMA

1990 and regulated by

CAC.

viii Auditing Accounts are audited by

the Auditor- General

through the approved

External Auditors.

Accounts are audited

by approved External

Auditors.

Ix Accounting Fund accounting is

adopted.

Proprietary approach

is preferred.

x Efficiency Measured by services

rendered.

Measured by profits,

capital appreciation,

etc.

Xi Treatment of

Dividend

Dividends are not

paid/declared to

shareholders.

Dividends are often

declared/paid to

shareholders.

Xii AGM No AGM of stakeholders 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.

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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.

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QUESTION 6

(a) RIVER BASIN AUTHORITY, OLUOKUN STATE

VALUE ADDED STATEMENT FOR THE YEAR ENDED 31

DEC, 2009

N‟000 %

Turnover 41,100,000

Less: Budget in goods and

services

6,800,200

Value Added from

Operations and Other

Income

34,299,800

Add Other Income -

Less Other Expenses -

Total Value Added 34,299,800 100.00

Applied as follows:

Employees 15,000,000 43.73

Government (Tax) - -

Providers of Capital 4,000,000 11.66

Provision for growth and

expansion

15,299,800 44.61

TOTAL VALUE DISTRIBUTED 34,299,800 100.00

Notes to the Account

Bought-in-goods and

services

Purchase of weed control

chemical

3,600,000

Lubricant and oil 1,600,100

Purchase of Stationery 1,100,100

Utility (Water, light, etc) 500,000

6,800,200

Providers of Capital

Interest on Bank Loan 1,040,000

Interest on Agric. Bank Loan 2,960,000

4,000,000

Provision for Growth and

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Expansion

Depreciation Charges 2,000,000

Surplus realized on ordinary

operation

13,299,800

15,299,800

Employees

Salaries & Pension 15,000,000

(b). 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.

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ICAN/102/z/4 EXAMINATION NO.............................


PROFESSIONAL EXAMINATION III – NOVEMBER 2010

MULTI-DISCIPLINARY CASE STUDY


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

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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

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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) The company was not making any profit;

(b) Divisions within the group were losing money and were overstaffed;

(c) No unit growth – divisions were declining;

(d) No management strategies, goals or plans in place

(e) No advertising

(f) Image was old and faded;

(g) 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) attack problems concerning divisions and PROSPECT PLC`S image

(b) improve marketing, inventory management and replace obsolete plant, and

(c) improve communications.

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The key to attacking attitude problem centred on marketing and to be successful, any

plan depended on three critical issues

(1) The corporate and division owners are to “buy in” to it;

(2) The plan had to be simple enough to be executed, and

(3) 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.

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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

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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

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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.

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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%).

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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 = R

i (R

m – R

f) β

j

Where: Rs

= Return of the equity, Ri = Return on Security,

Rm

= Return on the market portfolio

Rf is the risk free rate and β

j 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 risk-

free 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

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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

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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-on-

asset 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.

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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

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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

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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;

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(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.

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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

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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.

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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

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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.

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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.

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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 after-

tax 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 medium-

sized 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).

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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.

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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.

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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

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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

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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

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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-and-

long-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.

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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

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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 of machine at

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

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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 17

Depreciation 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

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APPENDIX III: ORGANISATION CHART: PROSPECT GROUP

BOARD OF DIRECTORS

CHAIRMAN

GROUP

MANAGING DIRECTOR

EXECUTIVE EXECUTIVE EXECUTIVE

EXECUTIVE EXECUTIVE

DIRECTOR DIRECTOR DIRECTOR

DIRECTOR DIRECTOR

MARKETING INDUSTRIAL PRODUCTS AUTOMOTIVE PRODUCTS

MINING FINANCE

INDUSTRIAL HOUSE SECURITY AUTOMATION AUTOMOTIVES APPAREL

QUARRY HAULAGE FINANCE PRODUCTS WARES

FASTENERS CONTROLLER

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APPENDIX IV: PROSPECT GROUP: PRODUCTS LINES, SALES AND OPERATING INCOME

(Nm)

GROUP MAJOR PRODUCT LINES SALES

2009

OPERATING INCOME 2009

Industrial Products Reagents, Chemicals, DSM Agro,

Sprayers, Footwears, DSM

Energy

200.5 31.8

Security Products

Lock sets, Padlocks, Door

closures, Electronic locking

system

112.6 12.3

Housewares

Blenders, Food processors,

Irons, Coffee makers, Electric

knives

149.3 4.4

Apparel/fasteners

Snap fasteners, rivets, burrs

brass zippers

149.1 21.7

Automation/Electrical

Pneumatic valves, Cylinders,

regulators, tyre valves, printing

machines

123.2 12.0

Mining

Laterite, Bridge stones, Pellets 83.2 4.3

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APPENDIX V

PROSPECT GROUP

FINANCIAL INFORMATION IN PROXY COMPANIES

BETA

LONG TERM

LIABILITIES TO

CAPITALISATION

A. Industrial products

Apopo Plc 0.90 0.45

Toyed Plc 1.05 0.30

Bosco Plc 0.76 0.42

Dendo Plc 1.20 0.51

Average 0.98 0.42

B. Housewives

Vauve Plc 0.85 0.38

Aloyd Plc 0.75 0.46

Ponco Plc 0.85 0.31

Average 0.82 0.38

Automation/Automatives

C. Gee Plc 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

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APPENDIX VI: PROSPECT GROUP: INDUSTRIAL PRODUCTS LTD

Draft Balance Sheet, as at 31 December 2005

N‟000 N‟000 N‟000

Cost Dep.

Fixed assets

Tangible assets:

Land and Buildings 40,000 - 40,000

Plant 36,315 19,284 17,031

Fixtures and Fittings 3,855 1,225 2,630

80,170 20,509 59,661

Intangible assets:

Goodwill 20,000

Investment: trade investment(at cost) 45,000

Current assets

Stock 40,166

Debtors 35,802

Deferred Development Expenditure 15,000

90,968

Current liabilities

Bank Overdraft 15,209

Trade Creditors 63,420

Director‟s Loans 10,000 (88,629)

Working Capital 2,339

127,000

Long term liabilities

7% Debentures 30,000

Accrued Interest 4,200 (34,200)

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92,800

Capital and Reserves

Authorized share capital

50,000,000 ordinary shares @ N2. 100,000

40,000,000 7% cumulative preference

Shares @ N1. 40,000

140,000

Allotted share capital

40,000,000 ordinary shares @ N2 80,000

40,000,000 7% cumulative preference

Shares @ N1 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

Annual Bad debt

losses as a

percentage of sales

Collection cost as a

percentage of sales

1 0.5 1.0

2 1.0 1.5

3 2.0 4.0

APPENDIX VII

PROSPECT PLC – PROPOSED INVESTMENT IN PRODUCTION OF E-BANKING MACHINE

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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 Discount Present Value

Year N factor N

1. Training cost 1,500,000 0.9091 (1,363,650)

2. Additional cash contribution

10 x 1000 x N50 500,000

3. 10 x 1000 x N50 500,000 2.261 1,130,500

4. 10 x 1000 x N50 500,000

Net Present Value (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.

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Calculation of Net Present Value

Annual Cash Outflow:

Unit cost of production per standard cost N2,800

less general fixed overhead (see note 1) 150

Unit cost directly attributable to the machine 2,650

Total annual production cost

N2,650 x 1000 N2,650,000

plus: opportunity cost of using skilled labour (note 2)

10 x 1000 x N50 500,000

Interest payment on loan 200,000

Total annual cash outflow (years 1 -4) 3,350,000

Other cash flows

Purchase of equipment (year o) 1,000,000

Annual cash inflow: Payment from

Distributor in arrears

(years 2 – 5) 1000 x N3,500 3,500,000

Calculation of Net Present Value

Year Cash Cash D.F. P.V.

Outflow Inflow

0 (1,000,000) - 1.0 (1,000,000)

1 (3,350,000) - 0.9091 (3,045,485)

2 (3,350,000) 3,500,000 0.8264 123,960

3 (3,500,000) 3,500,000 0.7513 112,695

4 (3,500,000) 3,500,000 0.6830 102,450

5 3,500,000 0.6209 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

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N N

Materials 1,000

Labour:

Skilled: 10hrs @ N60 per hour 600

Semi-skilled: 10 hours @ N50 per hour 500

Prime cost 2,100

Overheads:

Variable: 20 hours @ N20 per hour 400

Fixed:

Specific: 20 hours @ N7.50 per hour 150

General: 20 hours @ N7.50 per hour 150 700

Total Cost 2,800

Profit Margin 25% 700

Selling Price per machine 3,500

APPENDIX X

PROPOSED ELECTRONIC SECURITY DEVICE PROJECT AT AUTOMATIVE/ELECTRICAL

DIVISION

Year 0

(N‟000)

Year 1

(N‟000)

Year 2

(N‟000)

Year 3

(N‟000)

Year 4

(N‟000)

Year 5

(N‟000)

Investment depreciable

fixed assets

4,500

Cumulative investment

Working capital 300 400 500 600 700 700

Sales 3,500 4,900 5,320 5,740 5,320

Materials 500 650 900 1,000 950

Labour 1,065 1,120 1,620 1,720 1,720

Overhead 200 200 200 200 200

Interest 576 576 576 576 576

Depreciation 900 900 900 900 900

3,241 3,446 4,196 4,396 4,346

Taxable profit 659 1,954 1,724 2,044 1,674

Taxation 264 782 690 818 670

Profit after tax 395 1,172 1,034 1,226 1,004

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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 N N

Technician grade

Salary & benefits 42,800

Number x 105

Total direct cost of technician grade 1 4,494,000

Technician grade 2

Salary & benefits 54,800

Number x 195

Total direct cost of technician grade 2 10,686,000

Total variable cost 15,180,000

Fixed costs

Supervision 1,200,000

Occupancy costs 1,100,000

Utilities 320,000

Insurance 50,000

Other 50,000

Total fixed cost 2,720,000

Total cost 17,900,000

Number of technician grade 1 105

Number of technician grade 2 195

Total technicians 300

Number of man months 3,000

Average number of billable hours per month per technician 130

Projected number of billable hours 468,000

Cost per hour projected for 2010 N38.25

Note: Cost per hour 2009 35.05

APPENDIX XII

PROSPECT GROUP: TABLE OF ACTIVITY FOR COMPUTERIZATION OF

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ACCOUNTING SYSTEM

Activity Activity Description Immediate Time

Predecessor Most Most Most

optimistic likely 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

ATTEMPT ALL QUESTIONS

PART I: 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

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A. Hybrid

B. Mini

C. Super

D. Mainframe

E. 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. Penultimate year

B. Ultimate year

C. Pre-penultimate year

D. Preceeding year

E. None of the above.

4. Which ONE of the statements below does NOT describe the term “Degree of

Leverage?”

A. The elasticity of earnings to change in debt

B. The level of retained earnings to debenture

C. The level of current assets to fixed assets

D. The sensitivity of earnings to change in capital structure

E. 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. Price dictator

B. Monopsony

C. Price monopolist

D. Discriminating monopolist

E. Dominating monopolist.

6. The Federal Government policies that attempt to reduce the volatility of export

prices are called

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A. Export prices volatility policies

B. Export substitution policies

C. Commodity stabilization policies

D. Commodity price monitoring policies

E. 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. Mathematical programming model

B. Pareto optimality model

C. Sensitivity Analysis model

D. Goal programming model

E. 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. Merger

B. Backward integration

C. Piece-meal acquisition

D. Sub-subsidiary control

E. 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. Random sampling

B. Cluster sampling

C. Systematic sampling

D. Stratified sampling

E. Purposeful sampling.

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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. 2,490 units

B. 1,550 units

C. 1,480 units

D. 3,020 units

E. 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 ………………..

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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 ………….

15. System implementation is not complete without ……………..

16. A computer security system where list of authorized users of a company`s

network are established and maintained is …………………….

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 ………….

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24. Given the following functions:

TR = 10Q, TC = 50 + 5Q, Sa = 20. If BEP is represented

by Sb, S

b 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 is

called …………………

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)

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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)

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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. (2 Marks)

(Total 8 Marks)

QUESTION 6

(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. (2 Marks)

(Total 8 Marks)


SOLUTIONS TO MULTIPLE CHOICE QUESTIONS

1. A

2. A

3. A

4. C

5. D

6. C

7. D

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8. C

9. D

10. B


SOLUTIONS TO SHORT-ANSWER QUESTIONS

1. Corporate or Capital Restructuring

2. Stock split

3. Venture capital

4. Ke = gMve

gdo

)(1

Where do = dividend in year 1

G = growth rate.

MVe = Market Value of Equity per share.

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

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18. Accrual principle

19. Post Balance sheet

20. Dance approach

21. The situational or Contingency theory

22. 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.

16P5=

5)-(16

!16! =

11!

!16 =

11!

12.15.14.13.16 = 524,160

23. 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.

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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.


SOLUTION 1

(a) REDUCTION AND RECONSTRUCTION ACCOUNT

Ordinary share

Capital (written down to 50k)

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 20,000

Dev. Exp. 15,000

P & L bal. 27,200

Written off

N‟000

20,000

20,000

20,000

40,000

5,000

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

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Stock written down 16,000

Doubtful debts 3,580

62,200

19,580

186,780

186,780

(b) BALANCE SHEET AS AT 1 JANUARY 2006

Fixed Assets N‟000 N‟000

Land and Buildings at valuation 50,000

Plant at valuation 18,811

Fixtures and fittings (at written down value) 2,630

71,441

Current assets

Stocks 24,166

Debtors (N35,802 – N3,580) 32,222

Bank (see workings) 20,591

76,979

Current liabilities:

Trade creditors (43,420)

Working capital 33,559

105,000

Long term liability

10% Debenture (secured) (40,000)

65,000

Represented by:

Authorized share capital:

200,000,000 Ordinary shares @ 50k 100,000

40,000,000 9% Pref. shares @ N1 40,000

140,000

Issued share capital

90,000,000 ord. shares @ 50k 45,000

20,000,000 9% cum. Pref. shares @ N1 20,000

65,000

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Workings

Bank Account

N‟000 N‟000

Issued of Debenture 10,000 Balance b/f 15,209

Sale of trade investment 50,000 Creditors 20,000

Debenture interest 4,200

Balance c/f 20,591

60,000 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) 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

(iii) 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:

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Before 80,000:70,000 or 1.4:1

After 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.


SOLUTION 2

(a) Annual cash outflow

N

Unit cost of production per standard cost 2,800

Less: Specific fixed overhead 150

General fixed overhead 150

Annual production 2,500

Total annual cash outflow 1,000

N

1-4

Other cash outflows 2,500,000

Purchase of equipment year 1 1,000,000

Investment in recruitment training year 1 1,500,000

Opportunity cost of using skilled labour year 1 1,500,000

Payment by distributor 3,500,000

Calculation of NPV

Year Cash outflow Cash inflow DF Present value

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0 (1,000,000) - 1.0 (1,000,000)

1 (4,500,000) 3,500,000 0.9091 (909,100)

2 (2,500,000) 3,500,000 0.8264 826,400

3 (2,500,000) 3,500,000 0.7515 751,300

4 (2,500,000) 3,500,000 0.6830 683,000

351,600

Decision: The company should purchase the equipment.

(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) activities of competitors

(ii) quality of the product

(iii) potential life cycle of the product

(iv) acceptability of the product

(v) continual demand for the product

(vi) availability of other components

(v) availability of raw materials.

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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 Time

a m b tei

A 1 – 2 4 6 8 6

B 2 – 3 5 7 15 8

C 2 – 4 4 8 12 8

D 3 – 6 15 20 25 20

E 3 – 5 10 18 26 18

F 4 – 6 8 9 16 10

G 5 – 7 4 8 12 8

H 6 – 7 1 2 3 2

I 7 – 8 6 7 6 7

where tei = a + 4m + b

6

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E

18 G

B 8

A 8 D 7

6 20 I

8 2

C H

10

F

Paths Durations

A – B –E – G – I 6+ 8 + 18 + 8 + 7 = 47

A – C – F – H – I 6 + 8 + 10 + 2 + 7= 33

A – B – D –H – I 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.

0

2

1

5

4 3

6 7

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(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

Cash

flow

Book

profit

Cash

flow

Book

profit

Cash

flow

Book

profit

Cash

flow

Book

profit

Cash

flow

Annual cash revenues 500 500 500 500 500 500 500 500 500 500

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 after tax cash flow 400 400 400 400 400


COMPUTATION OF NET PRESENT VALUE

Year Annual

cash flow

D. F. Present

value

0 1,500,000 1.0 (1,500,000)

1 400,000 0.8926 357,040

2 400,000 0.7972 318,880

3 400,000 0.7118 284,720

4 400,000 0.6355 254,200

5 400,000 0.5674 226,960

5 Salvage 105,000 0.5674 59,577

Net present value 1,377

COMPUTATION OF THE NET ADVANTAGE OF LEASE

Year After-tax

operating

expenses paid

by lessor

After-tax

rental

expenses

Tax shield

interest

Tax shield on

dep.

Total

1 50,000 210,000 75,000 150,000 (385,000)

2 50,000 210,000 62,716 150,000 (372,716)

3 50,000 210,000 49,204 150,000 (359,204)

4 50,000 210,000 34,341 150,000 (344,341)

5 50,000 210,000 17,991 150,000 (327,991)

Year Total D. F. Present

value

1 (385,000) 0.9091 350,004

2 (372,716) 0.8264 308,013

3 (359,204) 0.7513 269,870

4 (344,341) 0.6830 235,185

5 (327,991) 0.6209 203,650

(1,366,722)

Salvage value 105,000 105,000 0.5674 59,577

Initial outlay 1,500,000

(Net advantage of lease) 73,701

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181

AMORTISATION SCHEDULE

Year Instalment

payment

Interest Principal

repayment

Balance

0 - - - 1,500,000.00

1 395,673.96 150,000.00 245,673.96 1,254,326.04

2 395,673.96 125,432.60 270,241.36 984,084.68

3 395,673.96 98,408.47 297,265.49 686,819.19

4 395,673.96 68,681.92 326,992.04 359,827.15

5 395,673.96 35,982.72 359,691.24 135.91

Annual instalment payment =

i

nr )1(1

000,500,1

=

791.3

000,500,1

= N395,673.96

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.

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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.

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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.

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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) Purpose and scope of engagement.

(ii) Facts of major importance.

(iii) Matters discussed with supervisors/managers.

(iv) Details of current practices.

(v) Recommandation.

(vi) 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

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(ii) measures to obstruct, protect and defend the system from

illegal operations e.g. use of operators permissions, restriction

to certain functions.

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.

(b) The key motivating factors at PROSPECT GROUP include the following:

(i) Reward for hardwork through higher pay.

(ii) Cooperative attitude encouraged by management.

(iii) Openness, commitment and sincerity of top management.

(vi) Maintenance of favourable relationship with unions.

(v) Part ownership of the company by employees.

(vi) Boost of morale of employees by installation of computer system.

(vii) Provision of conducive work environment.

(viii) Low employee turnover due to flexible rules for its employees.

(c) A company‟s capital may be restructured for the following reasons:

(i) As a possible alternative to liquidation.

(ii) 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.

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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.