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					  THE INSTITUTE OF CHARTERED ACCOUNTANTS
                 OF NIGERIA




NOVEMBER 2010 PROFESSIONAL EXAMINATION II



               Question Papers

             Suggested Solutions

                     Plus

              Examiners‟ Reports
                                PATHFINDER


                                   FOREWORD
This issue of the PATHFINDER is published principally, in response to a growing
demand for an aid to:

(i)     Candidates preparing to write future examinations of the Institute of Chartered
        Accountants of Nigeria (ICAN);

(ii)    Unsuccessful candidates in the identification of those areas in which they lost
        marks and need to improve their knowledge and presentation;

(iii)   Lecturers and students interested in acquisition of knowledge in the relevant
        subjects contained herein; and

(iv)    The profession; in improving pre-examinations and screening processes, and
        thus the professional performance of candidates.

The answers provided in this publication do not exhaust all possible alternative
approaches to solving these questions. Efforts had been made to use the methods,
which will save much of the scarce examination time. Also, in order to facilitate
teaching, questions may be altered slightly so that some principles or application of
them may be more clearly demonstrated.

It is hoped that the suggested answers will prove to be of tremendous assistance to
students and those who assist them in their preparations for the Institute‟s
Examinations.


                                  NOTES

              Although these suggested solutions have been published
              under the Institute‟s name, they do not represent the views of
              the Council of the Institute. The suggested solutions are
              entirely the responsibility of their authors and the Institute
              will not enter into any correspondence on them.



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         PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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                         TABLE OF CONTENTS



SUBJECT                                         PAGES


FINANCIAL REPORTING AND ETHICS                    4 – 27


STRATEGIC FINANCIAL MANAGEMENT                   28 – 59


ADVANCED TAXATION                                59 – 90


PUBLIC SECTOR ACCOUNING & FINANCE                60 - 91


MULTI-DISPINARY CASE STUDY                      92 - 178




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          PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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ICAN/102/Q/2                                               EXAMINATION NO...................................
               THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA
                  PROFESSIONAL EXAMINATION II – NOVEMBER 2010
                         FINANCIAL REPORTING AND ETHICS
SECTION A: Attempt All Questions
PART I           MULTIPLE- CHOICE QUESTIONS                (20 MARKS)
1.       Which of the following options is excluded from the class of rational agents, and
         hence cannot be subjected to moral judgement?

         (i)     Moral minors
         (ii)    The insane
         (iii)   The senile

         A.      (i) and (ii) only
         B.      (ii) and (iii) only
         C.      (i) and (iii) only
         D.      (ii) only
         E.      (i), (ii) and (iii)

2.       An action is good if only it promotes happiness for the greatest number of
         people. This is an example of which ONE of these ethical theories?

         A.      Contractarianism
         B.      Utilitarianism
         C.      Majoritarian Morality
         D.      Ethical Considerationism
         E.      Sympathetic Morality

3.       Government grants available to an enterprise are considered for inclusion in the
         accounts

         A.      if the grant is not a financing device.
         B.      if it is to enable the government participate in the ownership.
         C.      if the grant is recognised as government assistance to the organization.
         D.      where there is reasonable assurance that the enterprise will comply with
                 the conditions attached to them.
         E.      where contingency related to a government grant is recognised.

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              PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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4.   The amount of contract revenue may increase or decrease from one period to
     the next in all of the following, EXCEPT

     A.      a contractor and a customer may agree variations of claims in the period
             subsequent to that which the contract was initially agreed.
     B.      the amount of revenue agreed in a fixed price contract may increase as a
             result of cost escalation clauses.
     C.      the amount of contract revenue may decrease as a result of penalties
             arising from delay caused by the contractor.
     D.      when a fixed price contract involves a fixed price per unit of output,
             contractor revenue increases as the number of units is increased.
     E.      negotiations have reached an advanced stage such that the customer will
             accept the claim.

5.   Undisclosed assets revaluation surplus in the Financial Statements of a
     company is known as

     A.      revaluation reserve.
     B.      capital reserve.
     C.      secret/hidden reserve.
     D.      asset revaluation reserve.
     E.      contingency reserve.

6.   All the following are forms of business combinations, EXCEPT

     A.      merger.
     B.      acquisition.
     C.      amalgamation.
     D.      absorption.
     E.      joint Venture.




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          PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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7.    The theory that holds that it is morally acceptable for one to do what one feels
      is in one‟s self-interest, is an example of which of these moral theories?

      A.    Selfish Immorality
      B.    Humanistic Morality

      C.    Ethical Egoism
      D.    Ethical Altruism
      E.    Unethical Egoism

8.    The claim that there is only one correct moral code or system of moral principle
      which supplies the single correct answer to every moral question, is attributed
      to which of these?

      A.    Moral Subjectivism
      B.    Moral Objectivism
      C.    Moral Totality
      D.    Moral Globalization
      E.    Moral Uniqueness

9.    The statement that there is no such thing as correct or incorrect moral code for
      human conduct, is ascribed to which of these?

      A.    Moral Relativism
      B.    Moral Universalism
      C.    Moral Non-Wrongness
      D.    Moral Nihilism
      E.    Moral Incorrigibility

10.   Which of these moral theories that holds that human nature determines the
      correct moral laws of nature that human beings should follow?

      A.    Moral Fellowship
      B.    Natural Morality
      C.    Natural Law Theory
      D.    Natural Egoism
      E.    Ethical Naturalism




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       PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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11.   The following statements are true of a parent company, EXCEPT

      A.      the financial statements of a group are presented as those of a single
              economic entity.

      B.      control is the power to govern the financial and operating policies of an
              entity so as to obtain benefits from its activities.

      C.      a group is a parent and all its subsidiaries.

      D.      non-controlling interest is the equity in a subsidiary not attributable
              directly or indirectly to a parent.

      E.      a parent is an entity that must have at least three subsidiaries.

12.   The following are the generally recognised potential problems of using ratios
      for comparison purposes, EXCEPT

      A.       inconsistent definition of ratios.
      B.       financial statements that have been deliberately manipulated.
      C.      different companies may adopt different accounting policies.
      D.      different managerial policies e.g. different companies offer customers
              different payment terms.
      E.      profit for the year may result in higher cash flow.

13.   Potential users of financial reports do NOT include ONE of the following:

      A.      Equity investors
      B.      Educationists
      C.      Creditors
      D.      Suppliers
      E.      Employees

14.   In using the accounting ratios, comparison is commonly made between all BUT
      ONE of the following:

      A.      Previous accounting periods
      B.      Other companies (mostly in the same type of business)
      C.      Budget and expectations


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           PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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      D.      Government statistics
      E.      Emolument of the chief executive

15.   The integration of social and ethical criteria into investors‟ investment decision
      is known as

      A.      ethical Investing.
      B.      social Investing.
      C.      moral Investing.
      D.      socio-ethical Investing.
      E.      socio-moral Investing.

16.   The use of ethical, social and environmental criteria in the selection and
      management of investment, generally consisting of company shares is known as

      A.      ethical investment.
      B.      social investment.
      C.      moral investment.
      D.      socio-ethical investment.
      E.      socio-moral investment.

17.   One of the fundamental precepts of Corporate Social Responsibility which
      requires business leaders to acknowledge and accept the legitimate claims,
      rights and needs of other groups in society is known as

      A.      Voluntary Social Responsibility.
      B.      Involuntary Social Responsibility.
      C.      Unlimited Social Responsibility.
      D.      Limited Social Responsibility.
      E.      Liberal Social Responsibility.




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           PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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18.   The basic principles of a good corporate governance system include:

        i.    Transparency
       ii.    Competence
      iii.    Integrity
      iv.     Proper alignment of interests and allocation of responsibilities

      A.      i and iv only
      B.      ii and iii only
      C.      i, ii and iii only
      D.      i, ii, iii and iv
      E.      ii, iii and iv only

19.   The framework for ethical decision making that is useful for exploring ethical
      dilemmas and identifying ethical courses of action does NOT include ONE of the
      following:

      A.      Recognition of an ethical issue
      B.      Evaluation of alternative actions
      C.      Making a decision and testing it
      D.      Acting and reflecting on the outcome
      E.      Engaging a professional person for consultation

20.   Which of the following is ordinarily computed and reported as part of the
      financial statements of a large organisation?

      A.      Current ratio
      B.      Return on assets
      C.      Book value per share
      D.      Earnings per share
      E.      Price earnings ratio




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           PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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PART II        SHORT-ANSWER QUESTIONS                            (20 MARKS)

 1.    Responsibility is divided into Retrospective Responsibility and ………..
       Responsibility.
 2.    The action that purports to benefit others primarily without any form of egoism
       is ……………...
 3.    A risk management technique that mixes a wide variety of investments within a
        portfolio is called ..........................
 4.    The duration between the purchase of a firm‟s inventory and the collection of
       account receivable for a sale of that inventory is known as .........................
5.     Kabir Ventures Ltd. had sales last year of N530 million including cash sales of
       N50 million. If its average collection period was 40 days, its ending account
       receivable is closest to ..............................
 6.    A scheme approved by the court in which the nominal value of a company‟s
        paid up share capital is reduced is termed ......................
 7.    The process through which a person learns the values and behaviour patterns
       considered appropriate by an organisation or group is called …....…………..
 8.    The Utilitarian theory of justice ties the question of economic distribution to the
       promotion of ………......……

9.     An approach to Business Ethics that attempts to change economic concepts with
       the aim of facilitating moral action is termed ....…………….
 10.   The Libertarian associates justice with ........………….
 11.   Payments made to a parent company by a subsidiary out of pre-acquisition
       profits are known as ...........................
 12.   The Institute of Chartered Accountants of Nigeria (ICAN) requires that its
       members who are in Public Practice take up insurance policy with reputable
       insurance companies. What is the name of the insurance policy required?
 13.   A component of an entity that engages in business activities from which it may
       earn revenue and incur expenses is described by IFRS 8 as ..........................



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         PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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14.   The organisation which is empowered by law to incorporate, register and wind-
      up companies in Nigeria is called ....................................
15.    Two features of a business entity are .......................... and .................................
16.   The standards of behaviour that groups expect of their members is referred to as
      ................................
17.   Ethics must be promoted and institutionalized in an organization in order to
      build credibility and ...............................
18.   The ethical challenge in companies is often triggered by .............................
19.   A method of accounting whereby an interest in a jointly controlled entity is
      initially recorded at cost and adjusted thereafter for the post-acquisition change
      in the venture‟s share of net assets of the jointly controlled entity is called
      ..........
20.   The bringing together of separate entities or businesses into one operating
      entity is called ...............................




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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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SECTION B – ATTEMPT QUESTION ONE AND ANY OTHER THREE                      (60 MARKS)

QUESTION 1 –CASE STUDY

Topic: Variance Reporting
Characters: Olabisi, Director of Manufacturing and Computer Services
            Tunde, Manager, Manufacturing Department 207
            Bose, Supervisor, Manufacturing Department 201

Olabisi has been with Peace Auto Parts Manufacturing Company for 23 years. Recently,
he was appointed Director of Manufacturing and Computer Services. In just six weeks
in this new position, he has moved to reduce the amount of information provided to
manufacturing department managers by 60 percent. He argues that excess data is
distracting, expensive to provide and usually unused.

Tunde has been the Department Manager for 12 years. During a coffee break with
some of his department production supervisors, Tunde is quite vocal about the change.
“Who‟s this guy Olabisi to tell us what data we need? He needs to be out here for a few
weeks to find out what it‟s like. Keep it quiet, but I‟ve got a contact in Computer
Services who‟ll get me all the data analysis I want for just a N3,000 bill each month.
It‟s a good deal, and Olabisi will never know. How does he expect us to make good
decisions about those variances without enough data? This guy in Computer Services
can get any of you data, if you need it.”

Bose, overhearing Tunde, is shocked. “Is that ethical, Tunde? Do you really need that
extra data? Can‟t you get the information without going around Olabisi? I sure don‟t
want to pay for anything Mr. Olabisi doesn‟t want me to have.”

“Bose , you've only been a supervisor for six months,” Tunde replies. “It‟s just how the
firm operates. Try it, and you'll see it‟s worth the N3,000. You can't make good
decisions with the stuff Olabisi gives us now.” Bose doesn't respond, and the coffee
break ends with people returning to their jobs.

Later that evening, Bose begins to think about what Tunde said. She knows that he is a
good manager, but she does not want to have to buy information to do her job
correctly. Tomorrow, she is scheduled for a staff meeting with Mr. Olabisi. She is
uncertain about what to do or say, if anything.




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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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Required
   (a) What are the relevant facts?                                            (3 marks)
   (b) What are the ethical issues?                                            (2 marks)
   (c) Applying the Kant‟s Categorical Imperative, advise Bose on the
       action(s) she should take.                                             (10 marks)
                                                                        (Total 15 marks)
QUESTION 2

 a)   Explain briefly Ethical Issues in business.                             (5 marks)

 b)   State TWO examples each of ethical issues relating to the following areas:

         i.   Society
        ii.   Internal and industry practice
       iii.   Marketing
       iv.    Product
        v.    Supply chain                                                    (10 marks)
                                                                        (Total 15 marks)

QUESTION 3

a) Explain the term “conflict of interest”.                                    (7 marks)

b) Situate conflict of interest within the accounting profession, especially as an
   external auditor to a firm                                             (8 marks)
                                                                   (Total 15 marks)

QUESTION 4

Why should an accountant get involved in the study of ethics, given that all human
beings, including accountants, have moral beliefs they follow?         .. (15 Marks)




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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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QUESTION 5

a) State the meaning of the following terms as contained in IAS 27 - Consolidated and
   Separate Financial Statements:
       i.     Consolidated Financial Statements
      ii.     Subsidiary
     iii.     Non controlling interest
     iv.      Control                                                  (6 Marks)

   b) Explain briefly THREE of the disclosure requirements in Consolidated Financial
      Statements.                                                   (9 marks)
                                                               (Total 15 Marks)

QUESTION 6

Identify and explain FIVE potential users of financial reports and their information
needs                                                           (Total 15 marks)




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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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SECTION A

PART I:         SOLUTIONS TO MULTIPLE CHOICE QUESTIONS

   1.       E
   2.       B
   3.       D
   4.       E
   5.       C
   6.       E
   7.       C
   8.       B
   9.       D
   10.      C
   11.      E
   12.      E
   13.      B
   14.      E
   15.      A
   16.      B
   17.      A
   18.      D
   19.      E
   20.      D

EXAMINERS‟ REPORT

The questions test various aspects of the syllabus. The candidates demonstrated clear
understanding of them. This translated into good performance by most candidates.

PART II:    SOLUTIONS TO SHORT ANSWER QUESTIONS

   1.       Prospective
   2.       Altruism
   3.       Diversification
   4.       Cash conversion cycle or Cash operating cycle
   5.       N52.6million or N53million {(40/365 x (530-50) million}
   6.       Capital reduction

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           PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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      7.           Socialization or Societalisation
      8.           Social Well-being/Happiness
      9.           Prescriptive or Normative

      10.          Liberty or Individual right or Entitlement
      11.          Pre-acquisition dividends
      12.          Professional Indemnity Insurance Policy
      13.          Operating segment or Reportable segment
      14.          Corporate Affairs Commission (CAC)
      15.          Legal status, Ownership of assets and Profit oriented   (any two)
      16.          Group norms or Code of Conduct or Professional Ethics
      17.          Public trust/Confidence
      18.          Financial problems
      19.          Equity method
      20.          Business combination.

EXAMINERS‟ REPORT

The questions test most areas of the syllabus with particular emphasis on effective use
of terminologies in Ethics.

The performance of candidates was fair. Candidates are advised to make use of their
Study Packs and recommended texts on the subject to improve on their performance in
future.

SOLUTIONS TO SECTION B

QUESTION 1 – CASE STUDY

(a)         Relevant facts about the Case:

            (i)       Olabisi has reduced the amount of data on Reports sent to departments.
            (ii)      Tunde secretly buys data from someone in the Computer Services
                      Department to supplement the variance report he receives.
            (iii)     Bose knows of Tunde practice of buying data, thinks it is unethical, but
                      does not know what to do about it.
            (iv)      Olabisi, the Director of Manufacturing and Computer Services is a long
                      standing employee of the organisation for the past 23 years.



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              PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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      (v)    Olabisi was recently appointed as the Director of Manufacturing and
             Computer Services.
      (vi) He has moved to reduce the amount of information provided to Managers
             by 60%.
      (vii) Tunde has been the Departmental Manager of the Organisation for 12
             years, and he advised Bose to obtain information at a cost.
      (viii) Bose is the Supervisor, Manufacturing Department, and she is in a
             dilemma as to whether she should yield to Tunde‟s advice or not.

(b)   Ethical Issues Involved:
      (i)    Should Tunde buy data for his use in managing his Department?
      (ii)   Should Bose tell Olabisi (or any one else) what Tunde is doing?
      (iii) Should Bose use the data source in Computer Services?
      (iv) The appropriateness of disobeying a superior officer‟s instruction.
      (v)    The superior‟s intention of obtaining the information without cost from
             undisclosed source.

(c)   Emmanuel Kant made a major contribution to Ethics of duty. For him, the moral
      values of actions, decisions and propositions are not dependent on a particular
      situation or on the consequences of the action. Rather, morality was simply a
      question of certain eternal, abstract and unchangeable principles that humans
      should apply to all ethical problems.
      To be moral, therefore, one must consciously act according to rules previously
      calculated by „reason‟ to be right or just, and the motive for observing those
      rules must be respected for duty alone. He, however, articulated the categorical
      imperative as a theoretical framework to guide our commitment to duty. By this
      he meant that this theoretical framework should be applied to every moral issue
      regardless of who is involved, profits and who is harmed by the principles once
      applied in specific situations.

      The „categorical imperative‟ consists mainly of three formulations. We would
      make use of the first two formulations in this case.
      The first formulation states, “Act only according to that maxim by which you can
      at the same time will that it should become a universal law.”
      This means that for any action to be morally right, it must be capable of being
      consistently universalisable. By implication, if any action is moral for me, it
      must be moral for anyone else; everyone should be able to follow the same
      underlying principle, it gives no room for any exceptions.



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       PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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The second formulation otherwise referred to as the principle of humanity goes
thus: “Act so that you treat humanity, whether is your own person or in that of
another, always as an end and never as a means only.”
Kant‟s emphasis here is on the rational nature of humans as free, intelligent
and self directing beings. This nature of rationality is the basis for his/her value
as an end in itself. Because of this, “a rational being is worthwhile, has dignity
and is worthy of respect. Hence each person should be treated by every person
as an end, with respect and dignity …” This formulation forbids us to „use‟
people and manipulate them merely as means to our own ends.

Consider the different possible alternative actions that Bose can take, which
may include:
(i)    Telling Mr. Olabisi of the situation when she meets with him tomorrow.

(ii)    Asking Tunde to stop his data purchases.
(iii)   Turning Tunde in to Mr. Olabisi‟s anonymously.
(iv)    Buying information for herself if and when she needs it.
(v)     Do nothing.

Given the main tenets of Kant‟s Categorical Imperative, Bose has a duty to tell
the truth always, to uncover any unethical practice in her organisation not
minding who will be affected and to protect another person from any form of
manipulations for selfish interests.
The best option, therefore, would be for Bose to first confront Tunde and ask
him to stop his data purchases. The reason is that, a lot of frictions and crises
could be avoided if Tunde heeds to this advice.
But Bose should be smart enough to decipher and discern what Tunde‟s
reaction would likely be so that she would not have failed to prevent any harm
being done on Olabisi. By implication, she would have to tell Olabisi what
Tunde‟s is. Going by Kant‟s first formulation of the Categorical Imperative, this
would be a good option because if she were Olabisi, she would have wished
that someone exposes such unethical intent to her.

Finally, I will strongly advise Bose against turning Tunde in to Olabisi
anonymously. The reason being because, it would be difficult for her to remain
anonymous since she had earlier on kicked against Tunde‟s decisions.




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  PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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EXAMINERS‟ REPORT

The question tests candidates‟ understanding of Kant‟s Categorical Imperative
principles in Ethics. It also tests candidates‟ ability to identify ethical issues in the Case
Study.

The overall performance of the candidates was poor.

The commonest pitfalls of the candidates include:

(i) Lack of awareness of Kant‟s Categorical Imperative and its application.
(ii) Inability to identify ethical issues in the Case Study.

It is important for candidates to appreciate that examiners would continue to examine
questions which require application of ethical principles; hence, they are advised to
make use of recommended texts and journals on ethics. These would expose them to
relevant ethical principles and how they can be applied within the context of the
accounting profession.


QUESTION 2

(a) Ethical issues are problems, situations, or opportunities that require a person or
    organisation to choose among several actions that must be evaluated as right or
    wrong. Most ethical issues relate to conflicts of interest, fairness and honesty,
    communications, or organisational relationship both internal and external.

   In general, businesses seem to be more concerned with ethical issues that could
   hurt the firm through negative publicity, such as bribery, and issues related to
   consumers and the general public, such as environmental impact. Scandals related
   to bribes, deceptive communications, and ecological disasters have severely
   damaged public trust in business institutions and have helped to focus attention on
   activities that could do further harm.

   Therefore, studying ethical issues helps to prepare us to identify potential problems
   within an organisation and to understand alternatives and ethical solutions to the
   problem.



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         PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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(b) Two examples each of ethical issues relating to the following areas:

   (i) Society.
        Involvement in the Community/Obligation to protect, preserve & improve
           the environment
        Honesty, truthfulness and fairness in marketing
        Use of animals in product testing
        The degree of safety built into product design
        Donation to good cause
        The extent to which a business accepts its alleged responsibilities for
           mishaps, spillages and leakages
        The selling of addictive products e.g. tobacco
        Involvement in the arms trade
        Trading with repressive regimes.

   (ii) Internal and industry practice.
            Treatment of customers – e.g. honouring the spirit as well as the letter of
             the law in respect to warranties and after sales service
            The number and proportion of women and ethnic minority people in senior
             positions
            The organisation‟s loyalty to employees when it is in difficult economic
             conditions
            Employment of disabled people
            Working conditions and treatment of workers

           Bribes to secure contracts
           Child labour in the developing world

  (iii) Marketing.
           Dumping – selling at loss to increase market share and destroy
            competition in order to subsequently raise prices
           Price fixing cartels
           „Bait and switch‟ selling – attracting customers and then subjecting them
            to high pressure selling techniques to switch to a more expensive
            alternative
           Counterfeit goods and brand piracy
           Copying the style of packaging in an attempt to mislead consumers
           Deceptive advertising
           Unethical practices in market research and competitor intelligence


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          PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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      (iv) Product.
              Selling goods abroad which are banned at home
              Omitting to provide information on side effect
              Unsafe products
              Built in obsolescence
              Wasteful and unnecessary packaging
              Deception on size and content
              Inaccurate and incomplete testing of products
              Treatment of animals in product testing.

      (v) Supply chain.
             The use of child labour and forced labour
             Production in sweatshops
             Violation of the basic rights of workers
             Ignoring of health, safety and environmental standards.

EXAMINERS‟ REPORT

The question tests candidates‟ knowledge on ethical issues in business and it requires
specific examples of ethical issues in various areas of business.

The performance of candidates was good. Although, majority of the candidates were
able to explain ethical issues in business but some could not give specific examples in
various areas of business.

Candidates are advised to pay more attention to various forms of ethical issues in
business and how they can be addressed effectively.


QUESTION 3

(a)      Explaining the term “Conflict of Interest.”

         (i)    Conflict of interest exists when an individual must choose whether to
                advance his or her own interest
         (ii)   It exists when there is a clash in one‟s moral conviction and another
                person‟s proposal



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           PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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      (iii) Such competing interest can make it difficult for a professional to fulfil
             his or her duties impartially
      (iv) A conflict of interest can create an appearance of impropriety that can
            undermine confidence in the accountant, his professional activity, and
            the profession
      (v) To avoid conflict of interest, one must be able to separate his private
      interest from the business dealings of his employer or client.

(b)   Identifying the conflict of interest within the accounting profession, especially
      as an external auditor to a firm:

      (i)    Acting for two competing clients.
             Assurance firms are at liberty to have clients who are in competition
             with each other. However, the firm should ensure that it is not the
             subject of dispute between the clients. It must also manage its work so
             that the interests of one client do not adversely affect the other. Where
             acceptance or continuance of an engagement would, even with
             safeguards, materially prejudice the interests of any client, the
             appointment should not be accepted or continued.

      (ii)   Provision of services other than audit for the same firm.
             Auditors often give their clients business advice unrelated to audit. In
             such a position, they may well become involved when clients are
             involved in issues such as share issues and take-overs.
             Neither situation is inherently wrong for an auditor to be in – With
             regard to share issue, audit firms should not underwrite an issue of
             shares to the public of a client they audit.
             In a take-over situation, if the auditors are involved in the audit of
             both predator and target company, they must take extra care. They
             should not:
             - be the principal advisor to either party
              - issue reports assessing the accounts of either party other than
                their audit report.




             If they find they possess material confidential information, they    should
             contact the appropriate body or regulator.



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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
                                  PATHFINDER
        (iii)   Self Interest Threat.
                A conflict between members‟ and clients‟ interest might arise if
                members compete directly with a client, or have a joint venture or
                something similar with a company that is in competition with the client.
                A professional public accountant (external auditor) has the moral
                responsibility to protect the interest of the public by providing objective
                and accurate financial reporting which will be released to the public by
                the firm; the management of the company could request for
                overstatement of profit in order to mislead the public and hence continue
                in business without fear of losing out. The situation becomes worse when
                the auditor has some pressing financial needs which will be taken care of
                by the money that may accrue when the client produces fraudulent
                financial report.
                Here the auditor faces the dilemma of choosing to advance his selfish
                interest by taking the bribe and solve his own pressing financial
                problems or protecting public interest by declining.

EXAMINERS‟ REPORT

The question tests the application of ethics in accounting profession with special
emphasis on conflict of interest as it affects external auditors when carrying out their
duties as professional accountants.

Candidates are required to explain the term “Conflict of Interest” and also to give
instances where it may arise, most especially for audit firms in particular and
accounting profession in general.

The pitfalls noted include the following:

(i)   Inability to correctly explain the meaning of “Conflict of Interest”.

(ii) Discussing Auditor‟s Independence and factors that may impair Auditor‟s
     Independence instead of “Conflict of Interest”.

(iii) Inability to give specific instances when conflict of interest may arise.

The candidates are advised to pay more attention to the application of ethical
principles, particularly as they affect Accountants, Auditors and other related
professionals. It is also important for candidates to be sufficiently familiar with the


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          PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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basic ethical problems that can arise as they carry out their professional duties as
Accountants.

QUESTION 4

Accountants cannot afford not to study ethics for the following reasons:

(i)   Possibility of conflicting ethical principles:
      Due to conflicting ethical principles it may be difficult to determine what to do
      in certain circumstances. In this case, ethics can provide insights into how to
      adjudicate between conflicting principles and show why certain courses of action
      are more desirable than others.


(ii) Individual Accountant may hold some inadequate beliefs or cling to inadequate
     values.
     Subjecting those beliefs or values to ethical analysis may show their inadequacy.
     It could be that at one time you thought some things were wrong but now you
     think they are acceptable, or vice versa. For instance, some would claim that
     while accounting firms operate within the letter of the law in attesting to the fact
     that companies followed Generally Accepted Accounting Principles (GAAP), they
     had an ethical obligation to encourage more realistic financial pictures. Also, at
     one time accountants thought it unacceptable to advertise. Today, it seems a
     justifiable practice. So, ethical reflection can make us more knowledgeable and
     conscientious in moral matters.

(iii) Development of abilities needed to deal with ethical conflicts.
      The study of ethics helps us to understand whether and why our opinions are
      worth holding on to. As an Accountant, what do I do when I need to choose
      between keeping a job and violating professional responsibilities? Ethics
      provides the Accountant with the likely thing to do when his responsibility to his
      family conflicts with his professional responsibility.

(iv) Recognition of issues in accounting that have ethical implications.
     Some moral beliefs an individual accountant holds may be inadequate because
     they are simple beliefs about complex issues. The study of ethics can help in
     sorting out these complex issues, by seeing what principles operate in those
     cases.



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         PROFESSIONAL EXAMINATION II – NOVEMBER 2010
                                 PATHFINDER
(v)    Identification and application of basic ethical principles.
      The final reason for studying ethics is to learn to identify the basic ethical
       principles that can be applied to action. That should help develop the skill of
       determining what should be done and an understanding of why it should be
       done. When faced with trying to decide what to do in a difficult situation, it is
       often helpful to have a checklist for basic questions or considerations that need to
       be raised and applied to the situation to help determine what the outcome
       should be. Just as one learns the principles of accounting in order to apply them
       to specific situations, one also needs to learn the principles of ethics that govern
       human behaviour in order to apply them when faced with difficult ethical
       situations. The study of ethics makes us aware of the number and types of moral
       principles that can be used in determining what should be done in a situation
       involving ethical matters.

EXAMINERS‟ REPORT

The question tests the purpose of studying ethics by Accountants. It also tests the
importance of ethics to the accountancy profession in general.

Candidates are required to explain possibility of conflicting ethical principles, and also
to state the reasons why some Accountants may hold inadequate beliefs when faced
with issues in accounting that have ethical implications.

Most candidates demonstrated inadequate understanding of the question and
performance was generally poor.

The major pitfall was that candidates misinterpreted the question and they were
discussing ICAN Code of Conduct instead of answering the question.
Candidates are advised to study questions properly before answering them.

It is also important for candidates to appreciate that Ethics is an important aspect of
this paper; therefore, special attention must be paid to this part of the Syllabus for
better performance in future.




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          PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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QUESTION 5

(a).   (i)    Consolidated Financial Statements are the financial statements of a
       group presented as those of a single economic entity.

       (ii)    A Subsidiary is an entity, including an unincorporated entity that is
       controlled by another entity known as the parent.




       (iii)   Non-controlling interest is the equity in the subsidiary not attributable
       directly or indirectly to a parent.

       (iv)    Control is the power to govern the financial and operating policies of
       an entity so as to obtain benefits from its activities.

(b)    The following disclosures shall be made in Consolidated Financial Statements,
       according to Schedule II paragraph 68 of CAMA:

       (i)   The nature of the relationship between the parent and subsidiary when
       the parent does not own, directly or indirectly through   subsidiaries, more
       than half of the voting power.

       (ii)    The reasons why the ownership, directly or indirectly through
               subsidiaries, of more than half of the voting or potential voting power
               of an investee does not constitute control.

       (iii)   The end of the reporting period of the financial statements of a
               subsidiary when such financial statements are used to prepare
               consolidated financial statements and are as of a date or for a period
               that is different from that of the parent‟s financial statements, and the
               reason for using a different date or period.

       (iv)    The nature and extent of any significant restrictions on the ability of
               subsidiaries to transfer funds to the parent in the form of cash
               dividends or to repay loans or advances.




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         PROFESSIONAL EXAMINATION II – NOVEMBER 2010
                                PATHFINDER
      (v)     A schedule that shows the effects of any changes in a parent‟s
              ownership interest in a subsidiary that does not result in a loss on the
              equity attributable to owners of the parent.

      (vi)    If control of a subsidiary is lost, the parent shall disclose the gain or
              loss, if any.

      (vii)   A list of investment in subsidiaries, jointly controlled entities and
              associates including the name and country of incorporation.

      (viii) Where separate financial statements are prepared by a jointly
             controlled entity or an investor, in an associate, the reason for
             preparing separate financial statements, the list of significant
             investment and country of incorporation of the investee must be
             disclosed.


EXAMINERS‟ REPORT

The question tests candidates‟ understanding of the requirements of IAS 27 on
Separate Financial Statements as well as disclosure requirements when preparing
Consolidated Financial Statements.

The performance of the candidates was fair.

Most candidates were able to define the basic terms in accordance with the
International Accounting Standard No. 27, but they displayed inadequate
understanding of the disclosure requirements.

Candidates are advised to pay more attention to Statements of Accounting Standards.




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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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QUESTION 6

Financial reporting is not an end in itself. It is a means of communicating to the users
of the financial reports. Information is useful in making choices among alternative
uses of scarce resources, though, the objective stems largely from the needs and
interests of those users.

Potential users of financial reports and their information needs include:

(a)   Equity investors.
      Equity investors in an entity are interested in the entity‟s ability to generate net
      cash inflows because their decisions relate to the amounts, timing, and
      uncertainties of those cash flows. To an equity investor, an entity is a source of
      cash in the form of dividends (or other cash distributions) and increases in the
      prices of shares or other ownership interests. Equity investors are directly
      concerned with the ability of the entity to generate net cash inflows and with
      how the perception of that ability affects the prices of its equity interests.
      They are also interested in the ability of the company to issue scrip, which
      will increase their shareholding and consequently increase their cash inflow.

(b)   Creditors, including purchasers of trade debt instruments.
      These provide finance to an entity by lending cash (or other assets) to it.
      Like investors, creditors are interested in the amounts, timing and uncertainty
      of an entity‟s future cash flows. To a creditor, an entity is a source of cash in the
      form of interest, repayments of borrowings and increase in the prices of debt
      securities.

(c)   Suppliers.
      They provide services rather than financial capital. They are interested in
      assessing the likelihood that amounts an entity owes them will be paid as at
      when due.

(d)   Employees.
      They provide services to equity; employees and their representatives are
      interested in evaluating the stability, profitability, and growth of their
      employer. They are interested in information that helps them to assess the
      entity‟s continuing ability to pay salaries and wages and to provide incentive
      payments and retirement and other benefits.



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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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(e)   Customers.
      To its customers, an entity is a source of goods and services. Customers are
      interested in assessing the entity‟s ability to continue to provide those goods or
      services, especially if they have a long-term involvement with, or are dependent
      on the entity.

(f)   Governments and their agencies and regulatory bodies.
      These are interested in the activities of an entity because they are in various
      ways responsible for seeing that economic resources are allocated efficiently.
      They also need information to help in regulating the activities of entities,
      determining and applying taxation policies, preparing national income and
      similar statistics.

(g)   Management.
      This requires financial reports to obtain financial information among others to
      effectively perform their function of planning and controlling the operation of
      the enterprise.

(h)   Financial Analyst.
      This like Accountants, Stockbrokers, etc. will need the financial information to
      determine the performance of the entity in order to give constructive advice as
      to whether their clients should invest in a particular company or not.

(i)   Competitors.
      Competitors require the financial statements of companies in the same line of
      business or the same industry for the purpose of comparison. This will make
      them know their position and facilitate effective analysis of their strengths,
      weaknesses, opportunities and threats within the industry. This will also enable
      competing companies know how they are faring among their peers and make
      them evolve appropriate policies and/or actions for improvement.

(j)   Researchers.
      Researchers require financial information for inter-firm and inter-period
      comparisons to guide students and consultants.

EXAMINERS‟ REPORT

The question tests candidates‟ knowledge on users of financial statements and their
individual information needs.

Majority of the candidates understood the question and the performance was good.

                                                                                  29

        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
                                    PATHFINDER
ICAN/                                                     EXAMINATION NO...................................
          THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA
             PROFESSIONAL EXAMINATION II – NOVEMBER 2010
                     STRATEGIC FINANCIAL MANAGEMENT

                                         Time allowed – 3 hours

SECTION A: Attempt All Questions
PART 1      MULTIPLE-CHOICE QUESTIONS (20 Marks)
1.   Which of the following functions is NOT performed at a lower management level?

        A.    Supervision of cash receipts and payments.
        B.    Safeguarding cash balances
        C.    Record keeping and reporting
        D.    Custody and safeguarding securities and valuable papers
        E.    Planning and control of funds

2.      The following are the characteristics of strategic decision EXCEPT they

        A.    are concerned with the scope of the organisation‟s activities.
        B.    match the organisation‟s activities to the environment in which it operates.
        C.    match an organisation‟s activities to its resource capability.
        D.    involve major decisions about the allocation or re-allocation of resources.
        E.    affect the short-term direction that the organisation takes.

3.      Which of the following short-term investment opportunities is NOT available to
        companies?

        A.    Treasury bills
        B.    Commercial papers
        C.    Certificates of deposits
        D.    Bonds
        E.    Bank deposits




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             PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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4.   Baumol‟s model on cash management is not based on ONE of the following
     assumptions.

     A.    A firm is able to forecast its cash needs with certainty.
     B.    A firm‟s cash payments occur uniformly over a period of time.
     C.    The opportunity cost of holding cash is known and it does not change over
           time.
     D.    The firm will incur the same transaction cost whenever it converts securities
           to cash.
     E.    The net cashflow is normally distributed with a zero mean and standard
           deviation.

5.   Which of the following simplifying assumptions is NOT commonly made in
     examining the relationship between capital structure and cost of capital?

     A.    There is no income tax
     B.    The firm pursues a policy of paying all its earnings as dividends
     C.    Investors have identical subjective probability distributions of operating
           income
     D.    The operating income is expected to be static
     E.    A firm can change its capital structure almost instantaneously without
           incurring transaction costs

6.   Which of the following reasons for valuing securities is NOT correct?

     A.    To determine the purchase consideration in an absorption or merger scheme
     B.    To ascertain the total amount of the estate of a deceased investor
     C.    To determine the fair price at which shares of a company could be
           purchased
     D.    To meet the stock exchange requirements
     E.    To estimate the break-up value of a company in liquidation




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          PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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7.    Given the following data in respect of Alariwo Plc, calculate the P/E ratio:
      Share Price    N5.00; and
      EPS            N0.82

      A.    4.10
      B.    6.10
      C.    6.12
      D.    6.14
      E.    6.22

 8.   Which of the following statements may NOT be a reason for issuing bonus shares?

      A.    Bonus shares tend to bring the market price per share within a more
            popular range
      B.    Bonus shares increase the number of outstanding shares
      C.    The rate of dividend tends to increase
      D.    Issuing of bonus shares improves the prospects of raising additional funds
      E.    The share capital base increases and the company may achieve a more
            respectable size in the eyes of the investing community

 9.   Which of the following is NOT one of the core decision areas in financial
      management?

      A.    Investment decision
      B.    Finance decision
      C.    Dividend decision
      D.    Liquidity decision
      E.    Credit management decision

 10. The traditional approach to the valuation of a company assumes that

      A.    the gearing of a company is changed immediately by issuing debts to
            purchase equity or vice-versa.
      B.    all earnings are distributed in form of dividend.
      C.    business risk fluctuates regardless of how the company invests its funds.
      D.    taxation is ignored.
      E.    earnings are assumed to have zero growth into perpetuity.


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           PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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11. An integrated approach to the strategy making process provides a framework
    which consists of the following parts EXCEPT

    A.    analysing the present internal and external conditions.
    B.    identifying and evaluating the present strategy.
    C.    searching for strengths and weaknesses within the present strategy and
          environment.
    D.    considering changes in the existing strategy.
    E.    choosing the strategy that best satisfies the objectives.

12. Mr Adeyemi obtained a three-year loan of N10,000 @ 9% from his employer to
    buy a motorcycle. The loan is expected to be repaid in three equal end-of-year
    instalments. What is the annual instalment?

    A.    N3,905
    B.    N3,921
    C.    N3,951
    D.    N3,975
    E.    N3,981.

13. An investor expects a perpetual sum of N500 annually from his investment. What
    is the present value of this perpetuity if his interest rate is 10%?

    A.    N5,000
    B.    N5,200
    C.    N5,300
    D.    N5,400
    E.    N5,500.

14. The following are relevant factors in taking a decision to raise money through
    loan stock EXCEPT

    A.    issue costs.
    B.    capital repayment.
    C.    control.
    D.    servicing costs.
    E.    interest repayment.



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         PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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15.   Who has the overall responsibility for the attainment of corporate governance objectives
      in an organisation?

      A.    Top executive officer
      B.    Shareholders
      C.    Work force
      D.    Audit Committee
      E.    Board of Directors

16.   Which of the following is an aspect of the intermediation functions in the Nigerian
      financial system?

      A.    Denomination intermediation
      B.    Maturity intermediation
      C.    Risk Intermediation
      D.    Interest rate intermediation
      E.    Liquidity intermediation



17.   Strategic planning serves the following purposes in an organisation EXCEPT

      A.    clear definition of the purpose of the organisation and establishment of realistic
            goals and objectives consistent with that mission in a definite time frame.
      B.    communication of those goals and objectives to the organisation‟s constituents.
      C.    development of a sense of ownership of the company‟s plan.
      D.    reflecting on how a specific function will contribute to the achievement of a
            department‟s corporate priorities and defence tasks.
      E.    provision of a base from which progress can be measured and establishment of a
            mechanism for informed change when needed.

18.   Which of the following does NOT explain the essence of corporate planning?

      A.    The probability of future outcome of events is unknown
      B.    Predictions are susceptible to errors
      C.    The future is unpredictable
      D.    Decision makers cannot be assertive on future events
      E.    Decision relating to corporate planning rests on hunches


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           PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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19.   In relation to capital investment, a managerial option

      A.    applies only to new projects.
      B.    limits the flexibility of management‟s decision-making.
      C.    limits the downside risk of an investment project.
      D.    limits the profit potential of a proposed project.
      E.    extends the risk of executed projects.

20.   Which of the following is NOT a limitation of capital rationing?

      A.    The assumption that projects are infinitely divisible may not always be true in
            practice
      B.    An investment policy outcome may be less than optimal
      C.    The risk associated with the different projects and managements attitude to risk
            are not considered
      D.    The linearity relationship can be faulted
      E.    If there is capital rationing in more than one year and more than two projects are
            involved, ranking by discounted profitability index is not adequate




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           PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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    PART II – SHORT-ANSWER QUESTIONS (20 Marks)

    1.    Strategy formulation is ultimately the responsibility of............................

    2.    The secondary goal of a corporate organisation is................................

    3.    The two main theories relating to the effect of capital structure on the value of
          the company are....................... and ..............................

    4.    A schedule statement of projected cash inflows and cash outflows over some
          period is known as........................

    5.    What is the name given to an income received by the firm for goods and
          services, to be supplied in future?

    6.    A financial instrument which entitles an investor to buy new shares of a
          company during a specified period in future, at a price determined now, is
          called...............................

    7.    Issue of shares of new companies are usually offered to the public for
          subscription at........................value.

    8.    The process of guaranteeing to buy new public or rights issues if the issues are
          NOT fully subscribed by the public is called................................

    9.    The development of financial strategy in an organization is the responsibility of
          the...................................

    10.   The process of policy formulation, establishment of goals and objectives and the
          development of strategies is known as ...........................

    11.   The level at which an order should be placed to replenish inventory is known
          as...........................

    12.   Offers to the existing shareholders to subscribe cash for additional shares in the
          proportion of their existing shareholdings at a price which is appreciably below
          the current market price are referred to as .......................
.
    13.   The formula for determining the rate of return on a single asset is given
          as...............................



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            PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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14.   The technique used in determining the viability, time of completion, costs and
      resources of rescheduling alternative strategies is called.............................


15.   The company‟s objective of maximising market price per share is synonymous
      with …………………..

16.   When a listed company delays or fails to notify the Stock Exchange of any new
      development which may substantially affect the price of its security, an investor
      can out-perform the market thereby resulting in …………….. capital market.

17.   The process of developing and maintaining a strategic fit between the
      organisation‟s goals and capabilities and its changing marketing opportunities
      is the responsibility of the …………………..

18.   A continuous process whereby people make decisions about how outcomes are
      to be accomplished, what products will be produced, how success is measured
      and evaluated and how budgetary resources are allocated is known
      as………………..

19.   Whenever there is a budget ceiling or a constraint on the amount of funds that
      can be invested during a specific period, there will be need
      for………………………

20.   The terminology used to describe the value of a project‟s asset when sold
      externally is known as …………………….




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       PROFESSIONAL EXAMINATION II – NOVEMBER 2010
                                 PATHFINDER

SECTION B -ANSWER QUESTION ONE AND ANY OTHER THREE (60 Marks)
QUESTION 1 - CASE STUDY

LAPEKUN LIMITED

Lapekun Limited is considering the purchase of a locally manufactured machine for N3
million. In view of the fact that the shares of the company are not quoted, it finds it
difficult to raise money through the issue of shares. The purchase of this machine
becomes absolutely necessary if the sales target given to the sales manager is to be
achieved. In order to ensure that the machine is purchased, the domineering
proprietor of the company and the accountant met informally to decide on how to
source for funds.
Many finance options were considered and they eventually agreed to negotiate for a
loan from Microfinance Bank Ltd. The bank agreed to give the company a loan of N2.5
million, which means that the company will have to source for the balance of N0.5
million elsewhere. However, the company has no tangible collateral with which to
secure additional loan to cover the balance of the value of the machine. In view of this
difficulty, the finance officer offered to advance the shortfall. The proprietor graciously
accepted this offer.
The duration of the loan is 20 years with an interest rate of 12% per annum. The
annual interest charge is to be calculated on the balance outstanding at the beginning
of each year. Repayment is to be made in 20 equal annual instalments. Each
instalment will include both interest and capital. A working capital of N250,000 will
be required at the beginning of the year. The amount will be sourced internally. The
machine is expected to generate net cashflows of N540,000 per annum for FIVE
consecutive years from its predominantly local sales.

You are required to determine
(a)   the amount to be paid in each year on the loan;              (5 Marks)
(b)   the NPV of the machine and advise on its viability; and      (5 Marks)
(c)   identify FIVE features of small scale enterprises.           (5 Marks)
                                                            (Total 15 Marks)

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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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QUESTION 2

(a)    Explain the term “rights issue”.                                       (2 Marks)
(b)    Differentiate between “rights issue” and “public issue”.               (3 Marks)
(c)    (i) Rapala Plc is about to make a one-for-three rights issue. Its current capital
            structure is as follows:
            6 million Ordinary shares of N1 each (current market value is N6.20 per
                share)

                 15% Debentures (Redeemable at par in 10 years time) – N6 million.

       (ii) The money raised from the rights issue may be used to execute the
            following;
             Buy back all the 15% debentures at their current market value. It is
                expected that this investment will be priced to offer investors a yield of
                9% which is the current market-yield on debenture loan.
             Finance a new project costing N1.6 million.

       You are required to determine the

       (i)     finance required to redeem the debentures and finance the new project.
                                                                               (5 Marks)
       (ii)    issue price per share;                                          (1 Mark )

       (iii) theoretical ex-rights price; and                                   (2 Marks)
       (iv) theoretical nil paid value of a right per share                     (2 Marks)
      NOTE:

      The total finance required for (i) and (ii) should be rounded up to the next
      N100,000 for the purpose of the rights issue.
                                                                    (Total 15 Marks)

QUESTION 3

(a)     State the formula for calculating the rate of return on equity shares
                                                                                (2 Marks)

(b)     Calculate the rate of return on equity share using the following information:
        Price at the beginning of the year N60.00

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              PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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       Dividend paid at the end of the year N2.40
       Price at the end of the year N69.00                                     (3 Marks)


      (c) Explain FIVE areas in which the financial management in a business
        organisation can benefit from information and communication technology.
                                                                 (10 Marks)
                                                                    (Total 15 Marks)
QUESTION 4

Abija Plc‟s and Bayela Plc‟s balance sheet extracts are set out below. Abija Plc is
proposing to take over Bayela Plc by means of an issue of its own shares in exchange
for those of Bayela and has to decide on the terms of its offer.
                                                Abija Plc       Bayela Plc
                                                     N‟000            N‟000
            Ordinary Shares of N1 each         1,000,000             500,000
            Preference Share Capital            200,000                    -
            Share Premium Account                        -            20,000
            Profit and Loss Account             380,000               40,000
            10% Debentures                      150,000               50,000
                                               1,730,000             610,000


Other pieces of information concerning the two companies are as follows:
                                                         Abija Plc         Bayela Plc
Maintainable     annual      profits   after   tax
attributable to equity                                 N 240,000,000      N 150,000,000
Current market value of ordinary shares                          2.40              2.70
Current EPS                                                      0.24              0.30
P/E ratio                                                            10                 9
Current market price of debts                                   125%              125%




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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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Required:
Determine the offer which the directors of Abija Plc would make to the shareholders of
Bayela Plc on each of the following bases:
a)     Net Asset                                                           (3 Marks)
b)     Earnings                                                            (4 Marks)
c)     Market value                                                        (2 Marks)
d)     Financial analysis                                                  (6 Marks)

The company‟s income tax rate is 30%.
                                                                    (Total 15 Marks)

QUESTION 5

BIROM PLc is considering investment in a computer-controlled machine which can be
replaced by an identical one when it gets to the end of its economic life. The machine
has a maximum life of four years but, as its productivity declines with age, it could be
replaced after either one, two, three or four years. The financial details of the machine
are as given below:
                                             N‟000
Cost                                     6,000,000
Running cost:
Year   1                                     450,000
       2                                     480,000
       3                                     570,000
       4                                     630,000
Scrap value after:
Year   1                                 4,500,000
       2                                 3,900,000
       3                                 3,000,000
       4                                 2,100,000
The Board of Directors of BIROM Plc is concerned with deciding on its replacement
policy.

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           PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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As the financial manager of the company, you are required to advise the board on the
optimal replacement policy of the machine assuming that the company‟s cost of
capital is 10%.
                                                                         (15 Marks)




QUESTION 6
“The role of planning cannot be over emphasised in the attainment of corporate
objectives”:
(a)   In relation to the above statement, explain each of the following concepts:
          (i) Operational planning;
          (ii) Tactical planning; and
         (iii) Strategic planning.
                                                                                    (6 Marks)
(b)   State Three functions of each of the following:
          (i) Central Securities Clearing System (CSCS); and
          (ii) Securities and Exchange Commission (SEC)
                                                                                    (9 Marks)
                                                                           (Total 15 Marks)




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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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SOLUTIONS TO SECTION A

PART 1: MULTIPLE-CHOICE QUESTIONS

1.    E
2.    E
3.    D
4.    E
5.    D
6.    D
7.    B
8.    C
9.    E
10.   C
11.   D
12.   C
13.   A
14.   C
15.   E
16.   D
17.   D
18.   A
19.   C
20.   E




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      PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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Tutorials

7.           N 5.00              = 6.098
             N 0.82
                                 = 6.10

12.           N 10,000          = N 3,951
            2.531(Cum DF)
             DF = Discounting Factor

13.          P = N 5.00          = N 5,000
                 0.10

EXAMINERS‟ REPORT

The questions test candidates‟ knowledge of various aspects of the syllabus. Virtually
all the candidates attempted the questions and performance was fair.
Candidates are advised to ensure adequate coverage of all sections of the syllabus for
better performance.




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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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PART II SHORT-ANSWER QUESTIONS

1.    Board of Directors
2.    Profit maximisation
3.    Traditional view; Net operating income
4.    Cash budget
5.    Deferred income
6.    Warrant
7.    Par or Nominal
8.    Underwriting
9.    Head of Finance or Finance Officer
10.   Corporate planning
11.   Re-order level or Re-order point
12.   Rights issue
13.   Annual income + (ending price – beginning price) x 100 %
            beginning price                                  1
                 OR
      Capital Gain / Loss + dividend x 100 % ie di + (P1-P0) x 100
         Price at Start of period       1            P0         1
             OR
      Income / Returns         x 100 %
      Investment / Capital        1

14.   Program Evaluation Review Technique (PERT).
15.   Maximisation of shareholders‟ wealth
16.   Inefficient
17.   Top management
18.   Tactical planning
19.   Capital Rationing
20.   Abandonment value or scrap value

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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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EXAMINERS‟ REPORT

The questions test candidates‟ knowledge of various aspects of the syllabus.
Candidates‟ performance was average.

Candidates are advised to study extensively and adequately to cover the syllabus
when preparing for the examinations of the Institute for better result.




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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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SOLUTIONS TO SECTION B

QUESTION 1 - CASE STUDY

LAPEKUN LIMITED


(a)   Calculation of the annual repayment
      A      =     [1-(1 + r)-n]
                         r

             =     1 –( 1.12)-20
                       0.12


             =       7.4694


             : . Annual repayment               =     N2,500,000
                                                         7.4694

                                                =     N 334,698.90


(b)   Calculation of the NPV of the machine
      Year         NCF              DF@               PV
                   (N)              12%               (N)
      0           (3,000,000)       1.0000          (3,000,000)
      0             (250,000)       1.0000           (250,000)
      1-5            540,000        3.6048           1,946,592
      5                   250       0.5674             141,850
                                          NPV       -1,161,558


      Advice:
      The machine should not be bought, as its purchase would result in the
      reduction of the shareholders‟ wealth by N1,161,558.

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          PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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(c)      Features of small-scale enterprises.
         These include:
         i.    The ownership of the firm and its control are not often separated, that is,
               both are in most cases in the hands of a few closely related people,
               probably within the same family.
        ii.    The companies‟ shares are usually not quoted on the stock market;
       iii.    The informal relationship among employees in the organization dominates
               the formal relationship;
       iv.     In most cases, their inputs are locally sourced;
        v.     Management structure is uncomplicated, hence there is a speedy decision-
               taking process;
       vi.     They contribute to the domestic capital formation;
      vii.     Low setup costs;
      viii.    Accelerating rural development and contributing to stemming urban
               immigration and problems of congestion in large cities through employment
               generation;
       ix.     Provide links between agriculture and industries; and
        x.     Supplying parts and components to large scale industries.


EXAMINERS‟ REPORT

Part „a‟ of the question tests candidates‟ knowledge of annuity while part „b‟ tests
candidates‟ understanding of one of the techniques of investment appraisal. Part „c‟ of
the question, however, tests candidates‟ knowledge of the features of Small Scale
Enterprises (SMEs).

Over 80% of the candidates attempted the question and most of them did well in part
„b‟ but demonstrated lack of adequate understanding of parts „a‟ and „c‟, hence
performance was average.
Candidates‟ commonest pitfall in part „a‟ was their inability to remember the annuity
formula, hence they were unable to calculate the annual „loan repayment.



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              PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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Their pitfall in part „b‟ was their inability to compute the projects Net Present Value
(NPV) correctly owing to their failure to recognise the recovery of working capital at
the end of the project‟s life. However, in part „c‟, candidates focused on the features of
sole proprietorship instead of Small Scale Enterprises (SMEs).

Candidates are advised to read wide, understand and interprete questions
appropriately before attempting them. They should also make effort to remember key
formulae.

QUESTION 2
(a)   Rights Issue –This is an offer to the existing shareholders of securities listed in the
      primary market to subscribe for additional shares in the proportion of their
      existing shareholdings at a price lower than the current market price of the
      shares. It is the most common method of raising capital by private and public
      companies.

(b)   Differences between “rights issue” and “public issue”

      (i)     Rights issue is usually more successful than public issue because it is made
              to investors who are familiar with the operations of the company.

      (ii)    A rights issue involves selling of ordinary shares to the existing shareholders
              while a public issue involves raising of share capital directly from the
              public.

      (iii) The flotation costs of a rights issue are significantly lower than those of a
            public issue because a rights issue is not underwritten.

      (iv) A rights issue may be made by private companies as well as public
           companies whereas a public issue can only be made by public companies.

      (v)     A rights issue does not lead to dilution of control except the rights are not
              fully taken up by the shareholders whereas a public issue can lead to
              dilution of control.




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             PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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(b)   (i)      Finance required:
              The finance required to redeem the debenture and finance the new project is
              the addition of the current price of the debenture and the cost of the new
              project. This is obtained as follows:

              Calculation of the current value of the debenture
              15% Redeemable debenture                                         = N 6,000,000
              Annual interest                                                  = N 900,000


                      Year          Item             Cashflow         DCF @            PV
                                                          N            9%             (N)

                     1 – 10    Interest               900,000         6.4177         5,775,930

                       10      Debt                  6,000,000        0.4224         2,534,400
                               redeemed

                               Current value                                         8,310,330


              Current value of the 15% redeemable debenture            =       N 8,310,330
              Cost of the proposed project (given)                     =       N 1,600,000
              Therefore, the finance required is                       =       N 9,910,330

                                                                      = N10,000,000 approx.

      (ii)    Calculation of issue price per share

              Finance required                        =       N 10,000,000 (c (i) above)

              No of shares issued (6,000,000/3)       =       2,000,000 shares


              Issue price                             =       N10,000,000
                                                               2,000,000

                                                      =       N5.00




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             PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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    (iii) Calculation of theoretical ex-rights price
                                                                   N
             3 shares at N6.20                                    18.60
             1 share at N5.00                                      5.00

             4 shares                                             23.60

             Theoretical ex-rights price               =          N23.60/4

                                                       =          N5.90

     (iv) Calculation of nil paid value of a right per share

             Theoretical ex-rights price        =      N5.90
             Less: Issue price                             5.00
                                                           0.90
             Nil paid value                     =      0.90/3
                                                =      N0.30
EXAMINERS‟ REPORT

The question tests candidates‟ understanding of „rights‟ and „public‟ issues under the
capital market operations.

Candidates‟ understanding of the „c‟ part of the question was very low while they had
a fair knowledge of the „a‟ and „b‟ parts. Many candidates attempted the question but
performance was poor especially in the „c‟ part which requires some calculations.
Unfortunately, this part carries the highest mark.
Candidates‟ commonest pitfall in part „c‟ of the question was their inability to
determine the present price of the debenture which would have helped in calculating
the finance required and assist in solving the remaining parts of the question under
part „c‟, that is, c (ii – iv).

Candidates are advised to always cover the Institute‟s syllabus adequately, and make
use of the Pathfinder and Study Packs.



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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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QUESTION 3
(a)   The formula for calculating the rate of return on equity shares is
       Annual income + (Ending price – Beginning price) X 100 %
                            Beginning price                 1
                                   OR
      Capital Gain / Loss + dividend X 100 % ie di + (P1-P0) x 100 %
             Price at start of period     1          P0         1

(b)   Calculation of the rate of return
      Using the formula in (a) above, the rate of return works out as follows:
      N2.40 + (N69.00 - N60,00) X 100%
                N60.00                  1
                    =      N11.40 X 100
                              60       1
                   =      19%
(c)   The areas in which the financial management of a business firm will benefit
      from information and communication technology (ICT) include the following:
      (i)   Financial Planning – this function of the financial manager can be
            performed with greater ease through the use of spreadsheets and other
            financial softwares to evaluate the present and projected financial
            performance of a business. Through information and communication
            technology, companies can determine the financing needs and analyse
            alternative methods of financing more quickly and relatively easier.
            Financial manager receives immense support from Decision Support
            System (DSS) when he takes long-term financial planning decisions
            involving many assumptions that jointly affect these decisions. Where for
            instance, there is a need to test the effect of a change in any of the
            assumptions on the result (sensitivity analysis), computerized financial
            planning models can be programmed to carry this out instantaneously.
            The specific areas of financial planning that receive this type of support
            from DSS include the effect of different sales values, different selling




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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
                           PATHFINDER
        prices, and different input costs on the forecast figure in the projected
        financial statements.


(ii)    Working Capital Management – On a real time or periodic basis, ICT
        system can be used to collect information on all cash receipts and
        payments within the company. ICT is applicable in the area of cashflow
        forecasts and management. It makes it possible to spot future cash
        deficits or surpluses.
        In addition to cash management, it could also be used for inventory
        management to determine the economic order quantity and optimum
        level of inventory investment to maximize profitability.


(iii)   Capital Investment Appraisal – Spreadsheet models that incorporate
        present value analysis of expected cash flows and probability analysis of
        risk to determine optimal mix of capital projects are available for
        evaluating the profitability and financial impact of proposed capital
        expenditure. It also provides support in the areas of evaluation of the
        effect of alternative discount rates on projects net present values where
        cash flows that have to be estimated go into fairly distant future.
(iv)    Investment Management – System / Service helps financial managers to
        make buying / selling or holding decisions for various types of securities
        and for developing an optimal mix of securities, which minimizes risks
        and maximizes investment income for the business.


(v)     Optimisation problems – The decision support system (DSS) model base
        might have optimal models such as linear programming. These models
        could be used to provide solutions to problems involving optimisation of
        a given objective (profit maximisation or cost minimisation) in the face of
        many (at least more than two) interacting variables and complex
        relationships.


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  PROFESSIONAL EXAMINATION II – NOVEMBER 2010
                                PATHFINDER
             The limiting factors might be labour, machine hours, capital and others
             which incidences jointly affect profit or cost.


      (vi)   Financial and Profit Analysis - The ICT, through the use of DSS based
             financial planning models, provide support where there is need to assess
             different financing plans and their impact on the critical variables such
             as earnings per share (EPS), debt equity ratio (gearing ratio), etc.
             Financial managers are usually interested in every aspect of the financial
             analysis since it is their overall responsibility to see that the resources of
             the firm are used most effectively and efficiently and that the firm‟s
             financial condition is sound.

EXAMINERS‟ REPORT

The „a‟ and „b‟ parts of the question test candidates‟ understanding of the formula for
the calculation of return on capital and its interpretation in relation to the market
value of equity shares. The „c‟ part tests candidates‟ knowledge of information
technology and its benefits to the financial manager.
Few candidates attempted the question and their performance was poor. Most
candidates did not understand the requirements of the question and therefore did not
attempt it.

Candidates‟ commonest pitfall in part „a‟ of the question was their inability to
remember the formula and this also affected their performance in the „b‟ part of the
question since the formula is expected to be used in solving it. In part „c‟, candidates
failed to interprete and note the specific requirements of the question hence they
failed to proffer correct solution to it.
Candidates‟ are advised to take time to read, understand and interprete questions
appropriately and note specific requirements before attempting them. They should
also make effort to remember key formulae.




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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
                                 PATHFINDER
QUESTION 4

Calculation of offer price by Abija Plc to shareholders of Bayela Plc based on :
(a)   Net asset basis

      Net Asset Value (NAV)              =       Value attributable to equity
                                                      No of ordinary shares
      NAV for Abija                      =      N 1,380,000,000
                                                 1,000,000,000
                                         =      N1.38

      NAV for Bayela                     =      N560,000,000
                                                 500,000,000
                                         =      N1.12
      Comment
      Abija Plc is expected to issue 112 of its own shares in exchange for every 138 of
      those in Bayela Plc, which it acquires


      To acquire the whole of the issued share capital of Bayela Plc, Abija Plc should
      issue.
      500,000,000 x 112     =     405,797,101 new N1 shares
         138

(b)   Earnings Basis
      Earnings per share (EPS)           =      Total earnings attributable to equity
                                                             No. of shares
      EPS for Abija Plc                  =      N240,000,000
                                                1,000,000,000
                                         =      N0.24
      EPS for Bayela plc                 =      N150,000,000
                                                 500,000,000
                                         =      N 0.30
      Comment



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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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      Abija Plc is expected to issue 30 new shares in exchange for 24 existing shares
      in Bayela Plc. This leads to a total issue of


              500,000,000 x 30            =      625,000,000 new N1 shares
                   24

(c)   Market value Basis
      The current market price of Abija Plc share is N2.40 and that of Bayela Plc‟s
      share is N2.70. To maintain the market value of the holdings, Abija Plc should
      issue 9 new shares for each 8 of Bayela‟s shares (i.e 270 for 240). Therefore, the
      total number of shares to be issued is
             N500,000,000 x 9             =      562,500,000 new N1 shares
                   8
(d)   Financial Analysis
      Abija Plc current cost of equity (assuming no expected growth) is:

      Maintainable annual profit          x 100%
      Market value of equity                 1

                                          =      N 240,000,000             x 100%
                                                 N2,400,000,000               1
                                          =      10% per annum
      Abija Plc cost of debt is:          Coupon rate x Nominal value
                                                        Market value
                                          =    10% x 100
                                                       125
                                          =    8%
             The after tax cost of debt is therefore 8 (1-tax rate)
                                          =      8 (0.7)
                                          =      5.6% per annum
      Abija Plc WACC is: (10 x N2,400,000,000) + [5.6 x (N150,000,000x1.25]
                                             N2,587,500,000
                          =     9.68% per annum




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       PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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      The maximum price that Abija Plc would be prepared to pay to Bayela Plc for
      this to be an acceptable “project” under conventional capital project appraisal
      methods
      is:                       Earnings of Bayela Plc
                               Cost of capital of Abija Plc
                                        =      N 150,000,000
                                                  0.0968
                                        =      N1.549,586,777
      This implies issuing                     N 1,549,586,777
                                                   N2.40
                                        =     645,661,157 new shares in Abija Plc for
                                              the equity in Bayela Plc
      This is an offer of about 129 new shares in Abija Plc for 100 shares in Bayela Plc
      as follows:                 645,661,157 =       1.29 : 1 or 129 : 100
                                        500,000,000


EXAMINERS‟ REPORT

The question tests candidates‟ knowledge of the different methods of valuing business
units for share exchange under mergers and acquisitions.
Few candidates attempted the question and performance was poor. Many of the
candidates that attempted the question did not understand the concepts tested and
this led to their poor performance.

Candidates‟ commonest pitfalls were their inability to interprete the question correctly
and use of wrong figures in computing the number of shares to be offered to the
shareholders of the target company.
Candidates‟ are advised to always cover the syllabus adequately and give
considerations to all sections of the syllabus in their preparations for the Institute‟s
examinations. They should also improve their knowledge on mergers and acquisitions
for better result in future.




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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
                                    PATHFINDER
QUESTION 5


YEAR          DF (10%)           1            2           3             4


0             1.0000         (6,000,000) (6,000,000) (6,000,000) (6,000,000)


1             0.9091         (409,095)     (409,095)   (409,095)     (409,095)


2             0.8264           __          (396,672)   (396,672)     (396,672)


3             0.7513           __           __         (428,241)     (428,241)


4             0.6830           __           __            __         (430,290)


PV of Costs                (6,409,095) (6,805,767)     (7,234,008) (7,664,298)
PV of Scrap value          4,090,950     3,222,960      2,253,900     1,434,300
NPV                      (2,318,145)     (3,582,807)   (4,980,108)   (6,229,998)
Divide by Annuity factor     0.9091        1.7355        2.4868        3.1698


Annual Equivalent Cost       (2,549,934) (2,064,424) (2,002,617) (1,965,423)




ADVICE


Year 4 has the least Annuity Equivalent Cost; hence the machine should be replaced
every four years.


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         PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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EXAMINERS‟ REPORT

The question tests candidates‟ knowledge of replacement and abandonment decisions.

Many candidates attempted the question and performance was just fair. Most of the
candidates that attempted the question are familiar with the topic but they appear to
have poor understanding of the underlying principles involved in solving it.
Candidates‟ commonest pitfalls were their inability to calculate the Annual Equivalent
Cost (AEC) which is expected to form the basis for the advise. In addition, many
candidates had problems in the lay-out of their solutions and also failed to use the
correct present value.

Candidates are advised to practise with questions on similar topic during their
preparations for the Institute‟s examinations. They should also endeavour to prepare
adequately before sitting for the examinations. The pathfinder and the institute study
packs are strongly recommended for use by candidates.


QUESTION 6

(a)   (i)       Operational planning is concerned with how a specific function or
                operation contributes to the achievement of the department‟s corporate
                priorities and defence tasks. It is required of Senior Managers who are
                tasked with a functional or horizontal responsibility to be well grounded
                in operational planning.

      (ii)      Tactical planning is a continuous process of decision making about the
                accomplishment of outcomes such as what products will be produced,
                how success is measured and evaluated and how budgetary resources
                are allocated. It is a process of developing detailed short–term decision
                about what is to be done, who is to do it and how it is to be done. It is a
                Middle Level Management responsibility.

      (iii)     Strategic planning is the process of developing and maintaining strategic
                fit between the organization‟s goals and capabilities and its changing
                market opportunities. It involves defining a clear company mission,
                setting supporting objectives, designing a sound business portfolio, and
                coordinating functional strategies. It is Top Level Management‟s
                responsibility.

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             PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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(b)   (i)    The functions of the Central Securities Clearing System (CSCS) Include:
              Serving as a central depository for share certificates of companies
                quoted on the Nigerian Stock Exchange;

                Serving as a sub-registry for all quoted securities in conjunction with
                 registrars of quoted companies;

                Issuing Central Securities identification numbers to stockbrokers and
                 investors;

                Clearing and settlement of stock market transactions; and

                Safe keeping / custodian of local and foreign instruments.

      (ii)   Functions of the Securities and Exchange Commission (SEC) include:

                Determining the amount, timing and pricing of securities to be issued
                 in the market;

                Registering all securities to be traded in the capital market;

                Promoting and protecting the integrity of the securities market
                 against abuses arising from insider trading practices;

                Auditing the books of companies and other dealing institutions in the
                 stock exchange.

                Registering all the stock exchange dealers; and

                Determining the basis for allotment of securities in the public offer to
                 ensure a wide spread of ownership.

EXAMINERS‟ REPORT

Part „c‟ of the question tests candidates‟ knowledge of the differences between
strategic, tactical and operational planning under corporate strategy. The „b‟ part tests
candidates‟ knowledge of the functions of one of the key participants in the money
and capital markets. – Securities and Exchange Commission (SEC). In addition, it tests



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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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candidates‟ knowledge of emerging issues in the stock market with particular
reference to the Central Securities Clearing System (CSCS).
Many candidates attempted the question and performance was average. Majority of
the candidates understood the „a‟ part of the question but the „b‟ part was not well
understood. Functions of the Securities and Exchange Commission (SEC) were confused
for the functions of the Central Securities Clearing Systems CSCS.

Candidates‟ commonest pitfalls were their inadequate knowledge of CSCS hence the
mix up in the functions of CSCS and SEC in the part „b‟ of the question. In addition,
some of the candidates did not understand the meaning of the three planning
concepts stated in the question and were therefore unable to give satisfactory
explanation of each.

Candidates are advised to read wide, and in depth for better result. They should not
limit themselves to reading only textbooks but extend their readings to include
business journals, magazines, newspapers and write-ups on the stock exchange and
also familiarize themselves with current development and terminologies for better
result.




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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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ICAN/102/F/4                                    EXAMINATION NO.............................

            THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA
               PROFESSIONAL EXAMINATION II – NOVEMBER 2010
                            ADVANCED TAXATION
                           Time allowed – 3 hours
SECTION A Attempt all questions

PART I MULTIPLE-CHOICE QUESTIONS (20 MARKS)

1.     Under the Personal Income Tax Acts CAP P8 LFN 2004, what is the period of
       assessment for income tax purposes?

       A.      12 months from 1 April
       B.      12 months from 1 January
       C.      12 months from 1 July
       D.      12 months from 30 September
       E.      12 months from 31 December

2.     Which Government Agency is responsible for the administration of the Value
       Added Tax in Nigeria?

       A.      Federal Inland Revenue Service
       B.      Directorate of Value Added Tax
       C.      Federal Ministry of Finance
       D.      State Inland Revenue Service
       E.      Federal Ministry of Justice

3.     How is the legislation currently regulating Company‟s Income Tax in Nigeria
       captioned?

       A.      Company‟s Income Tax Act 1990, as amended
       B.      Finance Miscellaneous Taxation Provisions
       C.      Federal Inland Revenue Board
       D.      Companies Income Tax Act CAP C21 LFN 2004
       E.      Personal Income Tax Act




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         PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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4.   Who bears the cost of an appeal brought before the Tax Appeal Tribunal?

     A.     The Tax Auditors
     B.     The Legal Practitioners
     C.     Each Party to the Appeal
     D.     The Tax Authority
     E.     The Tax Consultants

5.   Which of the following statements is applicable to the grant of full
     tax relief period(s) to a Pioneer Company?

     A.     Two periods of two years each
     B.     One period of two years followed by one period of one year
     C.     One period of three years followed by one period of two years
     D.     One period of two years followed by another period of two years
     E.     Two periods of one year each

6.   What is the tax at specified rate on dividends, rents, royalties and interest
     received as well as payments for contracts of supply executed called?

     A.     Chargeable tax
     B.     Assessable tax
     C.     Adjusted tax
     D.     Withholding tax
     E.     Value Added tax

7.   Which of the following is the correct assessable profit subjected to Education
     Tax?

     A.     Adjusted profit after giving effect to loss relief, balancing charge and
            capital allowance
     B.     Adjusted profit before giving effect to loss relief, balancing charge but
            after capital allowance
     C.     Adjusted profit before giving effect to loss relief, balancing charge and
            capital allowance
     D.     Adjusted profit after giving effect to only loss relief
     E.     Adjusted profit after giving effect to only balancing allowance and loss
            relief.


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8.    The assessable profit of Praise Limited for the tax year 2009 was N7.5 Million,
      with N10 million Loss Relief and N10 million balancing charge. What is the
      education tax payable?

      A.    N110,000
      B.    N130,000
      C.    N145,000
      D.    N150,000
      E.    N90,000

9.    Which of these is an Indirect Tax?

      A.    Value Added Tax
      B.    Capital Gains Tax
      C.    Education Tax
      D.    Companies Income Tax
      E.    Personal Income Tax

10.   Which of the following is an attribute of a good tax system?

      A.    Universality
      B.    Directability
      C.    Indirectability
      D.    Effectability
      E.    Reversibility

11.   Which of the following is NOT a Capital Allowance?

      A.    Annual Allowance
      B.    Personal Allowance
      C.    Investment Allowance
      D.    Initial Allowance
      E.    Balancing Allowance




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12    Which of the following is NOT a duty of the Joint Tax Board?

      A.    To settle disputes among the States as regards tax matters
      B.    To enforce compliance with Federal Government Revenue matters
      C.    To promote uniformity both in the application and incidence of the
            provision of tax laws on individuals throughout the country
      D.    To settle disputes among States with regards to residence and remittance
      E.    To advise the government on request in respect of double taxation
            arrangement, rates of capital allowances and other tax matters

13.   Which of the following is NOT a condition for granting capital allowances?

      A.    The claimant must have incurred qualifying capital expenditure
      B.    The claimant must remain the beneficial owner of the assets at the end of
            the basis period
      C.    The qualifying capital expenditure must be in use mainly for the purpose
            of business of the claimant
      D.    The qualifying capital expenditure must have been in use for at least two
            years
      E.    The qualifying capital expenditure must have been in use during the
            basis period

14.   On which of the following is education tax computed in line with the provisions
      of Income Tax Act Cap C21 LFN 2004?

      A.    Chargeable income
      B.    Assessable profit
      C.    Adjusted profit
      D.    Earned income
      E.    Unearned income

15.   Which of the following is an objective of taxation?

      A.    To raise money for Government officials
      B.    To raise money for Projects only
      C.    To exercise control on Individuals‟ expenses
      D.    To redistribute Income and Wealth of the Citizens


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       PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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     E.    To raise money for States and Federal Inland Revenue Service

16   Which of the following is NOT true for data entry in Excel when applying same
     for tax computations?

     A.    Values may be calculated with the use of formulas
     B.    Data can be calculated accurately
     C.    Information is displayed visually
     D.    Cell can contain only values
     E.    Labels are text headings

17   Which of the following is a member of the Federal Inland Revenue Service
     Board?

     A.    The Registrar General of the Corporate Affairs Commission or his
           representative
     B.    The Auditor General of Nigeria or his representative
     C.    The Accountant General of Nigeria or his representative
     D.    The Secretary of the Joint Tax Board
     E.    A Director in the Federal Budget office

18   What is the due date for filing Annual Tax Returns to Federal Inland Revenue
     Service by an ongoing business?

     A.    Eighteen months from the company‟s accounting year end
     B.    Six months from the company‟s accounting year end
     C.    Five months from the company‟s accounting year end
     D.    Seven months from the company‟s accounting year end
     E.    31December of the year following the year of accounts

19   What is the Principal Place of Residence of a Partner for tax purposes?

     A.    Where he sleeps regularly during the assessment year
     B.    His state of origin as at January of the assessment year
     C.    His employment address as at 1 January of the assessment year
     D.    His place of birth as at 1 January of the assessment year
     E.    The place in which he resides at 1 January of an assessment year




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20.   Which of the following is true of withholding tax?

      A.    It can be used as offset against education tax liability
      B.    It can be used as offset against back year liability
      C.    It is an advance payment of tax which is deducted at source
      D.    It is a tax on contract regarded as final tax
      E.    It is an amount paid to suppliers by Non-Governmental Organisations

PART II SHORT-ANSWER QUESTIONS (20 Marks)

1.    An allowable expense under Petroleum Profit Tax Act Cap P13 LFN 2004, which
      is also a form of tax is called........................

2.    What is the tax imposed on companies that fail to commence business after six
      months of incorporation?

3.    What is the percentage of tax payable available as rebate to a company which
      filed a self assessment?

4.    Conscious refusal to pay tax by committing a criminal act such as making false
      returns to the tax office is called ……………….

5.    What tax is due on gains made on the disposal of chargeable assets?

6.    Which body is charged with the responsibility for imposing and collecting
      Petroleum Profit Tax in Nigeria?

7.    The day when a company‟s pioneer status is deemed to commence is called
      …………….

8.    Under Capital Gains Tax CAP CI LFN 2004, what is claimable when the sales
      proceeds have been fully re-invested in the replacement of assets for the
      purpose of the company‟s business?

9.    When a new firm or business is exempted from the burden of income tax for a
      period of time, such firm or business is said to be on …………………………




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10.   An International Treaty set up by the United Nations to prevent fiscal evasion of
      taxes on income and capital goods between countries is
      called………………………….

11.   An advance payment on account to be applied as tax credit to settle the income
      tax liability of the year to which the income that suffered the deduction relates,
      is called………………………

12.   If a firm of tax consultants was paid an amount of N450,000 by a client, what
      was the gross fee payable?

13.   Further to Question 12, what is the Withholding Tax deducted?

14.   Which principle of taxation provides that those with the same level of income
      should pay the same amount of tax?

15.   The enabling Law for the Federal Inland Revenue Service Board (FIRSB) is
      called …………………

16.   What is the punishment for an offence by any person who obstructs or hinders
      an officer of the Federal Inland Revenue Service in the performance of his/her
      duties?

17.   For a newly incorporated company, due date for filing its first tax returns is
      ………….. months after its accounting year end or ……………… months from
      the date of incorporation, whichever is earlier.

18.   The two types of tax audit embarked upon by the Federal Inland Revenue
      Service are …………. and …………...

19.   The tax payers‟ conscious efforts which involve anticipating a set of
      circumstances and the identification of opportunities to minimize or defer tax
      liabilities within the law is referred to as ………………..

20.   Under the Personal Income Tax Act, CAP P8, LFN 2004, any individual that does
      not have a permanent principal place of residence in a year of assessment is
      referred to as an ………………….




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SECTION B - ATTEMPT QUESTION ONE AND ANY OTHER THREE (60 MARKS)

CASE STUDY

QUESTION 1

STAPLES LIMITED

Staples Limited is a company engaged in the manufacturing and importation of
certain raw materials. The finished products are sold to wholesalers and some to
designated large organizations.

During the course of the audit, it was discovered that the company did not register for
Value Added Tax (VAT). The Managing Director complained that an additional charge
of 5% on his company‟s products, will make them non competitive with similar
products in the market.

Most of his customers also deduct withholding tax from their invoiced values when
making payments.

Required:

As the tax consultant to the company, advise the Managing Director on:
a) The procedure for registration and penalties for non – compliance with the
    provisions of Value Added Tax Cap V1 LFN 2004.                          (7 Marks)
b) The differences between Withholding Tax and Value Added Tax.             (8 Marks)
                                                                   (Total 15 marks)
QUESTION 2

(a)   In accordance with the provisions of Personal Income Tax Act, CAP P8, LFN
      2004, who are the Members of:
      (i)     Joint State Revenue Committee; and
      (ii)    Local Government Revenue Committee?                      (6 Marks)
(b)   State FIVE merits of the withholding tax system.                 (5 Marks)
(c)   List the stages in a typical tax audit process.                  (4 Marks)
                                                                (Total 15 Marks)




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QUESTION 3

(a)   Mrs. Bestfeed has been on active employment as Secretary of a Company since
      1978 and is now preparing for her retirement. Apart from her employment
      emolument, Mrs. Bestfeed runs a private Cybercafé (an enterprise) on
      weekends.

      Her income from various sources in recent years are as follows:


      2009
                                                               N
      Annual Basic Salary                                  3,200,000
      Annual Transport Allowance                             320,000
      Annual Housing Allowance                               640,000
      Annual Leave Bonus                                     740,000
      Overtime                                               274,000
      Benefits in kind (Airtime)                              95,000
      Annual Meal Subsidy                                     32,000
      Entertainment & Utility allowance                       64,000
      Other Income
      Net Interest on Deposits (2008)                        162,000
      Net Interest on Deposits (2009)                        154,800
      Net Rental Income (2008)                               225,000
      Net Rental Income (2009)                               234,000


      Adjusted Profit from Cybercafé in 2008 was N925,000 and Capital Allowances
      computed for the business amounted to N716,000.

      Mrs. Bestfeed is a widow with three children in Private Universities, with total
      school fees payment of N1,250,500 per annum. She also maintains her two
      aged brothers up to N155,000 per annum and pays N120,000 as annual
      mortgage repayment on her personal building, plus an approved pension

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         contribution of 71/2% of her total annual basic salary, transport and housing
         allowances.

         Required:

         Compute Mrs. Bestfeed Chargeable Income and Tax Payable for 2009 Year of
         Assessment.                                                   (11 Marks)

(b)      (i)       What is a Double Taxation Treaty?                            (2 Marks)

         (ii)      Explain the relief available to a Nigerian Company, which has paid tax
                   on a profit upon which Commonwealth Income Tax has been paid.
                                                                                 (2 Marks)
                                                                         (Total 15 Marks)
QUESTION 4

   (a)          Domboshawa Airlines and Logistics Limited, a Zimbabwean Company, was
                duly registered in Hutinre after the country‟s independence in 1980. The
                company is fully involved in the business of transporting passengers and
                goods to and from Nigeria since 1997. It has the following operational
                details for the year ended 31 October 2008.
                                                                                 N
                Operating Income from passenger tickets from Lagos Airport 28,524,000
                Operating Income from passenger tickets from Abuja Airport 17,293,000
                Income from goods loaded into aircraft from Lagos
                and Abuja Airports                                          26,460,000
                Income from passenger tickets outside Nigeria              203,160,000
                Income from goods loaded into aircraft outside Nigeria      74,110,000

                The following expenses were debited to Profit
                and Loss Account for the period:
                  -       Provision for depreciation                          22,990,000
                  -       Administrative and marketing expenses               46,200,000
                  -       Operation Staff Salaries                           123,920,000
                  -       Provision for bad debts (General)                     6,997,000
                  -       Fines paid to Federal Airport Authorities          .3
1,500,000




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Required:

      Using the information given above, compute;

      (i)       The Adjusted Profit of Domboshawa Airlines and Logistics Limited for
               the year ended 31 October 2008.                            (5 marks)

      (ii)     the Nigerian Income tax liability using the current Nigerian Tax rates
               for the relevant year of assessment.                        (5 marks)

(b)   Toluwalase Enterprises Limited had 31 May as its accounting date. The
      company is contemplating on changing its Accounting year end to coincide with
      the Government year end of 31 December.

      You are required to state steps to be followed in determining the Assessable
      Profits, if the change is eventually effected.                      (5 marks)
                                                                   (Total 15 Marks)

QUESTION 5

(a)   Mention any FIVE categories of Instruments that could become subject of Stamp
      Duties under the Stamp Duties Act CAP S8 LFN 2004.                  (5 marks)

(b)   MELTDOWN CONSTRUCTION LIMITED purchased a bulldozer on hire purchase on
      1 February 2007 and paid a sum of N28,500,000 as a deposit on the purchase
      price.

      The cash price of the bulldozer at the time of purchase was N45,000,000, but
      Meltdown Construction Limited was allowed to pay the balance in twenty
      monthly instalments of N1,000,000 each with effect from 1 March 2007.

      You are required to calculate the Capital Gains Tax for the relevant year of
      assessment, assuming that the bulldozer was sold for:
            (i)    N48,400,000 after the payment of instalment on 3 December,
                   2007.                                                 (5 marks)
            (ii)   N49,600,000 after the payment of instalment on 5 September,
                   2008.                                                 (5 marks)
                                                              (Total 15 Marks)


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QUESTION 6

Ofuobi Nigeria Plc, a large multinational entity, has four (4) subsidiaries which are
engaged in the following distinct businesses – Pharmaceuticals, Telecommunications,
Petroleum operations (Extraction) and Agricultural production.

The Group Managing Director has approached you to find a permanent solution to the
recurring problems which the organization is facing regarding tax compliance issues.
He is keen on having in place a system of monitoring regular/prompt compliance by
the Group.

You are aware that each of the subsidiaries has well staffed Finance Department but
not so for the Holding Company.

You believe that the solution to the Group Managing Director‟s problems rests in the
setting up of a Computer Department/Unit within the Group‟s Head Office.

Required:

What are the Key Data/Issues to be maintained by the Department/Units?
                                                                         (15 Marks)
                                     TAX RATES
   1. CAPITAL ALLOWANCES
                                             Initial %           Annual %
      Office Equipment                         50                  25
      Motor Vehicles                           50                  25
      Office Building                          15                  10
      Furniture & Fittings                     25                  20
      Industrial Building                      15                  10
      Non-Industrial Building                  15                  10
      Plant and Machinery – Agricultural
                             Production          95                 NIL
                           – Others              50                 25




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2.    INVESTMENT ALLOWANCE                     10%

3.    TAX – FREE ALLOWANCE:
                                             Maximum Per Year
                                                     N
      Rent                                       150,000
      Transport                                   20,000
      Utility                                     10,000
      Meal Subsidy                                  5,000
      Entertainment                                 6,000
      Leave                                  10% of Annual Basic Salary

4.    PERSONAL INCOME TAX RELIEFS / ALLOWANCES

(a) Personal Allowance         – N5,000 plus 20% of Earned Income
        (b) Children Allowance – N2,500 per annum per unmarried child
                                       subject to a maximum of four children.

      (c) Dependent Relative –   N2,000 each
      (d) Disabled Persons –     N5,000 or 10% of Earned Income (which ever is
                                 higher)
      (e) Life Assurance    –    Actual Premium paid

5.    RATES OF PERSONAL INCOME TAX:
                                  Taxable Income                Rate of Tax
                                        N                              %
      First                           30,000                           5
      Next                            30,000                          10
      Next                            50,000                          15
      Next                            50,000                          20
      Over                           160,000                          25

      Note: Annual income of N30,000 and below is exempted from tax but a
            minimum tax of 0.5% will be charged on the total income.

6.    COMPANIES INCOME TAX RATE              30%
7.    EDUCATION TAX                           2%


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8.    CAPITAL GAINS TAX                      10%
9.    VALUE ADDED TAX                         5%
10.   WITHHOLDING TAXES

      Type of payment                        Rates           Rates
                                          (Companies)   (Non- corporate)
      Dividend, Interest, Rent                10%             10%
      Royalties                               15%             15%
      Contract supplies                        5%             5%
      Building construction activities         5%             5%
      Consultancy/Professional services       10%             5%
      Management services                     10%             5%
      Commissions                             10%             5%
      Technical services                      10%             5%
      Directors fees                          10%             10%




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SOLUTIONS TO SECTION A

PART I MULTIPLE-CHOICE QUESTIONS

1.    B
2.    A
3.    D
4.    C
5.    C
6.    D
7.    C
8.    D
9.    A

10.   A

11.   B

12.   B

13.   D

14.   B

15.   D

16.   D

17.   A

18.   B

19.   C

20.   C

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Tutorial

8. 2/100 x N7,500,000 = N150,000

NOTE:

The balancing charge and the loss relief are not relevant to the calculation.

EXAMINERS‟ REPORT

The questions test various areas of the syllabus.
Candidates‟ performance was generally above average.

Candidates are advised to continue to read all areas of the syllabus.




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PART II         SHORT-ANSWER QUESTIONS

1.        education Tax.
2.        Pre-Operational levy.
3.        The rebate was 1% before the relevant section was repealed in 2007.
4.        tax evasion.
5.        Capital Gains Tax.
6.        Federal Inland Revenue Service.
7.        production day.
8.        Roll-over relief.
9.        Tax holiday.
10.       Double taxation agreement.
11.       Withholding tax.
12.       N450,000.
13.       N22,500.
14.       Canon of horizontal equity.
15.       The Federal Inland Revenue Service (Establishment) Act, 2007.

16.       A fine of N200,000 or an imprisonment of up to three years or both fine and
          imprisonment.

17.       six; or within eighteen.

18.       Desk, field audits.

19.       tax planning.

20.       itinerant worker.




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Tutorials:

12.    The payment of N450,000 includes 5% VAT, hence 5% of N450,000 = N22,500.



       The element of fee in the payment to the Consultants = N427,500. ie N450,000
       – N22,500.
       The client in paying the N427,500 must have deducted 5% withholding tax from
       the fee.

      Therefore      N427,500 = 95% of the fee
      Then           100% = 100/95 x N427,500
                          = N450,000

13.    Since the element of fee in Q12 is N427,500, this must have suffered
       withholding tax of 5%.

       Therefore, Withholding Tax = N450,000 – N427,500 = N22,500.

EXAMINERS‟ REPORT

The questions test all areas of the syllabus.

All the candidates attempted the questions and performance was well above average.

The few candidates that performed poorly in this area are advised to study harder.




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SOLUTION TO SECTION B

QUESTION 1     CASE STUDY

(a)     The Managing Director,
        Staples Limited,
        Ikeja

Dear Sir
Our review of your tax affairs revealed that your company is yet to register with the
Federal Inland Revenue Service (FIRS) for Value Added Tax purpose.

Please be informed that the provisions of the VAT Act Cap VI LFN 2004 requires taxable
persons to register for VAT purpose within six months of incorporating the business.

Find below the steps to be taken to register your company for VAT.

(i)     the company should write a letter of application for registration.
(ii)    Obtain the Vat application form (VAT from 001) from the tax office.
(iii)   complete the form by supplying the following information:
        - The full name of your company;
        - Registered/business address;
        - Company incorporation number: and
        - Date of incorporation.
(iv)    commencement date, nature of business/services to be rendered.
(v)     signature and stamp (bearing the company‟s name) in the relevant sections of
        the application form by the officers of the company.
(vi)    file the application form together with photocopy of the certificate of
        incorporation.
(vii)   Obtain a Tax Identification Number (TIN) after the Federal Inland Revenue
        Service official must have confirmed the receipt of the VAT application and
        sighted the original Certificate of Incorporation.

As vatable person engaged in taxable supplies, you are required to quote the TIN on
all your correspondences with the Federal Inland Revenue Service (FIRS), on all your
invoices, charge VAT at rate of 5% and file monthly VAT returns within 21 days after
the end of every month
The penalties for not complying with Vat provisions include;


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   (i)     a fine of N10,000.00 for the first month for not registering and N5,000.00 for
           each month the failure continues.

   (ii)    a fine of N5,000.00 for every month for not filing Vat returns.

   (iii)   a fine of 150% plus 5% interest above the CBN rediscount rate for failure to
              charge VAT on taxable supplies/services.

(b) DIFFERENCES BETWEEN WITHHOLDING TAX (WHT) AND VALUE ADDED TAX (VAT)
    Withholding Tax (WHT) is an advance payment of Income Tax and the purpose is to
    bring the tax payer to the tax net thereby widening the income tax base. In other
    words, the WHT system is used to track down tax payers and their incomes, which
    may otherwise not be reported by them.

    When income on which WHT is deducted at source is finally brought to the notice of
    the tax authority and the appropriate tax is computed, credit is given for WHT
    deducted at source on the presentation of the original Withholding Tax receipts.

    The tax payer will be required to pay only the balance of the tax due after the
    determination of the final tax liability and the grant of credits for the WHT suffered at
    source. Withholding Tax is nothing more than a collection machinery designed to
    curb tax evasion. It is not a separate tax on its own.

    Value Added Tax (VAT) on the other hand, is a consumption tax, payable on the goods
    and services consumed by any person whether government agencies, business
    organizations or individuals. The target of VAT is consumption of goods and services
    and unless an item is specifically exempted by law, the consumer is liable to the tax.

    With the above explanations coupled with the discussions we had in your office, we
    believe you will have no hesitation in completing the forms attached to this letter.
    We shall be in your office tomorrow to collect the completed forms to enable us file for
    registration in the appropriate VAT office of the Federal Inland Revenue Service
    (FIRS). You will please attach a copy of your Certificate of Incorporation. The Federal
    Inland Revenue Service (FIRS) will, however, require to sight the original. Please
    leave the original Certificate and the completed forms with your secretary. We shall
    endeavour to return same before close of business.




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Should you require further clarifications, please do not hesitate to contact us.

Yours faithfully,


Akangba Jaje & Co.
Consultants.

EXAMINERS‟REPORT

The question tests Value Added Tax, Withholding Tax and Professional opinion.
Performance was below average.
The major pitfall was that the candidates did not understand the question as a
professional advice which requires a good knowledge of the provisions of VAT Act, and
Withholding Tax Act.
Candidates are advised to prepare adequately for the Institute‟s examinations and
understand the nitty gritty of the provisions of the various Acts, the professional duties
of consultants to the clients and ways of writing professional opinion.

QUESTION 2

(a)(i) Members of the Joint State Revenue Committee are:
            - The Chairman of the State Internal Revenue Service who acts as
              Chairman to the Committee;
            - The Chairman of Local Government Revenue Committee;
            - A Representative of the Bureau of Local Government Affairs, not below
              the rank of Director;
            - A Representative of the Revenue Mobilisation Allocation and Fiscal
              Commission (as Observer);
            - State Sector Commander of Federal Road Safety Commission (FRSC) as an
              Observer; and
            - Legal Adviser of the State Internal Revenue Service;
              The Secretary to the Committee – a staff of the State Internal Revenue
              Service. (The secretary is not a member of the committee).
       (ii)   Members of the Local Government Revenue Committee are:
              -      The Supervisor for Finance as the Chairman;

              -      Three Local Government Councilors as Members; and


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               -     Two other persons experienced in Revenue matters to be
                     nominated by the Chairman of the Local Government on their
                     personal merits.

(b)   Merits of Withholding Tax System include;

      (i)      helping to broaden the tax base by bringing many people into the tax
               net.
      (ii)     making tax payment less cumbersome to the tax payer who may not have
               to border themselves going to the Revenue office to perform their civic
               duty.
      (iii)    bringing obscure transactions to the notice of the tax authorities, thus
               increasing tax yield.
      (iv)     reducing the incidence of tax evasion.

      (v)      ensuring a regular inflow of tax revenue to coffers of the various
               governments.
      (vi)     helping to educate the taxpayer as well as the collecting agents.
      (vii)    enhancing voluntary tax compliance.

(c)   Stages in Tax Audit Process include:

      (i)      Selection of the taxpayer to be audited;
      (ii)     Preliminary review of the taxpayer‟s file;
      (iii)    Notification of taxpayer;
      (iv)     Pre-audit meeting;
      (v)      Field work;
      (vi)     Post audit meeting;
      (vii)    Interim audit report;
      (viii)   Post audit review by regional/headquarter‟s audit unit;
      (ix)     Reconciliation meetings; and
      (x)      Final Audit Report;




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EXAMINERS‟ REPORT

The question tests candidates‟ knowledge of composition of Joint State Revenue
Committee and Local Government Revenue Committee, Withholding Tax and Tax Audit
Process.
Many candidates attempted the question and performance was below average.

It was evident that most candidates used residual knowledge by repeating all they
listed in one Committee in the other. Candidates exhibited scanty knowledge of Tax
Audit Process.

Candidates are advised to get good grips of what a question requires as repeating
points in different requirements will not earn them any mark.

QUESTION 3
(a)                            MRS BESTFEED
                           INCOME TAX COMPUTATIONS
                          FOR 2009 YEAR OF ASSESSMENT
                                           N                    N
EARNED INCOME
Employment Income:
- Annual Basic Salary                                          3,200,000
- Annual Transport Allowance                                     320,000
- Annual Housing Allowance                                       640,000
- Annual Leave Bonus                                             740,000
- Overtime                                                       274,000
- Benefit in kind (Airtime)                                       95,000
- Annual Meal Subsidy                                             32,000
- Entertainment & Utility Allowance                               64,000
                                                               5,365,000
Trading Income (PYB)
- Profit from Cybercafé                     925,000
Capital Allowances Restricted (W1)         (616,667)
                                                                 308,333
TOTAL EARNED INCOME                                            5,673,333

UNEARNED INCOME
2009 Gross Interest on Deposits (W2)       172,000
2009 Gross Rental Income (W3)              260,000


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TOTAL UNEARNED INCOME                                 432,000
TOTAL INCOME                                        6,105,333
General Charges and Non-Taxable
Payments
- Mortgage Payment                    120,000
- Pension Contribution (W4)           312,000
- Housing Allowance                   150,000
- Transport Allowance                  20,000
- Meal Subsidy                          5,000
- Utility Allowance                    10,000
- Entertainment Allowance               6,000
- Leave Allowance (W5)                320,000
                                                      (943,000)
STATUTORY TOTAL INCOME                               5,162,333

Reliefs

Personal Allowance
       (N5,000 + 20% of N5,673,333)   1,139,667
Children Allowance (N2,500 x 3)           7,500
Dependant Relatives (N2,000 x 2)           4,000
                                                    (1,151,167)
CHARGEABLE INCOME                                  4,011,166

TAX DUE
              N                                          N
First        30,000   @ 5%                              1,500
Next         30,000   @ 10%                             3,000
Next         50,000   @ 15%                             7,500
Next         50,000   @ 20%                            10,000
Next      3,851,166   @ 25%                           962,792
          4,011,166                                  984,792
          =====

Tax Suffered at source
On Dividend (W2)                      18,000
On Rent      (W3)                     25,000
                                                       (43,000)
Net Tax Payable                                       941,792


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WORKING NOTES

W1    Capital Allowances:                                            N
      Capital Allowance available                                  716,000
      C/A Restricted to 662/3 of N925,000                         (616,667)
      Unabsorbed C/A C/Fwd                                          99,333

W2
      2009 Gross Dividend = 100/90 x 162,000/1              =     N180,000
      W/Tax on Dividend = N180,000 – N162,000               =       18,000

W3
      2009 Gross Rental Income = 100/90 x 225,000/1       =       N250,000
      W/Tax on Rent            = N250,000 – N225,000      =        N25,000

W4    Pension Contribution:
                                                                     N
      Annual Basic Salary                                        3,200,000

      Annual Transport Allowance                                   320,000
      Annual Housing Allowance                                     640,000
      Gross Salary                                              4,160,000
      Pension Contribution @ 7½%                                N 312,000

W5    Allowable Leave Bonus
      Restricted to 10% of Annual Basic Salary
      Of N3,200,000                                 =      /100 of N3,200,000
                                                          10

                                                    =     N320,000
(b)
      (i)    Double Taxation Treaty:
             A double taxation treaty is a bilateral agreement aimed at affording
             relief from double taxation, by exempting certain classes of income from
             one or other of the territories which are parties to such agreement.

      (ii)   Commonwealth Relief to a Nigerian Company:




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             Where a Nigerian Company (Resident Taxpayer) has paid tax on a profit,
             upon which Commonwealth Income Tax has been paid; such company
             will be entitled to relief as follows:

          If the Commonwealth Rate of Tax (CRT) does not exceed one half of the
           Nigerian Rate of Tax (NRT), the rate at which relief is to be given shall be
           the Commonwealth Rate of Tax (CRT).

           That is:
                  If CRT < ½ NRT; Relief = CRT.
          In any other case, the rate at which relief is to be given shall be one half
           of Nigerian Rate of Tax (NRT).

             That is:
                    If CRT > ½ NRT; Relief = ½ NRT

EXAMINERS‟ REPORT

The question tests knowledge of Personal Income Tax, with regards to earned Income,
unearned Income, disallowable expenses, reliefs, grossing up of Interest Income and
calculation of Tax Due.

Many candidates attempted the question but performance was average.
Candidates could not segregate earned Income from unearned Income, and statutory
total income. Candidates‟ knowledge of Double Taxation Treaty and Commonwealth
Reliefs was scanty.

Candidates are advised to work harder before sitting for the Institute‟s examinations,
especially a question that deals on practical daily occurrences of Personal Income Tax
should be a point of interest to them.




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QUESTION 4

(a) (i)
                  DOMBOSHAWA AIRLINE AND LOGISTICS LIMITED
                     COMPUTATIONS OF ADJUSTED PROFIT
                    FOR THE YEAR ENDED 31 OCTOBER, 2008

                                        N               N
NIGERIAN INCOME

Operating Income from
Lagos Passengers tickets            28,524,000

Operating Income from
Abuja Passengers tickets            17,293,000

Income from Goods on Lagos
and Abuja rate                      26,460,000
                                                     72,277,000

INCOME FROM OTHER ROUTE
Income from Passengers tickets
outside Nigeria                     203,160,000

Income from Goods loaded
outside Nigeria                      74,110,000
                                                    277,270,000
GLOBAL INCOME                                       349,547,000

Allowable Expenses
Administrative & Marketing            46,200,000
Operation Staff Salaries             123,920,000
                                                    (170,120,000)
ADJUSTED PROFIT                                      179,427,000




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(ii)                DOMBOSHAWA AIRLINE AND LOGISTICS LIMITED
                             INCOME TAX LIABILITY
                             FOR 2009 ASSESSMENT

           Adjusted Profit Ratio
                                 =      Adjusted Profit x 100
                                        Global Income
                                  =     179,427,000 x 100
                                        349,547,000
                                  =     51.33%
           Depreciation Ratio
                                  =    Depreciation x 100
                                       Global Income
                                  =    22,990,000 x 100
                                      349,547,000
                                  =    6.58%
           Capital Allowance
                                  =     Depreciation Rate x Nigerian Income
                                  =     N6.58% x 72,277,000
                                  =     N4,755,827

                                                 N                    N
       Nigerian Adjusted Profit                                  72,277,000.00

       Capital Allowances
       For the year                           4,755,827.00
       Relieved
       (Restricted to 66.67% of N72,277,000)
              = 48,184,667         limited to                     (4,755,827.00)
                         -
       Taxable Profit                                            67,521,173.00

       Income Tax Liability thereon @ 30%                         20,256,352.00

WORKING NOTES

The following expenses are disallowed for tax purpose under CITA, CAP C18, LFN 2004:
    Depreciation of N22,990,000
    General Bad Debts Provision of N6,997,000


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     Fines paid to Federal Airport Authorities N1,500,000.
    Note:
      Only specific bad debts are allowable for tax purpose.
(b)    Steps to be followed in determining Assessable Profit for Change of Accounting
       Date
       (i)    Determine the year in which the change occurs. The year of change is
              that which the company fails to make up its accounts based on the old
              date.
       (ii)   Determine the first three discretionary years commencing from the first
              year determined in (i) above.
       (iii) Calculate the assessable profits for the three discretionary years on the
              old accounting date basis.
       (iv) Calculate the assessable profit for the three discretionary years on the
              new accounting date basis.
       (v)    It is the practice of the Federal Inland Revenue Service to choose the
              higher of (iii) and (iv) above.

EXAMINERS‟ REPORT

The „a‟ part of the question tests candidates‟ knowledge of Taxation on foreign air
operation with respect to transportation of passengers and goods to and from Nigeria,
while the „b‟ part tests candidates‟ knowledge of change of accounting date.
Less than 75% of the candidates attempted this question and performance was below
average.
Candidates did not understand the calculation of adjusted Profit ratio, the
depreciation ratio and the use of depreciation ratio in calculating capital allowances.
Candidates are advised not to relegate any part of the syllabus to the background.
They need to have adequate knowledge of all parts of the syllabus.

QUESTION 5
(a) Categories of Instruments subject to Stamp Duties under the Stamp Duties Act,
   CAP S8, LFN 2004 include:
   1.    Agreements;
   2.    Appraisement;
   3.    Bank Notes, Bills of Exchange and Promissory Notes;
   4.    Bills of Exchange;


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      5.          Bills of Lading;
      6.          Contract Notes;
      7.          Conveyances on sale and other conveyances;
      8.          Duplicates and Counterparts;
      9.          Exchange, Partition or Division;
      10.         Leases;
      11.         Letters or Power of Attorney and Voting Powers;
      12.         Marketable Securities;
      13.         Mortgages;
      14.         Notarial Acts;
      15.         Policies of Insurance;
      16.         Receipts;
      17.         Settlements;
      18.         Share Warrants;
      19.         Warrants for Good; and
      20.         Share Capital of Companies.
      21.         Documents requiring postage stamp: and
      22.         Transactions in the Capital Market.


(b)         (i)                      MELTDOWN CONSTRUCTION LIMITED
                                     COMPUTATIONS OF CAPITAL GAINS TAX
                                       FOR 2007 YEAR OF ASSESSMENT

                                                 N              N            N

Sales Proceed of Bulldozer                                               48,400,000

Cost of Bulldozer

Deposit Paid                                               28,500,000



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Instalments Paid
(10 months @ N1,000,000 each) 10,000,000

Interest Portion paid (W2)                           (1,750,000)
                                                      8,250,000
                                                                      (36,750,000)

Chargeable Gains                                                          11,650,000
Capital Gains Tax thereon @ 10%                                            1,165,000

      (ii)
                      MELTDOWN CONSTRUCTION LIMITED
                     COMPUTATIONS OF CAPITAL GAINS TAX
                         FOR 2008 YEAR OF ASSESSMENT
                                     N             N                          N

Sales Proceed of Bulldozer                                                 49,600,000

Cost of Bulldozer

Deposit Paid                                            28,500,000

Instalments Paid
     (19 months @ N1m each)            19,000,000

     Less Interest Portion paid (W3)   (3,325,000)
                                                      15,675,000

                                              (44,175,000)
      Chargeable Gains                                               5,425,000
      Capital Gains Tax thereon @ 10%                                 542,500

WORKING NOTES

(W1) Calculation of Hire Purchase Interest
                                                              N
      Hire Purchase Price:
      -     Deposit (1/2/2007)                               28,500,000
      -     20 Instalments Payable


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             (March 2007 to October 2008)
             @ N1,000,000 per month                          20,000,000

                                                             48,500,000

      Cash Price                                           45,000,000)

      Hire Purchase Interest for 20 months                   3,500,000

(W2) Calculation of Hire Purchase Interest up to 1/12/2007

      Hire Purchase Interest Payable                         N3,500,000

      Hire Purchase Interest at the time
      of Disposal – 3/12/2007

      N3,500,000     x   10
         20                                            N1,750,000

(W3) Calculation of Hire Purchase Interest up to 1/10/2008
     Hire Purchase Interest for 19 months
     at the time of Disposal (i.e. 5/9/2008)
            =      N175,000 x 19months                     N3,325,000

EXAMINERS‟ REPORT

The question tests candidates‟ knowledge of instruments subject to Stamp Duties and
Hire Purchase installments in Capital Gain Tax.

Many candidates attempted the question, but performance was very poor.
Majority of the candidates did more of guess work in listing the instruments that could
become subject of Stamp Duties in the „a‟ part of the question. The „b‟ part was
completely misunderstood by majority of the candidates.

Candidates are advised to study adequately with the aim of having basic knowledge of
these areas of the syllabus.




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QUESTION 6

KEY DATA AND ISSUES INVOLVED IN INSTALLING A GOOD COMPUTERISED TAX
COMPLIANCE MONITORING SYSTEM IN THE GROUP‟S HEAD OFFICE
In view of the desire of the Group Managing Director in finding a permanent solution
to the problems encountered in monitoring regular and prompt compliance with tax
issues by the Group, it is recommended as follows:

HARDWARE

An Information Technology (IT) consultant and other members of the steering
committee should be appointed to supervise the selection and purchase of appropriate
computer hardware for installation.

SOFTWARE

Compatible software should also be purchased that will network all modules for ease
of preparation of monthly report and meeting all recurrent obligations including Tax
matters.

ISSUES

(a)   The new process will provide data of what constitutes income for tax purposes
      for each subsidiary. When correctly done, VAT resulting from turnover will be
      ascertained,

(b)   Detailed records of all purchases especially to capture input VAT incurred on
      purchases,

(c)   Details of Fixed Assets and calculation of monthly depreciation.

(d)   Details of allowances and reliefs claimable for Agricultural and Petroleum
      Operations. Also, other details of allowable expenses in all the various
      departments in accordance with the Companies Income Tax Act Cap C21 LFN
      2004 and Value Added Tax Cap VI LFN 2004 should be contained in the system.

(e)   Due dates for filing annual tax returns, monthly Value Added Tax Returns and
      monthly Pay As You Earn (PAYE) returns.

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(f)   Schedule of deduction and payment of Withholding Tax.

(g)   Tax Identification Number (TIN) of each of the companies within the group.

(h)   All the tax computations for all relevant years of assessment, capital allowance
      and taxes paid.

(i)   Monitoring of status of tax compliance by both the Holding Company and the
      Subsidiaries

(j)   Adequate training and workshops for staff members concerned.


EXAMINERS‟ REPORT

This question tests candidates‟ knowledge of the use of Information Technology in
taxation.

Few candidates attempted the question and performance was poor.

Candidates‟ knowledge of this area of the syllabus appeared to be grossly inadequate.
Candidates are advised to have basic knowledge of Information Technology as it
relates to taxation.




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ICAN/                                              EXAMINATION NO..............................

                THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA
                   PROFESSIONAL EXAMINATION ll - NOVEMBER 2010
                       PUBLIC SECTOR ACCOUNTS AND FINANCE

                                  Time allowed – 3 hours

SECTION A: Attempt All Questions

PART I         MULTIPLE-CHOICE QUESTIONS (20 Marks)

1.       Which of the following is the biggest revenue source in recent times in Nigeria?

         A.    Companies Income Tax.
         B.    Education Tax.
         C.    Capital Gains Tax.
         D.    Petroleum Profits Tax.
         E.    Import/Excise Duties.

2.       Which of the following is NOT an example of “financing activities” in the
         preparation of government accounting cash flow statement?

         A.    Proceeds from loans.
         B.    Proceeds from the sale of assets.
         C.    Proceeds from bank overdraft.
         D.    Dividends received.
         E.    Repayment of loans.

3.       Into which account are the proceeds of the PAYE of the Armed Forces, Police
         Forces, Foreign Service officers and Residents of the Federal Capital Territory
         paid?

         A.    Special Fund Account.
         B.    Development Fund Account.
         C.    Contingency Fund Account.
         D.    Federation Account.
         E.    Consolidated Revenue Fund Account.




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4.   Which Warrant is expected to be in operation for a maximum of six months or
     until the budget has been approved?

     A.    Supplementary (Contingency) Warrant.
     B.    Annual General Warrant.
     C.    Provisional General Warrant.
     D.    Supplementary General Warrant.
     E.    Supplementary (Statutory Expenditure) Warrant.

5.   For which of the following will corporations NOT obtain the approval of the
     Supervising Ministry?

     A.    The budget.
     B.    Signing of foreign agreement.
     C.    Payment of staff monthly salaries.
     D.    The bye laws.
     E.    Increasing the price of its goods and services.

6.   The main objective of government is to

     A.    provide adequate welfare.
     B.    stabilize balance of trade.
     C.    increase its expenditure.
     D.    reduce its income.
     E.    determine supply.

7.   Which of the following statutory officers does NOT have his salaries and
     consolidated allowances chargeable directly to the Consolidated Revenue Fund?

     A.    Commissioner of the Police Service Commission.
     B.    Accountant – General of the Federation.
     C.    Chairman Code of Conduct Bureau.
     D.    Chief Judge of the Federal Court of Appeal.
     E.    Chairman Federal Character Commission.

8.   Which of the following standards sets out the requirements for financial
     reporting by governments and other related public sector organizations?

     A.    International Government Accounting Standards.
     B.    International Accounting Standards.
     C.    International Public Sector Accounting Standards.

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      D.    International Financial Reporting Standards.
      E.    Government Accounting, Auditing and Financial Reporting Standards.

9.    To which of the following can any officer found guilty of the contravention of
      any of the provisions of the Code of Conduct Tribunal appeal?

      A.    Magistrate Court.
      B.    Court of Appeal.
      C.    Supreme Court.
      D.    Federal High Court.
      E.    State High Court.

10.   Which of the following is a „not-for-profit‟ entity expected to prepare?

      A.    Trading and Profit and Loss Account.
      B.    Balance Sheet.
      C.    Value Added Statement.
      D.    Cash Flow Statement.
      E.    Income and Expenditure Account.

11.   Which of the following ratios does not indicate the working capital of a
      parastatal?

      A.    Current ratio.
      B.    Quick ratio.
      C.    Gearing ratio.
      D.    Debtors‟ payment period.
      E.    Creditors‟ payment period.

12.   Which of the following is a disadvantage of payback period method of
      investment appraisal?

      A.    It is a measure of liquidity.
      B.    It is used as a safeguard against risk.
      C.    It is not difficult to calculate and understand.
      D.    It does not consider the time value of money.
      E.    It serves as a useful screen to evaluate projects.




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13.   Which of the      following   is   NOT   a   Memorandum     Accounts   Book    in
      Government?

      A.    Departmental Vote Expenditure Allocation Book.
      B.    Dishonoured Cheques Register.
      C.    Paper Money Register.
      D.    Cash Book.
      E.    Cheque Summary Register.


14.   Which of the following entries records the purchase of sodium chloride, for cash,
      by Atuma State Water Corporation?

      A.    Debit Materials Account, Credit Goods Account
      B.    Debit Cash Account, Credit Goods Account
      C.    Debit Materials Account, Credit cash Account
      D.    Debit Cash Account, Credit Purchases Account
      E.    Debit Materials Account, Credit Stock Account.

15.   What is the budgeting technique which requires every item of
      expenditure to be justified as if the activity or programme is taking
      off for the first time?

      A.    Incremental budgeting.
      B.    Line item budgeting.
      C.    „Zero-base‟ budgeting.
      D.    Planning, programming and budgeting system.
      E.    Performance budgeting.

16.   What is the revenue allocation principle which requires that the States from
      which the bulk of revenue is generated should receive an extra share above
      other States?

      A.    Derivation.
      B.    Generation.
      C.    Even development.
      D.    National interest.
      E.    Independent revenue.




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17.   Which of the following fiscal policy measures can help to protect infant
      industries?

      A.   Increase in Value-Added Tax rate
      B.   Increase in import duties.
      C.   Increase in export duties.
      D.   Increase in excise duties.
      E.   Reduction in subsidies.

18.   Which of the following is NOT an instrument of government‟s domestic
      borrowing?

      A.      Treasury Bills.
      B.      Treasury Certificates.
      C.      Bill of exchange.
      D.      Government Development Stocks.
      E.      Revenue Bonds.

19.   Which of the following international financial institutions grants balance of
      payments support facilities to countries in need?

      A.      London Club of Creditors.
      B.      Paris Club of Creditors.
      C.      The World Bank.
      D.      International Monetary Fund.
      E.      African Development Bank.

20.   Which of the following is an instrument of fiscal policy?

      A.      Discount rate.
      B.      Open Market Operation.
      C.      Reserve requirements.
      D.      Government expenditure.
      E.      Selective credit control.




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PART I SHORT-ANSWER QUESTIONS (20 Marks)

1.    The sourcing of the cash requirements of a public sector organization and the
      effective application of same in such manner that projects are executed
      unhindered is known as_______________________

2.    A summary of total receipts and payments as posted in the cash book of a self-
      accounting unit is called______________________

3.    A debt for which no fund has been set up and whose maturity period is short is
      known as________________________

4.    The supervision of the activities of a government entity with the authority and
      responsibility to control or exercise significant influence over the financial and
      operating decisions of the organization is called_____________________

5.    The method adopted where the implementation of a project is to be accelerated
      is known as_____________________

6.    Evidence that a contractor or supplier has performed its obligation under a
      procurement contract up to a level stipulated but not implying completion is
      called___________________

7.    Under the Fiscal Responsibility Act of 2007, the projected amount expected to
      be utilized in granting tax reliefs, tax holidays and tax concessions
      is_____________

8.    Not later than ninety days following the end of each year, the distribution from
      the Federation Account shall be rendered to both Houses of National Assembly
      by the _____________________

9.    The sharing of revenue among the States of the Federation is called
      ____________

10.   A non-statutory discretional assistance from the Federal Government to a State
      which is not tied to a particular project is a ____________

11.   The use of taxation and public expenditure by the government to influence
      aggregate economic activities is called ____________

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12.   In taxation, the object being taxed, such as income or property, is the
      ____________

13.   The spill-over effects of the production and consumption activities of economic
      units such as pollution on others are called ____________

14.   A National Plan which is adjusted yearly in keeping with the requirement of the
      economy is called ____________

15.   The independent body charged with the responsibility of sharing revenue
      among the three levels of government in Nigeria is the ________________.

16.   The economic system which encourages private ownership of resources is
      called_________________

17.   State any two criteria of revenue allocation in Nigeria.

18.   The tax structure that tends to bridge the income gap between the rich and poor
      is the ________________.

19.   A public debt for which no provision is made for its repayment is known
      as________________.

20.   Taxes levied on goods and services are classified as ___________________


SECTION B: ATTEMPT QUESTION 1 AND ANY OTHER THREE (60 Marks)

QUESTION 1

CASE STUDY – WORN OUT CONTROLS

GETWELL Specialist Hospital was hurriedly commissioned when there was an outbreak
of cholera epidemic in Baraje town, by the EMMONY State Government in January,
2006.

The first external auditor had been qualifying his report annually because
“everything” on internal control was virtually upside down, except the regular
provisions of the health care to the patients. The external auditor clamoured for the


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establishment of an Internal Audit Department as a panacea to curb, correct and arrest
the collapse of the “internal control.”

The unit was eventually established in December, 2008. In addition to the normal
routine assignments of the unit, it was mandated as a matter of urgency, to review the
financial statements of the hospital for the period, 1 January to 31 December, 2008,
which the external auditor will work upon in April, 2009.

The Internal Audit unit submitted a comprehensive interim report covering the
operations in the following departments: Finance/Accounts, Stores, Pharmacy and
General Out-patients. The report was catalogue of woes, disaster, colossal losses,
misappropriations, etc. Extracts from the report are highlighted below:

(i)     The losses and shortages in all the units visited were colossal because of the
        obvious “worn out controls” in the hospital;
(ii)    The records in all the stores, especially the Main/Central Store were
        inadequately and wrongly prepared. Records were kept in arrears of five to six
        months. More than 80% of the physical items identified in the stores had no
        bearing to their store records;
(iii)   The only attempt at “stock taking” ever done was in mid – 2008 by the stores
        personnel and there were no acceptable records of the exercise;
(iv)    Items received into the Main/Central store for which payments were made had
        their “invoices” and “goods received notes” not processed in the store;


(v)     Issues from the stores were not rightly executed; nearly every issue was done in
        hurry and for emergency sake;
(vi)    Fixed assets, particularly/motor vehicles, accident vehicles, generators,
        intensive care equipment, X-ray equipment etc, could not be ascertained with
        accuracy. There was no fixed assets register.
(vii)   Cash count at the Treasury and all cash points were non-existent. There were
        bank reconciliation statements on four out of the eleven operated. These bank
        reconciliation statements were haphazardly prepared, hence they were
        misleading;
(viii) Less than 60% of the cash takings in the hospital in the last three months had
       been banked and the balance had been used to grant advances and pay staff
       salary/wage. Cash records were in arrears for over four months and three of the


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       seven cashiers had absconded with the hospital‟s fund and a principal officer in
       the Treasury is missing; and
(ix)   There was a long list of unsettled cash advances and cheque exchange, most of
       which were not properly authorized. Despite the seriousness of this action,
       management did not take appropriate disciplinary action against the cashiers.
       The internal audit department was worried over the situation and had advised
       the management of the hospital to call for a “Board of Enquiry” or “Losses
       Committee” to ascertain and recover the colossal losses and shortages.

You are required to:

(a)    State the TWO types of losses incurred in this hospital.
                                                                                (2 marks)
(b)    State any FOUR major likely causes of the colossal losses in this hospital.
                                                                               (4 marks)
(c )   In line with the provisions of the Financial Regulations, 2006, is the „Losses
       Committee‟ the more appropriate in this situation then the „Board of Enquiry‟?
                                    (2marks)
(d)    State any FIVE issues to be considered before setting up a „Board of Inquiry‟.
                                                                                 (5marks)
(e)    Give any TWO reasons why cheque exchange and/or cash advance is considered
       a serious offence.                                                   (2 marks)
                                                                        (Total 15 marks)

QUESTION 2

Ireakari Local Government is considering projects A and B which have the following
cash flows:

Year                          0        1         2          3          4         5
Cash flows        A (N)     1,300     250       750        400        150       100
                  B (N)     1,200     400       500        600        600       300

Required:

(a)    Use the table above to compute the Net Present Value (NPV) of the two projects,
       given that the cost of capital is 15%. All calculations to 2 decimal places.

                                                                              (11 Marks)

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(b)      Advise the government on which of the projects to undertake and give reasons
         for your answer.                                                  (4 Marks)
                                                                   (Total 15 Marks)

QUESTION 3

Confluence Local Government is considering embarking on an investment and has
been presented with the following three alternatives:

                                        EL                   EM                    EN
                                      N‟000                  N‟000                 N‟000
      Initial Cash Outlay             15,000                20,000                20,000
      Residual Value                   1,000                 1,000                 1,000

                                       EL                    EM                    EN
                                      N‟000                  N‟000                 N‟000
                Yr 1                  6,000                 10,000                 1,000
                Yr 2                  7,000                 10,000                 6,000
                Yr 3                  8,000                  1,000                10,000
                Yr 4                  9,000                  1,000                20,000

Assume that the projects are mutually exclusive.

You are required to advise the Council on the most viable project, using

(a)      Payback period; and                                             (5marks)
(b)      Accounting Rate of Return, methods.                             (10 marks)
                                                                  (Total 15 Marks)

QUESTION 4

The following transactions were anticipated by the office of the Accountant-General of
Falcun Federation for the year ended 31 December 2009:

                                        N(million)
Revenue Anticipated:
Import duties                             35,000
Export duties                            118,000
Excise duties-Local companies          1,875,000

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Petroleum profit tax                     625,500
Capital gains tax                         87,000
Royalty on oil                           900,000
Crude oil sales proceeds                 750,000
Companies income tax                      75,000
Personal income tax:
Military personnel                        70,000
Officers of the Foreign Affairs Ministry  35,000
Residents of Federal Capital Territory    45,350
Quarrying licenses                        42,900


                                        N(million)
Medical fees                             96,540
Visa Fees                                65,500
Repayment of loan by Local Govt.        730,000
Rent of Government Land                 225,000
Overpayment Recoverable                  95,000

The following expenditure items were also anticipated:

                                        N(million)
a.      Establishment cost                807,500
b.      Personnel cost                  1,267,500
c.      Special expenditure               312,500
d.      Transfer to Development Fund      425,000

During the year, the following transactions took place:

(i)     Balance on the Consolidated Revenue Fund as at 1 January, 2009 was N850,
        725 million;

(ii)    There was a problem in Bayana State which gave rise to N1,750 million
        being withdrawn from the Contingency Fund. However, N1,365
        million was transferred back before 31 December, 2009;

(iii)   Due to incessant political crisis in the Federation, only 80 per cent of the
        budgeted revenue was realized. Similarly, the expenditure incurred was limited
        to 75% of the estimated figures; and


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(iv)     The balance in the Federation Account as at 31 December, 2008 was N1,800
         billion.
You are required to:

(a)      Prepare the Federation Account Statement as at 31 December, 2009 and
         distribute same, based on the existing revenue sharing formula, viz:

         Federal                          48.6 per cent
         States                           24.0 per cent
         Local Governments                20.0 per cent
         Special Fund                     7.5 per cent                 (5 ½ marks)

(b)  Prepare the Consolidated Revenue Fund for Falcun Federation for the period
     under review, in accordance with the provisions of the Finance (Control and
     Management) Act 1958 (as Amended)                                (9 ½ marks)
                                                                 (Total 15 marks)
QUESTION 5

(a)      We have various users of Public Sector Accounting information. State any THREE
         internal users and any THREE external users of the information.
         (6 Marks)

(b)      State six differences between Government Accounting and Private Sector
         Accounting.                                             (9 Marks)
                                                             (Total 15 Marks)

QUESTION 6
                    RIVER BASIN AUTHORITY, OLUOKUN STATE
  INCOME AND EXPENDITURE ACCOUNTS FOR THE YEAR ENDED 31 DECEMBER, 2009
                                                 N                N
           Gross Income                                      41, 100, 000
           Costs incurred

      Salaries and Pension                      15,000,000
      Purchase of weed control chemical
                                                  3,600,000
      Depreciation (tractors, etc)                2,000,000
      Lubricants and Oil                          1,600,100


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      Purchase of stationery                    1,100,100
      Utility (water, light, etc)                 500,000               (23,800,200)
                                                                          17,299,800

      Interest due

      Bank loan                                 1,040,000
      Agric bank loan                           2,960,000                (4,000,000)
      Surplus realized on
      Ordinary operations                                                 13,299,800
      Surplus for last year b/f                                            9,500,200
      Surplus carried forward                                             22,800,000

You are required to:

(a)      Prepare the Value Added Statement for the year ended 31 December, 2009;
                                                                           (10 marks)
(b)      Briefly differentiate between “Value-Added” and
         “Value Added Statement.”                                           (5 marks)
                                                                     (Total 15 marks)

SOLUTIONS TO SECTION A

PART l MULTIPLE CHOICE QUESTIONS
  1.       D
  2.       B
  3.       E
  4.       C
  5.       D
  6.       A
  7.       B
  8.       C
  9.       B
  10.      E
  11.      C
  12.      D
  13.      C
  14.      C
  15.      A


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      16.         B
      17.         C
      18.         D
      19.         D
      20.         D

EXAMINERS‟ REPORT

The questions have a good spread and adequately cover the two aspects of the
syllabus – the public sector accounts and public finance. The candidates performed
creditably well.

PART II SHORT-ANSWER QUESTIONS

1.          Cash control.
2.          Transcript.
3.          Floating debt.
4.          Oversight.
5.          Selective or Limited Tender procedure.
6.          Interim Performance Certificate.
7.          Tax Expenditure Projections.
8.          Accountant-General.
9.          Horizontal Revenue Allocation/Horizontal Distribution.
10.         General or Non-matching grant.
11.         Fiscal policy.
12.         Tax base.
13.         Externalities.

14.         Rolling plan
15.         Revenue Mobilization Allocation and Fiscal Commission (RMAFC).
16.         Capitalism/Capitalist Economy/Free Enterprise/Market Economy/System/Liassez-
            faire.
17.         Derivation, Even development, Need, National interest, Equality of
            states, Independent Revenue, Population
18.         Progressive.
19.         Unfunded.
20.         Indirect.


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EXAMINERS‟ REPORT

The short answer questions test the various aspects of the syllabus. Candidates‟
performance was generally above average, an indication that they were generally
exposed to the various aspects of the syllabus. Candidates can still improve by
familiarizing themselves with new principles, concepts and technical terms related to
this subject.

SOLUTIONS TO SECTION B

QUESTION 1

CASE STUDY

Two types of losses in the hospital are:

(a)   (i)     Loss of stores; and
      (ii)    Loss or shortages of funds.

(b)   Likely major causes of losses include:

      i)      Poor or weak internal control.
      ii)     Inadequate record keeping of essential books.
      iii)    Lack of sound stores control and management.
      iv)     Obvious non-existence of cash and bank operation control.
      v)      Non-existence of the required controls on fixed assets.
      vi)     Poor staffing, putting a “square peg in a round hole” and no standard
              organizational set up.
      vii)    Delayed introduction of the Internal Audit Department;
      viii)   The hospital was hurriedly commissioned without any plan, rules and
              regulations to guide its operations; and
      ix)     Non-adequate consideration of the external auditors‟ recommendations.


(c)   The “Board of Enquiry” is more appropriate/applicable here

(d)   The Board of Enquiry should be set up If

      i)      fraud is probable;
      ii)     the loss is substantial;
      iii)    several officers are involved;

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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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                  iv)   the responsibility of officers is not clearly defined;
                  v)    the loss took place over a period of time; and
                  vi)   collution is suspected.

            (e) Cheque exchange and/or cash advance is considered a serious offence because it

                 i)     is a veritable tool for fraud;
                 ii)    could be used to conceal the true position of case on hand;
                 iii)   is a good example of „teeming and lading;
                 iv)    may impair the liquidity position of the hospital; and
                 v)     deprives an organization the use of its resources.

           EXAMINERS‟ REPORT

           The question tests candidates‟ understanding of some aspects of treasury procedures
           on loss of funds and stores, and internal control system in a public institution.
           Candidates are expected to demonstrate familiarity with the provisions of the Financial
           Regulations (2006).

           All the candidates attempted the question. The general performance was average.
           There was a clear indication that candidates did not have proper understanding of the
           Financial Regulations relating to the issues that were tested in the question.
           Candidates are advised to always take some time to understand case studies before
           attempting the questions. It is also necessary for candidates to familiarize themselves
           with Financial Regulations and other relevant publications.

           QUESTION 2

           (a)    IREAKARI LOCAL GOVERNMENT PROJECTS EVALUATION

                                          PROJECT                                       PROJECT B
                                                A
 Year       Di Discounting
        Year Cash flows Values                                    Cash flows                 Values
               Factor                                                     (N)
15%dD           (N)      (N)                 (N)                                                 (N)
                  15%
          0      1.00 (1          (
                              (1,300)     (1,300)                     (1,200)               (1,200)
 0.87     1
        0.87     0.87           250       217.50                          400               348.00
 0.76     2
        0.76     1.76           750       570.00                          500               380.00


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0.66     3
       0.66     1.66          400        264.00                      600                   396.00
0.57     4
       0.57     1.57          150
                                85.50     85.50                      600                   342.00
0.50     5
       0.50     1.50 100      100
                                50.00     50.00                      300                   150.00
                                         (113.00)                                          416.00

          Formula:
          NPV
          where
          A     −      cash flow
          r     −      cost of capital (15%)
          C     −      initial outlay
          t     −      time

          NPVA =       N (− 1,300 + 1,187)     = N − 113.00

          NPVB =       N (− 1,200 + 1,616) = N 416.00

          (b)    Based on the above calculations, Ireakari local government should embark on
                 project B because it gives a positive Net Present Value (NPV) of N416.00. This
                 means that project B is more viable as its investment value obtained is higher
                 than its outlay.

                 DISCOUNT TABLE

                             DISCOUNT                       TABLE
                             Year                           DF 15%
                             0                              1.000
                             1                              0.8696
                             2                              0.7561
                             3                              0.6575
                             4                              0.5718
                             5                              0.4972

          EXAMINERS‟ REPORT

          This is a straightforward question on public project appraisal. It requires candidates‟
          ability to calculate the Net Present Value (NPV) and determine the viability or
          otherwise of a project, based on expected cash flows.


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Majority of the candidates attempted the questions and the performance was quite
impressive. However, a few of the candidates approximated their calculations to more
than two decimal places, contrary to the requirements of the question and they lost
valuable marks.

Candidates are advised to follow strictly the requirements of questions as given.

QUESTION 3

CONFLUENCE LOCAL GOVERNMENT

(i)   Payback period
                                 EL            EM            EN
                                 N „000        N „000        N „000
      Initial Cash Outlay        15,000        20,000        20,000

      Less: Yr 1 inflow            6,000       10,000         1,000
                                   9,000       10,000        19,000

      Less: Yr 2 inflow            7,000       10,000         6,000
                                   2,000          -          13,000

      Less: Yr 3 inflow            8,000          -          10,000
                                     -            -           3,000

      Less: Yr 4 inflow              -            -          20,000
                                     -            -             -

Payback Period for EL is 2 years + (2000/8000*12) = 2 years, 3 months.
Payback Period for EM is 2years.
Payback Period for EN is 3 years + (3000/20000*12) = 3 years, 2 months.




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ADVICE

From the above, Project EM should be chosen because it has the shortest payback
period.

(ii) Accounting Rate of Return
                                       EL           EM                   EN
                                       N(000)       N(000)               N 000)
         Annual Profit
            Yr 1                     6,000           10,000               1,000
            Yr 2                     7,000           10,000               6,000
            Yr 3                     8,000            1,000              10,000
            Yr 4                     9,000            1,000              20,000
     Total profit                   30,000           22,000              37,000
        No of yrs                      4                4                   4
    Average Annual                 N 7,500         N 5,500             N 9,250
        Accounting Profit

Average Investment =

                                          EL             EM                   EN
                                          N(000)         N(000)               N(000)
         Cash Outflow                     15,000         20,000               20,000
         Residual Value                    1,000          1,000                 1,000
              Total                       16,000         21,000               21,000
                                             2              2                    2
               Average                    N8,000         N10,500              N10,500
                     inve
                     stm
                     ent
ARR =
                                   7,500             5,500               9,250
                         =
                                   8,000            10,500              10,500

                                   0.937             0.523               0.881
                         =
                             Q   94%               52%                88%


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      ADVICE

      From the above, Project EL should be selected as it yields the highest accounting
      rate of return of 94%.

EXAMINERS‟ REPORT

This is a question on investment criteria applied to public sector projects. It tests
candidates understanding of the criteria of payback and accounting rate of return
methods in project evaluation. Using these criteria, candidates are expected to
appraise economic viability of the three projects and advise the Council accordingly.

The question was very popular as over four-fifths of the candidates demonstrated good
understanding of the appraisal methods.

QUESTION 4

FALCON FEDERATION

Federation Account Statement As At December 31, 2009
                                             N million                   N million
      Balance b/f – 1/1/2009                                             1,800,000
      Import duties                              28,000
      Export duties                              94,400
      Excise duties – Local                  1,500,000
      Petroleum Profit Tax                     500,400
      Capital Gains Tax                          69,600
      Royalty on oil                           720,000
      Crude oil sales                          600,000
      Companies income tax                       60,000                  3,572,400
                                                                         5,372,400

      Sharing:                                     %                     N million
                                                  48.5                   2,605,614
      Federal
      States                                      24.0                   1,289,376
      Local Governments                           20.0                   1,074,480
      Special fund                                 7.5                     402,930
                                                                         5,400
                                                                         5,372,400


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b). FALCON FEDERATION

Consolidated Revenue Fund as at 31 December, 2009
                                              N million                     N million
 Balance b/f – 1/1/2009                                                      850,725
 Issues from contingency                        1,750
 Transfer to contingency                       (1,365)                           385
 Revenue (1/1/09-W(i)                       3,729,846
       Expenditure        (1/1/09-            1,790,625                     1,939,221
       31/12/09) W (ii)
       Transfer to development                                              (318,750)
                     Fund
              Balance     as    at                                          2,471,581
                     31.12.2009

Notes/Workings:

   i)    These are the revenues items accruing to Falcun State alone, viz

                                                   N million
        Personal income tax:
        Military                                         56,000
        Foreign Affairs Ministry                         28,000
        Residents of FCT                                 36,280
        Quarrying licenses                               34,320
        Medical fees                                     77,232
        Visa fees                                        52,400
        Repayment of loan by local
        governments                                 584,000
        Rent on government land                         180,000
        Overpayment recoverable                          76,000
        Federation Account -Allocation                2,605,614
        To Consolidated Revenue Fund                  3,729,846

   ii) The summary of overhead costs anticipated, limited to 75%:

                                                   N million
        Establishment cost                          605,625
        Personnel cost                              950,625

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       Special expenditure                          234,375
       To Consolidated Revenue Fund               1,790,625


EXAMINER‟S REPORT

The question tests candidates‟ knowledge of the preparation of the Federation Account
Statement and the Consolidated Revenue Fund (CRF) Account.
The performance, however, was below average. The candidates did not have proper
understanding of the question. Most of them did apply the operating condition of 80%
of budgeted revenue realizable and 75% of expenditure incurable as stated in the
question. Another common pitfall was the expression of naira value in „thousands‟ or
ordinary naira value, instead of Naira value in Millions.

Candidates are advised to always take note of instructions in questions and be mindful
of correct interpretation of same. They should also avail themselves of valuable and
relevant materials contained in Study Packs and Pathfinders of the Institute.

QUESTION 5

(a)   The following are the internal users of government accounting information and
      their uses:

      Internal

      a.      The trade union
      b.      The employee
      c.      The Administrator in the ministry
      d.      The Management in the Ministry
      e.      The subordinates who are given with control
External Users

These are those who use Government Financial information that are not prepare within
their Department, e.g.

      a.      Members of the legislature and selected committees of the houses.



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       b.       Government other than the reporting government e.g. State and Local
                Governments.
       c.       Researchers and representative of the media.
       d.       The general public.
       e.       Sectional groups in the population e.g. Political Parties, Human Right
                Groups etc.
       f.       Foreign interest like Paris Club, London Club etc.
       g.       Regional Organization e.g. EU, ECOWAS, etc.
       h.       Rating Agencies e.g. Flitch.

 Tutorials on Internal Users

 a.    They use it to agitate for better welfare of staff increase in salary.
 b.    They use it to argue or agitate for increase in salary.
 c.    They use it for planning and control.
 d.    They use it for planning and control.
 e.    They use it to execute government.

 (b)   Comparison Of Government Accounting And Private Sector Accounting

S/NO        Differences                         Public              Private
I           Objectives             Provision of adequate            To maximise profit.
                                   welfare services at
                                   reasonable cost.
ii          Accounting Basis       The government records           The    private  sector
                                   its financial transactions       records are shown on
                                   on cash basis.                   accrual basis.
iii         Income/Revenue         Revenue is from members          Income is from the
                                   of the public in form of         sales of goods and
                                   taxation, custom duties,         services.
                                   etc.
iv          Treatment of cost of   Written off immediately          The costs are spread
            Fixed Assets           after     purchase       and     over the estimated
                                   payment.                         useful life of the fixed
                                                                    assets.
v.          Accountability          The      government       is    Business/private entity
            /Responsibility        primarily responsible      to    is responsible to the
                                   the citizenry.                   shareholders.



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vi.         Exclusion principle     Benefit does not match         Goods and services
            on provision of         contribution. Services are     depend on how much
            goods and services      rendered irrespective of       is paid.
                                    the contributions of those
                                    benefitting from them.
vii.        Formation               Comes in various forms.        Incorporated
                                    Ministries,     parastatals;   companies         are
                                    they have their Enabling       controlled by CAMA
                                    Acts.                          1990 and regulated by
                                                                   CAC.
viii         Auditing                Accounts are audited by       Accounts are audited
                                     the   Auditor-     General    by approved External
                                     through the approved          Auditors.
                                     External Auditors.
Ix           Accounting              Fund     accounting     is    Proprietary approach
                                     adopted.                      is preferred.
x            Efficiency              Measured by services          Measured by profits,
                                     rendered.                     capital appreciation,
                                                                   etc.
Xi           Treatment of            Dividends     are    not      Dividends are often
             Dividend                paid/declared          to     declared/paid to
                                     shareholders.                 shareholders.
Xii          AGM                     No AGM of stakeholders        AGM      is   held  in
                                                                   conformity with CAMA
                                                                   (as amended).

    EXAMINERS‟ REPORT

    The question is on the uses of public sector accounting information and also tests
    candidates‟ knowledge of the differences between Government Accounting and Private
    Sector Accounting.

    Majority of the candidates attempted the question and the overall performance was
    above average. The candidates demonstrated fair understanding of the question. A
    major pitfall was the inability of candidates to identify what constitutes the major
    technical differences between the two forms of accounting. Those issues identified by
    the candidates in most cases did not bring out the differences so clearly.




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                            PATHFINDER
Candidates should endeavour to read wide and desist from resorting to residual
knowledge in answering examination questions. Study packs and Pathfinder of the
Institute should be consulted for better understanding and performance.




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QUESTION 6


(a)    RIVER BASIN AUTHORITY, OLUOKUN STATE
        VALUE ADDED STATEMENT FOR THE YEAR ENDED 31 DEC, 2009


                                                N‟000             %
      Turnover                             41,100,000
      Less: Budget in goods and             6,800,200
      services
      Value       Added    from            34,299,800
      Operations     and  Other
      Income
      Add Other Income                          -
      Less Other Expenses                       -
      Total Value Added                    34,299,800           100.00

      Applied as follows:
      Employees                            15,000,000            43.73
      Government (Tax)                           -                  -
      Providers of Capital                  4,000,000            11.66
      Provision for growth and             15,299,800            44.61
      expansion
      TOTAL VALUE DISTRIBUTED              34,299,800           100.00
      Notes to the Account
      Bought-in-goods and
      services
      Purchase of weed control              3,600,000
      chemical
      Lubricant and oil                     1,600,100
      Purchase of Stationery                1,100,100
      Utility (Water, light, etc)             500,000
                                            6,800,200
      Providers of Capital
      Interest on Bank Loan                 1,040,000
      Interest on Agric. Bank Loan          2,960,000
                                            4,000,000
      Provision for Growth and

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       Expansion
       Depreciation Charges                        2,000,000
       Surplus realized on ordinary               13,299,800
                     operation
                                                  15,299,800
              Employees
              Salaries & Pension                  15,000,000

(b).   Value Added is the wealth created by the combined efforts of both the
       organization and   its employees. It is the amount by which the sales value of
       production was enhanced by the effort of the organization and its employees.

       “Value Added Statement” is the information format prepared to show how the
       excess of turnover over bought-in-materials and services, has been applied; to
       items such as provisions for depreciation, employees, government and providers
       of capital.

       EXAMINERS‟ REPORT

       The focus of the question is on “Value-Added” and “Value-Added Statement”.
       Candidates are expected to differentiate between them. They are also to
       demonstrate ability to prepare the Value-Added Statement from income and
       expenditure account information.

       Over 90% of the candidates attempted the question and the overall performance
       was very good. Students demonstrated that they were familiar with published
       financial statements of companies as they applied suitable different formats for
       the statement. However, the definition of “Value-Added” and “Value-Added
       Statement” posed a great challenge to some of the candidates.

       Candidates are advised to be familiar with technical terms of the subject by
       studying relevant current text books, study packs and Pathfinder of the
       Institute.




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                               PATHFINDER
ICAN/102/z/4                                          EXAMINATION NO.............................


               THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA
                 PROFESSIONAL EXAMINATION III – NOVEMBER 2010
                          MULTI-DISCIPLINARY CASE STUDY
                               Time allowed – 3 hours

PROSPECT GROUP

PROSPECT PLC was founded in 1970, immediately after the Nigerian civil war as
Prospect Nig Enterprises. Later in 1990, to reflect the company‟s several acquisitions
and diversifications, the company‟s name was changed to Prospect Limited.

DECISION TO GO PUBLIC

By 2005, it was apparent to the company‟s management that further expansion would
only be possible with larger scale of operations which could be achieved by either
raising capital from a public issue of shares or acquisitions or some kind of merger.

At the April 2005 management retreat, the senior management of Prospect Limited
discussed taking the company to the capital market for several reasons. The company
so formed would be a legal entity, its shares would be transferable. It would have
perpetual succession; that is, continuity despite changes among members. It would
have its own management and its memorandum and articles of association which,
among other matters may limit its capacity to enter into binding contracts. Its affairs
will be regulated in considerable detail by the Companies and Allied Matters Acts 1990
(CAMA) and other statutory and non-statutory regulations.

Management had no liquidity for its holdings and no market for its shares, therefore,
there was a desire to create liquidity for its shares and allow management to diversify
some of its wealth. The management team, with an average age of less than fifty,
viewed going public as presenting challenges and additional experience.

In August 2005, Prospect Limited invited six Investment banks, that had expressed
interest in the offering to a „bake-off‟ (a competition where investment bankers
attempt to sell their services to management). After their presentations, Detonic Bank
was chosen as the lead underwriter for PROSPECT Limited‟s offer. In October 2005, the

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prospectus and the underwriting agreement were issued. In the initial filings, the
nominal value of the shares was fifty kobo per share, but the price was forecast to be
between two and three naira per share. Detonic advised PROSPECT Ltd to reduce the
price to between one naira fifty kobo and two naira per share. The management
refused and maintained that it should be at least two naira fifty kobo per share and
the original nominal value remained. A “road show” was arranged for the
underwriters and PROSPECT Ltd`s management to sell the issue to institutional
investors. After the closing of the share offer, the allotment was made as follows:
management of old PROSPECT owned twenty seven percent, former owners of
PROSPECT PLC twenty percent and the balance of fifty three percent was owned by the
public and before the multicity road show was completed, the offer was
oversubscribed three times. At the end of November 2005, the share was finally priced
at three naira. Even though Prospect was officially a public company at that point, its
shares were not officially traded until the deal was closed on 15 December 2005. The
shares began trading above the offering price and seemed to reach a barrier at seven
naira per share and took one dip to four naira, but by early February 2006 had
reached a high of nine naira before falling back to six naira fifty kobo at end of April
2006.

NEW MANAGEMENT

In 2008 sales and profits of the group continued to decline, a trend that had been on
since 2006 and Chief Alatise Gbenga, the Group Chairman could no longer avoid the
issue. He concluded that the best option was to go outside the company and bring in a
professional manager with no direct ties with any of the directors or division and
management staff of PROSPECT PLC. In Chief Alatise‟s view, a housecleaning was in
order and special management talent was needed.

In November 2008, Mr. Kola Ikumawoyi joined PROSPECT Plc as Managing Director,
Chief Alatise continued as Chairman of the Board. Mr Ikumawoyi was recruited from a
major competitor in the industrial distribution industry where he had served as
Executive Director. In view of the challenges facing PROSPECT Plc, Kola seemed to be
the ideal choice. In addition to his strong industry and marketing background, he also
had a warm and outstanding personality and a very high level of energy and
optimism. As one student who interviewed him remarked, “His openness and candor
catches you off guard. You don‟t usually expect a Managing Director to be so open and
honest about issues”.
Kola faced the additional challenge of attempting to correct PROSPECT PLC`S
problems while still faced with the same old directors on the Board. Even though Chief


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Alatise was able to recruit Kola, the Managing Director did not always have a full
support of the Board, many of whom viewed him with skepticism. Kola promised that
he would be restructuring PROSPECT PLC`S top management by recruiting
outstanding individuals to provide a new leadership and a professional team to lead
PROSPECT PLC`S turnaround.

Mallam Iwalesin Oladele was hired in January 2009 as Executive Director
(Administration and Operations). Iwalesin was recruited from Coca-Cola Plc. In March,
Ms Chika Ike was brought in as Executive Director (Marketing and Corporate
Development), Chika was in the consulting business and had served as Manager in
Steakhouse Ltd and as Director in Kokumo Limited.

Richard Popoola joined the company in June from Ronky Communications, a Lagos
based advertising and public relations firm, to fill the position of Executive Director
(Marketing Communications and Field Marketing Services) and Personal Assistant to
the Managing Director. Jerry Gbenga was brought in as manager in July, he had been
an Area Sales Manager for Toyota Motors and previously served as manager at
Thermocool Limited.

With the majority of the new management team in place during 2009, Kola began to
embark on the quest to turn the company around and build comprehensive group. The
major problems facing the new management team were:

(a)   The company was not making any profit;
(b)   Divisions within the group were losing money and were overstaffed;
(c)   No unit growth – divisions were declining;
(d)   No management strategies, goals or plans in place
(e)   No advertising
(f)   Image was old and faded;
(g)   Directors/managers were bottom line oriented with nothing being re-invested in
      business.

To turn the organization around, Kola and his management team embarked on a
strategy that encompassed three points:

(a)   attack problems concerning divisions and PROSPECT PLC`S image
(b)   improve marketing, inventory management and replace obsolete plant, and
(c)   improve communications.



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The key to attacking attitude problem centred on marketing and to be successful, any
plan depended on three critical issues

(1)   The corporate and division owners are to “buy in” to it;
(2)   The plan had to be simple enough to be executed, and
(3)   It had to provide visible evidence of working by improving profit for the
       division and group owners.

INTEGRATION/EXPANSION

Sola Nigeria Limited was engaged in electrical and fluid (mostly pumps) equipment
maintenance and sales for mid-market size companies. In this regard, it was
relatively capital intensive. Its most recent year-end financial statement reflects
revenue of one hundred and twelve million Naira (N112m), operating income of
Twenty eight million Naira (N28m), depreciation of Seven million Naira (N7m), net
income after taxes of twelve million Naira (N12m), total assets of seventeen million
Naira (N17m), interest-bearing debt of fifty four million Naira (N54m) and
shareholders‟ equity of forty million Naira (N40m).

Its cash position was negligible. The company has five million and six hundred
thousand Naira (N5.6m) shares outstanding and its current share price is sixteen
Naira.

The company has attracted the attention of Prospect Group, which was considering
acquiring Sola Nigeria Limited. Prospect Group and its investment banker believed
that by offering a premium of fifty per cent (50%), Sola Nigeria Limited could be
acquired. At present, Sola Nigeria Limited‟s free cash flow (excluding interest on debt)
is shown in appendix I.

Prospect Group believed that with synergy, it could grow its earnings before interest
and taxes by twenty per cent (20%) for three years and then by twelve per cent (12%)
for the next three years. At the same time, it believed it could hold capital expenditure
and working capital additions to a combined increase (from the present eleven million
Naira (N11m) of only two million Naira (N2m) per year. At the end of six years,
Prospect Group assumed that free cash flow would grow at five per cent (5%) per
annum into perpetuity. It also assumes that the cost of capital for such investment
was fifteen per cent (15%). Comparable recently acquired companies had the medium
valuation ratios shown in appendix II.



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In 2010, the management of Prospect is considering the closure of its internal printing
department. If the proposal sailed through the approval of next meeting of the Board
of Directors, the staff of the department were to be redeployed to other departments
within the group. The department prints all the company‟s publicity materials and it
also carries out other printing jobs as required. An external firm offered to produce all
the company‟s printing requirements for a total cost of eighteen thousand Naira
(N18,000) per month.

The internal printing department‟s cost includes the following: a total of one hundred
and sixty thousand (160,000) sheets of customized paper were used each month, at a
cost of one hundred Naira (N100) per two thousand (2000) sheets. The contract for
supply of the paper required three months‟ notice of cancellation. The company did
not hold inventory of the best paper but any excess could be sold for the net price of
forty Naira (N40) per two thousand (2,000) sheets, a total of four hundred (400) litres
of fluorescent ink are used each month, at a cost of three Naira sixty kobo (N3.60) per
litre. The contract for supply of this ink requires one month‟s notice of cancellation.
No inventory of ink was held but any excess could be sold for one Naira net per litre.
Other paper and material costs amount to five thousand, seven hundred Naira
(N5,700) per month, the printing machinery was rented for nine thousand Naira
(N9,000) per month. It was operated for one hundred and twenty hours (120 hours)
each month. The rental contract could be cancelled with two months‟ notice.

The two employees in the department were each paid twenty thousand Naira
(N20,000) per month. The company had a no-redundancy policy which meant that the
employees were guaranteed employment even if the department closed. Overhead
cost for the printing department was as follows: Variable overheads were eight Naira
per machine hour. The variable overheads vary in direct proportion to the machine
hours operated. Fixed overhead represents an apportionment of central overheads
which would not alter as a result of the printing department‟s closure.

ORGANISATION

The corporation was organized into six product groups (Appendix III & IV, Appendix III
describes the organization chart and Appendix 2 describes the groups major products).
All of the products benefited from well-known product trademarks and most of their
products were leaders in their market segments.

Prospect Plc was operated in a highly decentralized fashion. The product groups were
allowed considerable discretion in establishing and implementing the strategies


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appropriate to their areas of business. The primary central mechanisms employed by
headquarters were annual and quarterly reviews of budgets submitted from each of
the divisions.

Each of the three divisions was headed by a General Manager, who were told that they
were expected to act as if they were the Managing Director of independent companies.
Each division was regarded by Head Office as a profit centre and the performance of
each divisional manager was evaluated on the basis of his profit performance.

PROSPECT Plc did not have a single unified accounting system that was used in all its
operating units. This was due to the fact that PROSPECT Plc had acquired many
companies over the years and the acquired companies were allowed to continue with
most of the elements of their accounting systems, even after they became part of
PROSPECT Plc. The accounting policies set at corporate Head Office tended to describe
minimum reporting requirements and every general accounting policy rather than
detailed instructions that had to be followed, for example, the accounting policy
manual specified that the operating units were to follow the full absorption method of
accounting „whereby most fixed and variable costs are recognized in inventory and
cost of sales accounting‟ but it did not provide further description as to how the full
absorption method was to be accomplished.

In specific terms, each division was expected to achieve a net return on sales of at
least six percent. Operations were planned on an annual basis, linked to a financial
year end of December 31. Prior to the beginning of each financial year, divisional
managers were required to submit budgets showing the net profit, in excess of the six
per cent sales revenue, that they expect to earn. At this stage, adjustments were often
made to the budget as a result of consultation and negotiation between divisional
managers and Head Office. Once agreed, the budget formed the basis for evaluating
performance in the ensuing year.

However, the Head Office required each division to maintain an elaborate budget and
control system. The following points summarize the budget and control system in each
division:

First, one, three, and five year budgets were prepared each year. Second, the
Executive Director overseeing the division looked for three and five years‟ budgets that
stretched the division‟s capabilities, that is, divisions were pushed to devise programs
that increased value. Three, these budgets were developed and approved first at the
divisional level, then by the Executive Director at the Head Office assigned to the


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division and then by Corporate Head Office. Four, every three months, the division
must reconcile actual performance to budget and write detailed reports on the
corporate actions taken.

Five, each Executive Director assigned to the division visited each division quarterly
for three days of meetings that involved extensive reviews of the budgets and
operating results. These meetings involved all the senior managers in the division. Six,
divisional senior managers are neither compensated nor rewarded for meeting budget
targets. Rather, they were evaluated on their ability to develop new markets, solve
short-run problems, add value to their organization and to PROSPECT PLC, manage
and motivate their subordinates. These performance evaluation criteria were quite
subjective, but the corporate Executive Director assigned to the division had a great
deal of in-depth personal contact with each of the senior people in his or her division
and were able to arrive at suitable performance evaluations.

Preparing for these meetings with the corporate Executive Directors and developing
the budgets requires the involvement of all the senior managers in the division, one
manager remarked “I‟d hate to see how much money we could be making if we didn‟t
have to spend so much time in budget and financial review meetings”.

It turned out that PROSPECT PLC was not unique in the amount of senior management
time spent on budgeting and financial reviews. A survey of large publicly quoted
companies in Nigeria supports the PROSPECT PLC system. Researchers found that
innovative firms in complex environments characterized by high uncertainty and
change used much more elaborate formal financial control (budgeting systems than
did firms in more stable, mature industries) innovative companies seemed to employ
more financial controls than less innovative companies.

CAPITAL INVESTMENT PROCEDURES AND FINANCING

Like most companies, Prospect Group had layered levels of approval with the largest
being approved only by the Board of Directors, each division was charged with
preparing capital budgeting requests, item by item. Routine types of expenditure
could be lumped together. However, any major expenditure had to be documented as
to expected cash flow, payback, internal rate of return and a qualitative assessment of
the risk involved. These proposals were reviewed by the corporate analysis and
control office headed by Mrs. Lalupon Adedeogun while neither she nor her boss Mr.
Phillip Azika had final authority, they made recommendations on each of the larger
projects.



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Projects fell into one of two categories: profit adding and profit sustaining. The profit
adding projects were those where the cash flows could be estimated and discounted
cash flow methods employed. The profit sustaining projects were those that did not
provide a measurable return. Rather, they were projects necessary to keep the
business going. For example, environment and health control certain corporate assets.
Approximately twenty per cent of the projects proposed and accepted in Naira volume
were profit sustaining in nature. For profit-adding projects, the fifteen per cent (15%)
required rate of return was used as the hurdle rate.

Projects that fell below this return simply were not sent forward. The use of the
discount rate was supplemented by the financial goal of achieving growth in sales and
earnings per share without undue diminution in the quality of the earnings streams.
This objective was sufficiently “fuzzy” that most did not take cognizance of it in the
capital budgeting process. Rather, the fifteen per cent return was key variable. It was
simply assumed that if projects provided return in excess of this figure, they would
have given the company a continuing growth in “quality” earnings per share.

Overall, the company has a total debt-to-equity ratio of one point four five (1.45).
However, much of the total debt is represented by accounts payable and accruals. All
borrowings are controlled at the corporate level, and there is no formal allocation of
debt or equity funds to the individual divisions. Everything is captured in the
minimum hurdle rate of fifteen per cent (15%). However, some of the divisions are
characterized by having to undertake a number of lease contracts in order to expand
their division and departments within the division.

While the required rate of return of the company once represented a blending of debt
and equity financing, this no longer was the case. In recent years, it has been
adjusted on a subjective basis, in keeping with returns earned by competitors in the
industry, Prospect Group has little difficulty financing itself; it enjoyed a high
investment rating by many financial institutions in Nigeria. It also has ample lines of
credit with prominent financial institutions.

Mr. Phillip Azika‟s office was charged with determining what would happen if the
company moved from a single required rate of return to multiple hurdle rates. His
group focused in using external market valuations for the required rate of return of the
various divisions. For debt capital, it proposed using the company‟s overall rate of
interest on bonds. In early 2009, the rate was approximately ten per cent. The
company fixed a tax rate of approximately forty per cent (40%).



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For the required return on equity capital, the study group used the capital asset
pricing model (CAPM). In this context, the measure of risk in beta, the co-variability of
a stock‟s return with that of the overall market as represented by Nigerian Stock
Exchange stock index.

The return on equity is simply
Rs     =     Ri     (Rm – Rf) βj

Where: Rs = Return of the equity, Ri = Return on Security,
       Rm = Return on the market portfolio
       Rf is the risk free rate and βj is the beta of security j.

In early 2009, three month Treasury Bills yielded approximately three point one per
cent (3.1%), three year treasury bills yielded approximately four point six per cent
(4.6%) and long term treasury bills of five years yielded approximately five point four
per cent (5.4%). Mr. Azika‟s group proposed using five year Treasury rate as the risk-
free rate in their calculations. Estimates by various Mortgage banks of the required
return on the overall market portfolio of ordinary shares average eleven per cent in
early 2009.

Mr. Azika and his staff proposed the use of proxy or “pure play” companies, that is,
companies that were closely identified with the business of the division, but that had
publicly traded her shares. After extensive study, Mr. Azika and his staff proposed the
list of companies shown in appendix V. For industry products for division, there were
a reasonable number of proxy companies. This was not the case for mining division or
the automotive division. Unfortunately, for the automotive division, some of the larger
companies were divisions of multi-division companies. In particular, Jacet Limited
was part of Jacet International and could not be differentiated from the mining
division. Some of the largest mining companies are either government owned or
privately owned, so that they do not appear in the sample. However, the study group
felt that the proxy companies were representatives and that the summary information
was useful. For the betas, the group proposed using a simple average for each
category of proxy companies. This meant a beta of zero point nine eight (0.98) for
mining products, zero point eight two (0.82) for automotive and one point two seven
(1.27) for industrial products.

Concerning debts employed to get blended costs of capital, Prospect Group recently
established a target long-term liabilities to capitalization ratio of forty per cent (40%).
Capitalization consisted of all long-term liabilities (including the current portion of
long term debt), plus shareholders‟ equity. The target of forty per cent (40%) was


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somewhat higher than existing ratio. For capital expenditure purposes, the recent
financing vehicles were felt to be long-term liabilities and equity, not short-term debt,
payables and accruals.

The mining division and the automotive divisions did not need that much in debt
funds, as their internal cash flows were sufficient to finance most capital expenditure
(the mining division uses short-term debt to carry inventories). Originally, Mr. Azika
proposed that for calculation purposes, these two divisions have long-term liability to
capitalization ratio of zero point three five (0.35). Given the growth rate in demands
of the industrial product division, he proposed that this division have a ratio of zero
point four five (0.45). The representative of the industrial products division objected
to this percentage, claiming that it should be higher. When Mr. Azogwu, the Director of
the industrial products division learned of this, he went directly to Mr. Azika and Mrs.
Adedoyin. He claimed that if the industrial division were to stand alone, it could
command a ratio of at least zero point six zero (0.60) based on its real estate value, in
order to have a debt-ratio consistent with the main aggressive companies in the
industry.

Mr. Azogwu threatened to take the matter directly to Mr. Kola Ikumawoyi, the Group
Managing Director, unless he got his way. Eventually, Mr. Azogwu and Mr. Azika
struck a compromise and agreed to a long-term liability to capitalization ratio of zero
point five zero (0.50) for the industrial products division. To accommodate this change
within the overall capital structure objectives of the group, Mr. Azika cut the mining
division ratios to zero point three zero (0.30).

In order to allow for profit-sustaining projects, Mr. Azika proposed grossing up the
divisional required returns with twenty per cent (20%) of the projects on average being
profit-sustaining which were presumed to have a zero per cent expected return, the
“gross up” multiplier was one point two five (1.25), that is, if a division were found to
have an overall after-tax required return of nine point six per cent (9.6%), it would be
grossed up to be twelve per cent (12%) i.e. 9.6% (1.25) = 12%.

As profit-sustaining projects were a cost of doing business, profit-adding projects had
to earn enough to carry them. The simple gross-up was easiest to apply, and Mr. Azika
proposed that it be the same for all the divisions.

When Hajia Lemu Awawu, Deputy Group Managing Director and Financial Controller,
Prospect Group, was talking with Mr. Azika, she reminded him that the question of
simple versus simple required return was not resolved yet, therefore it would be useful


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to calculate a required return for the overall Group in the same manner as was due for
the divisions. The beta for Prospect Group in early 2009 was one point zero five (1.05)
and it had been relatively static in recent years. It was felt that a target long-term
liabilities-to-capitalization ratio of zero point four zero (0.40) should be employed.

As the required return reports would be completed shortly, Mr. Philip Azika, needed to
arrange a meeting among himself, other members of Senior management and the
Executive Directors of the three divisions. He asked Mrs. Adedoyin to present the
report to management.

The meeting would be an important one because the decisions reached would
determine the method by which capital would be allocated to the various divisions
both now and in the future; it also would establish the standard for judging return-on-
asset performance. Mr. Ikumawoyi was anxious to get the matter resolved so that
management would be on a solid footing when it went to the Board of Directors in
March 2010 for capital allocation, while Mr. Asogwu, the Director of the Industrial
Products division, was familiar with the report, the other Directors of the other two
divisions were not. Mr. Asogwu made it known to Mr. Ikumawoyi that although he
could live with the system proposed in the report, he felt it would be simpler to have a
single required rate of return for all the divisions. “If your objective is competitive
advantage and growth, fundamentals of the business, these financial whizzes do not
produce value for the shareholders – we do. Don‟t shackle us with too many
constraints” was a statement he made in passing to Mr. Ikumawoyi.

Also, Prospect Group wished to use equipment that cost one million (N1.0m) and that
will have a zero residual value at the end of five years to beef up its industrial
products. Management was satisfied that the equipment would represent an
attractive project with a positive net present value. The company approached a lessor
with regards to a financial lease and the Lessor agreed to lease the equipment at an
annual rental of three hundred thousand Naira (N300,000) over five years, with each
payment to be made in advance. Alternatively, the company could finance the
purchase of the equipment by borrowing the one million Naira (N1m) at an internal
rate of twenty per cent (20%) per annum.




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INDUSTRIAL PRODUCTS DIVISION

In 2009, the court approved the scheme of reconstruction and recapitalization brought
to it by PROSPECT PLC relating to its industrial products distribution division. The
scheme was to take effect in January 2010. The draft balance sheet of the division is
set out in Appendix VI.

Particulars of the re-organization were as follows: The ordinary shares were to be
written down to fifty kobo each; the preference dividend was three years in arrears,
the preference shareholders were to waive their rights to these dividends and in return
were to choose whether they wish to convert their holdings to a new issue of nine per
cent cumulative preference shares or ordinary shares of fifty kobo each on a four to
one basis. Fifty percent of the preference shareholders have elected to take this latter
alternative.

The debentures were secured on the freehold buildings, the entire debenture being
held by Trans Bank Plc. Arrears of debenture interest were to be paid at once. Trans
Bank Plc agreed to conversion of the existing issue of debentures to a new issue with
an interest rate of ten per cent and to take up a further ten million naira (10,000,000)
of these debentures in view of the increased value of the collateral. The bank overdraft
would be repaid in full and amounts totaling twenty million naira (N20,000,000)
would be paid to the trade creditors once.

The Directors would waive half of the loans owed to them while the balance would be
met by the issue to them of ordinary shares of fifty kobo each. Goodwill, deferred
development expenditure and the balance on the profit and loss account would be
written off in full. Whilst plant would be revalued at eighteen million eight hundred
and eleven thousand naira (N18,811,000). The land and buildings would be revalued
at fifty million naira (N50,000,000) and trade investment is to be sold for fifty million
naira (N50,000,000). Sixteen million naira (N16,000,000) would be written off the
stocks and provision of ten percent for doubtful debts would be made.

Globalization embodied integration of international markets for goods, services,
technology, finance and to some extent labour, improves on the process of structural
change, underpinned by transformation from an agricultural to an industrial economy,
with critical implication for growth, equity and poverty. In this context, structural
adjustment or liberalization policies, symbolizing measures to stimulate structural
change by re-organising production, focus on shifting emphasis from national to the
global market and forging closer interaction between the national (domestic) and the


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global economy.      In fact, shrinking global economic frontiers have created
opportunities and opened new markets.

Dramatic reforms and remarkable economic recovery and growth in some developing
countries particularly in Latin America, South and East Africa have kindled foreign
interest and confidence, encouraging new investments and enabling domestic
companies to access international equity capital directly as well as seeking listing on
foreign stock markets. The 1990s was a decade of widespread policy reforms in many
emerging economies, a trend which has continued into the 2000s. Such policies, trade
liberalization, deregulation etc were common place.

The progress made by some emerging economies particularly in Africa has shown that
good and consistent macro-economic policies impacted positively on investment flows
and the capital market. In essence, economic policy fundamentals must be right and
stable to strengthen investors‟ confidence and stimulate participation in the economy.
Indeed, good and stable macro-economic policies aimed at reducing inflations to a
tolerable level, strengthening the local currency and bringing down public sector
deficit among others are beneficial, as foreign investors are usually concerned about
high rates of inflation which reduce investment value while depreciating local
currency rate, thereby reducing foreign currency value of domestic investments.

Economic reforms in Nigeria and some African countries incorporated policies which
were specifically aimed at improving the foreign investment climate. These include
the elimination of policies which discriminated against foreigners, simplification of
investment and remittance procedures, as well as the provision of special incentives
for foreign investors. To enhance the attractiveness of the local market many countries
including Nigeria also abolished capital gains taxes while withholding taxes were
reduced and in a few cases abolished.

The adequacy and efficiency of social and economic infrastructure such as electricity,
roads, water, communication facilities, transport, health care etc., are crucial to
domestic and foreign direct investment. Countries with these facilities have therefore
tended to attract more direct foreign investments than countries with inefficient
infrastructural facilities.

One fundamental issue which was addressed by emerging economies in the quest for
foreign investment was the establishment of appropriate legal and regulatory
frameworks to achieve the most effective system of investor protection. The system of
protection has to be such that ensures fairness, efficiency, transparency and to


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minimize abuses. Improvement in the quality of information about many emerging
economies enhanced their transparency and stimulated foreign interest in them.

Political stability is one of the most crucial factors in ensuring economic and securities
market development. Investors both domestic and foreign, understandably consider
the safety of their funds in deciding whether or not to invest or retain their
investments in any country. Political instability exposes investment to high risks and
encourages capital flight and inhibits economic growth. Evidently, many emerging
economies instituted economic reforms alongside political reform in the 2000s and are
today important recipients of foreign investment capital.

It is well known that the foreign investment climate in Nigeria in the recent past has
not been conducive leading to a spate of divestments even by the nation‟s traditional
and long standing investors, who have perhaps moved to more favourable
environments. Although, more measures are desirable and are already being
considered by government to “win the hearts” of foreign investors into Nigeria, the
repeal of the Exchange Control Act 1962 and the Nigerian Enterprises Promotion Act
1989 are laudable and should be seen as the first step towards setting up a conducive
investment environment. There is no doubt that with the right economic and political
climate, Nigeria with its size, huge resources and vantage position in Africa, stands a
good chance of attracting significant resource inflows and even serving as a “feeder”
to less developed countries in the sub-region.

By the repeal of both Acts, the major restrictions to easy flow of foreign investments
have been removed. Foreign investors can now access the Nigerian market fully and
freely without having to seek the approval of the Minister and without requiring a
local partner to do so. In effect, no distinction now exists between local and foreign
entrepreneurs in respect of investments in the country as both classes of investors are
now treated equally.

With these and other restrictions removed, the country should ultimately witness an
impressive flow of direct and portfolio investments.

Under sound and stable economic environment, foreign investments could flow in via
the following avenues:

(i)   foreign firms establishing wholly owned subsidiaries or entering into joint
      ventures/partnerships with Nigerians firms;



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(ii)    return of some traditional investors who have exited the Nigerian market;

(iii)   commitment of new funds by existing foreign investors into enterprises
        domiciled in Nigeria

(iv)    Investment in the Nigerian Stock Market, and

(v)     domestic companies sourcing funds in the global capital market.

If the economic environment improves reasonably well, Nigeria‟s country risk rating
should improve, which could in turn stimulate new capital inflows as confidence is
rekindled.

Prospect Group used these challenges to its advantage by consolidating its presence in
the Western sub-region. Today, the company is looking globally, not merely into
exports but also for establishing manufacturing bases. The company is to commit
corporate resources in areas where it is or can become leaders. In the current
financial year, the company aims to make inroads into new markets, both
independently and through strategic business alliances. Ghana and Angola units
would be operational in the current financial year. Cameroun, Sao Tome and Liberia
are some of the areas that the company will be focusing on in the future. Like in the
past, in the coming years too, the company will launch new products, strengthen and
consolidate existing markets.

Alongside this marketing thrust is a constant upgrading of manufacturing technology
and a commitment to research technology and development. It is however important
to sustain these catalysts of growth through dedicated manpower. To this, Prospect
Group attracts professionals of high caliber while constantly upgrading the skills and
knowledge of existing employees. It is this optimum utilization of corporate resources
at all levels that is sustaining the company‟s leadership profile.

The second phase of expansion and modernization has been completed successfully
during the year. Manufacturing capacity, and expansion of projects have also been
completed for products like reagents, chemicals, sprayers and DSM Agro. Total
investments in machines and land and buildings were N25.87 million and N11.65
million respectively. In Ikeja Industrial Estate, the second unit for manufacturing of a
popular brand of the products has also been set up and production has commenced in
the current year.



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A new plant in Ikeja Industrial Estate is under construction for food processing to meet
the requirements of growing demand for popular fruit juices. An integrated facility
has also been designed at Ilesa for the housewives range which was found to be very
popular and encouraging among consumers. At the same site, in Ilesa, a joint venture
along with Andex Nigeria Limited is being commissioned to extend the different range
of natural gum into profitable speciality products. Besides this, the company has
successfully launched many new products. These products have been well received in
the market.

Prospect Finance Limited, a subsidiary of the company has recorded an impressive
growth of 168% in the profits during 2007-2008 and is actively pursuing the activities
of leasing, hire purchase and investments. The company‟s industrial products division
had successfully launched its new range of products in 2006 and the products have
shown encouraging response from the market.

Growth in the demand of the products of the company in the Nigerian market is
satisfactory, particularly, with the sale of chemical reagents among the range of
products. The turnover of the division recorded an impressive growth of 25%.

The company has an ambitious plan to extend their range of consumer products to
include domestic products like shaving foam, hair creams, shampoos, variants of
herbal toothpaste. By adding these new products, the company hopes to achieve a
35% growth in export to other West African countries. In this context, it may be
pointed out that the Prospect Group has floated two companies: a manufacturing unit
in Sierra Leone in the name of Prospect Limited and another company Prospect
International Limited in Liberia.

In Sierra Leone, Prospect Group has taken seventy six per cent (76%) equity and the
balance of twenty four per cent (24%) has already been contributed by Healey Limited,
London.
The land for the manufacturing activity has been procured, the company has
appointed legal and liaison consultants and the construction of the factory building is
in progress. The expected date of commencement of commercial production is April
2011. The other company, Prospect International Limited is appraising the possibility
of setting up a pharmaceutical and bulk drug plant overseas either on its own or with
a collaborator. The company has successfully developed an anti cancer drug, namely,
Lactuxel. The response to the drug in Nigeria and abroad is very encouraging. The
company therefore plans to set up a manufacturing facility for the product in Canada
to cater for the US market. In this context, the company, entered into a joint venture


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agreement with Lawry International Limited, an affiliate of Lawry Incorporation, USA.
The joint venture company will be named as Prosivough Incorporated with fifty per
cent (50%) equity holding by each collaborator. The commercial production at
Prosivough Incorporated is expected to commence in April 2011.

During the years 2008 and 2009, the sales at the West African sub-region markets has
been satisfactory. New markets were established in Sao Tome, Cameroun and Ghana.
Further entry is planned for South Africa and Angola. The company has set up a
trading office in Algeria with the necessary permission from the Government of the
Federal Republic of Nigeria.

Prospect Gabon Limited, a joint venture subsidiary company set up in Gabon, in its
second year of commercial production has completed the installation of the plant for
the extraction of the Texas baccatta leaves and will commence production shortly. The
company is in the process of implementing an expansion programme for
manufacturing of herbal toothpaste, shampoo and shaving cream.
The company has been promoting research and development activities through the
efforts of Prospect Foundation. The Prospect Foundation is gaining more and more
recognition because of the research work and successful completion of the research
projects which have helped in providing the necessary research and development
inputs in the area of company‟s business both in health care and in consumer non
durables. Successful completion of the clinical trials and other product. Development
works were done on many new herbals and Ayurvedic products in 2008-2009. The
company launched new products like TOLAC, TADEN and TIKARA. A high fibre, sugar
free nature care variant has also been developed which is currently undergoing a
market research and is likely to be introduced in the current financial year. A number
of cosmetic products are under development both for domestic and export markets.
Many of these products are in their final stages of approval and are likely to be
commercialized next year.

The company has been able to successfully complete the clinical trials on human
volunteers of the novel anti-cancer drug Lactuxel. Two more bulk drug technologies
were developed, scaled up and commercial production of these products, “vix
Flucanozole” (anti-fungal, anti-biotic) and “citizen dihydrochloride” (a second
generagion anti-histamine) were started.

Active management of business and disciplined execution of growth strategies by the
company have delivered seven consecutive years of earnings growth and excellent
return to shareholders.


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Mr. Popoola Ajayi, the Executive Director in the industrial products division expects
that the 2010 net sales for the division should be four hundred and forty five million
Naira (N445m) and believes that the division will continue to market aggressively its
products as it has done in the past. Before making these sales forecasts for 2010,
Popoola analyzed the impact of high interest costs on the firm‟s debt. He began with
the firm‟s 2009 and 2008 balance sheet of the division as prepared by the finance
department. He did not ask for a pro forma income statement because he was likely to
prepare it himself. In addition to knowing the forecasted sales figure, Popoola knew
that the firm is to budget three relatively stable items for 2010. Office and marketing
salaries, fifteen million Naira (N15m), sales expenses and promotion, twenty one
million Naira (N21m) and miscellaneous overheads is ten million Naira (N10m).
Popoola knew that if the firm did not borrow any additional funds, the industrial
division would be incurring an annual interest of twelve million Naira (N12m) in 2010.

Having gathered this data, Popoola had a look at collection costs and bad debt losses
that were included in the general and administrative expenses above, he decided to
forecast these items using data from the division‟s risk class category that was
reviewed on a regular basis. The finance manager normally prepared an estimate of
the collection costs and bad debt losses to be allocated to each category of customers.
These estimates were compared against actual data at the end of each year and for the
last five years, the estimates proved to be fairly accurate. The bad debts losses were
based on actual losses over the past seven years and collection costs well allocated
based on the routine expenses and special collection efforts required for each category
of customers. Appendix VII shows the result from this process.

Popoola decided to have a meeting with A. J. Aaron, the division‟s finance manager,
after receiving this data on industrial product division. Aaron supported four months
back that the Company should change its credit policy from 2/10 net 30 to 2/10 net 60.
He argued the new policy would increase receivables, collection costs and bad debt
losses but would provide additional sales and profits to the group. Aaron estimated
that though selling expenses would rise but the level of receivables would also
increase. If the additional profits were high enough, it would make sense to borrow
money at fifteen per cent (15%) to finance these receivables. Popoola asked Aaron to
check out the changing terms of trade to 2/10 net 15. This would reduce receivables
and allow the firm to pay off a portion of the fifteen per cent (15%) notes, Aaron
indicated that selling expenses would probably drop by one point two five (1.25), but
this savings would probably be more than offset by the loss of sales and profits. From
this discussion, it appeared that Aaron was willing to make another appraisal of both


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alternatives and he indicated that he could get back to Popoola with the effect of each
alternative on sales.

Aaron submitted his forecast for 2010 sales with each alternative to Popoola, he
pointed out that during the period 2005 – 2009, industrial products sold on terms 2/10
net 30. With these terms in 2010, the division could expect eighty million Naira
(N80m) of sales to category one customers, one hundred and five million Naira
(N105m) of sales to category two customers, sixty million Naira (N60m) of sales to
category three customers and five million Naira (N5m) of sales to category five
customers. Based on past data, thirty per cent (30%) of the total customers would take
the two per cent (2%) discount while the others would pay in thirty five (35) to forty
(40) days.

A quick check of Aaron‟s calculation indicated to Popoola that they were in agreement
that the 2/10 net alternatives could be relied on. Popoola knew that the cost of goods
sold would be approximately seventy five per cent (75%) at four hundred and forty five
million (N445m) of sales and he estimated that they could run eighty per cent (80%) at
two hundred and two million five hundred thousand Naira (N202.5m) of sales and
seventy per cent (70%) at three hundred million Naira (N300m). The general and
administrative expenses, with the exception of the collection costs, bad debts losses
and selling expenses were in effect, fixed for 2010. Using these assumptions, Popoola
was prepared to develop the data and reach a decision on the optimal credit policy for
industrial products division of Prospect Group. He decided that they would not change
policies in future unless the new policy gives either an increase in sales of twenty five
per cent (25%) or an increase in profit of fifteen per cent (15%) or more.

AUTOMATION DIVISION

PROSPECT PLC is contemplating repackaging its products in the automation division,
the introduction of the products would enhance e-banking. A new equipment costing
ten million naira (N10,000,000) would have to be bought to manufacture the machine,
but PROSPECT PLC could accommodate all other aspects of the new equipment for
example, the requirements for factory and warehouse space within the company‟s
existing facilities. The equipment has an annual capacity of ten thousand units of the
machines and could be used for four to five years before being scrapped at zero value.
PROSPECT PLC sets selling prices for its product on the basis of cost-plus calculations.
Its current Chief Accountant has prepared the following standard cost figures
(Appendix V) to enable a target selling price to be set.



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The standard has been based on the capacity of the equipment i.e. ten thousand
(10,000) units per annum. The marketing department, in conjunction with the
industrial products distribution division has signed a five year contract to take all the
budgeted production at a price of three thousand, five hundred naira (N3,500). The
industrial product distributors would pay the Automation division for the machine
annually in arrears i.e. first payment would be made in one year and one day after the
start of production. The automation division holds one month‟s stock of materials, and
on average, pays suppliers one month nine days after delivery.

A trainee accountant, attached to the division, has been asked to prepare a cashflow
and Net Present Value (NPV) calculations for the five years during which the machine
might be produced. Additional information provided to aid his calculations are that
the equipment is to be financed by a loan at the going interest rate of ten percent per
annum, the company will thus pay annual interest charges of two hundred thousand
(N200,000) on the loan; the division allocated fixed overheads on the basis of direct
labour hours. The general overheads present allocations of the division‟s existing fixed
overheads to produce the machine. The specific overhead charge is an allocation, on a
straight line basis of the depreciation of the new equipment over its useful life of five
years.

Skilled labour is in short supply. During the first year of the machine production,
skilled labour would have to be diverted from existing product lines. Currently, the
average cash contribution generated per skilled labour hour is fifty naira. Skilled
labour could be made available for the remaining three years of the machines
production by carrying out a recruitment and training during the first year. This
programme would entail a one-off cost of one million and five hundred thousand naira
(N1,500,000) and if undertaken, would enable the diverted labour to return to its
usual work after one year of manufacturing the machine.

The current rates of company tax are forty percent on taxable profits over seven million
and five hundred thousand (N7,500,000) and a sliding scale for profits is between
these levels. The plant attracts a written – down allowance of twenty five per cent at
cost or a written–down allowance of twenty five per cent at cost or written-down
value. The figures and notes produced by the trainee accountant are contained in
Appendix IX.

The automotive division is considering investing in the production of an electronic
security device and the manufacturing of lazer printer AZ2000Q. The finance and the
marketing departments have undertaken an analysis of the proposed projects.


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The financial implication and market survey which showed the expected market life of
the electronic device for the first five years of production have been submitted for the
approval of the Board of Directors of Prospect Group. The main features of the analysis
is as shown in appendix X. The committee that works on the feasibility of the
electronic security device has recommended that the project should not be undertaken
because the estimated annual accounting rate of return is only twelve point three per
cent (12.3%).

The notes attached to the feasibility study indicated that the figures in appendix VII
relating to cash flow and profit estimates have been prepared in terms of present day
costs and prices, because the committee assumed that the sales price could be
increased to compensate for any increase in costs. However, other information
indicates that the selling prices, working capital requirements and overhead expenses
are expected to increase by five per cent annually; material costs and labour costs are
expected to increase by ten per cent every year, while capital allowances (tax
depreciation) are allowable for taxation purposes against profits at twenty five per
cent (25%) per year on a reducing balance basis, the machinery for the production of
the electronic device has no expected salvage value at the end of the five years. For
the purpose of this project, the automotive divisions real after-tax weighted average
cost of capital is estimated to be eight per cent (8%) per year, and the nominal after-
tax weighted average cost of capital is fifteen per cent (15%) per year.

On the manufacture of AZ2000Q printer, the Director of Marketing was concerned as
the division reviewed for the costs of the printer, which she is planning to launch next
month. The AZ2000Q is a new commercial printer that Prospect designed for medium-
sized direct mail businesses. The basic system price was set at seventy five thousand
Naira (N75,000), the unit manufacturing cost of the AZ2000Q is forty seven thousand
Naira (N47,000) and selling and administrative cost is budgeted at thirty three per
cent (33%) of the selling price. The maintenance price she planned to announce was
eighty five Naira (N85) per hour of Prospect technician time. While the seventy five
thousand Naira (N75,000) base price is competitive, eighty five Naira (N85) per hour
is a bit higher than the industry average of eighty two Naira (N82) per hour.
However, Monisola Makinwa, the Director of Marketing in the automotive division
believed she could live with the eighty five Naira (N85) price. She is concerned,
because she has just received a memo from the Field Service department of the
division stating that they were increasing their projected hourly charge for service of
thirty five Naira (N35) to thirty eight Naira (N38).



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The eighty five Naira price Mrs. Makinwa was prepared to charge for service was
based on last year‟s thirty five Naira. The Service Manager thought that using last
year‟s cost was conservative since field service had been downsizing and she expected
the cost to go down not up. The thirty five Naira cost still did not yield the sixty per
cent (60%) margin on service that was the standard for other Prospect‟s divisions.
Makinwa had difficulty justifying the higher costs without significantly reducing sales.
Given the higher cost of the division, field technicians and the prices charged for
maintenance by the competitors, she will not be able to make the profit target in her
plan. The lazer printers being introduced by Prospect is an innovation over existing
lazer printers by the competitors. In particular, they have specialized paper transfer
mechanism to handle the customized heavier paper, varying paper sizes and high
speed paper flow rates. With such high paper flow rates, printers require regular
adjustments to prevent paper jams and misalignments. Prospect‟s nationwide field
service department for its automotive decision, has about 300 employees who
maintain these printers and other related products.

The standard automotive division sales contract contains two parts: the purchase price
of the equipment and maintenance contract for the equipment. All automotive
division printers are maintained by the Field Service personnel, and the maintenance
contract specifies the price per hour that was charged for routine and unscheduled
maintenance.      Most of the profit in the automotive division comes from printer
maintenance. Printers have about five to ten per cent mark-up over manufacturing
and selling costs, but the mark-up on maintenance has historically averaged about
sixty per cent.

The printers manufactured by Prospect‟s Automative division have substantial amount
of built-in-intelligence to control the printing and for self-diagnostics. Each printer
has its own microcomputer with memory to hold the data to be printed. These internal
micro-computers also keep track of printing statistics and can alert operator to
impending problems (low toner, paper alignment problems, form breaks). When
customers change their operating system or computer, this often necessitates a
Prospect service call to ensure that the new system is compatible with the printer. The
standard service contract calls for normal maintenance after a fixed number of
impression (pages) for example AZ2000Q requires service after every five hundred
thousand pages are printed. Its micro-computer is programmed to call Prospect Plc`s
central computer to schedule maintenance whenever the machine has produced three
hundred and seventy five thousand (375,000) pages since the last servicing.




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The Automotive division is organized into engineering, manufacturing, marketing,
field service and administrative departments. Engineering designs the new printers
and provides consulting services to marketing and field service regarding system
installation and maintenance. Engineering department is evaluated as a cost centre.

Manufacturing department produces the printers, which are assembled from
purchased parts and sub-assemblies. Prospect Plc`s comparative advantage is quality
control and design. Manufacturing also provides parts for field service maintenance.
Manufacturing is treated as a cost centre and evaluated based on meeting cost targets
and delivery schedules. Manufacturing‟s unit cost is charged to marketing for each
printer sold.

Marketing department is responsible for designing the marketing campaign, pricing
the printers and managing the Field sales staff. The Automotive division sells six
different printers, each has a separate Marketing Program Manager.            The sixth
Marketing Manager thought that using last year‟s cost was conservative since Field
Service had been downsizing and she expected the cost to go down not up. The thirty
five Naira cost still did not yield the sixty per cent (60%) margin on service that was
the standard for other Prospect‟s divisions. Makinwa had difficulty justifying a higher
cost without significantly reducing sales. Given the higher cost of the division field
technicians and the prices charged for maintenance by the competitors, she will not be
able to make the profit target in her plan.

Field sales is organized around four regional managers responsible for the sales office
of their region. Each of the sales offices has a direct sales force that contacts potential
customers and sells the six programs. Sales people receive a salary and a commission
depending on the printer and option sold. The sales person continues to receive
commissions from ongoing revenues paid by the account for service. Since ongoing
maintenance forms a significant amount of a printer‟s total profit, the sales people
have an incentive to keep the customers with Prospect Plc.

Field service contains the technical people who install and maintain the printers
headed by Ayobami Gbenga, a General Manager. Field service is a cost centre and its
direct and indirect costs are charged to programs when the printers are serviced. The
price charged is based on the budgeted rate set at the beginning of the year. Any
difference between the actual amount charged to the programs and the total cost
incurred by the Field service group is charged to the division overhead account and
not to the marketing programs.



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Administration manages human resources, finance, accounting and field leases. It
handles customer billings and collections, payroll and negotiating office space for the
field service people. Administration is evaluated as a cost centre while local office
space is managed by administration, the cost of the office space is allocated to the
field service and service group and included in their budgets and monthly operating
statements.

Each Prospect Plc`s printer sold requires a service contract. The AZ2000Q‟s service
contract calls for normal maintenance every five hundred thousand (500,000) pages at
a price of fifty kobo per one thousand pages. Normal maintenance requires three
hours, the typical AZ2000Q prints twelve million pages per year. Besides normal
maintenance, (sometimes called preventive maintenance) unscheduled maintenance
occurs due to improper operator set ups, paper jams, system upgrades and harsh
usage of the equipment. Past statistical studies shows that each normal maintenance
hour generates zero point five zero (0.50) unscheduled maintenance hours.
Unscheduled maintenance is billed to the customer at the service contract rate of
eighty five Naira (N85) per hour.

When maintenance is performed on a particular machine, the service revenues less
field service costs are credited to the Marketing Manager for that program. All the
programs actual service profits are compared with the plan, they form part of MM‟s
performance evaluation. The field sales person receives a commission based on the
total service revenue generated by the account. In evaluating each new printer
program, Prospect Plc uses the following procedures: profits from service are expected
to create an annuity that will last for five years at 18% interest; to evaluate a proposed
new printer, the one-year maintenance profit is multiplied by 3.127 to reflect the
present value of the future service profits each printer is expected to generate over its
life (about five years).

Any parts used during service are charged directly to the customer and do not flow
through field service budgets or operational statements.        Automotive division
purchases most of the printers‟ parts from outside suppliers and the customer pays
only a token mark-up. Marketing department does not receive any revenue nor is it
charged any costs when customers use parts in the service process. The reason for not
charging customers a larger mark-up on parts stems from an antitrust case filed
against Prospect Plc and other printer companies six years ago. A third-party service
company, Salawu Limited sued the printers manufacturers for restraint of trade
claiming they prevented Salawu Limited from maintaining the printers by only selling
replacement parts at very high prices. To prevent other such claims, Prospect sells


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parts at a small mark-up over costs, yet Salawu Limited and other third party service
firms have never been able to penetrate Prospect Plc service markets, because their
lazer printing technology changes rapidly and an outside company cannot keep a
workforce trained to fix the latest products. Besides, each printer usually has at least
two engineering modifications each year to fix problems or upgrade the printer or its
microcomputer hardware and/or software. An outside service company cannot learn of
these changes and provide the same level of service as Prospect Plc.

The automotive division of Prospect Group had two types of technicians, Tech 1s and
Tech 2s. Both were trained to repair electromechanical problems but Tech 2s had
more training in electronics and computers to work on the latest, most sophisticated
printers.

Field service had been trying to reduce the size of the service workforce in the last few
years through voluntary retirements and attrition. As the printers became more
sophisticated, they became more reliable, the newer systems had self diagonising
software that allowed a service technician to call up a customer‟s printer and run a
diagnostic program. Often, the problem was solved over the phone line having a
Prospect technician handling the repair in the software. If a mechanical problem was
detected, the technician dispatched a repair person (often a tech 1s) with the right
part. Also, past customers replaced their older printers with newer ones that required
less maintenance. The result was excess capacity in the field staff.

The voluntary retirements over the past few years did not produce the reductions
necessary to eliminate the excess capacity. In 2009, field service went through a very
large involuntary reduction of its workforce through attrition, early retirements and
terminations. Prospect Group reduced the number of technicians in the automotive
division by 75% in 2010. The company simultaneously improved the skill level of its
remaining field force substantially.

Makinwa‟s 2010 sales plan for the AZ2000Q calls for 120 placements that year and a
programmed profit projection of about N2.5 million based on capitalizing the service
income using the 3.127 annuity factor. If she were to raise the service price much
above N0.51 per 1,000 pages, they would lose sales, which are already ambitious. She
called Ayobami and raised “phil,” she began, “explain to me how you downsized your
field personnel, cut some office allocations, consolidated inventories and reduced
other fixed costs yet the price I‟m being charged for service increased from N35 to
N38. I thought the whole purpose of the field service reorganization was to streamline



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and make us more cost competitive. You know that our service costs were out of line
without competitors.

We were planning to charge N85 an hour for the AZ2000Q maintenance contract.
Even at N85 per hour I would be violating the corporate policy of maintaining a 60%
mark up on service rule, I would have to charge N87.63 per hour if you had kept your
cost to me at N35.05. But with your cost of N38.25 and my price of N85 the margin
falls to 55%. I already had to get special permission to lower the margin to 59% with
the N35.05.”

Ayobami replied, “well, there are a number of issues that you have just raised. Let me
respond to a few over the phone now and suggest that we meet to discuss this more
fully when I‟m back in the office. In the meantime, I‟ll send you our budget for next
year that derived the N38.35 rate.

Regarding the key question as to how our hourly rate could go up after downsizing it
is really quite simple. We had a lot of idle time being built into the numbers with
people just pretending to be busy. Had we not downsized, the hourly charge would
have gone up even more than it did. For example, on the AZ2000Q that you
mentioned, we would have used 3.25 hours per normal servicing had we kept our
labour force mix of Tech 1s and 2s, the same as in 2009 and our variable costs for Tech
1s and 2s would have increased to the 2010 amounts because of wage increase and
inflation. Let me get you our numbers, so you can see for yourself how much progress
we have been making.” That afternoon, Mrs. Makinwa received a fax from Ayobami
(see appendix XI).

MINING DIVISION

PROSPECT PLC is also thinking whether to purchase or lease an automatic casting
machine in its mining division. The machine will cost one million and five hundred
thousand Naira (N1,500,000) and for tax purposes, will be depreciated towards a zero
salvage value over a five-year period to 2013. However, at the end of the fifth year,
the machine actually has an expected salvage value of two hundred and ten thousand
naira (N210,000), since the machine is depreciated toward a zero book value at the
end of the five years. The salvage value is fully taxable at the firm‟s marginal tax rate
of forty percent (40%); hence, the after-tax salvage is only one hundred and five
thousand naira (N105,000). PROSPECT PLC utilized the straight line depreciation
method to the one million and five hundred thousand naira (N1,500,000) toward a
zero salvage value. Furthermore, the project is expected to generate annual cash


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revenues of five hundred thousand naira (N500,000) per annum over the next five
years (net of cash operating expenses but before depreciation and taxes). PROSPECT
PLC has a target debt ratio of forty percent for projects of this type which is imposed on
its after-tax cost of capital of twelve percent (12%). Also PROSPECT can borrow funds at
a cost before tax rate of ten percent. The operating expenses associated with the asset
that will be paid by the lessor, if PROSPECT PLC leases generally consist of certain
maintenance expenses and insurance. PROSPECT PLC estimates them to be one
hundred thousand naira (N100,000) per year over the life of the project. The annual
lease payments are given and equal to four hundred and twenty thousand Naira
(N420,000).

HUMAN RESOURCES, ACCOUNTING AND INFORMATION SYSTEMS

Underlying PROSPECT PLC‟s operational capabilities is an employee relations
philosophy aimed at closely linking each employee with the company‟s short-and-
long-term goals. It‟s management feels that mission-oriented employees are more
productive. Employees are asked to put out more effort in return for higher pay, yet
their efforts go beyond a straight work-harder-for-more-money arrangement. Their
efficiency and commitment allow PROSPECT PLC to hold down overall costs while
paying higher wages.

PROSPECT PLC looks for special people to fill its vacant positions. “We draft great
attitudes”, according to the Managing Director, Mr Kola Ikumapayi, “If you don‟t have
a good attitude, we don‟t want you no matter how skilled you are. We can change skill
levels through training, we can‟t change attitudes. We are fanatics about hiring the
right people. We want to give them latitude to be individuals on their job. We want
them to be good-natured and have a good-humoured approach to life and have fun
doing their job”.

Unlike many of its competitors, PROSPECT PLC`S employees are unionized. By
maintaining a favourable relationship with the unions, management has been able to
negotiate flexible work rules for its employees. Relationships throughout the company
are cooperative, and people take pride in their organization. Even though PROSPECT
PLC`S workforce is ninety percent unionized, its employees own ten per cent of the
company, the highest in the industry. Annual employee turnover was a mere seven per
cent (the industry‟s lowest) and eighty per cent of promotions came from within. In
2009, five thousand people applied for jobs in PROSPECT PLC, only two hundred were
hired, based on their ability, among other things, to work hard, to have fun, and to be
a part of the company‟s extended family.


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The finance, information systems, and human resources divisions report to the
Managing Director‟s office. The reporting requirements for the company has been
recently streamlined by implementation of an IBM AS400 computer system in January
2009. This new system allowed for a reduction of five people in administrative office.
The new staff and system have resulted in streamlined financial reporting and
extended reporting to the field sales force and to PROSPECT PLC`S customers.
Improved order and cost tracking, as well as the automating of many previously
manual reports have also resulted. PROSPECT PLC recently awarded the contract for
the computerization of its wages, billing, shipping and accounts receivable. The
computer company sent the following information about the system installation to
PROSPECT PLC (see appendix XII).

After the installation, the new system was test run to ensure it works effectively and
meets the expectation of the company, there was a parallel running of the old system
with the new one. In 2009 financial year audit exercise, Mr Oshinbolu Rotimi, who is
the partner in charge of the audit of PROSPECT PLC during the interim work assigned
an audit assistant, Mr. Arowele Ojo to review the accounting system and the internal
control. The assistant determined the following information concerning the new IT
system and the processing and control of shipping notices and customer invoices.

Each of the major computerized functions – wages, shipping, billing, accounts
receivable and so on – is permanently assigned to a specific computer operator, who is
responsible for making program changes, running the program, and reconciling the
computer log. Responsibility for the custody and control of the magnetic tapes and
system documentation is randomly rotated among the computer operators monthly to
prevent any one person from having access to the tapes and documentation at all
times. Each computer programmer and operator has access to the computer room via a
magnetic card and a digital code that is different for each card. The systems analyst
and the supervisor of the computer operators do not have access to the computer
room.

The system‟s documentation consists of the following items: program listing, error
listing, logs, and record layout. To increase efficiency, batch totals and processing
controls are omitted from the system. PROSPECT PLC ships products directly from two
warehouses, which forward shipping notices to its General Accounting department.
The billing clerk enters the price of the item and accounts for the numerical sequence
of shipping notices and also prepares daily adding machine tapes of the units shipped



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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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and sales amounts. Shipping notices and adding machines tapes are forwarded to the
IT department for processing. The computer output consists of

(a)   A three-copy invoice which is forwarded to the billing clerk.

(b)   A daily sales register showing the aggregate totals of units shipped and sales
      amounts that the computer operator compares with the adding machine tapes.

The billing clerk mails two copies of each invoice to the customer and retains the third
copy in an open invoice file that serves as a detailed accounts receivable record.

LIST OF APPENDICES

APPENDIX I:        Sola Nigeria Limited Cash Flow Statement Extract

APPENDIX II:       Comparative Ratio Analysis of recently acquired companies

APPENDIX III:      Organisation Chart of Prospect Group

APPENDIX IV:       Prospect Group: Products lines, sales and operating income

APPENDIX V:        Prospect Group Financial Information on Proxy Companies

APPENDIX VI:       Prospect Group Industrial Products Limited Draft Balance Sheet

APPENDIX VII:      Industrial Products Division Bad Debts Losses & Collection costs by
                   category of customers

APPENDIX VIII:     Prospect Group – Proposed Investment in production of E-Banking
                   machine

APPENDIX IX:       Standard cost for the manufacturing                of   machine   at
                   automation/electrical division

APPENDIX X:        Proposed electrical security device project at Automotive/Electrical
                   division

APPENDIX XI:       Automotive/Electrical division field service budgeted hourly rates
                   for 2010


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APPENDIX XII:      Prospect Group: Table of Activity for the computerization of
                   accounting system

                                    APPENDIX I

                               SOLA NIGERIA LIMITED

                CASH FLOW (EXCLUDING INTEREST ON DEBT)

                                                          N‟m
                Operating profit after tax                 17
                Depreciation                                7
                Total                                      24
                Less: Capital expenditures                  8
                Working capital additions                   3
                Free cash flow                             13


                                   APPENDIX II

  COMPARATIVE RATIO ANALYSIS OF RECENTLY ACQUIRED COMPANIES



                Equity value-to book                      2.9x
                Enterprise value-to sales                 1.4x
                Equity value to earnings                 15.3x
                Enterprise value to EBIT                  7.8x




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            APPENDIX III: ORGANISATION CHART: PROSPECT GROUP

                            BOARD OF DIRECTORS


                                  CHAIRMAN




                                 GROUP
                            MANAGING DIRECTOR




EXECUTIVE                 EXECUTIVE                              EXECUTIVE
EXECUTIVE EXECUTIVE
DIRECTOR                  DIRECTOR                               DIRECTOR
DIRECTOR       DIRECTOR
MARKETING            INDUSTRIAL PRODUCTS                  AUTOMOTIVE PRODUCTS
MINING         FINANCE




            INDUSTRIAL     HOUSE         SECURITY   AUTOMATION   AUTOMOTIVES APPAREL
            QUARRY     HAULAGE            FINANCE     PRODUCTS       WARES
                               FASTENERS                                    CONTROLLER




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 APPENDIX IV: PROSPECT GROUP: PRODUCTS LINES, SALES AND OPERATING INCOME
                                  (Nm)


       GROUP               MAJOR PRODUCT LINES            SALES   OPERATING INCOME 2009
                                                          2009
Industrial Products   Reagents, Chemicals, DSM Agro,      200.5             31.8
                      Sprayers, Footwears, DSM
                      Energy
Security Products     Lock sets, Padlocks, Door           112.6             12.3
                      closures, Electronic locking
                      system
Housewares            Blenders, Food processors,          149.3             4.4
                      Irons, Coffee makers, Electric
                      knives
Apparel/fasteners     Snap fasteners, rivets, burrs       149.1             21.7
                      brass zippers
Automation/Electrical Pneumatic valves, Cylinders,        123.2             12.0
                      regulators, tyre valves, printing
                      machines
Mining                Laterite, Bridge stones, Pellets     83.2              4.3




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                         APPENDIX V
                       PROSPECT GROUP
          FINANCIAL INFORMATION IN PROXY COMPANIES

                                              LONG TERM
                                  BETA      LIABILITIES TO
                                           CAPITALISATION
A. Industrial products
   Apopo Plc                       0.90         0.45
   Toyed Plc                       1.05         0.30
   Bosco Plc                       0.76         0.42
   Dendo Plc                       1.20         0.51
Average                            0.98         0.42


B. Housewives
   Vauve Plc                       0.85         0.38
   Aloyd Plc                       0.75         0.46
   Ponco Plc                       0.85         0.31
Average                            0.82         0.38


Automation/Automatives
C. Gee Plc                         1.10         0.55
   Howeg Plc                       1.35         0.48
   Atuka Plc                       1.24         0.15
   Chenco Plc                      1.35         0.48
   Pecaco Plc                      1.10         0.30
   Average                         1.23         0.39




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APPENDIX VI: PROSPECT GROUP: INDUSTRIAL PRODUCTS LTD


Draft Balance Sheet, as at 31 December 2005

                                              N‟000    N‟000       N‟000
                                              Cost     Dep.
Fixed assets

Tangible assets:
Land and Buildings                            40,000     -         40,000
Plant                                         36,315     19,284    17,031
Fixtures and Fittings                          3,855       1,225    2,630

                                              80,170     20,509    59,661

Intangible assets:
Goodwill                                                           20,000
Investment: trade investment(at cost)                              45,000
Current assets
Stock                                                    40,166
Debtors                                                  35,802
Deferred Development Expenditure                         15,000

                                                         90,968

Current liabilities
Bank Overdraft                                15,209
Trade Creditors                               63,420
Director‟s Loans                              10,000    (88,629)
Working Capital                                                      2,339
                                                                   127,000

Long term liabilities
7% Debentures                                            30,000
Accrued Interest                                          4,200    (34,200)

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                                                                    92,800



Capital and Reserves
Authorized share capital
50,000,000 ordinary shares @ N2.                          100,000
40,000,000 7% cumulative preference
Shares @ N1.                                               40,000
                                                          140,000

Allotted share capital
40,000,000 ordinary shares @ N2                                      80,000
40,000,000 7% cumulative preference
Shares @ N1                                                          40,000
                                                                    120,000

Profit and loss account                                             (27,200)

                                                                     92,800

                                  APPENDIX VII

                 INDUSTRIAL PRODUCTS DIVISION
BAD DEBTS LOSSES AND COLLECTION COSTS BY CATEGORY OF CUSTOMERS

         Risk       Annual Bad debt      Collection cost as a
       Category        losses as a       percentage of sales
                   percentage of sales
           1               0.5                   1.0
           2               1.0                   1.5
           3               2.0                   4.0


                                  APPENDIX VII

 PROSPECT PLC – PROPOSED INVESTMENT IN PRODUCTION OF E-BANKING MACHINE



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NOTES:

1. Skilled labour.

 (a)   This is the scarce resource of the company. If labour is to be moved from one
       area of production to another, it is necessary to ensure that the contribution
       earned on the new production is at least equal to that which would have been
       earned elsewhere. Accordingly, the contribution forgone by switching skilled
       labour to the production of the machine has been included as a cost of the
       machine.

 (b) The option to recruit and train new labour has been rejected on the ground that
     the cost of recruitment and training exceeds the discounted value of the
     expected benefits. See calculation below:


                                        Cashflow           Discount       Present Value
Year                                       N                 factor              N

1. Training cost                        1,500,000            0.9091        (1,363,650)
2. Additional cash contribution
   10 x 1000 x N50                      500,000

3. 10 x 1000 x N50                      500,000              2.261         1,130,500

4. 10 x 1000 x N50                      500,000


       Net Present Value                                                   (233,150)

2. Taxation: This has been ignored because of the difficulty in establishing the rate of
   tax applicable to PROSPECT. Over the last decade, PROSPECT has sometimes paid
   tax at the small company rate. Sometimes at the marginal rate, and at times has
   had no taxable profit.

3. General fixed overheads. These have been excluded from cost of production, as
   they are not related to the manufacturing of the machine, and will be incurred
   whether or not the machine is produced.



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Calculation of Net Present Value

Annual Cash Outflow:

Unit cost of production per standard cost                      N2,800
less general fixed overhead (see note 1)                          150
Unit cost directly attributable to the machine                  2,650

Total annual production cost
N2,650 x 1000                                                N2,650,000
plus: opportunity cost of using skilled labour (note 2)
10 x 1000 x N50                                                  500,000
Interest payment on loan                                         200,000
Total annual cash outflow (years 1 -4)                         3,350,000

Other cash flows

Purchase of equipment (year o)                   1,000,000
Annual cash inflow: Payment from
Distributor in arrears
(years 2 – 5) 1000 x N3,500                      3,500,000

Calculation of Net Present Value
Year Cash                  Cash                  D.F.          P.V.
      Outflow              Inflow
0     (1,000,000)          -                     1.0           (1,000,000)
1     (3,350,000)          -                     0.9091        (3,045,485)
2     (3,350,000)          3,500,000             0.8264           123,960
3     (3,500,000)          3,500,000             0.7513           112,695
4     (3,500,000)          3,500,000             0.6830           102,450
5                          3,500,000             0.6209         2,173,150

                           Net Present Value (NPV)             (1,533,230)

Recommendation by the trainee Accountant: Do not purchase the equipment to
manufacture the e-banking machine.

                                    APPENDIX IX
 STANDARD COST FOR THE MANUFACTURING OF MACHINE AT ELECTRICAL DIVISION


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                                                       N              N
     Materials                                                     1,000

     Labour:
     Skilled: 10hrs @ N60 per hour                                   600
     Semi-skilled: 10 hours @ N50 per hour                           500
     Prime cost                                                    2,100

     Overheads:
     Variable: 20 hours @ N20 per hour               400
     Fixed:
     Specific: 20 hours @ N7.50 per hour             150
     General: 20 hours @ N7.50 per hour              150             700
     Total Cost                                                    2,800
     Profit Margin 25%                                               700
     Selling Price per machine                                     3,500


                                         APPENDIX X
         PROPOSED ELECTRONIC SECURITY DEVICE PROJECT AT AUTOMATIVE/ELECTRICAL
                                       DIVISION

                                Year 0      Year 1     Year 2        Year 3    Year 4     Year 5
                               (N‟000)     (N‟000)    (N‟000)       (N‟000)   (N‟000)    (N‟000)
Investment         depreciable   4,500
fixed assets
Cumulative investment
Working capital                   300          400           500       600       700        700
Sales                                        3,500         4,900     5,320     5,740      5,320
Materials                                      500           650       900     1,000        950
Labour                                       1,065         1,120     1,620     1,720      1,720
Overhead                                       200           200       200       200        200
Interest                                       576           576       576       576        576
Depreciation                                   900           900       900       900        900
                                             3,241         3,446     4,196     4,396      4,346
Taxable profit                                 659         1,954     1,724     2,044      1,674
Taxation                                       264           782       690       818        670
Profit after tax                               395         1,172     1,034     1,226      1,004


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Total initial investment is N4,831,000. Average annual after tax profit is N966,200.

                                   APPENDIX XI
                          AUTOMATIVE DIVISION
             FIELD SERVICE PROJECTED HOURLY RATE FOR 2010
Variable costs                                                       N            N
Technician grade
Salary & benefits                                                   42,800
   Number                                                       x     105
Total direct cost of technician grade 1                                        4,494,000
Technician grade 2
Salary & benefits                                                    54,800
   Number                                                           x 195
Total direct cost of technician grade 2                                       10,686,000
Total variable cost                                                           15,180,000
Fixed costs
Supervision                                                    1,200,000
Occupancy costs                                                1,100,000
Utilities                                                        320,000
Insurance                                                         50,000
Other                                                             50,000
Total fixed cost                                                               2,720,000
Total cost                                                                    17,900,000
Number of technician grade 1                                           105
Number of technician grade 2                                           195
Total technicians                                                      300
Number of man months                                                 3,000
Average number of billable hours per month per technician              130
Projected number of billable hours                                              468,000
Cost per hour projected for 2010                                                 N38.25
Note: Cost per hour 2009                                                          35.05




                                   APPENDIX XII
          PROSPECT GROUP: TABLE OF ACTIVITY FOR COMPUTERIZATION OF

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                                       ACCOUNTING SYSTEM

Activity        Activity Description             Immediate                Time
                                                 Predecessor   Most        Most      Most
                                                               optimistic likely   pessimistic


A          Select the computer model             -             4            6         8
B          Design input/output system            A             5            7         15
C          Design Monitoring System              A             4            8         12
D          Assemble computer Hardware            B             15          20         25
E          Develop the main programs             B             10          18         26
F          Dev. Input/output routines            C             8            9         16
G          Create data base                      E             4            8         12
H          Install the system                    D,F           1            2         3
I          Test and implement                    G,H           6            7         8




                    ATTEMPT ALL QUESTIONS
PART I:         MULTIPLE-CHOICE QUESTIONS                      (10 Marks)

1. Which ONE of the following best describes Gross National Product (GNP)?

    A.  The total value of all goods and services produced in the country during the
       year less taxation
    B. The total value of all goods and services produced in the country during the
       year plus net income from abroad
    C. The total of all consumption in the country during the year
    D. The total of all incomes earned in the country during the year
    E. Gross National Income at factor cost less capital consumption.

2. The main classes of digital computers include all EXCEPT

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           PROFESSIONAL EXAMINATION II – NOVEMBER 2010
                               PATHFINDER

   A.   Hybrid
   B.   Mini
   C.   Super
   D.   Mainframe
   E.   Micro.



3. On cessation of a business or a trade, a gap occurring in the basis period for the
   penultimate and ultimate years for the purpose of initial allowances is deemed to form part
   of

   A.   Penultimate year
   B.   Ultimate year
   C.   Pre-penultimate year
   D.   Preceeding year
   E.   None of the above.

4. Which ONE of the statements below does NOT describe the term “Degree of
   Leverage?”

   A.   The elasticity of earnings to change in debt
   B.   The level of retained earnings to debenture
   C.   The level of current assets to fixed assets
   D.   The sensitivity of earnings to change in capital structure
   E.   The impact of capital structure on company performance.

5. A supplier who is able to segregate the market for his goods and charge differential
   prices between the poor and the rich is called

   A.   Price dictator
   B.   Monopsony
   C.   Price monopolist
   D.   Discriminating monopolist
   E.   Dominating monopolist.

6. The Federal Government policies that attempt to reduce the volatility of export
   prices are called


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        PROFESSIONAL EXAMINATION II – NOVEMBER 2010
                                 PATHFINDER

   A.   Export prices volatility policies
   B.   Export substitution policies
   C.   Commodity stabilization policies
   D.   Commodity price monitoring policies
   E.   Export monitoring policies.

7. A mathematical technique used in scarce resource allocation with a view to
   optimizing the decision process in a multifarious objective environment subject to
   certain constraints is known as

   A.   Mathematical programming model
   B.   Pareto optimality model
   C.   Sensitivity Analysis model
   D.   Goal programming model
   E.   Critical path analysis model.

8. A situation where a company gains control over another company by successive
   purchases of shares over a period of time is known as

   A.   Merger
   B.   Backward integration
   C.   Piece-meal acquisition
   D.   Sub-subsidiary control
   E.   Associated company.




9. A sampling method which involves the selection of the nth item/subject from serially listed
   population, where n is any number usually determined by dividing the population by the
   required sample size is known as

   A.   Random sampling
   B.   Cluster sampling
   C.   Systematic sampling
   D.   Stratified sampling
   E.   Purposeful sampling.


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10. Monthly demand for a company‟s product is 800 units, ordering cost per order is
    N250, purchase cost per unit is N5 and carrying cost of 20% per annum. The EOQ is

      A.    2,490 units
      B.    1,550 units
      C.    1,480 units
      D.    3,020 units
      E.    1,986 units.


 PART II         SHORT-ANSWER QUESTIONS (30 Marks)

 1.        A company in distress but whose economic worth as an operating entity is
           greater than its liquidation value should opt for ……………..

 2.        A method by which the number of outstanding shares is increased through a
           proportional reduction in the par value of the share is called ……………….

 3.        Risk capital invested in a new or young company for research and development
           and/or growth is referred to as ………………….

 4.        The dividend valuation model where annual dividend growth is expected is
           given by Ke = ………………..

 5.        Public sector audit is principally divided into ………….. and ………….

 6.        A lease which runs for considerably less than the useful life of the assets
           concerned is ………………….

 7.        Tax attributable to timing difference is known as ………………….

 8.        The Institute of Chartered Accountants of Nigeria Disciplinary Tribunal has the
           powers of a Federal High Court and appeal against its verdicts can only go to
           the …………..

 9.        Tangible assets are depreciated over time while wasting assets …………… and
           intangible assets ………………..



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10.   Under PPTA, tax and royalty on gas transferred from the natural gas liquid to
      gas-to-liquids facilities are ………..% and ………..% respectively.

11.   A method of comparing one company‟s financial ratio with another within the
      same industry is referred to as ……………

12.   The time limit for a claim of tax credit under a double taxation agreement is
      ………………..

13.   The name of the meeting that a public company must hold within a period of six
      (6) months from the date of its incorporation is ………………..

14.   The right of the insurer, having paid the insured to take over any right that the
      insured has against the person who caused the loss is called ………….
15.   System implementation is not complete without ……………..
16.   A computer security system where list of authorized users of a company`s
      network are established and maintained is …………………….

17.   The authority that is explicitly given by the principal in which the agreement
      sets out the obligations of the agent and the precise powers, he has to carry out
      those obligation is called …………………

18.   The accounting principle that makes distinction between the receipt of cash and
      the right to receive cash, the payment of cash and the legal obligation to pay
      cash is known as ……………….

19.   Transactions occurring subsequent to balance sheet date that lend insight to
      amount and information disclosed in the financial statement are known as
      ……………..

20.   Communication approach involving patterns, movements and creativity as
      propounded by Clampit (1991) is the …………….

21.   The managerial theory that situate leadership style on maturity of subordinates
      is called……………..

22.   In how many ways can 5 passengers sit in a compartment having 16 vacant
      seats?

23.   In queuing theory, the rate of arrival over the service rate is known as ………….


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24.   Given the following functions:
      TR     =      10Q, TC      =   50 + 5Q,      Sa = 20. If BEP is represented
      by Sb, Sb is ………….. and margin of safety is ………….

25.   A tax assessment where there has been a valid objection is termed ……………..

26.   Portfolio that offers the lowest risk (standard deviation) for its expected return
      and the highest expected return for its level of risk is called ………………

27.   NEEDS is the acronym for …………………

28.   The act of examining underlying documents in support of transactions or event
      is known as ……………………

29.   A measure of variation or dispersion among the items in a population is called
      …………………

30.   The software that provides individual authentication and identification         is
      called …………………
SECTION B
QUESTION 1

(a)   With reference to Appendix III and other relevant information in the case,
      prepare reduction and reconstruction accounts of the Industrial product division
      of PROSPECT GROUP.                                                    (6 Marks)

(b)   Prepare the Balance Sheet of the Industrial product division of PROSPECT
      GROUP as at January 1,2006 after the recapitalization.          (3 Marks)

(c)   With the aid of three ratios, comment briefly on changes in the financial
      position of PROSPECT GROUP consequent upon the reorganization.     (3 Marks)
                                                                 (Total 12 Marks)




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QUESTION 2

(a)    Prepare a revised cashflow forecast and Net Present Value (NPV) for the
       proposed e-banking machine by the Automation division.        (6 Marks)

(b)    List the strengths and weaknesses of the budgeting and control system at
       PROSPECT GROUP.                                                (2 Marks)

(c)    Apart from cashflow, what other factors should PROSPECT GROUP management
       take into consideration in appraising the e-banking machine?        (2 Marks)
                                                                    (Total 10 Marks)

QUESTION 3

(a)    Using Appendix VI, construct a flowchart for the programme of computerization
       of some parts of the accounting system.                            (4 Marks)

(b)    Determine the critical path and compute the expected project completion time.
                                                                            (3 Marks)

(c)    Taking into consideration the financial condition of PROSPECT GROUP, advise
       the management on whether to purchase or lease the equipment for the
       Automation Division.                                               (7 Marks)
                                                                   (Total 14 Marks)
QUESTION 4

(a)   In the context of the case study, define attitude and identify its components
       attitude.                                                                (2 Marks)

(b)    Identify the weaknesses of the internal control in the new computerized system
       and inefficiency in the procedures for processing and controlling shipping
       notices and customer invoices in PROSPECT GROUP.                      (5 Marks)
                                                                       (Total 7 Marks)




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QUESTION 5

(a)   If you are engaged as the management consultant for the management audit of
      PROSPECT GROUP. List and explain briefly any SIX specific steps you would take
      to carry out the assignment.
      (6 Marks)

(b)   Outline four contents of management Audit Report.                    (2 Marks)
                                                                     (Total 8 Marks)
QUESTION 6
(a)   When data can be input on-line through a computer terminal, there is a
      possibility of unauthorized input. Discuss the various security control
      components that PROSPECT GROUP should put in place to prevent such
      unauthorized access.                                          (5 Marks)

(b)   Evaluate the human capital management of PROSPECT GROUP by outlining key
      motivating factors in the group.                               (2 Marks)

(c)   State four reasons why company capital may be restructured.         (2 Marks)
                                                                     (Total 8 Marks)
MULTI-DISCIPLINARY CASE STUDY
SOLUTIONS TO MULTIPLE CHOICE QUESTIONS

1.    A

2.    A

3.    A

4.    C

5.    D

6.    C

7.    D



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                                 PATHFINDER
8.    C

9.    D

10.   B

MULTI-DISCIPLINARY CASE STUDY

SOLUTIONS TO SHORT-ANSWER QUESTIONS

1.    Corporate or Capital Restructuring
2.    Stock split
3.    Venture capital
             do(1  g )
4.    Ke =              g
               Mve
      Where do = dividend in year 1
      G = growth rate.
      MVe = Market Value of Equity per share.

5.    Pre-audit and post-audit
6.    Operating
7.    Deferred
8.    Court of Appeal
9.    Depleted and amortized
10.   0% and 0% - S.10 (A) of PPTA
11.   Comparative Trend Analysis
12.   2 years after Year of Assessment
13.   Statutory meeting
14.   Doctrine of subrogation
15.   Pilot testing
16.   Firewalls

17.   Delegation

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          PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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18.   Accrual principle
19.   Post Balance sheet
20.   Dance approach
21.   The situational or Contingency theory
22.   524,160 - This question is on arrangement of passengers where the order of
      arrangement is important and it is therefore a permutation problem. i.e.
                16!          16!    16.15.14.13.12
      16P5=            !   =     =                 = 524,160
              (16 - 5)       11!          11!
23.   Traffic Intensity
24.   10 and 10
      At BEP, TR = TC i.e. 100 = 50 + 5
           5Q = 50
            Q = 10.
      Margin of Safety = Sa – Sb
                          = 20   – 10
                          =10
25.   Revised assessment
26.   Optimal
27.   National Economic Empowerment Development Strategy
28.   Vouching
29.   Standard deviation/variance
30.   Password.


EXAMINER‟S REPORT

The question in Part (a) and (b) was on Critical Path Analysis while part (c) was on
Lease or Buy Option. Only few candidates had an idea of Critical Path analysis and
the few were unable to draw the chart accurately. Consequently, they failed to
identify the path and compute the project completion time.



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       PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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   In Part (c), most candidates could not calculate the Cash Flows required for evaluating
   the Lease or Buy decision.

   As a result of the above, candidates‟ performance was very poor.
   Once again, candidates are enjoined to always remember that they need the
   knowledge of previous subjects they have passed earlier to properly answer questions
   in Multi Disciplinary Case Study.

   MULTI-DISCIPLINARY CASE STUDY

   SOLUTION 1

   (a)       REDUCTION AND RECONSTRUCTION ACCOUNT

                               N‟000                                   N‟000
Ordinary share                              Ordinary share capital     80,000
Capital (written down to 50k) 20,000        Preference shares          40,000
                                            7% Debenture               30,000
Ordinary share capital                      Cash – 10% Debenture       10,000
(issued to 50% preference                   Directors‟ loan            10,000
shareholders)                               Revaluation of plant       1,780
                              20,000        Revaluation of land and
9% cumulative Preference                    buildings                  10,000
shares                                      Profit on sale of trade
                                            investments                 5,000
Capital (issued to 50%
preference shareholders)      20,000

10% Debenture
                              40,000
Ordinary share capital (to
Directors)
                                5,000
Goodwill          20,000
Dev. Exp.         15,000
P & L bal.        27,200

Written off


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                               62,200
Stock written down 16,000
Doubtful debts      3,580
                               19,580

                               186,780                     186,780




   (b)             BALANCE SHEET AS AT 1 JANUARY 2006

   Fixed Assets                                           N‟000        N‟000
   Land and Buildings at valuation                                    50,000
   Plant at valuation                                                 18,811
   Fixtures and fittings (at written down value)                       2,630
                                                                      71,441
   Current assets
   Stocks                                                24,166
   Debtors (N35,802 – N3,580)                            32,222
   Bank (see workings)                                   20,591
                                                         76,979
   Current liabilities:
   Trade creditors                                      (43,420)
   Working capital                                                    33,559
                                                                     105,000
   Long term liability
   10% Debenture (secured)                                           (40,000)
                                                                       65,000
   Represented by:
   Authorized share capital:
   200,000,000 Ordinary shares @ 50k                    100,000
   40,000,000 9% Pref. shares @ N1                       40,000
                                                        140,000
   Issued share capital
   90,000,000 ord. shares @ 50k                                       45,000
   20,000,000 9% cum. Pref. shares @ N1                               20,000
                                                                      65,000


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           PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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Workings
                                     Bank Account

                                   N‟000                                    N‟000
Issued of Debenture                10,000      Balance b/f                 15,209
Sale of trade investment           50,000      Creditors                   20,000
                                               Debenture interest           4,200
                                               Balance c/f                 20,591
                                   60,000                                  60,000

(c)(i) The company‟s liquidity has improved from a potentially dangerous situation to
       one of relative comfort. Using the quick ratio (acid-test ratio) the position
       before and after reorganization can be compared:

        Before       35,802:88,629 or 0.4:1

        After        52,813:43,420 or 1.2:1

        Sufficient quick assets now exist with which to meet the claims of creditors
        should they demand payment simultaneously. Also, after re-organisation, the
        company has funds to finance running expenses.

(ii)    The company‟s working capital ratio shows a marked improvement. Since the
        company now places less emphasis on finance from outsiders for its working
        capital, greater security may now be offered to potential creditors (and it may
        be possible to negotiate more favourable terms with suppliers). The relevant
        ratios, before and after reorganization are :

        Before       90,968:88,629 or 1.03:1

        After        76,979:43,420 or 1.77:1

(iii)   The company‟s gearing becomes higher after reorganization. The amount
        required to service the preference share dividend and debenture interest has
        risen by N900,000 per annum and the higher gearing will tend to make the
        ordinary shares more speculative. The reduction in the amount of equity capital
        may also result in a higher earnings per share (EPS) and possibly a higher
        dividend than was potentially possible before reorganization. The relevant
        ratios, before and after reorganization are:


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         PROFESSIONAL EXAMINATION II – NOVEMBER 2010
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      Before         80,000:70,000 or 1.4:1
      After          45,000:65,000 or 0.69:1

EXAMINERS‟ REPORT

The question tests candidates‟ knowledge of capital reduction and reconstruction.
About 90% of the students attempted the question but their performance was very
poor.
The commonest pitfall, was candidates‟ failure to arrange the figures in the Balance
Sheet orderly and inability to compute ratios correctly.
Candidates should be aware of the need to read wide, most especially, areas they have
covered in the previous examinations in preparation for this subject such as
acceptable presentation of accounts and ratio analysis.

MULTI-DISCIPLINARY CASE STUDY

SOLUTION 2

(a)   Annual cash outflow
                                                                     N
      Unit cost of production per standard cost                    2,800
      Less: Specific fixed overhead                                  150
             General fixed overhead                                  150
      Annual production                                            2,500
      Total annual cash outflow                                    1,000

                                                                     N
1-4
Other cash outflows                                             2,500,000
Purchase of equipment year 1                                    1,000,000
Investment in recruitment training year 1                       1,500,000
Opportunity cost of using skilled labour year 1                 1,500,000
Payment by distributor                                          3,500,000

Calculation of NPV

      Year        Cash outflow                 Cash inflow    DF           Present value


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           0       (1,000,000)                       -          1.0     (1,000,000)
           1       (4,500,000)                   3,500,000    0.9091      (909,100)
           2       (2,500,000)                   3,500,000    0.8264        826,400
           3       (2,500,000)                   3,500,000    0.7515        751,300
           4       (2,500,000)                   3,500,000    0.6830        683,000
                                                                            351,600
Decision: The company should purchase the equipment.

(b)(i) STRENGTHS

       -       autonomy of the managers to set budgets
       -       performance evaluation based on profit performance
       -       division of the budget into short and long term
       -       the stages of the budget approval: bottom to top promote goal
               congruence
       -       revision and monitoring of the budget on quarterly basis.



(ii)   WEAKNESSES

       -       decentralization may weaken Head office
       -       the 3, 5 year budget forecast may be a wasteful exercise because of
               environmental uncertainties.
       -       time and money is being wasted on budget monitoring
       -       managers are not compensated on budget attainment.

(c)    Other factors that should be considered include the following:

       (i)     activities of competitors
       (ii)    quality of the product
       (iii)   potential life cycle of the product
       (iv)    acceptability of the product
       (v)     continual demand for the product
       (vi)    availability of other components
       (v)     availability of raw materials.




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EXAMINER‟S REPORT

The question tests candidates‟ knowledge of Capital Budgeting. The general
performance of candidates was extremely poor. The candidates lacked adequate
understanding of the question and parts thereof because they seemed to have
forgotten the technicalities and theoretical background behind Capital Budgeting.

The candidates failed to identify the required figures for the computation of Cash Flow
forecast to calculate the Net Present Value. In part (b), they failed to identify the
strengths and weaknesses in the company‟s budgeting process as revealed in the
case. Most candidates also failed to identify other factors to be taken into
consideration in project selection apart from Cash Flow as asked for in part (c).

Candidates need to realize that Capital Budgeting is an important area in
management and a good understanding of this is required of a competent accountant.
Therefore candidates must ensure adequate knowledge of this topic in the future.

SOLUTION 3

(b)   Calculation of Expected Time Activity

            Activity                Time
                               a           m    b           tei
        A         1–2           4           6    8           6
        B         2–3           5           7   15           8
        C         2–4           4           8   12           8
        D         3–6         15           20   25          20
        E         3–5         10           18   26          18
        F         4–6           8           9   16          10
        G         5–7           4           8   12           8
        H         6–7           1           2    3           2
        I         7–8           6           7    6           7

where tei     =        a + 4m + b
                             6




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                                   PATHFINDER

                                      E
                                                5G
                                   2 18
                               B                      8
0      A          1            8            D                      7     7
       6                                  20                 6     I
                           8                         2
                       C                        4     H
                                   3 10
                                      F

    Paths                                       Durations

    A – B –E – G – I                            6+ 8 + 18 + 8 + 7 = 47
    A–C–F–H–I                                   6 + 8 + 10 + 2 + 7= 33
    A – B – D –H – I                            6 + 8 + 20 + 2 + 7= 43

    Therefore, the critical path is A – B – E – G – I
    and expected time the Project would be completed is 47 days.




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     (c)    Step 1: Computation of NPV – should the equipment be purchased.

                                   COMPUTATION OF PROJECT ANNUAL AFTER TAX
                                CASH FLOW ASSOCIATED WITH EQUIPMENT PURCHASE


                 YEAR                       1                   2                   3                   4                   5
                                   N000         N000   N000         N000   N000         N000   N000         N000   N000         N000
                                   Book         Cash   Book         Cash   Book         Cash   Book         Cash   Book         Cash
                                   profit       flow   profit       flow   profit       flow   profit       flow   profit       flow
Annual cash revenues                500         500     500         500     500         500     500         500     500         500
Less depreciation                   300          -      300          -     300           -     300           -     300           -
Net revenue before taxes            200         500     200         500    200          500    200          500    200          500
Less taxes 50%                      100         100     100         100    100          100    100          100    100          100


Annual after tax cash flow                      400                 400                 400                 400                 400




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                             PROFESSIONAL EXAMINATION II – NOVEMBER 2010
                      COMPUTATION OF NET PRESENT VALUE

             Year        Annual                D. F.                Present
                        cash flow                                    value
              0          1,500,000            1.0                  (1,500,000)
              1            400,000          0.8926                     357,040
              2            400,000          0.7972                     318,880
              3            400,000          0.7118                     284,720
              4            400,000          0.6355                     254,200
              5            400,000          0.5674                     226,960
          5 Salvage        105,000          0.5674                      59,577
                                      Net present value                  1,377

                  COMPUTATION OF THE NET ADVANTAGE OF LEASE

Year        After-tax       After-tax        Tax shield      Tax shield on         Total
            operating        rental           interest           dep.
          expenses paid     expenses
            by lessor
 1           50,000          210,000           75,000             150,000        (385,000)
 2           50,000          210,000           62,716             150,000        (372,716)
 3           50,000          210,000           49,204             150,000        (359,204)
 4           50,000          210,000           34,341             150,000        (344,341)
 5           50,000          210,000           17,991             150,000        (327,991)


            Year                     Total                D. F.               Present
                                                                               value
              1                  (385,000)              0.9091                  350,004
              2                  (372,716)              0.8264                  308,013
              3                  (359,204)              0.7513                  269,870
              4                  (344,341)              0.6830                  235,185
              5                  (327,991)              0.6209                  203,650
                                                                            (1,366,722)
Salvage value 105,000                105,000            0.5674                   59,577
Initial outlay                                                                1,500,000
 (Net advantage of lease)                                                        73,701




       PROFESSIONAL EXAMINATION II – NOVEMBER 2010
                             PATHFINDER


                            AMORTISATION SCHEDULE

 Year        Instalment         Interest           Principal    Balance
              payment                             repayment
  0               -                -                   -       1,500,000.00
  1          395,673.96        150,000.00         245,673.96   1,254,326.04
  2          395,673.96        125,432.60         270,241.36     984,084.68
  3          395,673.96         98,408.47         297,265.49     686,819.19
  4          395,673.96         68,681.92         326,992.04     359,827.15
  5          395,673.96         35,982.72         359,691.24         135.91

                                             1,500,000
Annual instalment payment        =
                                           1  (1  r )  n
                                             i
                                       1,500,000
                                 =
                                         3.791
                                 =     N395,673.96

Decision criteria: First the project‟s NPV of purchase of N1,377 indicating that the
asset should be purchased. However, the net advantage to leasing, it was found
that the financial lease was the preferred method of financing the acquisition of
the equipment.


EXAMINER‟S REPORT

The question tests candidates‟ knowledge of Leasing and Critical Path analysis.
The question in Part (a) and (b) was on Critical Path Analysis while part (c) was on
Lease or Buy Option. Only few candidates had an idea of Critical Path analysis and
the few were unable to draw the chart accurately. Consequently, they failed to
identify the path and compute the project completion time.

In Part (c), most candidates could not calculate the Cash Flows required for
evaluating the Lease or Buy decision.

As a result of the above, candidates‟ performance was very poor.
Once again, candidates are enjoined to always remember that they need the
knowledge of previous subjects they have passed earlier to properly answer
questions in Multi Disciplinary Case Study.

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SOLUTION 4

(a)   Attitude can be defined as a predisposition or readiness to respond in a
      certain way to a person, object, idea or situation.

The three components of attitudes are: cognition, affect and behavior.
The cognition component is beliefs and perceived knowledge about the subject of
the attitude.

The affective component includes the feelings associated with the subject, often
conveying likes and dislikes.

The behavioural component stems from the perceptions and feelings as an
intention to act in a certain way.

(b)   Weakness in the internal control of the new computerised system:
      (i)  The major computerized function is permanently assigned to a
           specific computer operator.

      (ii)    A single computer operator is responsible for program changes,
              running the program and recruiting the computer log.

      (iii)   The system analyst and supervisor of the computer operators do not
              have access to the computer room.

      (iv)    Responsibility for the custody and control of the magnetic tapes and
              documentation is solely with the computer operators.

      (v)     Inconsistent policies.

      Weakness in the processing and controlling shipping notices and customer
      invoices:
      (i)    The billing clerk enters the price as well as prepares daily adding
             machine tapes of units shipped without anybody checking his work.

      (ii)    Omission of batch totals and processing controls from the system.

      (iii)   The shipping notice goes only to the General Accounting, not to
              inventory or purchasing department or other relevant units.

      (iv)    The daily sales show only the aggregate total of units shipped.

      (v)     The distribution of the invoices.

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EXAMINERS‟ REPORT

The question tests students‟ knowledge of management theory of attitude and
internal control system in auditing.
Part (a) of the question asked for the definition of attitude and its components in
the context of the case while part (b) asked the candidates to identity the
weaknesses in the Internal Control. Many candidates understood the question but
found it difficult to properly define attitude and its components. Also candidates
found it difficult to identify the internal control weaknesses and inefficiency in the
procedures for processing and controlling shipping notices to aid customer
invoices.
Candidates should learn how to sift through procedures and identify weaknesses
inherent in a procedure.


SOLUTION 5

(a)   Before commencing a management audit engagement, it is pertinent for the
      auditor to plan and outline briefly and concisely an audit programme as it
      relates to the areas being studied. The following steps represent the real
      crux of an efficient management audit programme.

Step 1: Organisation structure. The auditor should study the organization and
compare the existing structure with that shown in the company‟s organization chart
(if any).

Step 2: Policies and practices. The auditor should carry out a study to find out
what action must be taken to improve the effectiveness of the policies and
procedures.
Step 3: Regulations. Determine whether or not due regard has been given by the
company for full compliance with all local, state and federal regulations.

Step 4: Systems and procedures. Study the systems and procedures for possible
defects or irregularities in the elements examined and seek out methods to bring
about possible improvements.

Step 5: Operations. Evaluate operations to ascertain what is necessary for income
effective controls and efficient results.

Step 6: Personnel. Study the general personnel requirements and their application
to the work in the area under appraisal.


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Step 7: Layout and physical equipment. Determine whether or not improvement
could be made in the layout and in better or greater use of physical equipment.

Step 8: Report. Prepare a report of findings with suggested recommendations for
improvement.

(b)   The contents of management audit report (in outline form).

      (i)     Purpose and scope of engagement.
      (ii)    Facts of major importance.
      (iii)   Matters discussed with supervisors/managers.
      (iv)    Details of current practices.
      (v)     Recommandation.
      (vi)    Appendices/exhibits.



EXAMINERS‟ REPORT

The question tests the steps to follow in carrying out a management audit.
Ordinarily, the question should not pose any problem for any serious candidate.
However, majority of the candidates lacked proper and in-depth understanding of
the topic and as such most of those who attempted the question peformed poorly.

Candidates are advised to study widely in the course of preparation for future
examinations.

SOLUTION 6

(a)   There are various ways of protecting computer systems from unauthorized
      assessment which include the following:

      1.      Operations Security:
              (i)   to prevent unauthorized users to access or use data.
              (ii)  to prevent authorized users from misusing the data or
                    damaging it through ignorance

      2.      Preventive and Proactive measures. These measures include:
              (i)   precautionary measures to safeguard the system from external
                    threats and unauthorized persons e.g. use of passwords



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               (ii)   measures to obstruct, protect and defend the system from
                      illegal operations e.g. use of operators permissions, restriction
                      to certain functions.

      3.       Detective measures which include:
               (i)    measure to sense and report unauthorized operations
               (ii)   measure to discover and identify illegal operations and
                    intruders.

      4.       Physical security. This includes the following controls:
               (i)   physical access control
               (ii)  fire prevention and detection equipment
               (iii) storage of working media in fireproof stations.

(b)   The key motivating factors at PROSPECT GROUP include the following:

      (i)      Reward for hardwork through higher pay.
      (ii)     Cooperative attitude encouraged by management.
      (iii)    Openness, commitment and sincerity of top management.
      (vi)     Maintenance of favourable relationship with unions.
      (v)      Part ownership of the company by employees.
      (vi)     Boost of morale of employees by installation of computer system.
      (vii)    Provision of conducive work environment.
      (viii)   Low employee turnover due to flexible rules for its employees.

(c)   A company‟s capital may be restructured for the following reasons:

      (i)    As a possible alternative to liquidation.
      (ii)   To tidy up a balance sheet which might otherwise show large number
             of different reserves.
      (iii) A capital re-organisation scheme may be used to effect a change in
             the relative rights of different classes of shareholders.
      (iv) When operating losses are being incurred continuously.
      (v)    The book value of the ordinary share capital is overstated.
      (vi) The company is unable to meet its obligations as and when due.
      (vii) There is rapid labour turnover particularly loss of skilled labour.
      (viii) The fixed assets of the company are too weak or old to put the
             company into the path of success and growth.




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EXAMINERS‟ REPORT

The question tests candidates‟ knowledge of computer system, human capital
management and the reason why a company‟s capital may be restructured.
This question was in three parts, which are direct and should have been easy for
candidates with fair knowledge of computer system, management theory and
financial management.


Candidates‟ understanding of each part of the question is shallow. Part (a) on
Computer system which should have been a cheap source of marks was wrongly
approached. They only control most candidates mentioned is the use of Password
while others are not mentioned. Part (b) on Human Capital Management has all
the answers in the case but only a few candidates could identify them. Also, most
of the candidates failed to identify four reasons why a Company‟s capital may be
restructured as required in part (c) of the question.

Inadequate preparation and lack of understanding are the undoing of most
candidates. There is a need for adequate preparation on the part of the candidates
for future examinations.




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