ACCOUNTING FOR DECISION MAKING MBA ENRICHMENT EXERCISES AND SOLUTIONS

Transcription

1 ACCOUNTING FOR DECISION MAKING MBA ENRICHMENT EXERCISES AND SOLUTIONS

2 CONTENTS ENRICHMENT EXERCISES Page 1. Accounting information and managerial decisions 3 2. Financial statements and accounting concepts 4 3. Accounting for and presentation of assets, liabilities and owners equity 6 4. Income statement and cash flows 9 5. Financial Analysis Cost-volume-profit (CVP) relationships Cost analysis for planning, control and decision-making Transfer pricing for decentralised enterprises Corporate governance 36 Present value tables 37 SOLUTIONS 1. Accounting information and managerial decisions Financial statements and accounting concepts Accounting for and presentation of assets, liabilities and owners equity Income statement and cash flows Financial Analysis Cost-volume-profit (CVP) relationships Cost analysis for planning, control and decision-making Transfer pricing for decentralised enterprises Corporate governance 92 2

3 TOPIC 1 ACCOUNTING INFORMATION AND MANAGERIAL DECISIONS 1. Accounting information is required by various individuals and organizations in order to make decisions. Explain why each of the following user groups need accounting information relating to a business. 1.1 Customers 1.2 Suppliers 1.3 Government 1.4 Owners 1.5 Lenders 1.6 Employees 1.7 Investment analysts 1.8 Community representatives 1.9 Managers 2. Explain how external auditors and internal auditors differ as far as their main duty is concerned. 3. Tabulate 5 differences between management accounting and financial accounting. 4. Whilst there are differences between the information needs of mangers and other users, use examples to show how there could be an overlap of between the needs of managers and other users. 3

4 TOPIC 2 FINANCIAL STATEMENTS AND ACCOUNTING CONCEPTS FINANCIAL STATEMENTS 1. The income statement for Heidi Limited revealed an increase in profit of R However, during the same financial period the bank balance declined by R How would you explain this apparent discrepancy? FINANCIAL STATEMENT RELATIONSHIPS 2. Discuss how the following financial statements are integrated: Income statement Statement of changes in equity Balance sheet Statement of cash flows ACCOUNTING CONCEPTS 3. Critically discuss the following accounting concepts: 3.1 Materiality 3.2 Conservatism 4. Explain the significance of the following accounting concepts in the preparation of a balance sheet of an enterprise. Support your answer with examples. 4.1 Going concern 4.2 Full disclosure 4.3 Consistency 4

5 ACCOUNTING EQUATION AND FINANCIAL STATEMENTS 5. Required 5.1 Use the format of the accounting equation presented below to analyse the transactions of Gwala Stores. Use + for an increase and for a decrease. 5.2 Thereafter prepare the: Income statement the month ended 31 August Statement of changes in equity for the month ended 31 August Balance Sheet at 31 August Statement of changes in Cash Flows for the month ended 31 August Assets = Equity + Liabilities Equipment Inventory Receivables Bank = Capital Income Expenses + Payables TRANSACTIONS FOR AUGUST T Gwala, the proprietor, transferred R from her personal banking account into a bank account in the name of her business. 05 Purchased equipment by cheque, R Bought stationery for office use on credit, R The rent for August 20.9 was paid by cheque, R Fees collected from customers for services rendered, R

6 TOPIC 3 ACCOUNTING FOR AND PRESENTATION OF ASSETS, LIABILITIES AND OWNERS EQUITY 1. Pixma Limited began operations in January 20.9 with R obtained from selling ordinary shares at a par value of R2 each. Some of the major transactions for the year included the following: It purchased plant and equipment for R as well as land and buildings for R , financing the purchase with a mortgage bond of R , a long-term loan of R , and cash for the balance. During the year the company used cash to reduce the mortgage bond balance by R and to repay R towards the long-term loan. The company also invested R in short-term marketable securities. On 01 October 20.9, the company issued a further shares at R3 each. Depreciation expense for the year was R The net profit after tax for the year ended 31 December 20.9 was R Dividends for the year (declared and paid) amounted to R REQUIRED 1.1 From the information provided above, calculate the amount that should be reflected for each of the following items in the Balance Sheet of Pixma Limited at the financial year end 31 December 20.9: Non-current assets Retained earnings Total owners equity Non-current liabilities 1.2 Explain why it is important for Pixma Limited to consistently take advantage of cash discounts offered by creditors for early settlement of accounts. 1.3 Explain how the shareholders of Pixma Limited can benefit from financial leverage. 6

7 1.4 Name 2 control measures that you would recommend to prevent the following from occurring at Pixma Limited for each of the following situations: Payments made without proper authorization Theft of stock from the warehouse 2. Name 4 decisions that need to be made before calculating the depreciation expense for an asset. Also explain what impact these decisions will have on reported profits. 3. The first-in-first-out (FIFO), last-in-last-out (LIFO) and the weighted average cost (AVCO) methods may be used to value inventory. Answer the following questions related to the use of these methods during a period of rising prices: 3.1 Which method will show the highest gross profit? Why? 3.2 Which method will show the lowest gross profit? Why? 3.3 How will the valuation of inventories using the AVCO method compare with the FIFO and LIFO methods? 3.4 Which method will show the highest closing inventory figure in the balance sheet? Why? 3.5 Which method will show the lowest closing inventory figure in the balance sheet? Why? 3.6 Comment on the closing inventory figure if the AVCO method is used. 4. Name 4 instances when the net realizable value of inventory would be lower than the cost price of the inventory held. 5. What would be the effect of not taking into account the fact that a debt is bad, when preparing the financial statements, on the reflection of financial performance and financial position? 6. State which of the following items would appear on the balance sheet of Jensen Manufacturers as an asset. Explain your reasoning in each case. 6.1 R4 000 owing to Jensen Manufacturers by a customer who will never be able to pay. 6.2 The hiring by Jensen Manufacturers of a new marketing manager who is confident of increasing profits by over 50% over the next four years. 6.3 Purchase of a machine that will save Jensen Manufacturers R per year. It is presently being used by the business but has been acquired on credit and is not yet paid for. 7

8 7. The following is a list of balances extracted from the financial records of Manhattan Ltd on 30 November R Debtors Land and buildings Inventories Bank overdraft Equipment Loan from Kia Bank Motor vehicles Creditors Required 7.1 Prepare the balance sheet of Manhattan Ltd at 30 November Provide an interpretation of the balance sheet by making reference to the following: The liquidity of the business The mix between current and non-current assets The financial structure of the balance sheet (finance provided by owners and outsiders) 8

9 TOPIC 4 INCOME STATEMENT AND CASH FLOWS INCOME STATEMENT 1. Edgar Limited has an authorized share capital of ordinary shares at a par value of R2 each shares have been issued at par value. Study the Income statement of Edgar Limited for the year ended 30 September 20.9 and answer the questions that follow: Edgar Limited Income statement for the year ended 30 September 20.9 (R) Net sales Cost of sales ( ) Gross profit Selling, general and administrative expenses ( ) Income from operations Other income/expenses Interest expense (6 000) Other income Profit on disposal of asset Profit before tax Income tax (33 000) Net profit Earnings per share? 1.1 The earnings per share for the year ended 30 September 2008 was 45 cents. As a director of Edgar Limited would you satisfied with the earnings per share for the year ended 30 September 20.9? Motivate your answer. 1.2 The interest rate on loans is 15% per annum. If there was no increase or decrease in the loan balance during the financial year, calculate the loan balance. 9

10 1.3 Calculate the gross profit ratio for the year ended 30 September Thereafter state two possible reasons why this ratio is lower than the ratio for the previous financial year. 1.4 Recommend two ways in which Edgar Limited can improve its profitability. 2. MVP Ltd presented the income statement below for its most recent financial year. R Sales Cost of sales Gross profit Operating expenses Income from operations Other income Other expenses Profit before tax Income tax Net profit Answer the following questions: 2.1 Explain the difference between sales and other income. 2.2 MVP Ltd would like to earn a large gross profit by selling its products at a much higher price than its cost. Describe two factors that may prevent it from doing so. 2.3 Explain how cost of sales, operating expenses and other expenses are different from one another. 2.4 Explain why cost of sales, operating expenses, other expenses and income tax are listed separately in the income statement rather than being lumped together as one item? 2.5 Explain why the income statement presented above is inadequate to provide a proper interpretation of the financial result of MVP Ltd for the financial year. 10

11 3. The income statement for 20.9 and 20.8 given below were extracted from the accounting records of Afri Manufacturers Ltd: Afri Manufacturers Ltd Income statement for the year ended 31 December Net sales Cost of sales (R) ( ) (R) ( ) Gross profit Selling, general and administrative expenses (92 000) (65 000) Income from operations Other income/expenses Non-operating income Interest expense (90 500) (57 000) Profit before tax Income tax (12 000) (15 900) Net profit Required Refer to the income statement of Afri Manufacturers Ltd for 20.9 and 20.8 and comment on the performance of the company including the operating profit earned. Take into account that the profit margin (percentage net profit after tax to sales) for the industry was 4.51% for 20.8 and 2.60% for

12 CASH FLOW STATEMENT 4. What impact would changes in the balance sheet items listed below have on the cash position of an enterprise? Place a tick ( ) in the correct column. Change in balance sheet items Inflow of cash Outflow of cash Increase in current assets other than cash Decrease in current assets other than cash Increase in non-current assets Decrease in non-current assets Increase in current liabilities Decrease in current liabilities Increase in non-current liabilities Decrease in non-current liabilities 5. Study the extracts of the Cash flow statement of Vuyo Limited for the year ended 30 June 20.9 and answer the questions that follow. Extracts of Cash Flow Statement for the year ended 30 June 20.9 R Cash flow from operating activities Cash flow from investing activities ( ) Additions to plant and equipment ( ) Cash flow from financing activities Increase in Long-term borrowings What do you understand by Cash generated from operating activities R ? 5.2 Name one transaction that improves cash flow but does not increase profit. 5.3 There is a combination of a positive net cash flow from operating activities (R ) and a negative cash flow from investing activities (R ). Is this good for the company? Explain. 12

13 6. The cash flow statement for Mega Ltd is provided below: Mega Ltd Cash flow statement for the year ended 31 December 20.9 R Cash flow from operating activities Profit before interest and tax i.e. operating profit Adjustments to convert to cash from operations Non-cash flow adjustments Add: Depreciation Profit before working capital changes Working capital changes (80 485) Increase in inventory (55 170) Increase in receivables (53 061) Increase in payables Cash generated from operations Cash flow from investing activities Proceeds from sale of plant and equipment Cash flow from financing activities ( ) Long-term borrowings redeemed ( ) Net decrease in cash (9 113) Cash balance (31 December 20.8) Cash balance (31 December 20.9) Use the cash flow statement to answer the following questions: 6.1 How did the company use its cash flows from operating and investing activities? 6.2 Why were depreciation and increase in payables added to operating profit in computing the cash flow from operating activities? 6.3 Is the cash flow statement above presented according to the direct method or indirect method? Explain how the method used above is different from the alternative method. 6.4 Based on the cash flow information above, how does the company appear to be performing? Explain. 13

14 7. Required Study the extracts of the Cash flow statement of Siya Limited for the year ended 30 November 20.9 and state your observations. Extracts of Cash Flow Statement for the year ended 30 November 20.9 R Cash flow from operating activities Cash flow from investing activities ( ) Additions to plant and equipment (Property and machinery) Sale of investments ( ) Cash flow from financing activities Proceeds from issue of ordinary shares Increase in Long-term borrowings Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year

15 8. You are provided with the following information: Asic Ltd INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 20.6 R Sales Cost of sales ( ) Gross profit Operating expenses ( ) Directors fees Auditor s fees Depreciation on equipment Depreciation on vehicles Loss on sale of asset Other non-disclosable costs Operating profit Other income: Investment income Interest expense: on debentures (3 900) Profit before tax Income tax (77 595) Profit for the year STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.6 Preference share capital Ordinary share capital Retained earnings Total Balance on 01 January Issue of share capital Profit for the year Dividends:Preference (15 450) (15 450) :Ordinary interim (18 750) (18 750) :Ordinary final (35 250) (35 250) Balance on 31 December

16 Asic Ltd BALANCE SHEET AS AT 31 DECEMBER ASSETS Non-current assets Property, plant and equipment (Note 1) Financial assets: Investment Subsidiary company Investment Listed shares (at cost) 20.6 R R Current assets Inventories Trade and other receivables Trade debtors Cash and cash equivalents Bank Petty cash Total assets EQUITY AND LIABILITIES Equity Share capital Retained earnings Non-current liabilities Long-term borrowings: 13% Debentures Current liabilities Trade and other payables Trade creditors South African Revenue Services (Income tax payable) Shareholders for dividends Bank overdraft Total equity and liabilities

17 Note 1 Property, plant and equipment Land and buildings Equipment Vehicles Land and buildings Equipment Vehicles Cost Accumulated depreciation (82 500) ( ) (45 000) (90 000) Carrying value Additional information 1. Equipment was sold for cash, R The cost price of the equipment sold was R and the accumulated depreciation on it to the date of sale was R Equipment was also purchased for cash. 2. Additions were made to the buildings for cash. 3. Ordinary shares were issued at par value. REQUIRED Prepare the Cash Flow Statement for the year ended 31 December

18 TOPIC 5 FINANCIAL ANALYSIS 1. Excerpts of financial data for Polar Enterprises are as follows: Income statement (R) 20.9 (R) Sales (10% credit) Cost of sales (10% credit purchases) Operating profit Profit before tax Tax (25%) Net profit after tax Balance sheet Non-current assets Current assets Inventories Accounts receivable Marketable securities Cash Current liabilities Accounts payable Other current liabilities Required 1.1 Calculate the gross margin, operating margin and profit margin for and Comment on your answers calculated in question Calculate the current ratio and acid test ratio at the end of each year. How has the enterprise s liquidity changed over this period? 1.4 Compute the following for (ratios for 20.9 are given in brackets): Inventory turnover (20.9: 9.04 times) Debtors collection period (20.9: days) Creditors payment period (20.9: days) Turnover to net assets ( ) 18

19 1.5 What is your interpretation of the enterprise s performance with respect to your answers in question 1.4? 2. Answer the questions below based on the following information. Income tax is calculated at 35% of profit. Vuyo Traders Sipho Stores (R) (R) (R) (R) Operating profit Profit after tax Non-current debt (10% p.a.) Owners equity Note: The enterprise has no current liabilities. Required 2.1 Calculate the return on assets for both enterprises for Calculate the return on equity for both enterprises for Which enterprise is more profitable? Explain. 2.4 Should Vuyo Traders be satisfied with its return on assets? Explain. 3. In 20.10, Mestle Wholesalers had R of assets, R of current liabilities and R non-current liabilities. Operating profit was R , interest expense was R and the tax rate was 40%. Required 3.1 Calculate the following ratios: Debt to assets Debt to equity Interest coverage 3.2 Comment on your answers obtained in question

20 4. The following information was extracted from the financial statements of Premier Limited: Income statement (R) 20.9 (R) Profit after tax Statement of changes in equity Interim dividends Final dividends Ordinary share capital (par value R2) Ordinary share premium Retained earnings Other Market price per share Required 4.1 Calculate the following ratios for (ratios for 20.9 are given in brackets): Return on equity (10.04%) Earnings per share (25 cents) Dividends per share (4.67 cents) Earnings retention (81.32%) Price/Earnings ratio (15) 4.2 Comment on your answers obtained in question

21 TOPIC 6 COST-VOLUME-PROFIT (CVP) RELATIONSHIPS EXPANDED CONTRIBUTION MARGIN MODEL 1. The following budgeted details for 20.9 relate to a product manufactured by Manto Ltd: Sales R Variable cost per unit sold R7.50 Total fixed cost R Sales volume units Required Consider the following situations independently: 1.1 Calculate the operating profit. 1.2 Suppose sales increase by R without changes to any costs. By what amount will contribution margin and operating profit increase? 1.3 Suppose fixed costs increase by R By how much must sales increase if operating profit was to remain unchanged? 1.4 Would you recommend an advertising programme costing R5 000 that would generate an additional R of sales? Why? 1.5 Calculate the volume of sales required to achieve an operating profit of R Consider the following situations independently and in each case motivate your answer by doing the relevant calculations: 1.6 Should management consider a drop of R2 per unit in the selling price if sales volume is expected to increase by 200 units? 1.7 Should management adopt the following proposal? Decrease the selling price by R4 and increase marketing costs by R8 000 with the expectation of an increase in sales to units. 21

22 2. Rissik Limited manufactures product D. The budgeted details for 20.9 are as follows: Selling price per unit R12 Variable cost per unit sold R5 Total fixed cost R Required Calculate the number of units that must be sold in order to earn an operating profit of R (answer expressed to the nearest whole number). BREAK-EVEN POINT 3. Sepata Enterprises makes sandals. The fixed costs of operating the workshop for a month total R Each pair of sandals requires material that cost R20. Each pair of sandals takes 2 hours to make, and the business pays the sandal makers R12.50 an hour. The sandal makers are all on contract and if they do not work for any reason, they are not paid. Each pair of sandals is sold to shoe stores at R70. The business expects to sell 350 pairs of sandals per month. Questions 3.1 Calculate the number of pairs of sandals that the business must sell in order to break even each month. 3.2 Why is it necessary for the management of Sepata Enterprises to know the break-even point? 3.3 Suppose the business has an opportunity to rent a sandal-making machine. Doing so would increase the total fixed costs of operating the workshop for a month to R Using the machine will reduce the labour time to 1 hour for each pair of sandals. The sandal makers will still be paid R12.50 per hour Calculate the break-even quantity if the machine is rented After considering the information given and the calculations you made, should the machine be rented or not? Calculate and comment on the margin of safety (calculated in units) for each option i.e. without the machine and with the machine. 22

23 4. The following budgeted data relates to a product produced by Gnome Manufacturers and to a similar product produced by Humpty Manufacturers for 20.9: Gnome Humpty R R Selling price per unit Direct material cost per unit Direct labour cost per unit 12 6 Direct overhead cost per unit 8 4 Fixed factory overhead costs Fixed administration costs Expected sales for each manufacturer is units. Required 4.1 Calculate the total revenues required to break even for each manufacturer. 4.2 Which manufacturer experiences a higher operating leverage? Motivate your answer by doing the relevant calculations. 4.3 What is the consequence of a small drop in sales to an enterprise that has a high operating leverage? Use a calculation to support your answer. 4.4 Calculate the margin of safety (expressed as a percentage) for each manufacturer. 23

24 5. The following budgeted information for the year ended 31 October 20.9 is provided by Sonke Ltd, a manufacturer of a single product called Rimex: Sales ( units X R12 per unit) R Total variable cost ( units X R5.40 per unit) R Total fixed costs R The sales forecast for the year ended 31 October 20.9 is 15% less than the actual sales for the year ended 31 October The sales director produced three proposals to improve the position: Proposal A involves launching an aggressive marketing campaign. This would involve a single additional fixed cost of R for advertising. Sales commission will increase by R1.20 per unit. Sales volume is expected to increase by 10% above the budgeted sales of units with no change in the unit selling price. Proposal B involves a 10% reduction in the unit selling price. Fixed selling overheads will also reduce by R The sales volume is expected to be units. Proposal C involves a 10% reduction in the unit selling price and this is estimated to bring the sales volume back to the level as the year ended 31 October Required For each of the three proposals, calculate the break-even quantity (answer expressed to the nearest whole number). 24

25 TOPIC 7 COST ANALYSIS FOR PLANNING, CONTROL AND DECISION-MAKING BUDGETS 1. Budgets are half used if they serve only as a planning device. Comment on this statement. 2. What are the principal considerations involved in preparing a production budget? 3. The following is the sales forecast (in units) of Manco Ltd that manufactures two products viz. product X and product Y: November 20.6 December 20.6 January 20.7 Product X Product Y The selling price per unit of product X is R20 and the selling price of product Y is R30. Required Prepare a sales budget for the period 1 November 20.6 to 31 January PC Solutions makes and sells computers. On 31 March 20.6, the entity had 60 computers in inventory. The company s policy is to maintain a computer inventory of 5% of the following month s sales. The sales forecast of the entity for second quarter of the year is: April computers May computers June 900 computers Required Draw up a production budget for April and May

26 5. Computek Ltd sells computers. At the beginning of May 20.9 the business had an overdraft of R and the bank had asked that it be settled by the end of October As a result, the directors decided to review their plans for the next 6 months and the following is the cash budget that was subsequently drawn up for the 6 months ending 31 October Computek Ltd Cash Budget for the 6 months ended 31 October 20.9 May Jun Jul Aug Sep Oct R 000 R 000 R 000 R 000 R 000 R 000 Cash receipts Cash sales Cash payments Cash purchase of merchandise Administration expenses Loan repayments Selling expenses Shop refurbishment Tax payment 44 Cash surplus (shortfall) (14) (52) (28) (24) Opening cash balance (70) (20) (12) Closing cash balance (20) (12) (36) Additional information (a) The business maintains a minimum monthly inventory level of R of merchandise. (b) The gross profit margin is 40%. Question What problems are likely to be faced by Computek Ltd during the 6 month period May to October 20.9? Suggest ways in which the business may deal with these problems. 26

27 VARIANCE ANALYSIS 6. GMX Ltd uses the standard costing system. The standards are as follows: Standards Material J Labour Variable overheads Fixed overheads Normal production R5 per kg 4 R50 per hour R11 per labour hour R per month Actual information for the month October 20.8 is: Material J used 20 R5,20 per kg Labour R48 per hour Variable overheads R12 per labour hour Fixed overheads R Production units manufactured Required 6.1 Calculate the raw material usage variance. Also provide possible reasons for the variance. 6.2 Calculate the direct labour rate variance. 6.3 Calculate the direct labour efficiency variance. 6.4 Calculate the variable overhead efficiency variance. 27

28 7. Zimba Manufacturers uses the standard costing system. The following information for September 20.9 is available in respect of product H that it manufactures: Budgeted figures Variable manufacturing overheads Fixed manufacturing overheads Number of labour hours Expected production R R units Actual results Variable manufacturing overheads Fixed manufacturing overheads Number of labour hours worked Actual production R R units Required 7.1 Calculate the fixed overhead spending variance. 7.2 Calculate the fixed overhead volume variance. 7.3 Calculate the variable overhead efficiency variance. Also provide possible reasons for the variance. 28

29 ACCEPTANCE OF A SALES OFFER 8. Kremo Limited produces only premium ice cream. The factory has a capacity of 10 million litres but only plans to produce 8 million litres. The variable costs per litre associated with producing and selling 8 million litres are as follows: R Ingredients 5.00 Packaging 1.00 Direct labour 2.00 Variable overheads 0.50 Sales commission 0.50 Total variable costs 9.00 The selling price per litre is R12 and the fixed costs for producing the ice cream is R An ice cream distributor from Gauteng not normally served by Kremo Limited has offered to buy 2 million litres at R8.90 per unit. Since the distributor approached the company directly, there is no sales commission. REQUIRED 8.1 Calculate the operating profit or loss. 8.2 As the manager of Kremo Limited, would you accept or reject the offer? Substantiate your answer by calculating the differential profit or loss from accepting the offer. 29

30 9. Femino Enterprises produces product Z that it sells for R63 each. The costs of producing and selling units of product Z are estimated as follows: Variable costs per unit: Direct materials R15.00 Direct labour R9.00 Factory overhead R6.00 Selling and administrative expenses R7.50 R37.50 Fixed costs: Factory overhead R Selling and administrative expenses R To date, this year, units have been produced and sold. An additional units are expected to be sold on the domestic market during the remainder of the year. Femino Enterprises received an offer from Zambesi Traders for units of product Z at R42 each. Zambesi Traders will market the product in Zambia under its own brand name, and no additional selling and administrative expenses associated with the sale will be incurred by Femino Enterprises. The sale to Zambesi Traders is not expected to affect domestic sales of product Z and the additional units could be produced during the current year using excess capacity. Required Should the proposal be accepted? Motivate your answer. MAKE OR BUY DECISION 10. Dubai Ltd needs a component for one of its products. It can subcontract production of the component to a subcontractor who can provide the component at R20 each. Dubai Ltd can produce the component internally for total variable costs of R15 per component. Dubai Ltd has no spare capacity, so it can only produce the component internally by reducing its output of another of its products. While it is making each component it will lose contributions (contribution margin) of R12 from the other product. Required 10.1 Should the component be subcontracted or produced internally? Motivate your answer Name two problems Dubai Ltd may experience if it decides to subcontract any of its components. 30

31 11. Trike Enterprises assembles tricycles with motors. It also produces a component for assembly. The costs of making this component for May 20.9 are as follows: R Direct Material Labour and other variable costs Fixed overheads allocated Total cost Number of units produced Per unit cost A recently established spare part manufacturer approached Trike Enterprises with a proposal of supplying this component at R210. Required What would be your advice to Trike Enterprises? 31

32 CAPITAL INVESTMENT APPRAISAL NOTE: WHERE APPLICABLE, USE THE PRESENT VALUE TABLES SUPPLIED AT THE END OF THE ENRICHMENT EXERCISES. 12. The following information relates to two capital expenditure projects. Because of capital rationing, only one project can be accepted. Project A Project B Initial cost R R Expected life 5 years 5 years Expected scrap value R R Expected net cash inflows: R R End of year The company estimates its cost of capital is 12%. Depreciation is calculated using the straight-line method. Required 12.1 Calculate the payback period for project B. (Answer expressed in years and months) 12.2 Calculate the accounting rate of return for project A. (Answer expressed to 2 decimal places) 12.3 Calculate the net present value of project A. (Round off amounts to the nearest Rand) 12.4 Using your answers from questions 12.2 and 12.3, should project A be considered for acceptance? Why? 13. The financial manager at Reno Ltd had to choose between these two projects, Turbo and Gusto, which have the following after-tax cash inflows: 32

33 Year Turbo 0 R R R Gusto R R R R Both projects require an initial investment of R All cash flows take place at the end of the year except the original investment in the project which takes place at the beginning of the project. Required 13.1 Calculate the net present value (NPV) for each project, using a discount rate of 12%. Which project would you choose? Why? 13.2 Calculate the Internal Rate of Return (IRR) for both projects. Which project should be chosen? Why? 14. Your company has the option to invest in machinery in projects F and G but finance is only available to invest in one of them. You are given the following projected data: Project F Project G R R Initial cost Net cash inflows: Year 1 Year 2 Year 3 Year 4 Year Additional information 1. All cash flows take place at the end of the year except the original investment in the project which takes place at the beginning of the project. 2. Project F machinery will be disposed of at the end of year 5 with a scrap value of R Project G machinery will be disposed of at the end of year 4 with a nil scrap value. 33

34 4. Depreciation is calculated on a straight line basis. 5. The discount rate to be used by the company is 14%. Required 14.1 Calculate the payback period for project F. (Answer must be expressed in years and months) 14.2 Calculate the accounting rate of return for project F. (Answer expressed to 2 decimal places) 14.3 Calculate the net present value of each project. (Round off amounts to the nearest Rand) 14.4 Using the answers from question 14.3, which project should be chosen? Explain why. 15. A machine with a purchase price of R is estimated to eliminate manual operations by R per year. The machine will last 5 years and have no residual value at the end of its life. Required Calculate the internal rate of return. 34

35 TOPIC 8 TRANSFER PRICING FOR DECENTRALISED ENTERPRISES 1. Briefly discuss the use of market-based transfer price as the transfer price between divisions of the same entity. 2. It is possible to adopt an approach that allows divisional managers to arrive at negotiated prices for inter-divisional transfers. 2.1 Under what circumstances would you recommend negotiated transfer prices? 2.2 Discuss the possible implications of negotiated transfer pricing on divisional performance of a selling division that sells the whole of its output to another division. 3. A company has two divisions. The output of Division A is product Alpha. There is a market outside the company for product Alpha, but this product is mainly used by Division B which has first call on Division A s output. The output of division B is Product Beta and is sold on the external market. Product Alpha has the following cost structure: Variable cost per unit R8 Fixed cost per unit R2 Management has decided on a target rate of return of 12% for each division. The cost structure of product Beta is given below: Transfer price? Variable cost per unit R15 Fixed cost per unit R7 Market price per unit R28 Required 3.1 Determine the transfer price of product Alpha per unit using the variable cost method. 3.2 Determine the transfer price of product Alpha per unit using the cost-plus method. 3.3 Calculate the selling price of product Beta (for each of the two transfer methods). 3.4 Explain two drawbacks of using variable cost transfer prices. 35

36 TOPIC 9 CORPORATE GOVERNANCE 1. The King Report states that contracts of directors of companies should not extend to more than three years and that these contracts should no longer be open-ended. Do you agree with this recommendation? Motivate your answer. 2. Explain how the board of directors of a company should manage the company's ethics performance. 3. How can the board (of directors) ensure that the company acts as a responsible corporate citizen? 4. Explain the role played by internal audit in a company and also explain the responsibility of the board in this regard. 5. What steps may be taken by a company to ensure that appropriate persons are appointed as directors? 6. The board is not only responsible for the company s financial bottom line, but for the company s performance in respect of its triple bottom line. Explain what you understand by triple bottom line. 7. A director is a steward of the company. The ethics of governance requires that in this stewardship role, each director be faithful to the four basic ethical values of good corporate governance (responsibility, accountability, fairness and transparency). In performing their stewardship role directors need to exercise the following five moral duties: conscience, care, competence, commitment and courage. Explain what is meant by each of these five moral duties. 8. Explain the function of external auditors. 36

37 APPENDIX 1 Present value of R1: PVFA (k,n) = Number of 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 25% Periods * * * * * 37

38 APPENDIX 2 Present value of a regular annuity of R1 per period for n periods : PVFA (k,n) = n i=1 = Number of 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% Periods

39 TOPIC 1 ACCOUNTING INFORMATION AND MANAGERIAL DECISIONS 1.1 Customers: To assess the ability of the business to continue in business and satisfy the needs of customers. 1.2 Suppliers: To assess the ability of the business to pay for the goods and services provided. 1.3 Government: To assess the amount of tax the business should pay. 1.4 Owners: To assess how effectively the business is managed and to make judgements about likely levels of risk and return in the future. 1.5 Lenders: To assess the ability of the business to pay interest and the principal sum lent. 1.6 Employees: To assess the ability of the business to provide employment and to reward them for their labour. 1.7 Investment analysts: To assess the possible risks and returns associated with the business in order to determine its investment potential so that they could advise their clients accordingly. 1.8 Community representatives: To assess the ability of the business to continue to provide employment for the community and use community resources, to engage in corporate social responsibility projects etc. 1.9 Managers: To assist them in making decisions and plans for the business and to help them to exercise control to ensure that plans succeed. 2. The main duty of external auditors is to report to shareholders and others whether, in their opinion, the financial statements show a true and fair view, and comply with statutory, regulatory and accounting standard requirements. The role of internal auditors is to provide an independent appraisal function within an organisation to examine and evaluate its activities as a service to the organisation with the aim of assisting members of the organisation in the effective discharge of their responsibilities. 39

40 3. Management accounting Financial accounting User groups Internal users: Managers External: Owner(s); Lenders, Creditors; Investors Nature of reports Reports tend to be specific usually with some decision in mind. Reports tend to be general-purpose useful to a wide range of users. Legal requirements Management accounting reports are not required by law since they are for internal use only. Financial reports are required by law and are also regulated in terms of content and format. GAAP Management accounting reports are not subject to the practices and principles of GAAP (Generally Financial reports must conform to the practices and principles set by GAAP. Accepted Accounting Practice). Time focus The emphasis is on the future but also provides information on past It reflects on the financial result and financial position for the past period. performance. Nature of information Information used may be less objective and verifiable. Objective and verifiable information is needed to prepare reports. Frequency of reporting Reports are produced as often as required by managers even on a weekly basis. Reports are produced annually although some businesses prepare half-yearly or even quarterly reports. Focus on the whole or parts of the business Focuses on parts of the business e.g. a certain department as well as the business as a whole. Focuses on the performance of the business as a whole. 4. Managers will at times be interested in the historic overview of business operations of the sort provided to other users. Equally, other users would be interested in receiving information relating to the future e.g. profit forecasts, non-financial information such as product innovations. Etc 40

41 TOPIC 2 FINANCIAL STATEMENTS AND ACCOUNTING CONCEPTS 1. Due to the practice of adhering to the recognition of revenue concept, accrual concept and matching concept, revenue and expenses are not the same as cash received and cash paid and the net profit does not normally reflect the net cash flows for the period. Although making a profit will increase wealth, cash is only one form in which wealth may be held. Wealth may also be held in other forms such as inventory, land and buildings, equipment etc. 2. The net profit in the income statement also appears in the statement of changes in equity as an addition to retained earnings. The net profit also affects the retained earnings component of equity in the balance sheet. The statement of changes in equity and balance sheet are integrated. The retained earnings also appear as part of equity in the balance sheet. The balance sheet and the statement of cash flows are also integrated. The cash that appears in the balance sheet also appears as the end of the financial year cash in the statement of cash flows Materiality The materiality principle urges one to disclose significant matters in the financial reports and to eliminate trivial details. What may be significantly material in one instance to warrant full disclosure may not justify complete reporting in another circumstance. For instance, an item involving R1 000 may be material enough to justify full disclosure for a small business, but would probably not justify disclosure as a separate item for a company as large as, say, Samsung. No objective test of materiality exists. Deciding what is material or not depends largely on management policy. 41

42 3.2 Conservatism This principle calls for a conservative approach on the part of the accountant in his/her estimations, opinions and selection of procedure. Losses should be recognized and reflected in the financial statements if a reasonable likelihood exists that they may occur. On the other hand, anticipated gains and other financial benefits should not be realized. A drawback of this principle is that it may make the business appear to be in a more unfavourable position than is actually the case Going concern The balance sheet is prepared on the assumption that the entity will continue to operate in the future. If for example the entity is aware of its intention to liquidate, the amounts shown in the balance would now have to show the liquidation values. 4.2 Full disclosure Lack of full disclosure by not including all the necessary information in the balance sheet may result in its users being misled or making inappropriate decisions. For example certain explanations or notes about investments may be omitted. 4.3 Consistency This concept is important when making trend comparisons of the balance sheet for several years. For example, the change in the valuation method of inventories would make trend comparison difficult. 42

43 Assets = Equity + Liabilities Equipment Inventory Receiv. Bank = Capital Income Expenses + Payables Gwala Stores INCOME STATEMENT FOR THE MONTH ENDED 31 AUGUST 20.9 R Revenue Expenses (9 000) Net profit Gwala Stores STATEMENT OF CHANGES IN EQUITY FOR THE MONTH ENDED 31 AUGUST 20.9 Opening balance 0 Additional capital contributed Net profit Closing balance

44 5.2.3 Gwala Stores BALANCE SHEET AT 31 AUGUST 20.9 ASSETS Non-current assets: Property, plant and equipment Current assets: Cash Total assets EQUITY AND LIABILITIES Equity Current liabilities: Accounts payable Total equity and liabilities Gwala Stores STATEMENT OF CHANGES IN CASH FLOWS FOR THE MONTH ENDED 31 AUGUST 20.9 R Cash flows from operating activities Net profit Working capital changes Increase in accounts payable Cash flows from investing activities (50 000) Purchase of plant, machinery and equipment (50 000) Cash flows from financing activities Capital contributed Net increase in cash for the year Cash (opening balance) 0 Cash (closing balance)

45 TOPIC 3 ACCOUNTING FOR AND PRESENTATION OF ASSETS, LIABILITIES AND OWNERS EQUITY NON-CURRENT ASSETS R Land and buildings Plant and equipment Less: Depreciation ( ) RETAINED EARNINGS R Balance (31 December 20.8) 0 Net profit Dividends ( ) Balance (31 December 20.9) TOTAL OWNERS EQUITY R Ordinary share capital ( ) Share premium Retained earnings NON-CURRENT LIABILITIES R Mortgage bond ( ) Long-term loan ( )

46 1.2 The percentage cash discount, when converted to an annualised return on investment, can be a very attractive return. The creditworthiness of a company, when evaluated by credit rating agencies and credit grantors, is affected by its consistent use of cash discounts. Etc. 1.3 If Pixma Limited can borrow money at an interest rate of, say, 12% and use the money to purchase assets that realise a return that is greater than 12%, then the shareholders will get a greater return on investment than if they provided the funding Cheques must be signed by two persons. Payments should only be made when supported by authorized vouchers. Etc Proper records must be kept of all stock received and issued. Requests for stock from the warehouse must be authorised. Security cameras may be installed. Etc 2. Four decisions *The cost of asset (e.g. whether to include interest charges or not) *The expected residual or disposal value of the asset *The expected useful life of the asset *The choice of the depreciation method *The percentage per annum Effect on reported profits Making different choices for the above matters will result in a different pattern of depreciation charges over the life of the asset and therefore a different pattern of reported profits. 46

47 3.1 FIFO will show the highest gross profit because sales are matched with the earlier (and cheaper) purchases. 3.2 LIFO will show the lowest gross profit because sales are matched with the more recent (costlier) purchases. 3.3 The AVCO method will usually give a figure which is between these two extremes. 3.4 The closing inventory figure in the balance sheet will be highest with the FIFO method. This is because the cost of inventory still held will be based on the more recent (and costlier) purchases. 3.5 The closing inventory figure in the balance sheet will be lowest with the LIFO method. This is because the cost of inventory still held will be based on the earlier (and cheaper) purchases. 3.6 The AVCO method will usually give a figure between these two extremes. 4. *The inventory is damaged or deteriorated. *The inventory is obsolete. *The market price of the inventory has fallen. *The inventory item is being used as a loss leader. 5. The effect would be to overstate the assets (debtors/accounts receivable) in the balance sheet and to overstate profit in the income statement as the loss/expense (which has been recognized) will not result in any future benefits The amount owing by any customer is typically shown as an asset (accounts receivable). However, since the debtor is unable to pay, the item cannot provide future benefits and the R4 000 owing would not be regarded as an asset. 6.2 The hiring of a new marketing manager cannot be considered as an acquisition of an asset. One reason is that the business does not have exclusive rights of control over that manager (perhaps only to his/her services). Furthermore the value of the manager cannot be measured in monetary terms with any degree of reliability. 6.3 The machine can be considered as an asset even if it has not yet been paid for. Once the business has agreed to purchase the machine and has accepted it, the machine is legally owned by the business even if payment is still outstanding. 47

48 Manhattan Ltd Balance Sheet at 30 November 20.9 ASSETS Non-current assets Land and buildings Plant and equipment Motor vehicles Current assets Inventories Accounts receivable Total assets EQUITY AND LIABILITIES Equity Non-current liabilities Loan from Kia Bank Non-current liabilities Accounts payable Bank overdraft Total equity and liabilities The liquidity of the business Liquid assets amounting to R (R R ) is available to meet the short-term obligations of R (R R ). Whilst the liquid assets are greater, none of it is cash and furthermore it is not easy to convert inventories to cash at short notice. Also, a large amount is tied up in accounts receivable and if debtors do not abide by the credit terms and/or if credit terms are greater than 30 days, the business may experience liquidity problems. 48

49 7.2.2 The mix between current and non-current assets Current assets total R whilst the non-current assets equal R When too much of funds are tied up in non-current assets, the business could be vulnerable to business failure. This is because non-current assets are typically not easy to turn into cash in order to meet short-term debts. Converting many non-current assets into cash may lead to substantial losses as such assets are not always worth in the open market what the business paid for them or what they may be worth to the business The financial structure of the balance sheet The own capital (equity) is 1.70 times greater than the outside capital (long-term liability). However, the long-term liability of R brings with it the obligation to pay interest and make large capital repayments at regular intervals. 49

50 TOPIC 4 INCOME STATEMENT AND CASH FLOWS 1. Edgar Limited 1.1 Earnings per share = R X 100c = 38.5 cents No. EPS has dropped by 6.5 cents. 1.2 R6 000 = 15% Loan balance = R6 000 X = R Gross profit ratio = Gross profit X 100 Net sales = R X 100 R = 56% - Goods may have been sold below the normal selling price. - Monthly or seasonal sales may have been held. - Some goods may have been incorrectly priced (lower) Negotiate with suppliers for higher discounts, to reduce costs. - Seek alternative suppliers for better deals. - Use substitute materials but do not compromise quality. - Reduce administrative expenses by cutting down on overtime. - Pay off the loan as soon as possible to reduce interest expense. 50

51 2. MVP Ltd 2.1 Sales reflect the amount an enterprise earns by selling its products. It is revenue generated through the enterprise s primary operating activities. Other income is not directly related to the enterprise s primary operating activities. They are considered non-operating items and are reported separately on the income statement, example interest on investment. 2.2 Competition is one factor that will prevent it from doing so. The products must be also be priced at amounts that customers are willing to pay. 2.3 Cost of sales refers to the cost to the enterprise of goods sold to customers. It is an expense linked directly with the revenue generated through sales. Operating expenses are costs of resources incurred as part of operating activities that are not directly associated with specific goods. Other expenses are expenses not directly related to the enterprise s primary operating activities. They are considered non-operating items. 2.4 A separate disclosure is required as each item is relevant to various decision makers (concept of materiality). If they were grouped together it would diminish the ability of decision-makers to make important economic decisions. The separate listing also distinguishes expenses that result from the enterprise s primary operating activities. 2.5 The income statement of the previous year is not provided to enable one to make a comparison of the performance of the enterprise over the past year. Income statements of the previous years will enable users to do a trend analysis. 51

52 3. Afri Manufacturers Ltd The performance of the company in 20.9 appears lacklustre compared to The profit after tax dropped from R to R Since profit is a function of turnover, let s examine the profits of both years in relation to their respective turnovers. The ratio of profit to sales (profit margin) for 20.9 was 2.79% whilst that of 20.8 was 4.12%. The previous year performance appears better. However, when one compares the profit margins achieved to the industry average, one finds that the company s performance in 20.8 was below the industry average of 4.51% whereas in 20.9 the performance was better than the industry (2.60%). Operating profit on sales decreased from 10.21% to 0.60%. Etc 4. Change in balance sheet items Inflow of cash Outflow of cash Increase in current assets other than cash Decrease in current assets other than cash Increase in non-current assets Decrease in non-current assets Increase in current liabilities Decrease in current liabilities Increase in non-current liabilities Decrease in non-current liabilities 5. Vuyo Limited 5.1 The operating activities the company yielded a positive inflow of funds of R It has sufficient funds to finance its day-to-day activities. 5.2 A debtor pays an amount owed. A bank loan is received. Additional capital is raised. Etc 52

53 5.3 Yes. It is a sign of both good performance and growth. The excess cash from operating activities is available for the purchase of plant and equipment. The value of the company increases as it grows. As the company expands by purchasing additional assets, more products are produced and sold, which in turn improves profitability and operating cash flows. 6. Mega Ltd 6.1 Cash flows from operating and investing activities were used to redeem longterm borrowings. 6.2 Depreciation expense does not require the payment of cash (non-cash item) and is thus added to profit to determine cash flows. An increase in payables implies that resources have been used but payment has not been made. Increase in payables is added to profit to calculate operating cash flow. 6.3 The indirect method is used. The indirect method explains cash flows from operating activities by explaining the change in each of the non-cash operating accounts in the balance sheet. The direct method explains how much cash was received or paid during the year for each item reported. It thus reflects (as operating activities) cash received from customers, cash paid to merchandise suppliers, cash paid to employees and cash paid for operating expenses. 6.4 The company does not appear to be performing well. Its cash flow from operations (R33 980) is significantly lower that it s operating profit (R61 047). The increase in merchandise suggests that the company was not selling the inventory it was purchasing fast enough. The increase in receivables suggests that the company was experiencing difficulty in collecting from its customers. The increase in payables implies that the company was having difficulty in paying its suppliers. 53

54 The sale of plant and equipment to generate cash is a sign of poor financial performance. The cash from operating activities was inadequate to meet its obligations resulting in the sale of assets to raise cash. In the long-term the company cannot continue selling assets to repay debt. 7. Siya Limited s operations appear to be quite profitable (Cash generated from operating activities is R ). The company appears to be on an expansion spree. The company s expansion is most likely funded by the issue of shares (R ) and the divestment of non-current investment (R ) although funds were available from operations (R ) and long term borrowings (R50 000). The company seems to be building up a large cash balance. One needs to explore the reasons for increasing the cash balance. 54

55 8. Asic Ltd CASH FLOW STATEMENT FOR THE YEAR ENDED 31 DECEMBER 20.6 R Cash flows from operating activities Profit before interest and tax (Operating profit) (a) Adjustments to convert to cash from operations Non-cash flow adjustments Add: Depreciation (b) Loss on disposal of asset (c) Profit before working capital changes Working capital changes (2 640) Increase in inventory (d) (990) Decrease in receivables (e) Decrease in payables (f) (16 620) Cash generated from operations Interest paid (g) (3 900) Investment income (h) Dividends paid (i) (57 750) Income tax paid (j) (62 595) Cash flow from investing activities ( ) Investment in listed shares (k) Investment in subsidiary company (l) Non-current assets purchased (m) Proceeds from sale of equipment (n) (21 525) (25 500) ( ) Cash flow from financing activities Proceeds from issue of ordinary shares (o) Long-term borrowings redeemed (p) ( ) Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year (q) (7 500) Cash and cash equivalents at end of year (r) (1 800) 55

56 (a) Calculations and explanatory notes: Profit before interest and tax This amount is obtained from the Income statement (operating profit). (b) Depreciation The amount is obtained from the Income statement. (c) Loss on disposal of asset The amount is obtained from the Income statement. (d) Increase in inventory The increase is calculated by comparing the inventory figures for both years: R R = R990 (The amount is bracketed as it represents a use of cash.) (e) Decrease in receivables The decrease is calculated by comparing the Trade and other receivables figures for both years: R R = R (The amount represents a source of cash.) (f) Decrease in payables The decrease is calculated by comparing the Trade and other payables figures for both years: R R = R (The amount is bracketed as it represents a use of cash.) (g) Interest paid The amount is obtained from the Income statement. (h) Investment income The amount is obtained from the Income statement. 56

57 (i) Dividends paid The amount paid is calculated as follows: Dividends due on 31 December 20.5 (39 000) Dividends for the year (69 450) Dividends due on 31 December (57 750) Note: Dividends due on 31 December 20.5/20.6 is obtained from the item Shareholders for dividends in the Balance sheet. Dividends for the year are obtained from the Statement of changes in equity: R R R = R (j) Income tax paid The amount paid is calculated as follows: Income tax due on 31 December 20.5 (30 000) Income tax for the year (77 595) Income tax due on 31 December (62 595) Note: Income tax due on 31 December 20.5/20.6 is obtained from the item South African Revenue Services in the Balance sheet. Income tax for the year is obtained from the Income statement. (k) Investment in listed shares The amount is calculated by comparing the figures for Investment Listed shares (in the Balance sheet) for both years: R R98 475= R (The amount is bracketed as it represents a use of cash.) 57

58 (l) Investment in subsidiary company The amount is calculated by comparing the figures for Investment Subsidiary company (in the Balance sheet) for both years: R R60 000= R (The amount is bracketed as it represents a use of cash.) (m) Non-current assets purchased The amount is obtained by using the figures for both years for Land and buildings and Equipment in the Balance sheet and after consideration was given to the additional information: Land and buildings purchased: R R = R Equipment purchase is calculated as follows: Carrying value of equipment on 31 December Additions (Purchase of equipment) * Disposals at carrying value (Cost R Acc. dep. R2 250) (37 500) Depreciation (R R2 250) (R82 500) (39 750) Carrying value of equipment on 31 December *Purchase of equipment is calculated as follows: (R R R39 750) (R ) = R Non-current assets purchased = R R = R (n) Proceeds from sale of equipment The amount is calculated by using figures from the Income statement (Loss on sale of equipment) and after consideration was given to the additional information: Carrying value of equipment sold is : Cost R Acc. dep. R2 250 = R However, the equipment was sold at a loss of R Therefore the proceeds from the sale of equipment is R (R R21 000). (o) Proceeds from issue of ordinary shares The amount is obtained from the Statement of changes in equity. 58

59 (p) Long-term borrowings redeemed The amount is obtained by comparing the figures for both years for 13% Debentures (Long-term borrowings) in the Balance sheet: R R = R (The amount is bracketed as it represents a use of cash.) (q) Cash and cash equivalents at beginning of year This is calculated by using the figures for Cash and cash equivalents and Bank overdraft as at 31 December 20.5: Cash and cash equivalents Bank overdraft (9 000) Net unfavourable balance (7 500) (r) Cash and cash equivalents at end of year This is calculated by using the figures for Cash and cash equivalents and Bank overdraft as at 31 December 20.6: Cash and cash equivalents 900 Bank overdraft (2 700) Net unfavourable balance (1 800) Other calculations Profit before working capital changes R R = R Cash generated from operations: R R2 640 = R Cash flows from operating activities: R R R R R = R Net increase in cash and cash equivalents This amount can be calculated by comparing the cash balances of 20.5 and 20.6 i.e. a net unfavourable balance of R7 500 (20.5) turned into a net unfavourable balance of R1 800 (20.6) resulting in a net increase in cash and cash equivalents of R The net increase can be verified as follows: R R R = R

60 TOPIC 5 FINANCIAL ANALYSIS Gross margin = Gross profit X 100 Gross margin = Gross profit X 100 Sales 1 Sales 1 = R X 100 = R X 100 R R = 18.22% = 17.44% Operating margin Operating margin = Operating profit X 100 = Operating profit X 100 Sales 1 Sales 1 = R X 100 = R X 100 R R = 6.03% = 6.85% Profit margin Profit margin = Net profit after tax X 100 = Net profit after tax X 100 Sales 1 Sales 1 = R X 100 = R X 100 R R = 4.29% = 4.75% 1.2 Gross margin has increased marginally while operating margin and profit margin showed a slight decrease. The cost of sales is high in relation to sales. It thus appears that Zebcom Enterprises is operating on very low profit margins. Operating expenses does appear to be high as there is a large difference between the gross margin and profit margin. 60

61 Current ratio Current ratio = Current assets = Current assets Current liabilities Current liabilities = R = R R R = 2.63:1 = 8.46: Acid test ratio Acid test ratio = Current assets Inventory = Current assets Inventories Current liabilities Current liabilities = R R = R R R R = 1.27:1 = 4.99:1 The liquidity has deteriorated considerably from the previous year. However, one could say that high liquidity ratios for 20.9 may point towards slack management in respect of the inventories and idle cash. The ratios for have dropped to more acceptable levels Inventory turnover = Cost of sales Average inventory = R R = times N.B. Average inventory = (R R ) 2 = R

62 20.10 Debtor collection period = Accounts receivable X 365 Credit sales = R X 365 R = days Creditor payment period = Accounts payable X 365 Credit purchases = R X 365 R = days Note: Credit purchases are calculated as follows: R Cost of sales Add: Closing inventory Less opening inventory ( ) Total purchases Credit purchases = 10% of R = R

63 20.10 Turnover to net assets Sales Net assets = R R R = R R = 4.59:1 1.5 Inventory turnover has increased from 9.04 times to times per annum suggesting that the enterprise sold inventory at a faster rate. Debtors collections seem to be good with the outstanding debt expected to be collected within 30 days. Creditors accounts are being settled earlier than the previous year and the enterprise should not settle accounts earlier than required unless a discount for early settlement is forthcoming. The sales generated by each rand of net assets have increased greatly from R2.13 to R4.59. This also indicates that the net assets required to support a level of sales have decreased. 2.1 Vuyo Traders Sipho Stores Return on assets Return on assets = Operating profit X 100 = Operating profit X 100 Total assets 1 Total assets 1 = R X 100 = R X 100 R R = 40% = 28% N.B. Total assets = R R = R (Vuyo Traders) Total assets = R R = R (Sipho Stores) 63

64 2.2 Vuyo Traders Return on equity = Profit after tax X 100 Owners equity 1 = R X 100 R = 15% Sipho Stores Return on equity = Profit after tax X 100 Owners equity 1 = R X 100 R = 46.67% 2.3 Sipho Stores. It achieved a return of 46.67% compared to Vuyo Traders return of 15%. 2.4 Yes. A 40% return is greater than the cost of borrowing funds (10%). It is also greater than the inflation rate and the return that one could get from alternative investments e.g. fixed deposits Debt to assets = Total debt X 100 Total assets 1 = R X 100 R = 40% 64

65 20.10 Debt to equity = Non-current debt X 100 Owners equity 1 = R X 100 R = 50% N.B. Owners equity = R R R = R Interest coverage = Operating profit Interest expense = R R = 4.17 times 3.2 The debt to assets ratio indicates that 40% of Mestle Wholesalers assets come from borrowed funds. The debt to equity ratio indicates that the creditors supply Mestle Wholesalers with 50 cents for every Rand supplied by the owners. Mestle Wholesalers earned its interest obligations 4.17 times over in 20.10; or one could say that profit before interest and tax was 4.17 times as large as interest. The business can therefore meet its interest obligations 65

66 4.1 Return on equity = Profit after tax X 100 Owners equity 1 = R X 100 R = 8.47% Earnings per share = Net profit after tax Number of ordinary shares issued = R X = 25 cents Dividend per share = Dividends for the year Number of ordinary shares issued = R X = 5 cents Earnings retention ratio = Earnings per share Dividend per share X 100 Earnings per share 1 = 25 cents 5 cents X cents 1 = 20 cents 25 cents = 80% OR 66

67 Earnings retention ratio = Retained earnings for the year X 100 Profit due to ordinary shareholders 1 = R R X 100 R = R X 100 R = 80% 20.9 Price earnings ratio = Market price per share Earnings per share = 400 cents 25 cents = 16 times 4.2 Return on equity has decreased slightly (from 10.04% to 8.47%). A comparison with alternative investments of a similar risk would indicate whether the profitability is low or not. Earnings per share remained stable and there was a slight drop in the dividends per share. The company retains a high percentage of the net profit (over 80%) which may not please all shareholders. The price earnings ratio has increased from (15 to 16 times) indicating greater investor confidence in the company. Investors are willing to pay 16 times earnings for the shares. 67

68 TOPIC 6 COST-VOLUME-PROFIT (CVP) RELATIONSHIPS Per unit x Volume = Total % Sales Variable costs Contribution margin x = % Fixed costs Operating profit Contribution margin and operating profit will increase by R6 250 (R X 62.5%). 1.3 Contribution margin must increase by the same amount if operating profit was to remain the same. Sales must increase by R4 800 (R %). 1.4 Yes. The increase in contribution margin would be R6 250 (R X 62.5%) which is R1 250 more than the cost of the advertising (R5 000). 1.5 Per unit x Volume = Total % Sales Variable costs Contribution margin x = % Fixed costs Operating profit Work to the middle to obtain the required sales volume (R R12.50 = units) 68

69 OR 1.5 Target sales volume = = = Fixed costs + Target profit Contribution margin per unit R R R units 1.6 Per unit x Volume = Total Sales Variable costs Contribution margin x = Fixed costs Operating profit No. They should reject the proposal. Contribution margin and operating profit will decrease by R Per unit x Volume = Total Sales Variable costs Contribution margin 8.50 x = Fixed costs Operating profit Yes. Operating profit increases from R to R i.e. by R

70 2. Per unit x Volume = Total Sales Variable costs 12 5 Contribution margin 7 x = Fixed costs Operating profit Work to the middle to obtain the required sales volume (R R7 = units) OR 2. Target sales volume = Fixed costs + Target profit Contribution margin per unit = = R R R units 3. Workings Per unit x Volume = Total Sales R Variable costs R45 Contribution margin R25 x 350 = R8 750 Fixed costs (5 000) Operating profit R3 750 Note: Variable costs include material cost of R20 per unit and labour cost of R25 per unit (R12.50 X 2 hours). 70

71 3.1 Break even quantity = Fixed costs Contribution margin per unit = = R5 000 R units 3.2 It makes it possible to compare the expected volume of activity (350 units) with the break-even point (200 units) and so make a judgement about risk. Planning to operate slightly above the break-even point is risky as a small drop in volume of activity could lead to loss. 3.3 Workings Per unit x Volume = Total Sales R Variable costs R32.50 Contribution margin R37.50 x 350 = R Fixed costs (9 375) Operating profit R3 750 Note: Variable costs include material cost of R20 per unit and labour cost of R12.50 per unit (R12.50 X 1 hour) Break even quantity = Fixed costs Contribution margin per unit = = R9 375 R37, units 71

72 3.3.2 With both options, a profit of R3 750 is expected. However, the break-even point differs. Without the machine, the actual volume of sales could drop by 43.86% (from 350 to 200) before the business will fail to make a profit. With the machine a 28.67% drop in sales (from 350 to 250) would be enough to cause the business to fail to make a profit. On the other hand, for each additional pair of sandals above the expected 350, an additional profit of only R25 would be made without the machine whereas R37.50 would be made with the machine Without the machine With the machine Margin of safety = = 150 units = 100 units The option of not renting the machine might be preferable since the margin of safety between the expected volume of activity and the break-even point is greater. For the same level of activity, the risk will be lower without renting the machine. However, ones attitude towards risk is important. As pointed out previously, sales above 350 units mean a higher profit per unit with the use of the machine. 72

73 4. Workings -Gnome Per unit x Volume = Total % Sales Variable costs Contribution margin 24 x = % Fixed costs Operating profit R Workings Humpty Per unit x Volume = Total % Sales Variable costs Contribution margin 36 x = % Fixed costs Operating profit R Gnome Total revenues at break even = = = Total fixed cost Contribution margin ratio R % R

74 Humpty Total revenues at break even = = = Total fixed cost Contribution margin ratio R % R Note: Alternative method is to calculate break even quantity and then multiply by selling price per unit. 4.2 Gnome Operating leverage = Contribution margin Operating profit = R R = 1.45:1 Humpty Operating leverage = Contribution margin Operating profit = R R = 1.71:1 The above calculations show that Humpty Manufacturers has a higher operating leverage. 4.3 Humpty Manufacturers has a higher operating leverage. Suppose that its sales drop by 10%. Let us see by what percentage operating profit will fall. 74

75 R Sales (1 800 X R60) Variable costs (1 800 X R24) (43 200) Contribution margin Fixed costs Operating profit Operating profit dropped from R to R34 800, a percentage decrease of 17.14%. One can therefore see that the consequence of a small drop in sales is a relatively larger percentage decrease in operating profit. 4.4 Gnome Margin of safety = Sales Break even sales X 100 Sales = R R X 100 R = 68.75% Humpty Margin of safety = Sales Break even sales X 100 Sales = R R X 100 R = 58.33% 75

76 5. A B C (R) (R) (R) Sales Variable cost Marginal income Fixed cost PROPOSAL A Break-even quantity = Total fixed cost Marginal income per unit = = R R units PROPOSAL B Break-even quantity = Total fixed cost Marginal income per unit = = R R units PROPOSAL C Break-even quantity = Total fixed cost Marginal income per unit = = R R units 76

77 TOPIC 7 COST ANALYSIS FOR PLANNING, CONTROL AND DECISION-MAKING BUDGETING 1. A budget is a planning device as it guides executives to anticipate the influence and impact of a given set of events on the firm s business and its resources. A budget also serves as an effective tool for managerial control by providing a proper yardstick for the evaluation of actual performance. Etc. 2. Quantity required to meet projected sales. Opening and closing levels of inventories. Maximum production capacity of the firm. Available storage facilities. Amount of investment required. Etc. 3. Sales budget Product November December January Product X Product Y Units/price 3 000@R @R30 R Units/price 4 500@R @R30 R Units/price 4 000@R @R30 R Production budget April May Sales forecast (in units) Desired closing inventory of finished goods Total budgeted production needs Opening inventory of finished goods (60) (50) Required production

78 5. Problems: The company will not be able to achieve the requirement of settling the overdraft by the end of October. Although the initial overdraft is expected to be eliminated in June, a study of the closing cash balance each month thereafter suggests that the cash balance is expected to get worse each month. Except for the first 2 months, a cash shortfall is expected for the rest of the budgeted period. The company expects a decline in sales each month from July to October. Dealing with the problems: The shop refurbishment could be postponed. The company could obtain funds from the shareholders or other investors. It may try to stimulate sales in some way. Ways could be found to reduce overhead expenses. Sales were declining, yet selling expenses are high investigate this. 6.1 Raw material usage variance (Actual quantity Standard Quantity) X Standard price = ( ) X R5 = R250 (unfavourable) Possible reasons for the variance: Poor control over materials Faulty standards Changes in the quality of material supplied Etc 6.2 Direct labour rate variance (Actual rate Standard rate) X Actual hours = (R48 R50) X = R (favourable) 78

79 6.3 Direct labour efficiency variance (Actual time worked Standard time allowed) X Standard rate = ( hrs hrs) X R50 = R (favourable) 6.4 Variable overhead efficiency variance (Actual hours Standard hours) X Standard rate = ( ) X R11 = R5 500 (favourable) 7.1 Fixed overhead spending variance Actual fixed overheads Budgeted fixed overheads = R R = R3 008 (unfavourable) 7.2 Fixed overhead volume variance Budgeted fixed overheads Standard fixed overheads = R (1 680 units X 4 hrs X R12) = R R = R3 840 (favourable) Note: Standard fixed overheads = Number of units produced X Standard time to make 1 product X Standard rate per hr Standard time to make 1 product = hrs units = 4 hours Standard rate per hour = Standard fixed overheads standard number of labour hrs = R = R12 79

80 7.3 Variable overhead efficiency variance (Actual hours Standard hours) X Standard rate = ( ) X R5 = R800 (unfavourable) Note Standard hours = Number of units produced X Standard time to make 1 product = X 4 hours = R6 720 Standard rate = R hours = R5 Possible reasons for the variance: Absenteeism Efficiency of employees Working conditions Etc 8.1 R Sales ( X R12) Variable costs ( X R9) ( ) Contribution margin Fixed costs ( ) Operating profit R Differential revenue from accepting the offer ( X R8.90) Differential cost by accepting the offer ( X [R9 R0.50]) ( ) Differential profit from accepting the offer Accept the offer as a differential profit of R is expected. 80

81 9. A comparison of the sales offer of R42 with the selling price of R63 indicates that the offer should be rejected. However, Femino Enterprises has excess capacity and one should focus on the relevant cost, which in this case is the variable cost. The differential profit from accepting the offer is calculated as follows: Differential revenue from accepting the offer: R42 R Differential cost by accepting the offer: R30 (R15+R9+R6) (R ) Differential profit from accepting the offer. R The offer should therefore be accepted The relevant cost of internal production of each component is: Variable cost of production of the component R15 Opportunity cost of lost production of the other product R12 R27 It is obviously more costly (R27) than the R20 per component which will have to be paid to the subcontractor. Dubai Ltd should therefore subcontract the component Loss of control of quality Potential unreliability of supply Etc. 11. The relevant cost is the variable cost per unit which is calculated as follow: R Direct Material Labour and other variable costs Total variable costs Number of units produced

82 Variable cost per unit (R ) R The variable cost of making the component (R201.18) is cheaper than buying it (R210). Trike Enterprises should therefore make the component in its plant Project A Investment ( ) Year 1 Cash flow ( ) Year 2 Cash flow ( ) Year 3 Cash flow (40 000) Year 4 cash flow Payback period is 3 years 3months Note: R40 000_ X 12 mths R = 2.4 months 12.2 Accounting rate of return (Project A) = Average annual profit X 100 Average investment 1 = R X 100 R = 24.76% Note: Depreciation = R R = R = R per year 82

83 Calculation of accounting profit Cash flow Depreciation/Scrap value = Accounting profit ( ) ( ) ( ) ( ) ( ) *(40 000) R R *(40 000) is scrap value Average annual profit = R years = R Project A Year Cash inflow Discount Factor Present value Total PV Investment ( ) NPV (positive) Yes. ARR is higher than the cost of capital. NPV is positive. 83

84 Project Turbo Year Cash inflow Discount Factor 1 0 0, R R , R ,6355 Total PV Investment NPV (positive) Present Value 0 R R R R (R ) R1 473 Project Gusto Net inflow Discount factor Total Present value Investment NPV (negative) R X 3,0373 R (R ) (R12 536) Project Turbo should be chosen since the NPV is positive. The NPV for project Gusto is negative and is therefore rejected. 84

85 13.2 Project Turbo Step 1 We notice that the NPV is positive, and above zero, but not by a large margin. Step 2 We now pick a higher rate e.g. 13%. (Trial-and-error is used to obtain the higher rate.) Year Total PV Investment NPV Cash inflow 0 R R R Discount Factor 12% 0, ,7118 0,6355 Project Turbo Discount Factor 13% 0,8850 0,7831 0,6931 0,6133 Present value 12% 0 R R R R (R ) R1 473 Present value 13% 0 R R R R (R ) (R4 030) Step 3 Interpolation: The IRR is between 12% and 13%. IRR = 12% = 12% = 12.27% 85

86 Project Gusto Step 1 We notice that the NPV is negative. Step 2 We now pick a lower rate e.g. 10%. (Trial-and-error is used to obtain the higher rate.) Year 1-4 Cash inflow p.a. Disc. Factor 10% Disc. Factor 9% Disc. Factor 8% Present value 10% R ,1699 3,2397 3, Present value 9% Present value 8% Investment NPV (R5 375) (R1 606) R2 303 Step 3 Interpolation: The IRR is between 8% and 9%. IRR = 8% = 8% = 8.59% Decision: Project Turbo should be chosen as the IRR is greater. 86

87 Payback period (Project F) Investment ( ) Year 1 Cash flow ( ) Year 2 Cash flow (74 000) Year 3 Cash flow (34 000) Year 4 Cash flow Payback period is 3 years 10 months Note: R X 12 mths R = 9.27 months 14.2 Accounting rate of return (Project F) = Average annual profit X 100 Average investment = R7 200 X 100 R = 9% Note: Depreciation = R R = R = R per year 87

88 Calculation of accounting profit Cash flow Depreciation/Scrap value (24 000) (24 000) (24 000) (24 000) (24 000) *(20 000) *(20 000) is scrap value = Accounting profit R (18 000) R Average annual profit = R years = R7 200 Average investment = [ ] 2 = R Project F Year Cash inflow Discount Factor Present value Total PV Investment ( ) NPV (negative) (19 426) 88

89 Project G Year Cash inflow Discount Factor Present value Total PV Investment ( ) NPV (positive) Choose project G. The NPV is positive. 15. Use trial and error method Year 1-5 Investment NPV Cash inflow p.a. Discount Factor 13% Discount Factor 14% Present value 13% R R688 Present value 14% (R2 676) IRR = 13% = 13% = 13.20% 89

90 TOPIC 8 TRANSFER PRICING FOR DECENTRALISED ENTERPRISES 1. These are the actual prices that the supplying division sells the product to external clients for or they may the prices a competitor is offering. If a perfectly competitive market exists, the current market price is the most suitable basis for setting the transfer price. The supply of transfer goods at market prices usually results in optimal profits for the entire enterprise. In a perfectly competitive market, the supplying division should supply as much as is required by the receiving division at the current market price. If the receiving division s demand is greater then the supplying division can meet, additional supplies must be obtained from an outside supplier at market price. If the supplying division cannot sustain a profit in the long term at the current outside market price, then the enterprise will be better off not producing the product internally. It should rather purchase from outside suppliers Negotiated prices is suited to circumstances where there is an external market for the goods supplied by the buying and selling divisions and where divisional managers are free to accept or reject offers made by other divisions. Negotiated transfer prices are also appropriate when there are market imperfections for the product. 2.2 By not being able to sell outside the enterprise, the selling division is likely to be in a weak bargaining position and the transfer price may result in an under-par divisional performance. The inability of the manager of the selling division to negotiate with authority would affect the division s profitability negatively. 90

91 The transfer price of product Alpha using the variable cost method would be R Variable cost per unit R8.00 Fixed cost per unit R2.00 Total cost R10.00 Profit (12%) R1.20 Transfer price R Using variable cost method Transfer price R8.00 Variable cost per unit R15.00 Fixed cost per unit R7.00 Total cost R30.00 Profit (12%) R3.60 Selling price R33.60 Using cost plus method Transfer price R11.20 Variable cost per unit R15.00 Fixed cost per unit R7.00 Total cost R33.20 Profit (12%) R3.98 Selling price R The biggest problem with this method is that the receiving division will generate a profit at the expense of the supplying division. Quite often supplying divisions are reluctant to transfer their products at variable costs. Another problem is that variable cost per unit may not be constant over the entire range of output as increases may occur. Where the division is operating at full capacity, variable cost transfers will mean that inter-divisional sales will be less profitable than sales to external customers. 91

92 TOPIC 9 CORPORATE GOVERNANCE 1. Yes. Directors often abused their powers with regard to the duration of their contracts. Directors remained in their posts even though company performance was poor. Etc or No. Directors want job security. May lead to instability in the company. Etc 2. Good corporate governance requires that the board takes responsibility for creating and sustaining an ethical corporate culture in the company. The establishment and maintenance of an ethical corporate culture requires the governance of ethics, that is, that the board should ensure that the company has a well designed and properly implemented ethics management process consisting of the following four aspects: Ethics risk and opportunity profile: The board should ensure that an ethics risk profile is compiled, reflecting the company's negative ethics risks (threats) as well as its positive ethics risk (opportunities). Code of ethics: The board should ensure that a company code of ethics is developed, stipulating the ethical values or standards as well as more specific guidelines guiding the company in its internal and external stakeholders. Integrating ethics: The board should ensure that the company's ethical standards (code of ethics and related ethics policies) are integrated into the company's strategies and operations. This requires, among others, ethical leadership, management practices, structures and offices, education and training, communication and advice, and prevention and detection of misconduct for example, through whistle-blowing. 92

93 Ethics performance reporting and disclosure: The board should assess the company's ethics performance, and report and disclose findings to internal and external stakeholders. An ethical corporate culture will require that: -ethical practices for directors is a non-negotiable requirement; -the stewardship of a director is firstly towards the company and its shareholders. -sound moral values and ethics are propagated by the conduct of individuals; -the effectiveness of free enterprise and the market economy demands responsibility and it is important that business activity is directed by people with integrity, fairness and vision; -because fair competition is fundamental to the free enterprise system directors support laws regulating restraints of trade, unfair practices, abuse or the unscrupulous use of economic power and avoidance of collusion; and -ethics can never become an excuse for poor performance 3. The board should ensure that the company, as a responsible corporate citizen, does not undermine the sustainability of its social and natural environments, but rather protects and enhances them. Responsible corporate citizenship is necessary to protect the sustainability of the company and to ensure the ability of future generations to meet their needs. The interests of shareholders and stakeholders coincide over the long term. 4. Internal audit plays an important role in providing assurance to the management and the board regarding the effectiveness of internal controls. The board should ensure that assurance of internal control procedures provides reliable, valid and timely information for purposes of monitoring and evaluating the management and company performance. Internal controls should be established not only over financial matters but also operational, compliance and sustainability matters to manage the risks facing the company. The board should ensure that the internal audit plan is risk-centric, and that the internal audit function has given the audit committee a written assessment of the adequacy of the internal controls. 93

94 This assessment should be discussed by the audit committee, which should report the outcomes of that discussion to the board. 5. Boards should ascertain whether potential directors are competent to be appointed and can contribute to the business decisions to be made by the board. Prior to their appointment, their backgrounds should be investigated along the lines of the approach required for listed companies by the JSE. It is also important to ensure that new directors have not been declared delinquent nor are serving probation in terms of section 162 of the Act. The nomination committee should play a role in this process. 6. This means that the board should report to its shareholders and other stakeholders on the company s economic, social and environmental performance. Although a company is an economic institution, it remains a corporate citizen and therefore has to balance economic, social and environmental value. The triple bottom line approach enhances the potential of a company to create economic value. It ensures that the economic, social and environmental resources the company requires to remain in business are treated responsibly. By looking beyond immediate financial gain, the company ensures that its reputation, its most significant asset, is protected. There is growing understanding in business that social and environmental issues have financial consequences. The triple bottom line performance approach recognises the effect of the modern company on society and the natural environment. It acknowledges that companies need to act with economic, social and environmental responsibility. It is unethical for companies to expect society and future generations to carry the economic, social and environmental costs and burdens of its operations. Business itself needs to ensure that its impact on society and the natural environment is socially and environmentally sustainable. Good corporate citizenship is the establishment of an ethical relationship of responsibility between the company and the society in which it operates. As good corporate citizens of the societies in which they do business, companies have, apart from rights, also legal and moral obligations in respect of their social and natural environments. 94

95 The company as a good corporate citizen should protect, enhance and invest in the wellbeing of society and the natural ecology. Corporate citizenship and sustainability require business decision makers to adopt a holistic approach to economic, social, and environmental issues in their core business strategy. Only a holistic approach will allow for the effective management of business opportunities and risks. The expectation that business has an important role to play in responding to social and environmental challenges has become widely accepted. The debate on the need for voluntary business action or government regulation is being superseded by an understanding that an appropriate mix of both approaches is important. 7. Conscience: A director should act with intellectual honesty in the best interest of the company and all its stakeholders in accordance with the enlightened shareholder value approach. Conflicts of interest should be avoided. Independence of mind should prevail to ensure the best interest of the company and its stakeholders is served. Care: A director should devote serious attention to the affairs of the company. Relevant information required for exercising effective control and providing innovative direction to the company needs to be acquired. Competence: A director should have the knowledge and skills required for governing a company effectively. This competence should be developed continuously. Willingness to be regularly reviewed is a prerequisite for ensuring competence Commitment: A director should be diligent in performing directors duties. Sufficient time should be devoted to company affairs. Effort needs to be put into ensuring company performance and conformance. Courage: A director should have the courage to take the risks associated with directing and controlling a successful sustainable enterprise, but also the courage to act with integrity in all board decisions and activities. 95

96 8. External audit is an independent assurance function performed primarily for the benefit of the shareholders. The objective of an audit of financial statements is to enable the auditor to express an opinion as to whether the financial statements fairly present, in all material respects, the financial position of the company at a specific date and the results of operations and cash flow information for the period ended on that date, in accordance with an identified financial reporting framework and/or statutory requirements. The auditor s opinion enhances the credibility of the financial statements, but does not guarantee the future viability of the company or the effectiveness or efficiency with which the management has conducted the affairs of the company. 96