SOLUTION: CORPORATE REPORTING STRATEGY MAY 2008 QUESTION 1 (a) WORKINGS CONSOLIDATION SCHEDULE

Memo GH So Ltd: Ordinary share capital (60:40) Preference shares (0:100) Capital surplus: Re 20% at acquisition Re 40% at acquisition Minority interest 40% Post acquisition: 20%* (1,265,000 300,000) 40%* (1,265,000 665,000) Income surplus: Re 20% at acquisition Re 40% at acquisition Minority interest 40% Post acquisition: 20%* (2,026,000 700,000) 40%* (2,026,000 1,290,000) Adjustment for depreciation Dan Ltd: Capital surplus Income surplus Consultancy fee Cost of investment in so Ltd Adjustment for fair value Man Ltd: Ordinary share capital (60:40) Preference shares (25:75) Capital surplus (60:40) Income surplus At acquisition (60:40) Post acquisition (60:40) Cost of investment in Man Ltd Ordinary shares Preference shares Unrealized profit on stocks Totals Impairment loss Negative goodwill transferred to income statement Consolidated balances (303,000) 2,000,000 500,000 300,000 665,000 1,265,000 965,000 600,000 700,000 1,290,000 2,026,000 1,326,000 736,000 20 1,651,000 3,360,000 (2,440,000) (100,000) 1,600,000 400,000 950,000 1,100,000 610,000 (1,420,000) (100,000) (20,000) (348,000) 45,000 (770,000) 4,572,408 2,084,000 770,000 5,02,612 (50,000) (2,440,000) (40,000) 960,000 100,000 570,000 660,000 (1,420,000) (100,000) (8,000) (12,000) 770,000 4,572,408 2,084,000 4,303,61 2 (45,000) (40,000) (20,000) 640,000 300,000 380,000 440,000 244,000 366,000 140,000 516,000 810,400 265,200 294,400 12 1,651,000 3,360,00 0 50,000 Goodwill So Ltd GH 1,200,000 60,000 266,000 506,000 193,000 240,000 Goodwill Man Ltd GH Minority interest GH 800,000 500,000 Capital Surplus GH Cosn. I/S GH

Note: Bad debts recovered adjust the pre acquisition income surplus. Balance Sheets as at 31st March, 2008 Dan Ltd So Ltd Man Ltd GH GH GH
Assets Non-current Assets Property, plant & equipment Long term investments Goodwill Current Assets Stocks Accounts receivable Cash & bank balances Total Assets Liabilities and Owners Equity Current Liabilities Trade creditors Sundry creditors Accruals

Adjust. GH

Cons. B.S. GH

4,593,000 3,960,000 8,553,000

1,117,000 964,000 307,00 0 2,388,00 0 10,941,00 0

5,589,00 0 400,00 0 5,989,00 0

4,950,000 4,950,000

(99,980) (3,960,000)

15,032,020 400,000 15,432,020 303,000 2,575,800 1,908,000 607,200 5,091,000 20,826,020

Long-term Loans Owners Equity Stated capital Capital surplus Income surplus Minority interest

1,200,000 820,000 340,00 0 2,360,00 0 700,00 0

1,355,00 0 769,000 243,00 0 2,367,00 0 8,356,00 0

123,800 275,000 57,200 456,000 5,406,000

(20,000) (100,000)

195,600 80,700 49,700 326,000 420,000

(100,000)

2,320,600 1,640,700 669,700 4,631,000 1,640,000

1,025,00 0 740,000 280,000 2,045,00 0 520,000

2,000,000 950,000 1,710,000 ________ 4,660,000 5,406,000

2,870,000 2,084,000 5,028,612 4,572,408 14,555,020 20,826,020

Total Liabilities & Owners Equity

2,870,000 1,651,000 3,360,000 ________ _ 7,881,00 0

2,500,00 0 1,265,00 0 2,026,00

10,941,00 0

0 _______ _ 5,791,00 0 8,356,00 0

Consolidated balance sheet of Dan Ltd and its subsidiaries as at 31st March, 2008 GH Assets Non-current Assets Property, plant & equipments Goodwill Long-term investments Current Assets Stocks Accounts receivable Cash & bank balances Total Assets Liabilities and Equity Current Liabilities Trade creditors Sundry creditors Accruals Non-current Liabilities Long-term Loans Equity attributable to equity holders of the parent 3 15,032,020 303,000 400,000 15,735,020 2,575,800 1,908,000 607,200 5,091,000 20,826,020

2,320,600 1,640,700 669,700 4,631,000 1,640,000

Stated capital Capital Surplus Income surplus Minority interest Total Liabilities and Equity Notes (i) Property, plant & equipment comprised Buildings Plant & equipment Furniture & fittings Motor vehicles (ii) Stated capital Ordinary shares Reference shares

2,870,000 2,084,000 5,028,612 9,982,612 4,572,408 20,826,020

7,430,000 5,885,020 874,000 843,000 15,032,020 2,200,000 670,000 2,870,000

(b)

Control is defined as the power to govern the financial and operating policies of an entity or business so as to obtain benefits from its activities. The circumstances are, where a combining entity obtains: (i) (ii) (iii) (iv) power over more than one-half of the voting rights of the other entity by virtue of an agreement with other investors; or power to govern the financial and operating policies of the other entity under a statute or an agreement; or power to appoint or remove the majority of the members of the board of directors or equivalent governing body of the other entity; or power to cast the majority of votes at meetings of the board of directors or equivalent governing body of the other entity.

QUESTION 2 USING NET ASSET BASIS OF VALUATION The net asset basis is one of the main methods of share valuation. It is one of the bases which provide assets backing and security of the investment made. It is also used as a support for the other income basis valuation. 4

Net asset per share is determined by calculating net assets available to ordinary shareholders divided by the number of ordinary shares in issue. The net assets of Sombo Ltd can be calculated as follows; 31st December 2007 GH Assets Valuation: Property, Plant and Equipment Copyright (3,500 x 6.3528) Stock Debtors (22,000 8,500) Bank/ cash Less: Liabilities: Creditors Debentures NET assets available to Ordinary shareholders: Net assets per share EARNING YIELD BASIS This method is used when the company is acquiring controlling interest with reference to the profitability of the company. The share price is the earnings per share of the acquired company multiplied by price earnings ratio of similar quoted company. Since Somba Ltd is a private unquoted company one will have to adjust the price earning ratio of similar quoted company downwards to lower it as Sombo is a higher risk company. A risk premium of 100% is recommended for Sombo Ltd. Hence its price earning ratio would be (8 x 908) 7.2 times. The most recent earnings per share is 58,500 25,000,000 = = GH0.00234 GH0.0168 or GH0.00138 x 7.2 - GH0.009936 = 221,735 25,000,000 = GH0.0088649 240,000 22,235 14,500 13,500 16,000 306,235 12,500 72,000

84,500 221,735

Therefore the market price would be (7.20 x 0.00234)

Using the average earning per share the value of the company would be (26,000 + 32,000 + 18,000 + 38,000 + 58,500)/5 =

The share price may range from GH0.009936 to GH0.0168 per share. 5

(b)

Reasons for unquoted companies placing value on their shares: (i) (ii) (iii) (iv) When the company is making application for listing onto the stock exchange Where any of the shareholders is to dispose of his shares Where the shares are to be pledged as collateral securities Where two unquoted companies are to be merged or when it is being acquired by another company.

(c)

The earning yield and dividend yield are adjusted when valuing unquoted companies because of the following: (i) (ii) (iii) Lack of marketability of its shares In general most private companies lack competency in management as compared to quoted companies It is presumed to be a high risk security as compared with quoted companies.

QUESTION 3 (a) Position of the company on WINDING UP Operations GH Realization of assets: Land and Buildings Plant and Equipment Furniture and Fittings Motor Vehicles Copyrights (35% x 600) Investment (1,400 x 1.12%) Stock Debtors (45% x 16,600 x 30%) Others (55% x 16,600 x 60%) Amount available on liquidation Less Liabilities: Bank Overdraft Trade Creditors Sundry Creditors Short-term Loan Long-term Loan External Liabilities on Liquidation Analysis of liquidation repayment ratio = 38,227 = GH 14,000 650 980 1,100 210 1,568 12,000 2,241 5,478 38,227 11,500 12,800 6,800 5,000 4,000 40,100 GH0.95 per GH1.00

In case of liquidation unsecured liabilities will receive GH0.95 for every GH1.00 owed and the shareholders, both Ordinary and Preference will receive nothing. The total deficiency is (40,100 38,227 + 15,000) 16,873 should the company liquidate. Position of the company on RECONSTRUCTION Book Value GH 11,500 1,400 1,240 2,175 600 1,685 18,500 16,600 1,400 GCV GH 14,000 650 980 1,100 210 12,000 7,719 1,568 Loss GH (2,500) 750 260 1,075 390 1,685 6,500 8,881 (168) 95,160) 2,560 (1,600) (2,500) 10,173

Land and Building Plant and Equipment Furniture and Fittings Motor Vehicles Copyrights Goodwill Stock Debtors Investment Capital Surplus Income Surplus Debenture Interest (10% x 4,000 x 4) Short-term Loan (50% x 5,000) Maximum Capital Loss ADVICE TO DIRECTORS

It will be in their interest to re-organise since in the case of Liquidation they would have lost all their capital but if re-organised the company will only lose GH10,173 instead of the total deficiency of GH16,873 on liquidation. The creditors and loanholders will all lose part of their capital. Liquidation is a good option where the company has no better future and does not provide strategic product or service. In that case liquidation will save the value of the assets and lost wealth. (b) SOPY LTD RECONSTRUCTED BALANCE SHEET AS AT 1ST JANUARY 2008 GH GH Land and Buildings 14,000 Furniture and Fittings 650 Motor Vehicles 980 Furniture and Fittings 1,100 16,940 CURRENT ASSETS: Stock 12,000 Debtors 7,719 Investment 1,568 Bank 300 21,587 CURRENT LIABILITIES: Trade Creditors 12,800 7

Short-term Lon Stated Capital Long-term Loan Allocation of loss

2,500 15,300

6,287 23,227 19,227 4,000 23,227 Preference Shares 2,400 (673) 1,727

Balance b/f Loss allocated

Ordinary Shares 10,000 (9,500) 500 CASH/BANK Overdraft Creditors (6,800 1,600) Bank balance Issue of shares to existing holders

11,500 5,200 16,700 300 17,000

STATED CAPITAL Ordinary (500 + 17,000) Preference 17,500 1,727 19,227

(c)

Capital reconstruction Scheme A new company with different capital structure is formed to salvage the assets of the existing company which is then wound up. Structural Reconstruction Involves the reconstruction and reorganization of various activities or segments of the business.

QUESTION 4 (a) i. Cost of Investment Property Basic Cost; 12 Units x GH350,000 Add Legal Fees Professional Fees Property Transfer Fees Total Cost GH 4,200,000 45,000 30,500 84,000 4,359,500

ii. Investment property shall be recognised as an asset only when; it is profitable that the future economic benefits that are associated with the investment property will flow to the entity. the cost of the investment property can be measured reliably.

iii. Goodwill may be distinguished from other intangible non-current assets by reference to the following characteristics: - it is capable of realisation separately from the business as a whole - its value has no reliable or predictable relationship to costs which may have been incurred. v. Its value arises from various intangible factors such as skilled employees, effective advertising or strategic location. These inherent factors cannot be valued. the value of goodwill may fluctuate widely due to internal and external circumstances over relatively short periods of time.

the assessment of the value of goodwill is highly subjective (a) i. Profitability Both gross profit margin and net profit margin have fallen below the industry average. This may be the result of uncontrolled overhead cost on the presence of large obsolete equipment. Unless steps are taken quickly to improve the income account investors may shift their interest into more profitable companies in the industry. ii. Liquidity Both quick and current ratios fall far below those of the industry as confirmed by the fact that it takes longer to collect its debt than the industry. The problem may have been worsened by the fact that stocks stay longer at Farmers Friend Ltd than in the industry which is not the best use to which resources should be put. iii. Efficiency Even though Farmers Friend Ltd takes longer to collect its debts (5 days), this is compensated by an even longer time to settle the debts (20 days). This means that creditors provide free finance for its operations. However, the holding on to stocks for a long time (10 days) cannot be justified. This should be turned over in like manner as that assets turnover far exceeds that of the market. iv. Shareholders Investment Both dividend cover and dividend yield fall below that of the industry. Such a situation is not likely to excite investors especially income oriented investors who are seeking to recoup their investment in the shortest time possible. This poor performance may be due to the fact that high gearing ratio of Farmers Friend Ltd has effectively put its future in the hands of debenture holders who are reaping the bulk profits in the form of interest charges. Something drastic must be done. 9

(b)

Other information to be looked at during ratio analysis: i. ii. iii. iv. The content of any accompanying commentary or the account and other statements. The age and nature of the companys assets. Current and future development of the companys interests, at home and overseas, recent acquisitions or disposals of a subsidiary by the company. Any other noticeable features of the report and accounts, such as post balance sheet events, contingent liabilities, a qualified auditors report, the companys taxation position etc.

QUESTION 5 a) i. Replacement Cost Replacement cost is the cost of replacing the services of the existing asset. Given that changes in technology occur, it should not be thought of simply in terms of replacing by a physically identical asset. Rather, it should be thought of as the cost of replacing the service potential of the existing asset in the cheapest way possible. ii. Net Realisable Value Net realizable value for a fixed or current asset is the amount which would be received from selling the asset in its existing condition less any cost of disposal. A summation of the net disposal proceeds of all assets less liabilities would provide the break-up value of the firm and is therefore of relevance to many people interested in the affairs of the firm. iii. Economic Value This is also called value in use. In the case of a fixed asset, it will be used to provide services, ie to generate cash flows in future. The assets value is therefore determined by those cash flows. The expected cash flows are discounted to arrive at the present value. For the case of a current asset, its value in use is similarly dependent on the future cash flows from ultimate sale of the finished product less any cash payments to be incurred prior to completion. Here however, the time horizon is usually sufficiently short to enable us ignore the need for discounting. iv. Value to the Business This is also called deprived value and represents the amount of loss to be sustained if the firm were deprived of the particular asset. Its value is determined in two stages: first the higher of NRV and economic value is taken and compared with replacement cost and the lower of the two is taken as the value to the business (or deprived vale). (b) Three Concepts of Capital Maintenance: 10

i)

Money Capital Maintenance If the net assets at the end of the year exceed the net assets at the beginning of the year in simple historical financial terms, money capital has been maintained. Real Capital Maintenance This is maintenance of the general purchasing power of the opening capital of the equity shareholder. The use of real capital maintenance recognizes that there has been a decline in the general purchasing power of money and that more money is needed at the end of the year to give the same command over goods and services as was the case at the beginning of the year. Maintenance of Specific Purchasing Power This concept also recognizes that more money is needed at the end of the year to purchase the same amount of goods and services than at the beginning of the year. In this case, however, individual assets and services are affected by different pricelevel changes and this sometimes makes its use a rather complex one.

ii)

iii)

(c )

Concept of Capital Maintenance and the Determination of Profit:

The concept of capital maintenance is concerned with how an entity defines the capital that it seeks to maintain. It provides the linkage between the concepts of capital and the concepts of profit because it provides the point of reference by which profit is measured; it is prerequisite for distinguishing between an entitys return on capital and its return of capital; only inflows of assets in excess of amounts needed to maintain capital may be regarded as profit and therefore as a return on capital. Hence, profit is the residual amount that remains after expenses have been deducted from income. Several alternative interpretations of this concept have been offered some of which are as follows: (a) The Money amount Concept This is reflected in historical cost accounting. The aim of this concept is to maintain financial capital in money terms; therefore, the measurement of periodic profit should ensure that the monetary value of the shareholders equity is maintained intact. It assumes that money is stable. The Financial Capital Concept The objective of this concept is to maintain the financial capital of an enterprise in real terms by constantly updating the historical cost assets for changes in the value of money. This concept of capital maintenance purports to show the shareholders that their capital kept pace with general inflationary pressure during the financial period, by measuring profit in such a way as to take into account the changes in the price levels. The translation is effected by a general price index eg the retail price index. Real capital is money capital that has been adjusted to maintain its general purchasing power. It intends to maintain the shareholders 11

(b)

capital in terms of monetary units of constant purchasing power. It is therefore the concept used under the current purchasing power accounting Under this concept a profit is earned only if the financial (or money) amount of the net assets at end of a period exceeds the financial (or money) amount of net assets at the beginning of the period, after excluding any distributions to, and contributions from owners during the period. (c) The Operating Capability/Physical Capital concept This concept of capital maintenance asserts that profit is a residual after provision has been made for replacing the resources exhausted in the course of operation. Under this concept profit is earned only if the physical productive capacity of the business at the end of the period exceeds the physical productive capacity at the beginning of the period. It measures the operating or productive capacity of an entity at current cost in order to sustain the physical productive capacity or service potential of the entity. It is therefore called the replacement cost accounting. It takes into account changes in the prices of commodities specific to the enterprise, either directly or by using specific price indices to measure changes in the prices of similar commodities. This concept is used under the current cost accounting method of price level adjustment accounting.

(d)

The Disposal Wealth Concept Whereas all the above concepts of capital maintenance envisage the enterprise as a going concern, the disposal wealth concept suggests that the maintenance of capital should be viewed from the perspective of the realizable value of the assets of the enterprise. Accordingly, the measurement of periodic profit is required to take into account changes in the realizable value of the net assets attributable to the shareholders equity. This concept is also used under the current cost accounting method of price-level adjustment accounting. The Investment Purchasing Power/Economic Value Concept This concept defines the assets of an entity in terms of their potential earning power. The potential earnings power is expressed as the present value or economic value of all cash flows to be generated in the future. The assets value is determined by those cash flows and that it may be found by discounting those expected cash flows to arrive at the present value. This concept is again applied under the current cost accounting system.

(e)

QUESTION 1 (a)

DAN AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET AS AT 31 MARCH 2008 GH 303,000 15,052,00 0 400,00 12

Goodwill (40,000 + 308,000 45,000)

Property Plant and Equipment (4,593,000 + 4,950,000 100,000 = 20,000)

Long Term Investment

Current Assets Stock (1,117,000 + 1,355,000 + 123,800 - 20,000) Account Receivables (964,000 + 769,000 + 275,000 100,000) Cash and Bank Balance (307,000 + 243,000 + 57,200)

2,575,80 0 1,908,00 0 607,200 5,091,00 0 2,320,60 0 1,640,70 0 669,700 4,631,00 0

0 15,755,00 0

Current Liabilities Trade Creditors (1,200,000 + 1,025,000 + 195,600 100,000) Sundry creditors (820,000 + 740, 000 + 80,700) Accruals (340,000 + 280,000 + 49,700)

Financed by Stated Capital Income Surplus Capital Surplus

460,00 0 16,215,00 0 2,870,000 5,040,600 2,084,000 9,994,600 6,220,400 16,215,00 0

Minority Interest Long Term Debt

4,580,400 1,640,000

(b)

Control group accounting is the power to govern the financial and operating policies of an entity or business so as to obtain benefits from its activities. Control is presumed if: 1) the holding company has power over more than half of the voting right of the entity by virtue of an agreement with the investors, 2) power to appoint or remove majority of the board of directors or any governing body 3) power to govern the financial and operating activities by status or agreement.

Workings Dan Ltd

13

So Ltd

1st acquisition 30/6/2006 2nd acquisition 31/3/2007

Man ltd 30/9/2007

Shareholdings SO LTD ORD % 20 40 60 40 100 MAN LTD ORD PREF % %

Group Direct

30/6/2006 31/3/2007 30/9/2007 Group Total Interest Minority Interest

60 60 40 100

25 25 75 100

Calculation of goodwill So Ltd Date of acquisition Percentage Acq. (%) Cost of investment paid Consultancy fees paid Less proportion of net asset acq. Stated capital Pre acq surpluses Income Capital Revaluation of plant Bad debt recovered

30/6/2006 20 GH 640,000 GH 2,000,000 700,000 300,000 ________ 3,000,000 x 20% GH 2,000,000 1,200,000 665,000 (100,000) 90,000 3,855,000 x 40% GH 1,420,000 100,000 1,600,000 1,100,000 950,000 2,190,000 x 60% 100,000

31/3/2007 40 1,800,000 50,000

Good will Calculation of goodwill Man Ltd Investment in Ordinary Shares Investment in Preference Shares Net asset at acq. Stated Capital Ordinary Share Income Surplus Capital Surplus Preference Share Capital 400,000 x 25% Negative Goodwill

600,000 40,000

1,542,000 308,000

2,290,000 770,000 GH

Minority Interest Accounts Credit: 14

Stated Capital So Ltd Ordinary Share 2,000,000 x 40% - Man Ltd 1,600,000 x 40% Preference Shares So Ltd Man Ltd 400,000 x 75% Capital Surplus So Ltd 1,265,000 x 40% Man Ltd 950,000 x 40% Income Surplus So Ltd 2,026,000 x 40% Man Ltd 1,710,000 x 40% Debit Revaluation Loss 100,000 x 40% Minority Interest Consolidated Income Surplus Accounts Credit: Balance b/f of Dan Ltd Post Acq. Surplus of subsidiaries So Ltd 30/6/2006 (2,026,000 700,000) x 20% 31/3/2007 (2,026,000 1,200,000) x 40% Post Acq. Surplus of Subsidiaries Man Ltd (1,710,000 1,000,000) x 60% Dept Adj. on rev. Plant and Equip. 20% 100,000) Consultancy fees paid Capital Surplus (negative goodwill)

800,000 640,000 500,000 300,000 506,000 380,000 810,000 684,000 4,620,400 (40,000) 4,580,400

3,360,000 265,200 330,400 366,000 20,000 50,000 770,000 5,161,600

Less Debit: Post acq. Loss on revaluation 20% 100,000 Impairment loss on Goodwill Bad debt rec. credited to cost of control (90,000 x 40%) Unrealized profit Consolidated Income surplus Capital surplus Account Credit: Dan Ltd Bal Post acq of So Ltd So Ltd 20% (1,265,000 300,000) 40% (1,265,000 650,000)

20,000 45,000 36,000 20,000

(121,000) 5,040,600

1,651,000 193,000 240,000 15

2,084,000

16