ACC1002 PROJECT - CHALLENGER

Question 1

Challenger’s external/independent auditors are RSM Chio Lim LLP, and the Partner in

charge of audit is Woo E-Sah.

The role of external auditors is to examine financial statements, to verify that they are

prepared according to generally accepted accounting principles. (tb pg 6). The audit

opinion that Challenger got was unqualified.  This means that Challenger’s financial

statements, balance sheet and statement of changes in equity were prepared in

accordance with the Financial Reporting Standards (FRS) in Singapore and the

Accounting Standards Act.

An unqualified auditor’s opinion indicates that external users can rely on the fairness of

the financial statements, balance sheet and statement of changes in equity.

The auditor’s opinion is important to investors as it gives them confidence in the

accuracy of the figures reported. Thus, this enables them to make a more informed

analysis of the current and future profitability of the company, aiding them in making

better investment decisions. It is also important to creditors, who may want to

determine the likelihood of Challenger being able to repay future debts, if any, and gain

confidence in making future loans to them.

Question 2

There are two accounting methods for revenue recognition, i.e. accrual basis

accounting and cash basis accounting. Under accrual basis accounting, revenue is

recognized when earned and expenses when incurred. On the other hand, under

cash basis accounting, revenue is recognized when cash is received and expense is

recorded when cash is paid.

Since Challenger adopts the accrual basis accounting method (Sec 1:46, note 2),

inflows and outflows of cash do not directly affect Challenger’s revenue recognition

principle. For example, if Challenger were to provide a service to its customers and

the customer has yet to pay up, the revenue earned would still be recognized even

though there is no inflow of cash. Similarly, if Challenger has incurred an expense but

has yet to pay upfront, the expense will still be recognized even though there is no

outflow of cash. Hence, the receipts and payments of cash have no impact on

Challenger’s revenue recognition.

Question 3

Question 4a

Challenger uses the First-in-first out (FIFO) method. This method is appropriate because

Challenger is in the IT electronics industry, where inventories become outdated very

quickly. Hence, inventories acquired at the beginning of the fiscal year are likely to be

sold sooner. In addition, given that costs of consumer electronics are relatively steady, it

does not matter whether Challenger uses FIFO or Last-in-first out (LIFO) because first or

older costs will be similar to the latest or recent costs. However, given that Challenger is

a listed company, using the FIFO method over other inventory cost methods will assign

the lowest amount to cost of goods sold, hence yielding the highest gross profit and net

income. Financially, this will look good to current investors and future investors.

Question 4b

Question 5a

Challenger depreciates its plant and equipment using the straight-line depreciation

method, which divides the depreciation equally throughout the plant and equipment’s

life, making computation easy and convenient.

Straight line depreciation expense  =   Cost - Salvage Value

  Useful life

This policy is reasonable as Challenger belongs to the IT electronics industry, where

usage of plant and equipment is relatively constant from one year to the next (unlike

other industries such as manufacturing or construction, where usage of equipment

depends on demand). Furthermore, Challenger is a publicly listed company. Hence, it is

reasonable that they adopt this method of depreciation because it allows them to report

a higher net income in the earlier years to the stockholders. Financially, it makes

Challenger look better to current and potential investors.

(http://www.articlesbase.com/accounting-articles/straightline-or-double-down-depreciation-method-

1320996.html#ixzz1HmNDL2cj)

However, Challenger needs to weigh the trade-offs in choosing this method over the

other 2 depreciation methods; units-of-production and Double Declining Balance (DDB).

Units-of-production method offers a more accurate estimate of the asset’s useful life and

depreciation expense because it is based on usage. It also properly matches depreciation

expense with the related revenue. On the other hand, DDB reports higher depreciation

expense in the early periods of the asset’s useful life. This results in lower net profits and

thus, greater tax savings, which Challenger can use for investments.

Do pie charts X 2

Property 3.8%

Renovations 12.5% to 33%

Plant & Equipment 10% to 33%

Useful life of Challenger’s plant and equipment - 3 to 10 years

100%/10%= 10 years

100%/33% = 3 years

Shortest useful life is 3 years.

Question 6

Yes. Challenger made provisions for several contingent liabilities, which are potential

obligations that depend on a future event arising out of a past transaction or event. Since

these can be reasonably estimated, they are recorded as liabilities.

Challenger introduced the Star-shield warranty in 2009.

Dr Warranty Expense                       1063

 Cr Estimated Warranty Liability               1063

Corporate guarantee given to bank in favour of a subsidiary in 2008 and 2009

        Dr           Cash         350

           Cr                Notes/ Accounts Payable 350

** Supporting subsidiaries with deficits          1080 (2009)   528 000 (2008)

(GARETH TO CHECK - HOW TO WRITE JOURNAL ENTRIES)

Question 7a

Yes, the financial statements presented cover both the parent and the Group’s

subsidiaries. (Sec 1:45 - Note 1)

Challenger uses the consolidation accounting method for its consolidated financial

statements. These include the financial statements of the Company and all of its directly

and indirectly controlled subsidiaries. (Sec 1:45 -  Note 2)

With reference to the data given on the effective percentage of equity held by Group (Sec

1:74 - Note 16), Challenger owns 100% of all its subsidiaries, except for the following:

Incall Systems Pte Ltd (acquired 4 June 2008)

Singapore

Telephonic call centre and data management services

(PS Phuan & Co).

(Sec:1:44)

Question 7b

Yes. Since goodwill is an intangible asset and is measured as the excess of the cost of an

acquired entity over the value of the acquired net assets (subtracting the market value

of a company’s individual net assets (excluding goodwill) from the purchase price of the

company), the fact that goodwill on acquisition amounts to $535000 (Sec 1:85) suggests

that Challenger has paid more than the market values of their subsidiaries’ net assets.

(Check again)

Question 8

Question 9a

I disagree because judging from the increase in PPE (from $4674000 in 2008 to

$11119000 in 2009) and inventories (from $9229000 in 2008 to $15368000 in 2009),

it is apparent that Challenger has been using the cash and cash equivalents for

investment in building and new retail outlets. This expansionary strategy has resulted

in increased revenue (from $168723000 in 2008 to $191559000 in 2009) and profit

net of tax (from $5981000 in 2008 to $11145000 in 2009) and is likely to continue

result in increased profits in the future (provided that Challenger will be able to

control its operating expenses and costs of goods purchased) Since dividends issued

to shareholders are largely based on profits of the company, it will be good news to

them if Challenger is able to increase revenue by reinvesting some of previous years’

profits.

However, it must also be noted that net cash flow from operating activities in 2009

had actually declined (from $14572000 in 2008 to $8308000 in 2009), which might

have led to a decrease in dividends paid in that year because of lesser cash

available for distribution. If the company does not keep up a constant rate of

dividend, it is bad news for shareholders as dividend policy is a strong indication of

future profitability. In addition, cash and cash equivalents also helps determine the

short-term viability of a company, particularly its ability to pay its bills and its solvency.

Hence, a healthy cash flow would suggest to shareholders that Challenger is doing

well.

Question 9b

I disagree because the company may have bought inventories on credit as well, not just

using cash. This would be recorded in the accounts payable account, and not shown in

the CFS.

There is also an outstanding balance of 16.789M of trade payables. (Sec 1:85 - Note 26)

Trade payables, also known as accounts payable, refers to money owed to creditors,

lenders, vendors or suppliers for products or services rendered. Hence the existence of

these trade payables mean that some inventories could have been purchased on credit

terms of 30 days. Note 28E (Sec 1:90)

In addition, we realize that the decrease in cash and cash equivalents has been mainly

due to payment of dividends, acquisition of buildings, and capital expenditure incurred

for new retail stores (Sec 1: 13). Thus, we can conclude that the changes in cash amounts

are not solely from purchases in inventories alone.

Question 10

Interim Dividends are declared and distributed before the company’s annual earnings

have been known. These interim dividends are paid out of undistributed profits

(reserves) brought from previous periods.

CALCULATED VALUES

Dividend rate per share = 1.2 cents

Number of shares issued at end of year 2008 = 228, 543

Total interim dividends = $0.012 X 228, 543 = 2,742.516 = $ 2743

Number of shares issued at end of year 2009 = 228, 993

Total final dividends = $0.012 X 228, 993 = 2,747.916 = $ 2,748

Total dividends = 2747.916 + 2742.516  = 5490.432 = $ 5, 490

Dividends on equity are recognized as liabilities when declared.

Interim dividends are recognized when declared by the Directors.  (Sec 1:56)

NOTE 14 – Sec 1:71

Calculated figures –

a)           Dr         Retained earnings 5,490, 432

               Cr      Common interim dividend payable         2,742, 516

    Cr Final dividend payable 2,747, 916

b)         Dr          Common interim dividend payable 2,742, 516

Dr Common final dividend payable 2,747, 916

         Cr         Cash 5,490, 432

ACTUAL FIGURES FROM FS -

a)           Dr         Retained earnings 5,492

               Cr      Common interim dividend payable         2,747

    Cr Final dividend payable 2,745

b)         Dr          Common interim dividend payable 2,747

Dr Common final dividend payable 2,745

         Cr         Cash 5,492

Question 11

Judging the profitability of a company by its earnings per share (EPS) will be most

useful to the existing shareholder because EPS measures the amount of income

earned per each share of a company’s outstanding common stock. In other words, it

is the amount of income attributable to one share of common stock. By examining the

company's earnings using its EPS, the existing shareholder can measure the value

of earnings that he “owns” in addition to the earnings of the company as a whole. In

contrast, profit net of tax and total comprehensive income do not take the

amount of shares issued by the company into account. Hence, even though the

company may be earning high profits or income, if the amount of shares

issued is large, earnings per share will be low and this will be bad news for the

shareholder. (pls check the accuracy of this. Also, how do we use the values to

support our answer?)

Question 12a

Net profit margin = Net income / Net sales

Note: Challenger’s net sales is its group revenue

2009

Net profit margin = 11145 / 191559

≈ 0.05818

= 6%

2008

Net profit margin = 5981 / 168723

≈ 0.03544

= 4%

Trade receivable turnover = (Ending accounts receivable / Sales on account) x 365

2009

Trade receivable turnover = 2933 / 191559 x 365

≈ 5.588

= 6 days

2008

Trade receivable turnover = 1684 / 168723 x 365

≈ 3.643

= 4 days

Return on equity (ROE) = (Net income – Preferred dividends) / Average common

stockholders’ equity

2009

ROE = (11145 – 0) / 26548

≈ 0.4198

= 42% (Gareth, pls check do we use total equity or total shareholders’ fund, i.e.

26548 or 26286)

2008

ROE = (5981-0) / 20984

≈ 0.2850

= 29%

Quick ratio = Quick assets / Current liabilities

2009

Quick assets = Current assets - Inventories

= 40076 – 15368

= 24708

Quick ratio = 24708 / 25690

≈ 0.9617

= 0.96

2008

Quick assets = Current assets - Inventories

= 39564 – 9229

= 30335

Quick ratio = 30335 / 25168

≈ 1.205

= 1.21

Current ratio = Current assets / Current liabilities

2009

Current ratio = 40076 / 25690

≈ 1.559

= 1.56

2008

Current ratio = 39564 / 25168

≈ 1.571

= 1.57

Question 12b

Inventory turnover = Ending inventory / Cost of goods sold x 365

Cost of goods sold (COGS) = (Ending inventory / Inventory turnover) x 365

(SIying I think the formula is: Inventory Turnover = COGS / Average Inventory)

2009

COGS = (6131 / 36) x 365

≈ 62161.5

= $62162

2008

COGS = (1085 / 25) x 365

= $15841

Question 12c(i)

Total asset turnover = Net sales / Average total assets

(Net sales = Group Rev?)

2009

Total asset turnover = 11145 / ((53913 + 46748) / 2)

≈ 0.2214

= 0.22 times (Gareth, pls check if this is correct)

2008

Total asset turnover = 5981 / ((46748 + 38663) / 2)

≈ 0.1400

= 0.14 times (Gareth, pls check if this is correct)

Question 12c(ii)

Debt ratio = Total liabilities / Total assets

2009

Debt ratio = 27365 / 53913

≈ 0.5075

= 0.51 (Gareth, pls check if this is correct)

2008

Debt ratio = 25764 / 46748

≈ 0.5511

= 0.55 (Gareth, pls check if this is correct)

Question 12c(iii)

Times interest earned = Income before interest expense and income taxes /

Interest expense

2009

Times interest earned = 13652 / 0

= 0 (Gareth, pls check if this is correct)

2008

Times interest earned = (7989 + 4) / 4

≈ 1998.25

= 1998 (Gareth, pls check if this is correct)

Question 12c(iv)

Gross margin ratio = (Net sales – Cost of goods sold) / Net sales

2009

Gross margin ratio = (191559 – 62162) / 191559

≈ 0.6754

= 67.5%

2008

Gross margin ratio = (168723 – 15841) / 168723

≈ 0.9061

= 90.6%

Question 12c(v)

Return on total assets = Net Income / Average total assets

2009

Return on total assets = 11145 / ((53913 + 46748)) / 2)

≈ 0.2214

= 22.1%

2008

Return on total assets = 5981 / ((46748 + 38663)) / 2)

≈ 0.1400

= 14.0%

Question 12c(vi)

Book value (BV) per common share = Shareholders’ equity applicable to common

shares / Number of common shares outstanding

2009

BV per common share = 26286 / 1257056

≈ 0.02091

= $0.02 per share (Gareth, pls check if this is correct)

2008

BV per common share = 20781 / 1676775

≈ 0.01239

= $0.01 per share (Gareth, pls check if this is correct)

Question 12c(vi)

Price-Earnings (PE) ratio = Current market price of one share / Earnings per

share

2009

PE ratio = 0.2925 / 4.8

≈ 0.06093

= 0.06

2008

PE ratio / 2.58

≈ 0.06093

= 0.06

Question 13

Increase (Decrease)

2010 2009 Amount %Assets

Current assets:

Cash $ 12,000

$ 23,500

Accounts receivable, net 60,000

40,000

Inventory 80,000

100,000

Prepaid expenses 3,000

1,200

Total current assets $ 155,000

$ 164,700

Property and equipment:

Land $ 40,000

$ 40,000

Buildings and equipment, net 120,00

0 85,00

0

Total property and equipment $ 160,000

$ 125,000

Total assets $ 315,000

$ 289,700