读趣百科

One of your audit clients is Tye Co a company providing petrol, aviation fuel and similar oil based products to the government of the country it is based in. Although the company is not listed on any stock exchange, it does follow best practice regarding corporate governance regulations. The audit work for this year is complete, apart from the matter referred to below.

As part of Tye Co’s service contract with the government, it is required to hold an emergency inventory reserve of 6,000 barrels of aviation fuel. The inventory is to be used if the supply of aviation fuel is interrupted due to unforeseen events such as natural disaster or terrorist activity.

This fuel has in the past been valued at its cost price of $15 a barrel. The current value of aviation fuel is $120 a barrel. Although the audit work is complete, as noted above, the directors of Tye Co have now decided to show the ‘real’ value of this closing inventory in the financial statements by valuing closing inventory of fuel at market value, which does not comply with relevant accounting standards. The draft financial statements of Tye Co currently show a profit of approximately $500,000 with net assets of $170 million.

Required:

(a) List the audit procedures and actions that you should now take in respect of the above matter. (6 marks)

(b) For the purposes of this section assume from part (a) that the directors have agreed to value inventory at

$15/barrel.

Having investigated the matter in part (a) above, the directors present you with an amended set of financial

statements showing the emergency reserve stated not at 6,000 barrels, but reported as 60,000 barrels. The final financial statements now show a profit following the inclusion of another 54,000 barrels of oil in inventory. When queried about the change from 6,000 to 60,000 barrels of inventory, the finance director stated that this change was made to meet expected amendments to emergency reserve requirements to be published in about six months time. The inventory will be purchased this year, and no liability will be shown in the financial statements for this future purchase. The finance director also pointed out that part of Tye Co’s contract with the government requires Tye Co to disclose an annual profit and that a review of bank loans is due in three months. Finally the finance director stated that if your audit firm qualifies the financial statements in respect of the increase in inventory, they will not be recommended for re-appointment at the annual general meeting. The finance director refuses to amend the financial statements to remove this ‘fictitious’ inventory.

Required:

(i) State the external auditor’s responsibilities regarding the detection of fraud; (4 marks)

(ii) Discuss to which groups the auditors of Tye Co could report the ‘fictitious’ aviation fuel inventory;

(6 marks)

(iii) Discuss the safeguards that the auditors of Tye Co can use in an attempt to overcome the intimidation

threat from the directors of Tye Co. (4 marks)

The following trial balance relates to Sandown at 30 September 2009:

The following notes are relevant:

(i) Sandown’s revenue includes $16 million for goods sold to Pending on 1 October 2008. The terms of the sale are that Sandown will incur ongoing service and support costs of $1·2 million per annum for three years after the sale. Sandown normally makes a gross profit of 40% on such servicing and support work. Ignore the time value of money.

(ii) Administrative expenses include an equity dividend of 4·8 cents per share paid during the year.

(iii) The 5% convertible loan note was issued for proceeds of $20 million on 1 October 2007. It has an effective interest rate of 8% due to the value of its conversion option.

(iv) During the year Sandown sold an available-for-sale investment for $11 million. At the date of sale it had a

carrying amount of $8·8 million and had originally cost $7 million. Sandown has recorded the disposal of the

investment. The remaining available-for-sale investments (the $26·5 million in the trial balance) have a fair value of $29 million at 30 September 2009. The other reserve in the trial balance represents the net increase in the value of the available-for-sale investments as at 1 October 2008. Ignore deferred tax on these transactions.

(v) The balance on current tax represents the under/over provision of the tax liability for the year ended 30 September 2008. The directors have estimated the provision for income tax for the year ended 30 September 2009 at $16·2 million. At 30 September 2009 the carrying amounts of Sandown’s net assets were $13 million in excess of their tax base. The income tax rate of Sandown is 30%.

(vi) Non-current assets:

The freehold property has a land element of $13 million. The building element is being depreciated on a

straight-line basis.

Plant and equipment is depreciated at 40% per annum using the reducing balance method.

Sandown’s brand in the trial balance relates to a product line that received bad publicity during the year which led to falling sales revenues. An impairment review was conducted on 1 April 2009 which concluded that, based on estimated future sales, the brand had a value in use of $12 million and a remaining life of only three years.

However, on the same date as the impairment review, Sandown received an offer to purchase the brand for

$15 million. Prior to the impairment review, it was being depreciated using the straight-line method over a

10-year life.

No depreciation/amortisation has yet been charged on any non-current asset for the year ended 30 September

2009. Depreciation, amortisation and impairment charges are all charged to cost of sales.

Required:

(a) Prepare the statement of comprehensive income for Sandown for the year ended 30 September 2009.

(13 marks)

(b) Prepare the statement of financial position of Sandown as at 30 September 2009. (12 marks)

Notes to the financial statements are not required.

A statement of changes in equity is not required.

KFP Co, a company listed on a major stock market, is looking at its cost of capital as it prepares to make a bid to buy a rival unlisted company, NGN. Both companies are in the same business sector. Financial information on KFP Co and NGN is as follows:

NGN has a cost of equity of 12% per year and has maintained a dividend payout ratio of 45% for several years. The current earnings per share of the company is 80c per share and its earnings have grown at an average rate of 4·5% per year in recent years.

The ex div share price of KFP Co is $4·20 per share and it has an equity beta of 1·2. The 7% bonds of the company are trading on an ex interest basis at $94·74 per $100 bond. The price/earnings ratio of KFP Co is eight times.

The directors of KFP Co believe a cash offer for the shares of NGN would have the best chance of success. It has been suggested that a cash offer could be financed by debt.

Required:

(a) Calculate the weighted average cost of capital of KFP Co on a market value weighted basis. (10 marks)

(b) Calculate the total value of the target company, NGN, using the following valuation methods:

(i) Price/earnings ratio method, using the price/earnings ratio of KFP Co; and

(ii) Dividend growth model. (6 marks)

(c) Discuss the relationship between capital structure and weighted average cost of capital, and comment on

the suggestion that debt could be used to finance a cash offer for NGN. (9 marks)

A manufacturing company, Man Co, has two divisions: Division L and Division M. Both divisions make a single standardised product. Division L makes component L, which is supplied to both Division M and external customers.

Division M makes product M using one unit of component L and other materials. It then sells the completed

product M to external customers. To date, Division M has always bought component L from Division L.

The following information is available:

Division L charges the same price for component L to both Division M and external customers. However, it does not incur the selling and distribution costs when transferring internally.

Division M has just been approached by a new supplier who has offered to supply it with component L for $37 per unit. Prior to this offer, the cheapest price which Division M could have bought component L for from outside the group was $42 per unit.

It is head office policy to let the divisions operate autonomously without interference at all.

Required:

(a) Calculate the incremental profit/(loss) per component for the group if Division M accepts the new supplier’s

offer and recommend how many components Division L should sell to Division M if group profits are to be

maximised. (3 marks)

(b) Using the quantities calculated in (a) and the current transfer price, calculate the total annual profits of each division and the group as a whole. (6 marks)

(c) Discuss the problems which will arise if the transfer price remains unchanged and advise the divisions on a suitable alternative transfer price for component L. (6 marks)

Glove Co makes high quality, hand-made gloves which it sells for an average of $180 per pair. The standard cost of labour for each pair is $42 and the standard labour time for each pair is three hours. In the last quarter, Glove Co had budgeted production of 12,000 pairs, although actual production was 12,600 pairs in order to meet demand.

37,000 hours were used to complete the work and there was no idle time. The total labour cost for the quarter was $531,930.

At the beginning of the last quarter, the design of the gloves was changed slightly. The new design required workers to sew the company’s logo on to the back of every glove made and the estimated time to do this was 15 minutes for each pair. However, no-one told the accountant responsible for updating standard costs that the standard time per pair of gloves needed to be changed. Similarly, although all workers were given a 2% pay rise at the beginning of the last quarter, the accountant was not told about this either. Consequently, the standard was not updated to reflect these changes.

When overtime is required, workers are paid 25% more than their usual hourly rate.

Required:

(a) Calculate the total labour rate and total labour efficiency variances for the last quarter. (2 marks)

(b) Analyse the above total variances into component parts for planning and operational variances in as much detail as the information allows. (6 marks)

(c) Assess the performance of the production manager for the last quarter. (7 marks)