3 Answer THREE questions from a choice of seven in SECTION B.
4 All questions carry 25 marks. Marks for subdivisions of questions are shown in brackets.
5 No books, dictionaries, notes or any other written materials are allowed in this examination.
6 Calculators, including scientifi c calculators, are allowed providing they are not programmable and cannot store or recall information. Electronic dictionaries and personal organisers are NOT allowed. All workings should be shown.
7 Candidates who break ABE regulations, or commit any misconduct, will be disqualifi ed from the examinations.
8 Question papers must not be removed from the Examination Hall.
Q1 The trial balance for Tor enterprise as at 31 December 2008 is as follows:
£000 £000 Revenue 59,200 Purchases 33,120 Inventory 1 January 2008 5,560 Distribution costs 4,320 Administration costs 5,840 Land at valuation (note (iv)) 42,000 Property at cost (note (iii)) 32,000 Property accumulated depreciation as at 1 January 2008 8,520 Plant and equipment at cost (note (iii)) 51,200 Plant and equipment accumulated depreciation as at
1 January 2008 9,920 Trade receivables 16,480 Trade payables 8,960 Bank 640 Ordinary issued 50p shares 56,000 Share premium account 16,000 Revaluation reserve as at 1 January 2008 12,000 Retained earnings as at 1 January 2008 12,560 8% loan redeemable 2112 (note (ii)) 8,000 ––––––– ––––––– 191,160 191,160 ––––––– –––––––
(Note that fi gures in the above table are in £000s - thousands)
The following notes are applicable: (i) Inventory as at 31 December 2008 amounted to £6,240,000 at cost. A review of
inventory revealed the following: (a) Items costing £320,000 that had been included in the inventory at 31 December
2008 were found to have deteriorated. Their normal selling price was £480,000, but even after remedial work of £80,000, these items could only be sold for £360,000.
(b) Items sold on a sale or return basis had been omitted from the inventory as at 31 December 2008 and included in sales in December 2008. The cost of these items was £64,000 and their sale price was £96,000. All these items were returned in good condition to Tor in January 2009.
(ii) The interest on the loan has not been paid for the year ended 31 December 2008 and must be accrued.
(iii) Depreciation is to be calculated for the year ended 31 December 2008 as follows: (a) Property 2% per annum on cost (b) Plant and equipment 15% per annum on cost Depreciation calculated for the year is to be charged 80% cost of sales,
10% distribution costs and 10% administration costs. (iv) Land is to be revalued to £48,000,000 as at 31 December 2008.
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(v) Tax for the year ended 31 December 2008 is chargeable at 25% of profi ts for the year before receiving or paying dividends.
(vi) Adjustments for accruals and prepayments are required as follows:
Accruals Prepayments Distribution costs £76,000 £48,000 Administration costs £28,000 £24,000
Required:
Prepare the Income Statement for the year ended 31 December 2008 and the Balance Sheet as at that date for Tor in accordance with International Accounting Standards (IASs).
(25 marks)
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SECTION B
Answer THREE questions only. All questions carry equal marks.
Q2 On 1 January 2008 Sun enterprise acquired an 80% holding in Tan enterprise. The draft Balance Sheets of Sun and Tan as at 31 December 2008 are as follows:
Sun Tan £000 £000 ASSETS Non-current assets Patents – 475 Land, property, plant and equipment 3,138 552 Investment in Tan 600 – ––––– ––––– 3,738 1,027 ––––– ––––– Current assets Inventory 927 403 Trade receivables 975 423 Bank 326 132 ––––– ––––– 2,228 958 ––––– ––––– TOTAL ASSETS 5,966 1,985 ––––– –––––
EQUITY AND LIABILITIES Equity Ordinary shares 50p 2,000 700 Revaluation reserve 475 – Retained earnings 1,777 765 ––––– ––––– 4,252 1,465 ––––– ––––– Liabilities Current liabilities 1,714 520 ––––– ––––– TOTAL EQUITY AND LIABILITIES 5,966 1,985 ––––– –––––
(Note that fi gures in the above table are in £000s - thousands)
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The following information is also available: (i) At the acquisition date of 1 January 2008 the net assets of Tan had a book value of
£1,265,000. The following assets were revalued at the acquisition date as follows:
Book value 1 January 2008 Revaluation Patents £475,000 £500,000 Land £250,000 £600,000
The fair value of all other assets and liabilities at the acquisition date was equal to book value. No adjustments have been made to Tan’s accounts to refl ect these fair values.
(ii) The consideration paid by Sun for the 80% share of Tan comprised cash £600,000 and 700,000 50p shares with a fair value at 1 January 2008 of £1.25. The share issue made to acquire Tan has not yet been entered in Tan’s draft Balance Sheet as at 31 December 2008.
Required:
(a) Calculate the value of goodwill arising on the acquisition of Tan and explain the treatment of this goodwill in the consolidated accounts of Sun group in accordance with International Accounting Standards (IASs). (8 marks)
(b) Prepare the consolidated Balance Sheet for the Sun group as at 31 December 2008.(17 marks)
(Total 25 marks)
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Q3 There are several International Accounting Standards (IASs) that consider the accounting treatment of non-current assets. Two of these are:
(a) Describe the accounting treatments required by each of the two standards mentioned above. (14 marks)
(b) (i) An item of plant was purchased several years ago by X enterprise at a cost of £500,000. The current carrying value of this item of plant in X’s Balance Sheet is £360,000. X estimates that it could currently sell the item of plant for £310,000 but would also incur £20,000 in selling costs. X further estimates that the present value of the future expected cash fl ows to be derived from retaining the item of plant is £270,000.
Identify at what value the item of plant would be recorded in X’s Balance Sheet, showing all relevant accounting entries. (5 marks)
(ii) During the year ended 31 December 2008, X spent £12,000,000 on the construction of a large development. X has a centralised function for fi nance borrowing, and borrowing during the year ended 31 December 2008 was as follows:
� £5,000,000 bank overdraft at 16% interest per annum. � £6,000,000 5 year secured 8% loan note. � £5,000,000 5 year unsecured 10% loan note. X has a policy of capitalising borrowing costs where possible in accordance with
IAS 23.
Identify the accounting entries, including the amounts, to capitalise the relevant borrowing costs. (6 marks)
(Total 25 marks)
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Q4 (a) The Chief Executive Offi cer (CEO) of the enterprise you are employed by has asked you to explain the requirements of IAS10, Events After the Balance Sheet Date. The CEO particularly wishes to know:
� The difference between an adjusting and a non-adjusting event. � The accounting treatment for both of the above events. � The disclosure requirements of the standard.
Required:
Prepare a report giving the explanations requested by the CEO. (16 marks)
(b) The following events occur before the directors approve the fi nancial statements of the enterprise. The Balance Sheet date of the enterprise is 31 December 2008.
(i) A fi re on 4 January 2009 destroys all the inventory in one warehouse. The inventory had been valued as at 31 December 2008 at £350,000.
(ii) A customer who owed the enterprise £25,000 as at 31 December 2008 went into liquidation on 9 January 2009 and it is estimated that no funds will be available to pay creditors.
Required:
Identify the accounting treatment and any disclosure requirements for items (i) and (ii) in the fi nancial statements for the year ended 31 December 2008. (9 marks)
(Total 25 marks)
Q5 An enterprise may issue shares: � At par � At a premium � Via a rights issue � Via a bonus issue
Required:
(a) Describe, using numerical examples, each of the above four issues of shares.(12 marks)
(b) Discuss the differences between shareholders and debenture holders. (7 marks)
(c) Explain the factors determining the capital structure of an enterprise with particular reference to gearing. (6 marks)
(Total 25 marks)
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Q6 A substantial number of organisations are required to have their annual fi nancial statements audited. The auditors are required to provide an audit report that is published in the annual report of the organisation.
Required:
(a) An organisation is subject to external audit. Describe the type of information an external audit report should provide regarding the organisation and its fi nancial statements. (10 marks)
(b) Discuss the purposes of an external audit to all relevant stakeholders. (8 marks)
(c) Explain the relationship between internal and external audit within an organisation.(7 marks)
(Total 25 marks)
Q7 Alpha enterprise, a computer hardware manufacturer, has obtained accounting ratios relating to averages for similar organisations in the industry.
The average ratios for the period 1 January 2008 to 31 December 2008 are as follows:
Return on capital employed 21.6% Net assets turnover 1.6 times Gross profi t margin 25% Net profi t (before tax) margin 10.5% Current ratio 1.5:1 Quick ratio 0.8:1 Inventory holding period 42 days Trade receivables collection period 41 days Trade payables payment period 59 days Debt to equity 35% Dividend yield 5% Dividend cover 4 times
The summarised fi nancial statements for Alpha for the period 1 January 2008 to 31 December 2008 are as follows:
Income statement £000 Sales revenue 4,850 Cost of sales (3,740 ) ––––– Gross profi t 1,110 Other operating expenses (430 ) ––––– Operating profi t 680 Interest payable (68 ) Loss on sale of obsolete stock (240 ) ––––– Profi t before tax 372 Tax (180 ) ––––– Profi t after tax 192 –––––
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Changes in equity Retained profits 1 January 2008 358 Net profit for the period 192 Dividends paid (180 ) ––––– Retained profits 31 December 2008 370 –––––
Balance sheet £000 £000 Non-current assets 1,080 Current assets: Inventory 550 Trade receivables 640 1,190 ––––– ––––– Total assets 2,270 ––––– Share capital and reserves: Ordinary 50p shares 300 Retained profits 370 ––––– 670 Non-current liabilities: 7% loan note 600 Current liabilities: Bank overdraft 130 Trade payables 700 Tax 170 1,000 ––––– ––––– Total equity and liabilities 2,270 –––––
(Note that figures in the above table are in £000s - thousands)
The following information is also relevant: (i) The non-current assets cost £7,200,000 and accumulated depreciation as at
31 December 2008 is £6,120,000. (ii) Alpha’s ordinary shares averaged a market price of £12 throughout the period.
Required:
(a) Calculate (to one decimal place) the ratios for Alpha equivalent to those for the industrial averages. (7 marks)
(b) Write a report analysing the financial performance of Alpha based on a comparison with industrial averages. (14 marks)
(c) Explain the problems that are inherent when using industrial averages to compare performance. (4 marks)
(Total 25 marks)
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Q8 The financial statements for Spiral enterprise are as follows:
Income statement for the year ended 31 December 2008
Balance sheets as 31 December 2007 2008 £000 £000 Tangible non-current assets 784 1,088 Intangible non-current assets 60 54 Current assets: Inventories 580 520 Trade receivables 500 560 Cash 92 364 ––––– ––––– Total assets 2,016 2,586 ––––– ––––– Ordinary shares 25p 360 488 Reserves 608 830 Non-current liabilities 360 320 Current liabilities 688 948 ––––– ––––– Total equity and liabilities 2,016 2,586 ––––– –––––
(Note that figures in the above table are in £000s - thousands)
The following information is also available: (i) Dividends paid during the year amounted to £48,000. (ii) The proceeds from non-current tangible assets disposed of during the year was
£84,000. These assets had a carrying value before disposal of £76,000. Depreciation charged on all tangible non-current assets during the year was £148,000.
(iii) During the year £40,000 bonds were converted into 352,000 25p equity shares. (iv) Spiral also issued 160,000 25p shares for 32.5p cash during the year. (v) There was no purchase or disposal of intangible non-current assets during the year.
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(vi) Current liabilities as at 31 December 2007 and 2008 were as follows:
Property 2% x 32,000 = 640 512 64 64 Plant and equipment 15% x 51,200 = 7,680 6,144 768 768 ——— —— —— 6,656 832 832 ——— —— ——
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SECTION B
Q2 (a) Goodwill calculation
Fair value of consideration Cash 600,000 Shares 700,000 x 1,25 875,000 ————— 1,475,000 ————— Fair value of net assets of Tan as at 1.1.2008 Patents 500,000 Land 600,000 Other net assets (1,265,000 - 475,000 - 250,000) 540,000 ————— 1,640,000 ————— 80% of fair value of net assets = 1,312,000 ————— Goodwill 163,000 —————
International Accounting Standards require goodwill on consolidation to be measured at cost less any impairment losses.
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(b) Consolidated balance sheet of the Sun group as at 31 December 2008
Working 1 Net assets of Tan 1.1.2008 1,265 Net assets of Tan 31.12.2008 1,465 ——— Therefore net earnings period ended 31.12.2008 200 ——— Attributable to Sun group 80% 160 ———
Working 2 Net assets of Tan 31.12.2008 1,465 ——— 20% attributable to minority interest 293 Add 20% of revaluation at date of acquisition 375 75 ——— Minority interest 368 ———
The standard states that borrowing costs shall be recognised as an expense in the period in which they are incurred.
The standard goes on to state “except to the extent that they are capitalised”. Thus the
standard permits us to capitalise some borrowing costs. But which borrowing costs?
The answer is “borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset shall be capitalised as part of the cost of that asset”.
A qualifying asset for the capitalisation of borrowing costs is one that necessarily takes a substantial period of time to get ready for its intended use or sale.
Borrowing costs are defi ned as those costs that could be avoided if the asset had not been acquired. It can be quite diffi cult to identify a direct relationship between an asset and borrowing costs especially if funds are borrowed generally and controlled by a central function within the business. In these cases the standard permits us to apply a capitalisation rate to the expenditure on the asset. This rate is a weighted average.
Accounting treatment - IAS 36 - Impairment of Assets
The essential objective of IAS 36 is to ensure that all assets are not carried at a fi gure greater than their recoverable amount. Its essential requirement is that when an asset is impaired, that is its recoverable amount becomes less than its carrying amount in the books, this loss must be written off.
The impairment loss is written off to the income statement unless it reverses a previous revaluation in which case the impairment will be taken to the debit of the revaluation reserve up to the amount of the revaluation.
Recoverable amount is the higher of fair value less costs to sell and value in use.
Value in use is the present value of the future cash fl ows expected from the use of the asset.
(b) (i) Carrying value of plant 360,000 Fair value less costs to sell (310,000 - 20,000) 290,000 Value in use 270,000 Thus recoverable amount is 290,000 Therefore impairment is 70,000
Asset carried at 290,000 in balance sheet and 70,000 charge to income statement as impairment. Thus credit asset account 70,000 and debit income statement 70,000.
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(ii) Weighted average cost of capital is calculated as follow:
Borrowing costs to capitalise are £12m x 11.125% = £1.335m Debit asset construction account 1.335 Credit interest expense 1.335
Q4 (a) To: Chief Executive Offi cer
From: anon Date: Subject: IAS 10, Events After the Balance Sheet Date
Introduction IAS 10 concerns events that arise after the balance sheet date but for which evidence
exists at the balance sheet date. In the interests of accurate reporting, it is essential that these be refl ected in the fi nancial statements. If a proper understanding of the fi nancial position cannot be obtained without some disclosure, then notes must be provided to indicate those conditions existing at the balance sheet date.
Post-balance sheet events A post-balance sheet event is any event that occurs between the balance sheet date
and the date on which the fi nancial statements are approved by the board of directors.There are two main categories of post-balance sheet events.
Adjusting events These are events that provide additional evidence relating to conditions existing at the
balance sheet date. They require changes in amounts to be included in the fi nancial statements.
Examples are:
● The subsequent determination of the purchase price or the proceeds of sale of fi xed assets purchased or sold before the year-end.
● A valuation that provides diminution in the value of property. ● Guidance concerning the net realisable value of stocks, e.g. the proceeds of
sales after the balance sheet date, or the receipt or evidence that the previous estimate of accrued profi t on a long-term contract was materially inaccurate.
● The negotiation of amounts owing by debtors, or the insolvency of a debtor. ● Receipt of information regarding rates of taxation. ● Amounts received or receivable in respect of insurance claims which are in the
course of negotiation at the balance sheet date. ● Discovery of errors or frauds that show that the fi nancial statements were
incorrect.
FA0609 18
Non-adjusting events These are events that arise after the balance sheet date and concern conditions that
did not exist at the time. As a result they do not involve changes in amounts in the fi nancial statements. On the other hand, they may be of such materiality that their disclosure is required by way of notes, to ensure that fi nancial statements are not misleading.
Examples are:
● Mergers and acquisitions. ● Issues of shares and debentures. ● Purchases or sales of fi xed assets and other investments. ● Losses of fi xed assets or stocks as a result of catastrophe such as fi re or fl ood. ● Decline in the value of property and investment held as fi xed assets, if it can be
demonstrated that the decline occurred after the year-end. ● Government action, such as nationalisation. ● Strikes and other labour disputes.
Standard accounting practice
● Financial statements should be prepared on the basis of conditions existing at the balance sheet date.
● A material post-balance sheet event requires changes in the amounts to be included in the fi nancial statements, where it is either an adjusting event, or it indicates that application of a going concern concept to the whole or a material part of the company is not appropriate.
Disclosure requirements
● A material post-balance sheet event should be disclosed where it is a non-adjusting event of such materiality that its non-disclosure would affect the ability of the users of fi nancial statements to reach a proper understanding of the fi nancial position; or
● It is the reversal or maturity after the year-end of a transaction entered into before the year-end, the substance of which was primarily to alter the appearance of the company’s balance sheet.
● The disclosure should state, in note form, the nature of the event and an estimate of the fi nancial effect, or a statement that it is not practicable to make such an estimate.
● The estimate of the fi nancial effect should be disclosed before taking account of taxation, and the taxation implications should be explained, where necessary, for a proper understanding of the fi nancial position.
● The date on which the fi nancial statements are approved by the board of directors should be disclosed in the fi nancial statements.
(b) (i) The fi re is a post-balance sheet event but non-adjusting and therefore no account of it will be taken in the redrafting of the fi nancial statements. However, a note to the accounts will be required identifying the nature of the event and the amount of the fi nancial effect, i.e. the loss of £350,000.
(ii) Although the customer did not go into liquidation until 9.1.2008 this is an adjusting event as the £25,000 debt is now not recoverable. The debt of £25,000 must be written off to the income statement as an expense and the debtors fi gure in the balance sheet reduced by £25,000.
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Q5 (a) An issue of shares at par means that the issuer is asking the buyer to pay in cash the nominal value of the shares. Thus, if 2 million ordinary shares with a nominal/par value of 25p are issued the issuer will receive £500,000 in cash if all shares are bought.
An issue of shares at a premium means that the purchaser is being asked to pay a higher price than the nominal value. This will be because reserves have been built up in the enterprise issuing the shares and as the purchaser will have a share in these reserves they must pay towards them. For example, an enterprise may issue 2 million 25p shares at 50p, that is a 25p premium. The issuer will receive, if all shares are purchased, £1 millon and £500,000 will be recorded as ordinary shares issues and £500,000 as share premium.
A rights issue is a useful means of raising fresh capital from the existing shareholders. Under a rights issue the shares will be issued at a value below the current market value which encourages the existing shareholders to purchase the rights. For example, an enterprise with an issued share capital of 500,000 £1 shares may decide to raise an additional £100,000 by means of a rights issue of one rights for existing ten shares at £2 (where the current market value is £2.50). This rights issue will raise 50,000 x £2 = £100,000.
A bonus issue of shares is normally made when an enterprise has substantial undistributed profi ts generally much in excess of the issued capital. A bonus issue will capitalise these reserves into shares. For example, an enterprise with issued share capital of 500,000 £1 ordinary shares and retained profi ts of £1,000,000 may make a 2 for 1 bonus issue, thus issuing a further 1,000,000 £1 shares. It is important to note that no cash is involved in this issue and neither the enterprise nor the shareholder are any better off in theory.
(b) The differences between debenture holders and shareholders can best be seen from the following table:
Debentures are not capital and so they should not be grouped with the shares in the balance sheet but shown as non-current liabilities.
Debenture Holder Shareholder
Debentures are not part of the capital of a company.
Shares are part of the capital of a company.
Debentures rank fi rst for capital and interest.
Shares are postponed to the claims of debenture holders and other trade payables.
Debenture interest must be paid whether there are profi ts or not and is a charge to the profi t and loss account.
Dividends are payable out of profi ts only (appropriations) but only if there is adequate profi t.
Debentures are usually secured by a charge on the company’s assets.
Shares cannot carry a charge.
Debenture holders are trade payables, not members of the company, and usually have no control over it.
Shareholders are members of the company and have indirect control over its management.
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(c) Factors determining capital structure are generally the ability of the earnings to support the structure, the attitude of investors and the cost of capital. If an enterprise earns 20% on its capital employed and can borrow further loan funds at 10% then the shareholders will benefit through gearing up. However, if the return on capital employed is only 8% then there will be a gearing down from borrowing at 10%. Investors will also consider the security offered, that is the ability of the enterprise to meet interest payments. Cost of capital is calculated on a weighted average basis and the fundamental objective of financial management is to seek to provide adequate capital for the business requirements at minimum cost. Since debt capital is generally cheaper than equity capital the introduction of debt into the total mix will have the effect of reducing the overall cost of capital.
Q6 (a) The audit report is addressed to the shareholders of the company and is the auditor’s opinion on whether the financial statements show a true or fair view. The report should also:
● State which financial statements have been audited. ● Place emphasis on the fact that it is management’s responsibility to prepare the
financial statements and auditor’s purely to audit them. ● State that compliance with auditing standards in carrying out the audit has been
adhered to. ● Provide a brief overview of the work done to provide the auditor with the
evidence for the opinion. ● Provide details of the auditor and the date of the report. ● Provide details of ‘emphasis of matter’ - this is where an issue arises during the
audit that does not affect the opinion but the auditor believes it should be brought to the attention of recipients of the report.
An auditor may not be able to state that the financial statements provide a true and fair view after his audit in which case he must provide a modified report to that effect. The external report is included within the published financial statements.
(b) An external audit is carried out by persons from outside the organisation who investigate the accounting systems and transactions and ensure, as far as they are able, that the financial statements have been prepared in accordance with the underlying books, the law and applicable accounting standards. The external auditor needs from his investigation to place him/herself in a position to express an opinion whether the financial statements being reported upon show a true and fair view or not. This opinion, if positive, provides considerable reassurance to users of financial statements, particularly the current shareholders, the owners, that these accounts are reliable. It is important to identify what an external audit is not. It is not an attempt to find fraud, and it is not a management control. Fraud may be discovered during an audit, and the auditor will usually be well placed to give advice to management about potential improvements in the internal control system, but these benefits are incidental.
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(c) Relationship between internal and external audit When carrying out an external audit the auditor may make use of the internal audit
function during the course of the audit. If the external auditor does rely on the work of internal audit he will have to assure him/herself that the work has been:
● Carried out by suitably competent and proficient people. ● Well documented and evidenced in accordance with findings. ● Carried out using appropriate audit tests and techniques. ● Such that reasonable conclusions have been drawn and acted upon. ● Carried out without undue influence from others.
The external auditor will need to test the work of the internal audit function to confirm its adequacy.
Q7 (a) Ratio Calculation Alpha
Industry sector
Return on capitalemployed
372 + 68 interest/1,270 34.6% 21.6%
Net assets turnover 4,850/1,270 3.8 times 1.6 times
Gross profit margin 1,110/4,850 x 100 22.9% 25%
Net profit margin 372/4,850 x 100 7.7% 10.5%
Current ratio 1,190/1,000 1.2:1 1.5:1
Quick ratio 1,190 - 550/1,000 0.6:1 0.8:1
Inventory holding period 550/3,740 x 365 54 days 42 days
Trade receivable collection period
640/4,850 x 365 48 days 41 days
Trade payables paymentperiod
700/3,740 x 365 68 days 59 days
Debt to equity 600/670 x 100 90% 35%
Dividend yield
Dividend per share =180/600 = 30p marketvalue £12 therefore30/1,200 x 100
2.5% 5%
Dividend cover 192/180 1.1 times 4 times
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(b) To: From: Subject: Analysis of Alpha’s financial performance compared to sector average for the
period ended 31 December 2008 Date:
Operating performance Return on capital employed for Alpha is impressive being 1
12 times the sector average.
This performance is achieved by an asset turnover twice that of the sector. However, the gross profit margin is slightly lower than the sector, as is the net profit. If the loss on obsolete inventory is discounted the net profit margin for Alpha increases to 9,612/4,850) 12.6%. This is similar to sector averages. Indeed, excluding the issue of the obsolete inventory, Alpha has better control of its operating costs than the sector in general. Alpha’s superior performance is due to the fact that it makes its assets work twice as effectively as competitors. However, the high asset turnover figure may be misleading as Alpha’s non-current tangible assets appear quite old, (85% depreciated) and are likely to need replacing. Given the fact that Alpha is already high geared this may present problems for the future.
Liquidity Alpha’s liquidity is poor compared to the sector which is probably due to a high trade
payables and bank overdraft figure. The inventory turnover is also an issue, 54 days compared to 42 days, and could imply a need to write off further obsolete inventory.
Gearing Alpha’s gearing is more than twice that of the sector which may lead to difficulties when
seeking further finance to replace the old assets. However, shareholders are benefiting from this high gearing as a gearing up occurs due to the fact that overall return is 34.6% and loan notes only carry interest at 7%.
Investment ratios Dividend yield is poor and dividend cover is dangerously low. If performance does not
improve overall in the future it is likely that dividend payments may be cut which could lead to a reduction in share price.
Summary Alpha’s liquidity and gearing position gives cause for concern although its profitability
appears good. Alpha needs to deal with the issue of obsolete inventory and future financing of non-current tangible assets.
(c) Enterprises may use different accounting policies. For example, one enterprise may revalue its assets which will reduce the return on capital employed due to a higher depreciation charge and higher asset values. An enterprise may use different accounting practices, for example debt factoring or finance leasing. Many ratios use year-end balance sheet figures as a substitute for the average throughout the year. The year-end balance may not be indicative of the year. Individual ratios cannot be used in isolation. It is necessary to form a view of an enterprise's performance using several ratios.
FA0609 23
Q8 Cash flow statement for Spiral enterprise for the year ended 31 December 2008.
£000 £000 Net cash flow from operating activities (note 1) 800 Tax paid (40 + 88 - 64) (64) Interest paid (28) 708 ——— Net cash used in investing activities Payments to acquire tangible non-current assets (note 2) (528) Sale of non-current tangible assets 84 Interest received 12 Dividends received 40 (392) ——— Net cash used in financing activities Dividends paid (48) Issue of shares 52 4 ——— ——— Increase in cash balances 320 Opening cash (92 - 80) 12 ——— Closing cash balance (364 - 32) 332 ———
Note 1 Reconciliation of operating profit to net cash flow from operating Profit before interest and taxation 338 Depreciation 148 Impairment (60 - 54) 6 Profit on sale (8) 146 ——— ——— 484 Decrease in inventory 60 Increase on trade receivables (60) Increase in trade payables 316 316 ——— ——— 800 ———
Note 2 Tangible non-current assets 31.12.2007 784 Depreciation (148) ——— 636 Assets disposed of book value (76) ——— 560 Therefore purchased 528 ——— Balance 31 December 2008 1,088 ———
