ACC 207 Examination Corporate Accounting and Financial Statement Analysis

S & L Ltd imports construction machinery and lease them out to local small medium- sized enterprises. Its accounting year end is 31 December.

The machinery is imported at a cost of $100,000 per piece. The useful life of the machinery is five years and the residual value at the end of the useful life is expected to be immaterial in amount.

The fair market selling price of the machinery is $125,000 per piece, and the fair market interest rate is 6% per annum.

On 1 January 2001, S & L enters into a sales-type lease agreement with a customer. The agreement provides for:

Lease period:              5 years

Lease payments:         5 annual lease payments, commencing 31 December 2001

Required:

Apply the lease classification criteria to distinguish between a finance lease and an operating lease. Then demonstrate the accounting for leases by doing the following:

(a)       Determine the gross minimum lease payments for the whole lease period. (2 marks)
 
(b)       What is the total interest income for the lessor (S & L Ltd)? (1 mark)
 
(c)       Determine the gross profit on sale by the lessor. (2 marks)
 
(d)       Do a amortisation schedule for the lessor. (4 marks)

(e)       Prepare journal entries for the recording of the sales-type lease for the first two years, namely 2001 and 2002.
(9 marks)

(f)        Explain how leases are to be accounted in the books of the lease under IAS 17 leases.
(7 marks)

The directors of ABC Ltd are reviewing the impact of IRFS 2 Share-based payment on the financial statements for the year ended 31 May 2005 as they will be adopting the IFRS. However, the directors of ABC Ltd disliked having to apply the standard and have put forward the following arguments as to why they should not recognise an expense for share-based payments.

1. They feel that share options have no cost to the company and therefore, there should be no expense charged in the income statement
2.         They do not feel that the expense arising from share options under IRFS
2 actually meets the definition of an  expense under the Framework
document.
3. The directors are worried about the dual impact of IFRS on earnings per share as an expense is shown in the income statement and the impact of the share option is recognised in the diluted earnings per share calculation.
4. They feel that accounting for share-based payment may have an adverse impact on their company and may discourage it from introducing new share option plans.

The following share option schemes were in exercise at 31 May 2005:

Director’s
name Grant date Options
granted Fair value of
options at grant date Exercise
price Criteria Vesting
date Exercise
date
Joe 1/6/2003 20000 $5 $4.50 A 6/2005 6/2006
Ryan 1/6/2004 50000 $6 $6.00 B 6/2007 6/2008

The price of the company’s shares at 31 May 2005 is $12 per share and at 31 May 2004 was $12.50 per share.

The performance conditions (or criteria in the above table) which apply to the exercise of executive share options are as follows:

Performance Condition A

The share options do not vest if the growth in the company’s earnings per share (EPS)
for the year is less than 4%.

The rate of growth of EPS for the three years is:

2003 4.5%
2004 4.1%
2005 4.2%

The directors must still work for the company on the vesting date.
Performance Condition B

The share options do not vest until the share price has increased from its value of
$12.50 at the grant date (1 June 2004) to above $13.50.

The directors must still work for the company on the vesting date.

No directors have left the company since the issue of the share options and none are expected to leave before June 2007. The share vest and can be exercised on the first day of the due month.

Required:

(a)       Draft a report to the directors of ABC Ltd demonstrating the reasons why share- based payment should be recognised in financial statements and why the directors’ arguments are unacceptable.
(9 marks)

(b)       Demonstrate   the   accounting   for   ABC   Ltd’s   share-based   compensation explaining how much expense to recognise and why.
(9 marks)

(c)       With reference to the company that you are working in currently or one that you are familiar with, determine how important is it for employee to acquire and hold shares in the company. In your opinion, what level of staff should be covered   under   “employee   stock   ownership   plan   –   ESOP”?   Give   your arguments.
(7 marks)
Question 3

Suppose  you  are the  chief accountant  of Marks  &  Spencer,  a  UK  company.  The managing director has given you the below financial statements of its main competitor, Carrefour, a French company. He finds it difficult to review these statements in their non-UK format, presented below.

Carrefour
Statement of financial position as at 31 March 2005 (in Euro Millions)

 31.3.2005 31.3.2004   31.3.2005 31.3.2004
Assets €’mil €’mil Capital and
liabilities  €’mil €’mil
Tangible non-current
assets   Capital and
reserves   
Land 1,000 750 Share capital  850 750
Buildings 750 500 Share premium  100 0
Plant 200 150 Legal reserve  200 200
 1,950 1,400   1,150 950
Current assets      
Inventory 150 120 Profit & loss b/f  590 300
Trade
receivables 180 100 Net profit  185 290
Cash 20 200 Profit & loss c/f  775 590
 350 420    
   Net worth  1,925 1,540
Prepaidments 50 70    
   Liabilities   
   Trade payable  170 150
   Taxation  180 150
   Other payable  75 50
     425 350
 2,350 1,890   2,350 1,890
 
Carrefour
Statement of comprehensive income for the year ended 31 March 2005 & 2004 (in
Euro Million)

Required:

Prepare a report for the managing directors:

(a)       Calculate the following ratios for the two years 2004 & 2005: (i)        Account receivable turnover in days
(ii)       Current ratio
 
(iii)     Quick ratio
 

(12 marks)

(b)       Analyse with commentary on the performance of Carrefour from the findings in part (a) and other data from the financial statements provided.

You are to give possible reasons for the improvement or deterioration of the performance as part of your recommendation.
(13 marks)

Question 4

At the beginning of 2010, Swatow Pte Ltd raised $200 million of equity capital. The bulk of these proceeds were used to invest in a big project. The cost of equity is 5%.

 Beginning book value Net profit Dividends Ending book value
 $ m $ m $ m $ m
Year 2010 200 60 25 235
Year 2011 235 70 30 275
Year 2012 275 80 155 200

Required:

(a)       Discuss the discounted dividend model and use it to compute the value of equity at Year 2009.
(5 marks)

(b)       Assume the normal earnings for each of the years as follows:

Year 2010       30 million Year 2011       35 million Year 2012       30 million

Discuss the discounted abnormal earnings model and use it to compute the value of equity at year 2009.
(7 marks)
 
(c)       Discuss and calculate the equity value-to-book multiple.
 

(7 marks)

(d)       Discuss and compare the three valuation methods under (a), (b) and (c).
(6 marks)