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2017

INTEGRATED BUSINESS CASE STUDY TUTORIAL #1

EXCLUSIVE READ LIMITED

(‘SUGGESTED SOLUTION’)

Financial Accounting and External Reporting

Strategy, Risk Management and Governance

Management Decision Making and Control

Auditing and assurance

Financial Management

Taxation

Disclaimer: This integrated case study tutorial has been prepared by Endunamoo Board Course for the sole purpose of aiding

its registered candidates in obtaining and developing the skills and competencies required for a successful attempt in the

chartered accountancy professional examinations. The information contained herein is not intended to serve as endorsements,

sources of primary data, or illustrations of effective or ineffective administration and/or management. All names of persons, places,

and business entities mentioned in this case study are fictitious and any resemblances to real persons, living or dead, places and

business entities are purely coincidental.

© Endunamoo Board Course 2017 Exclusive Read Tutorial SS - 2

ENDUNAMOO BOARD COURSE 2017

INTEGRATED BUSINESS CASE STUDY: EXCLUSIVE READ LTD

SUGGESTED SOLUTION: MANAGEMENT DECISION MAKING AND CONTROL, FINANCIAL

MANAGEMENT, STRATEGY AND RISK MANAGEMENT

a) Calculation of the WACC appropriate for the evaluation of the project Marks

Cost of equity calculations

Unlevered beta of Amazing Inc 0,91 1

Amazing Inc is an appropriate proxy firm because of its exposure in the e-readers market

through Kindle Reader.

1

Alternative: Unlevered beta of Exclusive Read 1,02 1

Alternative: Full credit for a strong argument in line with CEO''s comments that the proposal

represents a new distribution channel but for the same product. In other words, if customers

stop reading books altogether, likely to impact the NPV of the proposed project. Or

Candidate raises concern regarding Amazing Inc being the sole and/or most appropriate

proxy taking into considerations the operations of Amazing.com - it sells various products in

addition to books and e-reader devices.

1

Long-term debt-equity ratio of Exclusive Devices (2 / 5) 40,00% 1

Exclusive Devices will be an independent company with its own risk profile and therefore a

different capital structure to Exclusive Read might be more appropriate 1

Alternative: Long-term debt-equity ratio of Exclusive Read 40,00% 1

Alternative: The investment in Exclusive Read requires a c.R3bn capital injection while the

market capitalisation of Exclusive Read is R14bn. It may be argued that the investment does

not appear significant enough as to alter the overall risk profile of the group and therefore

the existing long term capital structure of Exclusive Read might be appropriate. 1

Tax rate 28,00%

Equity beta of Exclusive Devices [0,91 x (1 + 40% x (1 - 28%)]

(relevered beta based on the project's capital structure) 1,17 2

Alternative: Equity beta of Exclusive Devices [1,02 x (1 + 40% x (1 - 28%)] 1,31 2

Risk free rate

R186 bond yield 8,07% 1

Use R186 since it is the longer dated bond and consistent with the evaluation of a long term

project 1

Alternative: R157 bond yield 7,01% 1

Alternative: Use R157 since short term bond and in line with CAPM approach which

determines the cost of capital on an annual basis 1

Market return

Market return based on historic returns 13,57% 1

The return measured over a long period of time, considered reliable as an estimate of

expected, long term return over the project's life 1

Alternative: Market return based on expected return 11,51% 1

Alternative: The return consistent with the short dated bond and consistent with the CAPM 1

Note: The rest of the marks focus on consistency with the figures above

Market risk premium (13,57% - 8,07%) 5,50% 1C

CAPM = Risk free rate + Beta * (Market risk premium) 14,52% 1C

After-tax cost of debt

R186 effective annual rate 8,07%

Quoted premium 2,50% ½


Pre-tax cost of debt 10,57% ½

Post-tax cost of debt (10,57 x 72%) 7,61% 1

WACC (2 / 7 x 7,61% + 5 / 7 x 14,52%) 12,54% 2

Available marks 16

Maximum marks 15

Part b) Determination of NPV for investment in Exclusive Devices Marks

R'000 2014 2015 2016 2017 2018

Cash flows Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Capital investment

New machinery (2 500

000 000 x 1,05 x 1,025) (2 690 625) 1

Installation costs (1 500) ½

Resale value of machine 40 000 ½

Working capital

Increase in inventory (400 000) (151 124) (73 851) (83 747) (94 969) 803 690 2

Inventory on hand 400 000 551 124 624 975 708 721 803 690 -

Operating cash flows

Total revenue 1 620 000 1 837 080 2 083 249 2 362 404 2 678 966 5

Lease payments (3 000) (3 000) (3 000) (3 000) (3 000) 1

Rental deposit (3 000) 3 000 1

Components & other

minor costs (based on

sold units) (803 628) (843 809) (886 000) (930 300) (976 815) 1

Labour hours

- Administration staff

(Existing cost which is

non-incremental) - - - - - 1

Contract workers (71 040) (59 520) (46 668) (48 409) (50 910) 1

HW CC hourly rate 80 80 80 80 80

Labour hours required 888 000 744 000 583 350 605 118 636 373 3

Market consultant cost

(Sunk cost) - - - - - 1

Opportunity cost of lost

contribution from book

sales (60 000) (60 000) (60 000) (32 000) (32 000) 1

Depreciation (Accounting

cost, non-cash flow) - - - - - 1

Water & energy costs (1 060) (1 219) (1 402) (1 612) (1 854) 1

Generators (Sunk cost) - - - - - 1

Factory supervisors (1 600) (1 600) (1 600) (1 600) (1 600) 1

Sales manager (Existing

cost which is non-

incremental) 1

2 existing representative

costs

(Existing cost which is

non-incremental) 1

10 new representative

costs (7 500) (7 500) (7 500) (7 500) (7 500) 1

Other fixed costs (180 000) (180 000) (180 000) (180 000) (180 000) 1

Marketing / advertising (50 000) (20 000) (20 000) (20 000) (20 000) 1


Total cash flows (3 098 125) 291 048 586 469 793 101 1 042 654 2 254 480

NPV at WACC 78 484 1C

Conclusion: Yes, it made

financial sense to launch

e-readers because the

NPV was positive. 1C

Available marks 29

Communication skills -

presentation 1

Maximum marks 26

Workings Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

C1: Total revenue

Compounded annual

growth rate

rate(N=4; PV=20 000

000; FV=24 310 125) 5% 2

Global e-reader sales 20 000 21 000 22 050 23 153 24 310 ½

Sales attributable to

South Africa (6%) 1 200 1 260 1 323 1 389 1 459 1

Sales attributable to

Exclusive Devices (30%) 360 378 397 417 438 1

Average sales price

(growth at 8%) 4 500 4 860 5 249 5 669 6 122 ½

Total revenue 1 620 000 1 837 080 2 083 249 2 362 404 2 678 966

C2: Labour hours

Units 360 000 378 000 396 900 416 745 437 582

Time per unit 2,50 2,00 1,50 1,50 1,50 1

Hours needed 900 000 756 000 595 350 625 118 656 373 1

Staff hours available (12 000) (12 000) (12 000) (20 000) (20 000) 1

Contract hours needed 888 000 744 000 583 350 605 118 636 373

Part c) Evaluation of the strategic implications of the project Marks

Financial and business implications

Funding of the project

The current market capitalisation of the company is R14 billion. If this project is to be funded 2:5,

and the initial investment is approximately R3.2 billion (refer NPV calc), that means shares

worth approximately R2.3 billion will need to be issued and debt of approximately R 0.91 billion

would be required. This has the following implications:

1

- In the current economic environment it may be difficult to find current or prospective

shareholders who have enough available funds to buy such a large value of shares. 1

- Current shareholders may not be able to fully fund the share issue which would mean there would

be a change in shareholding, and possibly controlling shareholding would come into play which

would affect the business operationally.

1

- In the current economic environment banks are likely to impose certain strict conditions, debt

covenants or restrictions for lending such a large sum of money. This means management will

have to manage and monitor the business closely to ensure they comply with all of the ratios,

repayment deadlines and other conditions imposed, which may impact the business operationally.

1


- If other investment opportunities arise in the near future it would be difficult to raise any more

funds (debt or equity) after such a large investment is required for e-readers thus the business may

lose out on future opportunities.

1

Workforce

The launch of e-readers will require "a reshuffle" in the entity and this could negatively impact

employee morale. 1

Exclusive Read has never used the services of Hard Workers CC but will be relying heavily on their

workers. 1

- The competence, efficiency, trustworthiness and reliability of the workers and management

of Hard Workers CC has not yet been proven, and if this is questionable it would greatly impact the

production of e-readers and the working environment in the factory.

1

- Limited control over the employees could make it difficult for factory supervisors to manage and

would affect the learning curve and ultimately the time and cost to make each unit. 1

- The existing factory staff complement of 60 workers may not be happy working with contract workers

as they may perceive them as a threat to their job security, as a security threat (e.g. risk of theft)

or they may not get along well due to personal differences. This would affect their productivity.

1

- Since this project is going to last for 5 years it would probably be better in the long-term for

Exclusive Devices to employ permanent staff, especially since unemployment is such a big problem

in South Africa.

1

Customers and competitiveness

It may be essential for Exclusive Read to launch e-readers in order to stay competitive and maintain

market share in their industry, as existing products that they have may not be able to compete

with new technology.

1

- Although existing customers are loyal to Exclusive Read, if they did not launch e-readers and

customers desired the equivalent product they would go to competitors to buy that product and

may slowly start to buy other products from competitors, changing their loyalty.

1

Although existing customers are loyal to Exclusive Read, not all current customers may be able to

afford e-readers and a number of new customers will need to be found if sales are to be

achieved. This would permanently change the customer mix. It would also probably require a change

in strategy and need sales teams to go into new areas (new product and new market = diversification

strategy which is high risk).

1

Other

It is not clear what the components and production inputs are for the products, but if some of the raw

materials are limited resources (e.g. minerals), Exclusive Read will need to think strategically about

how they will ensure that supply is not going to be interrupted.

1

Exclusive Read does not have the skills and expertise to manufacture and market e-readers. 1

- The importation of e-readers, as opposed to the manufacture of them which requires huge capital,

would negate a number of the above issues and may be a better option. 1

Total marks available 22

Maximum marks 13

Part d) Variance analysis Marks

LCD screens

Budgeted cost - Colour e-readers (1 348,50 x 60 000) (80 910 000)

Unfavourable price variance (6 090 000)

Actual cost - Colour e-readers (87 000 000) 1

Budgeted cost per unit - Colour (87 000 000 / 60 000) (Rand) 1 450,00 ½

Actual exchange rate 10,00

Budgeted / actual cost per unit - Colour (1 450 / 10) (US$) 145,00 ½

Implied budgeted exchange rate (1 348,50 / 145) 9,30 1


Total budgeted cost for LCD screens 305 970 000

Budgeted cost - Colour e-readers (1 348,50 x 80 000) (107 880 000)

Budgeted cost - B&W e-readers 198 090 000 ½

Budgeted cost per unit - B&W e-readers (198 090 000 / 220 000) 900,41 ½

Budgeted cost per unit - B&W e-readers (900,41 / 9,30) (US$) 96,82 ½

Actual cost per unit - B&W e-readers (96,82 x 1,10) (US$) 106,50 ½

Actual cost per unit - B&W e-readers (106,50 x 10) (Rand) 1 065,00 ½

Material price variance

- Colour (given) (6 090 000) ½

- B&W [(900,41 – 1 065) x 180 000] (29 626 394) 1

(35 716 394)

Material price variance due to:

Supplier price variance

- Colour (given) -

- B&W (96,82 x 10% x 10 x 180 000) (17 427 290) 1

Exchange rate variance

- Colour [(10,00 - 9,30) x 145 x 60 000] (6 090 000) 1

- B&W [(10,00 - 9,30) x 96,82 x 180 000] (12 199 104) 1

Sales margin mix variance

C1: Determine the standard / budgeted sales mix B&W Colour

Budgeted sales units 220 000 80 000

Sales mix 73,33% 26,67% 1

C2: Determine the actual sales volume in standard quantities

Actual sales units 240 000 240 000

B&W (240 000 x 73,33%) 180 000 176 000 ½

Colour (240 000 x 26,67%) 60 000 64 000 ½

C3: Determine the gross profit B&W Colour

Sales price 3 800,00 5 800,00 1

LCD screens (900,41) (1 348,50) 1C

Microchips (410,00) (820,00) 2

Contract workers (171,20) (171,20) 2

Overheads (238,90) (238,90) 5

Gross profit 2 079,49 3 221,40

C4: Sales margin mix variance

B&W [(180 000 - 176 000) x 2 079,49] (8 317 960) 1

Colour [(60 000 - 64 000) x 3 221,40] 12 885 600 1

Sales margin mix variance 4 567 640


C3.1: Cost per chip

Total chips (220 000 x 1 + 80 000 x 2) 380 000

Total budgeted costs 155 800 000

Cost per chip 410,00 1

C3.2: Overhead allocation rate

Labour cost - fixed (12 000 x 85 x 1,07) 1 091 400 1

Energy costs 4 428 500 1

Other fixed manufacturing costs 66 150 100 1

Total overhead costs 71 670 000

Total budgeted production 300 000

Overhead allocation rate 238,90 1

Available and maximum marks 25

Part e) Breakdown of the energy costs Budget Actual Marks

Electricity costs 3 811 500 4 065 600 2

Fuel costs 177 000 648 000 2

Depreciation 440 000 500 000 1

Total energy costs 4 428 500 5 213 600

Growth analysis % Growth

Electricity costs 6,7% 0,5

Fuel costs 266,1% 0,5

Depreciation 13,6% 0,5

Total energy costs 17,7% 0,5

Cost mix analysis Budget Actual

Electricity costs 86,1% 78,0% 1

Fuel costs 4,0% 12,4% 1

Depreciation 9,9% 9,6% 1

Total energy costs 100,0% 100,0%

Cost analysis % Growth

Electricity tariff (1,68 / 1,50 - 1) 12,00% 1

Fuel cost (15,00 / 14,75 - 1) 1,69% 1

Daily cost analysis Budget Actual

Electricity cost per day 15 750 18 480 1

Fuel cost per day 17 700 20 250 1

Reconciliation of actual and budgeted costs

Budgeted energy cost 4 428 500

Load shedding impact 42 900

Electricity [(32 - 10) x 3 811 500 / 242] (346 500) 1

Fuel [(32 - 10) x 177 000 / 10] 389 400 1

Price 506 400


Electricity [(1,68 - 1,50) x 220 x 11 000] 435 600 1

Fuel [(15,00 - 14,75) x 32 x 1 350] 10 800 1

Depreciation (550 000 - 440 000) 60 000 1

Usage 235 800

Electricity [220 x (11 000 - 10 500) x 1,50] 165 000 1

Fuel [32 x (1 350 - 1 200) x 14,75] 70 800 1

Actual energy cost 5 213 600

Commentary Marks

The increase in the energy is higher than the increase in the inflation rate as well as the original

budgeted rate of 15%. 1

The increase is primarily driven by the increased utilisation of the generators which resulted in higher

fuel costs and maintenance costs. 1

The higher fuel cost is attributable to increased usage because of load shedding. This is because

the daily cost of using fuel is more expensive compared to operating using electricity. 1

The impact of load shedding, however, was mitigated by the saving in the electricity bill, resulting

in a low impact of load shedding on the overall energy bill. 1

Although still above the inflation rate, it is encouraging to note that the increase in the electricity price

is below the expected increase of 15%. 1

However, given that electricity is the primary energy cost of the company (78% contribution), the

increase in the price has a significant impact in the overall energy bill. 1

The reconciliation highlights that the major difference between the budget and actual is attributable

to this price increase and it is of concern because it is beyond the control of management. 1

The reconciliation further highlights that the usage of electricity as well as fuel has increased. This

needs to be investigated in order to uncertain whether there might be problems with the machine. 1

Available marks 29

Maximum marks 16


Part f) Evaluation of Amazing Source proposal Marks

The bookseller program will be the program that is relevant to Exclusive Read 1

Participation in the program would adversely impact the operations of Exclusive Devices & and

Digicom - does the current recoverable amount of the CGUs take this into account, if not it might

lead to higher impact?

1

Participation in the program would entail providing the competitor with entry in the stores and

perpetuating the demise of the bricks and mortar book retailing operations of the Exclusive

Read (i.e. the biggest concern about this program is that it seems like Exclusive Read will be

promoting the competition.)

1

The margins are limited to the discount provided on acquisition - it does not appear it will be

possible to generate a higher margin from high volumes; this will likely affect its ability to recover the

cost of capital of 12.56%

1

Currently the standard profit per e-reader is much higher than the 6% discount offered on the

retail price 1

Exclusive Read will be purchasing a standard product - it might be difficult to establish a

competitive advantage over other independent retail stores 1

Exclusive Read will be purchasing a standard product - it might be difficult to upgrade the devices

to its customer's specification 1

It is not clear whether the 10% commission is a once-off annual fee or is it in perpetuity for

every e-book acquired from customers' Kindle devices 1

A significant adaption of the program might lead Exclusive Read to adopt the program out of the

risk of losing customers to its competitors 1

Who bears the risk of a general price decrease of the Kindle devices for inventory left unsold? 1

The financing of the devices should Exclusive Read decided to participate in the program. 1

Any benefits from participation, e.g. smaller space being rented, lower book inventory of traditional

trade physical books? 1

Being the largest national bookseller, is Exclusive Read in a position to negotiate an agreement

to allow Amazing to sell only books via the e-readers that are not physically sold at the stores?

(practical, this is the case with Kobo readers)

1

Is it possible to sell Exclusive Devices or Digicom to Amazing or any other third party should

Exclusive Read cease the manufacturing of e-readers and associated accessories as part of its

terms in participating in the programme?

1

Other strategies that Exclusive Read could undertake to combat the threat of Amazing Kindle

devices - making the experience of buying books excellent in its physical bookstores? 1

Available marks 15

Communication skill - clarity of expression 1

Maximum marks 10



INTEGRATED BUSINESS CASE STUDY: EXCLUSIVE READ LTD

SUGGESTED SOLUTION: FINANCIAL ACCOUNTING AND EXTERNAL REPORTING

Part a) Expense relating to the share-based payment Marks

Opening balance

[90 (1) x 15 000 (1) x (150 – {6 + 5 + 4} (1) + 6 x 50% (1) - 12 (½)) x 1 / 4 (1)]

Expected average revenue = (4,2 + 14,6) / 4 = 4,7 (1)

Therefore, 15 000 share options per staff expected to vest (42 525 000) 6½

Closing balance Original scheme

[90 x 12 000 (1) x (150 – {17 + 10 + 8} (1) + 10 (1) - 8 (½)) x 2 / 4 (1)]

Expected average revenue = (4,2 + 2,8 + 7,4) / 4 = 3,6 (1)

Therefore, 12 000 share options per staff expected to vest 63 180 000 5½

Modification

[(50 - 20) (1) x 12 000 x (150 - 35 + 25 x 40% - 8) x 6 / 30 (1)] (1P) 8 424 000 3

Expense relating to the share-based payment 29 079 000 1C

Available marks 16

Maximum marks 14

Part b) Accounting of the scheme in separate financial statements Marks

Exclusive Devices and Exclusive Retailers are the entities receiving the services of the

management staff. 1

In terms of IFRS2, the entity receiving the services shall measure the services as an equity settled

scheme when:

- the awards granted are its own equity instruments, or

- the entity has no obligation to settle the share-based payment transaction 1

In this case, the awards to be granted are the equity instruments of Exclusive Read, the parent. 1

In addition, there is no obligation on either Exclusive Devices or Exclusive Retailers to settle the

share-based payment transaction. 1

Therefore, the scheme would be accounted for as an equity settled scheme in the separate financial

statements of Exclusive Devices and Exclusive Retailers. 1C

Available marks 5

Maximum marks 4


Part c) Carrying amount of the investment in associate Marks

Cost of the investment 1 820 000

Upfront cash 1 020 000 ½

Deferred consideration [(1 900 000 – 1 020 000) / 1,10] 800 000 1

Transaction costs 60 000 1

Total consideration 1 880 000

Net asset value 4 935 000

Fair value adjustment [(150 000 - 90 000) (1) x 72% (1)] 43 200 2

Total net asset value 4 978 200

Net asset value acquired (4 978 000 x 40%) 1 991 280 ½

Total consideration 1 880 000 ½

Gain on bargain purchase 111 280 111 280

Movement in retained income (2 666 500 - 935 000) 1 731 500 1

Office equipment [43 200 / (60 (1) - 15) (1) x (9 + 12) (1)] (20 160) 3

Retained income attributable to investor 1 711 340 684 536 ½

Inter-company profit on closing inventory (145 000 x 20 / 120 (1) x 72% (1)) (17 400) (6 960) 2

Carrying amount of the investment in associate 2 668 856


Part d) Revenue from Contract with Toddlers Marks

(i) The modification will be accounted for as a separate contract

This is because the additional promised goods are distinct and the consideration for

additional goods reflects stand-alone selling prices

Original contract

Transaction price per book set = 23 700 000 / 15 000 = 1 580 1

Revenue [(10 000 - 5 500) x 1 580] 7 110 000 1

New contract

New transaction price per book set = (31 900 000 - 23 700 000) / 5 000 = 1 640 1

Revenue [(12 500 - 10 000) x 1 640] 4 100 000 1

Total revenue recognised in FY2015 11 210 000

(i) The modification will be accounted for as a termination of existing contract and a

creation of a new one

This is because the additional promised goods are distinct and the consideration for

additional goods does not reflect stand-alone selling prices

Original contract

Revenue (2 500 x 1 580) 3 950 000 1

New contract

Undelivered book sets at modification date = 15 000 - 5 500 - 2 500 = 7 000 1

Unrecognised portion of the transaction price = 7 000 x 1 580 = 12 640 000 1

Transaction price per book set = (31 900 000 - 12 640 000) / (7 000 + 5 000) = 1 605 1

Revenue [(12 500 - 5 500 - 2 500) x 1 605) 7 222 500 1

Total revenue recognised in FY2015 11 172 500

Available and maximum marks for part (i) 4

Available and maximum marks for part (ii) 5


Part e) Revenue from Contract with Barnes Marks

The principal issue is to determine whether Exclusive Read is acting as a principal or an agent in

the contract. 1

In terms of the agreement with Barnes, Exclusive Read is involved in the provision of the book titles to

a customer. Therefore, it needs to determine whether the nature of its promise is a performance

obligation to provide the specified books itself (i.e. it is a principal) or to arrange for Barnes to

provide the books (i.e. it is an agent) (IFRS15.B34).

1

Exclusive will be a principal in the contract if it controls the books before it transfers them to a

customer. In determining whether Exclusive Read obtains control of the books before it transfers them

to customer and whether it is a principal, Exclusive Read needs to consider the guidance in B37 of

IFRS 15 as follows:

1

Exclusive Read must be primarily responsible for fulfilling the contract: Although Exclusive Read

is the company physically interacting with the customer and transferring the physical copy of the

book, it is not ultimately responsible for fulfilling the contract because it does not take

control over the books and has the discretion to return any unsold books.

1

Exclusive Read must have inventory risk: Exclusive Read is not required to pay for the books

that remain unsold and there does not carry the risk of unsold books (no inventory risk). 1

Exclusive must have the discretion to establish the selling price with the customer: In terms of the

agreement with Barnes, Exclusive Read does not have any discretion to change the retail

price without Barnes' approval.

1

Exclusive Read is required to retain 15% of the selling price as compensation for its sales

efforts. This consideration appears to be in the form of a commission. 1

Exclusive Read must be exposed to the credit risk for the amount receivable from the customer:

Exclusive Read sells all its books on a cash basis and therefore there is no credit risk

exposure.

1

Therefore, it can be concluded that Exclusive Read's promise is to provide a service to Barnes of

selling the books through its stores and the entity is an agent in the transaction. 1C

As a result, the amount to be recognised as revenue during the year ended 31 December 2015 would

be R9,3 million, being the amount retained by Exclusive Read. 1

Since Exclusive Read is an agent no inventory balance would be recognised for the amount of

R800 000 relating to the books that are still in its possession. 1

Available marks 11

Communication skills - logical argument 1

Communication skills - clarity of expression 1

Maximum marks 9

Part f) Consolidating investment in Digicom Debit Credit Marks

Ordinary share capital (SCE) 1 000 000 ½

Retained income (SCE) 592 800 ½

Investment property (SFP) 400 000 1

Intangible asset: Reacquired right (SFP) (600 000 - 120 000) 480 000 2

Intangible asset: Brand (SFP) 250 000 1

Goodwill (SFP) 708 672 1C

Deferred tax liability (SFP) 311 472 6

Non-controlling interest (SCE) 240 000 1

Investment in Digicom (SFP) (3 000 000 - 120 000) (1)

* Off-market component lower than the penalty provision (1) 2 880 000 2

At-acquisition elimination entry

Accumulated depreciation (SFP) 168 000

Depreciation expense (P/L) (1 440 000 / 15) 96 000 1

Retained income (SCE) (96 000 x 9 / 12) 72 000 1

Reversing the depreciation expense recognised post acquisition


Income tax (P/L) (96 000 x 28%) 26 880 ½

Retained income (SCE) (72 000 x 28%) 20 160 ½

Deferred tax liability (SFP) 47 040

Recognition of deferred tax on depreciation adjustment

Investment property (SFP) 222 000

Fair value adjustment (P/L) (1 750 000 - 1 610 000) 140 000 1

Retained income (SCE) (1 610 000 - 1 528 000) 82 000 1

Recognition of fair value adjustment on the investment property

Income tax (P/L) (140 000 x 80% x 28%) 31 360 1

Retained income (SCE) (82 000 x 80% x 28%) 18 368 1


Recognition of deferred tax on fair value adjustment

Amortisation expense (P/L) [480 000 / (120 - 27) x 12] 61 935 1

Retained income (SCE) [480 000 / (120 - 27) x 9] 46 452 1

Accumulated amortisation / Intangible asset: Reacquired right (SFP) 108 387

Recognition of amortisation expense on reacquired right


Income tax (P/L) (61 935 x 28%) 17 342 ½


Recognition of deferred tax on amortisation of reacquired right

Amortisation expense (P/L) (250 000 / 3) 83 333 1

Retained income (SCE) (250 000 / 3 x 9 / 12) 62 500 1

Accumulated amortisation / Intangible asset: Brand (SFP) 145 833

Recognition of amortisation expense on brand


Income tax (P/L) (83 333 x 28%) 23 333 ½


Recognition of deferred tax on amortisation of brand

Available marks 28

Communication skills - presentation 1

Maximum marks 27

C1: Deferred tax Marks

Investment property

Carrying amount as at 1 April 2014: 1 128 000 (141 / 180 x 1 440 000) 1

Acquisition-date fair value: 1 528 000 (1 128 000 + 400 000) 1

- Below cost [(1 440 000 - 1 128 000) x 28%] 87 360 1

- Above cost [(1 528 000 - 1 440 000) x 80% x 28%] 19 712 1

Intangible asset: Reacquired right (480 000 x 28%) 134 400 1

Intangible asset: Brand (250 000 x 28%) 70 000 1

Deferred tax adjustment as at acquisition date 311 472


Part g) Investment in Protea Leaf Marks

Profit or loss

Impairment loss (2 800 000) 3

Reclassified gains on disposal 9 508 244 1

Other comprehensive income

Fair value adjustment during the year 4 528 157 4

Reclassified gains on disposal (9 508 244) 3

Alternative

Fair value adjustment during the year 1 728 157 3

Decrease in loss allowance 2 800 000 1

Reclassified fair value adjustments (8 385 305 x 40 000 / 50 000) (6 708 244) 2

Reclassified loss allowance (3 500 000 x 40 000 / 50 000) (2 800 000) 1


Communication skills


Step 1: Determine the effective interest rate

I 11,401%

N 5

PMT (1 500 x 50 000 x 10,50%) (7 875 000)

FV (1 500 x 50 000 x 1,06) (79 500 000)

PV (1 500 x 50 000 + 150 000) 75 150 000

Step 2: Prepare an amortisation table

FY2014 FY2015

Opening balance 75 150 000 75 842 852

Interest accrued 8 567 852 8 646 843

Coupon payments (7 875 000) (7 875 000)

Closing balance 75 842 852 76 614 695

Alternative 1

Step 3: Prepare a reconciliation of carrying amounts FY2014 FY2015

Opening balance 75 150 000 82 500 000


Coupon payments (7 875 000) (7 875 000)

Closing balance 75 842 852 83 271 843

Loss allowance (700 000) (2 800 000)

Amortised cost 75 142 852 80 471 843

Fair value adjustment 7 357 149 4 528 157

Fair value 82 500 000 85 000 000

Reclassified gains on disposal [40 / 50 x (7 357 149 + 4 528 157)] 9 508 244


Alternative 2


Opening balance 75 150 000 75 842 852


Coupon payments (7 875 000) (7 875 000)

Closing balance 75 842 852 76 614 695

Loss allowance (700 000) (3 500 000)

Amortised amount 75 142 852 73 114 695

Balance of fair value adjustment 7 357 149 11 885 305

Fair value 82 500 000 85 000 000

Reclassified gains on disposal (FY2015 is cumulative) (40 / 50 x 11 885 305) 9 508 244

Alternative 3


Opening balance 75 150 000 82 500 000


Coupon payments (7 875 000) (7 875 000)

Closing balance 75 842 852 83 271 843

Movement in fair value adjustment 6 657 149 1 728 157

Fair value 82 500 000 85 000 000

Movement in loss allowance (700 000) (2 800 000)

Reclassified gains on disposal

[40 / 50 x (6 657 149 + 1 728 157 + 700 000 + 2 800 000)] 9 508 244

Alternative 4


Opening balance 75 150 000 75 842 852


Coupon payments (7 875 000) (7 875 000)

Closing balance 75 842 852 76 614 695

Balance of fair value adjustment 6 657 149 8 385 305

Fair value 82 500 000 85 000 000

Movement in loss allowance (700 000) (3 500 000)

Reclassified gains on disposal [40 / 50 x (8 385 305 + 3 500 000)] 9 508 244


Part h) Impairment of CGU Debit Credit Marks

Cost of sales (P/L) 1 798 1

Impairment loss (OCI) 28 725 ½P

Impairment loss (P/L) 617 544 ½P

Goodwill (SFP) 567 ½

Accumulated impairment on manufacturing machine (SFP) 644 252 ½

Accumulated impairment on office equipment (SFP) 1 450 1

Inventory (SFP) (50 000 – 48 202) 1 798 1

Available marks 17

Maximum marks 15

Step 1: Carrying amount of the Exclusive Devices CGU Marks

Manufacturing machine 1 620 000 ½

Office equipment 77 450 ½

Inventory (based on the net realisable value) 48 202 1

Accounts receivable 80 000 ½

Accounts payable (79 950) ½

Goodwill (80% x 708 762) 567 1

Carrying amount of the CGU 1 746 269

Step 2: Determine impairment loss (if any)

Carrying amount of the CGU 1 746 269

Recoverable amount 1 100 000

Impairment loss 645 269 1

Step 3: Allocate the impairment loss

Impairment loss 645 269

First allocate to goodwill (567) 1

Balance to be allocated to remaining assets 645 702

Step 4: Allocate balance to

remaining assets

Carrying

amount

Impairment

loss

CV after

allocation Reallocation

CV after

reallocation

Manufacturing machine 1 620 000 (616 240) (1) 1 003 760 (28 012) (1) 975 748

Office equipment 77 450 (29 462) (1) 47 988 28 012 (1) 76 000

Inventory, out of scope as in terms of

IAS2 - Accounts receivable, out of scope as

in terms of IFRS9 -

1 697 450 (645 702) 1 051 748 - 1 051 748

Step 5: Impairment allocated to OCI Marks

Revalued book value of the manufacturing machine 1 620 000

Historic book value of the manufacturing machine 1 591 275

Balance of revaluation reserve 28 725 1

Total impairment loss allocated to the manufacturing machine (616 240 + 28 012) 644 252 1P

Balance recognised in profit or loss 615 527



INTEGRATED BUSINESS CASE STUDY: EXCLUSIVE READ

SUGGESTED SOLUTION: AUDITING AND ASSURANCE

Part a)

Risk and/or control concern Controls to be evaluated Marks

Unauthorised access to the company

database via the online platform which could

result in:

o Loss or misuse of confidential data (1)

o Manipulation of data (1)

Sales proceeds might not be recovered owing

to fraudulent transactions within the system.

(1)

Access controls such as logon ID’s,

passwords, user privileges (matrix) and

menus to restrict user access to data. (1)

Critical data not accessible through the

website. (1)

Firewalls to prevent and monitor illegal

access and separate intranet from the

internet. (1)

Use of reputable service providers (such as

PayPal) to facilitate the payment of goods

acquired online. (1)

7

Data on the system could be corrupted or destroyed through viruses. (1)

Virus protection software should be uploaded on

the website and updated on a regular basis. (1) 2

The company could be a victim of litigation

resulting from illegal use of customer’s credit cards.

Reputational damage. (1)

Identification of users through verification of

ID’s and IP addresses. (1)

Goods should not be delivered until the

transaction is confirmed with the bank. (1)

Online verification of credit cards with the

bankers. (1)

4

Data on the system may be incomplete owing to

manipulation or transactions lost through

inaccurate processing. (1)

Sequential numbering of transactions. (1)

2

The system is new and may not function effectively

in its initial stages. Hardware or Software

malfunctions could result in errors in recorded

transactions. (1)

Testing and approval of the system before

implementation. (1) 2

Staff may not be adequately trained resulting

in errors in the systems. (1)

Staff may not have the competence to manage

the new system. (1)

Staff duties may not be appropriately

segregated, providing staff with opportunities

to record invalid transactions. (1)

Staff training on new systems. (1)

Generation and distribution of adequate

systems documentation. (1)

Segregation between persons responsible

for the computer system and those dealing

with physical assets and the accounting

function. (1)

6

Input is online, increasing the possibility of

input error. There is greater dependence on

information looked up from master files. (1)

There is absence of a visible audit trail relating

to the initial capture of transactions. The

absence of processing controls could result in

inaccurate processing. (1)

The sheer volume of transactions could result

in errors going undetected. (1)

The system generates transactions – these

could be processed incorrectly. (1)

Invalid or unauthorised payments may be

made to suppliers. (1)

Transactions could be lost owing to lack of

back-ups. (1)

The following application controls should be

implemented:

Edit and validation checks over all input. (1)

User friendly design of user input screen. (1)

Use of standing data when transactions are

captured. (1)

Controls authorising all master file changes.

(1)

Production of exception reports and review

of those exception reports. (1)

Regular backups should be performed and

stored on separate server at a different

location from the operations of the company.

(1)

12

Available marks 35

Communication skills – clarity of expression and presentation (tabular format) 2


Part b) Marks

Sufficiency of management procedures performed and compliance with ISAs

Matevhu Tevhu has complied with ISA and ISQC 1 regarding engagement acceptance:

He has performed procedures to obtain relevant and reliable information to assess the

acceptability of the audit client

The firm has complied with ISQC 1 as it appears that the policies and procedures exist and are

applied before acceptance of a new client.

However, it is questionable whether the results of the above procedures were actioned

1

1

1

Friendship between Happy Merc and Jackson Rose (the firm’s managing partner)

As Mr Merc and Mr Rose consider each other great friends, the nature of the relationship between

them will have to be considered, as threats to independence may exist. (Familiarity threat to

independence).

Moreover, it will have to be evaluated whether Mr Rose will have any involvement in the planning,

performing, and/or completion of the audit, which may further increase the significance of the

threats (Alternative: Even if Mr Rose is not part of the engagement team, he is in the chain of

command of the audit firm – so he needs to be independent)

Even if this relationship does not affect “independence of mind”, consideration will have to be given

to whether it affects “independence in appearance”.

1

1

1

Performing company secretarial duties in addition to the audit

If a partner or employee of a firm serves as “Company Secretary” for an audit client, self-review

and advocacy threats to the firm’s independence would be created [section 290.148 of the IRBA

Code of Professional Conduct (“the Code”)]

Consideration should be given to whether the secretarial assistance requested extends beyond

mere routine and administrative duties, in which case the threats to the firm’s independence would

be too significant for any safeguards to be applied (and hence it would be inappropriate to take on

this engagement concurrently with the external audit).

By providing “secretarial assistance” to any company in the group, it will have to be evaluated

whether Amber Rose & Co can be deemed to be acting as company secretary, in which case it is

prohibited from being appointed as auditor of the company [in terms of the Companies Act, Act

No. 71 of 2008.

1

1

1

FD’s request not to re-evaluate the appropriateness of not undertaking an impairment test

This request may give rise to a material scope limitation, and as such will negatively affect the

acceptance decision – if the client cannot be persuaded to allow the necessary audit work to be

undertaken.

Jackson Auditors have to obtain sufficient appropriate audit evidence about the measurement of

the assets included in the Exclusive Devices and the recognition of an impairment loss to reduce

audit risk to an acceptably low level (e.g. refer to the requirements of ISAs 200 and 500).

In itself, the decision not to undertake an impairment test appears to be in contravention with

IAS36.96 which requires any goodwill that was acquired in a business combination and allocated

to a cash generating unit during the current period to be to tested for impairment before the end of

the current period. The acquisition of Digicom and the allocation of 80% of goodwill will give rise

to the requirement to apply this paragraph.

1

1

1

1

1

Client staff are not “able to cope with the increased legislative compliance”

This fact may increase the risk of non-compliance with laws and regulations governing the

company, and consideration will have to be given to the legal risks associated with accepting the

company as an audit client.

This risk is increased as there is evidence of non-compliance with the Companies Act (S45 and

75), environmental and safety legislation

It also brings into question the knowledge of the company’s staff about the IFRS requirements,

and consideration will have to be given to the possible implications of the increased audit time

requirements and costs to complete the engagement.

1

1

1

Part of group structure

By accepting Exclusive Devices, especially as it appears to be a significant component of the

Exclusive Read group, it will improve the efficiency of the group audit.

1

1


It will be easier to review the engagement file rather than relying on the work of other auditors

(Modanedi)

Management integrity seems to be a concern as evidenced by the following factors:

Non-compliance with IFRS with regards to the impairment testing of Exclusive Devices cash

generating unit

Refusal to pay outstanding audit fee because of the qualified audit opinion in the prior year

1

1

Compliance with IFRS

This risk is increased as there is evidence of non-compliance with the Companies Act (S45 and

75), environmental and safety legislation

It also brings into question the knowledge of the company’s staff about the IFRS requirements,

and consideration will have to be given to the possible implications of the increased audit time

requirements and costs to complete the engagement.

1

1

1

Skills and competence

Given that the nature of Exclusive Devices’ business is so different to those of the group

companies previously audited consideration should be given to the audit firm’s competence to

perform the engagement, and its capabilities, including time and resources, to do so.

Additional time may be spent to substantiate the work of the previous auditors, whose audit

manager was labelled as incompetent, to reduce the risk on group audit

1

1

Conflicts of interest

The firm should consider clients of the firm in the same industry and whether a conflict of interest may

arise or issues relating to confidentiality. 1

Communication with current auditors

It appears there’s a professional reason not to accept the engagement as:

Client didn’t inform current auditors of intention to replace them

No vacancy exists and auditors can only be removed at an AGM

The client hasn’t paid previous audit fees and a doubt exists as to whether our fees would be paid

The fact that they refuse access to working papers cannot be seen as reason as they are still the

appointed auditors (and in itself, creates a limitation of scope)

1

1

1

1

Available marks 30

Communication skills – clarity of expression and logical argument 2

Maximum marks 22


Part (c) Marks

Request a schedule of the FECs entered into by Exclusive Read during the 2015 financial year and

cast and cross cast the schedule and compare to the AFS. 1

For each of the FECs on the schedule, inspect the minutes of the board / management committee

meetings / mandate of the treasury function for authorisation of “formal documentation” where the FEC

is linked to future purchase transactions. 1

Inspect date of the meeting to ensure that this linkage is done at the date of inception of the

FEC. 1

Inspect the minutes where management has considered the designation of the FEC (i.e. cash

flow hedge) and / or the nature of the risk being hedged and an indication of how the company will

assess the hedging instrument’s effectiveness;

1

1

For a sample of FECs (or all FECs, if the number of FECs entered into is small), re-perform the

calculation (of FEC gain/loss versus anticipated forex loss/gain on the hedged purchase transactions)

to verify that the hedge was effective throughout. 1

Evaluate the future exchange rate (used in computing anticipated forex loss/gain) is reasonable,

by: enquiry from management as to how they arrived at the rate and inspecting the supporting

documents (e.g. FEC) to corroborate the rate.

1

1

Confirm with / obtain an external confirmation from the company’s bankers/ external sources

the spot rates used in the calculation (e.g. spot rate at inception of FEC) 1

For each FEC, ascertain whether the future purchase transactions, which are the subject of the

hedge, are highly probable by inspecting the related orders that have been placed for terms and

conditions attached to the orders (e.g. right to cancel; date of delivery; shipping conditions); and

number of books ordered.

1

1

Enquiring from management as to how they arrived at the estimate of the dollar price for a book

title and inspecting the supporting documents (e.g. external economic forecasts) to corroborate

the estimate. 1

Inspect the minutes of management meetings at the time the interim and year-end financial

statements were prepared for evidence that the effectiveness of the hedge was reassessed and

considered to be highly effective. 1

Inspect the accounting policy note to confirm that the approach followed is consistent with the

company’s policy for accounting for hedges (i.e. that the criteria of IFRS9 has been met) 1

Request that management includes reference in its written representation letter to the adherence

of the IFRS9 criteria when a financial instrument is designated as “cash flow hedge”. 1

Available marks 14

Communication skills – clarity of expression 1

Maximum marks 10



INTEGRATED BUSINESS CASE STUDY: LOCAL AIRPORTS COMPANY

SUGGESTED SOLUTION: TAXATION

Part (a) - Taxable income Mark

R

Sales, s1 GI definition 21 560 000 1

Cost of sales (21 560 000 x 100 / 120) (17 966 667) 1

Recoupment of stock donated at cost

s22(8) recoupment at cost 85 000 1

Recoupment of fringe benefit

s22(8) recoupment at MV 19 000 1

Total annuity dividend - not exempt in terms of

s10(2)(b) 110 000 1

Local dividend -

*Local dividend (Par (k) of GI definition) 68 000 1

*Section 10(1)(k) exemption (68 000) 1

Interest – taxable, s1 GI definition 32 300 1

Bad debt expenses (286 000)

*Trade debtors - deductible (257 000) 1

*Loan to supplier - not previously included in

income as per s11(i) - 1

*Interest on loan - deductible (29 000) 1

*Decrease in provision - accounting provision

prohibited by s23(e ) - 1

Interest income (R29 000 - R10 000) - taxable s1 GI definition 19 000 1

Provision for doubtful debts

s11(j) deduction 33 500

*2016 Allowance (R770 000 x 25%) (192 500) 1

*2015 Allowance

([R770 000 + R134 000] = R904 000 x 25%) 226 000 1

Legal expenses (5 700)

*Trade debtors – deductible

s11(c ) deduction (87 000) 1

*Loan to supplier - capital - 1

Factories (384 750)

*Section 13(1) allowance (R3 200 000 x 5%) (160 000) 1

*Lease payments - s11(a) deduction (R9 000 x 9) (81 000) 1

*Lease premium - s11(f) deduction

(R500 000 / 20 x 9 / 12) (18 750) 1

(36 885)

*Leasehold improvements - s11(g)

(R2 370 000 / 19,5 x 3 / 12) (30 385) 1

*S13(1) allowance on excess

(R2 500 000 - R2 370 000) x 5% (6 500) 1

s13(1) allowance on improvements

(R2 500 000 x 5%) (125 000) 1

It is more beneficial to use s13(1) on the

improvements instead of a combination of s11(g)

and s13(1) 1


Other operating expenses (1 340 800) 1

Depreciations - accounting provisions - 1

Allowances:

*Re-acquired right and brand - no allowance -

*Warehouse (R1 000 000 x 1 / 10) (100 000) 1

Section 12H allowance on learnership agreement (50 000) 1

1 724 883

S18A deduction of R85 000 limited to

10% x 1 724 883 = R172 488 (85 000) 1

Taxable income 1 639 883

Taxable capital gain calculation

Sum of capital gains - None - 1

Sum of capital losses (113 000)

1. Loan to supplier

Proceeds - 1

Base cost (100 000 + 13 000) (113 000) 2

Annual exclusion - ½

Aggregate capital gains or losses (113 000) ½

Assessed capital loss brought forward from 2015 - ½

Assessed capital loss carried forward to 2016 (113 000) ½

Communication skill - layout and presentation 1

Available marks 35

Maximum marks 35

Part b) Mark

Lindy

Thursday, March 10, 2016

Original purchase price of the old furniture is irrelevant

Market value of old furniture 50 000 Section 57A(a) - forms part of joint estate and therefore must be

shared equally (25 000)

25 000 1

Annual donation tax exemption for natural persons limited of R100

000 to R25 000 (25 000) - 1

Market value of old apartment (not forming part of joint estate) 8 000 000 1

Annual donation tax exemption for natural persons (limited to balance

of R75 000) (75 000) 7 925 000 1

Thursday, August 4, 2016

Market value of the block of flats donated to Children's Trust 3 000 000 1

S56(1)(h) - local charity meets the requirements of an exempt body (3 000 000) - 1

Friday, September 9, 2016 Usufruct farm - S57A(a), farm forms part of a joint estate

(R3 455 315 / 2) 1 727 657 1


Bare dominium farm - S57A(a), farm forms part of a joint estate ((R5

000 000 x 70%) / 2 - R1 727 657) 22 343 1

Value of donations 9 675 000

Donations tax at 20% 1 935 000 1

Capital Gains Tax

Old Furniture

Proceeds - MV on donation date par 38 50 000

Base Cost (60 000)

(10 000) Disregard the capital loss in terms of par 53 as furniture is a personal

use asset - 1

Capital gain on the old apartment 1 411 300

Proceeds - deemed disposal at market value 8 000 000 1

Base cost - acquisition cost (6 240 000) 1

Base cost - donations tax paid (Par 22) (348 700) 1

Capital gain on the block of flats 450 000

Proceeds - deemed disposal at market value 3 000 000 Paragraph 14 - property forms part of a joint estate (must be shared

equally) (1 500 000)

1 500 000 1

Base cost - acquisition cost (R2 100 000 x 50%) (1 050 000) 1

Base cost - donations tax paid - 1

Capital gain on the farm 2 150 000

Proceeds - deemed disposal at market value (R5 000 000 / 2) 2 500 000 1

Base cost - acquired at Rnil consideration - 1

Base cost - donations tax paid (350 000) 1

Annual exclusion (40 000) 1

Aggregate capital gains and losses 3 971 300

Assessed capital losses brought forward -

Net capital gain 3 971 300

Inclusion rate 40,00% 1

Taxable capital gain 1 588 520 1

Communication skills - presentation 1

Available marks 23

Maximum marks 23

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