Case Study – 150 Marks

Hash-Singh CC trading under Koo-lee Foods is a food manufacturing company based

in Julius Industrial Park situated in Rustenburg. The company was founded in 1942 by

the offspring of the Gani family who was sent as indentured labourers to South Africa.

The business was built with the vision on establishing the spirit of entrepreneurship for

the family to be firmly entrenched in the mainstream economy of South Africa.

Vision: To be the country’s most admired business in the providing of affordable food

products within South Africa.

Mission: To be the leading food manufacturer that provides affordable products that

contributes to the alleviation of poverty and food security within South Africa.

The business has grown and diversified under the leadership of 4 generations and is

now in a position to expand beyond being recognised as a family business. The CEO

(Hash Ali) and the MD (Sikh Singh) formulated a proposal to convert the business from

a close corporation into a private company. After extensive turbulent deliberations

amongst the family members the management team under the leadership on the grand

patriarch made the decision to register the new company under the name of Lekkerbek

Foods (Pty) Limited. The motivation for the proposal was that one of the senior

members of the close corporation has recently married a person from an indigenous

South African royal family from Rustenburg. The strategy for the proposal was to

provide 20 percent of the share capital to African blacks who have been working within

the family business for the last 50 years. The son of Hash Ali & Sikh Singh, who is the

accountant with a bookkeeping qualification, has recommended that 50 000 shares of

par value of R1 each be issued to the existing members of the close corporation at

premium of 50 cents per share. He also proposed that 10 000 ordinary shares be

issued at premium of R1 to a trust registered for the African Black employees. The

external Professional Accountants, Azma & Zuane Inc., informed the board that the

Companies Act 71 of 2008 no longer permits companies to have shares of par value

and thus recommended that the shares must be converted to share of no par value.

Mr. Rajah Singh, the Head of the Accounting Department, informed the shareholders

that they must implemented the recommendation of the Professional Accountants as

it means that they will get their money back for as the share capital must be reduced

to zero based on the principle of no par value shares.

Question:

(a) Discuss whether the interpretation and advice given by Mr. Rajah Singh

about the change to no par value shares is accurate and correct in terms of

the provisions of the Companies Act.

[5 marks]

Suggested solution:

The interpretation of Mr. Rajah Singh is incorrect because he lacks the

understanding of the concept of par and no par value shares. Par value shares

has a fixed/nominal value attached to the shares while no par value has no nominal

value. The type of shares affects the share capital value that should be reported

in the financial statements, viz. (i) par value shares will have a value equal to the

number of shares multiplied by its nominal and any amount paid by the investors

in excess of the nominal value is represented by the share premium, and (ii) no par

value shares will have a value equal to the amount received from the investors in

exchange for the shares. Irrespective of the type of shares, the share capital must

have a value based on the amount invested by the shareholders – represent the

capital invested by the shareholders. If the cash raised from an issue of shares is

returned to the shareholders, then it will represent a return of the capital invested

or the cancellation of the shares issued (similar to a share buy-back). Furthermore,

a company with no share capital cannot exist legally.

[5 marks]

(b) Record the journal entries to implement the recommendation of the

Professional Accountants to change the shares capital from par value to no

par value shares.

[4 marks]

Debit Credit

Bank 75,000

Share capital –no par value 75,000

[Issue of shares to the members of the CC]

Bank 20,000

Share capital – no par value 20,000

[Issue of shares to the Trust for employees]

[4 marks]

The business is one of the major employer in the area and its employees account for

approximately 40 percent of the work force in the Rustenburg area. The other

inhabitants are employed in occupation serving the mining economy of the region and

the informal sector such as road vendor and ‘spaza shops’. Hash Ali who regards

himself as a social entrepreneur expanded the business by concluding supply chain

management agreements and outsourcing support services to start-up and SME

businesses in the area as part of his transformation and growth strategy. Through this

strategy he has developed a business community social networking system. As a

result, all of the employees know each other socially; they know each other’s families

and their children go to school together.

The business model

The Accounting Department

The Head of the accounting department, Mr. Rajah Singh, is a self-made accountant

with a only a grade 9 school leaving certificate and 30 years experience as an

accountant in the business. Mr Rajah Singh receives his technical support on business

and financial reporting matters from his trusted high school teacher who has retired

some 10 years ago. The senior staff in the accounting is appointed based on sanguine

(blood) linage and generation hierarchy of the family tree. Often the development of

these appointments is under the tutelage and mentorship of Mr Rajah Singh. There

has been continued resistance from Mr. Rajah Singh to implement fully automated

accounting information system despite requests by the board to look at a more

integrated accounting solution that feeds into the business as whole.

Question:

(a) Discuss the potential financial reporting risks associated with the

employment of staff and the structure of the accounting department.

[6 marks]

Suggested solution:

The financial reporting risks caused by the structure of the accounting department:

Cause Risk

Appointment of family members to senior positions

Nepotism may cause friction and dissatisfaction in the department – low motivation and moral Senior members may not be competent to perform the duties as accountants – information risk in the financial statements Non-compliance to the accounting and reporting standards – negative effect on the reliability and faithful representation of financial information Non-adherence to deadlines which may results in business and financial

risks to the business – missed deadlines may result in penalties and fines

Resistance to the automation of the accounting system

Lack of accurate and reliable information for decision-making – incorrect and uninformed decisions made Timeliness of the availability and type of information and reports presented – not be aware of the risks of the business Limited access to information or information presented in silo/piece-meal format – management do not have a holistic view of the results of the business

[6 marks]

(b) Discuss the factors that must be taken into consideration when determining

whether the company requires a compilation, independent review or audit to

comply with the financial reporting requirements.

[5 marks]

Suggested solution:

The type of engagement required will depend on (i) the memorandum of

incorporation (MOI) and (ii) the public interest score. The principle factors that

affects the public interest score are:

Average number of employees for the year - a number of points that equal the

average number of employees during the financial year

Third party liability - one point for every R 1 million (or portion thereof) in third-

party liabilities at the financial year end

Revenue for the year - one point for every R 1 million (or portion thereof) in

turnover during the financial year

Beneficial interest - one point for every individual who, at the end of the

financial year, is known to directly or indirectly have a beneficial interest

[5 marks]

(c) Discuss whether the Professional Accountants provide “assurance” when

performing a compilation of financial statements as part of the Agreed upon

Engagement with their clients.

[3 marks]

Suggested solution:

“Implied” assurance is provided when performing a compilation engagement based

on the following:

Authority - the appointment of the professional accountant in in terms

Companies Act or the Close Corporations Act

Reasonable man’s test – the professional accountant is not protected by stated

that management is responsible for the drafting of the financial statements and

maintenance of the accounting records (reasonability tests must be applied to

assess the reliability of the financial statements)

Verification procedures – the financial information presented in the financial

statements must be verified using the procedures in terms of IRSS 4410

Assessment of the accounting policies – professional accountant must apply

professional judgement to determine if the accounting policies are appropriate

for the business

Compliance with accounting standards – professional accountant states that

the financial statements comply with the relevant accounting framework

[3 marks]

Manufacturing Operations

The manufacturing department uses marginal costing methods in determining the unit

costs of the products. The accounting department prepares the inventory records

using a costing method based on materials purchased and disregards manufacturing

overhead costs in the calculations. The following was an extract from the drafted

financial statements prepared by Mr. Rajah Singh:

“Accounting Policies: Inventory – inventory consists of raw materials, work-in-progress

and finished goods which are measured at the marginal costing method and cost

excluding production overheads using the Last-in-first-out method.”

Question:

(a) Provide a critique of the accounting policy for inventory included in the

financial statements by Mr. Rajah Singh in terms of the financial reporting

standards.

[4 marks]

Suggested solution:

The accounting policy for inventory has the following deficiencies:

Inventory cannot be measured using marginal costing – full absorption costing

must be used to reflect the asset at its aggregate cost

Inventory cannot be valued using the LIFO method of accounting – LIFO is not

an acceptable method in terms of the accounting standards

Inventory must be tested for impairment – inventory must be valued at the

lower of cost or net realisable value

[4 marks]

(b) Discuss the principle differences between the marginal costing and

absorption costing methods of valuing inventory in a manufacturing

business.

[4 marks]

Absorption costing Marginal costing

Cost takes into consideration both variable and fixed production costs

Cost takes into consideration variable production costs only

Fixed production costs are allocated to product cost using the overhead absorption rate

Fixed production costs are treated as period costs or expenses

Under or over absorbed costs are recognised as expenses/income via profit & loss

Not applicable

[4 marks]

(c) Discuss the impact of using the marginal costing method of valuing

inventory on the financial performance and financial position of the

business.

[3 marks]

Suggested solution:

The effect of applying marginal costing for the valuation of inventory has the

following effects on:

Financial performance: the cost of goods sold is understated (only based on

variable costs) while the expenses are overstated (fixed production costs are

expenses); the net effect is on the profit (generally profit is understated as a

results of the fixed production costs not being deferred as part of the cost of

inventory).

Financial position: the cost of inventory is understated as a results of the fixed

production costs being expensed – cost per unit is understated by the

overhead absorption rate.

[3 marks]

The industry has become hyper competitive. In order for the company in this sector to survive, the professional accountant has to assist management to develop strategies that focus on customer requirements, competitor reaction and cost management. A feature of this industry is the need for continuous innovation and improvement. Jo-Jo Mahlungu, the production manager at Lekkerbek Foods (Pty) Limited called in the Professional Accountant for assistance and advice – Agreed upon Engagement. He had just finished reviewing the report issued by Azma & Zuane that listed the financial benefits of implementing a combined JIT/TQM system. The cost/benefit report that reviewed this initiative was as follows:

First Year after implementation

2015

Subsequent Years 2016

onwards

Annual Expected Benefits Savings in inventory holding costs Reduction in Set-up cost Reduction in costs of waste and rework Increased revenue from customers as a result faster response time Cost of implementing JIT Increased Prevention and appraisal quality costs Increased cost of components

R

290000 110000 200000 180000

950000 55000

10% 5%

R

350000 150000 250000 300000

450000 45000

10% 10%

Decrease in components used**

**The annual volume of components purchased before the introduction of the JIT/TQM system includes the following components at the original price negotiated before the introduction of the new systems.

Component Quantity Price per component

A B C D

50000 100000 55000 70000

R3 R2 R1 R4

Jo-Jo Mahlangu has been planning the implantation of the JIT system for nearly a year now and feels some of the expectations of the proposed JIT/TQM system are not correct. For example, he cannot understand why the cost of materials should go up. In this regard, he feels that the company is using exactly the same suppliers so there is no logical reason for an increase in materials costs. Similarly, he cannot understand why there should be an increase in prevention and appraisal costs. He also feels that it is unfair that his performance evaluation for 2015 could be unfairly evaluated. Question: (a) For each component , calculate the expected costs of the extra materials to

be utilized [8 Marks]

Suggested solution:

A A B B C C D D

2015 2015 2015 2015 2015 2015 2015 2015

R3.00 R3.30 R 2.00 R 2.20 R 1.00 R 1.10 R 4.00 R 4.40

50000 47500 100000 95000 55000 52250 70000 66500

R 150000

R 156750 R 200000

R 209000

R 55000

R 57470

R 280000

R 292600

(6750) 1 mark

(9000) 1 mark

(2470) 1 mark

(12600 1 mark

2016 2016 2016 2016 2016 2016 2016 2016

R 3.00 R 3.30 R 2.00 R 2.20 R 1.00 R 1.10 R 4.00 R 4.40

50000 45000 100000 90000 55000 49500 70000 63000

R 150000

R 148750

R 200000

R 198000

R 55000

R 54450

R 280000

R 277200

1500 1mark

2000 1 mark

550 1 mark

2800 1 mark

*2015 : Extra Cost of material = R 6750 + R 9000 + R 2470 + R 12600 = R 30820 = R 31000 rounded off *2016: Savings for material = R 1500 + R 2000 + R 550 + R 2800 = R 6850 = R 7000 rounded off

[8 marks]

(b) Calculate the total savings and expected additional costs to be derived and incurred from introducing the JIT and TQM systems in 2015 and 2016.

[18Marks]

Suggested solution:

Costs and Revenues of JIT/TQM 2015 R

2016 R

MARKS

Savings Inventories Set-up Rework Increased Revenue Materials Costs* Total Savings

290000 110000 200000 180000 ZERO

780000

350000 150000 250000 300000 7000*

1057000

2 2 2 2 1 2

Costs Extra costs of JIT/TQM Prevention and appraisal Material Costs*

950000 55000 31000*

450000 45000

2 2

Net (Cost)/Benefit (256000) 562000 2 1 layout

[18 marks]

(c) Explain to Mr Mahlangu why the cost of materials will increase with the introduction of the JIT and TQM systems.

[2 Marks] Suggested solution: The net impact is that financial performance will deteriorate by R 256 000 in 2015 but will improve by R 562 000 in subsequent years.

[2 marks]

(d) Prepare a report to be issued to Lekkerbek Foods (Pty) Ltd discussing the net impact of the proposal to implement the JIT and TQM system as well as the impact on the company’s cost structure as a result of the introduction of both a JIT system, as well as a TQM system.

[8 Marks]

Suggested solution: It can be expected that initial impact of introducing JIT/TQM will increase cost because the company must still learn about the new system Furthermore once of capital costs are unlikely to be repeated in subsequent years As time goes by firm will benefit from experience curve and cycle times and efficiencies will improve It should be expected that material costs go up as suppliers will be asked to deliver in smaller quantities as well as guarantee quality for the new JIT system

Savings will be realized from more efficient use of material, better resource utilization, lower inventory levels, lower cycle times It can be expected that the costs of quality will increase with respect to prevention and appraisal costs However, these costs will be more than offset as a result of reduced internal and external failure Furthermore, better quality will reduce customer returns, complaints and they will purchase more

[8 marks]

The following information was extracted from the fixed asset register and appended

notes for the reporting period:

1. 90% of a warehouse with a cost of R 1,2 million and a fair value of R 1,56 million

was leased to tenants in the area and the remaining section was used by the

company for the storage of goods returned by customers. Ms. Garuneesa Radebe-

Ali the Senior Manager for Inventory Management recommended that 70% of the

warehouse be used by the company as a centralized distribution point in order to

mitigate the current risks and improve control over logistics. The board agreed to

implement the recommended and appointed attorneys to terminate the lease

agreements with some of the tenants. The total costs incurred to implement the

recommendations amounted to R 68,400 (inclusive of VAT) and R 230,000 for legal

fees and penalties for cancellation of the lease agreements respectively. At the

date the company took occupation of the warehouse its fair value was R 1,75

million.

Question:

(a) Discuss how the legal costs and penalties paid by the company to implement

the recommendation to occupy the warehouse should be treated for income

tax and VAT purposes.

[5 marks]

Suggested solution:

Legal Costs and Penalties - VAT and Income Tax implications Marks

VAT Implications

- The legal costs and the penalties are payments for services supplied by registered VAT vendors to Lekkerbek Foods, who is a registered VAT vendor for the purpose of making taxable supplies.

1

- VAT is accounted for on the earlier of invoice or payment. 1

- Therefore, Lekkerbek will claim an input tax of (R262 200 R68 400 +) x 14/114 = R40 600 in VAT tax period of ending January 2016

1,1

Income Tax Implications

- The penalties for cancellation of the lease agreements and the legal fees are incurred in the production of income and not of capital nature therefore (R262 200 + R68 400) x 100114= R290 000 will be allowed as deduction in the financial year of assessment ended 29 February 2016.

1,1 1

Available 7

Maximum 6

(b) Discuss how the implementation of the recommendation affects the

recognition and measure of the warehouse in the financial statements in

compliance with the financial reporting standards.

[6 marks]

Suggested solution:

The warehouse was previously classified as Investment Property as the major part

of the property was used to generate rental income. The recommendation of

management will result in the warehouse being used primarily by the business

resulting it to meet the definition of Property, Plant & Equipment. The change in

use will results in the re-classification of the warehouse as follows:

Investment Property – must be valued using the fair value method and any

gain or loss must be recognized via Profit & Loss. Before re-classification the

warehouse should be valued at its fair value of R 1.75 million resulting in a gain

of R 0.19 million which must be accounted for as a fair value gain in the Profit

& Loss.

Property, Plant & Equipment – the cost of the warehouse on re-classification

must be measured at its fair value of R 1.75 million. The warehouse must be

measured using the cost model, which implies that it should be depreciated at

an appropriate rate over its estimated useful life.

Expenses incurred – the expenses incurred to implement the recommendation

must be recognized as an expense and cannot be capitalized as part of the

cost of the warehouse.

[6 marks]

(c) Record the journal entries to implement the decision of the boards relating

to the warehouse in compliance with the financial reporting standards.

[5 marks]

Suggested solution:

Debit Credit

Property, Plant & Equipment 1,750,000

Investment Property 1,560,000

Fair value gain (P & L) 190,000

[Re-classification of warehouse]

Lease cancellation costs 230,000

Operating expenses 60,000

Input VAT control 8,400

Bank 298,400

[Expenses incurred to implement the decision]

[5 marks]

2. During September 2015 a delivery vehicle with a cost of R 340,000 and a carrying

amount at the date of the accident of R 90,000 was involved in an accident. The

insurance valuation regarded the vehicle to be irreparable and that a net amount

of R 270,000 (after deducting the purchase of the company at a price of R 60,000)

would be paid in respect of the claim. The company sold the damaged vehicle to

a “cut-shop” at a price of R 165,000. The vehicle was depreciated at the same rate

as the wear and tear allowance for income tax purposes.

Question:

(a) Discuss the tax implications (VAT and income tax) of the transactions

relating to the vehicle involved in the accident including its disposal in

compliance with the provisions of the Tax Acts.

[7 marks]

Suggested solution:

Income Tax Effects – Delivery Vehicle Note Calculation Marks

R

Taxable Income 12 500 000

Add – Recoupment 1 12 916

Wear and tear – Old delivery vehicle 2 ( 42 500)

Wear and tear – New delivery vehicle 3 ( 35 625)

Taxable income after adjustments 12 434 791 1

Notes

1. Recoupment

Old Delivery Vehicle

Cost Price as at 1 August 2012 340 000 1

s11(e) – Wear and Tear R340 000 /4 x 7/12

(49 583) 0.5

28 February 2013 290 417

s11(e) – Wear and Tear R340 000 /4 (85 000) 0.5

28 February 2014 205 417

s11(e) – Wear and Tear R340 000 /4 (85 000) 0.5

28 February 2015 120 417

s11(e) – Wear and Tear R340 000 /4 x 6/12

(42 500) 0.5

31 August 2015 77 917

Selling Price (R140 000 +(R62 700 x 100/114) 195 000 1,1

Tax Value (77 917) 1P

Recoupment 117 083

Proceeds (R195 000 – R117 083) 77 917 1P

Base Cost (R340 000 – R262 083) 77 917 1P

Capital Gain/Loss 0

As this is asset is replaced, para 65 of the Eight Schedule is applicable.

New Delivery Vehicle

s11(e) – Wear and Tear R342 000 /4 x 5/12

35 625 1

Deferred Recoupment

R117 083 x R35 625/R342 000 12 196 0.5P, 0.5P, 0.5P

Available 11.5

Maximum 11

(b) Record the journal entries to recognize the transactions, destruction and

disposal of the vehicle in compliance with the financial reporting standards.

[6 marks]

Suggested solution:

Debit Credit

Accumulated depreciation 250,000

Bank (insurance claim) 330,000

Profit on disposal of asset 199,474

Output Vat control 40,526

Motor vehicle (cost) 340.000

[Recognizing the insurance claim on vehicle destroyed]

Motor vehicle 52,632

Input VAT control 7,368

Bank 60,000

[Acquisition of vehicle destroyed]

Bank 165,000

Profit on disposal of asset 92,105

Output VAT control 20,263

Motor vehicle 52,632

[Disposal of vehicle as scrap]

[6 marks]

3. At 01 March 2015 (the beginning of the current reporting period) the board decided

that certain machinery used in the production process with a historical cost and

carrying amount of R 1,740,000 and R 1,015,000 should be revalued. The gross

replacement cost was estimated to be R 2,400,000 and the estimated useful life

and residual values were considered to be 10 years and R 180,000 respectively.

The machinery was depreciated on a straight-line basis to reduce the carrying

amount to its residual value of zero over an estimated useful life of 6 years.

Question:

(a) Discuss the difference, if any, between the revaluation and fair value

methods of measuring the carrying amounts of assets in the financial

statements.

[4 marks]

Suggested solution:

Fair value Revaluation

Fair value method measures the assets to reflect them at the market value

Revaluation method is the restatement of the historical cost of the asset to a market value which reflects the future economic benefits

Assumption is that the fair value represents the future economic benefits under the prevailing economic conditions

Assumption is that the market value represents the true value of the future economic benefits embedded in the asset

Any impairment of the asset is incorporated into the fair value of the asset

Impairment is recognized separately from the revaluation adjustment

Fair value adjustment is recognized via the Profit & Loss

Revaluation adjustment is recognized via Other Comprehensive Income

[4 marks]

(b) Record the journal entries to implement the revaluation of the machinery for

the reporting period ended 28 February 2016 in compliance with the financial

reporting standards.

[10 marks]

Suggested solution:

Cost Revalued Surplus

Cost 1 740 000 2 400 000 660 000

Accumulated depreciation 725 000 555 000 170 000

Carrying amount 1 015 000 1 845 000 830 000

Depreciation 111 333 222 000 Carrying amount 903 667 1 623 000

Cost 1 740 000 2 400 000 660 000

Accumulated depreciation 725 000 1 000 000 -275 000

Carrying amount 1 015 000 1 400 000 385 000

Depreciation 111 333 222 000 Carrying amount 903 667 1 178 000

Debit Credit

Machinery (cost) 660 000 Accumulated depreciation 275 000

Revaluation surplus (OCI) 385 000

[Revaluation of machinery] Depreciation expense 222 000 Accumulated depreciation 222 000

[Depreciation for the period] [10 marks]

(c) Advise the board how the revaluation surplus should be treated over the

remaining useful life of the machinery in the financial statements to comply

with the financial reporting standards.

[3 marks]

Suggested solution:

Subsequently recognition of the revaluation surplus:

amortised over the remaining useful life of the machinery – result in the

effectively reducing the depreciation expense to that based the historical cost

transfer the surplus to retained earnings when the assets is sold or de-

recognised

[3 marks]

All members of the board were given the right of taking goods for personal and

household consumption at a maximum cost of R 9,000 per month – this was not

included in the remuneration package as it was the family tradition and business

practice. Any goods taken in excess of the stipulated maximum amount was claimed

from their salaries. Furthermore, the members of the board were granted free use of

the company’s vehicles (registered in the name of the company but the members had

exclusive use of the vehicles). The cost of running and maintaining the vehicles were

the responsibilities of the members except for the senior members who were the

immediate children of the founding father.

Question:

(a) Discuss the tax implications (VAT and income tax) relating to the goods

taken by the members for:

(i) the company, and

(ii) the members of the board.

[9 marks]

(b) Discuss the tax implications (VAT and income tax) relating to the use of the

company’s vehicles granted members for:

(i) the company, and

(ii) the members of the board.

[11 marks]

The Professional Accounts of the company presented the following schedule to the

board as part of their value added service to their clients:

The Professional Accounts of the company presented the following schedule to the

board as part of their value added service to their clients:

2016 2015

Inventory 180 000 160 000

Accounts receivables 210 500 175 800

Cash and cash equivalent 58 000 55 400

Sales 1 500000 900000

Cost of Sales 860 000 540 000

Trade payables 234 500 260 000

Short term loan 200 000 150 000

Insurance payable 2 500 3 800

Dividends payable 55 000 77 000

*2014 the value of the inventory was 130 0000

Mr. Rajah Singh, commented that the ratios means nothing as it tries to present

information in a generic format which does not tell the real story as the monetary

values which reflect the true results and value of the business are hidden.

Furthermore, he claims that the family business has survived the test of time by looking

at the numbers (monetary amounts) in order to understand the performance and value

of the business – he commented “our forefathers did it that ways and today we are

enjoying the fruits of their wisdom; so why try to change”.

Question:

(a) Comment on the statement and opinion made by Mr. Rajah Singh about the

use of ratios in the context of understanding the performance and value of

the company.

[4 marks]

Suggested solution:

The comment made by Mr. Rajah Singh focuses on the limitation of ratios:

Nature and structure of the organization cannot be explained by the numbers

Benchmarking (average/moderate) does not reflect the goals of the organization

Financial information may not reflect the “true” value – inflationary conditions

versus historical cost

Seasonal fluctuations may distort the average results used in ratios

Historical results versus market results – distortion in comparison

Estimations, professional judge and the off-balance sheet reporting may distort

comparisons

Accounting policies and practices differ from organisations

Generalisation about the computation and interpretation of ratios

Indepenedent view and interpretation of ratios may not provide a holistic view

[4 marks]

(b) Comment on the following ratios of the company over the past three years

and provide the board with advice about the liquidity of the company.

1.1. Average inventory holding period

1.2. settlement period from receivables

1.3. settlement period for payable

[20 marks]

Suggested solution:

1.1 Average Inventory holding period :2016 = (180 000+160 000)/2 X 365 860 000

= 72 days

:2015 = (160 000+130 000)/2 X 365 540000 =98 days 1.2 settlement period from receivables 2016 = 210 500 X 365

1500 000×65%

= 79 days

2015 = 175 800 X 365

900 000*65%

=110 days

1.3 settlement period for payables 2016 = 234 500 X 365 (860 000+180 000-160 000

= 97 days

2015 = 260 000 X 365

(540 000+160 000-130 000)

= 167 days

2015 has a longer inventory holding period

This may indicate that lower demand 2015’s goods due to inefficient advertising

2015 take longer days to collect its debts

This may indicate power credit policy

Even though management tend to delay payments to suppliers that can damage their relationship

2015 have too many days to pay as compared to 2016.

Based on the above discussion 2016 is more efficient that than 2015.

Since the client want to invest in a most efficient entity, He should invest with 2016

[20 marks]

(c) Why might a company use various sources of finance?

[4 Marks]

Suggested solution:

Sources of funds can be internal or external. Internal sources sources the company

has control over compared with external funding. There is the time period for

borrowing and charges made that have to be taken into consideration. Expenditure

can be for revenue or capital expenditure. Capital expenditure is on goods which

can be used over a long time period such as machines and can be financed over

a long time period. Revenue expenditure is spent on items such as raw materials

or labour. This will be consumed quickly. Trade credit is a source of funds used to

purchase raw materials.

[4 marks]

(d) Using examples, explain why it is important that potential investors should

consider non-financial factors before making their investment decision

[4 marks]

Suggested solution:

Examples other than financial help to give a fuller picture of the likely future

performance of the company. For example it is important to look at the previous

performance of the company to identify trends and compare them with what is

happening in the market place. For example if company sales are increasing in a

shrinking market, this should send alarm bells to a potential investor. Why is the

market shrinking? The state of the economy might indicate the timing of

investment, for example: is the economy entering a downturn or is the economy

enjoying a boom?

[4 marks]